MCG CAPITAL CORP - FORM 10-Q - October 30, 2013

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EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-31293013.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-32193013.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-32293013.htm
EX-15.1 - LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION FROM ERNST & YOUNG - MCG CAPITAL CORPex-15193013.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-31193013.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, 2013
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.)
1001 19th Street North, 10th Floor
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 25, 2013, there were 71,212,013 shares of the registrant’s $0.01 par value Common Stock outstanding.


MCG CAPITAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2013
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)
REVIEW 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,
2013
December 31,
2012
 
(unaudited)
 
Assets
 
 
Cash and cash equivalents
$
96,384

$
73,588

Cash, securitization accounts
7,793

16,980

Cash, restricted
38,408

54,838

Investments at fair value
 
 
Non-affiliate investments (cost of $480,467 and $534,389, respectively)
301,343

365,639

Affiliate investments (cost of $46,139 and $69,500, respectively)
47,224

62,079

Control investments (cost of $62,664 and $64,898, respectively)
46,965

50,006

Total investments (cost of $589,270 and $668,787, respectively)
395,532

477,724

Interest receivable
4,356

2,700

Other assets
3,545

4,946

Total assets
$
546,018

$
630,776

Liabilities
 
 
Borrowings (maturing within one year of $4,001 and $15,038, respectively)
$
179,173

$
248,053

Interest payable
725

2,496

Other liabilities
2,619

8,499

Total liabilities
182,517

259,048

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, 2013 and December 31, 2012, 71,212 issued and outstanding on September 30, 2013 and 71,721 issued and outstanding on December 31, 2012
712

717

Paid-in capital
983,337

984,468

Distributions in excess of earnings
(426,810
)
(422,395
)
Net unrealized depreciation on investments
(193,738
)
(191,062
)
Total stockholders’ equity
363,501

371,728

Total liabilities and stockholders’ equity
$
546,018

$
630,776

Net asset value per common share at end of period
$
5.10

$
5.18



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)
2013
2012
2013
2012
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Non-affiliate investments (less than 5% owned)
$
10,060

$
9,174

$
28,915

$
35,401

Affiliate investments (5% to 25% owned)
1,238

1,418

4,560

4,856

Control investments (more than 25% owned)
1,289

1,243

4,462

4,696

Total interest and dividend income
12,587

11,835

37,937

44,953

Advisory fees and other income
 
 




Non-affiliate investments (less than 5% owned)
570

210

1,344

1,357

Control investments (more than 25% owned)
13

24

25

1,262

Total advisory fees and other income
583

234

1,369

2,619

Total revenue
13,170

12,069

39,306

47,572

Operating expense
 
 




Interest expense
2,316

2,974

7,003

12,728

Employee compensation








Salaries and benefits
644

2,018

3,610

8,684

Amortization of employee restricted stock awards
420

505

1,174

1,694

Total employee compensation
1,064

2,523

4,784

10,378

General and administrative expense
1,824

2,504

3,942

10,714

Restructuring expense
2

12

14

59

Total operating expense
5,206

8,013

15,743

33,879

Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
7,964

4,056

23,563

13,693

Net realized gain (loss) on investments
 
 




Non-affiliate investments (less than 5% owned)
109

—

(658
)
12,550

Affiliate investments (5% to 25% owned)
(7
)
—

(554
)
16,370

Control investments (more than 25% owned)
—

(5,394
)
51

(102,288
)
Total net realized gain (loss) on investments
102

(5,394
)
(1,161
)
(73,368
)
Net unrealized (depreciation) appreciation on investments
 
 




Non-affiliate investments (less than 5% owned)
(5,005
)
2,463

(10,374
)
(13,892
)
Affiliate investments (5% to 25% owned)
71

(3,662
)
8,506

(19,407
)
Control investments (more than 25% owned)
217

6,838

(807
)
92,109

Other fair value adjustments
(1
)
(17
)
(1
)
(46
)
Total net unrealized (depreciation) appreciation on investments
(4,718
)
5,622

(2,676
)
58,764

Net investment gain (loss) before income tax provision
(4,616
)
228

(3,837
)
(14,604
)
Loss on extinguishment of debt before income tax (benefit) provision
—

—

—

(174
)
Income tax provision
59

18

111

329

Net income (loss)
$
3,289

$
4,266

$
19,615

$
(1,414
)
Income per basic and diluted common share
$
0.05

$
0.06

$
0.28

$
(0.02
)
Cash distributions declared per common share
$
0.125

$
0.14

$
0.38

$
0.45

Weighted-average common shares outstanding—basic and diluted
71,218

73,431

71,313

74,588


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)
2013
2012
Increase in net assets from operations
 
 
Net operating income before net investment loss, loss on extinguishment of debt and income tax provision
$
23,563

$
13,693

Net realized loss on investments
(1,161
)
(73,368
)
Net unrealized appreciation on investments
(2,676
)
58,764

Loss on extinguishment of debt before income tax provision
—

(174
)
Income tax provision
(111
)
(329
)
Net income (loss)
19,615

(1,414
)
Distributions to stockholders
 
 
Distributions declared
(26,706
)
(33,793
)
Net decrease in net assets resulting from stockholder distributions
(26,706
)
(33,793
)
Capital share transactions
 
 
Repurchase of common stock
(2,272
)
(22,416
)
Amortization of restricted stock awards
 
 
Employee awards accounted for as employee compensation
1,174

1,694

Non-employee director awards accounted for as general and administrative expense
43

53

Common stock withheld to pay taxes applicable to the vesting of restricted stock
(81
)
(336
)
Net decrease in net assets resulting from capital share transactions
(1,136
)
(21,005
)
Total decrease in net assets
(8,227
)
(56,212
)
Net assets
 
 
Beginning of period
371,728

434,952

End of period
$
363,501

$
378,740

Net asset value per common share at end of period
$
5.10

$
5.20

Common shares outstanding at end of period
71,212

72,788



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)
2013
2012
Cash flows from operating activities
 
 
Net income (loss)
$
19,615

$
(1,414
)
Adjustments to reconcile net income to net cash provided by operating activities
 
 
Investments in portfolio companies
(85,029
)
(42,619
)
Principal collections related to investment repayments or sales
167,724

314,598

Decrease (increase) in interest receivable, accrued payment-in-kind interest and dividends
(5,948
)
9,717

Amortization of restricted stock awards
 
 
Employee
1,174

1,694

Non-employee director
43

53

Decrease in cash—securitization accounts from interest collections
2,431

5,475

Decrease in restricted cash—escrow accounts
5,881

327

Depreciation and amortization
1,019

6,120

Decrease in other assets
500

1,039

Decrease in other liabilities
(7,702
)
(1,676
)
Realized loss on investments
1,161

73,368

Net unrealized appreciation on investments
2,676

(58,764
)
Loss on extinguishment of debt
—

174

Net cash provided by operating activities
103,545

308,092

Cash flows from financing activities
 
 
Repurchase of common stock
(2,272
)
(22,416
)
Payments on borrowings
(68,879
)
(202,740
)
Proceeds from borrowings
—

21,400

Decrease (increase) in cash in restricted and securitization accounts
 


Securitization accounts for repayment of principal on debt
6,756

31,156

Restricted cash
10,549

(79,906
)
Payment of financing costs
(116
)
(1,030
)
Distributions paid
(26,706
)
(46,885
)
Common stock withheld to pay taxes applicable to the vesting of restricted stock
(81
)
(336
)
Net cash used in financing activities
(80,749
)
(300,757
)
Net increase in cash and cash equivalents
22,796

7,335

Cash and cash equivalents
 
 
Beginning balance
73,588

58,563

Ending balance
$
96,384

$
65,898

Supplemental disclosure of cash flow information
 
 
Interest paid
$
7,802

$
9,261

Income taxes paid
158

61

Paid-in-kind interest collected
2,161

8,510

Dividend income collected
680

8,149


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

MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2013 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Control Investments(4):
 
 
 
 
 
 
 
GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)(1)
4.3
%
—

4.3
%
$
13,331

$
10,959

$
11,557

 
Subordinated Debt (Due 12/16)(6)
2.5
%
—

2.5
%
11,519

6,975

—

 
 
Class B Voting Units (8.0%, 86,700 units)(5)
 
 
 
 
9,071

—

Jet Plastica
Investors, LLC(2)(9)
Plastic Products
Senior Debt A (Due 3/15)(1)(6)
2.4
%
7.5
%
9.9
%
5,232

3,897

—

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
%
3.0
%
15.0
%
10,762

10,758

10,758

 
 
Preferred LLC Interest (19.7%, 70,000 units)
 
 
 
 
13,364

17,010

Total control investments (represents 11.9% of total investments at fair value)
 
 
 
 
62,664

46,965

Affiliate Investments(3):
 
 
 
 
 
 
 
C7 Data Centers, Inc.
Business Services
Senior Debt (Due 9/17)(1)
9.5
%
—

9.5
%
16,850

16,569

16,743

Series B Preferred Units (10.0%, 7,142,857 units)
 
 
 
 
2,203

2,819

Contract Datascan Holdings, Inc.
Business Services

Subordinated Debt (Due 3/16)(1)
12.0
%
2.0
%
14.0
%
8,706

8,296

8,296

Series A Preferred Stock (10.0%, 2,313 shares)(1)(5)
 
 
 
 
2,387

2,657

Series B Preferred Stock (10.0%, 358 shares)(1)(5)
 
 
 
 
307

412

 
 
Common Stock (8,519 shares)(1)(5)
 
 
 
 
538

—

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

9.8
%
15,000

14,746

14,746

 
 
Limited Partner Interests (8.0%)(1)(2)
 
 
 
 
1,093

1,551

Total affiliate investments (represents 11.9% of total investments at fair value)
 
 
 
 
46,139

47,224



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

MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2013 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
Accurate Group Holdings, Inc.(2)
Business Services
Subordinated Unsecured Debt (Due 8/18)(1)
12.5
%
—

12.5
%
$
10,000

$
9,822

$
9,822

Series A Preferred Stock (974,805 shares)(5)
 
 
 
 
2,000

1,955

Advanced Sleep
Concepts, Inc.(2)
Home Furnishings
Senior Debt (Due 8/14 to 1/14)(1)
10.3
%
—

10.3
%
7,559

7,552

6,764

Subordinated Debt (Due 1/14)(1)(6)
—
%
10.0
%
10.0
%
3,677

3,352

—

Broadview Networks Holdings, Inc.
Communications
Common Stock (132,779 shares)(5)
 
 
 
 
159,579

875

 
Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 
—

—

 
 
Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 
—

—

Color Star Growers of Colorado, Inc.
Agriculture
Subordinated Debt (Due 11/16)(1)(6)
12.0
%
3.0
%
15.0
%
13,864

13,522

13,195

Community Investors, Inc.
Business Services
Senior Debt (Due 5/18)(1)
9.8
%
—

9.8
%
12,300

12,067

12,067

Preferred Stock (10.0%, 297,436 shares)(1)
 
 
 
 
309

309

 
 
Common Stock (2,564 shares)(1)(5)
 
 
 
 
3

45

Cruz Bay Publishing, Inc.
Publishing
Subordinated Debt (Due 3/15)(1)
5.0
%
7.3
%
12.3
%
21,130

21,086

21,086

Dorsey School of Business Holdings, Inc.
Education
Senior Debt (Due 6/18)(1)
9.5
%
—

9.5
%
10,000

9,857

9,857

Education Management, Inc.(11)
Education
Senior Debt (Due 6/15)(1)
10.5
%
—

10.5
%
23,300

23,176

22,248

G&L Investment Holdings, LLC(2)
Insurance
Subordinated Debt (Due 5/14)(1)
10.7
%
4.3
%
15.0
%
19,275

19,178

19,178

 
Series A Preferred Shares (14.0%,
5,000,000 shares)(5)
 
 
 
 
8,191

4,934

 
 
Class C Shares (621,907 shares)(5)
 
 
 
 
529

—

Golden Knight II CLO, Ltd.(10)
Diversified Financial Services
Income Notes (Due 4/19)
 
 
 
 
2,594

3,256

Hammond's Candies Since 1920 II, LLC
Manufacturing
Subordinated Debt (Due 9/18)(1)
10.0
%
4.0
%
14.0
%
9,284

9,121

9,121

Huron Inc.
Manufacturing
Subordinated Unsecured Debt (Due 8/18)(1)
10.0
%
4.0
%
14.0
%
13,187

12,949

12,949

Intrafusion Holding Corp.
Healthcare
Senior Debt (Due 6/18)(1)
12.0
%
—

12.0
%
11,500

11,281

11,281

Legacy Cabinets Holdings II, Inc.
Home Furnishings
Class B-1 Common Stock (2,000 shares)(5)
 
 
 
 
2,185

62

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

6.8
%
4,080

4,043

3,982

Maverick Healthcare
Equity, LLC
Healthcare
Preferred Units (10.0%, 1,250,000 units)(5)
 
 
 
 
2,021

2,013

 
Class A Common Units (1,250,000 units)(5)
 
 
 
 
—

—

Midwest Technical Institute, Inc.
Education
Senior Debt (Due 10/17)(1)
9.5
%
—

9.5
%
14,250

13,971

14,098

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

12.5
%
19,363

19,197

19,197

Oceans Acquisition, Inc.
Healthcare
Senior Debt (Due 12/17)(1)
10.8
%
—

10.8
%
12,710

12,443

12,443


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

MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2013 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(8)
Principal
Cost
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Rita’s Water Ice Franchise Company, LLC
Restaurants
Senior Debt (Due 11/16)(1)
14.0
%
—

