Attached files
file | filename |
---|---|
EX-15.1 - EXHIBIT 15.1 - MCG CAPITAL CORP | dex151.htm |
EX-31.2 - EXHIBIT 31.2 - MCG CAPITAL CORP | dex312.htm |
EX-31.3 - EXHIBIT 31.3 - MCG CAPITAL CORP | dex313.htm |
EX-32.3 - EXHIBIT 32.3 - MCG CAPITAL CORP | dex323.htm |
EX-32.1 - EXHIBIT 32.1 - MCG CAPITAL CORP | dex321.htm |
EX-31.1 - EXHIBIT 31.1 - MCG CAPITAL CORP | dex311.htm |
EX-32.2 - EXHIBIT 32.2 - MCG CAPITAL CORP | dex322.htm |
EX-10.3 - EXHIBIT 10.3 - MCG CAPITAL CORP | dex103.htm |
EX-10.2 - EXHIBIT 10.2 - MCG CAPITAL CORP | dex102.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 March 31, 2010
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
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. (Check one):
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 April 29, 2010, there were 76,553,845 shares of the registrants $0.01 par value Common Stock outstanding.
Table of Contents
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2010
TABLE OF CONTENTS
Table of Contents
ITEM 1. | FINANCIAL STATEMENTS |
Consolidated Balance Sheets
(in thousands, except per share amounts) |
March 31, 2010 |
December 31, 2009 |
||||||
(unaudited) | ||||||||
Assets |
||||||||
Cash and cash equivalents |
$ | 54,563 | $ | 54,187 | ||||
Cash, securitization accounts |
94,605 | 109,141 | ||||||
Cash, restricted |
9,038 | 21,232 | ||||||
Investments at fair value |
||||||||
Non-affiliate investments (cost of $574,631 and $560,347, respectively) |
550,988 | 531,974 | ||||||
Affiliate investments (cost of $25,959 and $38,845, respectively) |
32,702 | 44,388 | ||||||
Control investments (cost of $559,204 and $555,732, respectively) |
407,342 | 409,984 | ||||||
Total investments (cost of $1,159,794 and $1,154,924, respectively) |
991,032 | 986,346 | ||||||
Interest receivable |
7,638 | 6,025 | ||||||
Other assets |
14,509 | 14,218 | ||||||
Total assets |
$ | 1,171,385 | $ | 1,191,149 | ||||
Liabilities |
||||||||
Borrowings (maturing within one year of $608 and $13,327, respectively) |
$ | 534,892 | $ | 557,848 | ||||
Interest payable |
3,410 | 2,736 | ||||||
Other liabilities |
10,186 | 14,882 | ||||||
Total liabilities |
548,488 | 575,466 | ||||||
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 March 31, 2010 and December 31, 2009, 76,338 issued and outstanding on March 31, 2010 and 76,394 issued and outstanding on December 31, 2009 |
763 | 764 | ||||||
Paid-in capital |
1,006,337 | 1,005,085 | ||||||
Distributions in excess of earnings |
||||||||
Paid-in capital |
(162,783 | ) | (162,783 | ) | ||||
Other |
(51,006 | ) | (57,066 | ) | ||||
Net unrealized depreciation on investments |
(170,414 | ) | (170,317 | ) | ||||
Total stockholders equity |
622,897 | 615,683 | ||||||
Total liabilities and stockholders equity |
$ | 1,171,385 | $ | 1,191,149 | ||||
Net asset value per common share at end of period |
$ | 8.16 | $ | 8.06 |
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 March 31, |
||||||||
(in thousands, except per share amounts) |
2010 | 2009 | ||||||
Revenue |
||||||||
Interest and dividend income |
||||||||
Non-affiliate investments (less than 5% owned) |
$ | 14,846 | $ | 15,667 | ||||
Affiliate investments (5% to 25% owned) |
982 | 1,141 | ||||||
Control investments (more than 25% owned) |
5,783 | 9,789 | ||||||
Total interest and dividend income |
21,611 | 26,597 | ||||||
Advisory fees and other income |
||||||||
Non-affiliate investments (less than 5% owned) |
22 | 725 | ||||||
Control investments (more than 25% owned) |
113 | 484 | ||||||
Total advisory fees and other income |
135 | 1,209 | ||||||
Total revenue |
21,746 | 27,806 | ||||||
Operating expenses |
||||||||
Interest expense |
4,473 | 6,558 | ||||||
Employee compensation |
||||||||
Salaries and benefits |
4,796 | 3,798 | ||||||
Amortization of employee restricted stock awards |
1,227 | 1,537 | ||||||
Total employee compensation |
6,023 | 5,335 | ||||||
General and administrative expense |
2,811 | 3,975 | ||||||
Total operating expenses |
13,307 | 15,868 | ||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) |
8,439 | 11,938 | ||||||
Net realized (loss) gain on investments |
||||||||
Non-affiliate investments (less than 5% owned) |
(2,267 | ) | (65 | ) | ||||
Affiliate investments (5% to 25% owned) |
| (1,947 | ) | |||||
Control investments (more than 25% owned) |
| 16,265 | ||||||
Total net realized (loss) gain on investments |
(2,267 | ) | 14,253 | |||||
Net unrealized (depreciation) appreciation on investments |
||||||||
Non-affiliate investments (less than 5% owned) |
4,730 | (19,592 | ) | |||||
Affiliate investments (5% to 25% owned) |
1,200 | 1,617 | ||||||
Control investments (more than 25% owned) |
(6,114 | ) | (64,256 | ) | ||||
Derivative and other fair value adjustments |
87 | (353 | ) | |||||
Total net unrealized depreciation on investments |
(97 | ) | (82,584 | ) | ||||
Net investment loss before income tax provision (benefit) |
(2,364 | ) | (68,331 | ) | ||||
(Loss) gain on extinguishment of debt before income tax provision (benefit) |
(58 | ) | 5,275 | |||||
Income tax provision (benefit) |
62 | (172 | ) | |||||
Net income (loss) |
$ | 5,955 | $ | (50,946 | ) | |||
Earnings (loss) per basic and diluted common share |
$ | 0.08 | $ | (0.68 | ) | |||
Cash distributions declared per common share |
$ | | $ | | ||||
Weighted-average common shares outstandingbasic and diluted |
76,339 | 74,498 |
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)
Three months ended March 31, |
||||||||
(in thousands, except per share amounts) |
2010 | 2009 | ||||||
Increase (decrease) in net assets from operations |
||||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (provision) benefit |
$ | 8,439 | $ | 11,938 | ||||
Net realized (loss) gain on investments |
(2,267 | ) | 14,253 | |||||
Net unrealized depreciation on investments |
(97 | ) | (82,584 | ) | ||||
(Loss) gain on extinguishment of debt |
(58 | ) | 5,275 | |||||
Income tax (provision) benefit |
(62 | ) | 172 | |||||
Net income (loss) |
5,955 | (50,946 | ) | |||||
Capital share transactions |
||||||||
Amortization of restricted stock awards |
||||||||
Employee |
1,227 | 1,537 | ||||||
Non-employee director |
26 | 60 | ||||||
Forfeiture of restricted stock awards and dividends |
6 | | ||||||
Cancellation of common stock held as collateral for stockholder loans |
| (22 | ) | |||||
Stockholder loans |
||||||||
Unrealized appreciation on stockholder loans |
| (31 | ) | |||||
Repayment of stockholder loans |
| 22 | ||||||
Net increase in net assets resulting from capital share transactions |
1,259 | 1,566 | ||||||
Total increase (decrease) in net assets |
7,214 | (49,380 | ) | |||||
Net assets |
||||||||
Beginning of period |
615,683 | 658,911 | ||||||
End of period |
$ | 622,897 | $ | 609,531 | ||||
Net asset value per common share at end of period |
$ | 8.16 | $ | 8.02 | ||||
Common shares outstanding at end of period |
76,338 | 76,027 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
3
Table of Contents
Consolidated Statements of Cash Flows
(unaudited)
Three months ended March 31, |
||||||||
(in thousands) |
2010 | 2009 | ||||||
Cash flows from operating activities |
||||||||
Net income (loss) |
$ | 5,955 | $ | (50,946 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities |
||||||||
Investments in portfolio companies |
(35,408 | ) | (45,648 | ) | ||||
Principal collections related to investment repayments or sales |
33,044 | 67,102 | ||||||
Increase in interest receivable, accrued payment-in-kind interest and dividends |
(6,385 | ) | (2,644 | ) | ||||
Amortization of restricted stock awards |
||||||||
Employee |
1,227 | 1,537 | ||||||
Non-employee director |
26 | 60 | ||||||
Decrease in cashsecuritization accounts from interest collections |
4,001 | 3,776 | ||||||
Depreciation and amortization |
1,101 | 1,441 | ||||||
Unrealized appreciation on stockholder loans |
| (31 | ) | |||||
Decrease in other assets |
113 | 628 | ||||||
Decrease in other liabilities |
(3,935 | ) | (2,663 | ) | ||||
Net realized loss (gain) on investments |
2,267 | (14,253 | ) | |||||
Net change in unrealized depreciation on investments |
97 | 82,584 | ||||||
Loss (gain) on extinguishment of debt |
58 | (5,275 | ) | |||||
Net cash provided by operating activities |
2,161 | 35,668 | ||||||
Cash flows from financing activities |
||||||||
Payments on borrowings |
(23,014 | ) | (25,129 | ) | ||||
Proceeds from borrowings |
| 25,000 | ||||||
Decrease (increase) in cash in restricted and securitization accounts |
||||||||
Securitization accounts for repayment of principal on debt |
10,535 | (8,084 | ) | |||||
Restricted cash |
12,194 | (19,122 | ) | |||||
Payment of financing costs |
(1,500 | ) | (4,152 | ) | ||||
Net cash used in financing activities |
(1,785 | ) | (31,487 | ) | ||||
Net increase in cash and cash equivalents |
376 | 4,181 | ||||||
Cash and cash equivalents |
||||||||
Beginning balance |
54,187 | 46,149 | ||||||
Ending balance |
$ | 54,563 | $ | 50,330 | ||||
Supplemental disclosure of cash flow information |
||||||||
Interest paid |
$ | 3,049 | $ | 7,094 | ||||
Income taxes paid |
188 | 99 | ||||||
Payment-in-kind interest collected |
405 | 365 | ||||||
Dividend income collected |
| 5,196 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
4
Table of Contents
Consolidated Schedule of Investments
March 31, 2010 (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)(1) | $ | 14,616 | $ | 14,534 | $ | 14,534 | |||||
Preferred Units (10.8%, 17,100 units)(1) | 21,446 | 31,675 | |||||||||||
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) | | | |||||||||||
GMC Television Broadcasting, LLC(2) |
Broadcasting | Senior Debt A (4.3%, Due 12/16)(1) | 20,720 | 18,552 | 18,552 | ||||||||
Senior Debt B (4.3%, Due 12/16)(1)(7) | 3,000 | 2,747 | 2,893 | ||||||||||
Subordinated Debt (14.0%, Due 12/16)(1)(7) | 9,404 | 6,975 | | ||||||||||
Subordinated Unsecured Debt (16.0%, Due 12/16)(7) | 1,109 | 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) | 9,200 | 9,136 | 9,136 | ||||||||
Series A Preferred Units (10.0%, 86,000 units) | 9,095 | 783 | |||||||||||
Series B Preferred Units (10.0%, 30,000 units) | 3,000 | 105 | |||||||||||
Jet Plastica Investors, LLC (2) |
Plastic Products | Senior Debt (9.2%, Due 12/12)(1) | 12,798 | 12,714 | 12,714 | ||||||||
Subordinated Debt A (15.5%, Due 3/13)(1) | 19,358 | 19,179 | 19,179 | ||||||||||
Subordinated Debt B (17.0%, Due 3/13)(1)(7) | 20,394 | 17,560 | 4,225 | ||||||||||
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) | 28,719 | 28,563 | 28,563 | ||||||||
Series A Preferred Units (10.0%, 133,204 units) | 18,471 | 10,920 | |||||||||||
Series B Preferred Units (24,441 units) | 5,000 | 10,000 | |||||||||||
MTP Holding, LLC(6) | Communications-Other | Common LLC Interest (79,171 units) | 3 | 105 | |||||||||
NPS Holding Group, LLC(2)(5) |
Business Services | Senior Debt A1 (6.0%, Due 6/13)(1) | 4,702 | 3,411 | 3,931 | ||||||||
Senior Debt A2 (6.0%, Due 6/13)(1)(7) | 2,069 | 1,904 | | ||||||||||
Senior Debt A3 (6.0%, Due 6/13)(1)(7) | 7,872 | 6,228 | | ||||||||||
Series A Preferred Units (347 units) | | | |||||||||||
Series B Preferred Units (5.0%, 10,731 units) | 10,731 | | |||||||||||
Common Units (36,500 units) | | | |||||||||||
Orbitel Holdings, LLC(2) | Cable | Senior Debt (9.0%, Due 3/12)(1) | 16,300 | 16,233 | 16,233 | ||||||||
Preferred LLC Interest (10.0%, 120,000 units) | 13,996 | 13,317 | |||||||||||
PremierGarage Holdings, LLC (2)(6) |
Home Furnishings | Senior Debt (8.0%, Due 12/10-9/11)(1)(7) | 9,973 | 9,069 | 9,778 | ||||||||
Preferred LLC Units (400 units) | 400 | | |||||||||||
Common LLC Units (79,935 units) | 4,971 | | |||||||||||
RadioPharmacy Investors, LLC (2) |
Healthcare | Senior Debt (7.0%, Due 12/10)(1) | 8,500 | 8,488 | 8,488 | ||||||||
Subordinated Debt (15.0%, Due 12/11)(1) | 10,216 | 10,190 | 10,190 | ||||||||||
Preferred LLC Interest (8.0%, 70,000 units) | 8,123 | 125 |
Superior Industries Investors, LLC(2) |
Sporting Goods | Subordinated Debt (16.0%, Due 3/13)(1) | 21,381 | 21,301 | 21,301 | |||||
Preferred Units (8.0%, 125,400 units) | 15,566 | 17,609 | ||||||||
Total Sleep Holdings, Inc. (2)(6) |
Healthcare | Subordinated Debt (8.0%, Due 9/11)(7) | 12,278 | 11,780 | 4,152 | |||||
Unsecured Note (0.0%, Due 6/11)(7) | 375 | 332 | | |||||||
Series A Preferred Stock (10.0%, 3,700 shares) | 3,793 | | ||||||||
Series B Preferred Stock (10.0%, 2,752 shares) | 21,149 | | ||||||||
Common Stock (40,469 shares) | 1,000 | | ||||||||
Total Control Investments (represents 41.1% of total investments at fair value) |
559,204 | 407,342 | ||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
5
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
March 31, 2010 (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 (13.4%, Due 10/11)(1) | $ | 5,775 | $ | 5,698 | $ | 5,693 | |||||
Subordinated Debt (16.0%, Due 4/12)(1) | 5,176 | 5,096 | 5,041 | ||||||||||
Series A Preferred Stock (20.0%, 49 shares) | 297 | 45 | |||||||||||
Common Stock (423 shares) | 524 | | |||||||||||
Warrants to purchase Common Stock (expire 10/16) | 348 | | |||||||||||
Cherry Hill Holdings, Inc.(6) | Entertainment | Series A Preferred Stock (10.0%, 750 shares) | 907 | 867 | |||||||||
Stratford School Holdings, Inc.(2) | Education | Senior Debt (6.9%, Due 7/11-9/11)(1) | 3,440 | 3,410 | 3,403 | ||||||||
Subordinated Debt (14.0%, Due 12/11)(1) | 6,717 | 6,697 | 6,697 | ||||||||||
Series A Convertible Preferred Stock (12.0%, 10,000 shares) | 270 | 7,492 | |||||||||||
Warrants to purchase Common Stock (expire 5/15)(1) | 67 | 1,964 | |||||||||||
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 | Series A Preferred Stock (1,506,602 shares) | 1,500 | 1,500 | |||||||||
Total Affiliate Investments (represents 3.3% of total investments at fair value) |
25,959 | 32,702 | |||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
6
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
March 31, 2010 (unaudited)
(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 (10.2%, Due 6/12)(1)(8) | $ | 25,461 | $ | 24,640 | $ | 16,979 | |||||
Subordinated Debt (17.0%, Due 9/12)(1)(7) | 15,909 | 12,052 | | ||||||||||
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 (7.3%, Due 12/12)(1) | 5,980 | 5,961 | 5,961 | ||||||||
Subordinated Debt (10.1%, Due 12/12)(1) | 2,508 | 2,466 | 2,399 | ||||||||||
Warrants to purchase Common Stock (expire 11/15) | | 131 | |||||||||||
B & H Education, Inc. | Education | Series A-1 Convertible Preferred Stock (12.0%, 5,384 shares) | 1,716 | 5,358 | |||||||||
Coastal Sunbelt Holding, Inc. (2) |
Food Services | Senior Debt (9.1%, Due 8/14-2/15)(1) | 21,936 | 21,725 | 21,725 | ||||||||
Subordinated Debt (16.0%, Due 8/15)(1) | 8,594 | 8,520 | 8,520 | ||||||||||
Coastal Sunbelt Real Estate, Inc. |
Real Estate Investments | Subordinated Unsecured Debt (15.0%, Due 7/12) | 2,206 | 2,197 | 2,197 | ||||||||
Series A-2 Preferred Stock (12.0%, 20,000 shares) | 2,656 | 543 | |||||||||||
Warrants to purchase Class B Common Stock | | | |||||||||||
Construction Trailer Specialists, Inc.(2) |
Auto Parts | Senior Debt (14.9%, Due 06/13)(1) | 7,732 | 7,560 | 6,431 | ||||||||
Cruz Bay Publishing, Inc. | Publishing | Subordinated Debt (13.0%, Due 12/13)(1)(8) | 23,184 | 22,817 | 17,005 | ||||||||
CWP/RMK Acquisition Corp.(2)(6) |
Home Furnishings | Senior Debt (3.0%, Due 12/16)(7) | 600 | 597 | 426 | ||||||||
Dayton Parts Holdings, LLC (6) |
Auto Parts | Preferred LLC Interest (10.0%, 16,470 units) | 631 | 513 | |||||||||
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) | 4,887 | 4,834 | 4,834 | ||||||||
Equibrand Holding Corporation(2) | Leisure Activities | Senior Debt (9.5%, Due 6/11)(1) | 4,640 | 4,615 | 4,615 | ||||||||
Subordinated Debt (17.0%, Due 12/11)(1) | 9,764 | 9,706 | 9,706 | ||||||||||
G&L Investment Holdings, LLC(2) |
Insurance | Subordinated Debt (7.8%, Due 5/14)(1) | 17,500 | 17,048 | 15,863 | ||||||||
Series A Preferred Shares (14.0%, 5,000,000 shares) | 6,897 | 6,898 | |||||||||||
Class C Shares (621,907 shares) | 529 | 313 | |||||||||||
Golden Knight II CLO, Ltd. (6) |
Diversified Financial Services | Income Notes (8.0%, Due 4/19) | 3,575 | 2,175 | |||||||||
GSDM Holdings, LLC(2) | Healthcare | Senior Debt (7.5%, Due 2/13)(1) | 7,673 | 7,618 | 7,538 | ||||||||
Subordinated Debt (14.0%, Due 8/13)(1) | 8,008 | 7,977 | 7,977 | ||||||||||
Series B Preferred Units (12.5%, 4,213,333 units) | 4,397 | 2,030 | |||||||||||
Home Interiors & Gifts, Inc.(6)(10) |
Home Furnishings | Senior Debt (8.0%, Due 3/11)(7) | 4,141 | 3,667 | 21 |
Jenzabar, Inc. | Technology | Senior Preferred Stock (11.0%, 3,750 shares) | 6,122 | 6,122 | ||||||
Subordinated Preferred Stock (109,800 shares) | 1,098 | 1,098 | ||||||||
Warrants to purchase Common Stock (expire 4/16)(12) | 424 | 22,593 | ||||||||
Lambeau Telecom Company, LLC | Communications-CLEC | Senior Debt (12.0%, Due 2/13)(8) | 1,319 | 1,279 | 1,037 | |||||
Legacy Cabinets, Inc.(6) | Home Furnishings | Subordinated Debt (12.5%, Due 8/13)(1)(7) | 2,328 | 2,184 | | |||||
LMS INTELLIBOUND, INC.(2) |
Logistics | Senior Debt (8.6%, Due 3/146/14)(1) | 24,590 | 24,283 | 24,283 | |||||
Subordinated Debt (16.0%, Due 9/14)(1) | 7,000 | 6,854 | 6,854 | |||||||
Massage Envy, LLC | Leisure Activities | Senior Debt (11.0%, Due 12/14)(1) | 11,850 | 11,607 | 11,607 | |||||
Maverick Healthcare Equity, LLC |
Healthcare | Subordinated Debt (16.0%, Due 4/14)(1) | 13,006 | 12,873 | 12,873 | |||||
Preferred Units (10.0%, 1,250,000 units) | 1,467 | 1,587 | ||||||||
Class A Common Units (1,250,000 units) | | 71 | ||||||||
MCI Holdings LLC(2) | Healthcare | Subordinated Debt (12.7%, Due 4/13)(1) | 32,523 | 32,414 | 32,414 | |||||
Class A LLC Interest (4,712,042 units) | 3,000 | 9,486 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
7
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
March 31, 2010 (unaudited)
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Metropolitan Telecommunications Holding Company(2) | Communications- CLEC |
Senior Debt (11.3%, Due 12/11)(1) | $ | 19,179 | $ | 19,127 | $ | 19,127 | |||||
Warrants to purchase Common Stock (expire 9/13) | 1,843 | 10,403 | |||||||||||
Miles Media Group, LLC(2) | Business Services | Senior Debt (12.5%, Due 6/13)(1) | 17,143 | 16,890 | 16,890 | ||||||||
NDSSI Holdings, LLC(2) | Electronics | Senior Debt (9.9%, Due 9/13-3/14)(1) | 19,325 | 19,176 | 19,175 | ||||||||
Subordinated Debt (15.0%, Due 9/14)(1) | 22,664 | 22,607 | 22,607 | ||||||||||
Series A Preferred Units (516,691 units) | 718 | 718 | |||||||||||
Class A Common Units (1,000,000 units) | 333 | 569 | |||||||||||
Philadelphia Newspapers, LLC(6)(11) | Newspaper | Subordinated Unsecured Debt (16.5%, Due 6/14)(7) | 5,082 | 5,070 | | ||||||||
