MCG CAPITAL CORP - FORM 10-Q - October 29, 2012

Attached files

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EX-15.1 - LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION FROM ERNST & YOUNG - MCG CAPITAL CORPex-15193012.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-31193012.htm
EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-31293012.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-32293012.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-32193012.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
o    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
(Address of principal executive offices)
22209
(Zip Code)

(703) 247-7500
(Registrant's 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 o
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 o No o
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    o
Accelerated filer    x
Non-accelerated filer    o
Smaller reporting company    o
(Do not check if a 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 o No x
As of October 26, 2012, there were 72,788,426 shares of the registrant’s $0.01 par value Common Stock outstanding.


MCG CAPITAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2012
TABLE OF CONTENTS


 
 
PART I. FINANCIAL INFORMATION
 
 
ITEM 1. FINANCIAL STATEMENTS
 
 
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
CONSOLIDATED STATEMENTS OF CASH FLOWS
CONSOLIDATED SCHEDULE OF INVESTMENTS
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 
ITEM 4. CONTROLS AND PROCEDURES
 
 
PART II. OTHER INFORMATION
 
 
ITEM 1. LEGAL PROCEEDINGS
 
 
ITEM 1A. RISK FACTORS
 
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
 
ITEM 4. MINE SAFETY DISCLOSURES
 
 
ITEM 5. OTHER INFORMATION
 
 
ITEM 6. EXHIBITS
 
 
SIGNATURES



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MCG Capital Corporation
Consolidated Balance Sheets
(in thousands, except per share amounts)
September 30,
2012
December 31, 2011
 
(unaudited)
 
Assets
 
 
Cash and cash equivalents
$
65,898

$
58,563

Cash, securitization accounts
3,675

40,306

Cash, restricted
114,543

34,964

Investments at fair value
 
 
Non-affiliate investments (cost of $334,410 and $552,642, respectively)
320,177

552,301

Affiliate investments (cost of $69,796 and $58,425, respectively)
61,566

69,602

Control investments (cost of $257,829 and $406,151, respectively)
63,050

119,263

Total investments (cost of $662,035 and $1,017,218, respectively)
444,793

741,166

Interest receivable
4,158

4,049

Other assets
5,360

11,490

Total assets
$
638,427

$
890,538

Liabilities
 
 
Borrowings (maturing within one year of $1,000 and $32,983, respectively)
$
249,053

$
430,219

Interest payable
871

2,710

Dividends payable
—

13,092

Other liabilities
9,763

9,565

Total liabilities
259,687

455,586

Stockholders’ equity
 
 
Preferred stock, par value $0.01, authorized 1 share, none issued and outstanding
—

—

Common stock, par value $0.01, authorized 200,000 shares on September 30, 2012 and December 31, 2011, 72,788 issued and outstanding on September 30, 2012 and 76,997 issued and outstanding on December 31, 2011
728

770

Paid-in capital
988,785

1,009,748

Distributions in excess of earnings
 
 
Paid-in capital
(195,310
)
(195,310
)
Other
(197,883
)
(103,912
)
Net unrealized depreciation on investments
(217,580
)
(276,344
)
Total stockholders’ equity
378,740

434,952

Total liabilities and stockholders’ equity
$
638,427

$
890,538

Net asset value per common share at end of period
$
5.20

$
5.65



The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
1

MCG Capital Corporation
Consolidated Statements of Operations
(unaudited)
 
Three months ended
Nine months ended
 
September 30
September 30
(in thousands, except per share amounts)
2012
2011
2012
2011
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Non-affiliate investments (less than 5% owned)
$
9,174

$
15,954

$
35,401

$
49,168

Affiliate investments (5% to 25% owned)
1,418

1,801

4,856

5,284

Control investments (more than 25% owned)
1,243

2,025

4,696

8,952

Total interest and dividend income
11,835

19,780

44,953

63,404

Advisory fees and other income
 
 




Non-affiliate investments (less than 5% owned)
210

885

1,357

1,812

Control investments (more than 25% owned)
24

45

1,262

1,005

Total advisory fees and other income
234

930

2,619

2,817

Total revenue
12,069

20,710

47,572

66,221

Operating expense
 
 




Interest expense
2,974

3,960

12,728

11,778

Employee compensation








Salaries and benefits
2,018

2,683

8,684

9,567

Amortization of employee restricted stock awards
505

348

1,694

1,378

Total employee compensation
2,523

3,031

10,378

10,945

General and administrative expense
2,504

3,657

10,714

9,130

Restructuring expense
12

4,109

59

4,174

Total operating expense
8,013

14,757

33,879

36,027

Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
4,056

5,953

13,693

30,194

Net realized (loss) gain on investments
 
 




Non-affiliate investments (less than 5% owned)
—

281

12,550

(47,288
)
Affiliate investments (5% to 25% owned)
—

(1
)
16,370

(917
)
Control investments (more than 25% owned)
(5,394
)
(38,107
)
(102,288
)
(25,755
)
Total net realized loss on investments
(5,394
)
(37,827
)
(73,368
)
(73,960
)
Net unrealized appreciation (depreciation) on investments
 
 




Non-affiliate investments (less than 5% owned)
2,463

(2,305
)
(13,892
)
51,975

Affiliate investments (5% to 25% owned)
(3,662
)
1,613

(19,407
)
3,150

Control investments (more than 25% owned)
6,838

7,613

92,109

(55,227
)
Derivative and other fair value adjustments
(17
)
(146
)
(46
)
618

Total net unrealized appreciation on investments
5,622

6,775

58,764

516

Net investment gain (loss) before income tax provision
228

(31,052
)
(14,604
)
(73,444
)
Loss on extinguishment of debt before income tax provision
—

—

(174
)
(863
)
Income tax provision
18

10

329

29

Net income (loss)
$
4,266

$
(25,109
)
$
(1,414
)
$
(44,142
)
Income (loss) per basic and diluted common share
$
0.06

$
(0.33
)
$
(0.02
)
$
(0.58
)
Cash distributions declared per common share
$
0.14

$
0.17

$
0.45

$
0.49

Weighted-average common shares outstanding—basic and diluted
73,431

76,404

74,588

76,173


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
2


MCG Capital Corporation
Consolidated Statements of Changes in Net Assets
(unaudited)
 
Nine months ended
 
September 30
(in thousands, except per share amounts)
2012
2011
Decrease in net assets from operations
 
 
Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
$
13,693

$
30,194

Net realized (loss) gain on investments
(73,368
)
(73,960
)
Net unrealized appreciation (depreciation) on investments
58,764

516

Loss on extinguishment of debt before income tax provision
(174
)
(863
)
Income tax provision
(329
)
(29
)
Net income (loss)
(1,414
)
(44,142
)
Distributions to stockholders
 
 
Distributions declared
(33,793
)
(37,784
)
Net decrease in net assets resulting from stockholder distributions
(33,793
)
(37,784
)
Capital share transactions
 
 
Repurchase of common stock
(22,416
)
—

Amortization of restricted stock awards
 
 
Employee awards accounted for as employee compensation
1,694

1,378

Employee awards accounted for as restructuring expense
—

431

Non-employee director awards accounted for as general and administrative expense
53

46

Common stock withheld to pay taxes applicable to the vesting of restricted stock
(336
)
(1,453
)
Net forfeitures of restricted common stock
—

(11
)
Net decrease in net assets resulting from capital share transactions
(21,005
)
391

Total decrease in net assets
(56,212
)
(81,535
)
Net assets
 
 
Beginning of period
434,952

578,016

End of period
$
378,740

$
496,481

Net asset value per common share at end of period
$
5.20

$
6.44

Common shares outstanding at end of period
72,788

77,035



The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
3

MCG Capital Corporation
Consolidated Statements of Cash Flows
(unaudited)
 
Nine months ended
 
September 30
(in thousands)
2012
2011
Cash flows from operating activities
 
 
Net income (loss)
$
(1,414
)
$
(44,142
)
Adjustments to reconcile net loss to net cash provided by
operating activities
 
 
Investments in portfolio companies
(42,619
)
(243,966
)
Principal collections related to investment repayments or sales
314,598

336,172

Decrease in interest receivable, accrued payment-in-kind interest and dividends
9,717

21,453

Amortization of restricted stock awards
 
 
Employee
1,694

1,809

Non-employee director
53

46

Decrease in cash—securitization accounts from interest collections
5,475

1,515

Decrease (increase) in restricted cash—escrow accounts
327

(3,648
)
Depreciation and amortization
6,120

2,936

Decrease in other assets
1,039

1,021

Increase (decrease) in other liabilities
(1,676
)
428

Realized loss on investments
73,368

73,960

Net change in unrealized appreciation on investments
(58,764
)
(516
)
Loss on extinguishment of debt
174

863

Net cash provided by operating activities
308,092

147,931

Cash flows from financing activities
 
 
Repurchase of common stock
(22,416
)
—

Payments on borrowings
(202,740
)
(62,726
)
Proceeds from borrowings
21,400

5,000

Decrease (increase) in cash in restricted and securitization accounts
 


Securitization accounts for repayment of principal on debt
31,156

(58,686
)
Restricted cash
(79,906
)
16,049

Payment of financing costs
(1,030
)
(1,700
)
Distributions paid
(46,885
)
(35,418
)
Common stock withheld to pay taxes applicable to the vesting of restricted stock
(336
)
(1,453
)
Net forfeitures of restricted common stock
—

(11
)
Net cash used in financing activities
(300,757
)
(138,945
)
Net increase in cash and cash equivalents
7,335

8,986

Cash and cash equivalents
 
 
Beginning balance
58,563

44,970

Ending balance
$
65,898

$
53,956

Supplemental disclosure of cash flow information
 
 
Interest paid
$
9,261

$
10,397

Income taxes (refunded) paid
61

297

Paid-in-kind interest collected
8,510

20,410

Dividend income collected
8,149

12,355


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
4


MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2012 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(9)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Control Investments(4):
 
 
 
 
 
 
 
Broadview Networks Holdings, Inc.
Communications
Series A Preferred Stock (12.0%, 87,254 shares)(6)
 
 
 
 
$
81,984

$
552

 
Series A-1 Preferred Stock (12.0%,
100,702 shares)(6)
 
 
 
 
77,496

637

 
Series B Preferred Stock (12.0%, 1,282 shares)(6)
 
 
 
 
100

8

 
 
Class A Common Stock (4,731,031 shares)(6)
 
 
 
 
—

—

GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)(1)
4.4
%
—

4.4
%
$
17,574

15,146

15,729

 
Subordinated Debt (Due 12/16)(7)
2.5
%
—

2.5
%
11,231

6,976

—

 
 
Class B Voting Units (8.0%, 86,700 units)(6)
 
 
 
 
9,071

—

Intran Media, LLC
Other Media
Series A Preferred Units (10.0%, 36,300 units)(6)
 
 
 
 
9,095

400

Jet Plastica
Investors, LLC(2)(11)
Plastic Products
Senior Debt A (Due 3/15)(1)(7)
2.4
%
7.0
%
9.4
%
4,876

3,897

—

NPS Holding Group, LLC(2)(5)
Business
Services
Senior Debt Revolver (Due 6/13)(7)
6.3
%
2.5
%
8.7
%
4,011

2,360

4,367

Senior Debt A1 (Due 6/13)(7)
6.3
%
—

6.3
%
9,157

3,470

7,689

 
 
Senior Debt A2 (Due 6/13)(7)
6.3
%
—

6.3
%
2,069

1,905

32

 
 
Senior Debt A3 (Due 6/13)(7)
6.3
%
—

6.3
%
15,324

6,228

229

 
 
Series A Preferred Units (504 units)(6)
 
 
 
 
50

—

 
 
Series B Preferred Units (5.0%, 10,731 units)(6)
 
 
 
 
10,731

—

 
 
Common Units (36,500 units)(6)
 
 
 
 
—

—

RadioPharmacy
Investors, LLC(2)
Healthcare
Senior Debt (Due 12/16)(1)
7.5
%
—

7.5
%
7,640

7,640

7,640

 
Subordinated Debt (Due 12/16)(1)
12.0
%
4.0
%
16.0
%
10,521

10,517

10,517

 
 
Preferred LLC Interest (19.7%, 70,000 units)
 
 
 
 
11,163

15,250

Total Control investments (represents 14.2% of total investments at fair value)
257,829

63,050

Affiliate Investments(3):
 
 
 
 
 
 
 
Advanced Sleep  
Concepts, Inc.(2)
Home Furnishings
Senior Debt (Due 1/14)(1)
12.9
%
—

12.9
%
$
7,559

$
7,533

$
7,533

Subordinated Debt (Due 1/14)(1)(7)
12.0
%
4.0
%
16.0
%
5,813

5,385

3,112

 
 
Series A Preferred Stock (20.0%, 49 shares)(6)
 
 
 
 
344

—

 
 
Series B Preferred Stock (1,000 shares)(6)
 
 
 
 
—

—

 
 
Common Stock (423 shares)(6)
 
 
 
 
524

—

 
 
Warrants to purchase Common Stock
(expire 10/16)(6)
 
 
 
 
348

—

C7 Data Centers, Inc.
Business Services
Senior Debt (Due 9/17)(1)
9.5
%
—

9.5
%
10,000

9,641

9,641

Series B Preferred Units (10.0%, 7,142,857 units)(6)
 
 
 
 
2,000

2,000

Contract Datascan Holdings, Inc.
Business Services

Subordinated Debt (Due 3/16)(1)
12.0
%
2.0
%
14.0
%
8,531

7,985

7,782

Series A Preferred Stock (10.0%, 2,313 shares)(1)(6)
 
 
 
 
2,387

2,173

Series B Preferred Stock (10.0%, 358 shares)(1)(6)
 
 
 
 
307

279

 
 
Common Stock (8,519 shares)(1)(6)
 
 
 
 
538

—

IDOC, LLC
Healthcare
Senior Debt (Due 8/17)(1)
9.8
%
—

9.8
%
15,000

14,691

14,691

 
 
Limited Partner Interests (8.0%)(1)(2)(6)
 
 
 
 
1,012

1,012

Miles Media Group, LLC(2)
Business Services
Senior Debt (Due 6/16)(1)
12.5
%
—

12.5
%
17,238

16,978

13,343

Warrants to purchase Class A Units (expire 3/21) (1)
 
 
 
 
123

—

Total Affiliate investments (represents 13.8% of total investments at fair value)
 
 
 
 
69,796

61,566


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
5

MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2012 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(9)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
BarBri, Inc.
Publishing
Senior Debt (Due 6/17)(1)
6.0
%
—

6.0
%
$
6,099

$
6,043

$
6,113

Capstone Logistics, LLC(12)
Logistics
Senior Debt (Due 9/16)(1)
10.5
%
—

10.5
%
29,854

29,736

29,736

Chase Doors Holdings, Inc.
Manufacturing
Senior Debt (Due 12/15)(1)
9.5
%
—

9.5
%
22,037

21,857

21,913

Construction Trailer Specialists, Inc.(2)
Auto Parts
Senior Debt (Due 6/13)(1)
8.6
%
6.3
%
14.9
%
7,639

7,508

7,626

Cruz Bay Publishing, Inc.
Publishing
Subordinated Debt (Due 12/13)(1)(8)
6.7
%
6.5
%
13.2
%
28,094

22,930

18,107

CWP/RMK Acquisition Corp.(2)(6)
Home Furnishings
Senior Debt (Due 12/16)(7)
7.0
%
—

7.0
%
600

541

597

Education Management, Inc.
Education
Senior Debt (Due 6/15)(1)
4.0
%
5.3
%
9.3
%
26,305

26,102

25,487

Gans Communications,
L.P.(2)
Cable
Senior Debt (Due 10/17)(1)
6.3
%
—

6.3
%
5,015

4,995

5,024

G&L Investment Holdings, LLC(2)
Insurance
Subordinated Debt (Due 5/14)(1)
10.7
%
4.3
%
15.0
%
18,466

18,232

18,232

 
Series A Preferred Shares (14.0%,
5,000,000 shares)(6)
 
 
 


8,191

7,965

 
 
Class C Shares (621,907 shares)(6)
 
 
 


529

—

Golden Knight II CLO, Ltd.
Diversified Financial Services
Income Notes (Due 4/19)
8.0
%
—

8.0
%
 
3,071

2,717

Goodman Global, Inc.
Manufacturing
Senior Debt (Due 10/16)(1)
5.8
%
—

5.8
%
5,599

5,625

5,621

Industrial Safety Technologies, LLC(12)
Manufacturing
Senior Debt (Due 9/16)(1)
9.5
%
—

9.5
%
22,000

21,808

22,138

Jenzabar, Inc.(10)
Technology
Subordinated Preferred Stock (109,800 shares)
 
 
 
 
1,098

988

Legacy Cabinets Holdings II, Inc.
Home Furnishings
Class B-1 Common Stock (2,000 shares)(6)
 
 
 
 
2,185

—

Mailsouth, Inc.
Publishing
Senior Debt (Due 12/16)(1)
6.8
%
—

6.8
%
4,652

4,599

4,582

Maverick Healthcare
Equity, LLC
Healthcare
Preferred Units (10.0%, 1,250,000 units)
 
 
 
 
1,877

2,028

 
Class A Common Units (1,250,000 units)(6)
 
 
 
 
—

452

NDSSI Holdings,
LLC(2)
Electronics
Senior Debt (Due 12/12)(1)
12.8
%
1.0
%
13.8
%
30,096

30,035

30,035

 
Series D Preferred Units (30.0%, 2,000,000 units)(6)
 
 
 


2,000

3,000

 
 
Series A Preferred Units (516,691 units)(6)
 
 
 


718

—

 
 
Series B Convertible Preferred Units
(165,003 units)(6)
 
 
 


142

273

 
 
Class A Common Units (1,000,000 units)(6)
 
 
 


333

—


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
6

MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2012 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(9)
Principal
Cost
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Orbitz Worldwide, Inc.
Personal Transportation
Senior Debt (Due 7/14)(1)
3.2
%
—

3.2
%
$
2,808

$
2,715

$
2,746

Rita’s Water Ice Franchise Company, LLC
Restaurants
Senior Debt (Due 11/16)(1)
14.0
%
—

14.0
%
9,375

9,295

9,295

Sagamore Hill Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 8/14)(1)
12.0
%
—

12.0
%
9,800

9,727

9,727

SC Academy Holdings, Inc.
Education
Subordinated Debt (Due 7/16)(1)
12.0
%
—

12.0
%
13,500

13,412

13,412

Scotsman Industries, Inc.
Manufacturing
Senior Debt (Due 4/16)(1)
5.8
%
—

5.8
%
4,819

4,818

4,842

ShowPlex Cinemas, Inc.
Entertainment
Senior Debt (Due 5/15)(1)
9.5
%
—

9.5
%
7,427

7,312

7,312

Softlayer Technologies, Inc.
Business Services
Senior Debt (Due 11/16)(1)
7.3
%
—

7.3
%
13,755

13,634

13,846

South Bay Mental Health Center, Inc
Healthcare
Subordinated Debt (Due 10/17)(1)
12.0
%
2.5
%
14.5
%
8,176

8,029

8,029

Summit Business Media Parent Holding Company LLC
Information Services
Class E Series I Units (636 units)(1)(6)
 
 
 
 
4,120

352

Class E Series II Units (276 units)(1)(6)
 