14.0
%
$
9,375

$
9,315

$
9,315

Sagamore Hill Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 8/14)(1)
10.5
%
—

10.5
%
8,900

8,868

8,868

SC Academy Holdings, Inc.
Education
Subordinated Debt (Due 7/16)(1)
—
%
14.0
%
14.0
%
14,129

14,060

14,060

South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt (Due 10/17)(1)
12.0
%
2.5
%
14.5
%
18,683

18,379

18,478

Summit Business Media Parent Holding Company LLC
Information Services
Class E Series I Units (636 units)(1)(5)
 
 
 
 
4,120

547

Class E Series II Units (276 units)(1)(5)
 
 
 
 
1,788

60

Ted's Café Escondido Holdings, Inc.
Restaurants
Senior Debt (Due 12/18)(1)
9.5
%
—

9.5
%
14,000

13,676

13,676

The e-Media Club I, LLC
Investment Fund
LLC Interest (74 units)(5)
 
 
 
 
88

11

Virtual Radiologic Corporation
Healthcare
Senior Debt (Due 12/16)(1)
7.3
%
—

7.3
%
13,635

13,516

8,675

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

5.3
%
4,711

4,711

4,581

West World Media, LLC
Information Services
Senior Debt (Due 9/15)(1)
11.0
%
3.0
%
14.0
%
11,507

11,093

11,199

Class A Membership Units (25,000 units)(1)(5)
 
 
 
 
1

390

 
 
Warrant to purchase Class A Membership Units (expire 9/15)(1)(5)
 
 
 
 
324

378

Xpressdocs Holdings, Inc.
Business Services
Series A Preferred Stock (161,870 shares)(5)
 
 
 
 
500

368

Total non-affiliate investments (represents 76.2% of total investments at fair value)
 
 
 
 
480,467

301,343

Total Investments
 
 
 
 
 
 
$
589,270

$
395,532



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

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2012
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Control Investments(4):
 
 
 
 
 
 
 
GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)(1)
4.3
%
—

4.3
%
$
17,570

$
15,150

$
15,736

 
Subordinated Debt (Due 12/16)(6)
2.5
%
—

2.5
%
11,303

6,976

—

 
 
Class B Voting Units (8.0%, 86,700 units)(5)
 
 
 
 
9,071

—

Jet Plastica
Investors, LLC(2)(9)
Plastic Products
Senior Debt A (Due 3/15)(1)(6)
2.3
%
7.0
%
9.3
%
4,963

3,897

—

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
%
3.0
%
15.0
%
10,521

10,518

10,518

 
 
Preferred LLC Interest (19.7%, 70,000 units)
 
 
 
 
11,646

16,112

Total control investments (represents 10.5% of total investments at fair value)
64,898

50,006

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

12.9
%
$
7,559

$
7,539

$
7,199

Subordinated Debt (Due 1/14)(1)(6)
12.0
%
4.0
%
16.0
%
5,873

5,385

10

 
 
Series A Preferred Stock (20.0%, 49 shares)(5)
 
 
 
 
344

—

 
 
Series B Preferred Stock (1,000 shares)(5)
 
 
 
 
—

—

 
 
Common Stock (423 shares)(5)
 
 
 
 
524

—

 
 
Warrants to purchase Common Stock
(expire 10/16)(5)
 
 
 
 
348

—

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

9.5
%
10,000

9,659

9,659

Series B Preferred Units (10.0%, 7,142,857 units)
 
 
 
 
2,053

2,421

Contract Datascan Holdings, Inc.
Business Services

Subordinated Debt (Due 3/16)(1)
12.0
%
2.0
%
14.0
%
8,575

8,059

7,870

Series A Preferred Stock (10.0%, 2,313 shares)(1)(5)
 
 
 
 
2,387

2,203

Series B Preferred Stock (10.0%, 358 shares)(1)(5)
 
 
 
 
307

341

 
 
Common Stock (8,519 shares)(1)(5)
 
 
 
 
538

—

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

9.8
%
15,000

14,707

14,707

 
 
Limited Partner Interests (8.0%)(1)(2)
 
 
 
 
1,032

1,073

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

12.5
%
16,738

16,495

16,495

Warrants to purchase Class A Units (expire 3/21)(1)(5)
 
 
 
 
123

101

Total affiliate investments (represents 13.0% of total investments at fair value)
 
 
 
 
69,500

62,079



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

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2012
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
Accurate Group Holdings, Inc.(2)
Business Services
Subordinated Unsecured Debt (Due 6/18)(1)
12.5
%
—

12.5
%
$
10,000

$
9,802

$
9,802

Series A Preferred Stock (974,805 shares)(5)
 
 
 
 
2,000

2,000

BarBri, Inc.
Publishing
Senior Debt (Due 6/17)(1)
6.0
%
—

6.0
%
6,099

6,046

6,110

Broadview Networks Holdings, Inc.
Communications
Common Stock (132,779 shares)(5)
 
 
 
 
159,579

1,087

 
Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 
—

—

 
 
Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 
—

—

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

10.5
%
27,347

27,237

27,237

Chase Industries, Inc.
Manufacturing
Subordinated Unsecured Debt (Due 5/18)(1)
11.5
%
—

11.5
%
16,800

16,472

16,472

Color Star Growers of Colorado, Inc.
Agriculture
Subordinated Debt (Due 11/16)(1)
12.0
%
3.0
%
15.0
%
13,553

13,292

13,292

Construction Trailer Specialists, Inc.(2)
Auto Parts
Senior Debt (Due 6/13)(1)
8.6
%
6.3
%
14.9
%
6,445

6,434

6,434

Cruz Bay Publishing, Inc.
Publishing
Subordinated Debt (Due 3/15)(1)(7)
5.0
%
7.3
%
12.3
%
20,000

19,942

19,942

CWP/RMK Acquisition Corp.(2)
Home Furnishings
Senior Debt (Due 12/16)(6)
6.8
%
—

6.8
%
600

519

597

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

9.3
%
26,654

26,459

25,260

Gans Communications,
L.P.(2)
Cable
Senior Debt (Due 10/17)(1)
5.0
%
—

5.0
%
5,015

4,996

5,061

G&L Investment Holdings, LLC(2)
Insurance
Subordinated Debt (Due 5/14)(1)
10.7
%
4.3
%
15.0
%
18,667

18,462

18,462

 
Series A Preferred Shares (14.0%,
5,000,000 shares)(5)
 
 
 
 
8,191

8,067

 
 
Class C Shares (621,907 shares)(5)
 
 
 
 
529

—

Golden Knight II CLO, Ltd.(10)
Diversified Financial Services
Income Notes (Due 4/19)
 
 
 
 
2,989

2,847

Hammond's Candies Since 1920 II, LLC
Manufacturing
Senior Debt (Due 12/17)(1)
8.5
%
—

8.5
%
3,500

3,427

3,427

 
Subordinated Debt (Due 6/18)(1)
10.0
%
4.0
%
14.0
%
9,008

8,829

8,829

Jenzabar, Inc.
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)(5)
 
 
 
 
2,185

—

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

6.8
%
4,640

4,590

4,594

Maverick Healthcare
Equity, LLC
Healthcare
Preferred Units (10.0%, 1,250,000 units)
 
 
 
 
1,925

2,078

 
Class A Common Units (1,250,000 units)(5)
 
 
 
 
—

444

Midwest Technical Institute, Inc.
Education
Senior Debt (Due 10/17)(1)
9.5
%
—

9.5
%
17,063

16,682

16,682

NDSSI Holdings,
LLC(2)
Electronics
Senior Debt (Due 12/12)(1)
12.8
%
1.0
%
13.8
%
30,175

30,174

30,174

 
Series D Preferred Units (30.0%, 2,000,000 units)(5)
 
 
 
 
2,000

3,000

 
 
Series A Preferred Units (516,691 units)(5)
 
 
 
 
718

—

 
 
Series B Convertible Preferred Units
(165,003 units)(5)
 
 
 
 
142

187

 
 
Class A Common Units (1,000,000 units)(5)
 
 
 
 
333

—

Oceans Acquisition, Inc.
Healthcare
Senior Debt (Due 12/17)(1)
10.8
%
—

10.8
%
23,710

23,237

23,237


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

MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2012
(dollars in thousands)
 
 
 
Interest Rate(8)
Principal
Cost
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Orbitz Worldwide, Inc.(10)
Personal Transportation
Senior Debt (Due 7/14)(1)
3.2
%
—

3.2
%
$
2,808

$
2,728

$
2,702

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

14.0
%
9,375

9,301

9,301

Sagamore Hill Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 8/14)(1)
10.5
%
—

10.5
%
9,700

9,636

9,636

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

12.0
%
18,000

17,841

17,841

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

7.3
%
13,720

13,606

13,814

South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt (Due 10/17)(1)
12.0
%
2.5
%
14.5
%
18,333

17,984

18,219

Summit Business Media Parent Holding Company LLC
Information Services
Class E Series I Units (636 units)(1)(5)
 
 
 
 
4,120

439

Class E Series II Units (276 units)(1)(5)
 
 
 
 
1,788

13

Sunshine Media
Group, Inc.(2)
Publishing
Warrants to purchase Common Stock
(expire 1/21)(5)
 
 
 
 
—

—

The e-Media Club I, LLC
Investment Fund
LLC Interest (74 units)(5)
 
 
 
 
88

11

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

6.0
%
8,500

8,409

8,489

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

7.8
%
13,740

13,591

12,091

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

5.3
%
4,760

4,772

4,338

VS&A-PBI Holding LLC
Publishing
LLC Interest(5)
 
 
 
 
500

—

West World Media, LLC
Information Services
Senior Debt (Due 9/15)(1)
11.0
%
3.0
%
14.0
%
11,462

10,911

11,140

Class A Membership Units (25,000 units)(1)(5)
 
 
 
 
1

335

 
 
Warrant to purchase Class A Membership Units
(expire 9/15)(1)(5)
 
 
 
 
324

719

Xpressdocs Holdings, Inc.
Business Services
Series A Preferred Stock (161,870 shares)(5)
 
 
 
 
500

241

Total non-affiliate investments (represents 76.5% of total investments at fair value)
 
 
 
 
534,389

365,639

Total Investments
 
 
 
 
 
 
$
668,787

$
477,724



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

MCG Capital Corporation
Consolidated Schedule of Investments

(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) 
Equity security is non-income producing at period-end.
(6) 
Loan or debt security is on non-accrual status.
(7) 
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.
(8) 
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.
(9) 
During 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.
(10) 
Investment is not a qualifying asset under section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of total assets at the time of acquisition of any additional non-qualifying assets.
(11) 
In October 2013, we signed a letter of intent to exchange $5.0 million of our senior debt to Education Management, Inc. for $5.0 million of a new class of preferred stock of Education Management, Inc.  If the transaction is consummated as contemplated, Education Management, Inc. will become an affiliate.



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

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 Subsidiary—This subsidiary is a bankruptcy remote, special-purpose entity to which we transfer certain loans. The financing subsidiary, in turn, transfers the loans to a Delaware statutory trust. For accounting purposes, the transfers of the loans to the Delaware statutory trust is structured as an on-balance sheet securitization.
Small Business Investment Subsidiaries—We own Solutions Capital I, L.P., or Solutions Capital, 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. in order to apply for a second SBIC license. In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P. In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013 and was accepted by the SBA in May 2013. Neither receipt of such an invitation nor acceptance of the application from the SBA assures an applicant 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 and Solutions Capital II, 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; 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. Further, in connection with the preparation of these Condensed

12

Consolidated Financial Statements, we have evaluated subsequent events that occurred after the balance sheet date as of September 30, 2013 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, 2012.
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, 2013
December 31, 2012
September 30, 2013
December 31, 2012
(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
$
228,577

38.8
%
$
297,842

44.6
%
$
218,937

55.4
%
$
291,760

61.1
%
Subordinated debt




 
 




 
 
Secured
124,727

21.2

127,288

19.0

114,173

28.8

114,983

24.1

Unsecured
22,771

3.8

26,274

3.9

22,771

5.8

26,274

5.4

Total debt investments
376,075

63.8

451,404

67.5

355,881

90.0

433,017

90.6

Equity investments




 
 




 
 
Preferred
44,041

7.5

46,403

6.9

37,284

9.4

41,558

8.7

Common/common equivalents
169,154

28.7

170,980

25.6

2,367

0.6

3,149

0.7

Total equity investments
213,195

36.2

217,383

32.5

39,651

10.0

44,707

9.4

Total investments
$
589,270

100.0
%
$
668,787

100.0
%
$
395,532

100.0
%
$
477,724

100.0
%
Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of September 30, 2013, approximately 72.8% of the fair value of our loan portfolio had variable interest rates, based on a London Interbank Offer Rate, or LIBOR, benchmark or the prime rate, and 27.2% of the fair value of our loan portfolio had fixed interest rates. As of September 30, 2013, approximately 63.6% 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 2.5% and 6.0%. At origination, our loans generally have four- to six-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.