Provo Craft & Novelty Inc. | Leisure Activities | Senior Debt (8.0%, Due 3/16)(1) | 10,000 | 9,720 | 9,720 | ||||||||
Quantum Medical Holdings, LLC (2) |
Laboratory Instruments |
Senior Debt (6.3%, Due 5/11)(1) | 15,500 | 15,484 | 15,484 | ||||||||
Subordinated Debt (15.0%, Due 12/11)(1) | 18,032 | 17,962 | 17,962 | ||||||||||
Preferred LLC Interest (1,000,000 units) | 662 | 1,617 | |||||||||||
Restaurant Technologies, Inc. | Food Services | Senior Debt (17.6%, Due 2/12)(1) | 40,532 | 40,305 | 40,305 | ||||||||
Common Stock (47,512 shares) | 352 | 61 | |||||||||||
Warrants to purchase Common Stock (expire 6/14) | | 322 | |||||||||||
Sagamore Hill Broadcasting, LLC(2) |
Broadcasting | Senior Debt (15.5%, Due 8/11)(1)(8) | 26,758 | 25,950 | 24,952 | ||||||||
Sorenson Communications, Inc. | Information Services |
Senior Debt (6.0%, Due 04/14)(1) | 8,449 | 8,246 | 8,246 | ||||||||
Summit Business Media Intermediate Holding Company, LLC(6) | Information Services |
Subordinated Debt (15.0%, Due 7/14)(1)(7) | 6,896 | 5,995 | 295 | ||||||||
Teleguam Holdings, LLC(2) | Communications- Other |
Subordinated Debt (7.3%, Due 10/12)(1) | 20,000 | 19,887 | 18,147 | ||||||||
The e-Media Club I, LLC(6) | Investment Fund | LLC Interest (74 units) | 88 | 10 | |||||||||
The Matrixx Group, Incorporated | Plastic Products | Subordinated Debt (17.0%, Due 11/14)(1) | 14,772 | 14,772 | 14,772 | ||||||||
ValuePage, Inc.(6) | Communications- Other |
Senior Debt (12.8%, Due 6/08)(7) | 1,286 | 993 | 13 | ||||||||
VOX Communications Group Holdings, LLC(2)(6) | Broadcasting | Senior Debt (13.5%, Due 3/09)(1)(7) | 11,540 | 10,462 | 6,058 | ||||||||
Convertible Preferred Subordinated Notes (12.5%, Due 6/15-6/17)(7) | 2,238 | 1,414 | | ||||||||||
VS&A-PBI Holding LLC(6) | Publishing | LLC Interest | 500 | | |||||||||
Wireco Worldgroup Inc. | Industrial Equipment |
Senior Debt (2.5%, Due 2/14)(1) | 3,880 | 3,896 | 3,538 |
Xpressdocs Holdings, Inc.(2) | Business Services |
Senior Debt (11.5%, Due 4/12-4/13)(1)(8) | 20,049 | 19,886 | 19,814 | |||||||
Series A Preferred Stock (161,870 shares) | 500 | | ||||||||||
Total Non-Affiliate Investments (represents 55.6% of total investments at fair value) |
574,631 | 550,988 | ||||||||||
Total Investments |
$ | 1,159,794 | $ | 991,032 | ||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
8
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
March 31, 2010 (unaudited)
(dollars in thousands)
Counterparty |
Instrument |
Interest Rate |
Expiring | Notional | Cost | Fair Value(a) |
|||||||||||
Interest Rate Swaps |
|||||||||||||||||
SunTrust Bank |
Interest Rate SwapPay Fixed/Receive Floating |
10.0 | % | 11/10 | $ | 16,000 | $ | | $ | (330 | ) | ||||||
Interest Rate SwapPay Fixed/Receive Floating |
14.0 | % | 11/10 | 8,000 | | (165 | ) | ||||||||||
Interest Rate SwapPay Fixed/Receive Floating |
13.0 | % | 08/11 | 12,500 | | (279 | ) | ||||||||||
Interest Rate SwapPay Fixed/Receive Floating |
9.0 | % | 08/11 | 8,681 | | (193 | ) | ||||||||||
Total Interest Rate Swaps |
$ | 45,181 | $ | | $ | (967 | ) | ||||||||||
(a) | We include the fair value of these interest rate swaps in other liabilities on our Consolidated Balance Sheets. |
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, 2009
(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)(1) | $ | 14,436 | $ | 14,349 | $ | 14,349 | |||||
Preferred Units (10.8%, 17,100 units)(1) | 20,878 | 26,601 | |||||||||||
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) | | | |||||||||||
GMC Television Broadcasting, LLC(2) |
Broadcasting | Senior Debt A (4.3%, Due 12/16)(1) | 20,720 | 18,537 | 18,537 | ||||||||
Senior Debt B (4.3%, Due 12/16)(1)(7) | 3,000 | 2,799 | 2,963 | ||||||||||
Subordinated Debt (14.0%, Due 12/16)(1)(7) | 9,086 | 6,975 | | ||||||||||
Subordinated Unsecured Debt (16.0%, Due 12/16)(7) | 1,067 | 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 | 8,926 | 8,926 | ||||||||
Series A Preferred Units (10.0%, 86,000 units) | 9,095 | 1,330 | |||||||||||
Series B Preferred Units (10.0%, 30,000 units) | 3,000 | 159 | |||||||||||
Jet Plastica Investors, LLC (2) |
Plastic Products | Senior Debt (9.3%, Due 12/12)(1) | 12,533 | 12,441 | 12,441 | ||||||||
Subordinated Debt A (15.5%, Due 3/13)(1) | 18,713 | 18,520 | 18,520 | ||||||||||
Subordinated Debt B (17.0%, Due 3/13)(1)(8) | 19,563 | 17,560 | 11,826 | ||||||||||
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) | 28,603 | 28,440 | 28,440 | ||||||||
Series A Preferred Units (10.0%, 133,204 units) | 18,471 | 11,809 | |||||||||||
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 Holding Group, LLC(2)(5) |
Business Services | Senior Debt A1 (6.0%, Due 6/13)(1) | 4,702 | 3,382 | 3,382 | ||||||||
Senior Debt A2 (6.0%, Due 6/13)(1)(7) | 2,069 | 1,922 | 149 | ||||||||||
Senior Debt A3 (6.0%, Due 6/13)(1)(7) | 7,873 | 6,228 | | ||||||||||
Series A Preferred Units (347 units) | | | |||||||||||
Series B Preferred Units (5.0%, 10,731 units) | 10,731 | | |||||||||||
Common Units (36,500 units) | | | |||||||||||
Orbitel Holdings, LLC(2) | Cable | Senior Debt (9.0%, Due 3/12)(1) | 16,300 | 16,225 | 16,225 | ||||||||
Preferred LLC Interest (10.0%, 120,000 units) | 13,996 | 12,251 | |||||||||||
PremierGarage Holdings, LLC (2)(6) |
Home Furnishings | Senior Debt (8.0%, Due 12/10-9/11)(1)(7) | 9,953 | 9,149 | 9,887 | ||||||||
Preferred LLC Units (400 units) | 400 | 289 | |||||||||||
Common LLC Units (79,935 units) | 4,971 | | |||||||||||
RadioPharmacy Investors, LLC (2) |
Healthcare | Senior Debt (7.0%, Due 12/10)(1) | 8,500 | 8,484 | 8,484 | ||||||||
Subordinated Debt (15.0%, Due 12/11)(1) | 10,140 | 10,111 | 10,111 | ||||||||||
Preferred LLC Interest (8.0%, 70,000 units) | 8,123 | 69 |
Superior Industries Investors, LLC(2) |
Sporting Goods | Subordinated Debt (16.0%, Due 3/13)(1) | 20,212 | 20,126 | 20,126 | |||||
Preferred Units (8.0%, 125,400 units) | 15,272 | 18,977 | ||||||||
Total Sleep Holdings, Inc. (2)(6) |
Healthcare | Subordinated Debt (8.0%, Due 9/11)(7) | 12,037 | 11,780 | 5,271 | |||||
Unsecured Note (0.0%, Due 6/11)(7) | 375 | 332 | | |||||||
Series A Preferred Stock (10.0%, 3,700 shares) | 3,793 | | ||||||||
Series B Preferred Stock (10.0%, 2,752 shares) | 21,149 | | ||||||||
Common Stock (40,469 shares) | 1,000 | | ||||||||
Total Control Investments (represents 41.6% of total investments at fair value) |
555,732 | 409,984 | ||||||||
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, 2009
(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) | $ | 5,985 | $ | 5,890 | $ | 5,627 | |||||
Subordinated Debt (16.0%, Due 4/12)(1) | 5,125 | 5,034 | 4,817 | ||||||||||
Series A Preferred Stock (20.0%, 49 shares) | 297 | | |||||||||||
Common Stock (423 shares) | 524 | | |||||||||||
Warrants to purchase Common Stock (expire 10/16) | 348 | | |||||||||||
Cherry Hill Holdings, Inc. (6) |
Entertainment | Series A Preferred Stock (10.0%, 750 shares) | 907 | 906 | |||||||||
Stratford School Holdings, Inc.(2) |
Education | Senior Debt (6.9%, Due 7/11-9/11)(1) | 3,440 | 3,404 | 3,368 | ||||||||
Subordinated Debt (14.0%, Due 12/11)(1) | 6,717 | 6,695 | 6,695 | ||||||||||
Series A Convertible Preferred Stock (12.0%, 10,000 shares) | 240 | 6,835 | |||||||||||
Warrants to purchase Common Stock (expire 5/15)(1) | 67 | 1,846 | |||||||||||
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 (7.8%, Due 12/12)(1) | 12,859 | 12,794 | 12,794 | ||||||||
Series A Preferred Stock (1,506,602 shares) | 1,500 | 1,500 | |||||||||||
Total Affiliate Investments (represents 4.5% of total investments at fair value) |
38,845 | 44,388 | |||||||||||
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, 2009
(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 (10.3%, Due 6/12)(1)(8) | $ | 24,601 | $ | 24,155 | $ | 18,665 | |||||
Subordinated Debt (17.0%, Due 9/12)(1)(7) | 15,446 | 12,437 | | ||||||||||
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 (7.3%, Due 12/12)(1) | 6,280 | 6,258 | 6,258 | ||||||||
Subordinated Debt (10.1%, Due 12/12)(1) | 2,488 | 2,442 | 2,358 | ||||||||||
Warrants to purchase Common Stock (expire 11/15) | | 95 | |||||||||||
Amerifit Nutrition, Inc.(2) | Healthcare | Senior Debt (12.0%, Due 3/10)(1) | 2,567 | 2,559 | 2,559 | ||||||||
B & H Education, Inc. | Education | Series A-1 Convertible Preferred Stock (12.0%, 5,384 shares) | 1,669 | 5,383 | |||||||||
BLI Holdings, Inc.(2) | Drugs | Senior Debt (11.3%, Due 2/10)(1) | 10,393 | 10,216 | 10,213 | ||||||||
Coastal Sunbelt Holding, Inc. (2) |
Food Services | Senior Debt (9.1%, Due 8/14-2/15)(1) | 22,061 | 21,838 | 21,838 | ||||||||
Subordinated Debt (16.0%, Due 8/15)(1) | 8,509 | 8,430 | 8,430 | ||||||||||
Coastal Sunbelt Real Estate, Inc. |
Real Estate Investments | Subordinated Unsecured Debt (15.0%, Due 7/12) | 2,190 | 2,180 | 2,178 | ||||||||
Series A-2 Preferred Stock (12.0%, 20,000 shares) | 2,656 | 525 | |||||||||||
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) | 9,499 | 9,350 | 8,105 | ||||||||
Cruz Bay Publishing, Inc. | Publishing | Subordinated Debt (12.8%, Due 12/13)(1) | 20,000 | 19,805 | 13,998 | ||||||||
CWP/RMK Acquisition Corp.(2)(6) |
Home Furnishings | Senior Debt (3.0%, Due 12/16)(7) | 600 | 597 | 409 | ||||||||
Dayton Parts Holdings, LLC (6) |
Auto Parts | Preferred LLC Interest (10.0%, 16,470 units) | 631 | 615 | |||||||||
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) | 6,015 | 5,958 | 5,958 | ||||||||
Equibrand Holding Corporation (2) |
Leisure Activities | Senior Debt (9.5%, Due 6/11)(1) | 4,640 | 4,609 | 4,609 | ||||||||
Subordinated Debt (17.0%, Due 12/11)(1) | 9,643 | 9,577 | 9,577 | ||||||||||
G&L Investment Holdings, LLC(2) |
Insurance | Subordinated Debt (7.8%, Due 5/14)(1) | 17,500 | 17,021 | 15,778 | ||||||||
Series A Preferred Shares (14.0%, 5,000,000 shares) | 6,667 | 6,667 | |||||||||||
Class C Shares (621,907 shares) | 529 | 370 |
Golden Knight II CLO, Ltd. (6) |
Diversified Financial Services | Income Notes (8.0%, Due 4/19) | 3,575 | 1,836 | ||||||
GSDM Holdings, LLC(2) | Healthcare | Senior Debt (7.5%, Due 2/13)(1) | 7,673 | 7,611 | 7,527 | |||||
Subordinated Debt (14.0%, Due 8/13)(1) | 7,968 | 7,935 | 7,935 | |||||||
Series B Preferred Units (12.5%, 4,213,333 units) | 4,397 | 2,774 | ||||||||
Home Interiors & Gifts, Inc.(6)(10) | Home Furnishings | Senior Debt (8.0%, Due 3/11)(7) | 4,141 | 3,667 | 21 | |||||
Jenzabar, Inc. | Technology | Senior Preferred Stock (11.0%, 3,750 shares) | 6,019 | 6,019 | ||||||
Subordinated Preferred Stock (109,800 shares) | 1,098 | 1,098 | ||||||||
Warrants to purchase Common Stock (expire 4/16)(12) | 422 | 20,478 | ||||||||
Lambeau Telecom Company, LLC | Communications-CLEC | Senior Debt (12.0%, Due 2/13)(8) | 1,380 | 1,353 | 1,059 | |||||
Legacy Cabinets, Inc.(6) | Home Furnishings | Subordinated Debt (12.5%, Due 8/13)(1)(7) | 2,328 | 2,184 | | |||||
LMS INTELLIBOUND, INC.(2) | Logistics | Senior Debt (8.6%, Due 3/146/14)(1) | 25,193 | 24,848 | 24,848 | |||||
Subordinated Debt (16.0%, Due 9/14)(1) | 7,000 | 6,846 | 6,846 | |||||||
Maverick Healthcare Equity, LLC | Healthcare | Subordinated Debt (16.0%, Due 4/14)(1) | 12,894 | 12,753 | 12,753 | |||||
Preferred Units (10.0%, 1,250,000 units) | 1,432 | 1,432 | ||||||||
Class A Common Units (1,250,000 units) | | | ||||||||
MCI Holdings LLC(2) | Healthcare | Subordinated Debt (12.7%, Due 4/13)(1) | 32,307 | 32,186 | 32,186 | |||||
Class A LLC Interest (4,712,042 units) | 3,000 | 9,177 |
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, 2009
(dollars in thousands)
Portfolio Company |
Industry |
Investment(9) |
Principal | Cost | Fair Value | ||||||||
Metropolitan Telecommunications Holding Company(2) |
Communications- CLEC |
Senior Debt (10.8%, Due 12/11)(1) | $ | 20,327 | $ | 20,247 | $ | 20,247 | |||||
Warrants to purchase Common Stock (expire 9/13) | 1,843 | 9,989 | |||||||||||
Miles Media Group, LLC(2) |
Business Services | Senior Debt (12.5%, Due 6/13)(1) | 17,369 | 17,095 | 17,095 | ||||||||
NDSSI Holdings, LLC(2) | Electronics | Senior Debt (9.9%, Due 9/13-3/14)(1) | 19,373 | 19,209 | 18,473 | ||||||||
Subordinated Debt (15.0%, Due 9/14)(1) | 22,384 | 22,323 | 22,323 | ||||||||||
Series A Preferred Units (516,691 units) | 718 | 718 | |||||||||||
Class A Common Units (1,000,000 units) | 333 | 568 | |||||||||||
Philadelphia Newspapers, LLC (6)(11) |
Newspaper | Subordinated Unsecured Debt (16.5%, Due 6/14)(7) | 5,082 | 5,070 | | ||||||||
Powercom Corporation(6) | Communications- CLEC |
Warrants to purchase Class A Common Stock (expire 6/14) | 286 | | |||||||||
Quantum Medical Holdings, LLC (2) |
Laboratory Instruments |
Senior Debt (6.3%, Due 5/11)(1) | 15,500 | 15,481 | 15,481 | ||||||||
Subordinated Debt (15.0%, Due 12/11)(1) | 18,032 | 17,952 | 17,952 | ||||||||||
Preferred LLC Interest (1,000,000 units) | 640 | 1,357 | |||||||||||
Restaurant Technologies, Inc. | Food Services | Senior Debt (17.6%, Due 2/12)(1) | 39,824 | 39,567 | 39,567 | ||||||||
Common Stock (47,512 shares) | 352 | 51 | |||||||||||
Warrants to purchase Common Stock (expire 6/14) | | 149 | |||||||||||
Sagamore Hill Broadcasting, LLC(2) |
Broadcasting | Senior Debt (15.5%, Due 8/11)(1)(8) | 26,559 | 25,964 | 24,730 | ||||||||
Summit Business Media Intermediate Holding Company, LLC(6) | Information Services |
Subordinated Debt (15.0%, Due 7/14)(1)(7) | 6,647 | 5,996 | 896 | ||||||||
Teleguam Holdings, LLC(2) | Communications- Other |
Subordinated Debt (7.2%, Due 10/12)(1) | 20,000 | 19,876 | 17,989 | ||||||||
The e-Media Club I, LLC(6) | Investment Fund | LLC Interest (74 units) | 88 | 7 | |||||||||
The Matrixx Group, Incorporated | Plastic Products | Subordinated Debt (17.0%, Due 11/14)(1) | 14,662 | 14,662 | 14,662 | ||||||||
ValuePage, Inc.(6) |
Communications- Other |
Senior Debt (12.8%, Due 6/08)(7) | 1,274 | 993 | 3 | ||||||||
VOX Communications Group Holdings, LLC(2)(6) | Broadcasting | Senior Debt (13.5%, Due 3/09)(1)(7) | 11,483 | 10,463 | 6,025 | ||||||||
Convertible Preferred Subordinated Notes (12.5%, Due 6/15-6/17)(7) | 2,170 | 1,414 | | ||||||||||
VS&A-PBI Holding LLC(6) |
Publishing | LLC Interest | 500 | | |||||||||
WebMediaBrands Inc.(6) | Information Services |
Common Stock (148,373 shares) | 2,115 | 131 |
Wireco Worldgroup Inc. | Industrial Equipment | Senior Debt (2.5%, Due 2/14)(1) | 3,890 | 3,908 | 3,354 | |||||||
Xpressdocs Holdings, Inc.(2) |
Business Services | Senior Debt (11.5%, Due 4/12-4/13)(1)(8) | 20,208 | 20,055 | 19,630 | |||||||
Series A Preferred Stock (161,870 shares) | 500 | | ||||||||||
Total Non-Affiliate Investments (represents 53.9% of total investments at fair value) |
560,347 | 531,974 | ||||||||||
Total Investments |
$ | 1,154,924 | $ | 986,346 | ||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
13
Table of Contents
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2009
(dollars in thousands)
Counterparty |
Instrument |
Interest Rate |
Expiring | Notional | Cost | Fair Value(a) |
|||||||||||
Interest Rate Swaps |
|||||||||||||||||
SunTrust Bank |
Interest Rate SwapPay Fixed/Receive Floating | 10.0 | % | 11/10 | $ | 16,000 | $ | | $ | (426 | ) | ||||||
Interest Rate SwapPay Fixed/Receive Floating | 14.0 | % | 11/10 | 8,000 | | (213 | ) | ||||||||||
Interest Rate SwapPay Fixed/Receive Floating | 13.0 | % | 08/11 | 12,500 | | (245 | ) | ||||||||||
Interest Rate SwapPay Fixed/Receive Floating | 9.0 | % | 08/11 | 8,681 | | (170 | ) | ||||||||||
Total Interest Rate Swaps |
$ | 45,181 | $ | | $ | (1,054 | ) | ||||||||||
(a) | We include the fair value of these interest rate swaps in other liabilities on our Consolidated Balance Sheets. |
(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) | 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 February 22, 2009, Philadelphia Newspapers, LLC filed for Chapter 11 bankruptcy protection. |
(12) | On February 24, 2010, we exercised warrants to purchase 100,000 shares of common stock of Jenzabar, Inc. and we submitted the requisite payments for this stock. Our receipt of the common stock certificates from Jenzabar is pending. |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
14
Table of Contents
Notes to the Condensed Consolidated Financial Statements (Unaudited)
NOTE 1DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
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, L.P., 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, L.P., MCG also established another wholly owned subsidiary, Solutions Capital G.P., LLC, to act as the general partner of Solutions Capital I, L.P., while MCG is the sole limited partner.
Taxable SubsidiariesWe currently qualify as a regulated investment company, or RIC, for federal income tax purposes and, therefore, are not required to pay 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, L.P.; Solutions Capital G.P., LLC; and MCGs special-purpose financing subsidiaries: MCG Finance V, LLC and MCG Finance VII, 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 March 31, 2010 through the date these financial statements were issued.
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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, 2009.
CERTAIN RISKS AND UNCERTAINTIES
Since late 2007, the United States economy has been in a recession which has had a severe adverse impact on many companies, especially those in the financial services sector. These economic conditions continue to constrain the availability of debt and equity capital. Generally, the limited amount of available debt financing in the capital markets has shorter maturities, higher interest rates and fees and more restrictive terms than debt facilities available in the past. In addition, during the quarter ended March 31, 2010, the price of our common stock continued to trade below our net asset value, thereby making it undesirable to issue additional shares of our common stock. To address the diminished availability of debt and equity capital in 2008 and 2009, we undertook a number of initiatives aimed at securing our borrowing facilities and improving our liquidity, including the monetization of certain investments, the suspension of both origination activity and dividend distributions and the reduction of general and administrative costs. We have concluded that the implementation of these initiatives, combined with modest improvements in the economy beginning in mid-2009, have improved our financial and liquidity metrics sufficiently to allow us to begin origination activities and dividend distributions. Although there can be no assurance, we believe we have sufficient liquidity to meet our 2010 operating requirements, as well as liquidity for new origination opportunities and dividend distributions.