 
 
 
1,788

—

Sunshine Media
Group, Inc.(2)
Publishing
Warrants to purchase Common Stock
(expire 1/21)(6)
 
 
 
 
—

—

The e-Media Club I, LLC
Investment Fund
LLC Interest (74 units)(6)
 
 
 
 
88

11

The Gavilon Group, LLC
Agriculture
Senior Debt (Due 12/16)(1)
6.0
%
—

6.0
%
8,750

8,653

8,734

Virtual Radiologic Corporation
Healthcare
Senior Debt (Due 12/16)(1)
7.8
%
—

7.8
%
13,810

13,652

12,268

Visant Corporation
Consumer Products
Senior Debt (Due 12/16)(1)
5.3
%
—

5.3
%
4,851

4,864

4,684

VS&A-PBI Holding LLC
Publishing
LLC Interest(6)
 
 
 
 
500

—

West World Media, LLC
Information Services
Senior Debt (Due 9/15)(1)
11.0
%
3.0
%
14.0
%
11,423

10,823

11,008

Class A Membership Units (25,000 units) (1)
 
 
 


1

316

 
 
Warrant to purchase Class A Membership Units
(expire 9/15)(1)(6)
 
 
 


324

719

Xpressdocs Holdings, Inc.
Business Services
Series A Preferred Stock (161,870 shares)(6)
 
 
 


500

242

Total Non-Affiliate investments (represents 72.0% of total investments at fair value)
 
 
 
 
334,410

320,177

Total Investments
 
 
 
 
 
 
$
662,035

$
444,793


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
7

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
 
 
 
Interest Rate(9)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Control Investments(4):
 
 
 
 
 
 
 
Broadview Networks Holdings, Inc.
Communications
Series A Preferred Stock (12.0%, 87,254 shares)(6)
 
 
 
 
$
81,984

$
5,015

 
Series A-1 Preferred Stock (12.0%, 100,702 shares)(6)
 
 
 
 
77,496

5,788

 
 
Series B Preferred Stock (12.0%, 1,282 shares)(6)
 
 
 
 
100

74

 
 
Class A Common Stock (4,731,031 shares)(6)
 
 
 
 
—

—

GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)(1)
4.6
%
—

4.6
%
$
19,103

16,651

17,167

 
Subordinated Debt (Due 12/16)(1)(7)
2.5
%
—

2.5
%
10,950

6,976

—

 
 
Class B Voting Units (8.0%, 86,700 units)(6)
 
 
 
 
9,071

—

Intran Media, LLC
Other Media
Series A Preferred Units (10.0%, 36,300 units)(6)
 
 
 
 
9,095

400

 
 
Series B Preferred Units (10.0%, 12,700 units)(6)
 
 
 
 
3,000

—

 
 
Series C Preferred Units (10.0%,15,000 units)(6)
 
 
 
 
1,250

—

Jet Plastica
Investors, LLC(2)
Plastic Products
Senior Debt A (Due 3/15)(1)(7)
2.6
%
7.0
%
9.6
%
15,288

14,914

9,145

Senior Debt B (Due 6/15)(1)(7)
2.6
%
5.0
%
7.6
%
23,836

18,977

—

 
 
Senior Debt C (Due 6/16)(7)
—

2.5
%
2.5
%
6,299

6,250

—

 
 
Senior Debt D (Due 3/13-9/16)(7)
—

2.5
%
2.5
%
29,018

21,560

—

 
 
Series B Preferred Stock (8.0%, 10,000 shares)(6)
 
 
 
 
10,000

—

 
 
Preferred LLC Interest (8.0%, 301,595 units)(6)
 
 
 
 
34,014

—

NPS Holding Group, LLC(2)(5)
Business
Services
Senior Debt Revolver (Due 6/13)(1)(7)
6.3
%
2.5
%
8.7
%
3,909

2,360

4,116

Senior Debt A1 (Due 6/13)(1)(7)
6.3
%
—

6.3
%
9,157

3,470

5,237

 
 
Senior Debt A2 (Due 6/13)(1)(7)
6.3
%
—

6.3
%
2,069

1,905

32

 
 
Senior Debt A3 (Due 6/13)(1)(7)
6.3
%
—

6.3
%
15,324

6,228

230

 
 
Series A Preferred Units (504 units)(6)
 
 
 
 
50

—

 
 
Series B Preferred Units (5.0%, 10,731 units)(6)
 
 
 
 
10,731

—

 
 
Common Units (36,500 units)(6)
 
 
 
 
—

—

Orbitel Holdings, LLC(2)
Cable
Senior Debt (Due 2/13)(1)
10.0
%
—

10.0
%
18,580

18,512

18,512

 
Preferred LLC Interest (10.0%, 150,000 units)(1)
 
 
 
 
17,929

19,090

PremierGarage
Holdings, LLC(2)
Home Furnishings
Preferred LLC Units (400 units)(6)
 
 
 
 
400

—

Common LLC Units (79,935 units)(6)
 
 
 
 
4,971

—

RadioPharmacy
Investors, LLC(2)
Healthcare
Senior Debt (Due 12/16)(1)
7.5
%
—

7.5
%
8,176

8,176

8,176

 
Subordinated Debt (Due 12/16)(1)
12.0
%
3.0
%
15.0
%
10,362

10,355

10,355

 
 
Preferred LLC Interest (19.7%, 70,000 units)
 
 
 
 
9,726

15,926

Total Control Investments (represents 16.1% of total investments at fair value)
 
 
 
 
406,151

119,263


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
8

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
 
 
 
Interest Rate(9)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Affiliate Investments(3):
 
 
 
 
 
 
 
Advanced Sleep  
Concepts, Inc.(2)
Home Furnishings
Senior Debt (Due 1/14)(1)
13.4
%
—

13.4
%
$
5,859

$
5,851

$
5,851

Subordinated Debt (Due 1/14)(1)
12.0
%
4.0
%
16.0
%
5,640

5,614

5,614

 
 
Series A Preferred Stock (20.0%, 49 shares)
 
 
 
 
344

61

 
 
Series B Preferred Stock (1,000 shares)(6)
 
 
 
 
—

270

 
 
Common Stock (423 shares)(6)
 
 
 
 
524

—

 
 
Warrants to purchase Common Stock
(expire 10/16)(6)
 
 
 
 
348

—

Contract Datascan Holdings, Inc.
Business Services
Subordinated Debt (Due 3/16)(1)
12.0
%
2.0
%
14.0
%
8,402

7,778

7,353

Series A Preferred Stock (10.0%, 2,313 shares)(1)
 
 
 
 
2,387

1,931

 
 
Common Stock (4,806 shares)(1)(6)
 
 
 
 
477

—

Miles Media Group, LLC(2)(13)
Business Services
Senior Debt (Due 6/16)(1)
12.5
%
—

12.5
%
17,738

17,444

17,309

Warrants to purchase Class A Units
(expire 3/21) (1)(6)
 
 
 
 
123

523

Stratford School Holdings, Inc.(2)
Education
Senior Debt (Due 12/15)(1)
7.5
%
—

7.5
%
17,500

17,412

17,412

 
Series A Convertible Preferred Stock (12.0%, 10,000 shares)
 
 
 
 
123

10,191

 
 
Warrants to purchase Common Stock
(expire 5/15)(1)(6)
 
 
 
 
—

3,087

Total Affiliate Investments (represents 9.4% of total investments at fair value)
 
 
 
 
58,425

69,602


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
9

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
 
 
 
Interest Rate(9)
 
 
Fair 
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
BarBri, Inc.
Publishing
Senior Debt (Due 6/17)(1)
6.0
%
—

6.0
%
$
7,000

$
6,936

$
6,991

Bentley Systems, Incorporated
Information Services
Senior Debt (Due 12/16)(1)
5.8
%
—

5.8
%
9,900

9,810

9,810

Capstone Logistics, LLC
Logistics
Senior Debt (Due 9/16)(1)
10.5
%
—

10.5
%
29,957

29,816

29,816

Chase Doors Holdings, Inc.
Manufacturing
Senior Debt (Due 12/15)(1)
9.5
%
—

9.5
%
23,660

23,442

23,442

Coastal Sunbelt
Holding, Inc.(2)
Food Services
Senior Debt (Due 8/14-12/15)(1)
9.1
%
—

9.1
%
19,961

19,818

19,818

 
Subordinated Debt (Due 8/15)(1)
16.0
%
—

16.0
%
9,038

8,967

9,024

Coastal Sunbelt Real Estate, Inc.
Real Estate Investments
Series A-2 Preferred Stock (12.0%, 20,000 shares)
 
 
 
 
—

441

Construction Trailer Specialists, Inc.(2)
Auto Parts
Senior Debt (Due 6/13)(1)
8.6
%
6.3
%
14.9
%
8,020

7,877

7,575

Cruz Bay Publishing, Inc.
Publishing
Subordinated Debt (Due 12/13)(1)(8)
5.3
%
8.0
%
13.3
%
26,154

22,895

19,440

CWP/RMK Acquisition Corp.(2)
Home Furnishings
Senior Debt (Due 12/16)(7)
3.0
%
—

3.0
%
600

564

559

Data Based Systems International, Inc.
Business Services
Subordinated Debt (Due 8/16)(1)
10.0
%
4.0
%
14.0
%
9,004

8,834

8,989

Education Management, Inc.
Education
Senior Debt (Due 6/15)(1)
9.3
%
—

9.3
%
25,000

24,775

24,963

Focus Brands Inc. 
Restaurants
Senior Debt (Due 11/16)(1)
5.3
%
—

5.3
%
9,354

9,355

9,296

Gans Communications,
L.P.(2)
Cable
Senior Debt (Due 10/17)(1)
5.3
%
—

5.3
%
5,565

5,548

5,520

G&L Investment Holdings, LLC(2)
Insurance
Subordinated Debt (Due 5/14)(1)
10.7
%
4.3
%
15.0
%
17,882

17,565

17,565

 
Series A Preferred Shares (14.0%,
5,000,000 shares)
 
 
 
 
8,192

7,422

 
 
Class C Shares (621,907 shares)(6)
 
 
 
 
529

—

Golden Knight II CLO, Ltd.
Diversified Financial Services
Income Notes (Due 4/19)
8.0
%
—

8.0
%
 
3,053

2,207

Goodman Global, Inc.
Manufacturing
Senior Debt (Due 10/16)(1)
5.8
%
—

5.8
%
5,599

5,630

5,611

GSDM Holdings
Corp.(2)
Healthcare
Senior Debt (Due 1/16)(1)
11.5
%
6.0
%
17.5
%
26,777

26,536

26,536

 
Series B Preferred Stock (12.5%, 852,950 shares)
 
 
 
 
5,292

8,117

Haws Corporation
Manufacturing
Senior Debt (Due 12/15)(1)
10.5
%
—

10.5
%
16,500

16,320

16,320

Industrial Safety Technologies, LLC
Manufacturing
Senior Debt (Due 9/16)(1)
10.0
%
—

10.0
%
22,000

21,772

21,772

Jenzabar, Inc.(10)
Technology
Senior Preferred Stock (11.0%, 3,750 shares)
 
 
 
 
6,844

6,844

 
 
Subordinated Preferred Stock (109,800 shares)
 
 
 
 
1,098

988

 
 
Warrants to purchase Common Stock
(expire 4/16)(6)
 
 
 
 
422

16,858

Legacy Cabinets Holdings II, Inc.
Home Furnishings
Class B-1 Common Stock (2,000 shares)(6)
 
 
 
 
2,185

—

Mailsouth, Inc.
Publishing
Senior Debt (Due 12/16)(1)
6.8
%
—

6.8
%
4,963

4,901

4,888

Maverick Healthcare
Equity, LLC
Healthcare
Preferred Units (10.0%, 1,250,000 units)
 
 
 
 
1,744

1,882

 
Class A Common Units (1,250,000 units)(6)
 
 
 
 
—

484

Metropolitan Telecommunications
Holding Company(2)
Communications
Senior Debt (Due 3/14-12/16)(1)
8.1
%
—

8.1
%
23,770

23,630

23,630


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
10

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
 
 
 
Interest Rate(9)
Principal
Cost
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
NDSSI Holdings,
LLC(2)
Electronics
Senior Debt (Due 12/12)(1)
12.8
%
1.0
%
13.8
%
$
29,859

$
29,718

$
28,791

 
Series D Preferred Units (30.0%, 2,000,000 units)(6)
 
 
 
 
2,000

3,175

 
 
Series A Preferred Units (516,691 units)(6)
 
 
 
 
718

—

 
 
Series B Convertible Preferred Units (165,003 units)(6)
 
 
 
 
142

—

 
 
Class A Common Units
(1,000,000 units)(6)
 
 
 
 
333

—

Orbitz Worldwide, Inc.
Personal Transportation
Senior Debt (Due 7/14)(1)
3.4
%
—

3.4
%
3,014

2,883

2,604

Ozburn-Hessey Holding Company LLC
Logistics
Senior Debt (Due 4/16)(1)
8.3
%
—

8.3
%
4,378

4,426

3,868

Philadelphia Media Network, Inc.
Newspaper
Class A Common Stock
(1,000 shares)(6)
 
 
 
 
5,070

7

Qualawash Holdings, LLC
Repair Services
Subordinated Debt (Due 1/16)(1)
11.0
%
—

11.0
%
20,000

19,839

19,839

Rita’s Water Ice Franchise Company, LLC
Restaurants
Senior Debt (Due 11/16)(1)
14.0
%
—

14.0
%
9,375

9,282

9,282

Sagamore Hill
Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 8/14)(1)
12.0
%
1.0
%
13.0
%
11,114

11,018

11,018

Sally Holdings LLC
Cosmetics
Senior Debt (Due 11/13)(1)
2.6
%
—

2.6
%
8,531

8,541

8,521

SC Academy Holdings, Inc.
Education
Subordinated Debt (Due 7/16)(1)
12.0
%
—

12.0
%
13,500

13,398

13,471

Scotsman Industries, Inc.
Manufacturing
Senior Debt (Due 4/16)(1)
5.8
%
—

5.8
%
5,309

5,309

5,256

Service Champ, Inc.
Auto Parts
Subordinated Unsecured Debt (Due 2/17)(1)
12.0
%
2.3
%
14.3
%
12,111

12,009

12,203

ShowPlex Cinemas, Inc.
Entertainment
Senior Debt (Due 5/15)(1)
11.0
%
—

11.0
%
7,689

7,539

7,539

Softlayer Technologies, Inc.
Business Services
Senior Debt (Due 11/16)(1)
7.3
%
—

7.3
%
13,860

13,718

13,906

Summit Business Media Parent Holding Company LLC
Information Services
Class E Series I Units (636 units)(1)(6)
 
 
 
 
4,120

281

Class E Series II Units (276 units)(1)(6)
 
 
 
 
1,788

—

Sunshine Media
Group, Inc.(2)
Publishing
Warrants to purchase Common Stock
(expire 1/21)(6)
 
 
 
 
—

—

Tank Intermediate
Holding Corp.
Manufacturing
Senior Debt (Due 4/16)(1)
5.0
%
—

5.0
%
5,506

5,421

5,448

The e-Media Club I, LLC
Investment Fund
LLC Interest (74 units)(6)
 
 
 
 
88

11

The Gavilon Group, LLC
Agriculture
Senior Debt (Due 12/16)(1)
6.0
%
—

6.0
%
9,500

9,395

9,464

The Matrixx Group, Incorporated
Plastic Products
Subordinated Debt (Due 6/14)(1)
10.8
%
—

10.8
%
12,500

12,500

12,639

Virtual Radiologic Corporation
Healthcare
Senior Debt (Due 12/16)(1)
7.8
%
—

7.8
%
13,915

13,730

13,184

Visant Corporation
Consumer Products
Senior Debt (Due 12/16)(1)
5.3
%
—

5.3
%
4,851

4,866

4,563

VS&A-PBI Holding LLC
Publishing
LLC Interest(6)
 
 
 
 
500

—

West World Media, LLC
Information Services
Senior Debt (Due 9/15)(1)
11.0
%
3.0
%
14.0
%
11,301

10,577

10,577

Class A Membership Units
(25,000 units) (1)(6)
 
 
 
 
1

285

 
 
Warrant to purchase Class A Membership Units (expire 9/15)(1)(6)
 
 
 
 
324

719

Xpressdocs Holdings, Inc.(2)
Business Services
Senior Debt (Due 4/12-4/13)(1)
10.9
%
0.9
%
11.8
%
18,734

18,539

18,733

Series A Preferred Stock
(161,870 shares)(6)
 
 
 
 
500

109

Total Non-Affiliate Investments (represents 74.5% of total investments at fair value)
 
552,642

552,301

Total Investments
 
 
 
 
 
 
$
1,017,218

$
741,166


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
11

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
(1) 
Some or all of this security is held by our SBIC subsidiary or one of our other financing subsidiaries and may have been pledged as collateral in connection therewith. See Note 5—Borrowings to the Condensed Consolidated Financial Statements.
(2) 
Includes securities issued by one or more of the portfolio company’s affiliates.
(3) 
Affiliate investments represent companies in which we own at least 5%, but not more than 25% of the portfolio company’s voting securities.
(4) 
Control investments represent companies in which we own more than 25% of the portfolio company’s 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 company’s voting securities.
(6) 
Equity security 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, or PIK, 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 debt securities, presented by nature of indebtedness for a single issuer. PIK interest represents contractually deferred interest that is added to the principal balance of the debt security and compounded if not paid on a current basis. PIK may be prepaid by either contract or the portfolio company's choice, but generally is paid at the end of the loan term. Rates on preferred stock and preferred LLC interests, where applicable, represent the contractual rate.
(10) 
In February 2012, we accepted $23.7 million for our senior preferred stock and warrant position in Jenzabar.  The consideration received also settled any and all direct claims and counterclaims asserted in the litigation by and among the Company, Jenzabar and certain Jenzabar officers and directors.  We will receive the balance of the payment for our position in Jenzabar in the amount of $990,000 for our subordinated preferred stock and will exchange those shares upon the final dismissal of the litigation, including the dismissal of the derivative claims.
(11) 
In the three months ended June 30, 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets.  Including the proceeds from the liquidation, we have received $11.0 million of payments on our senior debt.  We anticipate receiving additional payments on our senior debt upon future collection of certain accounts receivable.
(12) 
In October 2012, Industrial Safety Technologies, LLC senior debt was repaid in full.
(13) 
Investment has been reclassified from a non-affiliate investment to an affiliate investment due to certain voting rights that the Company may have prior to the exercise of the warrants.





