MCG CAPITAL CORP - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



x		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		For the Quarter Ended March 31, 2004.

¨		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		Commission File Number: 0-33377

MCG CAPITAL CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		54-1889518
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1100 Wilson Boulevard, Suite 3000 Arlington, VA		22209
(Address of principal executive office)		(Zip Code)

(703) 247-7500
(Registrant’s telephone number, including area code)

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 and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

The number of shares of the registrant’s Common Stock, $.01 par value, outstanding as of May 6, 2004 was 38,734,329.

MCG CAPITAL CORPORATION

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2004

TABLE OF CONTENTS



PART I	FINANCIAL INFORMATION	3

	Selected Financial Data	3

Item 1.	Financial Statements (Unaudited)	4

	Consolidated Balance Sheets – March 31, 2004 and December 31, 2003	4

	Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003	5

	Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2004 and 2003	6

	Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003	7

	Consolidated Schedule of Investments as of March 31, 2004	8

	Consolidated Schedule of Investments as of December 31, 2003	14

	Notes to Consolidated Financial Statements	21

	Independent Accountants’ Review Report	29

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46

Item 4.	Controls and Procedures	47

PART II	OTHER INFORMATION	48

Item 1.	Legal Proceedings	48

Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	48

Item 3.	Defaults upon Senior Securities	48

Item 4.	Submission of Matters to a Vote of Security Holders	48

Item 5.	Other Information	48

Item 6.	Exhibits and Reports on Form 8-K	49

Signatures		50

PART I. FINANCIAL INFORMATION

In this Quarterly Report, the “Company”, “MCG”, “we”, “us” and “our” refer to MCG Capital Corporation and its wholly owned consolidated subsidiaries and its affiliated securitization trusts unless the context otherwise requires.

Selected Financial Data

The following table sets forth selected financial data from our unaudited financial statements. The selected financial data should be read in conjunction with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements (unaudited) and notes thereto included in this Quarterly Report.


	Three Months Ended March 31,
(dollars in thousands except per share amounts and statistical data)	2004		2003
Income Statement Data:
Operating income	$	22,205	$	18,539
Net operating income before investment gains and losses		9,841		10,946
Net income		2,097		8,897

Per Common Share Data:
Earnings per common share basic and diluted		0.06		0.30
Net operating income before investment gains and losses per common share basic and diluted		0.26		0.36
Net asset value per common share (a)		11.76		11.49
Cash dividends declared per common share		0.42		0.40

Selected Period-End Balances:
Total investment portfolio	$	684,573	$	648,422
Total assets		767,499		731,581
Borrowings		289,235		354,908

Other Data (at period-end):
Number of portfolio companies		83		77
Number of employees		88		56

(a)

Based on common shares outstanding at period-end.

Item 1. Financial Statements (unaudited)

MCG Capital Corporation

Consolidated Balance Sheets (unaudited)

(in thousands, except per share amounts)


	March 31, 2004			December 31, 2003

Assets
Cash and cash equivalents	$	37,862		$	60,072
Cash, securitization accounts		24,757			33,434
Investments at fair value
Commercial loans (cost of $618,059 and $615,253, respectively)		605,046			605,551
Investments in equity securities (cost of $120,313 and $112,850, respectively)		94,517			93,391
Unearned income on commercial loans		(14,990	)		(16,416	)

Total investments		684,573			682,526
Interest receivable		6,168			5,717
Other assets		14,139			9,166

Total assets	$	767,499		$	790,915

Liabilities
Borrowings	$	289,235		$	304,131
Interest payable		887			1,185
Dividends payable		16,268			16,267
Other liabilities		5,612			5,382

Total liabilities		312,002			326,965


Commitments and contingencies
Stockholders’ Equity
Preferred stock, par value $.01, authorized 1 share, none issued and outstanding		—			—
Common stock, par value $.01, authorized 100,000 shares, 38,733 issued and outstanding on March 31, 2004 and 38,732 issued and outstanding on December 31, 2003		387			387
Paid-in capital		540,766			529,168
Stockholder loans		(5,153	)		(5,293	)
Unearned compensation—restricted stock		(11,504	)		(4,911	)
Distributions in excess of earnings		(30,190	)		(26,240	)
Net unrealized depreciation on investments		(38,809	)		(29,161	)