13

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, 2013
December 31, 2012
September 30, 2013
December 31, 2012
(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
$
3,897

1.04
%
$
3,897

0.86
%
$
—

—
%
$
—

—
%
Not on non-accrual status
—

—

—

—

—

—

—

—

Total loans greater than 90 days past due
$
3,897

1.04
%
$
3,897

0.86
%
$
—

—
%
$
—

—
%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
23,849

6.34
%
$
12,880

2.85
%
$
13,195

3.71
%
$
607

0.14
%
Greater than 90 days past due
3,897

1.04

3,897

0.86

—

—

—

—

Total loans on non-accrual status
$
27,746

7.38
%
$
16,777

3.71
%
$
13,195

3.71
%
$
607

0.14
%
The following table summarizes our investment portfolio by industry at fair value:
 
September 30, 2013
December 31, 2012
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
104,598

26.4
%
$
106,119

22.2
%
Business services
74,689

18.9

64,947

13.6

Education
60,262

15.2

59,783

12.5

Publishing
25,069

6.4

30,646

6.4

Insurance
24,112

6.1

26,529

5.6

Restaurants
22,991

5.8

9,301

1.9

Manufacturing
22,070

5.6

28,728

6.0

Broadcasting
20,424

5.2

25,372

5.3

Agriculture
13,195

3.3

21,781

4.6

Information services
12,573

3.2

12,646

2.7

Home furnishings
6,826

1.7

7,806

1.6

Consumer products
4,581

1.2

4,338

0.9

Auto parts
—

—

6,434

1.3

Cable
—

—

5,061

1.1

Electronics
—

—

33,361

7.0

Logistics
—

—

27,237

5.7

Other(a)
4,142

1.0

7,635

1.6

Total
$
395,532

100.0
%
$
477,724

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

14

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.

15

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, 2013
(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
$
17,239

$
151,012

$
168,251

Subordinated secured debt
—

95,118

95,118

Unsecured subordinated debt
—

22,771

22,771

Preferred equity
3,256

9,580

12,836

Common/common equivalents
—

2,367

2,367

Total non-affiliate investments
20,495

280,848

301,343

Affiliate investments
 
 


Senior secured debt
—

31,489

31,489

Subordinated secured debt
—

8,297

8,297

Preferred equity
—

7,438

7,438

Total affiliate investments
—

47,224

47,224

Control investments
 
 


Senior secured debt
—

19,197

19,197

Subordinated secured debt
—

10,758

10,758

Preferred equity
—

17,010

17,010

Total control investments
—

46,965

46,965

Total assets at fair value
$
20,495

$
375,037

$
395,532

As of September 30, 2013, 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. As of each of September 30, 2013 and December 31, 2012, our portfolio contained zero non-majority control investments. 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 comprised 11.9% of our investment portfolio as of September 30, 2013. 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 in question. Also, in a limited number of cases, we use income approaches to determine fair value, 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 upon a hypothetical sale or exit and then allocate such value to the investment's securities in order of their relative liquidation preference. In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par. 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-Control Investments—Non-control investments comprised 88.1% of our investment portfolio as of September 30, 2013. Quoted prices were not available for 94.1% of our non-control investments as of

16

September 30, 2013. 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. In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.
•
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, 2013, these securities represented 5.2% of our investment portfolio. We utilize independent pricing services to arrive at 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, 2013, 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 99.0% 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 executive 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 the three and nine months ended September 30, 2013 and 2012, there were no transfers in or out of Level 1, 2 or 3.

17

The following table provides a reconciliation of fair value changes during the three months ended September 30, 2013 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, 2013
 
 
 
 
Senior secured debt
$
166,355

$
31,489

$
19,191

$
217,035

Subordinated secured debt
94,127

8,217

10,676

113,020

Unsecured subordinated debt
39,244

—

—

39,244

Preferred equity
12,706

7,261

16,220

36,187

Common/common equivalents equity
2,475

—

—

2,475

Total fair value as of June 30, 2013
314,907

46,967

46,087

407,961

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(1,267
)
(41
)
5

(1,303
)
Subordinated secured debt
(372
)
—

—

(372
)
Preferred equity
(3,134
)
105

211

(2,818
)
Common/common equivalents equity
(108
)
—

—

(108
)
Total realized/unrealized gain (loss)
(4,881
)
64

216

(4,601
)
Issuances
 
 
 
 
Senior secured debt
2,152

35

6

2,193

Subordinated secured debt
1,363

80

82

1,525

Unsecured subordinated debt
462

—

—

462

Preferred equity
8

72

579

659

Total issuances
3,985

187

667

4,839

Settlements
 
 
 
 
Senior secured debt
(6,348
)
6

(5
)
(6,347
)
Unsecured subordinated debt
(16,935
)
—

—

(16,935
)
Total settlements
(23,283
)
6

(5
)
(23,282
)
Sales








Senior secured debt
(9,880
)
—

—

(9,880
)
Total sales
(9,880
)
—

—

(9,880
)
Fair value as of September 30, 2013
 
 
 
 
Senior secured debt
151,012

31,489

19,197

201,698

Subordinated secured debt
95,118

8,297

10,758

114,173

Unsecured subordinated debt
22,771

—

—

22,771

Preferred equity
9,580

7,438

17,010

34,028

Common/common equivalents equity
2,367

—

—

2,367

Total fair value as of September 30, 2013
$
280,848

$
47,224

$
46,965

$
375,037

There were no purchases of level 3 investments during the three months ended September 30, 2013.

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 or sales of level 3 investments during the three months ended September 30, 2012.
Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the three months ended September 30, 2013 and 2012:
 
Three months ended September 30, 2013
Three months ended September 30, 2012
(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
$
(1,379
)
$
(35
)
$
5

$
(1,409
)
$
(10
)
$
(848
)
$
857

$
(1
)
Subordinated secured debt
(372
)
—

—

(372
)
1,983

(2,239
)
—

(256
)
Preferred equity
(3,134
)
106

211

(2,817
)
310

(517
)
611

404

Common/common equivalents equity
(108
)
—

—

(108
)
(33
)
(61
)
—

(94
)
Total change in unrealized appreciation (depreciation) on Level 3 investments
$
(4,993
)
$
71

$
216

$
(4,706
)
$
2,250

$
(3,665
)
$
1,468

$
53


19

The following table provides a reconciliation of fair value changes during the nine months ended September 30, 2013 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, 2012
 
 
 
 
Senior secured debt
$
163,125

$
48,060

$
23,376

$
234,561

Subordinated secured debt
96,585

7,880

10,518

114,983

Unsecured subordinated debt
26,274

—

—

26,274

Preferred equity
16,561

6,038

16,112

38,711

Common/common equivalents equity
3,048

101

—

3,149

Total fair value December 31, 2012
305,593

62,079

50,006

417,678

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(140
)
167

11

38

Subordinated secured debt
(473
)
190

—

(283
)
Preferred equity
(3,289
)
1,189

(820
)
(2,920
)
Common/common equivalents equity
(681
)
2,899

—

2,218

Total realized/unrealized gain (loss)
(4,583
)
4,445

(809
)
(947
)
Issuances
 
 
 
 
Senior secured debt
87,157

(9,020
)
49

78,186

Subordinated secured debt
8,416

237

240

8,893

Unsecured subordinated debt
13,432

—

—

13,432

Preferred equity
406

211

1,718

2,335

Common/common equivalents equity
3

—

—

3

Total issuances
109,414

(8,572
)
2,007

102,849

Settlements
 
 
 
 
Senior secured debt
(81,900
)
(7,718
)
(4,239
)
(93,857
)
Subordinated secured debt
(9,410
)
(10
)
—

(9,420
)
Unsecured subordinated debt
(16,935
)
—

—

(16,935
)
Total settlements
(108,245
)
(7,728
)
(4,239
)
(120,212
)
Sales
 
 
 
 
Senior secured debt
(17,230
)
—

—

(17,230
)
Preferred equity
(4,098
)
—

—

(4,098
)
Common/common equivalents equity
(3
)
(3,000
)
—

(3,003
)
Total sales
(21,331
)
(3,000
)
—

(24,331
)
Fair value as of September 30, 2013
 
 
 
 
Senior secured debt
151,012

31,489

19,197

201,698

Subordinated secured debt
95,118

8,297

10,758

114,173

Unsecured subordinated debt
22,771

—

—

22,771

Preferred equity
9,580

7,438

17,010

34,028

Common/common equivalents equity
2,367

—

—

2,367

Total fair value as of September 30, 2013
$
280,848

$
47,224

$
46,965

$
375,037

There were no purchases of level 3 investments during the nine months ended September 30, 2013.

20

The following table provides a reconciliation of fair value changes during the nine-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 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

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.

21

Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the nine months ended September 30, 2013 and 2012:
 
Nine months ended September 30, 2013
Nine months ended September 30, 2012
(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
$
(252
)
$
174

$
11

$
(67
)
$
1,175

$
(3,499
)
$
4,156

$
1,832

Subordinated secured debt
1,560

190

—

1,750

(1,484
)
(2,053
)
—

(3,537
)
Unsecured subordinated debt
—

—

—

—

81

—

—

81

Preferred equity
(3,086
)
1,189

(820
)
(2,717
)
(62
)
(129
)
(13,759
)
(13,950
)
Common/common equivalents equity
1,022

23

—

1,045

69

(669
)
—

(600
)
Total change in unrealized appreciation (depreciation) on Level 3 investments
$
(756
)
$
1,576

$
(809
)
$
11

$
(221
)
$
(6,350
)
$
(9,603
)
$
(16,174
)
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. Rather, 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, 2013:
 
 
 
 
 
 
 
($ in thousands)
Fair Value
Valuation Techniques
Unobservable
Inputs
Range
Weighted Average
 
Minimum
Maximum
Senior debt
$
201,698

Discounted cash flow
Market interest rate
5.7
%
12.7
%
8.8
%



Discounted cash flow
Discount rate
4.0
%
4.0
%
4.0
%



Market comparable companies
Revenue Multiple
0.2x

0.2x

0.2x




Market comparable companies
EBITDA multiple(a)
7.5x

7.5x

7.5x

Subordinated debt
136,944

Discounted cash flow
Market interest rate
12.2
%
16.7
%
13.7
%



Market comparable companies
Revenue multiple
0.2x

0.2x

0.2x




Market comparable companies
EBITDA multiple(a)
7.5x

7.5x

7.5x

Preferred and common equity
36,395

Market comparable companies
EBITDA multiple(a)
4.4x

10.0x

7.7x




Discount for minority interest
—
%
25.0
%
2.5
%



Residual assets
Discount rate
25.0
%
25.0
%
25.0
%
 
$
375,037

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

22

NOTE 4—CONCENTRATIONS OF INVESTMENT RISK
During the nine months ended September 30, 2013, we had concentrations in certain industries, including the healthcare, business services and education 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, 2013
December 31, 2012
September 30, 2013
September 30, 2012
(dollars in thousands)
Amount
% of Total Portfolio
Amount
% of Total Portfolio
Amount
% of Total Revenue
Amount
% of Total Revenue
Industry
 
 
 
 
 
 
 
 
Healthcare
$
104,598

26.4
%
$
106,119

22.2
%
$
10,189

25.9
%
$
7,023

14.8
%
Business services
74,689

18.9

64,947

13.6

6,073

15.4

5,658

11.9

Education
60,262

15.2

59,783

12.5

4,922

12.5

4,348

9.1

NOTE 5—BORROWINGS
As of September 30, 2013, we reported $179.2 million of borrowings on our Consolidated Balance Sheets at cost. The following table summarizes our borrowing facilities, the facility amounts and amounts outstanding.
 
 
September 30, 2013
December 31, 2012
(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

41,400

MCG Commercial Loan Trust 2006-1
 




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

—

37,151

37,151

Series 2006-1 Class C Notes(a)(c)
April 2018(b)
381

271

45,000

32,000

Series 2006-1 Class D Notes(d)
April 2018(b)
45,945

28,902

45,945

28,902

Bank of America Unsecured Revolver
 




 
 
Unsecured Revolving Note
November 2014
20,000

—

20,000

—

Total borrowings
 
$
216,326

$
179,173

$
298,096

$
248,053

__________
(a)    In April 2013, the Class B Notes were repaid in full and, in October 2013, the Class C Notes were repaid in full.
(b)    Borrowings under the MCG 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. 
(c)    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.
(d)    Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.
We estimate that the fair value of these borrowings as of September 30, 2013 was approximately $181.7 million, based on market data and current interest rates. This fair value is estimated from market quotes in an inactive market provided by an independent pricing service for $28.4 million of our borrowings (level 2) and a market-yield approach for $153.3 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

23

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, 2013, our ratio of total assets to total borrowings and other senior securities was 1,338%. 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.
Each of our borrowing facilities has certain financial covenants and non-financial covenants. We were in compliance with the covenants as of September 30, 2013 and 2012.
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. 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, 2013
2013(a)
$
4,001

2014
—

2015
—

2016
—

2017
—

Thereafter
175,172

Total
$
179,173

____________
(a) 
Reflects repayments we are required to make in connection with principal collections from collateral loans in our MCG Commercial Loan Trust 2006-1.
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 permits Solutions Capital to borrow up to $150.0 million from the SBA, which is the maximum amount of outstanding leverage available to single-license SBIC companies.
In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L. P. in order to apply for a second SBIC license. In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P. In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013 and was accepted by the SBA in May 2013. Neither receipt of such an invitation nor acceptance of the application from the SBA assures an applicant that the SBA will grant the additional license in any specified time period or at all. Currently, a second SBIC license would grant us the ability to borrow up to an additional $75.0 million from the SBA, or two times the amount of statutory equity capital we invest in Solutions Capital II, L.P. If approved and depending on available capital, we intend to fund the entire $37.5 million using unrestricted cash. In the second quarter of 2013, we invested $10.0 million of unrestricted cash in Solutions Capital II, L.P. and funded a small business loan to Dorsey School of Business Holdings, Inc, or Dorsey.  We also received pre-licensing investment approval from the SBA for the Dorsey investment which, if closed in accordance with our pre-investment documentation, will count toward the required statutory capital of $37.5 million in our second SBIC.
To realize the full $150.0 million in borrowings for which we have received approval to date under the SBIC program, we have funded a total of $75.0 million to Solutions Capital. As of each of September 30, 2013 and December 31, 2012, Solutions Capital had borrowed $150.0 million. We are permitted to use these funds to provide debt and equity capital to qualifying small businesses. However, we may not use these borrowings to provide additional financing 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.