The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
12

MCG Capital Corporation
Notes to the Condensed Consolidated Financial Statements (Unaudited)
NOTE 1—DESCRIPTION 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 Subsidiaries—These 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 Subsidiaries—We 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 March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L. P., and in May 2011, we submitted a license to the SBA to obtain an SBIC license for Solutions Capital II, L.P. On September 30, 2011, after discussions with the SBA, we elected to withdraw our application for a second license. In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  There is no assurance that the SBA will grant the additional license in any specified time period or at all. MCG is also the sole member of Solutions Capital G.P., LLC, which acts as the general partner of Solutions Capital I, L.P.
Taxable Subsidiaries—We 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, each of which holds one or more portfolio investments listed on our Consolidated Schedules 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, and be included in the calculation of 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 Statements of Operations.
The accompanying financial statements reflect the consolidated accounts of MCG and the following subsidiaries: Solutions Capital I, L.P.; Solutions Capital II, L.P.; Solutions Capital G.P., LLC; and MCG’s special-purpose financing subsidiary: 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

13

Statements, we have evaluated subsequent events that occurred after the balance sheet date as of September 30, 2012 through the date these financial statements were issued.
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, 2011.
NOTE 2—INVESTMENT PORTFOLIO
The following table summarizes the composition of our investment portfolio at cost and fair value:
 
COST BASIS
FAIR VALUE BASIS
 
September 30, 2012
December 31, 2011
September 30, 2012
December 31, 2011
(dollars in thousands)
Investments
at Cost
% of Total
Portfolio
Investments
at Cost
% of Total
Portfolio
Investments
at Fair Value
% of Total
Portfolio
Investments
at Fair Value
% of Total
Portfolio
Debt Investments
 
 
 
 
 
 
 
 
Senior secured debt
$
333,831

50.4
%
$
551,402

54.2
%
$
324,228

72.9
%
$
492,488

66.4
%
Subordinated debt
 
 
 
 
 
 
 
 
Secured
93,466

14.1

134,721

13.2

79,191

17.8

124,289

16.8

Unsecured
—

—

12,009

1.2

—

—

12,203

1.7

Total debt investments
427,297

64.5

698,132

68.6

403,419

90.7

628,980

84.9

Equity investments
 
 
 
 
 
 
 
 
Preferred
223,337

33.8

297,283

29.3

39,524

8.9

89,931

12.1

Common/common equivalents
11,401

1.7

21,803

2.1

1,850

0.4

22,255

3.0

Total equity investments
234,738

35.5

319,086

31.4

41,374

9.3

112,186

15.1

Total investments
$
662,035

100.0
%
$
1,017,218

100.0
%
$
444,793

100.0
%
$
741,166

100.0
%
Our debt instruments bear contractual interest rates ranging from 2.5% to 16.5%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of September 30, 2012, approximately 89.4% of the fair value of our loan portfolio had variable interest rates, based on a LIBOR benchmark or the prime rate, and 10.6% of the fair value of our loan portfolio had fixed interest rates. As of September 30, 2012, approximately 78.9% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR-based index and prime floors between 1.75% and 6.0%. At origination, our loans generally have four- to eight-year stated maturities. Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and generally will cease recognizing interest income on that loan until all principal and interest has been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.

14

The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status:
 
COST BASIS
FAIR VALUE BASIS
 
September 30, 2012
December 31, 2011
September 30, 2012
December 31, 2011
(dollars in thousands)
Investments
at Cost
% of Loan
Portfolio
Investments
at Cost
% of Loan
Portfolio
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
$
17,860

4.18
%
$
13,963

2.00
%
$
12,317

3.05
%
$
9,615

1.53
%
Not on non-accrual status
—

—

—

—

—

—

—

—

Total loans greater than 90 days past due
$
17,860

4.18
%
$
13,963

2.00
%
$
12,317

3.05
%
$
9,615

1.53
%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
12,902

3.02
%
$
69,241

9.92
%
$
3,709

0.92
%
$
9,704

1.54
%
Greater than 90 days past due
17,860

4.18

13,963

2.00

12,317

3.05

9,615

1.53

Total loans on non-accrual status
$
30,762

7.20
%
$
83,204

11.92
%
$
16,026

3.97
%
$
19,319

3.07
%
The following table summarizes our investment portfolio by industry at fair value:
 
September 30, 2012
December 31, 2011
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
71,887

16.2
%
$
84,660

11.4
%
Business services
61,623

13.9

78,468

10.6

Manufacturing
54,514

12.3

77,849

10.5

Education
38,899

8.7

69,124

9.3

Electronics
33,308

7.5

31,966

4.3

Logistics
29,736

6.7

33,684

4.5

Publishing
28,802

6.5

31,319

4.2

Insurance
26,197

5.9

24,987

3.4

Broadcasting
25,456

5.7

28,185

3.8

Information services
12,395

2.8

21,672

2.9

Home furnishings
11,242

2.5

12,355

1.7

Restaurants
9,295

2.1

18,578

2.5

Agriculture
8,734

2.0

9,464

1.3

Auto parts
7,626

1.7

19,778

2.7

Entertainment
7,312

1.6

7,539

1.0

Cable
5,024

1.1

43,122

5.8

Consumer products
4,684

1.0

4,563

0.6

Communications
1,197

0.3

34,507

4.7

Technology
988

0.2

24,690

3.3

Plastic products
—

—

21,784

2.9

Food services
—

—

28,842

3.9

Repair services
—

—

19,839

2.7

Cosmetics
—

—

8,521

1.2

Other(a)
5,874

1.3

5,670

0.8

Total
$
444,793

100.0
%
$
741,166

100.0
%
______________________
(a)    No individual industry within this category exceeds 1%.
 
 
 
 

15

NOTE 3—FAIR VALUE MEASUREMENT
We account for our investments in portfolio companies under Accounting Standard Codification Topic 820—Fair 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
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 transfers between these levels 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.

16

Assets Measured at Fair Value on a Recurring Basis
The following table presents the assets that we report at fair value on our Consolidated Balance Sheets by fair value hierarchy:
 
September 30, 2012
(in thousands)
Internal Models with Significant
Total Fair Value
Reported in
Consolidated
Balance Sheet
Observable Market Parameters  
(Level 2)
Unobservable
Market Parameters 
(Level 3)
Non-affiliate investments
 
 
 
Senior secured debt
$
68,460

$
174,874

$
243,334

Subordinated secured debt
—

57,780

57,780

Preferred equity
2,717

14,496

17,213

Common/common equivalents
—

1,850

1,850

Total non-affiliate investments
71,177

249,000

320,177

Affiliate investments
 
 
 
Senior secured debt
—

45,208

45,208

Subordinated secured debt
—

10,894

10,894

Preferred equity
—

5,464

5,464

Total affiliate investments
—

61,566

61,566

Control investments
 
 
 
Senior secured debt
—

35,686

35,686

Subordinated secured debt
—

10,517

10,517

Preferred equity
—

16,847

16,847

Total control investments
—

63,050

63,050

Total assets at fair value
$
71,177

$
373,616

$
444,793

As of September 30, 2012, we had no investments that had quoted market prices in active markets, which we would categorize as Level 1 investments under ASC 820. Cash and cash equivalents are carried at cost which approximates fair value and are Level 1 assets.
Valuation Methodologies and Procedures
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 company’s voting 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 company’s equity. Non-affiliate investments represent securities in which we own less than 5% of the portfolio company’s equity.
•
Majority-Owned Control Investments—Majority-owned control investments comprise 11.4% of our investment portfolio as of September 30, 2012. 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 earnings before interest, taxes, depreciation and amortization, or 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 consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.
•
Non-Majority-Owned Control Investments—Non-majority-owned control investments comprise 2.8% of our investment portfolio as of September 30, 2012. For our non-majority-owned control 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

17

market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower.
•
Non-Control Investments—Non-control investments comprise 85.8% of our investment portfolio as of September 30, 2012. Quoted prices are not available for 81.4% of our non-control investments as of September 30, 2012. 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 for which no quoted prices are available, 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 Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of September 30, 2012, these securities represented 16.0% of our investment portfolio. We utilize independent pricing services with certain of our fair value estimates. The majority of our level 2 investments are senior debt investments that are secured and collateralized. To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.
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 or is a new investment made within the last twelve months. In total, as of September 30, 2012, we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve-month period for 92.5% of our investment portfolio, calculated on a fair value basis.
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 sets our valuation policies and procedures and determines the fair value of our investments. The investment and valuation committee of our board of directors meets at least quarterly with our management to review management’s recommendations of fair value of our investments. 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.
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 each of the three and nine months ended September 30, 2012 and 2011, there were no transfers in or out of Level 1, 2 or 3.

18

The following table provides a reconciliation of fair value changes during the three-month period ended September 30, 2012 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 as of June 30, 2012
 
 
 
 
Senior secured debt
$
197,716

$
21,718

$
34,817

$
254,251

Subordinated secured debt
64,655

13,412

10,436

88,503

Preferred equity
14,140

2,662

15,754

32,556

Common/common equivalents equity
1,883

—

—

1,883

Total fair value as of June 30, 2012
278,394

37,792

61,007

377,193

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(10
)
(848
)
857

(1
)
Subordinated secured debt
1,848

(2,239
)
—

(391
)
Preferred equity
310

(517
)
588

381

Common/common equivalents equity
(33
)
(61
)
—

(94
)
Total realized/unrealized gain (loss)
2,115

(3,665
)
1,445

(105
)
Issuances
 
 
 
 
Senior secured debt
945

24,338

12

25,295

Subordinated secured debt
567

70

81

718

Preferred equity
46

3,319

482

3,847

Common/common equivalents equity
—

61

—

61

Total issuances
1,558

27,788

575

29,921

Settlements
 
 
 
 
Senior secured debt
(23,777
)
—

—

(23,777
)
Subordinated secured debt
(9,290
)
(349
)
—

(9,639
)
Preferred equity
—

—

23

23

Total settlements
(33,067
)
(349
)
23

(33,393
)
Fair value as of September 30, 2012
 
 
 
 
Senior secured debt
174,874

45,208

35,686

255,768

Subordinated secured debt
57,780

10,894

10,517

79,191

Preferred equity
14,496

5,464

16,847

36,807

Common/common equivalents equity
1,850

—

—

1,850

Total fair value as of September 30, 2012
$
249,000

$
61,566

$
63,050

$
373,616

There were no purchases of level 3 investments during the three months ended September 30, 2012.

19

The following table provides a reconciliation of fair value changes during the three-month period ended September 30, 2011 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 as of June 30, 2011
 
 
 
 
Senior secured debt
$
252,925

$
41,739

$
93,702

$
388,366

Subordinated secured debt
109,638

12,829

10,363

132,830

Unsecured subordinated debt
14,353

—

—

14,353

Preferred equity
30,610

13,466

86,724

130,800

Common/common equivalents equity
29,192

4,056

—

33,248

Total fair value as of June 30, 2011
436,718

72,090

190,789

699,597

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(1,081
)
9

(6,417
)
(7,489
)
Subordinated secured debt
189

(85
)
59

163

Unsecured subordinated debt
(17
)
—

(87
)
(104
)
Preferred equity
2,659

2,028

(24,024
)
(19,337
)
Common/common equivalents equity
832

(338
)
—

494

Total realized/unrealized gain (loss)
2,582

1,614

(30,469
)
(26,273
)
Purchases
 
 
 
 
Preferred equity
2,000

—

—

2,000

Total purchases
2,000

—

—

2,000

Issuances
 
 
 
 
Senior secured debt
53,748

530

1,971

56,249

Subordinated secured debt
659

161

82

902

Unsecured subordinated debt
75

—

—

75

Preferred equity
380

120

408

908

Common/common equivalents equity
325

—

—

325

Total issuances
55,187

811

2,461

58,459

Settlements
 
 
 
 
Senior secured debt
(23,603
)
(1,737
)
(370
)
(25,710
)
Subordinated secured debt
(9,553
)
—

(139
)
(9,692
)
Unsecured subordinated debt
—

—

87

87

Preferred equity
(212
)
—

(3
)
(215
)
Total settlements
(33,368
)
(1,737
)
(425
)
(35,530
)
Sales
 
 
 
 
Common/common equivalents equity
(65
)
—

—

(65
)
Total sales
(65
)
—

—

(65
)
Fair value as of September 30, 2011
 
 
 
 
Senior secured debt
281,989

40,541

88,886

411,416

Subordinated secured debt
100,933

12,905

10,365

124,203

Unsecured subordinated debt
14,411

—

—

14,411

Preferred equity
35,437

15,614

63,105

114,156

Common/common equivalents equity
30,284

3,718

—

34,002

Total fair value as of September 30, 2011
$
463,054

$
72,778

$
162,356

$
698,188


20

Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized (depreciation) appreciation that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the three months ended September 30, 2012 and 2011.
 
Three months ended September 30, 2012
Three months ended September 30, 2011
(in thousands)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Change in unrealized appreciation (depreciation)
 
 
 
 
 
 
 
 
Senior secured debt
$
(10
)
$
(848
)
$
857

$
(1
)
$
(1,081
)
$
9

$
(6,417
)
$
(7,489
)
Subordinated secured debt
1,983

(2,239
)
—

(256
)
189

(85
)
11,780

11,884

Unsecured subordinated debt
—

—

—

—

(17
)
—

332

315

Preferred equity
310

(517
)
611

404

2,447

2,028

916

5,391

Common/common equivalents equity
(33
)
(61
)
—

(94
)
767

(338
)
1,000

1,429

Total change in unrealized appreciation (depreciation) on Level 3 investments
$
2,250

$
(3,665
)
$
1,468

$
53

$
2,305

$
1,614

$
7,611

$
11,530


21

The following table provides a reconciliation of fair value changes during the nine months ended September 30, 2012 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, 2011
 
 
 
 
Senior secured debt
$
280,371

$
40,572

$
62,615

$
383,558

Subordinated secured debt
100,967

12,967

10,355

124,289

Unsecured subordinated debt
12,203

—

—

12,203

Preferred equity
28,978

12,453

46,293

87,724

Common/common equivalents equity
18,645

3,610

—

22,255

Total fair value December 31, 2011
441,164

69,602

119,263

630,029

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
980

(3,499
)
4,643

2,124

Subordinated secured debt
(1,790
)
(2,053
)
—

(3,843
)
Unsecured subordinated debt
(194
)
—

8

(186
)
Preferred equity
(903
)
2,479

(14,828
)
(13,252
)
Common/common equivalents equity
93

37

—

130

Total realized/unrealized gain (loss)
(1,814
)
(3,036
)
(10,177
)
(15,027
)
Issuances
 
 
 
 
Senior secured debt
4,787

27,935

103

32,825

Subordinated secured debt
9,521

329

241

10,091

Unsecured subordinated debt
172

—

—

172

Preferred equity
415

3,365

1,437

5,217

Common/common equivalents equity
—

61

—

61

Total issuances
14,895

31,690

1,781

48,366

Settlements
 
 
 
 
Senior secured debt
(111,264
)
(19,800
)
(31,675
)
(162,739
)
Subordinated secured debt
(50,918
)
(349
)
(79
)
(51,346
)
Unsecured subordinated debt
(12,181
)
—

(8
)
(12,189
)
Preferred equity
(12,103
)
—

(192
)
(12,295
)
Common/common equivalents equity
(16,844
)
—

—

(16,844
)
Total settlements
(203,310
)
(20,149
)
(31,954
)
(255,413
)
Sales
 
 
 
 
Preferred equity
(1,891
)
(12,833
)
(15,863
)
(30,587
)
Common/common equivalents equity
(44
)
(3,708
)
—

(3,752
)
Total sales
(1,935
)
(16,541
)
(15,863
)
(34,339
)
Fair value as of September 30, 2012
 
 
 
 
Senior secured debt
174,874

45,208

35,686

255,768

Subordinated secured debt
57,780

10,894

10,517

79,191

Unsecured subordinated debt
—

—

—

—

Preferred equity
14,496

5,464

16,847

36,807

Common/common equivalents equity
1,850

—

—

1,850

Total fair value as of September 30, 2012
$
249,000

$
61,566

$
63,050

$
373,616

There were no purchases of level 3 investments during the nine months ended September 30, 2012.

22

The following table provides a reconciliation of fair value changes during the nine-month period ended September 30, 2011 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, 2010
 
 
 
 
Senior secured debt
$
325,874

$
24,207

$
75,714

$
425,795

Subordinated secured debt
121,743

12,348

56,218

190,309

Unsecured subordinated debt
12,321

—

—

12,321

Preferred equity
24,741

13,197

178,357

216,295

Common/common equivalents equity
29,170

3,548

—

32,718

Total fair value December 31, 2010
513,849

53,300

310,289

877,438

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(2,601
)
(145
)
(36,608
)
(39,354
)
Subordinated secured debt
2,714

93

33,706

36,513

Unsecured subordinated debt
223

—

(87
)
136

Preferred equity
7,611

2,073

(78,194
)
(68,510
)
Common/common equivalents equity
2,542

213

—

2,755

Total realized/unrealized gain (loss)
10,489

2,234

(81,183
)
(68,460
)
Purchases
 
 
 
 
Senior secured debt
—

—

11,863

11,863

Preferred equity
2,000

—

4,300

6,300

Common/common equivalents equity
—

123

—

123

Total purchases
2,000

123

16,163

18,286

Issuances
 
 
 
 
Senior secured debt
73,360

21,425

44,185

138,970

Subordinated secured debt
30,253

464

1,143

31,860

Unsecured subordinated debt
1,867

—

—

1,867

Preferred equity
1,580

1,136

12,507

15,223

Common/common equivalents equity
533

62

—

595

Total issuances
107,593

23,087

57,835

188,515

Settlements
 
 
 
 
Senior secured debt
(104,438
)
(4,946
)
(6,268
)
(115,652
)
Subordinated secured debt
(53,777
)
—

(80,702
)
(134,479
)
Unsecured subordinated debt
—

—

87

87

Preferred equity
(212
)
(792
)
(12,171
)
(13,175
)
Common/common equivalents equity
(17
)
(228
)
—

(245
)
Total settlements
(158,444
)
(5,966
)
(99,054
)
(263,464
)
Sales
 
 
 
 
Senior secured debt
(10,206
)
—

—

(10,206
)
Preferred equity
(283
)
—

(41,694
)
(41,977
)
Common/common equivalents equity
(1,944
)
—

—

(1,944
)
Total sales
(12,433
)
—

(41,694
)
(54,127
)
Fair value as of September 30, 2011
 
 
 
 
Senior secured debt
281,989

40,541

88,886

411,416

Subordinated secured debt
100,933

12,905

10,365

124,203

Unsecured subordinated debt
14,411

—

—

14,411

Preferred equity
35,437

15,614

63,105

114,156

Common/common equivalents equity
30,284

3,718

—

34,002

Total fair value as of September 30, 2011
$
463,054

$
72,778

$
162,356

$
698,188


23

Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized (depreciation) appreciation that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the nine months ended September 30, 2012 and 2011.
 