RECENT ACCOUNTING PRONOUNCEMENTS
FAIR VALUE MEASUREMENTS
In January 2010, FASB issued Accounting Standard Update No. 2010-06Improving Disclosures about Fair Value Measurements, or ASU 2010-06. The January 2010 update amends Accounting Standards Codification Topic 820Fair Value Measurements and Disclosures, or ASC 820, to add new requirements for disclosures about significant transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements. In addition, the update clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for interim and annual reporting periods beginning after December 15, 2010. We adopted this standard beginning with our financial statements ending March 31, 2010. 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:
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Investments at Cost |
Percent of Total Portfolio |
Investments at Cost |
Percent of Total Portfolio |
||||||||||
Debt investments |
||||||||||||||
Senior secured debt |
$ | 406,111 | 35.0 | % | $ | 406,182 | 35.2 | % | ||||||
Subordinated debt |
||||||||||||||
Secured |
329,446 | 28.4 | 323,575 | 28.0 | ||||||||||
Unsecured |
38,576 | 3.3 | 38,436 | 3.3 | ||||||||||
Total debt investments |
774,133 | 66.7 | 768,193 | 66.5 | ||||||||||
Equity investments |
||||||||||||||
Preferred equity |
366,747 | 31.6 | 365,418 | 31.6 | ||||||||||
Common/common equivalents equity |
18,914 | 1.7 | 21,313 | 1.9 | ||||||||||
Total equity investments |
385,661 | 33.3 | 386,731 | 33.5 | ||||||||||
Total investments |
$ | 1,159,794 | 100.0 | % | $ | 1,154,924 | 100.0 | % | ||||||
The following table summarizes the composition of our investment portfolio at fair value:
|
| |||||||||||||
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||
Debt investments |
||||||||||||||
Senior secured debt |
$ | 379,600 | 38.3 | % | $ | 379,457 | 38.5 | % | ||||||
Subordinated debt |
||||||||||||||
Secured |
272,713 | 27.5 | 275,398 | 27.9 | ||||||||||
Unsecured |
30,760 | 3.1 | 30,618 | 3.1 | ||||||||||
Total debt investments |
683,073 | 68.9 | 685,473 | 69.5 | ||||||||||
Equity investments |
||||||||||||||
Preferred equity |
261,931 | 26.4 | 257,984 | 26.2 | ||||||||||
Common/common equivalents equity |
46,028 | 4.7 | 42,889 | 4.3 | ||||||||||
Total equity investments |
307,959 | 31.1 | 300,873 | 30.5 | ||||||||||
Total investments |
$ | 991,032 | 100.0 | % | $ | 986,346 | 100.0 | % | ||||||
Our debt instruments bear contractual interest rates ranging from 2.5% to 17.6%, a portion of which may be deferred. As of March 31, 2010, approximately 56.1% of the fair value of our loan portfolio was at variable rates, based on a LIBOR benchmark or prime rate, and 43.9% of the fair value of our loan portfolio was at fixed rates. As of March 31, 2010, approximately 38.4% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 3.5% 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 percentage 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:
March 31, 2010 | December 31, 2009 | |||||||||||||
(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 |
$ | 22,376 | 2.89 | % | $ | 22,377 | 2.91 | % | ||||||
Not on non-accrual status |
| | | | ||||||||||
Total loans greater than 90 days past due |
$ | 22,376 | 2.89 | % | $ | 22,377 | 2.91 | % | ||||||
Loans on non-accrual status |
||||||||||||||
0 to 90 days past due |
$ | 77,653 | 10.03 | % | $ | 60,629 | 7.89 | % | ||||||
Greater than 90 days past due |
22,376 | 2.89 | 22,377 | 2.91 | ||||||||||
Total loans on non-accrual status |
$ | 100,029 | 12.92 | % | $ | 83,006 | 10.80 | % | ||||||
The following table summarizes the fair value of loans more than 90 days past due and loans on non-accrual status:
|
| |||||||||||||
March 31, 2010 | December 31, 2009 | |||||||||||||
(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 |
$ | 6,092 | 0.89 | % | $ | 6,049 | 0.88 | % | ||||||
Not on non-accrual status |
| | | | ||||||||||
Total loans greater than 90 days past due |
$ | 6,092 | 0.89 | % | $ | 6,049 | 0.88 | % | ||||||
Loans on non-accrual status |
||||||||||||||
0 to 90 days past due |
$ | 21,768 | 3.19 | % | $ | 19,575 | 2.86 | % | ||||||
Greater than 90 days past due |
6,092 | 0.89 | 6,049 | 0.88 | ||||||||||
Total loans on non-accrual status |
$ | 27,860 | 4.08 | % | $ | 25,624 | 3.74 | % | ||||||
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The following table summarizes our investment portfolio by industry at cost:
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Investments at Cost |
Percent of Total Portfolio |
Investments at Cost |
Percent of Total Portfolio |
||||||||||
TelecommunicationsCLEC (competitive local exchange carriers) |
$ | 181,728 | 15.7 | % | $ | 183,208 | 15.9 | % | ||||||
Communicationsother |
20,883 | 1.8 | 20,872 | 1.8 | ||||||||||
Cable |
126,670 | 10.9 | 126,059 | 10.9 | ||||||||||
Healthcare |
134,601 | 11.6 | 136,645 | 11.8 | ||||||||||
Food services |
70,902 | 6.1 | 70,187 | 6.1 | ||||||||||
Broadcasting |
76,171 | 6.6 | 76,223 | 6.6 | ||||||||||
Plastic products |
98,239 | 8.5 | 97,197 | 8.4 | ||||||||||
Electronics |
42,834 | 3.7 | 42,583 | 3.7 | ||||||||||
Business services |
61,050 | 5.3 | 74,207 | 6.4 | ||||||||||
Sporting goods |
36,867 | 3.2 | 35,398 | 3.1 | ||||||||||
Leisure activities |
35,648 | 3.1 | 14,186 | 1.2 | ||||||||||
Laboratory instruments |
34,108 | 2.9 | 34,073 | 3.0 | ||||||||||
Logistics |
31,137 | 2.7 | 31,694 | 2.7 | ||||||||||
Technology |
7,644 | 0.7 | 7,539 | 0.7 | ||||||||||
Education |
12,160 | 1.1 | 12,075 | 1.0 | ||||||||||
Insurance |
24,474 | 2.1 | 24,217 | 2.1 | ||||||||||
Home furnishings |
32,851 | 2.8 | 33,061 | 2.9 | ||||||||||
Publishing |
24,462 | 2.1 | 21,450 | 1.8 | ||||||||||
Consumer products |
40,079 | 3.5 | 39,979 | 3.5 | ||||||||||
Information services |
19,075 | 1.6 | 14,069 | 1.2 | ||||||||||
Other media |
21,231 | 1.8 | 21,021 | 1.8 | ||||||||||
Drugs |
| | 10,216 | 0.9 | ||||||||||
Other(a) |
26,980 | 2.2 | 28,765 | 2.5 | ||||||||||
Total |
$ | 1,159,794 | 100.0 | % | $ | 1,154,924 | 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:
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||
TelecommunicationsCLEC |
$ | 169,401 | 17.1 | % | $ | 170,129 | 17.2 | % | ||||||
Communicationsother |
18,265 | 1.8 | 18,020 | 1.8 | ||||||||||
Cable |
133,733 | 13.5 | 128,386 | 13.0 | ||||||||||
Healthcare |
96,931 | 9.8 | 100,278 | 10.2 | ||||||||||
Food services |
70,933 | 7.2 | 70,035 | 7.1 | ||||||||||
Broadcasting |
52,455 | 5.3 | 52,255 | 5.3 | ||||||||||
Plastic products |
50,890 | 5.1 | 57,449 | 5.8 | ||||||||||
Electronics |
43,069 | 4.4 | 42,082 | 4.3 | ||||||||||
Business services |
42,135 | 4.3 | 54,550 | 5.6 | ||||||||||
Sporting goods |
38,910 | 3.9 | 39,103 | 4.0 | ||||||||||
Leisure activities |
35,648 | 3.6 | 14,186 | 1.4 | ||||||||||
Laboratory instruments |
35,063 | 3.5 | 34,790 | 3.5 | ||||||||||
Logistics |
31,137 | 3.1 | 31,694 | 3.2 | ||||||||||
Technology |
29,813 | 3.0 | 27,595 | 2.8 | ||||||||||
Education |
24,914 | 2.5 | 24,127 | 2.5 | ||||||||||
Insurance |
23,074 | 2.3 | 22,815 | 2.3 | ||||||||||
Home furnishings |
21,004 | 2.1 | 21,050 | 2.1 | ||||||||||
Publishing |
17,005 | 1.7 | 13,998 | 1.4 | ||||||||||
Consumer products |
16,979 | 1.7 | 18,665 | 1.9 | ||||||||||
Information services |
13,375 | 1.4 | 6,985 | 0.7 | ||||||||||
Other media |
10,024 | 1.0 | 10,415 | 1.1 | ||||||||||
Drugs |
| | 10,213 | 1.0 | ||||||||||
Other(a) |
16,274 | 1.7 | 17,526 | 1.8 | ||||||||||
Total |
$ | 991,032 | 100.0 | % | $ | 986,346 | 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. We include the fair value of these interest rate swaps in other liabilities on our Consolidated Balance Sheets. We do not designate any of our interest rate swaps as hedges for accounting purposes. Each quarter, we settle these interest rates swaps for cash. During the three months ended March 31, 2010 and 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.
As of March 31, 2010 and December 31, 2009, the notional amount of our interest rate swaps was $45.2 million and $45.2 million, respectively, and the fair value of these interest rate swaps included in our liabilities was $1.0 million and $1.1 million, respectively. 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 March 31, 2010:
(dollars in thousands) | As of March 31, 2010 | Three months ended March 31, 2010 |
|||||||||||||||||||
Date |
Interest | Notional | Cost |
Fair |
Unrealized
Appreciation (Depreciation) |
||||||||||||||||
Entered |
Expiring | Rate | Value | ||||||||||||||||||
07/08 |
11/10 | 10.0 | % | $ | 16,000 | $ | | $ | (330 | ) | $ | 96 | |||||||||
07/08 |
11/10 | 14.0 | % | 8,000 | | (165 | ) | 48 | |||||||||||||
03/09 |
08/11 | 13.0 | % | 12,500 | | (279 | ) | (34 | ) | ||||||||||||
03/09 |
08/11 | 9.0 | % | 8,681 | | (193 | ) | (23 | ) | ||||||||||||
Total |
$ | 45,181 | $ | | $ | (967 | ) | $ | 87 | ||||||||||||
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NOTE 3FAIR VALUE MEASUREMENT
We account for our investments in portfolio companies under 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.
Our investment portfolio is not composed of homogeneous debt and equity securities that could be valued with a small number of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with unique contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and complex, often factoring in hundreds of unique inputs, including the historical and forecasted financial and operational performance of the portfolio company, projected cash flows, market multiples, comparable market transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews, and numerous other inputs, too numerous to list quantitatively herein.
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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 March 31, 2010 | ||||||||||||||
(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 |
$ | | $ | 21,505 | $ | 267,275 | $ | 288,780 | ||||||
Subordinated secured debt |
| | 187,393 | 187,393 | ||||||||||
Unsecured subordinated debt |
| | 2,198 | 2,198 | ||||||||||
Preferred equity |
| 2,175 | 26,483 | 28,658 | ||||||||||
Common/common equivalents |
| | 43,959 | 43,959 | ||||||||||
Total non-affiliate investments |
| 23,680 | 527,308 | 550,988 | ||||||||||
Affiliate investments |
||||||||||||||
Senior secured debt |
| | 9,096 | 9,096 | ||||||||||
Subordinated secured debt |
| | 11,739 | 11,739 | ||||||||||
Preferred equity |
| | 9,903 | 9,903 | ||||||||||
Common/common equivalents |
| | 1,964 | 1,964 | ||||||||||
Total affiliate investments |
| | 32,702 | 32,702 | ||||||||||
Control investments |
||||||||||||||
Senior secured debt |
| | 81,725 | 81,725 | ||||||||||
Subordinated secured debt |
| | 73,581 | 73,581 | ||||||||||
Unsecured subordinated debt |
| | 28,562 | 28,562 | ||||||||||
Preferred equity |
| | 223,369 | 223,369 | ||||||||||
Common/common equivalents |
| | 105 | 105 | ||||||||||
Total control investments |
| | 407,342 | 407,342 | ||||||||||
Total assets at fair value |
$ | | $ | 23,680 | $ | 967,352 | $ | 991,032 | ||||||
LIABILITIES |
||||||||||||||
Interest rate swaps(a) |
$ | | $ | (967 | ) | $ | | $ | (967 | ) | ||||
Total liabilities at fair value |
$ | | $ | (967 | ) | $ | | $ | (967 | ) | ||||
(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 40.7% 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. |
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| Non-Majority-Owned Control InvestmentsNon-majority owned investments comprise 0.4% 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 58.9% of our investment portfolio. Quoted prices are not available for 95.9% of our non-control investments. 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 March 31, 2010, these securities represented 2.4% of our investment portfolio. |
Our valuation analyses incorporate the impact that key events could have on the securities values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales. Our valuation analyses also include 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 at least 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 derived through a sale of some or all of our investment in the portfolio company. Independent valuation firms performed valuations or reviewed valuations of 36 portfolio companies over the last four quarters, representing $845.9 million, or 85.4%, of the fair value of our total portfolio investments and $278.0 million, or 90.3%, of the fair value of our equity portfolio investments. In addition, the fair value of $106.3 million, or 10.7% of our total portfolio investments and $26.3 million, or 8.5% of the fair value of our equity portfolio, was derived from sales transactions involving the portfolio company. As set forth in more detail in the following table, in total, either we obtained a valuation or review from an independent firm or we considered recent sales transactions for 96.1% of the fair value of our investment portfolio as of March 31, 2010.
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As of March 31, 2010 | ||||||||||||||||||||
Investments at Fair Value | Percent of | |||||||||||||||||||
(dollars in thousands) |
Debt | Equity | Total | Debt Portfolio |
Equity Portfolio |
Total Portfolio |
||||||||||||||
Independent valuation/review prepared(a) |
||||||||||||||||||||
First quarter 2010 |
$ | 179,308 | $ | 201,993 | $ | 381,301 | 26.3 | % | 65.6 | % | 38.5 | % | ||||||||
Fourth quarter 2009 |
164,660 | 52,541 | 217,201 | 24.1 | 17.1 | 21.9 | ||||||||||||||
Third quarter 2009 |
90,893 | 10,345 | 101,238 | 13.3 | 3.3 | 10.2 | ||||||||||||||
Second quarter 2009 |
133,055 | 13,133 | 146,188 | 19.5 | 4.3 | 14.8 | ||||||||||||||
Total independent valuation/review |
567,916 | 278,012 | 845,928 | 83.2 | 90.3 | 85.4 | ||||||||||||||
Fair value derived from sales transaction |
||||||||||||||||||||
First quarter 2010 |
28,562 | 26,278 | 54,840 | 4.2 | 8.5 | 5.5 | ||||||||||||||
Third quarter 2009 |
51,690 | | 51,690 | 7.5 | | 5.2 | ||||||||||||||
Total derived from sales transaction |
80,252 | 26,278 | 106,530 | 11.7 | 8.5 | 10.7 | ||||||||||||||
New investments made during the 12 months ended March 31, 2010 |
29,573 | | 29,573 | 4.3 | | 3.0 | ||||||||||||||
Not evaluated during the 12 months ended March 31, 2010 |
5,332 | 3,669 | 9,001 | 0.8 | 1.2 | 0.9 | ||||||||||||||
Total investment portfolio |
$ | 683,073 | $ | 307,959 | $ | 991,032 | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
(a) | Independent valuations/reviews prepared more than one time during the twelve months ended March 31, 2010 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 1, 2 and 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 quarter ended March 31, 2010, there were no transfers in or out of Level 1, 2 or 3.
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The following table provides a reconciliation of fair value changes during the three-month period from December 31, 2009 through March 31, 2010 for all investments for which we determine fair value using unobservable (Level 3) factors.
(in thousands) |
Fair value measurements using unobservable inputs (Level 3) | |||||||||||||||
Non-affiliate Investments |
Affiliate Investments |
Control Investments |
Total | |||||||||||||
Fair value December 31, 2009 |
||||||||||||||||
Senior secured debt |
$ | 273,319 | $ | 21,789 | $ | 80,995 | $ | 376,103 | ||||||||
Subordinated secured debt |
183,684 | 11,511 | 80,202 | 275,397 | ||||||||||||
Unsecured subordinated debt |
2,179 | | 28,439 | 30,618 | ||||||||||||
Preferred equity |
26,587 | 9,242 | 220,320 | 256,149 | ||||||||||||
Common/common equivalents equity |
40,885 | 1,846 | 28 | 42,759 | ||||||||||||
Total fair value December 31, 2009 |
526,654 | 44,388 | 409,984 | 981,026 | ||||||||||||
Realized/unrealized gain (loss) |
||||||||||||||||
Senior secured debt |
(609 | ) | 286 | 342 | 19 | |||||||||||
Subordinated secured debt |
2 | 164 | (8,721 | ) | (8,555 | ) | ||||||||||
Unsecured subordinated debt |
2 | | | 2 | ||||||||||||
Preferred equity |
(542 | ) | 631 | 2,187 | 2,276 | |||||||||||
Common/common equivalents equity |
3,073 | 118 | 77 | 3,268 | ||||||||||||
Total realized/unrealized gain (loss) |
1,926 | 1,199 | (6,115 | ) | (2,990 | ) | ||||||||||
Issuances |
||||||||||||||||
Senior secured debt |
13,976 | 90 | 521 | 14,587 | ||||||||||||
Subordinated secured debt |
4,307 | 131 | 2,100 | 6,538 | ||||||||||||
Unsecured subordinated debt |
17 | | 123 | 140 | ||||||||||||
Preferred equity |
438 | 30 | 862 | 1,330 | ||||||||||||
Common/common equivalents equity |
1 | | | 1 | ||||||||||||
Total issuances |
18,739 | 251 | 3,606 | 22,596 | ||||||||||||
Settlements |
||||||||||||||||
Senior secured debt |
(19,411 | ) | (13,069 | ) | (133 | ) | (32,613 | ) | ||||||||
Subordinated secured debt |
(600 | ) | (67 | ) | | (667 | ) | |||||||||
Total settlements |
(20,011 | ) | (13,136 | ) | (133 | ) | (33,280 | ) | ||||||||
Fair value as of March 31, 2010 |
||||||||||||||||
Senior secured debt |
267,275 | 9,096 | 81,725 | 358,096 | ||||||||||||
Subordinated secured debt |
187,393 | 11,739 | 73,581 | 272,713 | ||||||||||||
Unsecured subordinated debt |
2,198 | | 28,562 | 30,760 | ||||||||||||
Preferred equity |
26,483 | 9,903 | 223,369 | 259,755 | ||||||||||||
Common/common equivalents equity |
43,959 | 1,964 | 105 | 46,028 | ||||||||||||
Total fair value as of March 31, 2010 |
$ | 527,308 | $ | 32,702 | $ | 407,342 | $ | 967,352 | ||||||||
There were no purchases or sales of Level 3 investments during the three months ended March 31, 2010.
The following table summarizes the unrealized (depreciation) appreciation on our Level 3 investments for the three months ended March 31, 2010.
Fair value measurements using unobservable inputs (Level 3) | |||||||||||||||
(in thousands) |
Non-affiliate Investments |
Affiliate Investments |
Control Investments |
Total | |||||||||||
Change in unrealized appreciation (depreciation) |
|||||||||||||||
Senior secured debt |
$ | (609 | ) | $ | 286 | $ | 342 | $ | 19 | ||||||
Subordinated secured debt |
2 | 164 | (8,721 | ) | (8,555 | ) | |||||||||
Unsecured subordinated debt |
2 | | | 2 | |||||||||||
Preferred equity |
(542 | ) | 631 | 2,187 | 2,276 | ||||||||||
Common/common equivalents equity |
3,359 | 118 | 77 | 3,554 | |||||||||||
Total change in unrealized appreciation (depreciation) on Level 3 investments |
$ | 2,212 | $ | 1,199 | $ | (6,115 | ) | $ | (2,704 | ) | |||||
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The following table provides a reconciliation of fair value changes during the three-month period from December 31, 2008 through March 31, 2009 for all investments for which we determine fair value using unobservable (Level 3) factors.
(in thousands) |
Fair value measurements using unobservable inputs (Level 3) | |||||||||||||||
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) |
||||||||||||||||
Senior secured debt |
(3,889 | ) | (116 | ) | (591 | ) | (4,596 | ) | ||||||||
Subordinated secured debt |
(6,254 | ) | 45 | (22,773 | ) | (28,982 | ) | |||||||||
Unsecured subordinated debt |
(393 | ) | | (5 | ) | (398 | ) | |||||||||
Preferred equity |
(1,053 | ) | (280 | ) | (24,630 | ) | (25,963 | ) | ||||||||
Common/common equivalents equity |
(5,480 | ) | | | (5,480 | ) | ||||||||||
Total realized/unrealized loss |
(17,069 | ) | (351 | ) | (47,999 | ) | (65,419 | ) | ||||||||
Issuances |
||||||||||||||||
Senior secured debt |
26,880 | | 14,564 | 41,444 | ||||||||||||
Subordinated secured debt |
952 | 129 | 2,985 | 4,066 | ||||||||||||
Unsecured subordinated debt |
17 | | 123 | 140 | ||||||||||||
Preferred equity |
677 | 30 | 6,118 | 6,825 | ||||||||||||
Common/common equivalents equity |
64 | | | 64 | ||||||||||||
Total issuances |
28,590 | 159 | 23,790 | 52,539 | ||||||||||||
Settlements |
||||||||||||||||
Senior secured debt |
(5,270 | ) | (948 | ) | (1,276 | ) | (7,494 | ) | ||||||||
Subordinated secured debt |
(22,022 | ) | (67 | ) | (82 | ) | (22,171 | ) | ||||||||
Preferred equity |
(843 | ) | | (4,354 | ) | (5,197 | ) | |||||||||
Total settlements |
(28,135 | ) | (1,015 | ) | (5,712 | ) | (34,862 | ) | ||||||||
Sales |
||||||||||||||||
Preferred equity |
(1,185 | ) | | (35,907 | ) | (37,092 | ) | |||||||||
Total sales |
(1,185 | ) | | (35,907 | ) | (37,092 | ) | |||||||||
Transfers into (out of) Level 3 |
||||||||||||||||
Senior secured debt |
11,223 | | (11,223 | ) | | |||||||||||
Subordinated secured debt |
16,882 | | (16,882 | ) | | |||||||||||
Total transfers into (out of) Level 3 |
28,105 | | (28,105 | ) | | |||||||||||
Fair value as of March 31, 2009 |
||||||||||||||||
Senior secured debt |
318,926 | 24,403 | 109,925 | 453,254 | ||||||||||||
Subordinated secured debt |
200,460 | 11,216 | 91,529 | 303,205 | ||||||||||||
Unsecured subordinated debt |
2,128 | | 25,695 | 27,823 | ||||||||||||
Preferred equity |
23,724 | 14,970 | 239,020 | 277,714 | ||||||||||||
Common/common equivalents equity |
42,863 | 3,903 | 2,584 | 49,350 | ||||||||||||
Total fair value as of March 31, 2009 |
$ | 588,101 | $ | 54,492 | $ | 468,753 | $ | 1,111,346 | ||||||||
There were no purchases of Level 3 investments for the three months ended March 31, 2009.
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The following table summarizes the unrealized (depreciation) appreciation on our Level 3 investments for the three months ended March 31, 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 |
$ | (3,889 | ) | $ | (116 | ) | $ | (591 | ) | $ | (4,596 | ) | ||||
Subordinated secured debt |
(6,254 | ) | 45 | (22,773 | ) | (28,982 | ) | |||||||||
Unsecured subordinated debt |
(393 | ) | | (5 | ) | (398 | ) | |||||||||
Preferred equity |
(988 | ) | (280 | ) | (40,887 | ) | (42,155 | ) | ||||||||
Common/common equivalents equity |
(5,415 | ) | | | (5,415 | ) | ||||||||||
Total change in unrealized (depreciation) appreciation on Level 3 investments |
$ | (16,939 | ) | $ | (351 | ) | $ | (64,256 | ) | $ | (81,546 | ) | ||||
NOTE 4CONCENTRATIONS OF INVESTMENT RISK
As of March 31, 2010, approximately 18.9% of the fair value of our investment portfolio was composed of investments in the communications industry. The 18.9% included 17.1% invested in CLECs and 1.8% invested in other communications companies, including an incumbent local exchange carrier, a paging service and a telecommunications tower company. As of December 31, 2009, approximately 19.0% of the fair value of our investment portfolio was composed of investments in the communications industry, including 17.2% invested in CLECs and 1.8% invested in other communications companies. For the three months ended March 31, 2010 and 2009, our portfolio companies in the communications industry contributed $1.0 million, or 4.5%, and $1.2 million, or 4.5%, 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 both March 31, 2010 and December 31, 2009, the fair value of our investment in Broadview represented $138.8 million, or 14.0% and 14.1%, respectively, of the fair value of our investment portfolio. We did not accrete any dividends with respect to our investment in Broadview during the three months ended March 31, 2010 or 2009, because we determined that the total value that we had recorded for this investment equaled the total enterprise value for this 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 three months ended | |||||||||||||||||||||||||||||
March 31, 2010 | December 31, 2009 | March 31, 2010 | March 31, 2009 | |||||||||||||||||||||||||||
(dollars in thousands) |
Amount | % of Total Portfolio |
Amount | % of Total Portfolio |
Amount | % of Total Revenue |
Amount | % of Total Revenue |
||||||||||||||||||||||
Industry |
||||||||||||||||||||||||||||||
Communications |
$ | 187,666 | 18.9 | % | $ | 188,149 | 19.0 | % | $ | 969 | 4.5 | % | $ | 1,244 | 4.5 | % | ||||||||||||||
Cable |
133,733 | 13.5 | 128,386 | 13.0 | 2,722 | 12.5 | 2,388 | 8.6 | ||||||||||||||||||||||
Healthcare |
96,931 | 9.8 | 100,278 | 10.2 | 2,599 | 12.0 | 3,751 | 13.5 | ||||||||||||||||||||||
Food services |
70,933 | 7.2 | 70,035 | 7.1 | 2,650 | 12.2 | 2,845 | 10.2 |
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NOTE 5BORROWINGS
As of March 31, 2010, we reported $534.9 million of borrowings on our Consolidated Balance Sheet at cost. We estimate that the fair value of these borrowings as of March 31, 2010 was approximately $458.5 million, based on market data and current interest rates. The following table summarizes our borrowing facilities and the potential borrowing capacity of those facilities and contingent borrowing eligibility of Solutions Capital I, L.P., a wholly owned subsidiary, as an SBIC, under the Small Business Investment Act of 1958, as amended.
March 31, 2010 | December 31, 2009 | ||||||||||||||||
(dollars in thousands) |
Maturity Date | Potential Maximum Borrowing |
Amount Outstanding |
Potential Maximum Borrowing |
Amount Outstanding | ||||||||||||
Private Placement Notes |
|||||||||||||||||
Series 2005-A |
October 2011 | $ | 32,379 | $ | 32,379 | $ | 34,307 | $ | 34,307 | ||||||||
Series 2007-A |
October 2012 | 16,189 | 16,189 | 17,154 | 17,154 | ||||||||||||
Commercial Loan Funding Trust |
|||||||||||||||||
Variable Funding Note |
August 2012(a) | 150,000 | 138,844 | 170,694 | 158,907 | ||||||||||||
Commercial Loan Trust 2006-1 |
|||||||||||||||||
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(b) |
April 2018 | 45,000 | 40,000 | 45,000 | 40,000 | ||||||||||||
Series 2006-1 Class D Notes(c) |
April 2018 | 47,500 | 29,880 | 47,500 | 29,880 | ||||||||||||
SBIC (Maximum borrowing potential)(d) |
(e) | 130,000 | 27,600 | 130,000 | 27,600 | ||||||||||||
Total borrowings |
$ | 721,068 | $ | 534,892 | $ | 744,655 | $ | 557,848 | |||||||||
(a) | Renewable each February at the lenders discretion. The lender provided this renewal in February 2010. In conjunction with this renewal, the legal final maturity date became August 2012. |
( b ) | 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. Subsequently, in April 2010 we purchased an additional $8.0 million of these notes for $4.4 million which will similarly be eliminated from this schedule during the quarter ended June 30, 2010. |
(c) | 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. |
(d ) | As of March 31, 2010, 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 March 31, 2010. Based on our funded capital, Solutions Capital I, L.P., subject to the SBAs approval, may borrow up to an additional $28.3 million to originate investments as of March 31, 2010. 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 single-license SBIC companies up to $150.0 million. |
(e ) | 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. The net worth covenant of our SunTrust Warehouse requires that we maintain a minimum stockholders equity of not less than $500.0 million, plus 50% of any equity raised after February 26, 2009. 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 debt. As of March 31, 2010, our ratio of total assets to total borrowings and other senior securities was 222%. 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 Private Placement Notes, through our bankruptcy remote, special-purpose, wholly owned subsidiaries. Therefore, these subsidiaries assets may not be available to our
28
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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.