24

As of September 30, 2013 and December 31, 2012, we had $209.8 million and $187.9 million, respectively, of investments in Solutions Capital and we had $36.7 million and $48.3 million, respectively, of restricted cash to be used for additional investments in Solutions Capital.
As of September 30, 2013, Solutions Capital had borrowings outstanding as summarized in the following table:
 
Amount Outstanding
 
(dollars in thousands)
September 30,
2013
December 31,
2012
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

41,400

3.38
%
Fixed
Total
$
150,000

$
150,000

4.33
%
 
MCG Commercial Loan Trust 2006-1
In April 2006, we completed a $500.0 million debt securitization through the MCG 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%. As of September 30, 2013, we have repaid all of the Class A and Class B Notes.
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, 2013 and December 31, 2012:
(dollars in thousands)
September 30, 2013
December 31, 2012
 
Amount
%
Amount
%
Securitized assets
 
 
 
 
Senior secured debt
$
59,692

60.9
%
$
136,513

74.2
%
Subordinated secured debt
30,001

30.6

30,025

16.3

Common Equity
606

0.6

452

0.3

Total securitized assets
90,299

92.1

166,990

90.8

Cash, securitization accounts
7,793

7.9

16,980

9.2

Total collateral
$
98,092

100.0
%
$
183,970

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.

25

Bank of America Unsecured Revolver
In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or Bank of America Unsecured Revolver. The Bank of America Unsecured Revolver will expire in November 2014. In August 2013, we executed an amendment to the Bank of America Unsecured Revolver that requires that we maintain a zero balance for a period of at least five consecutive days during the six-month period immediately preceding June 30th and December 31st of each year, which testing was previously required quarterly. In the event we borrow under the Bank of America Unsecured Revolver, we agreed to increase the interest rate on such advances from LIBOR plus 3.5% to LIBOR plus 4.0%. As of September 30, 2013, there were no borrowings outstanding on the Bank of America Unsecured Revolver.
The Bank of America Unsecured Revolver is subject to certain collateral requirements and financial covenants. Included among them are requirements that we maintain a ratio of all unencumbered assets to outstanding amounts under the Bank of America Unsecured Revolver of at least four-to-one, as well as a ratio of unencumbered cash and senior portfolio loans to outstanding amounts under the Bank of America Unsecured Revolver of at least three-to-one. The Bank of America Unsecured Revolver may be prepaid at any time.
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, which was terminated after we effected repurchases totaling approximately $29.4 million. During the three months ended September 30, 2013, we did not repurchase any shares of our common stock. During the nine months ended September 30, 2013, we repurchased 504,639 shares of our common stock at a weighted average purchase price of $4.50 per share, which was a 13.1% discount from our quarterly net asset value per share. On October 25, 2013, our board of directors authorized an additional stock repurchase program of up to $25.0 million. See Note 14—Subsequent Event. 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.
We requested and received the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engage in a stock repurchase program and agree not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans. Although there were 1,239,074 shares of our common stock available for issuance under our Third Amended and Restated 2006 Employee Restricted Stock Plan, as of September 30, 2013 and December 31, 2012, an aggregate of 40,505 and 107,924 shares of restricted stock, respectively, could be issued under our Third Amended and Restated 2006 Employee Restricted Stock Plan and our Third Amended and Restated 2006 Non-Employee Director Restricted Stock Plan before reaching the 10% threshold set forth in the SEC's order. The decrease in shares that could be issued under the restricted stock plans is attributable to the shares we repurchased under our stock repurchase program.

26

DISTRIBUTIONS
The following table summarizes our distributions per share declared since January 1, 2012:
Date Declared
Record Date
Payment Date
Amount
October 25, 2013
November 8, 2013
November 22, 2013
$
0.125

July 26, 2013
August 9, 2013
August 30, 2013
$
0.125

April 26, 2013
May 10, 2013
May 31, 2013
$
0.125

March 1, 2013
March 15, 2013
March 29, 2013
$
0.125

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

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, 2013, no shares of restricted stock were issued under the 2006 Plan. During nine months ended September 30, 2012, we issued 1,000,000 shares 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.
During the nine months ended September 30, 2013 and 2012, we recognized $1.2 million and $1.7 million, respectively, of compensation expense related to share-based compensation awards. As of September 30, 2013, 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, 2013, we had $3.2 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 2.3 years.
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, 2013 and 2012, we awarded 15,000 and 22,500 shares, respectively, of restricted common stock to non-employee directors. During the nine months ended September 30, 2013 and 2012, 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, 2013, 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 2.0 years.

27

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, 2013:
 
Shares
Weighted-Average
Grant Date
Fair Value per Share
Subject to forfeiture provisions as of December 31, 2012
1,142,020

$
4.70

Awarded
15,000

$
5.01

Forfeiture provision satisfied
(60,660
)
$
6.55

Forfeited
(3,620
)
$
7.09

Subject to forfeiture provisions as of September 30, 2013
1,092,740

$
4.58

NOTE 8—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, 2013, we incurred $14,000 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, 2013 through September 30, 2013:
(in thousands)
Severance
Benefits
Other
Total
Balance as of December 31, 2012
$
648

$
21

$
669

Additions
—

(11
)
(11
)
Accretion
14

—

14

Cash payments
(662
)
(10
)
(672
)
Balance as of September 30, 2013
$
—

$
—

$
—

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, 2013 and 2012, we recorded income tax provisions of $0.1 million and $0.3 million, respectively, which were primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.
From December 2001 through September 30, 2013, we declared aggregate per share distributions of $13.76. 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. All or a portion of the distributions that we paid to stockholders during fiscal years 2012, 2011, 2008, 2006, 2005, 2004 and 2003 represented a return of capital.

28

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, 2013, 75% would be from ordinary income and 25% 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.
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 subsequent 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.
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 book basis.

29

NOTE 10—EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted income per common share for the three and nine months ended September 30, 2013 and 2012:
(dollars in thousands, except per share amounts)
Three months ended September 30,
Nine months ended September 30,
 
2013
2012
2013
2012
Numerator for basic and diluted earnings per share
 
 
 
 
Net income (loss)
$
3,289

$
4,266

$
19,615

$
(1,414
)
Less: Dividends declared—common and restricted shares
(8,902
)
(10,274
)
(26,706
)
(33,793
)
Undistributed loss
(5,613
)
(6,008
)
(7,091
)
(35,207
)
Percentage allocated to common shares(a)
98.4
%
98.3
%
98.4
%
100.0
%
Undistributed earnings—common shares
(5,523
)
(5,906
)
(6,978
)
(35,207
)
Add: Dividends declared—common shares
8,760

10,099

26,284

33,793

Numerator for common shares outstanding excluding participating shares
3,237

4,193

19,306

(1,414
)
Numerator for participating unvested shares only
52

73

309

—

Numerator for basic and diluted earnings per share—total
$
3,289

$
4,266

$
19,615

$
(1,414
)
Denominator for basic and diluted weighted-average shares outstanding
 
 
 
 
Common shares outstanding
70,109

72,205

70,189

74,588

Participating unvested shares
1,109

1,226

1,124

—

Basic and diluted weighted-average common shares outstanding—total
71,218

73,431

71,313

74,588

Earnings (loss) per share—basic and diluted
 
 
 
 
Excluding participating unvested shares
$
0.05

$
0.06

$
0.28

$
(0.02
)
Including participating unvested shares
$
0.05

$
0.06

$
0.28

$
(0.02
)
 
 
 
 
 
 
(a) Basic and diluted weighted-average common shares:
 
 
 
 
Weighted-average common shares outstanding
70,109

72,205

70,189

74,588

Weighted-average restricted shares
1,109

1,226

1,124

—

Total basic and diluted weighted-average common shares
71,218

73,431

71,313

74,588

Percentage allocated to common shares
98.4
%
98.3
%
98.4
%
100.0
%
(b)     For the nine months ended September 30, 2012, we excluded 1,031 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

30

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, 2013 and December 31, 2012, we had $19.1 million and $23.0 million, respectively, of outstanding unused loan commitments. We estimate that as of each of September 30, 2013 and December 31, 2012, 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, 2013 and December 31, 2012, 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. The lease on our former headquarters in Arlington, Virginia expired 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 lease. In November 2012, we ceased using our old headquarters and recognized the remaining amounts due under that lease in other liabilities on our Consolidated Balance Sheet as of December 31, 2012. As of September 30, 2013, our obligations for the remaining terms of these leases was $0.5 million, of which $0.4 million will be payable during the next twelve months.

31

NOTE 12—FINANCIAL HIGHLIGHTS
The following schedule summarizes our financial highlights for the nine months ended September 30, 2013 and 2012:
 
Nine months ended
(in thousands, except per share amounts)
September 30
 
2013
2012
Per share data
 
 
Net asset value at beginning of period(a)
$
5.18

$
5.65

Net income(b)


 
Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
0.33

0.18

Net realized gain (loss) on investments
(0.02
)
0.79

Net unrealized (depreciation) appreciation on investments
(0.03
)
(0.98
)
Loss on extinguishment of debt before income tax (benefit) provision
—

—

Income tax provision
—

(0.01
)
Net income (loss)
0.28

(0.02
)
Net decrease in net assets resulting from distributions
(0.38
)
(0.45
)
Net increase (decrease) in net assets relating to stock-based transactions


 
Issuance of shares of restricted common stock(c)
—

(0.07
)
Repurchase of common stock
—

0.06

Net increase in stockholders’ equity from restricted stock amortization
0.02

0.03

Net increase (decrease) in net assets relating to share issuances
0.02

0.02

Net asset value at end of period(a)
5.10

5.20

Market price per share

 
Beginning of period
$
4.60

$
3.99

End of period
$
5.04

$
4.61

Total Return(d)
17.72
%
31.08
 %
Shares of Common Stock Outstanding(d)


 
Weighted-average—basic and diluted
71,313

74,588

End of period
71,212

72,788

Net assets


 
Average
$
367,445

$
406,263

End of period
$
363,501

$
378,740

Ratios (annualized)


 
Operating expenses to average net assets
5.74
%
11.14
 %
Net operating income to average net assets
8.60
%
4.50
 %
General and administrative expense to average net assets
1.44
%
3.52
 %
Return on average equity
7.16
%
-0.46
 %
__________________
(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].

32

NOTE 13—SIGNIFICANT SUBSIDIARY
We have determined that for the nine months ended September 30, 2013, RadioPharmacy Investors, LLC, or RadioPharmacy, is an unconsolidated portfolio company that has met the conditions of a significant subsidiary and therefore, we are presenting summarized financial information of RadioPharmacy as of the most recent periods for which data is available. RadioPharmacy is a private company, which has prepared financial statements in accordance with GAAP but not in accordance with Regulation S-X. In addition, the financial information of RadioPharmacy has not been audited. The following table sets forth summarized balance sheet information for RadioPharmacy as of August 31, 2013 and December 31, 2012.
(in thousands)
August 31, 2013
December 31, 2012
 
(unaudited)
(unaudited)
Assets:
 
 
Total current assets
$
6,129

$
5,868

Total non-current assets
19,509

18,783

Total assets
$
25,638

$
24,651

 
 
 
Liabilities and Stockholders' Equity:
 
 
Current liabilities
$
3,972

$
2,907

Long-term liabilities
19,537

19,679

Preferred stock
1

1

Other stockholders' equity
2,128

2,064

Total liabilities and stockholders' equity
$
25,638

$
24,651

The following table sets forth summarized income statement information for RadioPharmacy Investors, LLC for the eight months ended August 31, 2013 and 2012.
 
Eight months ended August 31,
(in thousands)
2013
2012
 
(unaudited)
(unaudited)
Sales
$
17,836

$
18,726

Gross margin
$
10,525

$
10,285

Net income (loss)
$
65

$
(241
)
NOTE 14—SUBSEQUENT EVENT
STOCK REPURCHASE PROGRAM
On October 25, 2013, our board of directors authorized a stock repurchase program of up to $25.0 million.
Under the program, MCG management is 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 MCG 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.


33

Review 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, 2013, the related consolidated statements of operations for the three- and nine- month periods ended September 30, 2013 and 2012, and the related consolidated statements of changes in net assets, cash flows and financial highlights for the nine-month periods ended September 30, 2013 and 2012. 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, 2012, 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 we expressed an unqualified audit opinion on those consolidated financial statements in our report dated March 5, 2013. In our opinion, the accompanying consolidated balance sheet as of December 31, 2012, 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 30, 2013


34

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 expectations regarding the approval process for a second SBIC license, which is subject to approval by the SBA in its sole discretion and may not be granted in any specified time period, or at all; our intentions with respect to funding in full our equity portion of a second SBIC license using unrestricted cash; 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; our expectations regarding the level and timing of monetizations during 2013 and 2014; our expectations with regard to projected origination pacing and anticipated aggregate investment levels; our expectation that we will substantially deploy our cash on-hand by late 2014/early 2015; future dividend distributions, the timing and amount of which are subject to, among other things, approval of our board of directors and which may never be declared or distributed; the timing of our pay off of our 2006-1 Trust; projected per share net operating income levels, which may never be realized; our plans with respect to hiring of asset management professionals focused primarily on originations; our intentions to repurchase shares of our common stock under our stock repurchase program and purchase debt for cash in open markets purchases and/or privately-negotiated transactions; the sufficiency of liquidity to meet 2013 operating requirements, as well as new origination opportunities and potential dividend distributions; the use of our available liquidity to pay dividends to our stockholders and to repurchase our common stock in the open market under our stock repurchase program; estimated 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; our decisions to make dividend distributions after taking into account our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio; our use of independent valuation firms to provide additional support for our internal analyses; our expectations regarding the outcome of legal proceedings incidental to our business; 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 that provides capital and advisory services to middle-market companies throughout the United States. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, refinance existing debt, buyouts, organic growth, working capital and other general corporate purposes.
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 limitations on our ability to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings (excluding small business investment company, or SBIC, debt) of at least 200% (i.e., the amount of debt generally may not exceed 50% of the value of our assets).