Nine months ended September 30, 2012
Nine months ended September 30, 2011
(in thousands)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Change in unrealized appreciation (depreciation)
 
 
 
 
 
 
 
 
Senior secured debt
$
1,175

$
(3,499
)
$
4,156

$
1,832

$
28,254

$
(145
)
$
(36,608
)
$
(8,499
)
Subordinated secured debt
(1,484
)
(2,053
)
—

(3,537
)
14,742

93

45,563

60,398

Unsecured subordinated debt
81

—

—

81

1,662

—

1,332

2,994

Preferred equity
(62
)
(129
)
(13,759
)
(13,950
)
7,116

2,990

(66,514
)
(56,408
)
Common/common equivalents equity
69

(669
)
—

(600
)
4,320

213

1,000

5,533

Total change in unrealized appreciation (depreciation) on Level 3 investments
$
(221
)
$
(6,350
)
$
(9,603
)
$
(16,174
)
$
56,094

$
3,151

$
(55,227
)
$
4,018

Significant Unobservable Inputs
Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with distinct contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and complex, often factoring in numerous different 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 other inputs too numerous to list quantitatively herein.
The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2012.
($ in thousands)
Fair Value
Valuation Techniques
Unobservable
Inputs
Range
 
Minimum
Maximum
Senior debt
$
255,768

Discounted cash flow
Market interest rate
6.9
%
12.9
%



Discounted cash flow
Discount rate
6.9
%
6.9
%



Market comparable companies
EBITDA multiple(a)
6.0x

7.5x




Pending transactions/Letters of intent
Discount
—
%
—
%
Subordinated debt
79,191

Discounted cash flow
Market interest rate
10.9
%
14.9
%



Market comparable companies
EBITDA multiple(a)
5.0x

7.5x




Pending transactions/Letters of intent
Discount
—
%
—
%
Preferred and common equity
38,657

Market comparable companies
EBITDA multiple(a)
4.4x

11.0x





Discount for minority interest
—
%
25.0
%



Pending transactions/Letters of intent
Discount
—
%
—
%



Residual assets
Discount
—
%
25.0
%
 
$
373,616

 
 
 
 
        
(a) 
EBITDA may include proforma adjustments and/or other addbacks based on specific circumstances related to each investment.

24

NOTE 4—CONCENTRATIONS OF INVESTMENT RISK
During the nine months ended September 30, 2012, we had concentrations in certain industries, including the healthcare, business services and manufacturing industries. The following table summarizes our fair value and revenue concentrations in each of those industries:
 
Investments at fair value
Revenue for the nine months ended
 
September 30, 2012
December 31, 2011
September 30, 2012
September 30, 2011
(dollars in thousands)
Amount
% of Total Portfolio
Amount
% of Total Portfolio
Amount
% of Total Revenue
Amount
% of Total Revenue
Industry
 
 
 
 
 
 
 
 
Healthcare
$
71,887

16.2
%
$
84,660

11.4
%
$
7,023

14.8
%
$
8,287

12.5
%
Business services
61,623

13.9

78,468

10.6

5,658

11.9

7,295

11.0

Manufacturing
54,514

12.3

77,849

10.5

4,348

9.1

3,660

5.5

NOTE 5—BORROWINGS
As of September 30, 2012, we reported $249.1 million of borrowings on our Consolidated Balance Sheets at cost. The following table summarizes our borrowing facilities, the facility amounts and amounts outstanding and contingent borrowing eligibility of Solutions Capital I, L.P., a wholly owned subsidiary, as an SBIC, under the SBIC Act.
 
 
September 30, 2012
December 31, 2011
(dollars in thousands)
Maturity Date
Total
Facility/
Program
Amount
Outstanding
Total
Facility/
Program
Amount
Outstanding
SBIC
 
 
 
 
 
2008-10B
September 2018
$
2,600

$
2,600

$
2,600

$
2,600

2009-10A
March 2019
12,000

12,000

12,000

12,000

2009-10B
September 2019
13,000

13,000

13,000

13,000

2010-10B
September 2020
27,500

27,500

27,500

27,500

2011-10A
March 2021
53,500

53,500

53,500

53,500

2012-10A
March 2022
41,400

41,400

41,400

20,000

Commercial Loan Trust 2006-1
 




 
 
Series 2006-1 Class A-1 Notes
April 2018(a)
—

—

63,389

63,389

Series 2006-1 Class A-2 Notes
April 2018(a)
—

—

2,983

2,983

Series 2006-1 Class A-3 Notes
April 2018(a)
—

—

50,711

50,711

Series 2006-1 Class B Notes
April 2018(a)
38,151

38,151

58,750

58,750

Series 2006-1 Class C Notes(b)
April 2018(a)
45,000

32,000

45,000

32,000

Series 2006-1 Class D Notes(c)
April 2018(a)
45,945

28,902

46,494

29,247

Commercial Loan Funding Trust
 




 
 
Variable Funding Note
January 2014(d)
—

—

150,000

55,822

Private Placement Notes
 




 
 
Series 2007-A
October 2011
—

—

8,717

8,717

Total borrowings
 
$
279,096

$
249,053

$
576,044

$
430,219

    
(a)    Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt. 
(b)    Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.
(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. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.
(d)    On May 15, 2012, this facility was repaid in full and terminated.
We estimate that the fair value of these borrowings as of September 30, 2012 was approximately $264.6 million, based on market data and current interest rates. This fair value is estimated from market quotes in an inactive market provided

25

by an independent pricing service for $93.6 million of our borrowings (level 2) and a market-yield approach for $171.0 million (level 3) of our borrowings.
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 ratio 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 September 30, 2012, our ratio of total assets to total borrowings and other senior securities was 481%.
We have funded our current secured borrowing debt facility through a bankruptcy remote, special-purpose, wholly owned subsidiary. Therefore, this subsidiary’s assets may not be available to our creditors. In some cases, advances under our secured debt facility are subject to certain collateral levels, collateral quality, leverage and other restrictive covenants. We continue to service those portfolio investments that we use as collateral in our secured borrowing facility.
The following table summarizes repayments of our borrowings based on the final legal maturity or the contractual principal collections of the outstanding loans that comprise the collateral, where applicable. Actual repayments could differ significantly due to future prepayments by our borrowers, modifications of our borrowers’ existing loan agreements, and monetizations.
(in thousands)
September 30, 2012
2012(a)
$
1,000

2013
—

2014
—

2015
—

2016
—

Thereafter
248,053

Total
$
249,053

     
(a) 
Reflects repayments we are required to make in connection with principal collections from collateral loans in our Commercial Loan Trust 2006-1.
SBIC Debentures
In December 2004, we formed a wholly owned subsidiary, Solutions Capital I, L.P., or Solutions Capital. Solutions Capital has a license from the SBA to operate as an SBIC under the SBIC Act. The license gave Solutions Capital the ability to borrow from the SBA up to $150.0 million, which is the maximum amount of outstanding leverage available to single-license SBIC companies.
To realize the full $150.0 million in borrowings for which we have received approval under this program, we have funded a total of $75.0 million to Solutions Capital. As of September 30, 2012 and December 31, 2011, Solutions Capital had borrowed $150.0 million and $128.6 million, respectively. We may use these funds to provide debt and equity capital to qualifying small businesses. However, we may not use these borrowings to originate debt to certain companies that are currently in our portfolio without SBA approval. In addition, we may not use these funds to provide working capital to MCG, Solutions Capital's parent company.
As of September 30, 2012 and December 31, 2011, we had $132.3 million and $182.4 million, respectively, of investments in our SBIC and we had $108.5 million and $28.8 million, respectively, of restricted cash to be used for additional investments in our SBIC.

26

Once drawn, the SBIC debt bears an interim interest rate of LIBOR plus 30 basis points. The rate then becomes fixed at the time of SBA pooling, which occurs twice each year, and is set to the then-current 10-year treasury rate plus a spread and an annual SBA charge. As of September 30, 2012, the SBIC had borrowings outstanding as summarized in the following table:
 
Amount Outstanding
 
(dollars in thousands)
September 30, 2012
December 31, 2011
Rate
Tranche
 
 
 
 
2008-10B
$
2,600

$
2,600

6.44
%
Fixed
2009-10A
12,000

12,000

5.34
%
Fixed
2009-10B
13,000

13,000

4.95
%
Fixed
2010-10B
27,500

27,500

3.93
%
Fixed
2011-10A
53,500

53,500

4.80
%
Fixed
2012-10A
41,400

20,000

3.38
%
Fixed
Total
$
150,000

$
128,600

4.33
%
 
In October 2008, we received exemptive relief from the SEC which allows us to exclude debt issued by Solutions Capital from the calculation of our consolidated BDC asset coverage ratio.
Commercial Loan Trust 2006-1
In April 2006, we completed a $500.0 million debt securitization through the Commercial Loan Trust 2006-1, or 2006-1 Trust, 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 were issued with interest at LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%.
All of the notes are secured by the assets of the 2006-1 Trust. The following table summarizes the fair value of the assets securitized under this facility as of September 30, 2012 and December 31, 2011:
(dollars in thousands)
September 30, 2012
December 31, 2011
 
Amount
%
Amount
%
Securitized assets
 
 
 
 
Senior secured debt
$
149,046

81.5
%
$
258,722

78.9
%
Subordinated secured debt
29,882

16.3

43,640

13.3

Common Equity
352

0.2

282

0.1

Total securitized assets
179,280

98.0

302,644

92.3

Cash, securitization accounts
3,675

2.0

25,195

7.7

Total collateral
$
182,955

100.0
%
$
327,839

100.0
%
We retain all of the equity in the securitization. The securitization included a five-year reinvestment period, which ended in July 2011.
The outstanding Class B, Class C and Class D Notes are term notes. The Class A-2 Notes initially provided for a five-year revolving period, which has expired. Therefore, we may not draw on the Class A-2 Notes. The Class A-3 Notes were a delayed draw class of secured notes, which were drawn in full between July 2006 and April 2007. 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.
Commercial Loan Funding Trust
Through the MCG Commercial Loan Funding Trust, we had a warehouse financing facility funded through SunTrust Bank. On May 15, 2012, we repaid in full the remaining $34.5 million balance and terminated the facility and recognized

27

$0.8 million of deferred financing fees in interest expense. The SunTrust Warehouse was secured primarily by MCG Commercial Loan Funding Trust’s assets, including commercial loans that we sold to the trust.
In January 2012, we entered into an amendment to the SunTrust Warehouse, which, among other things, accelerated the scheduled termination date to January 17, 2012 and set the final legal maturity of this facility to January 17, 2014. In connection with the execution of the amendment, we paid an amendment fee of $0.5 million and recognized in interest expense approximately $1.5 million of accelerated deferred financing fees.
PRIVATE PLACEMENT NOTES
In October 2007, we issued $25.0 million of Series 2007-A unsecured notes with a five-year maturity. Initially, the Series 2007-A notes bore interest at a 6.71% per annum, which rate was increased in 2009 to 8.96% per annum. In January 2012, we repaid the Series 2007-A notes in full.
NOTE 6—CAPITAL 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.
STOCK REPURCHASE PROGRAM
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million. Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. During the three months ended September 30, 2012, we repurchased 1,252,410 shares of our common stock at a weighted average purchase price of $4.49 per share, which was a 14.7% discount from our quarterly net asset value per share. During the nine months ended September 30, 2012, we repurchased 5,119,886 shares of our common stock at a weighted average purchase price of $4.38 per share, which was a 19.7% discount from our quarterly net asset value per share.
DISTRIBUTIONS
The following table summarizes our distributions per share declared since January 1, 2011:
Date Declared
Record Date
Payment Date
Amount
October 26, 2012
November 16, 2012
November 30, 2012
$
0.125

July 27, 2012
August 17, 2012
August 31, 2012
$
0.140

April 27, 2012
June 13, 2012
July 13, 2012
$
0.140

February 24, 2012
April 13, 2012
May 15, 2012
$
0.170

October 31, 2011
December 15, 2011
January 13, 2012
$
0.170

August 1, 2011
September 14, 2011
October 14, 2011
$
0.170

May 5, 2011
June 15, 2011
July 15, 2011
$
0.170

March 1, 2011
March 15, 2011
April 15, 2011
$
0.150


28

NOTE 7—SHARE-BASED COMPENSATION
EMPLOYEE SHARE-BASED COMPENSATION
Third Amended and Restated 2006 Employee Restricted Stock Plan
From time to time, we award shares of restricted common stock to employees under our Third Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, which our stockholders initially approved in June 2006. In May 2010, our stockholders approved an amendment to the 2006 Plan increasing the number of shares we may award from 3,500,000 to 6,050,000 shares. Shares of restricted common stock awarded under the 2006 Plan may be subject to the employees' meeting service or performance conditions specified at the time of award. The award date is the date on which the shares are awarded by the Compensation Committee of our board of directors, while the fair value of the respective stock award is based on the closing price of our common stock on the NASDAQ Global Select Market on the award date. We amortize restricted stock awards on a straight-line basis over the requisite service period and report this expense as amortization of employee restricted stock awards on our Consolidated Statements of Operations.
During the nine months ended September 30, 2012 and 2011, we issued 1,000,000 shares and 726,250 shares, respectively, of restricted stock under the 2006 Plan with a weighted-average fair value per share of common stock at the award date of $4.43 and $6.16, respectively.
During the nine months ended September 30, 2012 and 2011, we recognized $1.7 million and $1.4 million, respectively, of compensation expense related to share-based compensation awards. As of September 30, 2012, all the restricted share awards for which forfeiture provisions had not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares. As of September 30, 2012, we had $4.7 million of unrecognized compensation cost related to restricted common stock awarded to employees. We expect to recognize these costs over the remaining weighted-average requisite service period of 3.3 years.
Long-Term Incentive Plan
On July 23, 2009, our board of directors approved the Long-Term Incentive Plan, or the LTIP, which was effective for the three-year period ending July 22, 2012. LTIP participants, including our executive officers and key, non-executive employees, received 862,917 shares of our restricted common stock issued under the 2006 Plan and $3.0 million of cash bonuses upon the achievement of specific stock price thresholds. The plan expired on July 22, 2012 and no additional stock or cash awards can be issued under the LTIP. During each of the nine months ended September 30, 2012 and 2011, we recognized less than $0.1 million of compensation expense for the equity 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. In May 2010, our stockholders approved an amendment to the 2006 Non-Employee Plan that increased the number of shares we may award to non-employee members of our board of directors from 100,000 to 150,000 shares. During the nine months ended September 30, 2012 and 2011, we awarded 22,500 and 15,000 shares, respectively, of restricted common stock to non-employee directors. During each of the nine months ended September 30, 2012 and 2011, we recognized less than $0.1 million of compensation costs related to share-based awards to non-employee directors. We include this compensation cost in general and administrative expense on our Consolidated Statements of Operations. As of September 30, 2012, 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 2.1 years.

29

SUMMARY OF EMPLOYEE AND NON-EMPLOYEE DIRECTOR SHARE-BASED COMPENSATION
The following table summarizes our restricted stock award activity during the nine months ended September 30, 2012:
 
Shares
Weighted-Average
Grant Date
Fair Value per Share
Subject to forfeiture provisions as of December 31, 2011
430,510

$
6.14

Awarded
1,022,500

$
4.43

Forfeiture provision satisfied
(247,505
)
$
5.42

Forfeited
(35,355
)
$
6.87

Subject to forfeiture provisions as of September 30, 2012
1,170,150

$
4.72

NOTE 8—CORPORATE RESTRUCTURING AND 2011 RETENTION PLAN
Corporate Restructuring
On August 1, 2011, our board of directors approved a plan to reduce our workforce by 42%, including 22 current employees and 5 resignations. Affected employees received severance pay, continuation of benefits and, for employees who had been awarded restricted stock, additional lapsing of restrictions associated with restricted stock awards. We have accounted for these costs in accordance with ASC 420-10-Exit or Disposal Cost Obligations.
During the nine months ended September 30, 2012, we incurred $59,000 of restructuring expenses related to severance obligations, which we reported as a separate line item on our Consolidated Statements of Operations.
We included liabilities associated with our restructuring in other liabilities on our Consolidated Balance Sheets. The following table summarizes changes in the balance of our restructuring liabilities from January 1, 2012 through September 30, 2012:
(in thousands)
Severance
Benefits(a)
Other
Total
Balance as of December 31, 2011
$
2,472

$
54

$
2,526

Additions
—

—

—

Accretion
55

—

55

Cash payments
(1,674
)
(24
)
(1,698
)
Balance as of September 30, 2012
$
853

$
30

$
883

(a)    Includes the cost of severance and continuation of benefits.
2011 Retention Program
On August 1, 2011, our board of directors approved the MCG Capital Corporation 2011 Retention Program, or the Retention Program, for the benefit of our employees, including one of our named executive officers, but excluding our then: i) President and Chief Executive Officer; ii) Executive Vice President and Chief Financial Officer; iii) Executive Vice President of Business Development; and iv) Senior Vice President, General Counsel and Chief Compliance Officer. We designed the Retention Program to provide eligible employees with certain incentives related to their past service and continuing employment with MCG. The Retention Program consisted of an aggregate of $1.3 million in cash and up to 121,250 shares of restricted common stock.
Under the Retention Program, we awarded a cash bonus to eligible employees, representing a specified percentage of each eligible employee's respective annual cash bonus target for the fiscal year ending December 31, 2011. We paid half of the incentive bonus to eligible employees on March 31, 2012 and paid the remaining amount on September 30, 2012. Certain participating employees also received shares of restricted common stock that were issued under the 2006 Plan. The forfeiture provisions with respect to 50% of the shares of restricted common stock subject to each Retention Program award lapsed on March 31, 2012 and the remaining 50% lapsed on September 30, 2012.

30

NOTE 9—INCOME 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. 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 basis of assets and liabilities. In addition, we recognize deferred tax benefits associated with net operating carryforwards that we may use to offset future tax obligations. We measure deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences. During the nine months ended September 30, 2012, we recorded a $0.3 million income tax provision, which was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries. During the nine months ended September 30, 2011, we recorded less than a $0.1 million income tax provision.
On December 22, 2010, the Regulated Investment Company Modernization Act of 2010, or the Modernization Act, was enacted, which changed various technical rules governing the tax treatment of regulated investment companies. The changes are generally effective for taxable years beginning after the date of enactment. One of the more prominent changes addresses capital loss carryforwards. Under the Modernization Act, each RIC will be permitted to carry forward capital losses incurred in taxable years beginning after the date of enactment for an unlimited period. However, any losses incurred during those future taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to expire unused. Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short-term as permitted under previous regulation.
From December 2001 through September 30, 2012, we declared distributions per share of $13.26. 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 2011, 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. If we determined the tax attributes of our distributions as of September 30, 2012, 5% would be from ordinary income and 95% would be a return of capital. 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.
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.