The following table summarizes repayments of our borrowings 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.
March 31, 2010 | |||||||||
(in thousands) |
Debt with Recourse |
Debt
without Recourse |
Total | ||||||
2010(a) |
$ | | $ | 608 | $ | 608 | |||
2011 |
32,379 | 138,236 | 170,615 | ||||||
2012 |
16,189 | | 16,189 | ||||||
2013 |
| | | ||||||
2014 |
| | | ||||||
Thereafter(b) |
27,600 | 319,880 | 347,480 | ||||||
Total |
$ | 76,168 | $ | 458,724 | $ | 534,892 | |||
(a) | Certain of our borrowing facilities contain provisions that require that we apply a portion of the proceeds we receive from certain monetizations to paydown a portion of the outstanding balances. The amounts payable in 2010 reflect the paydowns we were required to make in connection with monetizations that occurred through March 31, 2010. |
(b) | Recourse on Solutions Capital I, L.P.s outstanding debt is limited to MCGs commitment of $65.0 million. As of March 31, 2010, we had $27.6 million of debt outstanding. |
The following table summarizes our aggregate outstanding borrowings as of March 31, 2010 and December 31, 2009, by interest rate benchmark:
(in thousands) |
March 31, 2010 |
December 31, 2009 | ||||||
Interest rate benchmark |
||||||||
LIBOR |
$ | 319,880 | $ | 319,880 | ||||
Commercial paper rate |
138,844 | 158,907 | ||||||
Fixed rate |
76,168 | 79,061 | ||||||
Total borrowings |
$ | 534,892 | $ | 557,848 | ||||
As of March 31, 2010, 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.
The following sections provide additional detail about each of our borrowing facilities.
PRIVATE PLACEMENT 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, or the Private Placement Notes, are five-year notes that require semi-annual interest payments.
In February 2009, the Private Placement Notes were amended. In connection with these amendments, we and the holders of the Private Placement Notes 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 was reduced 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 our Commercial Loan Trust 2006-1, or the 2006-1 Trust, and to our warehouse financing facility, or the SunTrust Warehouse, would not constitute defaults under the Private Placement 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% and the interest rate for the Series 2007-A unsecured notes, increased from 6.71% to 8.96%.
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The amendments also require us to offer to repurchase the Private Placement Notes with a portion of certain monetization proceeds at a purchase price of 102% of the principal amount to be purchased. In addition, we agreed to limit the amount of debt from the 2006-1 Trust and our common stock that we may repurchase. For every $5.0 million of Private Placement Notes we offer to purchase after February 26, 2009, we may repurchase $2.5 million of debt from the 2006-1 Trust. Once we have offered to purchase $35.0 million of Private Placement Notes, we may also repurchase $1.0 million of shares of our common stock for every $5.0 million increment of Private Placement Notes offered to be repurchased after February 26, 2009, provided that the amount of permitted debt repurchases under the 2006-1 Trust shall be reduced by the amount of any of our common stock repurchases made. We paid to the holders of the Private Placement Notes an amendment fee of $375,000, or 0.50%.
Prior to the May 2009 repayment of our revolving line of credit, we were required to use 60% of the cash net proceeds of any sale of unencumbered assets to reduce amounts outstanding under the Private Placement Notes and the revolving line of credit on a pro rata basis, based on then-outstanding amounts. After such repayment, of our revolving line of credit, 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 Private Placement 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%.
In October 2009, the Private Placement Notes were further amended, in part, to extend the maturity date of the Series 2005-A unsecured notes to October 2011 and to increase the interest rate thereunder to 9.98%.
As of March 31, 2010, the outstanding balances under the Series 2005-A and Series 2007-A Private Placement Notes were $32.4 million and $16.2 million, respectively. The following table summarizes the reductions in the borrowing capacity from monetization proceeds:
Private Placement Note Series 2005-A | Private Placement Note Series 2007-A | ||||||||||||
(in thousands) |
Monetization Payment |
Outstanding
Balances After Monetization Payment |
Monetization Payment |
Outstanding
Balances After Monetization Payment | |||||||||
Quarter Ended |
|||||||||||||
March 31, 2009 |
$ | 5,314 | $ | 44,686 | 2,658 | $ | 22,342 | ||||||
June 30, 2009 |
3,128 | 41,558 | 1,564 | 20,778 | |||||||||
September 30, 2009 |
3,917 | 37,641 | 1,958 | 18,820 | |||||||||
December 31, 2009 |
3,334 | 34,307 | 1,666 | 17,154 | |||||||||
March 31, 2010 |
1,928 | 32,379 | 965 | 16,189 |
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. The SunTrust Warehouse, which is structured to operate 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. The facility is funded by third parties through the commercial paper market with SunTrust Bank providing a liquidity backstop, subject to SunTrust Banks annual liquidity commitment.
In February 2010, SunTrust Bank provided its 2010 annual renewal of this liquidity facility. In connection with the 2010 renewal, the SunTrust Warehouse was modified in a number of ways, including; the legal final maturity date was extended to August 2012, subject to contractual terms and conditions, the minimum consolidated stockholders equity covenant was reduced from $525.0 million plus 50% of the proceeds from any equity issuances after February 26, 2009 to $500.0 million plus 50% of the proceeds from any equity issuances after February 26, 2009 and the facility borrowing commitment was reduced from $190 million to $150 million. In addition, the terms of the SunTrust Warehouse limit the total outstanding balance of fixed-rate loans, which was increased through this amendment from 40% to 55%. The interest rate on the SunTrust Warehouse remains unchanged at the commercial paper rate plus 2.50%. If a new agreement or extension is not executed by February 16, 2011, the SunTrust Warehouse 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 in the facility. We paid a $1.5 million, or 1.0%, facility fee for this renewal.
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Advances under the Class A VFC may be up to 64% of eligible collateral. The SunTrust Warehouse is non-recourse to us; therefore, in the event of a termination event or upon the legal final maturity date, the lenders under the SunTrust Warehouse may only look to the collateral to satisfy the outstanding obligations under this facility. The following table summarizes the collateral under the Commercial Loan Funding Trust as of March 31, 2010 and December 31, 2009.
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Amount | % | Amount | % | ||||||||||
Securitized assets |
||||||||||||||
Senior secured debt |
$ | 130,960 | 54.8 | % | $ | 140,483 | 53.0 | % | ||||||
Subordinated secured debt |
102,900 | 43.1 | 102,170 | 38.6 | ||||||||||
Total securitized assets |
233,860 | 97.9 | 242,653 | 91.6 | ||||||||||
Cash, securitization accounts |
4,901 | 2.1 | 22,129 | 8.4 | ||||||||||
Total collateral |
$ | 238,761 | 100.0 | % | $ | 264,782 | 100.0 | % | ||||||
Prior to the commencement of any amortization period, we will contribute 80% of net proceeds from monetizations of collateral financed in the SunTrust Warehouse to repay the outstanding borrowings. In addition, 7.5% of the sale of the first $100.0 million of unencumbered investment assets by us is being used to pay down the SunTrust Warehouse. As of March 31, 2010, we have sold $54.5 million in unencumbered investment assets resulting in $4.1 million of repayments under this provision.
COMMERCIAL LOAN TRUST 2006-1
In April 2006, we completed a $500.0 million debt securitization through 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 the 2006-1 Trust. The following table summarizes the assets securitized under this facility as of March 31, 2010 and December 31, 2009.
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Amount | % | Amount | % | ||||||||||
Securitized assets |
||||||||||||||
Senior secured debt |
$ | 192,364 | 46.4 | % | $ | 196,036 | 47.2 | % | ||||||
Subordinated secured debt |
132,361 | 31.9 | 132,169 | 31.8 | ||||||||||
Total securitized assets |
324,725 | 78.3 | 328,205 | 79.0 | ||||||||||
Cash, securitization accounts |
89,704 | 21.7 | 87,012 | 21.0 | ||||||||||
Total collateral |
$ | 414,429 | 100.0 | % | $ | 415,217 | 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 2006-1 Trust, which resulted in an $11.1 million gain on extinguishment of debt during the quarter ended December 31, 2008. 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 ended March 31, 2009. Subsequently, in April 2010, we purchased an additional $8.0 million of these notes for $4.4 million, which will result in the recognition of an additional $3.6 million gain on extinguishment of debt, excluding the effect of $0.1 million in deferred debt costs, during the quarter ending June 30, 2010. See Note 12Subsequent Events for additional information about the purchase of these notes.
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SBIC DEBENTURES
In December 2004, we formed a wholly owned subsidiary, Solutions Capital I, L.P. Solutions Capital I, L.P. has a license from the SBA to operate as an SBIC under the SBIC Act. As of March 31, 2010, the license gave Solutions Capital I, L.P. 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 March 31, 2010. Based on our current funded capital, Solutions Capital I, L.P. may, subject to the SBAs approval, borrow up to an additional $28.3 million to originate new investments as of March 31, 2010. 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 effective in February 2009, included a provision that increased the maximum amount of outstanding leverage available to single-license 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, L.P. 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 March 31, 2010. As of March 31, 2010 and December 31, 2009, we had $44.6 million and $30.8 million, respectively, of investments and we had $9.0 million and $21.2 million, respectively, of restricted cash to be used for investments in our SBIC. The American Recovery and Reinvestment Act of 2009 also increased the maximum amount of outstanding leverage available to SBIC companies with multiple licenses to $225.0 million on an aggregate basis, which represents a $50.0 million increase over the prior maximum of $175.0 million.
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 March 31, 2010, the SBIC had $27.6 million outstanding summarized in the following table:
Amount Outstanding | ||||||||||||||||
(dollars in thousands) |
March 31, 2010 |
December 31, 2009 |
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 | 12,000 | 5.34 | % | Fixed | 2.81 | % | 253 | ||||||||
2009-10B |
13,000 | 13,000 | 4.95 | % | Fixed | 3.44 | % | 151 | ||||||||
Total |
$ | 27,600 | $ | 27,600 | 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, L.P. from the calculation of our consolidated BDC asset coverage ratio.
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
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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.
NOTE 7SHARE-BASED COMPENSATION
EMPLOYEE SHARE-BASED COMPENSATION
Second Amended and Restated 2006 Employee Restricted Stock Plan
From time to time, we award shares of restricted common stock to employees under our Second 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 three months ended March 31, 2010 and 2009, we did not issue any shares of restricted stock under the 2006 Plan.
During the three months ended March 31, 2010 and 2009, we recognized $1.2 million and $1.5 million, respectively, of compensation expense related to share-based compensation awards. As of March 31, 2010, 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 three months ended March 31, 2010 and 2009. As of March 31, 2010, we had $3.7 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 1.3 years.
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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, are 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 | ||||
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 718Compensation-Stock 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 three months ended March 31, 2010, we recognized $0.3 million of compensation expense for these equity awards. During October 2009, our share price achieved the $3.00 and $4.00 price thresholds. Therefore a total of 432,500 shares were awarded, of which 288,300 vested immediately and the remaining 144,200 shares will vest in October 2010.
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 March 31, 2010, the fair value of these awards was $2.5 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 three months ended March 31, 2010, we recognized $0.8 million of compensation expense for these cash awards.
NON-EMPLOYEE DIRECTOR SHARE BASED COMPENSATION
During June 2006, our stockholders initially approved the 2006 Non-Employee Director Restricted Stock Plan, which was subsequently amended and restated and which we refer to as 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 three months ended March 31, 2010 and 2009, we did not award any shares of restricted common stock to non-employee directors. During the three months ended March 31, 2010 and 2009, we recognized less than $0.1 million and $0.1 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 March 31, 2010, 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 1.5 years.
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SUMMARY OF EMPLOYEE AND NON-EMPLOYEE DIRECTOR SHARE-BASED COMPENSATION
The following table summarizes our restricted stock award activity during the three months ended March 31, 2010:
Shares | Weighted-Average Grant Date Fair Value per Share | |||||
Subject to forfeiture provisions as of December 31, 2009(a) |
1,208,800 | $ | 5.42 | |||
Awarded |
| | ||||
Forfeiture period lapsed |
(114,000 | ) | 9.55 | |||
Forfeited(a) |
(13,700 | ) | 15.06 | |||
Subject to forfeiture provisions as of March 31, 2010 |
1,081,100 | $ | 5.09 | |||
(a) | Includes 9,200 performance shares held in trust with a weighted-average award date fair value of $19.37 per share. |
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 did not have a distribution requirement as a RIC for 2009 because we incurred certain losses for tax purposes in 2009 that we recognized for book purposes during 2008. On a continuing basis, we monitor distribution requirements in order to comply with 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 three months ended March 31, 2010 and 2009, we recorded an income tax provision of $0.1 million and an income tax benefit of $0.2 million, respectively, which were attributable to unrealized depreciation or appreciation and flow thru taxable income on certain investments held by our subsidiaries.
Historically, we have declared dividends that were paid the following quarter. We did not declare or pay any dividends during the three months ended March 31, 2010 or 2009. From December 2001 through March 31, 2010, 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.
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. During the three months ended March 31, 2010, we did not make any distributions to stockholders. On April 29, 2010, we declared a distribution of $0.11 per common share payable on July 2, 2010 to stockholders of record on June 2, 2010. See Note 12Subsequent Events for further information on this distribution and the tax attributes of this distribution. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.
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.
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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 March 31, 2010 and December 31, 2009:
(in thousands) |
March 31, 2010 | December 31, 2009 | ||||||||
Cost for federal income tax purposes |
$ | 1,099,178 | $ | 1,091,650 | ||||||
Gross unrealized appreciation |
||||||||||
Unrealized appreciation of fair value of portfolio investments (GAAP) |
69,606 | 62,705 | ||||||||
Book to tax differences |
90,227 | 88,898 | ||||||||
Gross unrealized appreciationtax basis |
159,833 | 151,603 | ||||||||
Gross unrealized depreciation |
||||||||||
Unrealized depreciation of fair value of portfolio investments (GAAP) |
(240,020 | ) | (233,022 | ) | ||||||
Book to tax differences |
(29,612 | ) | (25,624 | ) | ||||||
Gross unrealized depreciationtax basis |
(269,632 | ) | (258,646 | ) | ||||||
Net unrealized depreciationtax basis |
(109,799 | ) | (107,043 | ) | ||||||
Less: Unrealized depreciation of fair value of other assets (GAAP) |
1,653 | 1,739 | ||||||||
Total investments at fair value (GAAP) |
$ | 991,032 | $ | 986,346 | ||||||
The following table reconciles GAAP net income (loss) to taxable net income (loss) for the three months ended March 31, 2010 and the year ended December 31, 2009:
|
| |||||||||
(in thousands) |
Three months ended March 31, 2010 |
Year
ended December 31, 2009 |
||||||||
Net income (loss) |
$ | 5,955 | $ | (51,059 | ) | |||||
Difference between book and tax losses on investments |
(93 | ) | 48,078 | |||||||
Net change in unrealized depreciation on investments not taxable until realized |
97 | (97,631 | ) | |||||||
Capital losses in excess of capital gains |
2,267 | 54,245 | ||||||||
Timing difference related to deductibility of long-term incentive compensation |
867 | 6,091 | ||||||||
Taxable interest income on non-accrual loans |
4,352 | 14,949 | ||||||||
Dividend income accrued for GAAP purposes that is not yet taxable |
(1,329 | ) | (6,149 | ) | ||||||
Distributions from taxable subsidiaries |
| 144 | ||||||||
Federal tax provision (benefit) |
62 | (81 | ) | |||||||
Other, net |
63 | 323 | ||||||||
Taxable income (loss) before deductions for distributions |
$ | 12,241 | $ | (31,090 | ) | |||||
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 sets forth the computation of basic and diluted earnings (loss) per common share for the three months ended March 31, 2010 and 2009:
Three months ended March 31, |
||||||||||
(in thousands, except per share amounts) |
2010 | 2009 | ||||||||
Numerator for basic and diluted earnings (loss) per share |
||||||||||
Net income (loss) |
$ | 5,955 | $ | (50,946 | ) | |||||
Less: Dividends declaredcommon and restricted shares |
| | ||||||||
Undistributed earnings |
5,955 | (50,946 | ) | |||||||
Percentage allocated to common shares(a) |
98.5 | % | 100.0 | % | ||||||
Undistributed earningscommon shares |
5,866 | (50,946 | ) | |||||||
Add: Dividends declaredcommon shares |
| | ||||||||
Common shares |
5,866 | (50,946 | ) | |||||||
Add: Participating unvested shares |
89 | | ||||||||
Numerator for basic and diluted earnings (loss) per sharetotal |
$ | 5,955 | $ | (50,946 | ) | |||||
Denominator for basic and diluted weighted-average shares outstanding |
||||||||||
Common shares outstanding |
75,158 | 74,498 | ||||||||
Participating unvested shares(b) |
1,181 | | ||||||||
Basic and diluted weighted-average common shares outstandingtotal(b) |
76,339 | 74,498 | ||||||||
Earnings (loss) per sharebasic and diluted |
||||||||||
Excluding participating unvested shares |
$ | 0.08 | $ | (0.68 | ) | |||||
Including participating securities |
$ | 0.08 | $ | (0.68 | ) | |||||
(a) Weighted-average shares |
||||||||||
Basic weighted-average common shares |
75,158 | 74,498 | ||||||||
Weighted-average restricted shares |
1,181 | | ||||||||
Total(b) |
76,339 | 74,498 | ||||||||
Percentage allocated to common shares |
98.5 | % | 100.0 | % | ||||||
(b) For the three months ended March 31, 2009, we excluded 1,422 weighted-average shares of restricted common stock from the calculation of diluted loss per share because the inclusion of these shares would have had an anti-dilutive impact on the calculation of loss per share. |
|
Holders of unvested shares of our issued and outstanding restricted common stock are eligible to receive non-forfeitable dividends. As such, these unvested shares are participating securities requiring the two-class method of computing earnings per share. Pursuant to the two-class method, we report basic and diluted earnings per share both inclusive and exclusive of the impact of the participating securities.
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 we believe it is more likely than not that the matter will be resolved for approximately $1.0 million, including additional taxes, interest and penalties accrued through the settlement. If our appeal is not successful, we could be subject to up to $23.3 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. We accrued the majority of this $1.0 million estimated obligation, including $0.2 million of
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estimated tax expense recorded in 2009 and $0.3 million of estimated tax expense recorded during 2007. In addition, during 2009 and 2008, we recorded $0.1 million and $0.2 million, respectively, of estimated interest and penalties in general and administrative expense. If, in the future, we believe our total obligation associated with this examination were to increase, we would accrue the additional estimated amounts due. The 2006, 2007, 2008 and 2009 federal tax years remain open to examination by the IRS.
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.
We do not report the unused portions of these commitments on our Consolidated Balance Sheets. As of March 31, 2010 and December 31, 2009, we had $29.9 and $36.5 million, respectively, of outstanding unused loan commitments. We estimate that the fair value of these commitments was $0.1 million and $0.2 million, respectively based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. As of March 31, 2010 and December 31, 2009, we had no outstanding guarantees or standby letters of credit.
LEASE OBLIGATIONS
We lease our headquarters and certain other facilities under non-cancelable operating and capital leases which expire through 2013. We have sublet certain of our facilities to third parties. Certain leases contain provisions for rental options and rent escalations based on scheduled increases, as well as increases resulting from a rise in certain costs incurred by the lessor. As of March 31, 2010, our obligation for the remaining terms of these leases is $6.5 million, of which $2.3 million is payable during the twelve months ending March 31, 2011. These lease obligations are partially offset by $0.5 million of sublease income due over the remaining term of the subleases, of which $0.3 million is due during the twelve months ending March 31, 2011.
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NOTE 11FINANCIAL HIGHLIGHTS
The following schedule summarizes our financial highlights for the three months ended March 31, 2010 and 2009:
(in thousands, except per share amounts) |
Three months ended March 31, |
|||||||
2010 | 2009 | |||||||
PER SHARE DATA |
||||||||
Net asset value at beginning of period(a) |
$ | 8.06 | $ | 8.66 | ||||
Net income (loss)(b) |
||||||||
Net operating income before investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) |
0.11 | 0.16 | ||||||
Net change in unrealized depreciation on investments |
| (1.10 | ) | |||||
Net realized (loss) gain on investments |
(0.03 | ) | 0.19 | |||||
(Loss) gain on extinguishment of debt |
| 0.07 | ||||||
Income tax provision (benefit) |
| | ||||||
Net income (loss) |
0.08 | (0.68 | ) | |||||
Net increase in stockholders equity relating to stock-based transactions(a) |
||||||||
Net increase in stockholders equity from restricted stock amortization |
0.02 | 0.02 | ||||||
Dilutive effect of forfeiture provisions of previously issued restricted stock |
| 0.01 | ||||||
Net increase in stockholders equity from other stock transactions |
| 0.01 | ||||||
Net increase in stockholders equity relating to stock-based transactions |
0.02 | 0.04 | ||||||
Net asset value at end of period(a) |
$ | 8.16 | $ | 8.02 | ||||
MARKET PRICE PER SHARE |
||||||||
Beginning of period |
$ | 4.32 | $ | 0.71 | ||||
End of period |
$ | 5.21 | $ | 1.28 | ||||
TOTAL RETURN(c) |
20.60 | % | 80.28 | % | ||||
SHARES OF COMMON STOCK OUTSTANDING(c) |
||||||||
Weighted-averagebasic and diluted |
76,339 | 74,498 | ||||||
End of period |
76,338 | 76,027 | ||||||
NET ASSETS |
||||||||
Average (annualized) |
$ | 616,726 | $ | 660,665 | ||||
End of period |
622,897 | 609,531 | ||||||
RATIOS (ANNUALIZED) |
||||||||
Operating expenses to average net assets |
8.75 | % | 9.74 | % | ||||
Net operating income to average net assets |
5.55 | % | 7.33 | % | ||||
General and administrative expense to average net assets |
1.85 | % | 2.44 | % | ||||
Return on equity |
3.92 | % | (31.27 | )% |
(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
REPURCHASE OF COLLATERALIZED LOAN OBLIGATIONS
In April 2010, we repurchased for $4.4 million, in a privately negotiated transaction, a total of $8.0 million of our outstanding debt securities under our debt securitization through Commercial Loan Trust 2006-1, a wholly owned subsidiary. In connection with this repurchase, we expect to record a $3.6 million gain on the extinguishment of debt excluding the effect of $0.1 million in deferred debt costs during the quarter ending June 30, 2010. To date, we have repurchased an aggregate of $30.6 million of our outstanding debt securities under the Commercial Loan Trust 2006-1 for $10.5 million.
In order to reduce future cash interest payments and 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. 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.
JETBROADBAND ASSET PURCHASE AGREEMENT
In April 2010, JetBroadband Holdings, LLC, or JetBroadband, a majority-owned, control investment, signed a definitive agreement to sell substantially all of its assets to Shentel Cable Company, a wholly-owned subsidiary of Shenandoah Telecommunications Company. In December 2005, we made our initial debt and equity investment in JetBroadband. The total fair value of our debt and equity investments in JetBroadband as of December 31, 2009 was $50.2 million and after transaction expenses our cash proceeds in connection with the exit of this investment are expected to be approximately $49.7 million. Final closing of the sale transaction is subject to satisfaction of customary closing conditions, including regulatory approvals, and is expected to occur in mid-August 2010. In addition, in April 2010, prior to signing the definitive agreement with Shentel, we sold 22.5% of the entity that owns our equity investment in JetBroadband to a third party for $3.3 million.
Our debt and equity investments in JetBroadband are considered unencumbered assets according to the provisions of certain of our credit facilities, and as such, 40% of the net proceeds allocable to principal and equity will be used to prepay our Private Placement Notes when such payment is received and up to 7.5% of such proceeds will be used to repay our SunTrust Warehouse when such payment is received.
DISTRIBUTIONS DECLARED
On April 29, 2010, we declared a distribution of $0.11 per common share payable on July 2, 2010 to stockholders of record on June 2, 2010. If we determined the tax attributes of this distribution as of March 31, 2010, 100% would be from ordinary income. However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year and will be reported to each shareholder on a Form 1099. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.