35

We also make investments in qualifying small businesses through our wholly owned subsidiary licensed by the United States Small Business Administration, or the SBA, to operate as a SBIC under the Small Business Investment Act of 1958, as amended, or the SBIC Act. An SBIC is subject to a variety of regulations concerning, among other things, the size and nature of the companies in which it may invest and the structure of those investments.
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 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
•
Originations and Advances — For the three and nine month periods ended September 30, 2013, we made $4.2 million and $91 million, respectively, in originations and advances to new and existing portfolio companies.
•
Loan Monetizations — For the three and nine month periods ended September 30, 2013, we received $60.9 million and $162.4 million, respectively, in loan payoffs and amortization payments.
•
Equity Monetizations and Realizations — For the three and nine month periods ended September 30, 2013, we received $0.3 million and $8.1 million, respectively, in proceeds from the sale of equity investments, principally the sale of securities in each of Miles Media Group, LLC, NDSSI Holdings, LLC and Jenzabar, Inc.
•
Loans on Non-Accrual — As of September 30, 2013, loans on non-accrual were $27.7 million at cost (7.4% of the total loan portfolio), and $13.2 million at fair value (3.7% of the total loan portfolio). During the quarter ended September 30, 2013, CWP/RMK Acquisition Corp. repaid the principal balance of its loan and we put Color Star Growers of Colorado, Inc. on non-accrual status.
•
Operating Costs — For the three month period ended September 30, 2013, our total operating costs, excluding interest expense, were $2.9 million, or 0.5% of total assets of $546 million. During this same period, we incurred severance costs of $0.8 million, or 0.1% of total assets, that we included in total operating costs.
•
Reduced Leverage — From June 30, 2013 to September 30, 2013, we reduced our outstanding borrowings under our MCG Commercial Loan Trust, or 2006-1 Trust, by $25.8 million, reducing our borrowings under our 2006-1 Trust from $54.9 million to $29.2 million as of September 30, 2013. In October 2013, we further reduced our borrowings under our 2006-1 Trust by $4.0 million from $29.2 million to $25.2 million.
OUTLOOK
For the remainder of 2013, we anticipate monetizing an additional $20.0 million to $40.0 million of investments. For the twelve months ending December 31, 2013, we expect aggregate monetizations of approximately $190.0 million to $210.0 million of investments approximately two times the amount we projected at the beginning of 2013 and approximately 40% of our investment portfolio as of December 31, 2013. Over the next four quarters, we generally expect portfolio monetizations to range between $90.0 million to $120.0 million.
Over the four quarters ended September 30, 2013, we originated or advanced over $200.0 million to portfolio companies. Assuming the wind-down of our 2006-1 Trust and based on our total assets available for investment of approximately $500.0 million, over time we would expect to monetize and redeploy approximately $150.0 million to $200.0 million of capital per year and remain fully deployed. During the fourth quarter of 2013, we anticipate that we will originate or advance approximately $30.0 million to $45.0 million of investments.
We took active steps during the quarter ended September 30, 2013 to shift resources to the asset management portion of our business. Over the next six months, we intend to hire additional asset management professionals focused primarily on originations. We are targeting the origination of new loans and equity co-investments sufficient to end the year with total investments of $385 million to $420 million (calculated at fair value).
Before considering any potential implications of a second SBIC license, we anticipate that we will originate or advance the majority of our available capital by late 2014 or the first half of 2015. Depending on the level of monetizations, and assuming we can fully deploy our available capital by December 31, 2014, we expect to end calendar year 2014

36

with approximately $450.0 million to $500.0 million of total investments and $475.0 million to $525.0 million of total assets. We also anticipate paying off our 2006-1 Trust by December 31, 2014.
Driven primarily by the accelerated levels of monetization that we have experienced to date and taking into consideration the levels of monetizations that we expect over the next five fiscal quarters, we estimate that our net operating income, or NOI, per quarter, will range from $0.08 to $0.10 per share over the next two-to-three fiscal quarters before increasing to $0.11 to $0.13 per share as we fully deploy our capital. As a result and subject to approval by our board of directors, we anticipate maintaining our quarterly distribution at 12.5 cents per share over this horizon.
ACCESS TO CAPITAL AND LIQUIDITY
At September 30, 2013, we had $96.4 million of cash and cash equivalents available for general corporate purposes, as well as $36.8 million of cash in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC and $1.6 million of restricted cash held in escrow. In addition, we had $7.8 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 of the 2006-1 Trust.
At September 30, 2013, cash in securitization accounts included $6.3 million in the principal collections account of our 2006-1 Trust. In October 2013, we used the $6.3 million of securitized cash to repay borrowings of our 2006-1 Trust, a pro rata portion of which we received for the principal we own. 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, 2013, the net outstanding borrowings under the 2006-1 Trust were $29.2 million, which was reduced to $25.2 million in October 2013.
At September 30, 2013, $150.0 million of SBA borrowings were outstanding, the maximum available under our current SBIC license.
At September 30, 2013, we had full access to our $20.0 million unsecured revolving credit facility with Bank of America, N.A.
PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY
As of September 30, 2013, the fair value of our investment portfolio was $395.5 million, which represents a $82.2 million, or 17.2%, decrease from the $477.7 million fair value as of December 31, 2012. The following sections describe the composition of our investment portfolio as of September 30, 2013 and key changes in our portfolio during the nine months ended September 30, 2013.
Portfolio Composition
The following table summarizes the composition of our investment portfolio at fair value:
 
September 30, 2013
December 31, 2012
(dollars in thousands)
Investments at
Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Debt investments
 
 
 
 
Senior secured debt
$
218,937

55.4
%
$
291,760

61.1
%
Subordinated debt
 
 
 
 
Secured
114,173

28.8

114,983

24.1

Unsecured
22,771

5.8

26,274

5.4

Total debt investments
355,881

90.0

433,017

90.6

Equity investments
 
 
 
 
Preferred equity
37,284

9.4

41,558

8.7

Common/common equivalents equity
2,367

0.6

3,149

0.7

Total equity investments
39,651

10.0

44,707

9.4

Total investments
$
395,532

100.0
%
$
477,724

100.0
%
Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of September 30, 2013, approximately 72.8% of the fair value of our loan portfolio had variable interest rates, based on either the London Interbank Offer Rate, or LIBOR, or the prime rate,

37

and 27.2% of the fair value of our loan portfolio had fixed interest rates. As of September 30, 2013, approximately 63.6% 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 2.5% and 6.0%. At origination, our loans generally have four- to six-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, 2013
December 31, 2012
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
104,598

26.4
%
$
106,119

22.2
%
Business services
74,689

18.9

64,947

13.6

Education
60,262

15.2

59,783

12.5

Publishing
25,069

6.4

30,646

6.4

Insurance
24,112

6.1

26,529

5.6

Restaurants
22,991

5.8

9,301

1.9

Manufacturing
22,070

5.6

28,728

6.0

Broadcasting
20,424

5.2

25,372

5.3

Agriculture
13,195

3.3

21,781

4.6

Information services
12,573

3.2

12,646

2.7

Home furnishings
6,826

1.7

7,806

1.6

Consumer products
4,581

1.2

4,338

0.9

Auto parts
—

—

6,434

1.3

Cable
—

—

5,061

1.1

Electronics
—

—

33,361

7.0

Logistics
—

—

27,237

5.7

Other(a)
4,142

1.0

7,635

1.6

Total
$
395,532

100.0
%
$
477,724

100.0
%
______________________
(a)    No individual industry within this category exceeds 1%.
 
 
 
 
As of September 30, 2013, our ten largest portfolio companies represented approximately 51.7% of the total fair value of our investments. These ten companies accounted for 48.4% of our total revenue during the nine months ended September 30, 2013.
During the nine months ended September 30, 2013, we had concentrations in certain industries, including the healthcare, business services and education 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, 2013
December 31, 2012
September 30, 2013
September 30, 2012
(dollars in thousands)
Amount
% of Total Portfolio
Amount
% of Total Portfolio
Amount
% of Total Revenue
Amount
% of Total Revenue
Industry
 
 
 
 
 
 
 
 
Healthcare
$
104,598

26.4
%
$
106,119

22.2
%
$
10,189

25.9
%
$
7,023

14.8
%
Business services
74,689

18.9

64,947

13.6

6,073

15.4

5,658

11.9

Education
60,262

15.2

59,783

12.5

4,922

12.5

4,348

9.1


38

Changes in Investment Portfolio
During the nine months ended September 30, 2013, we completed $91.0 million of originations and advances compared to $48.1 million of originations and advances during the nine months ended September 30, 2012. The following table summarizes our total portfolio investment activity during the nine months ended September 30, 2013 and 2012:
 
Nine months ended
(in thousands)
September 30
 
2013
2012
Beginning investment portfolio
$
477,724

$
741,166

Originations and advances
91,032

48,070

Gross payments, reductions and sales of securities
(170,566
)
(331,256
)
Net realized loss
(961
)
(73,368
)
Unrealized depreciation
(5,286
)
(15,903
)
Reversals of unrealized depreciation
2,610

74,713

Origination fees and amortization of unearned income
979

1,371

Ending investment portfolio
$
395,532

$
444,793

Originations and Advances
The following table shows our originations and advances during the nine months ended September 30, 2013 and 2012 by security type:
 
Nine months ended September 30,
 
2013
2012
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
Senior secured debt
$
71,178

78.2
%
$
32,174

66.9
%
Subordinated debt
 
 
 
 
Secured
3,570

3.9

9,618

20.0

Unsecured
13,322

14.6

70

0.2

Total debt investments
88,070

96.7

41,862

87.1

Equity investments
 
 
 
 
Preferred equity
2,959

3.3

6,147

12.8

Common/common equivalents equity
3

—

61

0.1

Total equity investments
2,962

3.3

6,208

12.9

Total originations and advances
$
91,032

100.0
%
$
48,070

100.0
%

39

The following table shows our significant originations and advances:
(in thousands)
Nine months ended
 
September 30, 2013
Company
Originations
Draws/
Advances
PIK Advances/ Dividends
Total
Debt
 
 
 
 
Intrafusion Holdings, Inc.
$
21,500

$
—

$
—

$
21,500

Ted's Café Escondido Holdings, Inc.
14,000

—

—

14,000

Huron Inc.
13,000

—

322

13,322

Community Investors, Inc.
12,300

—

—

12,300

Dorsey School of Business Holdings, Inc.
10,000

—

—

10,000

C7 Data Centers, Inc.
—

7,000

—

7,000

Miles Media Group, LLC
—

3,450

—

3,450

Cruz Bay Publishing, Inc.
—

—

1,130

1,130

Education Management, Inc.
—

1,000

—

1,000

Other (< $1 million)
—

1,500

2,868

4,368

Total debt
70,800

12,950

4,320

88,070

Equity
 
 
 
 
RadioPharmacy Investors, Inc.
—

—

1,719

1,719

Other (< $1 million)
300

—

943

1,243

Total Equity
300

—

2,662

2,962

Total originations and advances
$
71,100

$
12,950

$
6,982

$
91,032

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, 2013 and 2012 by security type:
 
Nine months ended September 30,
 
2013
2012
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
 
 
 
 
 
Senior secured debt
$
141,011

82.7
%
$
203,331

61.4
%
Subordinated debt
 
 
 
 
Secured
4,500

2.6

51,347

15.5

Unsecured
16,935

9.9

12,189

3.7

Total debt investments
162,446

95.2

266,867

80.6

Equity investments
 
 
 
 
Preferred equity
5,117

3.0

43,792

13.2

Common/common equivalents equity
3,003

1.8

20,597

6.2

Total equity investments
8,120

4.8

64,389

19.4

Total gross payments, reductions and sales of securities
$
170,566

100.0
%
$
331,256

100.0
%
During the nine months ended September 30, 2013 and 2012, our gross payments, reductions and sales of securities by transaction type included:  
 
Nine months ended September 30,
(in thousands)
2013
2012
Principal repayments, reductions and loan sales
$
136,932

$
232,809

Sale of equity investments
7,440

56,241

Scheduled principal amortization
23,352

25,548

Collection of accrued paid-in-kind interest and dividends
2,842

16,658

Total gross payments, reductions and sales of securities
$
170,566

$
331,256


40

As shown in the following table, during the nine months ended September 30, 2013, we monetized all, or part of, 20 portfolio investments with proceeds totaling $144.9 million:
 
Nine months ended
 
September 30, 2013
(in thousands)
Principal Repayments and Proceeds from Loan Sales
Sale or Settlement of Equity Investments
PIK Interest and Dividend Prepayments
Total
Monetizations
 
 
 