31

NOTE 10—EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted income (loss) per common share for the three and nine months ended September 30, 2012 and 2011:
(dollars in thousands, except per share amounts)
Three months ended September 30,
Nine months ended September 30,
 
2012
2011
2012
2011
Numerator for basic and diluted earnings per share
 
 
 
 
Net income (loss)
$
4,266

$
(25,109
)
$
(1,414
)
$
(44,142
)
Less: Dividends declared—common and restricted shares
(10,274
)
(13,101
)
(33,793
)
(37,784
)
Undistributed loss
(6,008
)
(38,210
)
(35,207
)
(81,926
)
Percentage allocated to common shares(a)
98.3
%
100.0
%
100.0
%
100.0
%
Undistributed earnings—common shares
(5,906
)
(38,210
)
(35,207
)
(81,926
)
Add: Dividends declared—common shares
10,099

13,101

33,793

37,784

Numerator for common shares outstanding excluding participating shares
4,193

(25,109
)
(1,414
)
(44,142
)
Numerator for participating unvested shares only
73

—

—

—

Numerator for basic and diluted earnings per share—total
$
4,266

$
(25,109
)
$
(1,414
)
$
(44,142
)
Denominator for basic and diluted weighted-average shares outstanding
 
 
 
 
Common shares outstanding
72,205

76,404

74,588

76,173

Participating unvested shares(b)
1,226

—

—

—

Basic and diluted weighted-average common shares outstanding—total(b)
73,431

76,404

74,588

76,173

Earnings (loss) per share—basic and diluted
 
 
 
 
Excluding participating unvested shares
$
0.06

$
(0.33
)
$
(0.02
)
$
(0.58
)
Including participating unvested shares
$
0.06

$
(0.33
)
$
(0.02
)
$
(0.58
)
(a)    Basic and diluted weighted-average common shares:
 
 
 
 
Weighted-average common shares outstanding
72,205

76,404

74,588

76,173

Weighted-average restricted shares
1,226

—

—

—

Total basic and diluted weighted-average common shares
73,431

76,404

74,588

76,173

Percentage allocated to common shares
98.3
%
100.0
%
100.0
%
100.0
%
(b)    For the three months ended September 30, 2011 and for the nine months ended September 30, 2012 and 2011, we excluded 654, 1,031 and 813, respectively, of 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 in periods with net income. Pursuant to the two-class method, we report basic and diluted loss per share both inclusive and exclusive of the impact of the participating securities.
NOTE 11—CONTINGENCIES AND COMMITMENTS
LEGAL PROCEEDINGS
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.
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

32

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 September 30, 2012 and December 31, 2011, we had $21.3 million and $22.6 million, respectively, of outstanding unused loan commitments. We estimate that as of each of September 30, 2012 and December 31, 2011, 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. As of September 30, 2012 and December 31, 2011, we had no outstanding guarantees or standby letters of credit.
LEASE OBLIGATIONS
We lease our headquarters and certain other facilities and equipment under non-cancelable operating and capital leases which expire through 2014. We have sublet certain of our facilities to third parties. The lease on our headquarters office space in Arlington, Virginia will expire in February 2013. In August 2012, we entered into a lease agreement for new office space in Arlington, Virginia. The new lease term is from October 2012 to November 2014 with a base rent of $0.4 million per year. The base rent will not increase during the term of the new lease. As of September 30, 2012, our obligation for the remaining terms of these leases was $1.8 million, of which $1.3 million will be payable during the next twelve months.

33

NOTE 12—FINANCIAL HIGHLIGHTS
The following schedule summarizes our financial highlights for the nine months ended September 30, 2012 and 2011:
 
Nine months ended
(in thousands, except per share amounts)
September 30
 
2012
2011
Per share data
 
 
Net asset value at beginning of period(a)
$
5.65

$
7.54

Net income (loss)(b)


 
Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
0.18

0.40

Net unrealized appreciation (depreciation) on investments
0.79

—

Net realized (loss) gain on investments
(0.98
)
(0.97
)
Loss on extinguishment of debt before income tax provision
—

(0.01
)
Income tax provision
(0.01
)
—

Net income (loss)
(0.02
)
(0.58
)
Net decrease in net assets resulting from distributions
(0.45
)
(0.49
)
Net decrease in net assets relating to stock-based transactions


 
Issuance of shares of restricted common stock(c)
(0.07
)
(0.05
)
Repurchase of common stock
0.06

—

Net increase in stockholders’ equity from restricted stock amortization
0.03

0.02

Net decrease in net assets relating to share issuances
0.02

(0.03
)
Net asset value at end of period(a)
5.20

6.44

Market price per share

 
Beginning of period
$
3.99

$
6.97

End of period
$
4.61

$
3.96

Total Return(d)
31.08
 %
-36.59
 %
Shares of Common Stock Outstanding(d)


 
Weighted-average—basic and diluted
74,588

76,173

End of period
72,788

77,035

Net assets


 
Average
$
406,263

$
549,377

End of period
$
378,740

$
496,481

Ratios (annualized)


 
Operating expenses to average net assets
11.14
 %
8.77
 %
Net operating income to average net assets
4.50
 %
7.35
 %
General and administrative expense to average net assets
3.52
 %
2.22
 %
Return on average equity
-0.46
 %
-10.74
 %
    
(a)    Based on total number of shares outstanding.
 
 
(b)    Based on weighted-average number of shares outstanding.
 
 
(c)    Represents the effects of shares issued during the period and the lapsing of forfeiture provisions on restricted stock on earnings per share.
(d)    Total return = [(ending market price per share – beginning market price per share + dividends paid per share) / beginning market price per share].


34

Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
MCG Capital Corporation
We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation, including the consolidated schedule of investments, as of September 30, 2012, the related consolidated statements of operations, for the three- and nine- month periods ended September 30, 2012 and 2011, and the related consolidated statements of changes in net assets, cash flows and financial highlights for the nine- month periods ended September 30, 2012 and 2011. These financial statements are the responsibility of MCG Capital Corporation’s 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, 2011, 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 1, 2012 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, 2011, 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
October 29, 2012


35

ITEM 2. MANAGEMENT’S 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 Management's 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, net investment losses and general and administrative expenses and the factors that may affect such results; our use of independent valuation firms to provide additional support for our internal analysis; our expectations regarding the full use before expiration of certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments; the timing of our transition and move to a new corporate headquarters; potential cost reductions and efficiencies to be gained from changing internal investment software systems; projected future annual base compensation and benefits levels and annual non-compensation cost structure amounts; expected levels of transition plan and realignment costs; forecasted 2012 and 2013 per share net operating income amounts, which may not be realized; the limitation of future investing activities principally to debt investments; our level of investments in control companies beyond those that are currently in our portfolio; our decisions to make dividend distributions after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our BDC asset coverage ratio; our intentions to purchase debt for cash in open markets purchases and/or privately-negotiated transactions; the timing or approval of a second SBIC license by the SBA; the sufficiency of liquidity to meet 2012 operating requirements, as well as new origination opportunities and potential dividend distributions during the upcoming year; 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.
DESCRIPTION OF BUSINESS
We are a solutions-focused commercial finance company providing capital and advisory services to middle-market companies throughout the United States. For our core portfolio, 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 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, excluding SBIC debt.
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 distributions, 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

36

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
•
Board and Management Changes — On October 29, 2012, we announced the election on October 26, 2012 of B. Hagen Saville as our new President and Chief Executive Officer, effective as of November 1, 2012. Mr. Saville succeeds Richard W. Neu, who will remain as Chair of the Company's Board of Directors. Mr. Saville has been the Company's President and Chief Operating Officer since October 2011, before which he was Executive Vice President of Business Development from March 1998 to October 2011. Mr. Saville co-founded the Company in March 1998 and earlier in his career worked in both commercial and investment banking. He became a member of the Board in 2006. In addition, Board members A. Hugh Ewing, III and Wallace B. Millner, III have tendered their resignations effective December 31, 2012, at which point the Board will be reduced from seven members to five.
•
Equity Monetizations — For the three and nine month periods ended September 30, 2012, we received $0.3 million and $64.4 million, respectively, in proceeds from the sale of equity investments, principally the sale of securities in each of Orbitel Holdings, LLC, Stratford School Holdings, Inc., GSDM Holdings, LLC and Jenzabar, Inc.
•
Loan Monetizations — For the three and nine month periods ended September 30, 2012, we received $38.9 million and $266.9 million, respectively, in loan payoffs and amortization payments.
•
Originations and Advances — For the three and nine month periods ended September 30, 2012, we made $30.3 million and $48.1 million, respectively, in originations and advances to new and existing portfolio companies.
•
Open-Market Purchases of Our Stock — During the three months ended September 30, 2012, we repurchased 1,252,410 shares of our common stock at a weighted average purchase price of $4.49 per share. During the nine months ended September 30, 2012, we repurchased 5,119,886 shares of our common stock at a weighted average purchase price of $4.38 per share. We acquired these shares from sellers in open market transactions. We retire these shares upon settlement, thereby reducing the number of shares issued and outstanding.
•
Operational Realignment — During the three months ended September 30, 2012, we incurred costs associated with our transition plan of $0.2 million, consisting of $0.1 million in retention and inducement payments that we recorded as salaries and benefits and $0.1 million in severance related expenses that we recorded as general and administrative expense. For the nine months ended September 30, 2012, we incurred $7.2 million, or $0.10 per share, of costs associated with our transition plan. Upon completion of the transition service periods for several of our employees, we anticipate completing our staff realignment such that we will have approximately 20 full-time employees. As of October 15, 2012, we had 23 full-time employees and one part-time employee.
•
Liquidity and De-Leveraging Actions — In the third quarter, we continued to reduce our leverage by using $90.7 million of securitized cash to repay borrowings under our Commercial Loan Trust 2006-1. As of September 30, 2012, our debt to equity ratio was less than 0.7x and our asset coverage ratio was 481% excluding our small business investment company, or SBIC, debt which is exempt from the asset coverage ratio requirements under an SEC exemptive order.
OUTLOOK
As previously announced, we anticipate being substantially complete with our transition by the end of 2012, including moving to our new corporate office in November 2012. We are also evaluating a change to our internal investment software systems that we believe will help us further simplify our back office function and reduce the associated long-term carrying cost.
Excluding any residual transition costs and the costs that may be associated with running two information technology systems in parallel for part of 2013, we have finalized and reconfirmed our previous targets to operate with future annual base compensation and benefits levels within our expected targeted range of approximately $4.0 million to

37

$5.0 million and we have identified specific cost reductions that we expect will result in an embedded annual non-compensation cost structure of approximately $5.0 million to $5.5 million.
In the next six months, we anticipate potentially recording approximately $1.8 million, or $0.03 per share, in additional charges related to the final stage of our realignment process, comprised of an estimated $0.3 million related to the termination of our existing corporate lease, $0.6 million to write-off leasehold improvements and other abandoned or obsolete fixed assets, $0.5 million related to the possible termination of a software contract and $0.4 million for staff realignment decisions.
Driven by a pickup in origination activity relative to the level of monetizations projected throughout 2013, combined with the full deployment of liquidity, we continue to anticipate a 2013 NOI earnings level of $.45 to $.55 per share.  Furthermore, in the third quarter ended September 30, 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  There is no assurance that the SBA will grant the additional license in any specified time period or at all.
ACCESS TO CAPITAL AND LIQUIDITY
At September 30, 2012, we had $65.9 million of cash and cash equivalents available for general corporate purposes, as well as $107.7 million of cash in restricted accounts related to our SBIC that we could use to fund new investments in the SBIC and $5.9 million of restricted cash held in escrow. In addition, we had $3.7 million of cash in securitization accounts, that may only be used to make interest and principal payments on our securitized borrowings or distributions to MCG in accordance with the indenture agreement.
At September 30, 2012, cash in securitization accounts included $0.8 million in the principal collections account of our Commercial Loan Trust 2006-1. In October 2012, we used $1.0 million of securitized cash, including $0.2 million collected in October 2012, to repay borrowings of our Commercial Loan Trust 2006-1. The reinvestment period for this facility ended on July 20, 2011 and all subsequent principal collections received have been, and will be, used to repay the securitized debt.
At September 30, 2012, $150.0 million of United States Small Business Administration, or SBA, borrowings were outstanding, the maximum available under our current SBIC license.
PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY
As of September 30, 2012, the fair value of our investment portfolio was $444.8 million, which represents a $296.4 million, or 40.0%, decrease from the $741.2 million fair value as of December 31, 2011. The following sections describe the composition of our investment portfolio as of September 30, 2012 and describe key changes in our portfolio during the nine months ended September 30, 2012.
Portfolio Composition
The following table summarizes the composition of our investment portfolio at fair value:
 
September 30, 2012
December 31, 2011
(dollars in thousands)
Investments at
Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Debt investments
 
 
 
 
Senior secured debt
$
324,228

72.9
%
$
492,488

66.4
%
Subordinated debt
 
 
 
 
Secured
79,191

17.8

124,289

16.8

Unsecured
—

—

12,203

1.7

Total debt investments
403,419

90.7

628,980

84.9

Equity investments
 
 
 
 
Preferred equity
39,524

8.9

89,931

12.1

Common/common equivalents equity
1,850

0.4

22,255

3.0

Total equity investments
41,374

9.3

112,186

15.1

Total investments
$
444,793

100.0
%
$
741,166

100.0
%

38

Our debt instruments bear contractual interest rates ranging from 2.5% to 16.5%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of September 30, 2012, approximately 89.4% of the fair value of our loan portfolio had variable interest rates, based on a LIBOR benchmark or the prime rate, and 10.6% of the fair value of our loan portfolio had fixed interest rates. As of September 30, 2012, approximately 78.9% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR based index and prime floors between 1.75% 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.
The following table summarizes our investment portfolio by industry at fair value:
 
September 30, 2012
December 31, 2011
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
71,887

16.2
%
$
84,660

11.4
%
Business services
61,623

13.9

78,468

10.6

Manufacturing
54,514

12.3

77,849

10.5

Education
38,899

8.7

69,124

9.3

Electronics
33,308

7.5

31,966

4.3

Logistics
29,736

6.7

33,684

4.5

Publishing
28,802

6.5

31,319

4.2

Insurance
26,197

5.9

24,987

3.4

Broadcasting
25,456

5.7

28,185

3.8

Information services
12,395

2.8

21,672

2.9

Home furnishings
11,242

2.5

12,355

1.7

Restaurants
9,295

2.1

18,578

2.5

Agriculture
8,734

2.0

9,464

1.3

Auto parts
7,626

1.7

19,778

2.7

Entertainment
7,312

1.6

7,539

1.0

Cable
5,024

1.1

43,122

5.8

Consumer products
4,684

1.0

4,563

0.6

Communications
1,197

0.3

34,507

4.7

Technology
988

0.2

24,690

3.3

Plastic products
—

—

21,784

2.9

Food services
—

—

28,842

3.9

Repair services
—

—

19,839

2.7

Cosmetics
—

—

8,521

1.2

Other(a)
5,874

1.3

5,670

0.8

Total
$
444,793

100.0
%
$
741,166

100.0
%
______________________
(a)    No individual industry within this category exceeds 1%.
 
 
 
 
As of September 30, 2012, our ten largest portfolio companies represented approximately 54.3% of the total fair value of our investments. These ten companies accounted for 38.7% of our total revenue during the nine months ended September 30, 2012.
During the nine months ended September 30, 2012, we had concentrations in certain industries, including the healthcare, business services and manufacturing industries. The following table summarizes our fair value and revenue concentrations in each of those industries:
 
Investments at fair value
Revenue for the nine months ended
 
September 30, 2012
December 31, 2011
September 30, 2012
September 30, 2011
(dollars in thousands)
Amount
% of Total Portfolio
Amount
% of Total Portfolio
Amount
% of Total Revenue
Amount
% of Total Revenue
Industry
 
 
 
 
 
 
 
 
Healthcare
$
71,887

16.2
%
$
84,660

11.4
%
$
7,023

14.8
%
$
8,287

12.5
%
Business services
61,623

13.9

78,468

10.6

5,658

11.9

7,295

11.0

Manufacturing
54,514

12.3

77,849

10.5

4,348

9.1

3,660

5.5


39

Changes in Investment Portfolio
During the nine months ended September 30, 2012, we completed $48.1 million of originations and advances including $4.8 million of advances to three existing portfolio companies, compared to $270.5 million of originations and advances during the nine months ended September 30, 2011. The following table summarizes our total portfolio investment activity during the nine months ended September 30, 2012 and 2011:
 
Nine months ended
(in thousands)
September 30
 
2012
2011
Beginning investment portfolio
$
741,166

$
1,009,705

Originations and advances
48,070

270,505

Gross payments, reductions and sales of securities
(331,256
)
(368,937
)
Net gain (loss)
(73,368
)
(73,348
)
Unrealized (depreciation)
(15,903
)
(69,332
)
Reversals of unrealized (appreciation) depreciation
74,713

69,231

Origination fees and amortization of unearned income
1,371

(13,651
)
Ending investment portfolio
$
444,793

$
824,173

Originations and Advances
The following table shows our originations and advances during the nine months ended September 30, 2012 and 2011 by security type:
 
Nine months ended September 30,
 
2012
2011
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
Senior secured debt
$
32,174

66.9
%
$
224,300

82.9
%
Subordinated debt
 
 
 
 
Secured
9,618

20.0

31,368

11.6

Unsecured
70

0.2

1,884

0.7

Total debt investments
41,862

87.1

257,552

95.2

Equity investments
 
 
 
 
Preferred equity
6,147

12.8

12,444

4.6

Common/common equivalents equity
61

0.1

509

0.2

Total equity investments
6,208

12.9

12,953

4.8

Total originations and advances
$
48,070

100.0
%
$
270,505

100.0
%

40

The following table shows our significant originations and advances:
(in thousands)
Nine months ended
 
September 30, 2012
Company
Originations
Draws/
Advances
PIK Advances/ Dividends
Total
Debt
 
 
 
 
IDOC, LLC
$
15,000

$
—

$
—

$
15,000

C7 Data Centers, Inc.
10,000

—

—

10,000

South Bay Mental Health Center, Inc.
8,079

—

97

8,176

Advanced Sleep Concepts, Inc.
—

3,500

115

3,615

Education Management, Inc.
—

1,000

680

1,680

Other (< $1 million)
—

300

3,091

3,391

Total debt
33,079

4,800

3,983

41,862

Equity
 
 
 
 
C7 Data Centers, Inc.
$
2,000

$
—

$
—

$
2,000

RadioPharmacy Investors, LLC
—

—

1,437

1,437

IDOC, LLC
999

—

13

1,012

Other (< $1 million)
368

—

1,391

1,759

Total Equity
3,367

—

2,841

6,208

Total originations and advances
$
36,446

$
4,800

$
6,824

$
48,070

Repayments, Sales and Other Reductions of Investment Portfolio
The following table shows our gross payments, reductions and sales of securities during the nine months ended September 30, 2012 and 2011 by security type:
 
Nine months ended September 30,
 
2012
2011
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
 
 
 
 
 
Senior secured debt
$
203,331

61.4
%
$
224,375

60.8
%
Subordinated debt
 
 
 
 
Secured
51,347

15.5

86,186

23.4

Unsecured
12,189

3.7

142

—

Total debt investments
266,867

80.6

310,703

84.2

Equity investments
 
 
 
 
Preferred equity
43,792

13.2

56,045

15.2

Common/common equivalents equity
20,597

6.2

2,189

0.6

Total equity investments
64,389

19.4

58,234

15.8

Total gross payments, reductions and sales of securities
$
331,256

100.0
%
$
368,937

100.0
%
During the nine months ended September 30, 2012 and 2011, our gross payments, reductions and sales of securities by transaction type included:  
 
Nine months ended September 30,
(in thousands)
2012
2011
Principal repayments, reductions and loan sales
$
232,809

$
251,817

Sale of equity investments
56,241

45,879

Scheduled principal amortization
25,548

38,764

Collection of accrued paid-in-kind interest and dividends
16,658

32,477

Total gross payments, reductions and sales of securities
$
331,256

$
368,937


41

As shown in the following table, during the nine months ended September 30, 2012, we monetized all, or part of, 19 portfolio investments with proceeds totaling $300.6 million:
 
Nine months ended
 
September 30, 2012
(in thousands)
Principal Repayments and Proceeds from Loan Sales
Sale or Settlement of Equity Investments
PIK Interest and Dividend Prepayments
Total
Monetizations
 
 
 