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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 March 31, 2010, and the related consolidated statements of operations, changes in net assets, cash flows and financial highlights for the three-month periods ended March 31, 2010 and 2009. 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, 2009, 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 4, 2010 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, 2009, 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
May 4, 2010
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The following table summarizes key financial data for MCG Capital Corporation for the three months ended March 31, 2010 and 2009. 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 March 31, |
||||||||||
(in thousands, except per share amounts) |
2010 | 2009 | ||||||||
INCOME STATEMENT DATA |
||||||||||
Revenue |
$ | 21,746 | $ | 27,806 | ||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) |
8,439 | 11,938 | ||||||||
Net investment loss before income tax provision (benefit) |
(2,364 | ) | (68,331 | ) | ||||||
Distributable net operating income (DNOI)(a) |
9,666 | 13,475 | ||||||||
Net income (loss) |
5,955 | (50,946 | ) | |||||||
PER COMMON SHARE DATA |
||||||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) per common sharebasic and diluted |
$ | 0.11 | $ | 0.16 | ||||||
DNOI per common sharebasic and diluted(a) |
$ | 0.13 | $ | 0.18 | ||||||
Earnings (loss) per weighted-average common sharebasic and diluted |
$ | 0.08 | $ | (0.68 | ) | |||||
Cash dividends declared per common share |
$ | | $ | | ||||||
SELECTED PERIOD-END BALANCES |
||||||||||
Investment portfolio balances |
||||||||||
Fair value |
$ | 991,032 | $ | 1,114,992 | ||||||
Cost |
1,159,794 | 1,464,198 | ||||||||
Total assets |
1,171,385 | 1,255,340 | ||||||||
Borrowings |
534,892 | 631,245 | ||||||||
Total stockholders equity |
622,897 | 609,531 | ||||||||
Net asset value per common share outstanding(b) |
$ | 8.16 | $ | 8.02 | ||||||
OTHER PERIOD-END DATA |
||||||||||
Average size of investment |
||||||||||
Fair value |
$ | 17,087 | $ | 15,704 | ||||||
Cost |
19,996 | 20,623 | ||||||||
Number of portfolio companies |
58 | 71 | ||||||||
Number of employees |
65 | 70 | ||||||||
RECONCILIATION OF DNOI TO NET OPERATING INCOME BEFORE INVESTMENT LOSS, (LOSS) GAIN ON EXTINGUISHMENT OF DEBT AND INCOME TAX PROVISION (BENEFIT) |
||||||||||
Net operating income before investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) |
$ | 8,439 | $ | 11,938 | ||||||
Amortization of employee restricted stock awards |
1,227 | 1,537 | ||||||||
DNOI(a) |
$ | 9,666 | $ | 13,475 | ||||||
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDINGBASIC AND DILUTED |
76,339 | 74,498 | ||||||||
NUMBER OF COMMON SHARES OUTSTANDING AT PERIOD-END |
76,338 | 76,027 |
(a) | DNOI is net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit), 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 generally are 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. |
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The following table summarizes key financial data for MCG Capital Corporation for the three months ended March 31, 2010 and 2009. 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 March 31, |
||||||||||
(in thousands, except per share amounts) |
2010 | 2009 | ||||||||
PORTFOLIO COMPANY DATA (FAIR VALUE) |
||||||||||
Portfolio by type |
||||||||||
Debt investments |
||||||||||
Senior secured debt |
$ | 379,600 | $ | 456,377 | ||||||
Subordinated debt |
||||||||||
Secured |
272,713 | 303,490 | ||||||||
Unsecured |
30,760 | 27,823 | ||||||||
Total debt investments |
683,073 | 787,690 | ||||||||
Equity investments |
||||||||||
Preferred equity |
261,931 | 277,893 | ||||||||
Common equity/equivalents |
46,028 | 49,409 | ||||||||
Total equity investments |
307,959 | 327,302 | ||||||||
Total portfolio |
$ | 991,032 | $ | 1,114,992 | ||||||
% of total portfolio |
||||||||||
Debt investments |
||||||||||
Senior secured debt |
38.3 | % | 40.9 | % | ||||||
Subordinated debt |
||||||||||
Secured |
27.5 | 27.2 | ||||||||
Unsecured |
3.1 | 2.5 | ||||||||
Total debt investments |
68.9 | 70.6 | ||||||||
Equity investments |
||||||||||
Preferred equity |
26.4 | 24.9 | ||||||||
Common equity/equivalents |
4.7 | 4.5 | ||||||||
Total equity investments |
31.1 | 29.4 | ||||||||
Total portfolio |
100.0 | % | 100.0 | % | ||||||
YIELD ON AVERAGE LOAN PORTFOLIO AT FAIR VALUE |
||||||||||
Average 90-Day LIBOR |
0.3 | % | 1.2 | % | ||||||
Spread to avg. LIBOR on average loan portfolio |
12.4 | 11.9 | ||||||||
Impact of fee accelerations of unearned fees on paid/restructured loans |
0.1 | 0.1 | ||||||||
Impact of previously unaccrued loans |
| | ||||||||
Impact of non-accrual loans |
(0.8 | ) | (0.9 | ) | ||||||
Total yield on average loan portfolio |
12.0 | % | 12.3 | % | ||||||
COMPOSITION OF LOAN PORTFOLIO BY INTEREST TYPE (FAIR VALUE) |
||||||||||
% of loans with fixed interest rates |
43.9 | % | 39.6 | % | ||||||
% of loans with floating interest rates |
56.1 | % | 60.4 | % | ||||||
PERCENTAGE OF TOTAL DEBT INVESTMENTS (FAIR VALUE) |
||||||||||
Loans on non-accrual status |
4.1 | % | 4.8 | % | ||||||
Loans greater than 90 days past due |
0.9 | % | 0.1 | % | ||||||
PERCENTAGE OF TOTAL DEBT INVESTMENTS (COST) |
||||||||||
Loans on non-accrual status |
12.9 | % | 14.5 | % | ||||||
Loans greater than 90 days past due |
2.9 | % | 0.8 | % |
WEIGHTED AVERAGE PORTFOLIO COMPANY OPERATING METRICS(a) |
||||||||||
Annual revenue(b)(c) |
$ | 131,947 | $ | 124,241 | ||||||
Annual EBITDA(b)(c) |
23,445 | 17,685 | ||||||||
Loan to value of non-broadly syndicated portfolio companies |
61.0 | % | 63.8 | % | ||||||
Trailing twelve month equity EBITDA multiple(b)(d)(e) |
8.2x | 8.3x | ||||||||
Forward twelve month equity EBITDA multiple(b)(c)(d)(e) |
7.2x | 7.0x | ||||||||
EBITDA to interest ratio(b) |
2.8x | 2.5x | ||||||||
Debt to EBITDA ratio on the debt portfolio(e) |
5.6x | 6.0x |
(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 decision to make dividend distributions during 2010 based on the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio; 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 ability to enhance stockholder value by exploring new investment opportunities; 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 and our plans to improve the returns on our debt and equity portfolio; our ability to generate operating income from new investments and to support the reinstitution and future growth of distributions to stockholders; our need to access debt and equity capital in order to originate new investments; our expectations that revenues will increase as we originate additional investments and if LIBOR and prime interest rates increase from current levels; our expectation that loan origination activity together with the associated loan fees that we earn during the remainder of 2010 will be higher than the level we experienced in 2009; 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; the pacing of our origination activity and the deployment of capital in investments that are consistent with our investment strategy; our intentions to issue equity in the future that is accretive to our business and will contribute to our future growth; the tax treatment of dividends that could be payable in part in our common stock; our use of independent valuation firms to provide support for our internal valuation processes; the timing of, and our ability to, repurchase equity, additional debt securities and make stockholder distributions; the sufficiency of liquidity to meet operating requirements, origination activity and dividend distributions during the upcoming year; the outcome of our tax appeal with the Internal Revenue Service; our plans and ability to access our SBIC facility and to exclude debt from our BDC asset coverage ratio; general market conditions; the state of the economy 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.
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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 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, as amended, or the 1940 Act. As a BDC we must 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
Since late 2007, the United States economy has been in a recession, which has had a severe adverse impact on many companies, especially those in the financial services sector. Since that time, stock market values decreased, several financial institutions 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 recognized significant losses resulting primarily from a general decline in the fair value of their respective asset portfolios. However, since mid-2009, economic conditions became generally more favorable as real gross domestic product, or GDP, showed positive growth. In addition, equity and credit markets were characterized by increasing asset prices, lower volatility and improved liquidity during the second half of 2009. While we see the potential for improvement in 2010, the timing is uncertain.
In the event of renewed financial turmoil affecting the banking system and financial markets, additional consolidation of the financial services industry, or significant financial service institution failures, there could be a new or incremental tightening in the credit markets, low liquidity and extreme volatility in fixed-income, credit, currency and equity markets. In addition, the risk remains that there could be a number of follow-on effects from the credit crisis on our business.
Beginning in the third quarter of fiscal 2008, we initiated a strategic plan, 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 strategic plan set forth a number of major initiatives, including: the suspension of new loan activities and dividend distributions 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. We believe that our execution of this plan made significant progress toward restoring value for our stockholders.
During the third quarter of 2009 we developed a comprehensive strategic plan intended to further enhance stockholder value, close the gap between our share price and our NAV and enable the future resumption of dividends. While we are 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 also plan to improve the returns on our debt and equity portfolio by improving the operating performance or by multiple expansion of our investments. In addition, we will continue to monetize lower yielding equity investments (which
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had an annualized earnings yield of 1.8% as of March 31, 2010) 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 further narrowed 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 meet our goals with respect to leverage levels and unrestricted cash balances, we potentially may, depending on stock price and debt pricing levels, seek to repurchase our equity and additional debt securities, including our collateralized loan obligations, 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 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. As the gap between our NAV and our stock price narrows in the future, we may issue new equity that is accretive to our business and will contribute to our future growth.
The following is a summary of recent initiatives that we have undertaken under our 2009 strategic plan:
| Dividend DistributionsOn April 29, 2010, we reinstated our dividend distributions by declaring a distribution of $0.11 per common share payable on July 2, 2010 to stockholders of record on June 2, 2010. If we determined the tax attributes of this distribution as of March 31, 2010, 100% would be from ordinary income. However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year and will be reported to each shareholder on a Form 1099. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision. |
| Repurchases of Collateralized Loan ObligationsIn April 2010, we repurchased $8.0 million of collateralized loan obligations that had previously been issued by our wholly owned subsidiary, Commercial Loan Trust 2006-1 for $4.4 million, which represents a 45% discount from par and will result in our recognition of a $3.6 million gain on extinguishment of debt excluding the effect of $0.1 million of deferred debt costs for the quarter ended June 30, 2010. In total, since December 2008, we have repurchased a total of $30.6 million of collateralized loan obligations for approximately 34% of par. |
In addition to being able to extinguish this debt for approximately 34% 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 March 31, 2010, 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.
| Investment OpportunitiesWe are building the pace of our origination activity and expect to deploy capital in investments that are consistent with our investment strategy. Since reinstating our investment origination activities we have closed on four new deals totaling $39.0 million through April 29, 2010 and expect the pace of originations to increase as the year progresses. |
We have capacity to originate new investments without the need to access new debt and equity capital. As of April 29, 2010, we had $146.6 million available in our cash and cash equivalents; cash, securitization; and our cash, restricted accounts to fund new investments. In addition to this cash on hand as of April 29, 2010, we have the ability to borrow up to $50 million under our Series 2006-1 Class A-2 Notes and subject to the SBAs approval, Solutions Capital I, L.P. may also borrow up to an additional $26.3 million to originate investments based on our current funded capital.
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| MonetizationsSince initiating our deleveraging initiatives in July 2008, we have completed or announced 32 investment monetizations totaling $335.7 million, of which $324.1 million have been completed at 98.7% and 100.3% of their most recently reported cost and fair value, respectively, and one was completed at 23.8% and 42.3% of its most recently reported cost and fair value, repectively. 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. A comprehensive list of the first quarter of 2010 monetization activity is included in the Portfolio Composition section of this Managements Discussion and Analysis of Financial Condition and Results of Operations. |
| Renegotiation of AgreementsIn February 2010, we obtained a liquidity renewal from SunTrust Bank, for our SunTrust Warehouse, and further amended this facility to, among other things, provide for a legal final maturity for this facility of August 2012. These amendments relaxed key covenant requirements under the borrowing facilities. Most significantly, the minimum net worth requirement was reduced from $525.0 million plus 50% of the proceeds from equity issuances to $500.0 million plus 50% of the proceeds from equity issuances after February 26, 2009 for our SunTrust Warehouse. |
During 2009, we also successfully amended the agreements for our SunTrust Warehouse and our Private Placement Notes. Most significantly, these amendments relaxed key covenant requirements under the borrowing facilities. These amendments are described more fully in the Liquidity and Capital ResourcesBorrowings section of this Managements Discussion and Analysis of Financial Condition and Results of Operations.
OVERVIEW OF RESULTS OF OPERATIONS
During the three months ended March 31, 2010, we reported net income of $6.0 million, or $0.08 per diluted share, compared to a net loss of $50.9 million, or $0.68 per diluted share, during the three months ended March 31, 2009. Our net operating income during the three months ended March 31, 2010 was $8.4 million, or $0.11 per diluted share, compared to $11.9 million, or $0.16 per diluted share, during the three months ended March 31, 2009.
The $6.0 million of net income reported for the three months ended March 31, 2010 results from net operating income of $8.4 million offset by net investment losses of $2.4 million during the quarter. The $3.5 million, or 29.3%, decrease in net operating income during the three months ended March 31, 2010 from the three months ended March 31, 2009 was attributable primarily to a decrease in interest income resulting from lower average LIBOR, changes in the composition and the average balance of loans that are on non-accrual status and a decline in average loan balances. The net investment losses included $2.3 million of realized losses on our investments and $2.4 million of unrealized depreciation, which represents valuation write-downs of several portfolio investments, including $7.6 million of unrealized depreciation on our investment in Jet Plastica Investors, LLC. These losses were offset by a $2.3 million reversal of unrealized depreciation on our investments, resulting primarily from the sale of our common stock in WebMediaBrands Inc. The unrealized depreciation recognized on our portfolio investments was due predominantly to the performance of some of our portfolio companies.
PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY
As of March 31, 2010, the fair value of our investment portfolio was $991.0 million, which represents a $4.7 million, or 0.5%, increase from the $986.3 million fair value as of December 31, 2009. The following sections describe the composition of our investment portfolio as of March 31, 2010 and describe key changes in our portfolio during the three months ended March 31, 2010.
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PORTFOLIO COMPOSITION
The following table summarizes the composition of our investment portfolio at fair value:
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||
Debt investments |
||||||||||||||
Senior secured debt |
$ | 379,600 | 38.3 | % | $ | 379,457 | 38.5 | % | ||||||
Subordinated debt |
||||||||||||||
Secured |
272,713 | 27.5 | 275,398 | 27.9 | ||||||||||
Unsecured |
30,760 | 3.1 | 30,618 | 3.1 | ||||||||||
Total debt investments |
683,073 | 68.9 | 685,473 | 69.5 | ||||||||||
Equity investments |
||||||||||||||
Preferred equity |
261,931 | 26.4 | 257,984 | 26.2 | ||||||||||
Common/common equivalents equity |
46,028 | 4.7 | 42,889 | 4.3 | ||||||||||
Total equity investments |
307,959 | 31.1 | 300,873 | 30.5 | ||||||||||
Total investments |
$ | 991,032 | 100.0 | % | $ | 986,346 | 100.0 | % | ||||||
The following table summarizes our investment portfolio by industry at fair value:
March 31, 2010 | December 31, 2009 | |||||||||||||
(dollars in thousands) |
Investments at Fair Value |
Percent of Total Portfolio |
Investments at Fair Value |
Percent of Total Portfolio |
||||||||||
TelecommunicationsCLEC (competitive local exchange carriers) |
$ | 169,401 | 17.1 | % | $ | 170,129 | 17.2 | % | ||||||
Communicationsother |
18,265 | 1.8 | 18,020 | 1.8 | ||||||||||
Cable |
133,733 | 13.5 | 128,386 | 13.0 | ||||||||||
Healthcare |
96,931 | 9.8 | 100,278 | 10.2 | ||||||||||
Food services |
70,933 | 7.2 | 70,035 | 7.1 | ||||||||||
Broadcasting |
52,455 | 5.3 | 52,255 | 5.3 | ||||||||||
Plastic products |
50,890 | 5.1 | 57,449 | 5.8 | ||||||||||
Electronics |
43,069 | 4.4 | 42,082 | 4.3 | ||||||||||
Business services |
42,135 | 4.3 | 54,550 | 5.6 | ||||||||||
Sporting goods |
38,910 | 3.9 | 39,103 | 4.0 | ||||||||||
Leisure activities |
35,648 | 3.6 | 14,186 | 1.4 | ||||||||||
Laboratory instruments |
35,063 | 3.5 | 34,790 | 3.5 | ||||||||||
Logistics |
31,137 | 3.1 | 31,694 | 3.2 | ||||||||||
Technology |
29,813 | 3.0 | 27,595 | 2.8 | ||||||||||
Education |
24,914 | 2.5 | 24,127 | 2.5 | ||||||||||
Insurance |
23,074 | 2.3 | 22,815 | 2.3 | ||||||||||
Home furnishings |
21,004 | 2.1 | 21,050 | 2.1 | ||||||||||
Publishing |
17,005 | 1.7 | 13,998 | 1.4 | ||||||||||
Consumer products |
16,979 | 1.7 | 18,665 | 1.9 | ||||||||||
Information services |
13,375 | 1.4 | 6,985 | 0.7 | ||||||||||
Other media |
10,024 | 1.0 | 10,415 | 1.1 | ||||||||||
Drugs |
| | 10,213 | 1.0 | ||||||||||
Other(a) |
16,274 | 1.7 | 17,526 | 1.8 | ||||||||||
Total |
$ | 991,032 | 100.0 | % | $ | 986,346 | 100.0 | % | ||||||
(a) | No individual industry within this category exceeds 1%. |
Our debt instruments bear contractual interest rates ranging from 2.5% to 17.6%, a portion of which may be deferred. As of March 31, 2010, approximately 56.1% of the fair value of our loan portfolio was at variable rates, based on a LIBOR benchmark or prime rate, and 43.9% of the fair value of our loan portfolio was at fixed rates. As of March 31, 2010, approximately 38.4% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 3.5% 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 percentage of the total commitment and a fee on undrawn commitments.
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As of March 31, 2010, approximately 18.9% of the fair value of our investment portfolio was composed of investments in the communications industry. The 18.9% included 17.1% invested in CLECs and 1.8% invested in other communications companies, including an incumbent local exchange carrier, a paging service and a telecommunications tower company. As of December 31, 2009, approximately 19.0% of the fair value of our investment portfolio was composed of investments in the communications industry, including 17.2% invested in CLECs and 1.8% invested in other communications companies. For the three months ended March 31, 2010 and 2009, our portfolio companies in the communications industry contributed $1.0 million, or 4.5%, and $1.2 million, or 4.5%, respectively, of our total revenues.
As of March 31, 2010, our ten largest portfolio companies represented approximately 50.6% of the total fair value of our investments. These ten companies accounted for approximately 47.9% of our total revenue during the three months ended March 31, 2010. Our investment in Broadview Networks Holdings, Inc., or Broadview, a CLEC that we control, represents our single largest investment. As of March 31, 2010 and December 31, 2009, the fair value of our investment in Broadview represented $138.8 million and $138.8 million, or 14.0% and 14.1%, respectively, of the fair value of our investment portfolio. We did not accrete any dividends with respect to our investment in Broadview during the three months ended March 31, 2010 or 2009, because we determined that the total value that we had recorded for this investment equaled the total enterprise value for this 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 three months ended | |||||||||||||||||||||||
March 31, 2010 | December 31, 2009 | March 31, 2010 | March 31, 2009 | |||||||||||||||||||||
(dollars in thousands) |
Amount | % of Total Portfolio |
Amount | % of Total Portfolio |
Amount | % of Total Revenue |
Amount | % of Total Revenue |
||||||||||||||||
Industry |
||||||||||||||||||||||||
Communications |
$ | 187,666 | 18.9 | % | $ | 188,149 | 19.0 | % | $ | 969 | 4.5 | % | $ | 1,244 | 4.5 | % | ||||||||
Cable |
133,733 | 13.5 | 128,386 | 13.0 | 2,722 | 12.5 | 2,388 | 8.6 | ||||||||||||||||
Healthcare |
96,931 | 9.8 | 100,278 | 10.2 | 2,599 | 12.0 | 3,751 | 13.5 | ||||||||||||||||
Food services |
70,933 | 7.2 | 70,035 | 7.1 | 2,650 | 12.2 | 2,845 | 10.2 |
OVERVIEW OF CHANGES IN INVESTMENT PORTFOLIO
During the three months ended March 31, 2010, we made $40.7 million of originations and advances, including originations to three new portfolio companies and seven originations and advances to existing portfolio companies, compared to $52.8 million of originations and advances during the three months ended March 31, 2009. The following table summarizes our total portfolio investment activity during the three months ended March 31, 2010 and 2009:
Three months ended March 31, |
||||||||
(in thousands) |
2010 | 2009 | ||||||
Beginning investment portfolio |
$ | 986,346 | $ | 1,203,148 | ||||
Originations and advances |
40,663 | 52,806 | ||||||
Gross payments, reductions and sales of securities |
(33,449 | ) | (72,663 | ) | ||||
Net realized (loss) gain |
(2,267 | ) | 14,222 | |||||
Net unrealized depreciation |
(2,457 | ) | (69,134 | ) | ||||
Reversals of unrealized depreciation (appreciation) |
2,273 | (13,096 | ) | |||||
Amortization of unearned income |
(77 | ) | (291 | ) | ||||
Ending investment portfolio |
$ | 991,032 | $ | 1,114,992 | ||||
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The following table shows our originations and advances during the three months ended March 31, 2010 and 2009 by security type:
Three months ended March 31, | ||||||||||||
2010 | 2009 | |||||||||||
(dollars in thousands) |
Amount | % of Total | Amount | % of Total | ||||||||
Debt investments |
||||||||||||
Senior secured debt |
$ | 32,814 | 80.7 | % | $ | 41,778 | 79.1 | % | ||||
Subordinated debt |
||||||||||||
Secured |
6,387 | 15.7 | 4,076 | 7.7 | ||||||||
Unsecured |
132 | 0.3 | 127 | 0.3 | ||||||||
Total debt investments |
39,333 | 96.7 | 45,981 | 87.1 | ||||||||
Equity investments |
||||||||||||
Preferred equity |
1,329 | 3.3 | 6,825 | 12.9 | ||||||||
Common/common equivalents equity |
1 | | | | ||||||||
Total equity investments |
1,330 | 3.3 | 6,825 | 12.9 | ||||||||
Total originations and advances |
$ | 40,663 | 100.0 | % | $ | 52,806 | 100.0 | % | ||||
The following table shows our gross payments, reductions and sales of securities during the three months ended March 31, 2010 and 2009 by security type:
Three months ended March 31, | ||||||||||||
2010 | 2009 | |||||||||||
(dollars in thousands) |
Amount | % of Total | Amount | % of Total | ||||||||
Debt investments |
||||||||||||
Senior secured debt |
$ | 32,649 | 97.6 | % | $ | 7,777 | 10.7 | % | ||||
Subordinated secured debt |
667 | 2.0 | 22,171 | 30.5 | ||||||||
Total debt investments |
33,316 | 99.6 | 29,948 | 41.2 | ||||||||
Equity investments |
||||||||||||
Preferred equity |
| | 42,289 | 58.2 | ||||||||
Common/common equivalents equity |
133 | 0.4 | 426 | 0.6 | ||||||||
Total equity investments |
133 | 0.4 | 42,715 | 58.8 | ||||||||
Total gross payments, reductions and sales of securities |
$ | 33,449 | 100.0 | % | $ | 72,663 | 100.0 | % | ||||
During the three months ended March 31, 2010 and 2009, our gross payments, reductions and sales of securities by transaction type included:
Three months ended March 31, | |||||||
(in thousands) |
2010 | 2009 | |||||
Principal repayments |
$ | 25,819 | $ | 21,500 | |||
Scheduled principal amortization |
7,092 | 8,083 | |||||
Collection of accrued paid-in-kind interest and dividends |
405 | 5,562 | |||||
Sale of equity investments |
133 | 37,518 | |||||
Total gross payments, reductions and sales of securities |
$ | 33,449 | $ | 72,663 | |||
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SIGNIFICANT CHANGES IN PORTFOLIO
As shown in the following table, during the three months ended March 31, 2010, we monetized four portfolio investments with proceeds totaling $26.0 million:
Three months ended March 31, 2010 | ||||||||||||
(in thousands) |
Principal Repayments |
Sale of Equity Investments |
PIK Interest and Dividend Prepayments |
Total | ||||||||
Monetizations |
||||||||||||
Velocity Technology Enterprises, Inc. |
$ | 12,859 | $ | | $ | | $ | 12,859 | ||||
BLI Holdings, Inc. |
10,393 | | | 10,393 | ||||||||
Amerifit Nutrition, Inc. |
2,567 | | | 2,567 | ||||||||
WebMediaBrands Inc. |
| 133 | | 133 | ||||||||
Total monetizations |
25,819 | 133 | | 25,952 | ||||||||
Other scheduled payments |
7,092 | | 405 | 7,497 | ||||||||
Total gross payments, reductions and sales of securities |
$ | 32,911 | $ | 133 | $ | 405 | $ | 33,449 | ||||
The proceeds from all of these monetizations correlated closely with the most recently reported fair value of the associated investments.