 
NDSSI Holdings, LLC
$
29,356

$
3,237

$
831

$
33,424

Capstone Logistics, LLC
27,347

—

—

27,347

Chase Industries, Inc.
16,800

—

—

16,800

SoftLayer Technologies, Inc.
13,462

—

—

13,462

Intrafusion Holdings, Inc.
10,000

—

—

10,000

The Gavilon Group, LLC
8,000

—

—

8,000

Oceans Acquisition, Inc.
7,500

—

—

7,500

Constructions Trailer Specialists, Inc.
6,442

—

34

6,476

Barbri, Inc.
6,099

—

—

6,099

Gans Communications, L.P.
5,015

—

—

5,015

Other < 5 Million
6,911

3,864

—

10,775

Total monetizations
136,932

7,101

865

144,898

Other scheduled payments
23,352

339

1,977

25,668

Total gross payments, sales and other reductions of investment portfolio
$
160,284

$
7,440

$
2,842

$
170,566

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

41

The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of September 30, 2013 and December 31, 2012:
(dollars in thousands)
September 30, 2013
December 31, 2012
Investment
Rating
Investments at
Fair Value
% of Total
Portfolio
Investments at
Fair Value
% of Total 
Portfolio
1(a)
$
109,445

27.7
%
$
146,589

30.7
%
2
122,590

31.0

209,016

43.7

3
127,294

32.2

96,932

20.3

4
34,282

8.6

22,789

4.8

5
1,921

0.5

2,398

0.5

Total
$
395,532

100.0
%
$
477,724

100.0
%
_________________________
(a) 
As of September 30, 2013 and December 31, 2012, Investment Rating “1” included $82.9 million and $81.9 million, respectively, of loans to companies in which we also hold equity securities.
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place all or a portion of the loan on non-accrual status and will cease recognizing interest income on that loan until all principal and interest have been brought current through payment or 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.
For the three month period ended September 30, 2013, we put Color Star Growers of Colorado, Inc., or Color Star, on non-accrual status and we changed the Investment Rating from 3 to 4.
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, 2013
December 31, 2012
September 30, 2013
December 31, 2012
(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
$
3,897

1.04
%
$
3,897

0.86
%
$
—

—
%
$
—

—
%
Not on non-accrual status
—

—

—

—

—

—

—

—

Total loans greater than 90 days past due
$
3,897

1.04
%
$
3,897

0.86
%
$
—

—
%
$
—

—
%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
23,849

6.34
%
$
12,880

2.85
%
$
13,195

3.71
%
$
607

0.14
%
Greater than 90 days past due
3,897

1.04

3,897

0.86

—

—

—

—

Total loans on non-accrual status
$
27,746

7.38
%
$
16,777

3.71
%
$
13,195

3.71
%
$
607

0.14
%

42

The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2012 through September 30, 2013:
 
Nine months ended
 
September 30, 2013
(In thousands)
Cost
Fair Value
Non-accrual loan balance as of December 31, 2012
$
16,777

$
607

Additional loan on non-accrual status - Color Star
13,522

13,195

Change in unrealized gain (loss) on non-accrual loans
—

—

Payments received from loans on non-accrual status
(621
)
(621
)
Reversal of previously recognized unrealized loss on non-accrual loans(a)
—

1,946

Realized loss on non-accrual loans(a)
(1,932
)
(1,932
)
Total change in non-accrual loans
10,969

12,588

Non-accrual loan balance as of September 30, 2013
$
27,746

$
13,195

_________________________
(a) 
Represents the reversal of previously recognized unrealized loss and recognition of realized loss on the non-accrual loan attributed to Advanced Sleep Concepts, Inc. and reversal of previously recognized unrealized gain and recognition of realized gain on the non-accrual loan attributed to CWP/RMK Acquisition Corp.


43

Results of Operations
The following section compares our results of operations for the three months ended September 30, 2013 to the three months ended September 30, 2012.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
The following table summarizes the components of our net income for the three months ended September 30, 2013 and 2012:
 
Three months ended September 30,
Variance
(dollars in thousands)
2013
2012
$
Percentage
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Interest income
$
10,717

$
10,326

$
391

3.8
 %
Dividend income
847

867

(20
)
(2.3
)
Loan fees
1,023

642

381

59.3

Total interest and dividend income
12,587

11,835

752

6.4

Advisory fees and other income
583

234

349

149.1

Total revenue
13,170

12,069

1,101

9.1

Operating expenses
 
 
 
 
Interest expense
2,316

2,974

(658
)
(22.1
)
Employee compensation








Salaries and benefits
644

2,018

(1,374
)
(68.1
)
Amortization of employee restricted stock
420

505

(85
)
(16.8
)
Total employee compensation
1,064

2,523

(1,459
)
(57.8
)
General and administrative expense
1,824

2,504

(680
)
(27.2
)
Restructuring expense
2

12

(10
)
(83.3
)
Total operating expense
5,206

8,013

(2,807
)
(35.0
)
Net operating income before net investment gain (loss) and income tax (benefit) provision
7,964

4,056

3,908

96.4

Net investment gain (loss) before income tax provision
(4,616
)
228

(4,844
)
NM

Income tax provision
59

18

41

227.8

Net income (loss)
$
3,289

$
4,266

$
(977
)
(22.9
)
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, 2013 from the three months ended September 30, 2012.
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, 2013, the total yield on our average debt portfolio at fair value was 12.4% compared to 11.1% during the three months ended September 30, 2012. 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.

44

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, 2013 and 2012:
 
Three months ended September 30,
 
2013
2012
Average 90-day LIBOR
0.3
 %
0.4
 %
Spread to average LIBOR on average loan portfolio
12.0

10.9

Impact of fee accelerations of unearned fees on paid/restructured loans
0.6

0.3

Impact of non-accrual loans
(0.5
)
(0.5
)
Total yield on average loan portfolio
12.4
 %
11.1
 %
During the three months ended September 30, 2013, interest income was $10.7 million, compared to $10.3 million during the three months ended September 30, 2012, which represented a $0.4 million, or 3.8%, increase. This increase reflected a $1.2 million increase in interest income attributable to a 1.2% increase in our net spread to LIBOR, partially offset by a $0.5 million decrease in interest income resulting from a 4.2% decrease in our average loan balance, a decrease of $0.2 million due to interest rate floors and a $0.2 million decrease related to the decrease 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. Borrowers may, in some instances, be required to prepay PIK because of certain contractual provisions or they may choose to prepay; however, more typically, PIK is paid at the end of the loan term. The following table shows the PIK-related activity for the three months ended September 30, 2013 and 2012, at cost:
 
Three months ended September 30,
(in thousands)
2013
2012
Beginning PIK loan balance
$
9,336

$
5,625

PIK interest earned during the period
1,644

1,112

Payments received from PIK loans
(135
)
(623
)
Ending PIK loan balance
$
10,845

$
6,114

As of September 30, 2013, all of our PIK loans were accruing interest and, as of September 30, 2012, we were not accruing interest on $1.4 million 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.
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, 2013 and 2012, we recognized dividend income of $0.8 million and $0.9 million, respectively. In addition, during the three months ended September 30, 2013 and 2012, we received payments on accrued dividends of $0.2 million and $0.3 million, respectively. As of September 30, 2013, the balance of accrued dividends was $11.3 million.
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, 2013, we earned $0.6 million of advisory fees and other income, which represented a $0.3 million, or 149.1%, increase from the three months ended September 30, 2012. This increase resulted from an increase in prepayment fees related to a loan prepayment in the third quarter of 2013.

45

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, 2013, we incurred $2.3 million of interest expense, which represented a $0.7 million, or 22.1%, decrease from the same period in 2012. During these respective periods, our average cost to borrow increased to 4.9% from 4.3%, principally due to the repayment of securitized debt in our 2006-1 Trust which carries interest rates ranging from L+0.33% to L+2.25%, offset by a decrease in the amortization of deferred financing costs to $0.3 million from $0.8 million.
During the three months ended September 30, 2013, our average borrowings declined to approximately $183.5 million from an average of approximately $267.8 million for the same period in 2012, which accounted for a $0.9 million reduction in our interest expense. In addition, interest expense decreased by $0.5 million related to decreased amortization of debt issuance costs and $0.1 million due to a decrease in the average LIBOR rate from 0.43% to 0.26%. These decreases were offset by $0.8 million attributable to the spread to LIBOR increasing from approximately 2.71% to 3.95%.
We recognized $0.3 million in deferred financing costs during the three months ended September 30, 2013, down $0.5 million from the same period in 2012. The decrease is primarily attributable to $0.5 million in accelerated deferred financing fees related to repayment of securitized debt in our 2006-1 Trust 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, 2013, our employee compensation expense was $1.1 million, which represented a $1.5 million, or 57.8%, decrease from the same period in September 30, 2012. Our salaries and benefits decreased by $1.4 million, or 68.1%, due to a $1.0 million decrease in incentive compensation and a $0.4 million decrease in salaries and benefits primarily resulting from our operational realignment. As of September 30, 2013, we had 17 employees compared to 24 employees as of September 30, 2012.
GENERAL AND ADMINISTRATIVE
During the three months ended September 30, 2013, general and administrative expense was $1.8 million, which represented a $0.7 million, or 27.2%, decrease compared to the same period in 2012. General and administrative expense decreased $0.6 million due to reduced occupancy and other costs for our new corporate office space and $0.3 million due to a decrease in professional fees related to portfolio litigation. These decreases were offset by a $0.7 million increase in severance costs related to employee terminations in the third quarter of 2013.

46

NET INVESTMENT (LOSS) GAIN BEFORE INCOME TAX PROVISION
During the three months ended September 30, 2013, we recorded $4.6 million of net investment loss before income tax provision, compared to $0.2 million of net investment gains during the same period in 2012. 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, 2013:
 
 
Three months ended September 30, 2013
(in thousands)
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
G&L Investment Holdings, LLC
Insurance
Non-Affiliate
$
—

$
(2,915
)
$
—

$
(2,915
)
Other (< $1.0 million net gain (loss))
 
 
102

(1,715
)
(88
)
(1,701
)
Total
 
 
$
102

$
(4,630
)
$
(88
)
$
(4,616
)
In the third quarter of 2013, we recorded $2.9 million of unrealized depreciation on our investment in G&L Investment Holdings, LLC, to reflect a decrease in that portfolio company's operating performance.
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from the 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, 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 .
INCOME TAX (BENEFIT) PROVISION
During the three months ended September 30, 2013, we incurred a $59,000 income tax provision compared to an $18,000 income tax provision during the three months ended September 30, 2012. The income tax provision for both periods was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.

47

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
The following table summarizes the components of our net income for the nine months ended September 30, 2013 and 2012:
 
Nine months ended September 30,
Variance
(dollars in thousands)
2013
2012
$
Percentage
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Interest income
$
33,023

$
39,748

$
(6,725
)
(16.9
)%
Dividend income
2,662

2,840

(178
)
(6.3
)
Loan fees
2,252

2,365

(113
)
(4.8
)
Total interest and dividend income
37,937

44,953

(7,016
)
(15.6
)
Advisory fees and other income
1,369

2,619

(1,250
)
(47.7
)
Total revenue
39,306

47,572

(8,266
)
(17.4
)
Operating expenses
 
 
 
 
Interest expense
7,003

12,728

(5,725
)
(45.0
)
Employee compensation








Salaries and benefits
3,610

8,684

(5,074
)
(58.4
)
Amortization of employee restricted stock
1,174

1,694

(520
)
(30.7
)
Total employee compensation
4,784

10,378

(5,594
)
(53.9
)
General and administrative expense
3,942

10,714

(6,772
)
(63.2
)
Restructuring expense
14

59

(45
)
(76.3
)
Total operating expense
15,743

33,879

(18,136
)
(53.5
)
Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
23,563

13,693

9,870

72.1

Net investment gain (loss) before income tax provision
(3,837
)
(14,604
)
10,767

(73.7
)
Loss on extinguishment of debt before income tax (benefit) provision
—

(174
)
174

(100.0
)
Income tax provision
111

329

(218
)
(66.3
)
Net income (loss)
$
19,615

$
(1,414
)
$
21,029

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, 2013 from the nine months ended September 30, 2012.
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, 2013, the total yield on our average debt portfolio at fair value was 12.3% compared to 11.2% during the nine months ended September 30, 2012. 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.

48

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, 2013 and 2012:
 
Nine months ended September 30,
 
2013
2012
Average 90-day LIBOR
0.3
 %
0.5
 %
Spread to average LIBOR on average loan portfolio
11.9

10.7

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

0.4

Impact of non-accrual loans
(0.2
)
(0.4
)
Total yield on average loan portfolio
12.3
 %
11.2
 %
During the nine months ended September 30, 2013, interest income was $33.0 million, compared to $39.7 million during the nine months ended September 30, 2012, which represented a $6.7 million, or 16.9%, decrease. This decrease reflected a $10.4 million decrease in interest income resulting from a 23.9% decrease in our average loan balance. The decrease in interest income also reflected a decrease of $0.7 million due to interest rate floors, a $0.7 million decrease related to the decrease in LIBOR and a $0.5 million decrease resulting from the net impact of loans that had been on non-accrual status during the nine months ended September 30, 2013 that were accruing interest during the nine months ended September 30, 2012. These decreases were partially offset by a $5.5 million increase in interest income attributable to a 1.3% increase in our net spread to LIBOR.
PIK Income
The following table shows the PIK-related activity for the nine months ended September 30, 2013 and 2012, at cost:
 
Nine months ended September 30,
(in thousands)
2013
2012
Beginning PIK loan balance
$
9,043

$
15,653

PIK interest earned during the period
4,320

3,983

Payments received from PIK loans
(2,161
)
(8,510
)
Realized loss
(357
)
(5,012
)
Ending PIK loan balance
$
10,845

$
6,114

During the nine months ended September 30, 2013, the payments received from PIK loans included $1.0 million collected in conjunction with the partial repayment of our investment in Education Management, Inc., as well as $0.8 million collected in conjunction with the repayment in full of our investment in NDSSI Holdings, LLC. During the nine months ended September 30, 2012, we received payments on PIK loans from eight investments, including $2.9 million from Jet Plastica Investors, LLC, $1.8 million from GSDM Holdings Corp. and $1.3 million from Coastal Sunbelt Holding, Inc.
DIVIDEND INCOME
During the nine months ended September 30, 2013 and 2012, we recognized dividend income of $2.7 million and $2.8 million, respectively. In addition, during the nine months ended September 30, 2013 and 2012, we received payments on accrued dividends of $0.7 million and $8.1 million, respectively. As of September 30, 2013, the balance of accrued dividends was $11.3 million.
ADVISORY FEES AND OTHER INCOME
During the nine months ended September 30, 2013, we earned $1.4 million of advisory fees and other income, which represented a $1.3 million, or 47.7%, decrease from the nine months ended September 30, 2012. This decrease resulted from a decrease in prepayment fees related to loan prepayments.
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.