 
GSDM Holdings, Corp.
$
25,552

$
6,105

$
2,745

$
34,402

Stratford School Holdings, Inc.
17,500

16,370

171

34,041

Orbitel Holdings, LLC
17,775

12,934

2,929

33,638

Coastal Sunbelt Holding, Inc.
27,411

—

1,288

28,699

Jenzabar, Inc.
—

20,542

3,158

23,700

Metropolitan Telecommunications Holding Company
21,770

—

—

21,770

Qualawash Holdings, LLC
20,000

—

—

20,000

Xpressdocs Holdings, Inc.
17,855

—

707

18,562

Haws Corporation
16,500

—

—

16,500

The Matrixx Group, Incorporated
12,500

—

—

12,500

Service Champ, Inc.
11,693

—

488

12,181

Bentley Systems, Incorporated
9,900

—

—

9,900

Focus Brands, Inc.
9,235

—

—

9,235

Data Based Systems International, Inc.
9,000

—

213

9,213

Sally Holdings LLC
7,307

—

—

7,307

Tank Intermediate Holdings Corp.
4,868

—

—

4,868

Ozburn-Hessey Holding Company LLC
3,943

—

—

3,943

Coastal Sunbelt Real Estate, Inc.
—

53

—

53

Philadelphia Media Network, Inc.
—

44

—

44

Total monetizations
232,809

56,048

11,699

300,556

Other scheduled payments
25,548

193

4,959

30,700

Total gross payments, sales and other reductions of investment portfolio
$
258,357

$
56,241

$
16,658

$
331,256

The proceeds from 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

42

The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of September 30, 2012 and December 31, 2011:
(dollars in thousands)
September 30, 2012
December 31, 2011
Investment
Rating
Investments at
Fair Value
% of Total
Portfolio
Investments at
Fair Value
% of Total 
Portfolio
1(a)
$
132,195

29.7
%
$
283,755

38.3
%
2
145,917

32.8

290,583

39.2

3
139,685

31.4

142,639

19.2

4
20,824

4.7

11,683

1.6

5
6,172

1.4

12,506

1.7

Total
$
444,793

100.0
%
$
741,166

100.0
%
_________________________
(a) 
As of September 30, 2012 and December 31, 2011, Investment Rating “1” included $71.7 million and $109.1 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 have 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 PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status:
 
COST BASIS
FAIR VALUE BASIS
 
September 30, 2012
December 31, 2011
September 30, 2012
December 31, 2011
(dollars in thousands)
Investments
at Cost
% of Loan
Portfolio
Investments
at Cost
% of Loan
Portfolio
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
$
17,860

4.18
%
$
13,963

2.00
%
$
12,317

3.05
%
$
9,615

1.53
%
Not on non-accrual status
—

—

—

—

—

—

—

—

Total loans greater than 90 days past due
$
17,860

4.18
%
$
13,963

2.00
%
$
12,317

3.05
%
$
9,615

1.53
%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
12,902

3.02
%
$
69,241

9.92
%
$
3,709

0.92
%
$
9,704

1.54
%
Greater than 90 days past due
17,860

4.18

13,963

2.00

12,317

3.05

9,615

1.53

Total loans on non-accrual status
$
30,762

7.20
%
$
83,204

11.92
%
$
16,026

3.97
%
$
19,319

3.07
%

43

The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2011 through September 30, 2012:
 
Nine months ended
 
September 30, 2012
(In thousands)
Cost
Fair Value
Non-accrual loan balance as of December 31, 2011
$
83,204

$
19,319

Additional loans on non-accrual status-home furnishings
5,385

3,112

Payments received on loans on non-accrual status
(10,878
)
(10,878
)
Change in unrealized gain (loss) on non-accrual loans
—

4,148

Reversal of previously recognized unrealized loss on non-accrual loans(a)
—

47,274

Realized loss on non-accrual loans(a)
(46,949
)
(46,949
)
Total change in non-accrual loans
(52,442
)
(3,293
)
Non-accrual loan balance as of September 30, 2012
$
30,762

$
16,026

_________________________
(a) 
Represents the reversal of previously recognized unrealized loss and recognition of realized loss on non-accrual loans attributed to Jet Plastica Investors, LLC.


44

Results of Operations
The following section compares our results of operations for the three months ended September 30, 2012 to the three months ended September 30, 2011.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
The following table summarizes the components of our net income (loss) for the three months ended September 30, 2012 and 2011:
 
Three months ended
 
 
September 30, 2012
Variance
(dollars in thousands)
2012
2011
$
Percentage
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Interest income
$
10,326

$
17,128

$
(6,802
)
(39.7
)%
Dividend income
867

1,226

(359
)
(29.3
)
Loan fees
642

1,426

(784
)
(55.0
)
Total interest and dividend income
11,835

19,780

(7,945
)
(40.2
)
Advisory fees and other income
234

930

(696
)
(74.8
)
Total revenue
12,069

20,710

(8,641
)
(41.7
)
Operating expenses
 
 
 
 
Interest expense
2,974

3,960

(986
)
(24.9
)
Employee compensation




 
 
Salaries and benefits
2,018

2,683

(665
)
(24.8
)
Amortization of employee restricted stock
505

348

157

45.1

Total employee compensation
2,523

3,031

(508
)
(16.8
)
General and administrative expense
2,504

3,657

(1,153
)
(31.5
)
Restructuring expense
12

4,109

(4,097
)
(99.7
)
Total operating expense
8,013

14,757

(6,744
)
(45.7
)
Net operating income before net investment gain (loss) and income tax provision
4,056

5,953

(1,897
)
(31.9
)
Net investment gain (loss) before income tax provision
228

(31,052
)
31,280

NM

Income tax provision
18

10

8

80.0

Net income (loss)
$
4,266

$
(25,109
)
$
29,375

NM

NM=Not Meaningful
 
 
 
 
TOTAL REVENUE
Total revenue includes interest and dividend income, loan fees, advisory fees and other income. The following sections describe the reasons for the variances in each major component of our revenue during the three months ended September 30, 2012 from the three months ended September 30, 2011.
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. During the three months ended September 30, 2012, the total yield on our average debt portfolio at fair value was 11.1% compared to 10.9% during the three months ended September 30, 2011. The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.

45

The following table shows the various components of the total yield on our average debt portfolio at fair value for the three months ended September 30, 2012 and 2011:
 
Three months ended
 
September 30, 2012
 
2012
2011
Average 90-day LIBOR
0.4
 %
0.3
 %
Spread to average LIBOR on average loan portfolio
10.9

10.8

Impact of fee accelerations of unearned fees on paid/restructured loans
0.3

0.6

Impact of non-accrual loans
(0.5
)
(0.8
)
Total yield on average loan portfolio
11.1
 %
10.9
 %
During the three months ended September 30, 2012, interest income was $10.3 million, compared to $17.1 million during the three months ended September 30, 2011, which represented a $6.8 million, or 39.7%, decrease. This decrease reflected a $7.4 million decrease resulting from a 41.8% decrease in our average loan balance, a $0.6 million decrease resulting from the net impact of loans that were on non-accrual status during the three months ended September 30, 2012 that were accruing interest during the three months ended September 30, 2011 and a decrease of $0.3 million due to interest rate floors. These decreases were partially offset by a $1.3 million increase in interest income resulting from a 0.4% increase in our net spread to LIBOR and a $0.2 million increase in interest income related to the increase in LIBOR.
PIK Income
Interest income includes certain amounts that we have not received in cash, such as PIK interest. PIK interest represents contractually deferred interest that is added to the principal balance of the loan and compounded if not paid on a current basis. PIK may be prepaid by either contract or the portfolio company’s choice, but generally is paid at the end of the loan term. The following table shows the PIK-related activity for the three months ended September 30, 2012 and 2011, at cost:
 
Three months ended,
 
September 30
(in thousands)
2012
2011
Beginning PIK loan balance
$
5,625

$
15,279

PIK interest earned during the period
1,112

2,365

Interest receivable converted to PIK
—

230

Payments received from PIK loans
(623
)
(2,366
)
Ending PIK loan balance
$
6,114

$
15,508

As of September 30, 2012 and 2011, we were not accruing interest on $1.4 million and $6.2 million, respectively, of the PIK loans, at cost, shown in the preceding table. During the three months ended September 30, 2012, we received payments on PIK loans from five investments. The payments received from PIK loans during the three months ended September 30, 2011, included $1.7 million collected in conjunction with the partial repayment of our investment in Sagamore Hill Broadcasting, LLC, as well as PIK collected from seven other portfolio investments.
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. During the three months ended September 30, 2012 and 2011, we recognized dividend income of $0.9 million and $1.2 million, respectively. In addition, during each of the three months ended September 30, 2012 and 2011, we received payments on accrued dividends of $0.3 million.

46

ADVISORY FEES AND OTHER INCOME
Advisory fees and other income primarily include fees related to prepayment, advisory and management services, equity structuring, syndication, bank interest and other income. Generally, advisory fees and other income relate to specific transactions or services and, therefore, may vary from period to period depending on the level and types of services provided. During the three months ended September 30, 2012, we earned $0.2 million of advisory fees and other income, which represented a $0.7 million, or 74.8%, decrease from the three months ended September 30, 2011. This decrease resulted from a decrease of $0.7 million in advisory fees due to our lower investment activity in the third quarter of 2012 compared to the third quarter of 2011.
TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the three months ended September 30, 2012, we incurred $3.0 million of interest expense, which represented a $1.0 million, or 24.9%, decrease from the same period in 2011. Interest expense for the three months ended September 30, 2012 decreased $1.8 million due to a lower average borrowing balance in the third quarter of 2012 offset by a $0.8 million increase due to an increase in the average spread to LIBOR in the third quarter of 2012.
EMPLOYEE COMPENSATION
Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards. During the three months ended September 30, 2012, our employee compensation expense was $2.5 million, which represented a $0.5 million, or 16.8%, decrease from the same period in 2011. Our salaries and benefits decreased by $0.7 million, or 24.8%, due to a $1.0 million decrease in salaries and benefits primarily resulting from a 42% reduction in our workforce that occurred as part of the corporate restructuring that we implemented during 2011 offset by an increase in incentive compensation of $0.3 million.
GENERAL AND ADMINISTRATIVE
During the three months ended September 30, 2012, general and administrative expense was $2.5 million, which represented a $1.2 million, or 31.5%, decrease compared to the same period in 2011. General and administrative expense for third quarter of 2011 included professional fees paid for portfolio related litigation and other corporate initiatives that did not occur in the third quarter of 2012.

47

NET INVESTMENT GAIN BEFORE INCOME TAX PROVISION
During the three months ended September 30, 2012, we incurred $0.2 million of net investment gains before income tax provision, compared to $31.1 million during the same period in 2011. These amounts represent the total of net realized gains and losses, net unrealized appreciation (depreciation), 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 gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2012:
 
 
Three months ended September 30, 2012
(in thousands)
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Advanced Sleep Concepts, Inc.
Home Furnishings
Affiliate
$
—

$
(2,618
)
$
—

$
(2,618
)
Cruz Bay Publishing, Inc.
Publishing
Non-Affiliate
—

1,987

—

1,987

PremierGarage Holdings, LLC
Home Furnishings
Control
(5,371
)
—

5,371

—

Other (< $1 million net gain (loss))
 
 
(23
)
1,017

(135
)
859

Total
 
 
$
(5,394
)
$
386

$
5,236

$
228

•
In the third quarter of 2012, we recorded $2.6 million of unrealized depreciation on our investment in Advanced Sleep Concepts, Inc., to reflect a decrease in that portfolio company's operating performance.
•
We also recorded $2.0 million of unrealized appreciation on our investment in Cruz Bay Publishing, Inc., to reflect an improvement in that portfolio company's operating performance.
•
In addition, during the three months ended September 30, 2012, we wrote off our preferred and common equity investments in PremierGarage Holdings, LLC resulting in a realized loss of $5.4 million and a reversal of previously recorded unrealized depreciation of $5.4 million .
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from a change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.
The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2011:
 
 
Three months ended September 30, 2011
(in thousands)
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Broadview Networks Holdings, Inc.
Communications
Control
$
—

$
(24,697
)
$
—

$
(24,697
)
Jet Plastica Investors, LLC
Plastic Products
Control
—

(5,637
)
—

(5,637
)
Intran Media, LLC
Other Media
Control
—

(1,959
)
—

(1,959
)
Total Sleep Holdings, Inc.
Healthcare
Control
(38,081
)
—

38,054

(27
)
Stratford School Holdings, Inc.
Education
Affiliate
—

2,217

—

2,217

GSDM Holdings, Corp.
Healthcare
Non-Affiliate
—

1,857

—

1,857

NDSSI Holdings, LLC
Electronics
Non-Affiliate
—

1,277

—

1,277

Other (< $1 million net gain (loss))
 
 
254

(3,685
)
(652
)
(4,083
)
Total
 
 
$
(37,827
)
$
(30,627
)
$
37,402

$
(31,052
)
A summary of the reasons for significant changes in realized and unrealized (loss) and gain on investments and changes in unrealized appreciation and depreciation on investments for the three months ended September 30, 2011, are summarized below:
•
We recorded $24.7 million of unrealized depreciation on our investment in Broadview Networks Holdings, Inc., or Broadview, primarily to reflect, among other factors, continuing challenges in the bond market, a downgrade

48

of Broadview's corporate credit rating, delays by Broadview in refinancing its debt, as well as the near-term maturities of Broadview's debt facilities.
•
We recorded $5.6 million of unrealized depreciation on our investment in Jet Plastica Investors, LLC, to reflect a decrease in that company's operating performance and the multiple that we used to value the company.
•
We also wrote off our remaining investment in Total Sleep Holdings, Inc. during the quarter ended September 30, 2011, which resulted in the reversal of $38.1 million of previously unrealized depreciation and the realization of a $38.1 million loss.
INCOME TAX PROVISION
During the three months ended September 30, 2012, we incurred a $18,000 income tax provision compared to an $10,000 income tax provision during the three months ended September 30, 2011. The income tax provision for both periods was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
The following table summarizes the components of our net income (loss) for the nine months ended September 30, 2012 and 2011:
 
Nine months ended
 
 
September 30
Variance
(dollars in thousands)
2012
2011
$
Percentage
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Interest income
$
39,748

$
54,439

$
(14,691
)
(27.0
)%
Dividend income
2,840

5,840

(3,000
)
(51.4
)
Loan fees
2,365

3,125

(760
)
(24.3
)
Total interest and dividend income
44,953

63,404

(18,451
)
(29.1
)
Advisory fees and other income
2,619

2,817

(198
)
(7.0
)
Total revenue
47,572

66,221

(18,649
)
(28.2
)
Operating expenses
 
 
 
 
Interest expense
12,728

11,778

950

8.1

Employee compensation
 
 
 
 
Salaries and benefits
8,684

9,567

(883
)
(9.2
)
Amortization of employee restricted stock
1,694

1,378

316

22.9

Total employee compensation
10,378

10,945

(567
)
(5.2
)
General and administrative expense
10,714

9,130

1,584

17.3

Restructuring expense
59

4,174

(4,115
)
(98.6
)
Total operating expense
33,879

36,027

(2,148
)
(6.0
)
Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
13,693

30,194

(16,501
)
(54.6
)
Net investment gain (loss) before income tax provision
(14,604
)
(73,444
)
58,840

(80.1
)
Loss on extinguishment of debt before income tax provision
(174
)
(863
)
689

(79.8
)
Income tax provision
329

29

300

NM

Net income (loss)
$
(1,414
)
$
(44,142
)
$
42,728

NM

NM=Not Meaningful
 
 
 
 

TOTAL REVENUE
Total revenue includes interest and dividend income, loan fees, advisory fees and other income. The following sections describe the reasons for the variances in each major component of our revenue during the nine months ended September 30, 2012 from the nine months ended September 30, 2011.

49

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. During the nine months ended September 30, 2012, the total yield on our average debt portfolio at fair value was 11.2% compared to 10.8% during the nine months ended September 30, 2011.
The following table shows the various components of the total yield on our average debt portfolio at fair value for the nine months ended September 30, 2012 and 2011:
 
Nine months ended
 
September 30
 
2012
2011
Average 90-day LIBOR
0.5
 %
0.3
 %
Spread to average LIBOR on average loan portfolio
10.7

10.8

Impact of fee accelerations of unearned fees on paid/restructured loans
0.4

0.3

Impact of non-accrual loans
(0.4
)
(0.6
)
Total yield on average loan portfolio
11.2
 %
10.8
 %
During the nine months ended September 30, 2012, interest income was $39.7 million, compared to $54.4 million during the nine months ended September 30, 2011, which represented a $14.7 million, or 27.0%, decrease. This decrease reflected a $16.2 million decrease resulting from a 28.9% decrease in our average loan balance, a $1.1 million decrease resulting from the net impact of loans that were on non-accrual status during the nine months ended September 30, 2012 that were accruing interest during the nine months ended September 30, 2011 and a $0.4 million decrease due to interest rate floors. These decreases were partially offset by a $2.1 million increase in interest income resulting from a 0.2%  increase in our net spread to LIBOR and a $1.0 million increase in interest income related to the increase in LIBOR.
PIK Income
The following table shows the PIK-related activity for the nine months ended September 30, 2012 and 2011, at cost:
 
Nine months ended
 
September 30
(in thousands)
2012
2011
Beginning PIK loan balance
$
15,653

$
30,923

PIK interest earned during the period
3,983

6,458

Interest receivable converted to PIK
—

590

Payments received from PIK loans
(8,510
)
(20,410
)
PIK converted to other securities
—

(876
)
Realized loss
(5,012
)
(1,177
)
Ending PIK loan balance
$
6,114

$
15,508

During the nine months ended September 30, 2012, the payments received on PIK loans, included $2.9 million from Jet Plastica Investors, LLC, $1.8 million from GSDM Holdings Corp. and $1.3 million from Coastal Sunbelt Holding, Inc. The payments received from PIK loans during the nine months ended September 30, 2011, included $8.2 million and $4.7 million of PIK collected in conjunction with the respective sales of our investments in Restaurant Technologies, Inc. and Avenue Broadband LLC, as well as $1.7 million collected in conjunction with the partial repayment of our investments in Sagamore Hill Broadcasting, LLC.
DIVIDEND INCOME
During the nine months ended September 30, 2012 and 2011, we recognized dividend income of $2.8 million and $5.8 million, respectively. In addition, during the nine months ended September 30, 2012 and 2011, we received payments on accrued dividends of $8.1 million and $12.4 million, respectively.