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 Rating |
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 |
The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of March 31, 2010 and December 31, 2009:
(dollars in thousands) |
March 31, 2010 | December 31, 2009 | ||||||||||||
Investment Rating |
Investments at Fair Value |
% of Total Portfolio |
Investments at Fair Value |
% of Total Portfolio |
||||||||||
1 |
$ | 568,918 | (a) | 57.4 | % | $ | 573,231 | (a) | 58.1 | % | ||||
2 |
151,526 | 15.3 | 125,222 | 12.7 | ||||||||||
3 |
256,380 | 25.9 | 271,447 | 27.5 | ||||||||||
4 |
3,188 | 0.3 | 3,394 | 0.4 | ||||||||||
5 |
11,020 | 1.1 | 13,052 | 1.3 | ||||||||||
Total |
$ | 991,032 | 100.0 | % | $ | 986,346 | 100.0 | % | ||||||
(a) As of March 31, 2010 and December 31, 2009, Investment Rating 1 includes $206.7 million and $218.6 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.
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The following table summarizes loans on non-accrual status and loans greater than 90 days past due, at cost, as of March 31, 2010 and December 31, 2009:
March 31, 2010 | December 31, 2009 | |||||||||||||
(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 |
$ | 22,376 | 2.89 | % | $ | 22,377 | 2.91 | % | ||||||
Not on non-accrual status |
| | | | ||||||||||
Total loans greater than 90 days past due |
$ | 22,376 | 2.89 | % | $ | 22,377 | 2.91 | % | ||||||
Loans on non-accrual status |
||||||||||||||
0 to 90 days past due |
$ | 77,653 | 10.03 | % | $ | 60,629 | 7.89 | % | ||||||
Greater than 90 days past due |
22,376 | 2.89 | 22,377 | 2.91 | ||||||||||
Total loans on non-accrual status |
$ | 100,029 | 12.92 | % | $ | 83,006 | 10.80 | % | ||||||
The following table summarizes loans on non-accrual status and loans greater than 90 days past due, at fair value, as of March 31, 2010 and December 31, 2009:
March 31, 2010 | December 31, 2009 | |||||||||||
(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 |
$ | 6,092 | 0.89 | % | $ | 6,049 | 0.88 | % | ||||
Not on non-accrual status |
| | | | ||||||||
Total loans greater than 90 days past due |
$ | 6,092 | 0.89 | % | $ | 6,049 | 0.88 | % | ||||
Loans on non-accrual status |
||||||||||||
0 to 90 days past due |
$ | 21,768 | 3.19 | % | $ | 19,575 | 2.86 | % | ||||
Greater than 90 days past due |
6,092 | 0.89 | 6,049 | 0.88 | ||||||||
Total loans on non-accrual status |
$ | 27,860 | 4.08 | % | $ | 25,624 | 3.74 | % | ||||
The following table summarizes the changes in the cost and fair value of the loans in non-accrual status from December 31, 2009 through March 31, 2010:
Three months ended March 31, 2010 |
||||||||
(In thousands) |
Cost | Fair Value | ||||||
Non-accrual loan balance as of December 31, 2009 |
$ | 83,006 | $ | 25,624 | ||||
Additional loans on non-accrual statusplastic products |
17,560 | 4,225 | ||||||
Payments received from loans on non-accrual status |
(537 | ) | (520 | ) | ||||
Change in unrealized depreciation of loans on non-accrual status |
| (1,469 | ) | |||||
Total change in non-accrual loans |
17,023 | 2,236 | ||||||
Non-accrual loan balance as of March 31, 2010 |
$ | 100,029 | $ | 27,860 | ||||
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RESULTS OF OPERATIONS
The following section compares our results of operations for the three months ended March 31, 2010 to the three months ended March 31, 2009.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009
The following table summarizes the components of our net income (loss) for the three months ended March 31, 2010 and 2009:
Three months ended March 31, |
Variance | ||||||||||||||
(dollars in thousands) |
2010 | 2009 | $ | Percentage | |||||||||||
Revenue |
|||||||||||||||
Interest and dividend income |
|||||||||||||||
Interest income |
$ | 19,558 | $ | 24,054 | $ | (4,496 | ) | (18.7 | )% | ||||||
Dividend income |
1,329 | 1,824 | (495 | ) | (27.1 | ) | |||||||||
Loan fees |
724 | 719 | 5 | 0.7 | |||||||||||
Total interest and dividend income |
21,611 | 26,597 | (4,986 | ) | (18.7 | ) | |||||||||
Advisory fees and other income |
135 | 1,209 | (1,074 | ) | (88.8 | ) | |||||||||
Total revenue |
21,746 | 27,806 | (6,060 | ) | (21.8 | ) | |||||||||
Operating expenses |
|||||||||||||||
Interest expense |
4,473 | 6,558 | (2,085 | ) | (31.8 | ) | |||||||||
Employee compensation |
|||||||||||||||
Salaries and benefits |
4,796 | 3,798 | 998 | 26.3 | |||||||||||
Amortization of employee restricted stock awards |
1,227 | 1,537 | (310 | ) | (20.2 | ) | |||||||||
Total employee compensation |
6,023 | 5,335 | 688 | 12.9 | |||||||||||
General and administrative expense |
2,811 | 3,975 | (1,164 | ) | (29.3 | ) | |||||||||
Total operating expenses |
13,307 | 15,868 | (2,561 | ) | (16.1 | ) | |||||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) |
8,439 | 11,938 | (3,499 | ) | (29.3 | ) | |||||||||
Net investment loss before income tax provision (benefit) |
(2,364 | ) | (68,331 | ) | 65,967 | 96.5 | |||||||||
(Loss) gain on extinguishment of debt before income tax provision (benefit) |
(58 | ) | 5,275 | (5,333 | ) | NM | |||||||||
Income tax provision (benefit) |
62 | (172 | ) | 234 | NM | ||||||||||
Net income (loss) |
$ | 5,955 | $ | (50,946 | ) | $ | 56,901 | NM | |||||||
NM=Not Meaningful
TOTAL REVENUE
Total revenue includes interest and dividend income and advisory fees and other income. During the three months ended March 31, 2010, our total revenue was $21.7 million, which represents a $6.1 million, or 21.8%, decrease from the three months ended March 31, 2009. This decline was composed of: a $4.5 million, or 18.7%, decrease in interest income; a $1.1 million, or 88.8%, decrease in advisory fees and other income; and a $0.5 million, or 27.1%, decrease in dividend income. Loan fees increased slightly, reflecting our resumption of origination activities beginning in the quarter ended March 31, 2010. We expect that our revenues will increase further as we originate additional investments. In addition, since 56.1% of our loan portfolio is based upon LIBOR and prime interest rates, an increase in these interest rates from their current low levels will result in an increase in our interest income. The following sections describe the reasons for the variances in each major component of our revenue during the three months ended March 31, 2010 from the three months ended March 31, 2009.
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 March 31, 2010, the total yield on our average debt portfolio at fair value was 12.0% compared to 12.3% during the three months ended March 31, 2009. The weighted-average LIBOR was 0.3% during the three months ended March 31, 2010, compared to 1.2% during the three months ended March 31,
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2009. The spread to average LIBOR on our average loan portfolio at fair value during the three months ended March 31, 2010 was 11.8% compared to 11.1% during the three months ended March 31, 2009, 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 rate increases on certain loans that we amended since March 31, 2009.
During the three months ended March 31, 2010, interest income was $19.6 million, compared to $24.1 million during the three months ended March 31, 2009, which represented a $4.5 million, or 18.7%, decrease. This decrease reflected a $3.7 million decrease in our average loan balance, a $2.0 million decrease resulting from a 98 basis point reduction in average LIBOR and a $1.4 million decrease in interest income resulting from an increase in the average daily balance of loans on non-accrual status. These decreases were partially offset by a $1.4 million increase in interest income resulting from a 68 basis point increase in our spread to LIBOR and a $1.2 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 March 31, 2010 and 2009, at cost:
Three months ended March 31, |
||||||||
(in thousands) |
2010 | 2009 | ||||||
Beginning PIK loan balance |
$ | 33,436 | $ | 26,354 | ||||
PIK interest earned during the period |
3,615 | 4,294 | ||||||
Interest receivable converted to PIK |
233 | 749 | ||||||
Principal payments of cash on PIK loans |
(405 | ) | (365 | ) | ||||
Ending PIK loan balance |
$ | 36,879 | $ | 31,032 | ||||
As of March 31, 2010 and 2009, we were not accruing interest on $4.6 million and $3.1 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 March 31, 2010 and 2009:
Three months ended March 31, |
||||||||
(in thousands) |
2010 | 2009 | ||||||
Beginning accrued dividend balance |
$ | 88,898 | $ | 91,770 | ||||
Dividend income earned during the period |
1,329 | 1,824 | ||||||
Payment of dividends |
| (5,196 | ) | |||||
Ending accrued dividend balance |
$ | 90,227 | $ | 88,398 | ||||
During the three months ended March 31, 2010, our dividend income was $1.3 million, which represented a $0.5 million, or 27.1%, decrease from the three months ended March 31, 2009. Dividend income decreased $0.8 million as a result of the sale of two dividend-producing investmentsCoastal Sunbelt, LLC and LMS Intellibound Investors, LLC. This decrease was partially offset by $0.3 million of dividends that we began to recognize on two existing portfolio companies that had sufficient value to support the accretion of dividends.
In February 2009, the sale of our equity investment in LMS Intellibound Investors, LLC resulted in the payment of $4.6 million of dividends that we had accreted up to that date.
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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 March 31, 2010, our loan fees increased less than $0.1 million, or 0.7%, compared to the same period in 2009. We anticipate that loan origination activity together with the associated loan fees that we earn during the remainder of 2010 will be higher than the level we experienced in 2009.
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 March 31, 2010, we earned $0.1 million of advisory fees and other income, which represents a $1.1 million, or 88.8%, decrease from the three months ended March 31, 2009. This decrease was due primarily to lower advisory and management fees.
TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. During the three months ended March 31, 2010, we incurred $13.3 million of operating expenses, representing a $2.6 million, or 16.1%, decrease from the same quarter in the prior year. This decrease was composed of a $2.1 million decrease in interest expense and a $1.2 million decrease in general and administrative expense. These decreases were partially offset by a $0.7 million increase in employee compensation expense. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the three months ended March 31, 2010, we incurred $4.5 million of interest expense, which represented a $2.1 million, or 31.8%, decrease from the same period in 2009. The previously described reduction in average LIBOR from 1.2% in the first quarter of 2009 to 0.3% in the first quarter of 2010 resulted in a $1.6 million decrease in interest expense. In addition, a decrease in average borrowing balances resulted in a $0.6 million decrease in interest expense and our amortization of debt costs decreased $0.4 million. These decreases were partially offset by $0.5 million of additional interest, resulting from a widening of the interest rate spread from 2.2% during the three months ended March 31, 2009 to 2.5% during the three months ended March 31, 2010.
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 March 31, 2010, our employee compensation expense was $6.0 million, which represented a $0.7 million, or 12.9%, increase from the same period in 2009. Our salaries and benefits increased by $1.0 million, or 26.3%, primarily due to a $1.2 million increase in incentive compensation, partially offset by a $0.2 million decrease in salaries and benefits, reflecting a decrease in the number of employees from 70 at March 31, 2009 to 65 at March 31, 2010. During the three months ended March 31, 2010 and 2009, the base compensation for essentially all employees remained frozen at levels established in 2008 in order to help control general and administrative expenses. Effective April 1, 2010, most of our employees received an average 3% cost of living increase; however, the base salaries for our executive management team and other certain other key employees continue to remain frozen at 2008 levels.
During the three months ended March 31, 2010, we recognized $1.2 million of compensation expense related to restricted stock awards, compared to $1.5 million for the three months ended March 31, 2009, which represented a $0.3 million, or 20.2%, decrease. The lapsing of forfeiture provisions for previously awarded restricted stock accounted for the reduction in amortization of employee restricted stock, partially offset by the amortization of stock as part of our Long-Term Incentive Plan, or 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 March 31, 2010, general and administrative expense was $2.8 million, which represented a $1.2 million, or 29.3%, decrease over the same period in 2009. This decrease was primarily attributable to a $0.7 million decrease in professional fees and legal expenses, as well as a $0.3 million decrease in insurance costs.
NET OPERATING INCOME BEFORE NET INVESTMENT LOSS, (LOSS) GAIN ON EXTINGUISHMENT OF DEBT AND INCOME TAX PROVISION (BENEFIT)
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) for the three months ended March 31, 2010 totaled $8.4 million, compared with $11.9 million for the three months ended March 31, 2009. 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) gain on extinguishment of debt and income tax provision (benefit), 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 generally are 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 March 31, 2010, DNOI was $9.7 million, or $0.13 per share, compared to $13.5 million, or $0.18 per share, for the three months ended March 31, 2009. The following table shows a reconciliation of our reported net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) to DNOI for the quarters ended March 31, 2010 and 2009:
Three months ended March 31, |
||||||||
(in thousands, except per share data) |
2010 | 2009 | ||||||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) |
$ | 8,439 | $ | 11,938 | ||||
Amortization of employee restricted stock awards |
1,227 | 1,537 | ||||||
DNOI |
$ | 9,666 | $ | 13,475 | ||||
Per common share data (basic and diluted) |
||||||||
Weighted-average common shares outstanding |
76,339 | 74,498 | ||||||
Income (loss) per common share |
$ | 0.08 | $ | (0.68 | ) | |||
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax provision (benefit) per common share |
$ | 0.11 | $ | 0.16 | ||||
DNOI per common share |
$ | 0.13 | $ | 0.18 |
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NET INVESTMENT LOSS BEFORE INCOME TAX PROVISION (BENEFIT)
During the three months ended March 31, 2010, we incurred $2.4 million of net investment losses before income tax provision (benefit), compared to $68.3 million during the same period in 2009. 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 March 31, 2010:
(in thousands) | Three months ended March 31, 2010 |
||||||||||||||||||
Portfolio Company |
Industry |
Type |
Realized Loss |
Unrealized (Depreciation)/ Appreciation |
Reversal of Unrealized Depreciation |
Net (Loss)/ Gain |
|||||||||||||
Jet Plastica Investors, LLC |
Plastic Products | Control | $ | | $ | (7,601 | ) | $ | | $ | (7,601 | ) | |||||||
Active Brands International, Inc. |
Consumer Products | Non-affiliate | | (1,786 | ) | | (1,786 | ) | |||||||||||
Superior Industries Investors, LLC |
Sporting Goods | Control | | (1,662 | ) | | (1,662 | ) | |||||||||||
Total Sleep Holdings, Inc. |
Healthcare | Control | | (1,119 | ) | | (1,119 | ) | |||||||||||
Avenue Broadband LLC |
Cable | Control | | 4,506 | | 4,506 | |||||||||||||
Jenzabar, Inc. |
Technology | Non-affiliate | | 2,113 | | 2,113 | |||||||||||||
Orbitel Holdings, LLC |
Cable | Control | | 1,066 | | 1,066 | |||||||||||||
WebMediaBrands Inc. |
Information Services | Non-affiliate | (1,981 | ) | | 1,984 | 3 | ||||||||||||
Other |
(286 | ) | 2,113 | 289 | 2,116 | ||||||||||||||
Total |
$ | (2,267 | ) | $ | (2,370 | ) | $ | 2,273 | $ | (2,364 | ) | ||||||||
During the quarter ended March 31, 2010, we sold our common stock in WebMediaBrands Inc. for approximately the fair value of this investment reported as of December 31, 2009. The remaining unrealized depreciation shown in the above table resulted predominantly from a change in the performance of certain of our portfolio companies.
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 March 31, 2009:
(in thousands) | Three months ended March 31, 2009 | |||||||||||||||||||
Portfolio Company |
Industry |
Type |
Realized (Loss)/ Gain |
Unrealized Appreciation/ (Depreciation) |
Reversal
of Unrealized (Appreciation)/ Depreciation |
Net (Loss)/ Gain |
||||||||||||||
TNR Holdings Corp. |
Entertainment | Control | $ | | $ | (15,802 | ) | $ | | $ | (15,802 | ) | ||||||||
Total Sleep Holdings, Inc. |
Healthcare | Control | | (13,540 | ) | | (13,540 | ) | ||||||||||||
GMC Television Broadcasting, LLC |
Broadcasting | Control | | (6,218 | ) | | (6,218 | ) | ||||||||||||
Jenzabar, Inc. |
Technology | Non-affiliate | | (5,733 | ) | | (5,733 | ) | ||||||||||||
Superior Industries Investors, LLC |
Sporting Goods | Control | | (4,955 | ) | | (4,955 | ) | ||||||||||||
Broadview Networks Holdings, Inc. |
Communications | Control | | (3,822 | ) | | (3,822 | ) | ||||||||||||
Jet Plastica Investors, LLC |
Plastic Products | Control | | (3,522 | ) | | (3,522 | ) | ||||||||||||
CWP/RMK Acquisition Corp. |
Home Furnishings | Non-affiliate | | (3,511 | ) | | (3,511 | ) | ||||||||||||
Active Brands International, Inc. |
Consumer Products | Non-affiliate | | (2,679 | ) | | (2,679 | ) | ||||||||||||
Avenue Broadband LLC |
Cable | Control | | (2,085 | ) | | (2,085 | ) | ||||||||||||
Xpressdocs Holdings, Inc. |
Business Services | Non-affiliate | | (1,996 | ) | | (1,996 | ) | ||||||||||||
VOX Communications Group Holdings, LLC |
Broadcasting | Non-affiliate | | (1,256 | ) | | (1,256 | ) | ||||||||||||
LMS INTELLIBOUND, INC. |
Logistics | Non-affiliate | | (1,014 | ) | | (1,014 | ) | ||||||||||||
XFone, Inc. |
Communications | Affiliate | (1,969 | ) | | 1,969 | | |||||||||||||
LMS Intellibound Investors, LLC |
Logistics | Control | 16,257 | | (15,065 | ) | 1,192 | |||||||||||||
Other |
(35 | ) | (3,355 | ) | | (3,390 | ) | |||||||||||||
Total |
$ | 14,253 | $ | (69,488 | ) | $ | (13,096 | ) | $ | (68,331 | ) | |||||||||
As shown in the above table, we recorded $15.8 million of unrealized depreciation on TNR Holdings Corp., primarily resulting from a reduction of the multiples that we used to estimate its fair value. These changes and the remaining unrealized depreciation shown in the above table predominantly resulted from a change in the multiples that we used to estimate the fair value of the investments and, to a lesser extent, the performance of some portfolio companies.
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(LOSS) GAIN ON EXTINGUISHMENT OF DEBT
We incurred a $0.1 million premium when we repurchased $2.9 million of our private placement notes during the first quarter of 2010. 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. Subsequently, in April 2010, we repurchased an additional $8.0 million of collateralized loan obligations for $4.4 million that previously had been issued by our Commercial Loan Trust 2006-1, which will result in the recognition of an additional $3.6 million gain on extinguishment of debt excluding the effect of $0.1 million in deferred debt costs during the quarter ended June 30, 2010.
In 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 during the quarter ending March 31, 2009.
INCOME TAX PROVISION (BENEFIT)
During the three months ended March 31, 2010, we recorded a $0.1 million income tax provision compared to a $0.2 million income tax benefit during the three months ended March 31, 2009. Our income taxes primarily relate to unrealized appreciation and depreciation 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 we believe it is more likely than not that the matter will be resolved for approximately $1.0 million, including additional taxes, interest and penalties accrued through the settlement. If our appeal is not successful, we could be subject to up to $23.3 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. We accrued the majority of this $1.0 million estimated obligation, including $0.2 million of estimated tax expense recorded in 2009 and $0.3 million of estimated tax expense recorded during 2007. In addition, during 2009 and 2008, we recorded $0.1 million and $0.2 million, respectively, of estimated interest and penalties in general and administrative expense. If, in the future, we believe our total obligation associated with this examination were to increase, we would accrue the additional estimated amounts due. The 2006, 2007, 2008 and 2009 federal tax years remain open to examination by the IRS.
NET INCOME (LOSS)
During the three months ended March 31, 2010, we recorded net income of $6.0 million, compared to a net loss of $50.9 million during the three months ended March 31, 2009. This improvement 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 original maturities of 90 days or less. As of March 31, 2010 and December 31, 2009, we had $54.6 million and $54.2 million, respectively, in cash and cash equivalents. By April 29, 2010, this balance rose to $56.3 million. During January 2009, we invested cash-on-hand in interest-bearing deposit accounts. However, from February 2009 through December 2009, we maintained our cash in non-interest-bearing |
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accounts, which were fully insured by the U.S. Federal Deposit Insurance Corporation, or FDIC, under the FDICs Temporary Liquidity Guarantee Program. The FDICs Temporary Liquidity Guarantee Program was originally scheduled to expire on December 31, 2009, but subsequently was extended through June 30, 2010. Nonetheless, beginning in January 2010, a number of banks have opted out of this program. Because of the minimal availability of the Temporary Liquidity Guarantee Program beginning in January 2010 combined with some stabilization of the banking industry, during the quarter ended March 31, 2010, we redeployed a portion of our unrestricted cash into secure interest-bearing accounts. |
| 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 March 31, 2010 and December 31, 2009, we had $94.6 million and $109.1 million, respectively, in cash, securitization accounts. By April 29, 2010, this balance had decreased to $92.3 million. During 2010, we expect the balance in our cash, securitization accounts to decrease as we originate new loans. |
| 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, L.P., our SBIC, which generally is restricted to the origination of new loans from our SBIC. As of March 31, 2010 and December 31, 2009, we had $9.0 million and $21.2 million respectively, of restricted cash. By April 29, 2010, this balance had decreased to $1.4 million as a result of the SBICs origination of a $10.0 million debt investment in April 2010. |
For the three months ended March 31, 2010, our operating activities provided $2.2 million of cash and cash equivalents, compared to $35.7 million during the three months ended March 31, 2009, which represents a $33.5 million decrease. During the three months ended March 31, 2010, our financing activities used $1.8 million of cash, compared to $31.5 million during the three months ended March 31, 2009. This $29.7 million decrease in cash used by financing activities was due primarily to a $49.9 million net increase in cash held in securitization and restricted cash accounts and a $25.0 million decrease in proceeds from borrowings.
We believe our current liquidity, combined with our future cash flows from operations and expected monetizations should provide sufficient liquidity to meet our operating needs during the upcoming year.
CURRENT MARKET CONDITIONS
Since late 2007, the United States economy has been in a recession, which has had a severe adverse impact on many companies, especially those in the financial services sector. Since that time, stock market values decreased, several financial institutions 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 recognized significant losses resulting primarily from a general decline in the fair value of their respective asset portfolios. However, beginning in mid-2009, economic conditions became generally more favorable as GDP showed positive growth. In addition, equity and credit markets were characterized by increasing asset prices, lower volatility and improved liquidity during the second half of 2009. While we see the potential for improvement in 2010, the timing is uncertain.
In the event of renewed financial turmoil affecting the banking system and financial markets, additional consolidation of the financial services industry, or significant financial service institution failures, there could be a new or incremental tightening in the credit markets, low liquidity and extreme volatility in fixed-income, credit, currency and equity markets. In addition, the risk remains that there could be a number of follow-on effects from the credit crisis on our business, including the financial results of middle-market companies, like those in which we invest, will continue to experience deterioration, which ultimately could lead to difficulty in meeting debt service requirements and an increase in defaults.