49

INTEREST EXPENSE
During the nine months ended September 30, 2013, we incurred $7.0 million of interest expense, which represented a $5.7 million, or 45.0%, decrease from the same period in 2012. During these respective periods, our average cost to borrow decreased to 4.4% from 4.8%, principally due to a decrease in the amortization of deferred financing costs to $1.0 million from $5.3 million, offset by the repayment of securitized debt in our 2006-1 Trust, which carries interest rates ranging from L+0.33% to L+2.25%, and additional borrowings under the SBIC debenture program, which carry a weighted average fixed rate of 4.33%.
During the nine months ended September 30, 2013, our average borrowings declined to approximately $209.4 million from an average of approximately $349.6 million for the same period in 2012, which accounted for a $4.0 million reduction in our interest expense. In addition, interest expense decreased by $4.3 million related to decreased amortization of debt issuance costs and $0.5 million due to a decrease in the average LIBOR rate from 0.47% to 0.28%. These decreases were offset by $3.2 million attributable to the spread to LIBOR increasing from approximately 2.33% to 3.53%.
We recognized $1.0 million in deferred financing costs during the nine months ended September 30, 2013, down $4.3 million from the same period in 2012. The decrease is primarily attributable to $2.9 million in deferred financing fees related to our SunTrust Warehouse financing facility which terminated in 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, 2013, our employee compensation expense was $4.8 million, which represented a $5.6 million, or 53.9%, decrease from the same period in 2012. Our salaries and benefits decreased by $5.1 million, or 58.4%, due to a $3.3 million decrease in incentive compensation and a $1.8 million decrease in salaries and benefits primarily resulting from our operational realignment. As of September 30, 2013, we had 17 employees compared to 24 employees as of September 30, 2012.
GENERAL AND ADMINISTRATIVE
During the nine months ended September 30, 2013, general and administrative expense was $3.9 million, which represented a $6.8 million, or 63.2%, decrease compared to the same period in 2012. In the nine months ended September 30, 2012, general and administrative expense included $3.0 million in severance costs. In addition, general and administrative expense decreased $1.9 million due to reduced occupancy and other costs for our new corporate office space and $0.8 million due to a decrease in professional fees related to portfolio litigation.

50

NET INVESTMENT GAIN BEFORE INCOME TAX PROVISION
During the nine months ended September 30, 2013, we recorded $3.8 million of net investment losses before income tax provision, compared to $14.6 million of net investment losses during the same period in 2012. 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 nine months ended September 30, 2013:
 
 
Nine months ended September 30, 2013
(in thousands)
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Virtual Radiologic Corporation
Healthcare
Non-Affiliate
$
—

$
(3,341
)
$
—

$
(3,341
)
G&L Investment Holdings, LLC
Insurance
Non-Affiliate
—

(3,133
)
—

(3,133
)
Miles Media Group, LLC
Business Services
Affiliate
2,877

1,192

(1,170
)
2,899

Advanced Sleep Concepts, Inc.
Home Furnishings
Non-Affiliate
(3,424
)
(458
)
3,249

(633
)
Other (< $1 million net gain (loss))
 
 
(614
)
455

530

371

Total
 
 
$
(1,161
)
$
(5,285
)
$
2,609

$
(3,837
)
•
We recorded $3.3 million of unrealized depreciation on our investment in Virtual Radiologic Corporation to reflect a decrease in the indicated market price for that security.
•
During 2013, we recorded $3.1 million of unrealized depreciation on our investment in G&L Investment Holdings, LLC, to reflect a decrease in that portfolio company's operating performance.
•
We received $3.0 million for the sale of our equity investment in Miles Media Group, LLC, which resulted in a $2.9 million realized gain and a reversal of previously unrealized appreciation of $1.2 million.
•
In addition, during 2013, we wrote off our preferred and common equity investments in Advanced Sleep Concepts, Inc. resulting in a realized loss of $3.4 million and a reversal of previously recorded unrealized depreciation of $3.2 million.
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from the change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.

51

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. As of September 30, 2012, our fair value estimate of our investment in Broadview reflects this restructuring if consummated on the then 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, 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.
•
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 also received $44,000 for our equity investment in Philadelphia Media Network, Inc. and wrote off part of our equity investment in Intran Media, LLC which resulted 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., which resulted in a $16.4 million reversal of previously unrealized appreciation and the realization of a $16.4 million gain.

52

INCOME TAX PROVISION
During the nine months ended September 30, 2013, we incurred a $111,000 income tax provision compared to an $329,000 income tax provision during the nine months ended September 30, 2012. 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
Our financial liquidity principally comes from our cash on hand and the spread we earn on our investments (principally loans, over our cost to borrow) and gains and losses on our investments. In addition to making investments in portfolio companies, we may use our available liquidity to pay dividends to our stockholders and to repurchase our common stock in the open market under our stock repurchase program. For the nine months ended September 30, 2013, we declared 38 cents per share in dividends and paid $26.7 million in total dividends. We also repurchased 504,639 shares of our common stock for $2.3 million at a weighted average price of $4.50 per share.
For the nine months ended September 30, 2013, we earned 12.3% on our average loan portfolio at fair value of $383.8 million and our weighted average cost to borrow was 4.4% on average borrowings of $209.4 million. Including dividend income and fee income, we earned $23.6 million of net operating income and $19.6 million of net income.
At September 30, 2013, we had $96.4 million in cash and cash equivalents available for general corporate purposes, $36.8 million of cash in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC and $1.6 million of restricted cash held in escrow. In addition, we had $7.8 million 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 for the 2006-1 Trust. We also have access to the full principal amount under our $20 million unsecured revolving credit facility that we may use for general corporate purposes.
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.
Although there can be no assurance, we believe we have sufficient liquidity to meet our operating requirements for the remainder of 2013, as well as liquidity for new origination opportunities and potential dividend distributions.
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 represent 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, 2013 and December 31, 2012, we had $96.4 million and $73.6 million, respectively, in cash and cash equivalents. As of September 30, 2013, our cash and cash equivalents included $66.6 million 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, 2013 and December 31, 2012, we had $7.8 million and $17.0 million, respectively, in cash, securitization accounts.

53

•
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 by Solutions Capital. As of September 30, 2013 and December 31, 2012, we had $38.4 million and $54.8 million respectively, of restricted cash.
During the nine months ended September 30, 2013, our operating activities provided $103.5 million of cash and cash equivalents, and our financing activities used $80.7 million of cash and cash equivalents.
LIQUIDITY AND CAPITAL RESOURCES—BORROWINGS
As of September 30, 2013, we reported $179.2 million of borrowings on our Consolidated Balance Sheets at cost. The following table summarizes our borrowing facilities, the facility amounts and the amounts outstanding.
 
 
September 30, 2013
December 31, 2012
(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

41,400

MCG Commercial Loan Trust 2006-1
 




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

—

37,151

37,151

Series 2006-1 Class C Notes(a)(c)
April 2018(b)
381

271

45,000

32,000

Series 2006-1 Class D Notes(d)
April 2018(b)
45,945

28,902

45,945

28,902

Bank of America Unsecured Revolver
 




 
 
Unsecured Revolving Note
November 2014
20,000

—

20,000

—

Total borrowings
 
$
216,326

$
179,173

$
298,096

$
248,053

__________
(a)    In April 2013, the Class B Notes were repaid in full and, in October 2013, the Class C Notes were repaid in full.
(b)    Borrowings under the MCG 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. 
(c)    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.
(d)    Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.
As of September 30, 2013, our asset coverage ratio was 1,338%. This ratio does not include our SBIC debt which the SEC has permitted us to exclude from the asset coverage ratio requirements pursuant to an 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 our borrowing facilities mature, 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. We continue to service those portfolio investments that we use as collateral in our secured borrowing facility.

54

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 enabled Solutions Capital to borrow from the SBA up to $150.0 million, which is the maximum amount of outstanding leverage available to single-license SBIC companies.
In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L.P. in order to apply for a second SBIC license. In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013 and was accepted by the SBA in May 2013. Neither receipt of such an invitation nor acceptance of the application from the SBA assures an applicant that the SBA will grant the additional license in any specified time period or at all. Currently, a second SBIC license would grant us the ability to borrow up to an additional $75.0 million from the SBA, or two times the amount of statutory equity capital we invest in Solutions Capital II, L.P.  If approved and depending on available capital, we intend to fund the entire $37.5 million using unrestricted cash. In the second quarter of 2013, we invested $10.0 million of unrestricted cash in Solutions Capital II, L.P. and funded a small business loan to Dorsey School of Business Holdings, Inc, or Dorsey.  We also received pre-licensing investment approval from the SBA for the Dorsey investment which, if closed in accordance with our pre-investment documentation, will count toward the required statutory capital of $37.5 million in our second SBIC.
To realize the full $150.0 million borrowing for which we have received approval under the SBIC program, we have funded a total of $75.0 million to Solutions Capital. As of each of September 30, 2013 and December 31, 2012, Solutions Capital had borrowed $150.0 million. We are permitted to use these funds to provide debt and equity capital to qualifying small businesses. However, we may not use these borrowings to provide additional financing 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 to maintain 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 upon an event of default under the SBA-guaranteed debentures issued by Solutions Capital.
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, 2013.
 
Maturities
(in thousands)
Total
Less than
1 year
1-3 years
4-5 years
After 5
years
Borrowings
$
150,000

$
—

$
—

$
2,600

$
147,400

Collateral
 
 
 
 
 
Fair value of debt investments
204,075

2,636

34,863

154,352

12,224

Fair value of equity investments(a)
5,742

—

—

—

5,742

Cash, restricted account
36,737

36,737

—

—

—

Total collateral
$
246,554

$
39,373

$
34,863

$
154,352

$
17,966

____________
(a)    Equity investments do not have a stated maturity date.
MCG COMMERCIAL LOAN TRUST 2006-1
As of September 30, 2013, we had $29.2 million of securitized debt outstanding under the 2006-1 Trust, 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.

55

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)
$
29,173

$
4,001

$
—

$
25,172

$
—

Collateral
 
 
 
 
 
Fair value of debt investments
89,693

16,442

32,850

40,401

—

Fair value of equity investments(b)
606

—

—

—

606

Cash, securitization account
7,793

7,793

—

—

—

Total collateral
$
98,092

$
24,235

$
32,850

$
40,401

$
606

_____________
(a) 
Borrowings under the MCG 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 2006-1 Trust 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 complete the repayment of 2006-1 Trust prior to its April 2018 maturity.
BANK OF AMERICA UNSECURED REVOLVER
In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or Bank of America Unsecured Revolver. The Bank of America Unsecured Revolver will expire in November 2014. In August 2013, we executed an amendment to the Bank of America Unsecured Revolver that requires that we maintain a zero balance for a period of at least five consecutive days during the six-month period immediately preceding June 30th and December 31st of each year, which testing was previously required quarterly. In the event we borrow under the Bank of America Unsecured Revolver, we agreed to increase the interest rate on such advances from LIBOR plus 3.5% to LIBOR plus 4.0%. As of September 30, 2013, there were no borrowings outstanding on the Bank of America Unsecured Revolver.
The Bank of America Unsecured Revolver is subject to certain collateral requirements and financial covenants. Included among them are requirements that we maintain a ratio of all unencumbered assets to outstanding amounts under the Bank of America Unsecured Revolver of at least four-to-one, as well as a ratio of unencumbered cash and senior portfolio loans to outstanding amounts under the Bank of America Unsecured Revolver of at least three-to-one. The Bank of America Unsecured Revolver may be prepaid at any time.
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 2013 and 2012:
 
Nine months ended September 30,
(dollars in thousands)
2013
2012
Weighted-average borrowings
$
209,367

$
349,615

Average LIBOR
0.28
%
0.47
%
Average spread to LIBOR, excluding amortization of deferred debt issuance costs
3.53

2.33

Impact of amortization of deferred debt issuance costs
0.60

2.00

Total cost of funds
4.41
%
4.80
%

56

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, 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, which was terminated after we effected repurchases totaling approximately $29.4 million. During the nine months ended September 30, 2013, we repurchased 504,639 shares of our common stock at a weighted average purchase price of $4.50 per share, which was a 13.1% discount from our quarterly net asset value per share. On October 25, 2013, our board of directors authorized an additional stock repurchase program of up to $25.0 million. Under the program, we are authorized to repurchase shares of our common stock 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.
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, 2013, we had $19.1 million of outstanding unused loan commitments. We believe that our operations, monetizations, revolving credit facility 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, 2013, we had no outstanding guarantees or standby letters of credit.