50

ADVISORY FEES AND OTHER INCOME
During the nine months ended September 30, 2012, we earned $2.6 million of advisory fees and other income, which represented a $0.2 million, or 7.0%, decrease from the nine months ended September 30, 2011. This decrease included a decrease of $1.7 million in advisory fees due to our lower investment activity in the first nine months of 2012 compared to the first nine months of 2011 offset by an increase in prepayment penalties of $1.7 million related to six investment repayments in the first nine months of 2012.
TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the nine months ended September 30, 2012, we incurred $12.7 million of interest expense, which represented a $1.0 million, or 8.1%, increase from the same period in 2011. Interest expense for the nine months ended September 30, 2012 increased $3.2 million related to increased amortization of debt issuance costs, including $2.3 million of accelerated deferred financing fees related to the termination of our SunTrust Warehouse financing facility and $0.3 million of accelerated deferred financing fees related to prepayments of collateral in our Commercial Loan Trust 2006-1 facility. Interest expense also increased $0.7 million due to an increase in the average LIBOR rate by 0.18% and $0.7 million due to an increase in the spread to LIBOR during the first nine months of 2012 compared to the first nine months of 2011. These increases were partially offset by a $3.7 million decrease in interest expense due to a lower average borrowing balance in the first quarter of 2012.
EMPLOYEE COMPENSATION
Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards. During the nine months ended September 30, 2012, our employee compensation expense was $10.4 million, which represented a $0.6 million, or 5.2%, decrease from the same period in 2011. Our salaries and benefits decreased by $0.9 million, or 9.2%, due to a $3.1 million decrease in salaries and benefits primarily resulting from a 42% reduction in our workforce that occurred as part of the corporate restructuring that we implemented during 2011 offset by an increase in incentive compensation of $2.2 million primarily resulting from incentive and inducement bonuses paid in the first nine months of 2012.
During the nine months ended September 30, 2012, we recognized $1.7 million of compensation expense related to restricted stock awards, compared to $1.4 million for the nine months ended September 30, 2011, which represented a $0.3 million, or 22.9%, increase. The amortization of restricted stock awards during the nine months ended September 30, 2012 included accelerated amortization of $0.3 million related to employees who terminated in during 2012.
GENERAL AND ADMINISTRATIVE
During the nine months ended September 30, 2012, general and administrative expense was $10.7 million, which represented a $1.6 million, or 17.3%, increase compared to the same period in 2011. General and administrative expense for 2012 included $3.0 million in severance related expenses in connection with our operational realignment.

51

NET INVESTMENT GAIN (LOSS) BEFORE INCOME TAX PROVISION
During the nine months ended September 30, 2012, we incurred $14.6 million of net investment losses before income tax provision, compared to $73.4 million during the same period in 2011. 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 nine months ended September 30, 2012:
 
 
Nine months ended September 30, 2012
(in thousands)
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Broadview Networks Holdings, Inc.
Communications
Control
$
—

$
(9,680
)
$
—

$
(9,680
)
Miles Media Group, LLC
Business Services
Non-Affiliate
—

(4,023
)
—

(4,023
)
Orbitel Holdings, LLC
Cable
Control
(2,066
)
(1,966
)
805

(3,227
)
Advanced Sleep Concepts, Inc.
Home Furnishings
Affiliate
—

(2,604
)
—

(2,604
)
RadioPharmacy Investors, LLC
Healthcare
Control
—

(2,113
)
—

(2,113
)
Cruz Bay Publishing, Inc.
Publishing
Non-Affiliate
—

(1,368
)
—

(1,368
)
GSDM Holdings, LLC
Healthcare
Non-Affiliate
1,576

(849
)
(1,976
)
(1,249
)
Stratford School Holdings, Inc.
Education
Affiliate
16,370

(99
)
(13,056
)
3,215

NPS Holding Group, LLC
Business Services
Control
—

2,702

—

2,702

Jet Plastica Investors, LLC
Plastic Products
Control
(90,802
)
1,385

91,288

1,871

NDSSI Holdings, LLC
Electronics
Non-Affiliate
—

1,025

—

1,025

PremierGarage Holdings, LLC
Home Furnishings
Control
(5,371
)
—

5,371

—

Philadelphia Media Network, Inc.
Newspaper
Non-Affiliate
(5,027
)
(1
)
5,064

36

Intran Media, LLC
Other Media
Control
(4,250
)
—

4,250

—

Jenzabar, Inc.
Technology
Non-Affiliate
16,370

(1
)
(16,435
)
(66
)
Other (< $1 million net gain (loss))
 
 
(168
)
1,643

(598
)
877

Total
 
 
$
(73,368
)
$
(15,949
)
$
74,713

$
(14,604
)
•
In August 2012, Broadview filed a voluntary pre-packaged chapter 11 plan of reorganization. The plan provides that upon effectiveness of the plan, Broadview's existing noteholders will exchange their notes for new Broadview common stock representing 97.5% of the common stock of the reorganized company and $150 million in principal amount of new 10 1/2 % senior secured notes due in July 2017, and existing stockholders, including MCG, will each receive a pro rata share of the remaining 2.5% of the common stock of the reorganized company and two tranches of eight-year warrants with exercise prices set at equity values that imply full recovery for existing noteholders. As of September 30, 2012, our fair value estimate of our investment in Broadview reflects this potential restructuring if consummated on the contemplated terms.
•
In April 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets.  Including the proceeds from the liquidation, we received $11.0 million in payments on our senior debt and anticipate receiving additional payments on our senior debt upon future collection of certain accounts receivable, resulting in a $90.8 million realized loss and a $91.3 million reversal of unrealized depreciation in the second quarter of 2012.
•
In the second quarter of 2012, we received $34.0 million for the repayment of our debt and the sale of our equity investment in Stratford School Holdings, Inc., which resulted in a $16.4 million realized gain and a reversal of previously unrealized appreciation of $13.1 million.
•
We received $35.3 million for the repayment of our debt and the sale of our equity investment in Orbitel Holdings, LLC, which resulted in a $2.1 million realized loss and a reversal of previously unrealized depreciation of $0.8 million.
•
We received $34.7 million for the repayment of our debt and the sale of our equity investment in GSDM Holdings, LLC, which resulted in a $1.6 million realized gain and a reversal of previously unrealized appreciation of $2.0 million.

52

•
We recorded $4.0 million of unrealized depreciation on our investment in Miles Media Group, LLC, to reflect a decrease in the performance of that company.
•
We recorded $2.7 million of unrealized appreciation on our investment in NPS Holding Group, LLC, to reflect a contemplated transaction involving that company.
•
We received $44,000 for our equity investment in Philadelphia Media Network, Inc., wrote off our equity investments in PremierGarage Holdings, LLC and wrote off part of our equity investment in Intran Media, LLC resulting in realized losses and reversals of previously unrealized depreciation on those investments.
•
In February 2012, we accepted $23.7 million for our senior preferred stock and warrant position in Jenzabar, Inc., or Jenzabar, which resulted in a $16.4 million reversal of previously unrealized appreciation and the realization of a $16.4 million gain.
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from a change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.
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 nine months ended September 30, 2011:
 
 
Nine months ended September 30, 2011
(in thousands)
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Broadview Networks Holdings, Inc.
Communications
Control
$
—

$
(73,815
)
$
—

$
(73,815
)
Jet Plastica Investors, LLC
Plastic Products
Control
—

(6,911
)
—

(6,911
)
PremierGarage Holdings, LLC
Home Furnishings
Control
—

(5,381
)
—

(5,381
)
Intran Media, LLC
Other Media
Control
—

(6,487
)
—

(6,487
)
VOX Communications
Broadcasting
Non-Affiliate
(7,688
)
—

5,645

(2,043
)
Superior Industries Investors, Inc.
Sporting Goods
Control
988

—

(2,788
)
(1,800
)
Provo Craft & Novelty, Inc.
Leisure Activities
Non-Affiliate
(1,152
)
(1,160
)
1,151

(1,161
)
G & L Investment Holdings, LLC
Insurance
Non-Affiliate
—

(1,116
)
—

(1,116
)
Avenue Broadband LLC
Cable
Control
11,977

(325
)
(11,895
)
(243
)
Total Sleep Holdings, Inc.
Healthcare
Control
(38,081
)
—

38,054

(27
)
RadioPharmacy Investors, LLC
Healthcare
Control
—

8,029

—

8,029

GSDM Holdings, Corp.
Healthcare
Non-Affiliate
—

4,411

—

4,411

NPS Holding Group, LLC
Business Services
Control
—

3,921

—

3,921

Coastal Sunbelt Real Estate, Inc.
Real Estate Investments
Non-Affiliate
—

2,252

—

2,252

Stratford School Holdings, Inc.
Education
Affiliate
—

1,867

—

1,867

Cruz Bay Publishing, Inc.
Publishing
Non-Affiliate
—

1,583

—

1,583

Restaurant Technologies, Inc.
Food Services
Non-Affiliate
1,527

1,429

(1,842
)
1,114

GMC Television Broadcasting, LLC
Broadcasting
Control
(1,000
)
730

1,000

730

Active Brands International, Inc.
Consumer Products
Non-Affiliate
(39,706
)
—

39,829

123

Other (< $1 million net gain (loss))
 
 
(825
)
1,448

887

1,510

Total
 
 
$
(73,960
)
$
(69,525
)
$
70,041

$
(73,444
)
A summary of the reasons for significant changes in realized and unrealized (loss) and gain on investments and changes in unrealized appreciation and depreciation on investments for the nine months ended September 30, 2011 are summarized below.
•
We recorded $73.8 million of unrealized depreciation on our Broadview investment primarily to reflect, among other factors, continuing challenges in the bond market, a downgrade of Broadview's corporate credit rating, delays by Broadview in refinancing its debt, as well as the near-term maturities of Broadview's debt facilities.
•
We recorded $6.9 million of unrealized depreciation on our investment in Jet Plastica Investors, LLC, to reflect a decrease in that company's operating performance and the multiple that we use to value the company. In addition, we recorded unrealized depreciation to reflect an incremental investment that we made in this portfolio company during the nine months ended September 30, 2011, that we subsequently wrote down to zero.

53

•
We also recorded unrealized depreciation in our investments in PremierGarage Holdings, LLC and Intran Media, LLC during the nine months ended September 30, 2011, to reflect our portion of the estimated liquidation value of those companies.
•
We wrote off our remaining subordinated debt and equity investment in Total Sleep Holdings, Inc. resulting in the reversal of $38.1 million of previously unrealized depreciation and the realization of a $38.1 million loss.
•
We received payments of $2.1 million on the sale of Active Brands International, Inc.'s senior debt and wrote off our subordinated debt and equity investment in that portfolio company, which resulted in the reversal of $39.8 million of previously unrealized depreciation and the realization of a $39.7 million loss.
•
We received payments of $4.1 million in satisfaction of our $11.8 million debt investment in VOX Communications and wrote off our remaining investment in that portfolio company, which resulted in the reversal of $5.6 million of previously unrealized depreciation and the realization of a $7.7 million loss.
•
We sold our investment in Avenue Broadband LLC, which resulted in the reversal of $11.9 million of previously unrealized appreciation and the realization of a $11.9 million gain.
•
We sold our investment in Superior Industries Investors, Inc., which resulted in the reversal of $2.8 million of previously unrealized appreciation and the realization of a $1.0 million gain, including $1.8 million of transaction costs that we recorded at the time of sale.
LOSS ON EXTINGUISHMENT OF DEBT
We incurred a $0.2 million premium when we repurchased the remaining $8.7 million of our private placement notes during the first nine months of 2012. During the first nine months of 2011, we incurred a $0.9 million premium when we repurchased $17.4 million of our private placement notes.
INCOME TAX PROVISION
During the nine months ended September 30, 2012, we incurred a $0.3 million income tax provision compared to a $29,000 income tax provision during the nine months ended September 30, 2011. The income tax provision for both periods was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.
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 September 30, 2012 and December 31, 2011, we had $65.9 million and $58.6 million, respectively, in cash and cash equivalents. As of September 30, 2012, our cash and cash equivalents included $42.4 million that was held in interest-bearing accounts.
•
Cash, securitization accounts include principal and interest payments received on securitized loans, which, are held in designated bank accounts until monthly or quarterly disbursements are made from the securitization trusts. We are generally 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. 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. As of September 30,

54

2012 and December 31, 2011, we had $3.7 million and $40.3 million, respectively, in cash, securitization accounts.
•
Cash, restricted includes cash held for regulatory purposes and cash held in escrow. The largest component of restricted cash was represented by cash held by Solutions Capital I, L.P.,or Solutions Capital, a wholly owned subsidiary licensed as an SBIC under the SBIC Act, which generally is restricted to the origination of new loans from Solutions Capital. As of September 30, 2012 and December 31, 2011, we had $114.5 million and $35.0 million respectively, of restricted cash.
During the nine months ended September 30, 2012, our operating activities provided $308.1 million of cash and cash equivalents, and our financing activities used $300.8 million of cash and cash equivalents.
LIQUIDITY AND CAPITAL RESOURCES
We generally expect to limit our future investing activities principally to debt investments and do not intend to make significant investments in control companies beyond those that are currently in our portfolio. To help provide sustainable stockholder value, we expect to make future distributions to stockholders based upon an 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 BDC asset coverage ratio at the time of such decision. These distributions may be considered a return of capital.
In order to reduce future cash interest payments under our borrowings, as well as future amounts due at maturity or upon redemption under our borrowings, we may, from time to time, purchase 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.
As discussed in Liquidity and Capital Resources—Borrowings, the reinvestment periods for the Commercial Loan Trust 2006-1 facility has ended and all future principal collections from collateral in the facility will be used to repay the securitized debt.
Although there can be no assurance, we believe we have sufficient liquidity to meet our operating requirements for the remainder of 2012, as well as liquidity for new origination opportunities and potential dividend distributions.

55

LIQUIDITY AND CAPITAL RESOURCES—BORROWINGS
As of September 30, 2012, we reported $249.1 million of borrowings on our Consolidated Balance Sheets at cost. The following table summarizes our borrowing facilities, the potential borrowing capacity of those facilities and contingent borrowing eligibility of Solutions Capital, our SBIC.
 
 
September 30, 2012
December 31, 2011
(dollars in thousands)
Maturity Date
Total
Facility/
Program
Amount
Outstanding
Total
Facility/
Program
Amount
Outstanding
SBIC
 
 
 
 
 
2008-10B
September 2018
$
2,600

$
2,600

$
2,600

$
2,600

2009-10A
March 2019
12,000

12,000

12,000

12,000

2009-10B
September 2019
13,000

13,000

13,000

13,000

2010-10B
September 2020
27,500

27,500

27,500

27,500

2011-10A
March 2021
53,500

53,500

53,500

53,500

2012-10A
March 2022
41,400

41,400

41,400

20,000

Commercial Loan Trust 2006-1
 




 
 
Series 2006-1 Class A-1 Notes
April 2018(a)
—

—

63,389

63,389

Series 2006-1 Class A-2 Notes
April 2018(a)
—

—

2,983

2,983

Series 2006-1 Class A-3 Notes
April 2018(a)
—

—

50,711

50,711

Series 2006-1 Class B Notes
April 2018(a)
38,151

38,151

58,750

58,750

Series 2006-1 Class C Notes(b)
April 2018(a)
45,000

32,000

45,000

32,000

Series 2006-1 Class D Notes(c)
April 2018(a)
45,945

28,902

46,494

29,247

Commercial Loan Funding Trust
 




 
 
Variable Funding Note
January 2014(d)
—

—

150,000

55,822

Private Placement Notes
 




 
 
Series 2007-A
October 2011
—

—

8,717

8,717

Total borrowings
 
$
279,096

$
249,053

$
576,044

$
430,219

    
(a)    Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt. 
(b)    Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.
(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. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.
(d)    On May 15, 2012, this facility was repaid in full and terminated.
As of September 30, 2012, our asset coverage ratio was 481% excluding our SBIC debt which is exempt from the asset coverage ratio requirements under the SEC exemptive order.
Our access to current and future liquidity from our borrowing facilities depends on several factors, including, but not limited to: the credit quality of our investment portfolio, including those investments used to collateralize borrowing facilities; the magnitude of our investments in individual companies and the industries in which they operate; our compliance with specific covenants in each borrowing agreement; and the specific provisions of our borrowing facilities.
As each of our borrowing facilities matures, it is important that we have sufficient liquidity available to repay our borrowing obligations. We may obtain the liquidity for repayment of our borrowing facilities from a number of sources, including cash on-hand, the maturity or monetization of our investment portfolio, other borrowing facilities and equity issuances, and from other borrowing arrangements.
We have funded our current secured borrowing debt facility through a bankruptcy remote, special-purpose, wholly owned subsidiary. Therefore, this subsidiary’s assets may not be available to our creditors. In some cases, advances under our secured debt facility are subject to certain collateral levels, collateral quality, leverage and other restrictive covenants. We continue to service those portfolio investments that we use as collateral in our secured borrowing facility.

56

SBIC DEBENTURES
In December 2004, we formed a wholly owned subsidiary, Solutions Capital. Solutions Capital has a license from the SBA to operate as an SBIC under the SBIC Act. The license gave Solutions Capital the ability to borrow from the SBA up to $150.0 million, which is the maximum amount of outstanding leverage available to single-license SBIC companies.
To realize the full $150.0 million borrowing for which we have received approval under this program, we have funded a total of $75.0 million to Solutions Capital. As of September 30, 2012 and December 31, 2011, Solutions Capital had borrowed $150.0 million and $128.6 million, respectively. We may use these funds to provide debt and equity capital to qualifying small businesses. However, we may not use these borrowings to originate debt to certain companies that are currently in our portfolio without SBA approval. In addition, we may not use these funds for MCG’s, the parent company’s, working capital.
SBICs are subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of an SBIC license does not assure that an SBIC will receive SBA-guaranteed debenture funding, which is dependent upon continued compliance with SBA regulations and policies. The SBA, as a creditor, will have superior claim to Solutions Capital’s assets over our stockholders in the event we liquidate Solutions Capital or the SBA exercises its remedies under the SBA-guaranteed debentures issued by Solutions Capital upon an event of default. In the quarter ended September 30, 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  There is no assurance that the SBA will grant the additional license in any specified time period or at all.
The following table sets forth the maturity of Solutions Capital debentures, as well as the maturity of the investments and the current balance of restricted cash in Solutions Capital as of September 30, 2012.
 
Maturities
(in thousands)
Total
Less than
1 year
1-3 years
4-5 years
After 5
years
Borrowings
$
150,000

$
—

$
—

$
—

$
150,000

Collateral
 
 
 
 
 
Fair value of debt investments
127,832

—

21,438

98,365

8,029

Fair value of equity investments(a)
4,498

—

—

—

4,498

Cash, restricted account
108,548

108,548

—

—

—

Total collateral
$
240,878

$
108,548

$
21,438

$
98,365

$
12,527

     
(a)    Equity investments do not have a stated maturity date.
COMMERCIAL LOAN TRUST 2006-1
As of September 30, 2012, we had $99.1 million of securitized debt outstanding under the Commercial Loan Trust 2006-1, which matures in April 2018. We retain all of the equity in the securitization. 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. The securitization included a five-year reinvestment period, during which the trust was permitted to use principal collections received on the underlying collateral to purchase new collateral from us.

57

The following table sets forth the maturity of this facility, as well as the maturity of the securitized assets and the current balance of securitized cash in this borrowing facility.
 