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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 $4.32 as of December 31, 2009 to $5.21 as of March 31, 2010 and subsequently rose to $6.84 as of April 29, 2010, our stock continues to trade below its NAV, thereby making it undesirable to issue new equity. During the three months ended March 31, 2010, we recorded $2.4 million of net investment losses, resulting from the performance of certain portfolio companies. The $2.4 million of net investment losses includes $2.3 million of net realized losses, $2.4 million of net unrealized depreciation and $2.3 million of reversal of previously recognized unrealized depreciation that we realized upon the monetization of certain investments. The $4.6 million realized and unrealized losses on our investments represents net valuation write-downs of several portfolio investments, including $7.6 million of unrealized depreciation on our investment in Jet Plastica Investors, LLC. These losses were offset by a $2.3 million reversal of unrealized depreciation on our investments, resulting primarily from the sale of our common stock in WebMediaBrands Inc.
LIQUIDITY AND CAPITAL RESOURCES
Beginning in the third quarter of fiscal 2008, we initiated a strategic plan, 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 strategic plan set forth a number of major initiatives, including: the suspension of new loan activities and dividend distributions 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. We believe that our execution of this plan made significant progress toward restoring value for our stockholders.
During the third quarter of 2009 we developed a comprehensive strategic plan intended to further enhance stockholder value, close the gap between our share price and our NAV and enable the future resumption of dividends. While we are 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 also plan to improve the returns on our debt and equity portfolio by improving the operating performance or by multiple expansion of our investments. In addition, we will continue to monetize lower yielding equity investments (which had an annualized earnings yield of 1.8% as of March 31, 2010) 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 further narrowed 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 meet our goals with respect to leverage levels and unrestricted cash balances, we potentially may, depending on stock price and debt pricing levels, seek to repurchase our equity and additional debt securities, including our collateralized loan obligations, 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 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. As the gap between our NAV and our stock price narrows in the future, we may issue new equity that is accretive to our business and will contribute to our future growth.
The following is a summary of recent initiatives that we have undertaken under our 2009 strategic plan:
| Dividend DistributionsOn April 29, 2010, we reinstated our dividend distributions by declaring a distribution of $0.11 per common share payable on July 2, 2010 to stockholders of record on June 2, 2010. |
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If we determined the tax attributes of this distribution as of March 31, 2010, 100% would be from ordinary income. However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year and will be reported to each shareholder on a Form 1099. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision. |
| Repurchases of Collateralized Loan ObligationsIn April 2010, we repurchased $8.0 million of collateralized loan obligations that had previously been issued by our wholly owned subsidiary, Commercial Loan Trust 2006-1 for $4.4 million, which represents a 45% discount from par and will result in our recognition of a $3.6 million gain on extinguishment of debt excluding the effect of $0.1 million of deferred debt costs for the quarter ended June 30, 2010. In total, since December 2008, we have repurchased a total of $30.6 million of collateralized loan obligations for approximately 34% of par. |
In addition to being able to extinguish this debt for approximately 34% 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 March 31, 2010, 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.
| Investment OpportunitiesWe are building the pace of our origination activity and expect to deploy capital in investments that are consistent with our investment strategy. Since reinstating our investment origination activities we have closed on four new deals totaling $39.0 million through April 29, 2010 and expect the pace of originations to increase as the year progresses. |
We have capacity to originate new investments without the need to access new debt and equity capital. As of April 29, 2010, we had $146.6 million available in our cash and cash equivalents; cash, securitization; and our cash, restricted accounts to fund new investments. In addition to this cash on hand as of April 29, 2010, we have the ability to borrow up to $50 million under our Series 2006-1 Class A-2 Notes and subject to the SBAs approval, Solutions Capital I, L.P. may also borrow up to an additional $26.3 million to originate investments based on our current funded capital.
| MonetizationsSince initiating our deleveraging initiatives in July 2008, we have completed or announced 32 investment monetizations totaling $335.7 million, of which $324.1 million have been completed at 98.7% and 100.3% of their most recently reported cost and fair value, respectively, and one was completed 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. A comprehensive list of the first quarter of 2010 monetization activity is included in the Portfolio Composition section of this Managements Discussion and Analysis of Financial Condition and Results of Operations. |
| Renegotiation of AgreementsIn February 2010, we obtained a liquidity renewal from SunTrust Bank, for our SunTrust Warehouse, and further amended this facility to, among other things, provide for a legal final maturity for this facility of August 2012. These amendments relaxed key covenant requirements under the borrowing facilities. Most significantly, the minimum net worth requirement was reduced from $525.0 million plus 50% of the proceeds from equity issuances to $500.0 million plus 50% of the proceeds from equity issuances after February 26, 2009 for our SunTrust Warehouse. |
During 2009, we also successfully amended the agreements for our SunTrust Warehouse and our Private Placement Notes. Most significantly, these amendments relaxed key covenant requirements under the borrowing facilities. These amendments are described more fully in the Liquidity and Capital ResourcesBorrowings section of this Managements Discussion and Analysis of Financial Condition and Results of Operations.
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LIQUIDITY AND CAPITAL RESOURCESBORROWINGS
As of March 31, 2010, we reported $534.9 million of borrowings on our Consolidated Balance Sheet at cost. We estimate that the fair value of these borrowings as of March 31, 2010 was approximately $458.5 million, based on market data and current interest rates. The following table summarizes our borrowing facilities and the potential borrowing capacity of those facilities and contingent borrowing eligibility of Solutions Capital I, L.P., a wholly owned subsidiary, as an SBIC, under the Small Business Investment Act of 1958, as amended.
March 31, 2010 | December 31, 2009 | ||||||||||||||
(dollars in thousands) |
Maturity Date | Potential Maximum Borrowing |
Amount Outstanding |
Potential Maximum Borrowing |
Amount Outstanding | ||||||||||
Private Placement Notes |
|||||||||||||||
Series 2005-A |
October 2011 | $ | 32,379 | $ | 32,379 | $ | 34,307 | $ | 34,307 | ||||||
Series 2007-A |
October 2012 | 16,189 | 16,189 | 17,154 | 17,154 | ||||||||||
Commercial Loan Funding Trust |
|||||||||||||||
Variable Funding Note |
August 2012(a) | 150,000 | 138,844 | 170,694 | 158,907 | ||||||||||
Commercial Loan Trust 2006-1 |
|||||||||||||||
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(b) |
April 2018 | 45,000 | 40,000 | 45,000 | 40,000 | ||||||||||
Series 2006-1 Class D Notes(c) |
April 2018 | 47,500 | 29,880 | 47,500 | 29,880 | ||||||||||
SBIC (Maximum borrowing potential)(d) |
(e) | 130,000 | 27,600 | 130,000 | 27,600 | ||||||||||
Total borrowings |
$ | 721,068 | $ | 534,892 | $ | 744,655 | $ | 557,848 | |||||||
(a) | Renewable each February at the lenders discretion. The lender provided this renewal in February 2010. In conjunction with this renewal, the legal final maturity date became August 2012. |
( b ) | 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. Subsequently, in April 2010 we purchased an additional $8.0 million of these notes for $4.4 million which will similarly be eliminated from this schedule during the quarter ended June 30, 2010. |
(c) | 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. |
(d ) | As of March 31, 2010, 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 March 31, 2010. Based on our funded capital, Solutions Capital I, L.P., subject to the SBAs approval, may borrow up to an additional $28.3 million to originate investments as of March 31, 2010. 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 single-license SBIC companies up to $150.0 million. |
(e ) | 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. The net worth covenant of our SunTrust Warehouse requires that we maintain a minimum stockholders equity of not less than $500.0 million, plus 50% of any equity raised after February 26, 2009. Under these covenants, we must also maintain an asset coverage ratio of at least 180%.
As of March 31, 2010, our asset coverage ratio was 222% and had increased to 224% as of April 29, 2010 including the effect of our dividend declared on April 29, 2010. We have $28.3 million of unused, currently available borrowing capacity remaining in our SBIC subsidiary subject to the SBAs approval that is exempt from the asset coverage ratio requirements.
As of March 31, 2010, 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.
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We fund all of our current debt facilities, except our Private Placement 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.
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 three months March 31, 2010 and 2009:
For the three months ended | ||||||||
(dollars in thousands) |
March 31, 2010 | March 31, 2009 | ||||||
Weighted-average borrowings |
$ | 543,082 | $ | 635,631 | ||||
Average LIBOR |
0.26 | % | 1.25 | % | ||||
Average spread to LIBOR, excluding amortization of deferred debt issuance costs |
2.48 | 2.19 | ||||||
Impact of amortization of deferred debt issuance costs |
0.55 | 0.69 | ||||||
Total cost of funds |
3.29 | % | 4.13 | % | ||||
The 3.3% weighted-average cost of funds for the three months ended March 31, 2010 was 84 basis points less than the same period in 2009. This decrease resulted from a 99 basis point decrease in average LIBOR and a 14 basis point increase in the impact of amortization of deferred debt issuance costs, partially offset by a 29 basis point increase in the average spread to LIBOR.
The following sections provide additional detail about each of our borrowing facilities.
PRIVATE PLACEMENT 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, or the Private Placement Notes, are five-year notes that require semi-annual interest payments.
In February 2009, the Private Placement Notes were amended. In connection with these amendments, we and the holders of the Private Placement Notes 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 was reduced 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 our Commercial Loan Trust 2006-1, or the 2006-1 Trust, and to our warehouse financing facility, or the SunTrust Warehouse, would not constitute defaults under the Private Placement 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% and 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 Private Placement Notes with a portion of certain monetization proceeds at a purchase price of 102% of the principal amount to be purchased. In addition, we agreed to limit the amount of debt from the 2006-1 Trust and our common stock that we may repurchase. For every $5.0 million of Private Placement Notes we offer to purchase after February 26, 2009, we may repurchase $2.5 million of debt from the 2006-1 Trust. Once we have offered to purchase $35.0 million of Private Placement Notes, we may also repurchase $1.0 million of shares of our common stock for every $5.0 million increment of Private Placement Notes offered to be repurchased after February 26, 2009, provided that the amount of permitted debt repurchases under the 2006-1 Trust shall be reduced by the amount of any of our common stock repurchases made. We paid to the holders of the Private Placement Notes an amendment fee of $375,000, or 0.50%.
Prior to the May 2009 repayment of our revolving line of credit, we were required to use 60% of the cash net proceeds of any sale of unencumbered assets to reduce amounts outstanding under the Private Placement Notes and the revolving line of credit on a pro rata basis, based on then-outstanding amounts. After such repayment, of our revolving line of credit, 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 Private Placement 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%.
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In October 2009, the Private Placement Notes were further amended, in part, to extend the maturity date of the Series 2005-A unsecured notes to October 2011 and to increase the interest rate thereunder to 9.98%.
As of March 31, 2010, the outstanding balances under the Series 2005-A and Series 2007-A Private Placement Notes were $32.4 million and $16.2 million, respectively. The following table summarizes the reductions in the borrowing capacity from monetization proceeds:
Private Placement Note Series 2005-A | Private Placement Note Series 2007-A | |||||||||||
(in thousands) |
Monetization Payment |
Outstanding
Balances After Monetization Payment |
Monetization Payment |
Outstanding
Balances After Monetization Payment | ||||||||
Quarter Ended |
||||||||||||
March 31, 2009 |
$ | 5,314 | $ | 44,686 | 2,658 | $ | 22,342 | |||||
June 30, 2009 |
3,128 | 41,558 | 1,564 | 20,778 | ||||||||
September 30, 2009 |
3,917 | 37,641 | 1,958 | 18,820 | ||||||||
December 31, 2009 |
3,334 | 34,307 | 1,666 | 17,154 | ||||||||
March 31, 2010 |
1,928 | 32,379 | 965 | 16,189 |
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. The SunTrust Warehouse, which is structured to operate 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. The facility is funded by third parties through the commercial paper market with SunTrust Bank providing a liquidity backstop, subject to SunTrust Banks annual liquidity commitment.
In February 2010, SunTrust Bank provided its 2010 annual renewal of this liquidity facility. In connection with the 2010 renewal, the SunTrust Warehouse was modified in a number of ways, including; the legal final maturity date was extended to August 2012, subject to contractual terms and conditions, the minimum consolidated stockholders equity covenant was reduced from $525.0 million plus 50% of the proceeds from any equity issuances after February 26, 2009 to $500.0 million plus 50% of the proceeds from any equity issuances after February 26, 2009 and the facility borrowing commitment was reduced from $190 million to $150 million. In addition, the terms of the SunTrust Warehouse limit the total outstanding balance of fixed-rate loans, which was increased through this amendment from 40% to 55%. The interest rate on the SunTrust Warehouse remains unchanged at the commercial paper rate plus 2.50%. If a new agreement or extension is not executed by February 16, 2011, the SunTrust Warehouse 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 in the facility. We paid a $1.5 million, or 1.0%, facility fee for this renewal.
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Advances under the Class A VFC may be up to 64% of eligible collateral. The SunTrust Warehouse is non-recourse to us; therefore, in the event of a termination event or upon the legal final maturity date, the lenders under the SunTrust Warehouse may only look to the collateral to satisfy the outstanding obligations under this facility. The following table summarizes the collateral under the Commercial Loan Funding Trust as of March 31, 2010 and December 31, 2009.
March 31, 2010 | December 31, 2009 | |||||||||||
(dollars in thousands) |
Amount | % | Amount | % | ||||||||
Securitized assets |
||||||||||||
Senior secured debt |
$ | 130,960 | 54.8 | % | $ | 140,483 | 53.0 | % | ||||
Subordinated secured debt |
102,900 | 43.1 | 102,170 | 38.6 | ||||||||
Total securitized assets |
233,860 | 97.9 | 242,653 | 91.6 | ||||||||
Cash, securitization accounts |
4,901 | 2.1 | 22,129 | 8.4 | ||||||||
Total collateral |
$ | 238,761 | 100.0 | % | $ | 264,782 | 100.0 | % | ||||
Prior to the commencement of any amortization period, we will contribute 80% of net proceeds from monetizations of collateral financed in the SunTrust Warehouse to repay the outstanding borrowings. In addition, 7.5% of the sale of the first $100.0 million of unencumbered investment assets by us is being used to pay down the SunTrust Warehouse. As of March 31, 2010, we have sold $54.5 million in unencumbered investment assets resulting in $4.1 million of repayments under this provision.
COMMERCIAL LOAN TRUST 2006-1
In April 2006, we completed a $500.0 million debt securitization through 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 the 2006-1 Trust. The following table summarizes the assets securitized under this facility as of March 31, 2010 and December 31, 2009.
March 31, 2010 | December 31, 2009 | |||||||||||
(dollars in thousands) |
Amount | % | Amount | % | ||||||||
Securitized assets |
||||||||||||
Senior secured debt |
$ | 192,364 | 46.4 | % | $ | 196,036 | 47.2 | % | ||||
Subordinated secured debt |
132,361 | 31.9 | 132,169 | 31.8 | ||||||||
Total securitized assets |
324,725 | 78.3 | 328,205 | 79.0 | ||||||||
Cash, securitization accounts |
89,704 | 21.7 | 87,012 | 21.0 | ||||||||
Total collateral |
$ | 414,429 | 100.0 | % | $ | 415,217 | 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 2006-1 Trust, which resulted in an $11.1 million gain on extinguishment of debt during the quarter ended December 31, 2008. 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 ended March 31, 2009. Subsequently, in April 2010, we repurchased $8.0 million of our outstanding debt securities under our debt securitization through Commercial Loan Trust 2006-1, a wholly owned subsidiary for $4.4 million. In connection
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with this repurchase, we expect to record a $3.6 million gain on the extinguishment of debt excluding the effect of $0.1 million in deferred debt costs during the quarter ending June 30, 2010. To date, we have repurchased an aggregate of $30.6 million of our outstanding debt securities under the Commercial Loan Trust 2006-1 for $10.5 million.
SBIC DEBENTURES
In December 2004, we formed a wholly owned subsidiary, Solutions Capital I, L.P. Solutions Capital I, L.P. has a license from the SBA to operate as an SBIC under the SBIC Act. As of March 31, 2010, the license gave Solutions Capital I, L.P. 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 March 31, 2010. Based on our current funded capital, Solutions Capital I, L.P. may, subject to the SBAs approval, borrow up to an additional $28.3 million to originate new investments as of March 31, 2010. 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 effective in February 2009, included a provision that increased the maximum amount of outstanding leverage available to single-license 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, L.P. 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 March 31, 2010. As of March 31, 2010 and December 31, 2009, we had $44.6 million and $30.8 million, respectively, of investments and we had $9.0 million and $21.2 million, respectively, of restricted cash to be used for investments in our SBIC. The American Recovery and Reinvestment Act of 2009 also increased the maximum amount of outstanding leverage available to SBIC companies with multiple licenses to $225.0 million on an aggregate basis, which represents a $50.0 million increase over the prior maximum of $175.0 million.
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 March 31, 2010, the SBIC had $27.6 million outstanding summarized in the following table:
Amount Outstanding | ||||||||||||||||
(dollars in thousands) |
March 31, 2010 |
December 31, 2009 |
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 | 12,000 | 5.34 | % | Fixed | 2.81 | % | 253 | ||||||||
2009-10B |
13,000 | 13,000 | 4.95 | % | Fixed | 3.44 | % | 151 | ||||||||
Total |
$ | 27,600 | $ | 27,600 | 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, L.P. from the calculation of our consolidated BDC asset coverage ratio.
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 and the date of our 2010 Annual Meeting of Stockholders.
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During the three months ended March 31, 2010, we did not award any shares of restricted stock under the 2006 Plan. During the three months ended March 31, 2010, the forfeiture provisions lapsed on 99,000 shares of restricted stock pursuant to 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 up to an aggregate of 865,000 shares of our restricted common stock and up to $5.2 million in cash awards upon achievement of specified share price thresholds for our common stock within the LTIPs 36-month performance period. MCG achieved two of these market-price thresholds in October 2009, which resulted in the issuance of 432,500 shares of common stock to LTIP participants. The forfeiture provisions for 288,300 these shares of common stock lapsed immediately upon issuance. The forfeiture provisions for the remaining 144,200 of these shares of common stock will lapse in October 2010, contingent upon each eligible participants continued service until that time. In April 2010, MCG achieved a third market-price threshold under the LTIP after the price of shares of its common stock closed at, or above, $5 for twenty consecutive trading days, which resulted in the issuance of 216,300 shares of common stock to LTIP participants. The forfeiture provisions for 144,200 of these shares of common stock lapsed immediately upon issuance. The forfeiture provisions for the remaining 72,100 of these shares of common stock will lapse in April 2011, contingent upon each eligible participants continued service until that time. The LTIP also provided for a cash incentive upon the achievement of market price thresholds of $5, $6, $7 and $8 for twenty consecutive trading days. Upon the achievement of the $5 market price threshold in April 2010, the LTIP participants became eligible to receive cash awards totaling $1.0 million of which two-thirds was paid in April 2010 and the remaining one-third will be paid in one year, contingent upon the participants continued service until that time.
OFF-BALANCE SHEET ARRANGEMENTS
FINANCIAL INSTRUMENTS
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, guarantees, letters of credit and other financial commitments. 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.
We do not report the unused portions of these commitments on our Consolidated Balance Sheets. As of March 31, 2010, we had $29.9 million of outstanding unused loan commitments, as shown in the table below. We believe that our operations, monetizations and unrestricted cash will be liquidity sufficient to fund, as necessary, requests to draw on these unfunded commitments. We estimate that the fair value of these commitments was $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies. As of March 31, 2010, we had no outstanding guarantees or standby letters of credit.
(in thousands) | As of March 31, 2010 | |||||||||||
Unused commitments to portfolio companies |
Non-Affiliate Investments |
Affiliate Investments |
Control Investments |
Total | ||||||||
Revolving credit facilities |
$ | 17,684 | $ | 10,000 | $ | 1,500 | $ | 29,184 | ||||
Other |
77 | | 661 | 738 | ||||||||
Total unused commitments to portfolio companies |
$ | 17,761 | $ | 10,000 | $ | 2,161 | $ | 29,922 | ||||
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CONTRACTUAL OBLIGATIONS
The following table shows our contractual obligations as of March 31, 2010:
(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) |
138,844 | 608 | 138,236 | | | ||||||||||
Unsecured notes |
48,568 | | 48,568 | | | ||||||||||
SBIC |
27,600 | | | | 27,600 | ||||||||||
Total borrowings |
534,892 | 608 | 186,804 | | 347,480 | ||||||||||
Operating Leases |
6,463 | 2,285 | 4,139 | 39 | | ||||||||||
Total contractual obligations |
$ | 541,355 | $ | 2,893 | $ | 190,943 | $ | 39 | $ | 347,480 | |||||
(a) | Excludes the unused commitments to extend credit to our customers of $29.9 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. |
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.
We incurred certain losses for tax purposes in 2009 that we recognized for book purposes during 2008, which resulted in no statutorily required dividend payments in 2009. We did not declare a dividend during the quarter ended March 31, 2010. However, on April 29, 2010, we declared a distribution of $0.11 per common share payable on July 2, 2010 to stockholders of record on June 2, 2010. If we determined the tax attributes of this distribution as of March 31, 2010, 100% would be from ordinary income. However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year and will be reported to each shareholder on a Form 1099. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our 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. Historically, a portion of our distributions to our stockholders have been deemed a return of capital with the exception of one instance where none of the distributions were deemed a return of capital. 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 income (loss) to taxable net income (loss) for the three months ended March 31, 2010 and the year ended December 31, 2009:
(in thousands) |
Three months ended March 31, 2010 |
Year
ended December 31, 2009 |
||||||||
Net income (loss) |
$ | 5,955 | $ | (51,059 | ) | |||||
Difference between book and tax losses on investments |
(93 | ) | 48,078 | |||||||
Net change in unrealized depreciation on investments not taxable until realized |
97 | (97,631 | ) | |||||||
Capital losses in excess of capital gains |
2,267 | 54,245 | ||||||||
Timing difference related to deductibility of long-term incentive compensation |
867 | 6,091 | ||||||||
Taxable interest income on non-accrual loans |
4,352 | 14,949 | ||||||||
Dividend income accrued for GAAP purposes that is not yet taxable |
(1,329 | ) | (6,149 | ) | ||||||
Distributions from taxable subsidiaries |
| 144 | ||||||||
Federal tax provision (benefit) |
62 | (81 | ) | |||||||
Other, net |
63 | 323 | ||||||||
Taxable income (loss) before deductions for distributions |
$ | 12,241 | $ | (31,090 | ) | |||||
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, 2009.
VALUATION OF INVESTMENTS
FAIR VALUE MEASUREMENTS AND DISCLOSURES
We account for our investments at fair value in accordance with 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.
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 Fair Value Hierarchy |
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. In the event that such transfers were to occur in the future, we would recognize those transfers 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.
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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 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 40.7% 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 0.4% 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 58.9% of our investment portfolio. Quoted prices are not available for 95.9% of our non-control investments. 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. |
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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 March 31, 2010, these securities represented 2.4% of our investment portfolio. |
Our valuation analyses incorporate the impact that key events could have on the securities values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales. Our valuation analyses also include 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 at least 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 derived through a sale of some or all of our investment in the portfolio company. Independent valuation firms performed valuations or reviewed valuations of 40 portfolio companies over the last four quarters, representing $845.9 million, or 85.4%, of the fair value of our total portfolio investments and $278.0 million, or 90.3%, of the fair value of our equity portfolio investments. In addition, the fair value of $106.3 million, or 10.7% of our total portfolio investments and $26.3 million, or 8.5% of the fair value of our equity portfolio, was derived from sales transactions involving the portfolio company. As set forth in more detail in the following table, in total, either we obtained a valuation or review from an independent firm or we considered recent sales transactions for 96.1% of the fair value of our investment portfolio as of March 31, 2010.