57

CONTRACTUAL OBLIGATIONS
The following table shows our contractual obligations as of September 30, 2013:
(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)
$
29,173

$
4,001

$
—

$
25,172

$
—

SBIC
150,000

—

—

—

150,000

Total borrowings
179,173

4,001

—

25,172

150,000

Interest payments on borrowings(c)
50,002

7,163

14,272

14,114

14,453

Operating leases
464

398

66

—

—

Severance obligations(d)
931

931

—

—

—

Total contractual obligations
$
230,570

$
12,493

$
14,338

$
39,286

$
164,453

_______________
(a) 
Excludes the unused commitments to extend credit to our customers of $19.1 million as discussed above.
(b) 
Borrowings under the MCG 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 and employer taxes that we are obligated to pay 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 amount 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 aggregate per share distributions of $13.76.

58

The following table summarizes the distributions that we declared since January 1, 2011:
Date Declared
Record Date
Payable Date
Dividends per Share
October 25, 2013
November 8, 2013
November 22, 2013
$
0.125

July 26, 2013
August 9, 2013
August 30, 2013
$
0.125

April 26, 2013
May 10, 2013
May 31, 2013
$
0.125

March 1, 2013
March 15, 2013
March 29, 2013
$
0.125

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

If we determined the tax attributes of our distributions as of September 30, 2013, 75% would be from ordinary income and 25% 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. Therefore, a determination as to the tax attributes of the distributions made on a quarterly basis may not be representative of the actual tax attributes for a full year.  We intend to update stockholders quarterly with an estimated percentage of our distributions that resulted from taxable ordinary income.  The actual tax characteristics of distributions to stockholders will be reported to stockholders annually on a Form 1099-DIV. 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, 2012.
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.

59

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 premiums, 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; estimates of market interest rates that would otherwise be made available to our portfolio companies; 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 business 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 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 comprised 11.9% of our investment portfolio at fair value. 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 in question. 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

60

upon a hypothetical sale or exit and then allocates such value to the investment's securities in order of their relative liquidation preference. In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par. These valuation approaches also consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.
•
Non-Control Investments—Non-control investments comprised 88.1% of our investment portfolio at fair value. Quoted prices were not available for 94.1% of our non-control investments at fair value. 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. In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.
•
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, 2013, these securities represented 5.2% of our investment portfolio at fair value. We utilize independent pricing services to arrive at 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 engage 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, 2013, 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 to calculate 99.0% 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 executive 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

61

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, 2013.
($ in thousands)
Fair Value
Valuation Techniques
Unobservable
Inputs
Range
Weighted Average
 
Minimum
Maximum
Senior debt
$
201,698

Discounted cash flow
Market interest rate
5.7
%
12.7
%
8.8
%



Discounted cash flow
Discount rate
4.0
%
4.0
%
4.0
%



Market comparable companies
Revenue Multiple
0.2x

0.2x

0.2x




Market comparable companies
EBITDA multiple(a)
7.5x

7.5x

7.5x

Subordinated debt
136,944

Discounted cash flow
Market interest rate
12.2
%
16.7
%
13.7
%



Market comparable companies
Revenue multiple
0.2x

0.2x

0.2x




Market comparable companies
EBITDA multiple(a)
7.5x

7.5x

7.5x

Preferred and common equity
36,395

Market comparable companies
EBITDA multiple(a)
4.4x

10.0x

7.7x




Discount for minority interest
—
%
25.0
%
2.5
%



Residual assets
Discount rate
25.0
%
25.0
%
25.0
%
 
$
375,037

 
 
 
 
 
______________
(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 third quarter of 2013. However, certain leading and lagging indicators suggest continuing risk. 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, 2013, approximately 72.8% of our loan portfolio, at fair value, bore interest at a spread to either the LIBOR or the prime rate, and 27.2% at a fixed interest rate. As of September 30, 2013, approximately 63.6% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR base index and prime floors between 2.5% and 6.0%. The three-month weighted-average LIBOR interest rate was 0.26% as of September 30, 2013. 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.

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The following table shows a comparison of the interest rate base for our interest-bearing cash, outstanding commercial loans, at cost, and our outstanding borrowings as of September 30, 2013 and December 31, 2012:
 
September 30, 2013
December 31, 2012
(in thousands)
Interest Bearing Cash and Commercial Loans
Borrowings
Interest Bearing Cash and Commercial Loans
Borrowings
Money market rate
$
66,592

$
—

$
43,291

$
—

Prime rate
39

—

13,603

—

LIBOR
 
 
 
 
30-day
29,589

—

18,635

—

60-day
—

—

—

—

90-day
239,214

29,173

294,774

98,053

180-day
—

—

9,301

—

Fixed rate
107,233

150,000

115,091

150,000

Total
$
442,667

$
179,173

$
494,695

$
248,053

Based on our September 30, 2013 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, 2013, the quarterly average LIBOR was 0.26% and a 100-basis point decrease could not occur:
(dollars in thousands) 
 
Basis Point Change
Interest
Income
Interest
Expense
Net Income
100
$
1,056

$
292

$
764

200
3,256

583

2,673

300
6,374

875

5,499

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, 2013. 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, 2013, 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.

63

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, 2013 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, 2013, 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, 2012, 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, 2012, 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 "Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns", "You may not receive future distributions" and "Our wholly owned subsidiary is licensed by the SBA and is subject to SBA regulations. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or revoke or suspend our license" included in our Annual Report on Form 10-K for the year ended December 31, 2012 and adds the risk factor titled "A failure or the perceived risk of a failure to raise the statutory debt limit of the United States could have a material adverse effect on our business, financial condition and results of operations":
Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns.
From time to time, we target specific industries in which to invest on a recurring basis, which may result in significant concentrations in our portfolio. As a consequence, the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of such investments or a substantial write-down of any one investment. Beyond regulatory and income tax diversification requirements, we do not have fixed guidelines for industry concentration. In addition, while we generally decline to make investments in a particular industry or group of industries that would exceed 15.0% of our total assets at the time of closing, it is possible that as the values of our portfolio companies change, one industry or a group of industries may come to exceed such level. As a result, a downturn in an industry in which we have invested a significant portion of our total investments could have a materially adverse effect on us. As of September 30, 2013, 26.4%, 18.9% and 15.2% of our total investments at fair value were invested in healthcare, business services and education companies, respectively. Therefore, we are

64

susceptible to the economic circumstances in these industries, and a downturn in any one of these industries could have a material adverse effect on our results of operations and financial condition.
You may not receive future distributions.
In the event that the asset coverage ratio applicable to us as a BDC falls below 200%, we will be unable to make distributions until the ratio again meets or exceeds the threshold. If we do not distribute at least 90% of our investment company taxable income annually, we will suffer adverse tax consequences, including the possible loss of our status as a RIC for the applicable period. From December 2001 through September 30, 2013, we declared distributions totaling $13.76 per common share. Due to the market dislocation, we suspended our distributions from the third quarter of 2008 through the first quarter of 2010. We reinstated our distribution on April 29, 2010, and have continued to declare a quarterly dividend since that time; however, there can be no assurance that distributions will continue in the future.
We will make future decisions with respect to the actual level of 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 at the time of such decision. Regulatory constraints, our inability to achieve operating results or a decline in the performance of our business could prohibit our ability to make any future distributions. In addition, we may not be able to make distributions at a specific level or to increase the amount of these distributions from time to time.
Our wholly owned subsidiary is licensed by the SBA and is subject to SBA regulations. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or revoke or suspend our license.
Our wholly owned subsidiary, Solutions Capital, is licensed to operate as an SBIC and is regulated by the SBA. The SBIC license allows Solutions Capital to obtain leverage, or borrowings, by issuing SBA-guaranteed debentures, subject to receipt of a capital commitment from the SBA and other customary procedures. The SBA regulations require, among other things, an annual periodic examination of a licensed SBIC by an SBA examiner to determine the SBIC's compliance with the relevant SBA regulations, and the performance of a financial audit by an independent auditor.
The SBA regulations permit licensed SBICs to make long term loans to small businesses and invest in the equity securities of such businesses. Under current SBA regulations, a licensed SBIC may provide capital to small businesses having a tangible net worth not exceeding $18.0 million and an average net income after federal income taxes not exceeding $6.0 million for the two most recent fiscal years. In addition, a licensed SBIC must devote 25% of its investment activity to entities having a tangible net worth not exceeding $6.0 million and an average annual net income after federal income taxes not exceeding $2.0 million for the two most recent fiscal years. If a proposed portfolio company does not meet the foregoing requirements, the SBA regulations also provide alternative criteria for eligibility which depend on the industry in which the prospective portfolio company is engaged as well as other factors such as the number of employees and gross sales. The SBA also restricts the financing terms of investments by SBICs in portfolio companies, and prohibits funds from being deployed in support of certain purposes or industries. Compliance with SBA requirements may cause our SBIC subsidiary to forego attractive investment opportunities that are not permitted under SBA regulations.
A single-license SBIC subsidiary may currently borrow up to a maximum of $150.0 million when it has at least $75.0 million in private capital, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of January 2013, we have funded $75.0 million to Solutions Capital, and Solutions Capital has borrowed the maximum $150.0 million of SBA-guaranteed debentures. 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.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013.  However, receipt of a green light letter from the SBA does not assure that the SBA will ultimately issue an SBIC license and we have received no assurance or indication from the SBA either that we will receive a second SBIC license, or the timeframe in which we could expect to receive a second license should one ultimately be granted.
The SBA prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of a licensed SBIC. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, depending on the severity of

65

the violation, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or limit it from making new investments. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the SBIC Act or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our SBIC subsidiary is our wholly owned subsidiary and we rely on the ability to make investments through it.
A failure or the perceived risk of a failure to raise the statutory debt limit of the United States could have a material adverse effect on our business, financial condition and results of operations.
As has been widely reported, the United States Treasury Secretary has stated that the federal government may not be able to meet its debt payments in the relatively near future (currently February 2014) unless the federal debt ceiling is raised. If legislation increasing the debt ceiling is not enacted and the debt ceiling is reached, the federal government may stop or delay making payments on its obligations. A failure by Congress to raise the debt limit would increase the risk of default by the United States on its obligations, as well as the risk of other economic dislocations. If the U.S. Government fails to complete its budget process or to provide for a continuing resolution before the expiration of the current continuing resolution (currently January 2014), another federal government shutdown may result. Such a failure or the perceived risk of such a failure consequently could have a material adverse effect on the financial markets and economic conditions in the United States and throughout the world. It could also limit our ability and the ability of our portfolio companies to obtain financing, and it could have a material adverse effect on the valuation of our portfolio companies. Consequently, the continued uncertainty in the general economic environment, including the recent government shutdown and potential debt ceiling implications, as well in specific economies of several individual geographic markets in which our portfolio companies operate, could adversely affect our business, financial condition and results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
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.
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.

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The following table summarizes the shares of common stock that we have purchased during the three months ended September 30, 2013:
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, 2013
 
 
 
 
 
Restricted stock vesting(a)
1,940

$
5.36

(b) 
n/a
n/a
August 1 – 31, 2013
 
 
 
 
 
Dividend reinvestment requirements(c)
1,361

$
4.99

(d) 
n/a
n/a
September 1 – 30, 2013







Restricted stock vesting(a)
4,262

$
5.04

(b) 
n/a
n/a
Total
7,563

$
5.11

 
n/a
n/a
____________________
(a)
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.
(b)
Based on the weighted-average closing share prices of our common stock on the dates that the forfeiture restrictions lapsed.
(c) 
Represents stock purchased on the open market to satisfy dividend reinvestment requests.
(d) 
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.
TERMINATION OF OFFER LETTER
On October 28, 2013, Ehssan Peter Malekian, an Executive Vice President and Managing Director, executed a letter agreement with us, or the Letter Agreement, which terminated that certain offer letter dated July 23, 2001, or the Offer Letter. Under the terms of the Offer Letter, if the employment of Mr. Malekian was terminated by us other than for cause, then he would have received all of his accrued compensation and severance pay equal to three months of his then-current base salary.
Upon execution of the Letter Agreement, Mr. Malekian is eligible for participation in the MCG Capital Corporation 2011 Severance Pay Plan, as amended, or the 2011 Severance Pay Plan, which is applicable to all MCG employees who are not entitled to receive severance benefits under another agreement or letter in excess of any wages accrued as of any termination of employment.
The 2011 Severance Pay Plan provides MCG employees with certain benefits under defined events of termination of employment. Specifically, the plan provides that in the event that we terminate an eligible employee’s employment without cause or the employee resigns for good reason, the employee will be eligible for three, six or nine months of continuing separation pay, healthcare continuation benefits and lapsing of forfeiture provisions with respect to shares of restricted stock (based on years of service with MCG).
Under the 2011 Severance Pay Plan, if the employment of Mr. Malekian is terminated by us other than for cause, or if Mr. Malekian terminates his employment with us for good reason, Mr. Malekian would be eligible for nine months of

67

continuing separation pay, healthcare continuation benefits and lapsing of forfeiture provisions with respect to shares of restricted stock.
STOCK REPURCHASE PROGRAM
On October 25, 2013, our board of directors authorized a stock repurchase program of up to $25.0 million.
Under the program, MCG management is 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 MCG 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.
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
First Amendment to Financing Agreement dated as of August 8, 2013 between MCG Capital Corporation and Bank of America, N.A.

8-K
(0-33377)
August 8, 2013
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.
 
 
 
 


68

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 30, 2013
By:
/s/ B. HAGEN SAVILLE
 
 
 
B. Hagen Saville
 
 
 
Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
Date:
October 30, 2013
By:
/s/ KEITH KENNEDY
 
 
 
Keith Kennedy
 
 
 
Chief Financial Officer
(Principal Financial and Accounting Officer)


69

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