Maturities
(in thousands)
Total
Less than
1 year
1-3 years
4-5 years
After 5
years
Borrowings(a)
$
99,053

$
1,000

$
—

$
—

$
98,053

Collateral
 
 
 
 
 
Fair value of debt investments
178,928

19,721

47,214

106,948

5,045

Fair value of equity investments(b)
352

—

—

—

352

Cash, securitization account
3,675

3,675

—

—

—

Total collateral
$
182,955

$
23,396

$
47,214

$
106,948

$
5,397

     
(a) 
Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and all future principal collections from collateral in the facility have been and will be used to repay the securitized debt. 
(b) 
Equity investments do not have a stated maturity date.
We were able to use the cash in the securitized account, as well as proceeds from principal collections of securitized investments, to originate new loans until July 20, 2011. The reinvestment period ended on July 20, 2011 and all subsequent principal collections or monetization proceeds that we receive from collateral used to securitize this Commercial Loan Trust 2006-1 must be applied to the outstanding balance of that facility. Upon maturity of this facility, any remaining balance must be repaid, otherwise all or part of the associated collateral may be forfeited. As shown in the above table, repayments of principal of the collateral held by this facility are expected to permit the repayment of Commercial Loan Trust 2006-1 prior to its April 2018 maturity.
COMMERCIAL LOAN FUNDING TRUST
Through the MCG Commercial Loan Funding Trust, we had a warehouse financing facility funded through SunTrust Bank. On May 15, 2012, we repaid in full the remaining $34.5 million balance and terminated the facility and recognized $0.8 million of deferred financing fees in interest expense. The SunTrust Warehouse was secured primarily by MCG Commercial Loan Funding Trust’s assets, including commercial loans that we sold to the trust.
PRIVATE PLACEMENT NOTES
In October 2007, we issued $25.0 million of Series 2007-A unsecured notes with a five-year maturity. Initially, the Series 2007-A notes bore interest at a 6.71% per annum, which rate was increased in 2009 to 8.96% per annum. In January 2012, we repaid the Series 2007-A notes in full.
WEIGHTED-AVERAGE BORROWINGS AND COST OF FUNDS
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 2012 and 2011:
 
For the nine months ended
(dollars in thousands)
September 30, 2012
September 30, 2011
Weighted-average borrowings
$
349,615

$
521,652

Average LIBOR
0.47
%
0.29
%
Average spread to LIBOR, excluding amortization of deferred debt issuance costs
2.33

2.16

Impact of amortization of deferred debt issuance costs
2.00

0.53

Total cost of funds
4.80
%
2.98
%
LIQUIDITY AND CAPITAL RESOURCES—COMMON 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 net asset value of such stock,

58

except in limited circumstances, including approval by our stockholders of such a sale and certain determinations by our board of directors.
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million. Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. During the three months ended September 30, 2012, we repurchased 1,252,410 shares of our common stock at a weighted average purchase price of $4.49 per share, which was a 14.7% discount from our quarterly net asset value per share. During the nine months ended September 30, 2012, we repurchased 5,119,886 shares of our common stock at a weighted average purchase price of $4.38 per share, which was a 19.7% discount from our quarterly net asset value per share.
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 September 30, 2012, we had $21.3 million of outstanding unused loan commitments, as shown in the table below. We believe that our operations, monetizations and unrestricted cash will provide sufficient liquidity 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 September 30, 2012, we had no outstanding guarantees or standby letters of credit.

59

CONTRACTUAL OBLIGATIONS
The following table shows our contractual obligations as of September 30, 2012:
(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(b)
$
99,053

$
1,000

$
—

$
—

$
98,053

SBIC
150,000

—

—

—

150,000

Total borrowings
249,053

1,000

—

—

248,053

Interest payments on borrowings(c)
63,066

8,172

16,343

16,343

22,208

Operating leases
1,769

1,309

460

—

—

Severance obligations(d)
3,755

2,998

757

—

—

Total contractual obligations
$
317,643

$
13,479

$
17,560

$
16,343

$
270,261

     
(a) 
Excludes the unused commitments to extend credit to our customers of $21.3 million as discussed above.
(b) 
Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and all future principal collections from collateral in the facility have been and will be used to repay the securitized debt. 
(c) 
Interest payments are based on contractual maturity and the current outstanding principal balance of our borrowings and assume no changes in interest rate benchmarks.
(d) 
Represents remaining severance payments, benefits, deferred compensation and employer taxes that we are obligated to pay to employees who were terminated as a result of the corporate restructuring effected in August 2011 and for obligations stemming from the resignations of our former chief executive officer and former chief financial officer.
DISTRIBUTIONS
We currently qualify as a RIC for federal income tax purposes, which generally allows us to avoid paying corporate income taxes on any income or gains that we distribute to our stockholders. Generally, we intend to distribute sufficient dividends to eliminate taxable income and may distribute more than the taxable income which would be considered a return of capital. As a RIC, we are subject to a 4% excise tax to the extent that we do not distribute on an actual or deemed basis: (i) 98.0% of our current year ordinary income; and (ii) 98.2% of our current year net capital gain income.
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 and SBA regulations. 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 $13.26 per share.

60

The following table summarizes the distributions that we declared since January 1, 2009:
Date Declared
Record Date
Payable Date
Dividends per Share
October 26, 2012
November 16, 2012
November 30, 2012
$
0.125

July 27, 2012
August 17, 2012
August 31, 2012
$
0.140

April 27, 2012
June 13, 2012
July 13, 2012
$
0.140

February 24, 2012
April 13, 2012
May 15, 2012
$
0.170

October 31, 2011
December 15, 2011
January 13, 2012
$
0.170

August 1, 2011
September 14, 2011
October 14, 2011
$
0.170

May 5, 2011
June 15, 2011
July 15, 2011
$
0.170

March 1, 2011
March 15, 2011
April 15, 2011
$
0.150

November 2, 2010
December 9, 2010
January 6, 2011
$
0.140

August 3, 2010
September 7, 2010
October 4, 2010
$
0.120

April 29, 2010
June 2, 2010
July 2, 2010
$
0.110

If we determined the tax attributes of our 2012 distributions as of September 30, 2012, 5% would be from ordinary income and 95% would be a return of capital. A return of capital is a return of stockholder investment, rather than a return of earnings or gains derived from our investment activities. While not immediately taxable to the extent of a stockholder's basis in its shares, a stockholder's basis in the investment will be reduced by the nontaxable amount, which will result in additional gain or a lower loss when the shares are sold. 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.
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 Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011.
VALUATION OF INVESTMENTS
FAIR VALUE MEASUREMENTS AND DISCLOSURES
We account for our investments at fair value in accordance with Accounting Standard Codification Topic 820—Fair 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.

61

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 transfers between these levels 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.
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 equity security and the majority of the debt securities in our investment portfolio. Our contracts with our 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 company’s 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 company’s 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; market prices, when available; 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.
Generally, 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. When such market prices are not available, 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 company’s fair value. To determine a portfolio company’s fair value, we analyze its historical and projected financial results, as well as key market value factors. In determining a security’s 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 Investments—Majority-owned control investments comprise 11.4% 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 consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.

62

•
Non-Majority-Owned Control Investments—Non-majority owned control investments comprise 2.8% of our investment portfolio. For our non-majority owned control 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 Investments—Non-control investments comprise 85.8% of our investment portfolio. Quoted prices are not available for 81.4% 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 for which no quoted prices are available, 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 Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of September 30, 2012, these securities represented 16.0% of our investment portfolio. We utilize independent pricing services with certain of our fair value estimates. The majority of our level 2 investments are senior debt investments that are secured and collateralized. To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.
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 or is a new investment made within the last twelve months. In total, as of September 30, 2012, we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve month period for 92.5% of the fair value of our investment portfolio.
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 sets our valuation policies and procedures and determines the fair value of our investments. The investment and valuation committee of our board of directors meets at least quarterly with our management to review management’s recommendations of fair value of our investments. 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.
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.
Significant Unobservable Inputs
Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with distinct contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and

63

complex, often factoring in numerous different 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 other inputs too numerous to list quantitatively herein.
The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2012.
($ in thousands)
Fair Value
Valuation Techniques
Unobservable
Inputs
Range
 
Minimum
Maximum
Senior debt
$
255,768

Discounted cash flow
Market interest rate
6.9
%
12.9
%



Discounted cash flow
Discount rate
6.9
%
6.9
%



Market comparable companies
EBITDA multiple(a)
6.0x

7.5x




Pending transactions/Letters of intent
Discount
—
%
—
%
Subordinated debt
79,191

Discounted cash flow
Market interest rate
10.9
%
14.9
%



Market comparable companies
EBITDA multiple(a)
5.0x

7.5x




Pending transactions/Letters of intent
Discount
—
%
—
%
Preferred and common equity
38,657

Market comparable companies
EBITDA multiple(a)
4.4x

11.0x





Discount for minority interest
—
%
25.0
%



Pending transactions/Letters of intent
Discount
—
%
—
%



Residual assets
Discount
—
%
25.0
%
 
$
373,616

 
 
 
 
        
(a) 
EBITDA may include proforma adjustments and/or other addbacks based on specific circumstances related to each investment.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There were a number of indicators of modest growth in the United States' economy during the first nine months of 2012. However, certain leading and lagging indicators suggest continuing risk and volatility. In the event of renewed financial turmoil 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 their meeting debt service requirements and an increase in defaults.
Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates. Our net interest income is affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates. As of September 30, 2012, approximately 89.4% of our loan portfolio, at fair value, bore interest at a spread to LIBOR or prime rate, and 10.6% at a fixed interest rate. As of September 30, 2012, approximately 78.9% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on the LIBOR base index and prime floors between 1.75% and 6.0%. The three-month weighted-average LIBOR interest rate was 0.43% as of September 30, 2012. Thus, the LIBOR floors in these loan investments lessen the impact of such historically low LIBOR 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.

64

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 September 30, 2012 and December 31, 2011:
 
September 30, 2012
December 31, 2011
(in thousands)
Interest Bearing Cash and Commercial Loans
Borrowings
Interest Bearing Cash and Commercial Loans
Borrowings
Money market rate
$
42,437

$
—

$
51,211

$
—

Prime rate
32,623

—

27,867

—

LIBOR
 
 
 
 
30-day
18,355

—

71,794

—

60-day
—

—

12,500

—

90-day
314,719

99,053

462,293

237,080

180-day
9,296

—

14,038

—

Commercial paper
—

—

—

55,822

Fixed rate
52,304

150,000

109,640

137,317

Total
$
469,734

$
249,053

$
749,343

$
430,219

Based on our September 30, 2012 balance sheet, the following table shows the impact to net income of hypothetical base rate increases in interest rates, assuming no changes in our investment and borrowing structure. The impact to net income of hypothetical base rate decreases in interest rates is not shown in the following table because as of September 30, 2012, the quarterly average LIBOR was 0.43% and a 100-basis point decrease could not occur:
(dollars in thousands) 
 
Basis Point Change
Interest
Income
Interest
Expense
Net Income (Loss)
100
$
1,601

$
991

$
610

200
6,345

1,981

4,364

300
12,122

2,972

9,150

ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2012. 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 SEC’s 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 company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the foregoing evaluation of our disclosure controls and procedures as of September 30, 2012, our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

65

INTERNAL CONTROL OVER FINANCIAL REPORTING
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), occurred during the fiscal quarter ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.
From time to time, we are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations. During the quarter ended September 30, 2012, there were no new or material developments in legal proceedings.
ITEM 1A. RISK FACTORS.
Investing in our common stock may be speculative and involves a high degree of risk. In addition to the other information contained in this Quarterly Report on Form 10-Q, including our financial statements, the related notes, schedules and exhibits, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which could materially affect our business, financial condition and/or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and/or operating results.
Other than described below, there have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, which should be read together with the other risk factors and information disclosed elsewhere in this Quarterly Report on Form 10-Q and our other reports filed with the SEC.
The following disclosure replaces and supplements the risk factors titled "We have experienced a period of capital markets disruption. This disruption has contributed to a decrease in our NAV and stock price, and could have an adverse impact on our business and operations", "We have substantial indebtedness and if we do not service our debt arrangements adequately, our business could be harmed materially", "If we are not able to establish new credit facilities on favorable terms, our operations could be affected adversely", "Our financial results could be affected adversely if a significant portfolio investment fails to perform as expected or if the value of a portfolio company decreases" and "Our business depends on our key personnel" included in our Annual Report on Form 10-K for the year ended December 31, 2011:
We have experienced a period of capital markets disruption. This disruption has contributed to a decrease in our NAV and stock price, and could have an adverse impact on our business and operations.
The global markets continued to be characterized by substantially increased volatility, short-selling and an overall loss of investor confidence. While certain 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,

66

if we are forced to discount the value of our investments in order to monetize assets to provide liquidity to fund operations and meet our liability maturities. 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 facility, which could materially impair our business operations. Further asset value degradation may result from circumstances that we may be unable to control, such as a severe decline in the value of the U.S. dollar, a protracted economic downturn or an operational problem that affects third parties or us. Ongoing disruptive conditions could cause our stock price and NAV to decline, restrict our business operations and adversely impact our results of operations and financial condition.
We have substantial indebtedness and if we do not service our debt arrangements adequately, our business could be harmed materially.
Our securitized financing facility, the MCG Commercial Loan Trust 2006-1, has entered its amortization period and all principal payments received related to the securitized collateral will be used to reduce the outstanding borrowings under this facility. Our ability to service our debt arrangement depends largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures.
Under our debt securitization through MCG Commercial Loan Trust 2006-1, we are subject to various affirmative and negative covenants. In the event that there is a breach of one of the covenants contained in our debt facility that has not been cured within any applicable cure period the lenders thereunder would have the ability, in certain circumstances, to 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 the trust that serves as the vehicles for our securitization facility, and this trust, which is bankruptcy remote, holds legal title to these assets. As a result, the lenders under this facility may generally only look to the collateral in this facility to satisfy the outstanding obligations under the MCG Commercial Loan Trust 2006-1. However, in the event of a default on these loans held by the trust, we could potentially bear losses to the extent that the fair value of our collateral exceeds our borrowings.
Our debt securitization through MCG Commercial Loan Trust 2006-1 requires us to maintain credit ratings for each loan in the collateral pool of this facility as determined by specified international independent rating agencies. We are subject to periodic review and updates of these credit estimates by these rating agencies that could cause portions of the collateral to become disqualified as eligible assets if credit estimates deteriorate. If credit estimates deteriorate significantly, an event of default could be triggered under this facility, which would entitle the trustee to exercise available remedies, including selling the collateral securing this facility and applying the proceeds to reduce outstanding borrowings under this facility.
In addition to the credit facility, Solutions Capital has issued SBA debentures that require our SBIC to generate sufficient cash flow to make required interest payments. Further, Solutions Capital I, L.P. must maintain a minimum capitalization that if impaired could materially and adversely affect our liquidity, financial condition and results of operations. Our borrowings under our SBA debentures are collateralized by the assets of Solutions Capital.
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 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 establish new credit facilities on favorable terms, our operations could be affected adversely.
Our securitized financing facility, the MCG Commercial Loan Trust 2006-1, has entered its amortization period and all principal payments received related to the securitized collateral will be used to reduce the outstanding borrowings under the facility. No funds from this facility will be available to make new investments. We cannot be certain that we will be able to establish new borrowing facilities to provide capital for normal operations, including new originations. If we are unable to establish new facilities at a reasonable size, our liquidity will be reduced significantly. Even if we are able to consummate new borrowing facilities, we may not be able to do so on favorable terms. If we are unable

67

to repay amounts outstanding under our existing facility and it is declared in default, our operations could be affected adversely.
Historically, we have funded senior and subordinated debt to middle-market companies and purchased rated syndicated private debt in larger companies through our on-balance sheet securitization trust-Commercial Loan Trust 2006-1. This securitized trust included a five-year reinvestment period, during which the trust was permitted to use principal collections received from repayments of the underlying collateral to purchase new collateral from us. The reinvestment period ended on July 20, 2011 and all future principal collections received will be used to repay the securitized debt.
In addition to our MCG Commercial Loan Trust 2006-1 facility, Solutions Capital has issued SBA debentures that require our SBIC to generate sufficient cash flow to make required interest payments. Further, Solutions Capital must maintain a minimum capitalization that if impaired could materially and adversely affect our liquidity, financial condition and results of operations. Our borrowings under our SBA debentures are collateralized by the assets of Solutions Capital.
Our continued compliance with these requirements depends on many factors, some of which are beyond our control. Material net asset devaluation in connection with additional borrowings could result in an inability to comply with our obligation to restrict the level of indebtedness that we are able to incur in relation to the value of our assets or to maintain a minimum level of stockholders' equity.
Our financial results could be affected adversely if a significant portfolio investment fails to perform as expected or if the value of a portfolio company decreases.
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.
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.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
STOCK REPURCHASE PROGRAM
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million. Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases are made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. We retire immediately all such shares of common stock that we purchase in connection with the stock repurchase program.
NET ISSUANCE OF RESTRICTED STOCK
For certain employees, we may be deemed to have purchased through the net issuance of shares, a portion of the shares of restricted stock previously issued under our Third Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, for which the forfeiture provisions have lapsed to satisfy the respective employee’s income tax withholding obligations. We retire immediately all such shares of common stock that we purchase in connection with such net issuance to employees.

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DIVIDEND REINVESTMENT PLAN
As part of our dividend reinvestment plan for our common stockholders, we may direct the plan administrator to purchase shares of our common stock on the open market to satisfy dividend reinvestment requests related to dividends that we pay on outstanding shares of our common stock.
The following table summarizes the shares of common stock that we have purchased during the three months ended September 30, 2012:
Period/Purpose
Total number
of shares
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
July 1 – 31, 2012
 
 
 
 
 
Stock repurchase program(a)
257,388

$
4.49

 
257,388

$
17,047,068

Restricted stock vesting(b)
795

$
4.50

(c) 
n/a

n/a

Dividend reinvestment requirements(d)
752

$
4.70

(e) 
n/a

n/a

Total July 1 – 31, 2012
258,935

$
4.49

 
257,388

$
17,047,068

August 1 – 31, 2012
 
 
 
 
 
Stock repurchase program(a)
995,022

$
4.49

 
995,022

$
12,584,237

Dividend reinvestment requirements(d)
1,661

$
4.67

(e) 
n/a

n/a

Total August 1 – 31, 2012
996,683

$
4.49

 
995,022

$
12,584,237

September 1 – 30, 2012
 
 
 
 
 
Restricted stock vesting(b)
17,609

$
4.61

(c) 
n/a

n/a

Total
1,273,227

$
4.49

 
1,252,410

$
12,584,237

    
(a)
On January 17, 2012, we announced that our board of directors had authorized a stock repurchase program of up to $35.0 million.
(b)
Represents shares repurchased from our employees in connection with the net issuance of shares to satisfy employee tax withholding obligations in connection with the vesting of restricted stock.
(c)
Based on the weighted-average closing share prices of our common stock on the dates that the forfeiture restrictions lapsed.
(d)
Represents stock purchased on the open market to satisfy dividend reinvestment requests.
(e)
Represents the weighted-average purchase price per share, including commissions, for shares purchased pursuant to the terms of our dividend reinvestment plan.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not Applicable.
ITEM 4. MINE SAFETY DISCLOSURES.
Not Applicable.
ITEM 5. OTHER INFORMATION.
Not Applicable.


69

ITEM 6. EXHIBITS.
The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K. All exhibits listed in the following table are incorporated by reference except for those exhibits denoted in the last column.
 
 
Incorporated by Reference
 
Exhibit
No.
Description
Form and SEC
File No.
Filing Date
with SEC
Exhibit No.
Filed with this 10-Q
10.1
Sublease dated as of August 15, 2012 by and between MCG Capital Corporation and FBR & CO.
8-K
(0-33377)
August 16, 2012
10.1
 
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
 
 
 
*
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
 
 
 
†
*
Filed herewith.
 
 
 
 
†
Furnished herewith.
 
 
 
 


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SIGNATURES
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:
October 29, 2012
By:
/s/ RICHARD W. NEU
 
 
 
Richard W. Neu
 
 
 
Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
Date:
October 29, 2012
By:
/s/ KEITH KENNEDY
 
 
 
Keith Kennedy
 
 
 
Chief Financial Officer
(Principal Financial and Accounting Officer)


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