As of March 31, 2010 | |||||||||||||||||||
Investments at Fair Value | Percent of | ||||||||||||||||||
(dollars in thousands) |
Debt | Equity | Total | Debt Portfolio |
Equity Portfolio |
Total Portfolio |
|||||||||||||
Independent valuation/review prepared(a) |
|||||||||||||||||||
First quarter 2010 |
$ | 179,308 | $ | 201,993 | $ | 381,301 | 26.3 | % | 65.6 | % | 38.5 | % | |||||||
Fourth quarter 2009 |
164,660 | 52,541 | 217,201 | 24.1 | 17.1 | 21.9 | |||||||||||||
Third quarter 2009 |
90,893 | 10,345 | 101,238 | 13.3 | 3.3 | 10.2 | |||||||||||||
Second quarter 2009 |
133,055 | 13,133 | 146,188 | 19.5 | 4.3 | 14.8 | |||||||||||||
Total independent valuation/review |
567,916 | 278,012 | 845,928 | 83.2 | 90.3 | 85.4 | |||||||||||||
Fair value derived from sales transaction |
|||||||||||||||||||
First quarter 2010 |
28,562 | 26,278 | 54,840 | 4.2 | 8.5 | 5.5 | |||||||||||||
Third quarter 2009 |
51,690 | | 51,690 | 7.5 | | 5.2 | |||||||||||||
Total derived from sales transaction |
80,252 | 26,278 | 106,530 | 11.7 | 8.5 | 10.7 | |||||||||||||
New investments made during the 12 months ended March 31, 2010 |
29,573 | | 29,573 | 4.3 | | 3.0 | |||||||||||||
Not evaluated during the 12 months ended March 31, 2010 |
5,332 | 3,669 | 9,001 | 0.8 | 1.2 | 0.9 | |||||||||||||
Total investment portfolio |
$ | 683,073 | $ | 307,959 | $ | 991,032 | 100.0 | % | 100.0 | % | 100.0 | % | |||||||
(a) | Independent valuations/reviews prepared more than one time during the twelve months ended March 31, 2010 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 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 differ from the valuations currently assigned.
RECENT ACCOUNTING PRONOUNCEMENTS
FAIR VALUE MEASUREMENTS
In January 2010, FASB issued Accounting Standard Update No. 2010-06Improving Disclosures about Fair Value Measurements, or ASU 2010-06. The January 2010 update amends Accounting Standards Codification Topic 820Fair Value Measurements and Disclosures, or ASC 820, to add new requirements for disclosures
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about significant transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements. In addition, the update clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for interim and annual reporting periods beginning after December 15, 2010. We adopted this standard beginning with our financial statements ending March 31, 2010. Our adoption of this standard did not affect our financial position or results of operations.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Since late 2007, the United States economy has been in a recession, which has had a severe adverse impact on many companies, especially those in the financial services sector. Since that time, the stock market decreased, several financial institutions 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 recognized significant losses resulting primarily from a general decline in the fair value of their respective asset portfolios. However, since mid-2009, economic conditions became generally more favorable as real gross domestic product, or GDP, showed positive growth. In addition, equity and credit markets were characterized by increasing asset prices, lower volatility and improved liquidity during the second half of 2009. While we see the potential for improvement in 2010, the timing is uncertain.
In the event of renewed financial turnoil affecting the banking system and financial markets, 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 three months ended March 31, 2010, we experienced write-downs primarily in the plastic products industry due to a reduction in the performance of one of our portfolio companies caused by an increase in the cost of raw materials used by that company. 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 March 31, 2010, approximately 56.1% of our loan portfolio, at fair value, bore interest at a spread to LIBOR or prime rate, and 43.9% at a fixed interest rate. As of March 31, 2010, approximately 38.4% 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 enter derivative transactions in connection with our financing vehicles. During the 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.
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The following table shows a comparison of the interest rate base for our interest-bearing cash, outstanding commercial loans, at cost, and our outstanding borrowings as of March 31, 2010 and December 31, 2009:
March 31, 2010 | December 31, 2009 | |||||||||||||
(in thousands) |
Interest Bearing Cash and Commercial Loans |
Borrowings | Commercial Loans |
Borrowings | ||||||||||
Money market rate |
$ | 41,066 | $ | | $ | | $ | | ||||||
Prime rate |
39,440 | | 75,126 | | ||||||||||
LIBOR |
||||||||||||||
30-day |
49,460 | | 19,876 | | ||||||||||
60-day |
12,713 | | 12,441 | | ||||||||||
90-day |
314,090 | 319,880 | 306,563 | 319,880 | ||||||||||
180-day |
3,683 | | 3,683 | | ||||||||||
Commercial paper |
| 138,844 | | 158,907 | ||||||||||
Fixed rate |
354,747 | 76,168 | 350,504 | 79,061 | ||||||||||
Total |
$ | 815,199 | $ | 534,892 | $ | 768,193 | $ | 557,848 | ||||||
Based on our March 31, 2010 balance sheet, the following table shows the impact to net income of hypothetical base rate changes in interest rates, assuming no changes in our investment and borrowing structure:
(dollars in thousands) Basis Point Change(a) |
Interest Income |
Interest Expense |
Unrealized (Depreciation)/ Appreciation |
Net Loss | ||||||
100 |
1,806 | 4,587 | (500 | ) | (3,281 | ) | ||||
200 |
3,860 | 9,174 | (37 | ) | (5,351 | ) | ||||
300 |
7,216 | 13,762 | 425 | (6,121 | ) |
(a) | As of March 31, 2010, quarterly average LIBOR was 0.26%; thus, a 100 basis point decrease could not occur. |
From February 2009 through December 2009, we maintained our cash in non-interest-bearing accounts, which were fully insured by the FDIC, under the FDICs Temporary Liquidity Guarantee Program. The FDICs Temporary Liquidity Guarantee Program was originally scheduled to expire on December 31, 2009, but was subsequently extended through June 30, 2010. Nonetheless, beginning in January 2010, a number of banks opted out of this program. Because of the minimal availability of the Temporary Liquidity Guarantee Program beginning in January 2010 combined with some stabilization of the banking industry, during the quarter ended March 31, 2010, we redeployed a portion of our unrestricted cash into secure interest-bearing accounts. Consequently, we deposited a portion of our excess cash into secure interest-bearing accounts during the quarter ended March 31, 2010. As we redeploy additional cash into interest-bearing accounts and we originate new investments, our sensitivity to interest rate fluctuations and our net loss from a hypothetical increase in interest rates should decrease. As of March 31, 2010, we had a total of $158.2 million of unrestricted cash, restricted cash and cash in securitization accounts of which $117.1 million was in non-interest bearing accounts. For each $10.0 million of cash in these non-interest bearing accounts that we redeploy into variable interest rate investments, the net loss from our sensitivity to interest rate fluctuations will decrease by approximately $100,000 for each 100 basis point increase in interest rates.
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 March 31, 2010. 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.
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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 March 31, 2010, 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 March 31, 2010 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 March 31, 2010, 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, 2009.
Substantially all 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 NAV 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. Typically, there is not a public market for the securities of the privately held companies in which we have invested and will generally continue to invest. As a result, we value these securities quarterly 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 based on various factors during our valuation process and our investment and valuation committee reviews and approves these valuations. The types of factors that may be considered in the determination of the fair value of these investments include public and 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
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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 lingering effects of the recent capital markets disruption and recession could impair our portfolio companies financial position and operating results, which could, in turn, harm our operating results.
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 into a recession in late 2007, the stock market has declined, many 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 assurance these regulatory programs and proposals will have a long-term beneficial impact. Economic conditions have become generally more favorable beginning in mid-2009 as real gross domestic product, or GDP, showed positive growth. In addition, equity and credit markets were characterized by increasing asset prices, lower volatility and improved liquidity during the last nine months of the year. While we see the potential for improvement in 2010, the timing is uncertain. In the event of renewed financial turmoil affecting the banking system and financial markets, additional consolidation of the financial services industry or significant financial service institution failures, there could be a new or incremental tightening in the credit markets, low liquidity and extreme volatility in fixed-income, credit, currency and equity markets. In addition, the risk remains that there could be a number of follow-on effects from the credit crisis on our business.
To the extent that recessionary conditions continue or worsen, the financial results of middle-market companies, like those in which we invest, may continue to experience deterioration, which ultimately could lead to difficulty in meeting debt service requirements and an increase in defaults.
Adverse economic conditions have decreased the value of some of our loans and equity investments and a prolonged recession, or the after-effects of these conditions, may further decrease such value. These conditions have contributed to, and could continue to contribute to, additional losses of value in our portfolio and decreases 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 one or more of our portfolio companies may decrease during such periods. Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments.
Economic recessions or downturns could impair the ability of our portfolio companies to repay loans, which, in turn, could increase our non-performing assets, decrease the value of our portfolio, reduce our volume of new loans and have an adverse effect on our operating results.
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.
There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.
Even though we have structured some of our investments as senior loans, if one of our portfolio companies were to go bankrupt, 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 investments and subordinate all, or a portion, of our claims to that of other creditors. Holders of debt instruments ranking senior to our investments typically would be entitled to receive payment in full before we receive any distributions. After repaying such senior creditors, such portfolio company may not have any remaining assets to use to repay its obligation to us. We may also be subject to lender liability claims for actions taken by us with respect to a borrowers business or in instances in which we exercised control over the borrower. It is possible that we could become subject to a lenders liability claim, including as a result of actions taken in rendering significant managerial assistance.
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Investing in middle-market companies 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 companies. Investing 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 traded 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 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 managerial talents and efforts of an individual or a small group of persons. Therefore, the loss of any of its key employees could affect a portfolio companys ability to compete effectively and harm its 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 its 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 that 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 information necessary 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.
Portfolio company litigation could result in additional costs and the diversion of management time and resources.
In the course of providing significant managerial assistance to certain of our portfolio companies, we may serve as directors on the boards of such companies. To the extent that litigation arises out of our investments in these companies, we may be named as a defendant in such litigation, which could result in additional costs and the diversion of management time and resources.
Our financial position and results of operations could be affected adversely if a significant portion of our portfolio were 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 March 31, 2010, our investments in communications companies represented 18.9% of the fair value of our portfolio. Of the 18.9% investment, 17.1% represented investments in CLECs and 1.8% represented investments in other communications companies. In addition, as of March 31, 2010, our investments in cable, healthcare and food services portfolio companies represented 13.5%, 9.8% and 7.2%, respectively, of the fair value of our portfolio. If an industry in which we have significant investments or revenue concentrations 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.
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Broadview Networks Holdings, Inc., or Broadview, a CLEC serving primarily business customers, is our largest portfolio investment. As of March 31, 2010, we held preferred stock in Broadview with a $138.8 million fair value. As of March 31, 2010 and December 31, 2009, our investment in Broadview represented 14.0% and 14.1%, respectively, of the fair value of our investment portfolio. If Broadviews performance deteriorates or valuation multiples contract further in future periods, we may be required to recognize additional unrealized depreciation on this investment. Our ability to recognize income from our investment in Broadview in future periods depends on the performance and value of Broadview.
We operate in a highly competitive market for investment opportunities.
A number of entities compete with us to make the types of investments that we make. We compete with public and private funds, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity funds. Additionally, because competition for investment opportunities generally has increased in recent years among alternative investment vehicles, such as hedge funds, those entities have begun to invest in areas in which traditionally they have not invested. As a result of these entrants, competition for investment opportunities has intensified in recent years and may intensify further in the future. Some of our existing and potential competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions and valuation requirements that the 1940 Act imposes on us as a BDC. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this existing and potentially increasing competition, we may not be able to take advantage of attractive investment opportunities from time to time. We can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective.
We do not seek to compete primarily based on the interest rates we offer. We believe that some of our competitors make loans with interest rates that are comparable to, or lower than, the rates we offer.
We may lose investment opportunities if we do not match our competitors pricing, terms and structure. If we match our competitors pricing, terms and structure, we may experience decreased net interest income and increased risk of credit loss.
We have been in a period of capital markets disruption and recession. This disruption has contributed to a decrease in our NAV 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 have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a lack of liquidity. Initially, these market conditions were 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. During this period of disruption, the global markets have been characterized by substantially increased volatility, short-selling and an overall loss of investor confidence. While recent economic indicators have shown modest improvements in the capital markets, these indicators could worsen. In the event of renewed financial turmoil affecting the banking system and financial markets, additional consolidation of the financial services industry, or significant financial service institution failures, there could be a new or incremental tightening in the credit markets, low liquidity and extreme volatility in fixed-income, credit, currency and equity markets. In addition, the risk remains that there could be a number of follow-on effects from the credit crisis on our business.
We may be unable to monetize assets in a challenging market environment that may preclude 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 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
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downturn or an operational problem that affects third parties or us. Ongoing disruptive conditions could cause our stock price and NAV to decline, restrict our business operations and adversely impact our results of operations and financial condition. As of March 31, 2010, our common stock was trading at $5.21 per share, or at 63.8% of NAV.
Fluctuations in interest rates could affect our income adversely.
Because we sometimes borrow to make investments, our net income depends, in part, on the difference between the rate at which we borrow funds and the rate at which we invest these funds. 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 our interest-earning assets differently than the interest rates we pay on interest-bearing liabilities. As a result, significant changes in market interest rates could have a material adverse effect on our net income.
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. As of March 31, 2010, approximately 56.1% of the fair value of our loan portfolio was at variable rates based on a LIBOR benchmark or prime rate and approximately 43.9% of the fair value of our loan portfolio was at fixed rates. As of March 31, 2010, approximately 38.4% of the fair value of our loan portfolio had LIBOR floors between 1.5% and 3.5% 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.
Our shares of common stock may continue to trade at discounts from NAV, which limits our ability to raise additional equity capital.
Shares of closed-end investment companies frequently trade at a market price that is less than the NAV attributable to those shares. This characteristic of closed-end investment companies is separate and distinct from the risk that our NAV per share may decline. It is not possible to predict whether our common stock will trade at, above, or below NAV. In the recent past, the stocks of BDCs as an industry, including shares of our common stock, have traded below NAV and at near historic lows as a result of concerns over liquidity, leverage restrictions and distribution requirements. When our common stock trades below its NAV per share, we generally will not be able to issue additional shares of our common stock at the then-current market price without first obtaining approval for such issuance from our stockholders and our independent directors.
If we are not successful in our appeal to the Internal Revenue Service, we could be subject to up to $23.3 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 the matter will be resolved for approximately $1.0 million. 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. The 2006, 2007, 2008 and 2009 federal tax years remain open to examination by the IRS.
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 economic and capital market conditions in the U.S. have resulted in a reduction in the availability of debt and equity capital for the market as a whole, and financial services firms in particular. These conditions continue to constrain 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. 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 we generally are not able to issue
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and sell our common stock at a price below NAV per share without stockholder approval. These economic and market conditions 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 prolonged 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 on our operating results.
Stockholders may incur dilution if we sell shares of our common stock in one or more offerings at prices below the then-current NAV per share of our common stock.
During the past year, our common stock has traded consistently, and at times significantly, below NAV. The 1940 Act prohibits us from selling shares of our common stock at a price below the current NAV per share of our stock, subject to certain exceptions. One of these exceptions allows the sale of common stock at a price below NAV if the sale is approved by the holders of a majority of our outstanding voting securities and by holders of a majority of our outstanding voting securities who are not affiliated persons of us, and our board of directors must make certain determinations prior to any such sale.
If we were to sell shares of our common stock below NAV per share, such sales would result in an immediate dilution to the NAV per share. This dilution would occur as a result of the sale of shares at a price below the then-current NAV per share of our common stock and a proportionately greater decrease in a stockholders interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance. The greater the difference between the sale price and the NAV per share at the time of the offering, the more significant the dilutive impact would be. Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect, if any, cannot currently be predicted.
We may in the future decide to issue preferred stock, which would magnify the potential for gain or loss and the risks of investing in us in the same way as our borrowings.
Because preferred stock is another form of leverage and the dividends on any preferred stock we might issue must be cumulative, preferred stock has the same risks to our common stockholders as borrowings. Payment of any such dividends and repayment of the liquidation preference of such preferred stock must take preference over any dividends or other payments to our common stockholders, and preferred stockholders are not subject to any of our expenses or losses and are not entitled to participate in any income or appreciation in excess of their stated preference. In addition, holders of any preferred stock we might issue would have the right to elect members of the board of directors and class voting rights on certain matters, including changes in fundamental investment restrictions and conversion to open-end status and, accordingly, could veto any such changes.
If we fail to qualify as a RIC, 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 and maintain our status as a BDC, including:
| 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. Because we may use debt financing, we are subject to an asset coverage ratio requirement under the 1940 Act and we may be subject to certain financial covenants under our debt arrangements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and, thus, become subject to corporate-level income tax. |
| The income source requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest, gains from the sale of stock or securities or similar sources. |
| The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other acceptable securities; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Internal Revenue Code rules, by us and that |
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are engaged in the same or similar or related trades or businesses or of certain qualified publicly traded partnerships. Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and, therefore, will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could 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.
A failure on our part to maintain our qualification as a BDC would significantly reduce our operating flexibility.
If we were to continuously fail to qualify as a BDC, we might be subject to regulation as a registered closed-end investment company under the 1940 Act, which would significantly decrease our operating flexibility. In addition, failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the SEC to bring an enforcement action against us. For additional information on the qualification requirements of a BDC, see the disclosure under the caption Item 1. BusinessRegulation of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
We have substantial indebtedness and, if we do not service our debt arrangements adequately, our business could be harmed materially.
As of March 31, 2010, we had $534.9 million of outstanding borrowings under our debt facilities. As of March 31, 2010, the weighted-average annual interest rate on all of our outstanding borrowings was 2.7%, excluding the amortization of deferred debt issuance costs. 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, or SunTrust Warehouse, funded through Three Pillars Funding LLC, an asset-backed commercial paper conduit administered by SunTrust Robinson Humphrey, Inc., and 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 that the fair value of our collateral exceeds our borrowings. The fair value of our excess collateral was $224.5 million as of March 31, 2010.
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.
Decreases in the fair values of our portfolio company investments which we record as unrealized depreciation could affect certain covenants in our credit facilities. Our SunTrust Warehouse requires that we maintain a minimum stockholders equity of not less than $500.0 million plus 50% of the proceeds from any equity issuances after February 26, 2009. 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 March 31, 2010, our stockholders equity was $622.9 million. In the event that our investments 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
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distribution on our outstanding common stock, 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.
If we are not able to refinance or renew our debt or are not able to do so on favorable terms, our operations could be affected adversely.
As of March 31, 2010, we had $534.9 million of borrowings. In February 2010, we received the annual renewal of the liquidity facility that supports our SunTrust Warehouse, at which time the SunTrust Warehouse facility limit was reduced to $150.0 million. As of March 31, 2010, the facility limits for the SunTrust Warehouse and Private Placement notes were $150.0 million and $48.6 million, respectively.
Absent any acceleration events, the SunTrust Warehouse matures in August 2012 and the Private Placement Notes mature in October 2011 (with respect to the $32.4 million in notes remaining) and October 2012 (with respect to the $16.2 million in notes remaining). We cannot be certain that we will be able to renew our credit facilities as they mature or to establish 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 refinance such facilities and establish 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 if we 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 have significant influence over the entity. The stockholders 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 financial position and results of operations.
Investments in equity securities involve a substantial degree of risk.
We may purchase common stock and other equity securities, including warrants. Although equity securities historically have 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 in the event 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%, we will be unable to make distributions until our asset coverage ratio improves. If we do not distribute at least 90% of our investment company taxable 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 March 31, 2010, our asset coverage ratio was 222%. We have not paid a dividend since July 2008. During 2009, we incurred certain losses for tax purposes that we recognized for book purposes during 2008, which resulted in no statutorily required dividend payments in 2009. In order to preserve capital, we did not make distributions during 2009. However, on April 29, 2010, we declared a distribution of $0.11 per common share payable on July 2, 2010 to stockholders of record on June 2, 2010. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.
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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 future distributions. 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.
In the future, we may choose to pay distributions with shares of our own common stock. In that case, you may be required to pay tax in excess of the cash you receive.
While currently it is not our intention to do so, we may in the future elect to distribute taxable dividends that are payable, in part, in shares of our common stock. Under a recently issued IRS revenue procedure, we may treat a distribution of our stock as a dividend if, among other things, the stock is publicly traded on an established securities market and each stockholder may elect to receive his or her entire distribution in either cash or our stock subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which must be at least 10% of the aggregate declared distribution. Taxable stockholders receiving such distributions will be required to include the full amount of the distribution as ordinary income (or as a long-term capital gain to the extent such distribution is properly designated as a capital gain dividend). As a result, a U.S. stockholder may be required to pay tax with respect to such distribution in excess of any cash received. If a U.S. stockholder sells the stock it receives as a distribution in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. income taxes with respect to such distribution, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders decide to sell shares of our stock in order to pay taxes owed on distributions, it may put downward pressure on the trading price of our stock.
We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.
In accordance with 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. We include increases in loan balances resulting from contracted payment-in-kind arrangements 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. Accordingly, we may have to sell some of our investments at times we would not consider advantageous, raise additional debt or equity capital or reduce new investment originations to meet these distribution requirements. If we are not able to obtain cash from other sources, we may fail to qualify as a RIC and, thus, be subject to corporate-level income tax.
The disposition of our investments may result in contingent liabilities.
Most of our investments will involve private securities. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to certain potential liabilities. These arrangements may result in contingent liabilities that ultimately yield funding obligations that must be satisfied through our return of certain distributions previously made to us.
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. 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 fair 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 BDC and as a RIC if we do not satisfy one or more of the applicable criteria under the respective regulatory frameworks.
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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 the event that Western Investment, LLC prevails in the contested election of directors at our 2010 Annual Meeting of Stockholders, it would lead to the triggering of a good reason event under the employment agreement of Steven F. Tunney, our CEO, permitting him to elect to terminate his employment with us on favorable terms. In addition, under our SunTrust Warehouse, if either Steven F. Tunney 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 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.
Regulations governing our operation as a BDC will affect our ability to, and the way in which we, raise additional capital.
We have issued debt securities and may issue additional debt securities, preferred stock 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 and paying dividends and we 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 NAV 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 significant adverse effect on the profitability of our operations and our cost of doing business.
Changes in the laws, regulations or interpretations of the laws and regulations that govern BDCs, RICs, SBICs or non-depository commercial lenders could have a significant adverse 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 requirements that are more stringent 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.
Our wholly owned subsidiary is licensed by the SBA and is subject to SBA regulations.
Our wholly owned subsidiary, Solutions Capital I, L.P., is licensed to operate as an SBIC and is regulated by the SBA. The SBIC license allows our SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. The SBA regulations require, among other things, that a licensed SBIC be examined periodically, by an SBA examiner, to determine the SBICs compliance with the relevant SBA regulations and be audited by an independent auditor.
The SBA 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 our SBIC subsidiary to forego attractive investment opportunities that are not permitted under SBA regulations.
SBA regulations currently limit the amount that a single-license SBIC subsidiary may borrow up to a maximum of $150 million when it has at least $75 million in private capital; receives a capital commitment from the SBA; and has been through an examination by the SBA subsequent to licensing. As of March 31, 2010, our SBIC subsidiary had investments in five portfolio companies with a total fair value of $44.6 million.
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. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, depending on the
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severity of the violation, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or limit it from making new investments. In addition, 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 SBIC Act or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our SBIC subsidiary is our wholly owned subsidiary.
Our wholly owned SBIC subsidiary may be unable to make distributions to us that will enable us to meet or maintain RIC status, which could result in the imposition of an entity-level tax.
In order for us to continue to qualify for RIC tax treatment and to minimize corporate-level taxes, we will be required to distribute substantially all of our net ordinary income and net capital gain income, including income from certain of our subsidiaries, which includes the income from our SBIC subsidiary. We will be partially dependent on our SBIC subsidiary for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiary may be limited by the SBIC Act and SBA regulations governing SBICs from making certain distributions to us that may be necessary to maintain our status as a RIC.
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 experienced extreme volatility and disruption 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 BDCs 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. The market price and the liquidity of the market for our shares may from time to time be affected by a number of factors which include, but are not limited to, the following:
| our quarterly results of operations; |
| our origination activity, including the pace of, and competition for, new investment opportunities; |
| 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 the communications, cable and healthcare industries; |
| 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; |
| loss of RIC status; |
| 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 |
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| 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.
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ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. |
None.
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES. |
Not Applicable.
ITEM 4. | RESERVED. |
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 | |||||
10.1 | Amendment No. 1 to Amended and Restated Sale and Servicing Agreement, by and among MCG Capital Corporation, MCG Commercial Loan Funding Trust; Three Pillars Funding LLC; SunTrust Robinson Humphrey, Inc. and Wells Fargo Bank, National Association, dated as of February 17, 2010 | 8-K (0-33377) |
February 18, 2010 | 10.1 | ||||||
10.2 | MCG Capital Corporation Second Amended and Restated 2006 Employee Restricted Stock Plan | * | ||||||||
10.3 | MCG Capital Corporation Second Amended and Restated 2006 Non-Employee Director Restricted Stock Plan | * | ||||||||
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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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: May 4, 2010 | By: | /S/ STEVEN F. TUNNEY SR. | ||
Steven F. Tunney Sr. | ||||
Chief Executive Officer | ||||
Date: May 4, 2010 | By: | /S/ STEPHEN J. BACICA | ||
Stephen J. Bacica | ||||
Chief Financial Officer | ||||
Date: May 4, 2010 | By: | /S/ LINDA A. NIMMONS | ||
Linda A. Nimmons | ||||
Chief Accounting Officer |
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