Total stockholders’ equity		455,497			463,950

Total liabilities and stockholders’ equity	$	767,499		$	790,915

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Statements of Operations (unaudited)

(in thousands, except per share amounts)


	Three Months Ended March 31,

	2004			2003

Operating income
Interest and dividend income
Non-affiliate investments (less than 5% owned)	$	12,320		$	16,325
Affiliate investments (5% to 25% owned)		885			955
Control investments (more than 25% owned)		5,284			548

Total interest and dividend income		18,489			17,828
Advisory fees and other income
Non-affiliate investments (less than 5% owned) and other income		1,619			711
Control investments (more than 25% owned)		2,097			—

Total advisory fees and other income		3,716			711

Total operating income		22,205			18,539

Operating expenses
Interest expense		2,103			2,447
Employee compensation:
Salaries and benefits		2,885			1,884
Long-term incentive compensation		5,551			1,526

Total employee compensation		8,436			3,410
General and administrative expense		1,825			1,736

Total operating expenses		12,364			7,593

Net operating income before investment gains and losses		9,841			10,946

Net realized gains (losses) on investments
Non-affiliate investments (less than 5% owned)		1,904			(8,299	)
Control investments (more than 25% owned)		—			(11,397	)

Total net realized gains (losses) on investments		1,904			(19,696	)
Net change in unrealized appreciation (depreciation) on investments
Non-affiliate investments (less than 5% owned)		(3,493	)		15,079
Affiliate investments (5% to 25% owned)		(1,420	)		174
Control investments (more than 25% owned)		(4,735	)		2,394

Total net change in unrealized appreciation (depreciation) on investments		(9,648	)		17,647

Net investment losses		(7,744	)		(2,049	)

Net income	$	2,097		$	8,897

Earnings per common share basic and diluted	$	0.06		$	0.30
Cash dividends declared per common share	$	0.42		$	0.40
Weighted average common shares outstanding		37,823			30,067
Weighted average common shares outstanding and dilutive common stock equivalents		37,928			30,067

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Statements of Stockholders’ Equity (unaudited)

(in thousands, except per share amounts)


	Common stock			Paid-in Capital		Stock- holder Loans			Unearned Compen- sation— Restricted stock			Distributions (in excess of) less than earnings			Net Unrealized Depreciation on Investments			Total Stockholders’ Equity
	Shares	Amount		Paid-in Capital		Stock- holder Loans			Unearned Compen- sation— Restricted stock						Net Unrealized Depreciation on Investments			Total Stockholders’ Equity
Balance December 31, 2002	31,259	$	313	$	419,961	$	(5,513	)	$	(8,566	)	$	(1,824	)	$	(43,121	)	$	361,250
Net income (loss)													(8,750	)		17,647			8,897
Dividends declared, $0.40 per share													(11,936	)					(11,936	)
Amortization of restricted stock awards										958									958
Reduction in employee loans							15												15

Balance March 31, 2003	31,259	$	313	$	419,961	$	(5,498	)	$	(7,608	)	$	(22,510	)	$	(25,474	)	$	359,184

Balance December 31, 2003	38,732	$	387	$	529,168	$	(5,293	)	$	(4,911	)	$	(26,240	)	$	(29,161	)	$	463,950
Net income (loss)													11,745			(9,648	)		2,097
Dividends declared, $0.42 per share													(15,695	)					(15,695	)
Dividend reinvestment	1		—		28														28
Amortization of restricted stock awards										4,977									4,977
Vesting of restricted stock awards					11,570					(11,570	)								—
Reduction in employee loans							140												140

Balance March 31, 2004	38,733	$	387	$	540,766	$	(5,153	)	$	(11,504	)	$	(30,190	)	$	(38,809	)	$	455,497

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Statements of Cash Flows (unaudited)

(in thousands)


	Three Months Ended March 31,
	2004			2003

Operating activities
Net income	$	2,097		$	8,897
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		191			130
Amortization of restricted stock awards		4,977			958
Amortization of deferred debt issuance costs		337			349
Net realized (gains) losses on investments		(1,904	)		19,696
Net change in unrealized depreciation (appreciation) on investments		9,648			(17,647	)
Decrease in cash—securitization accounts from interest collections		1,201			3,351
Increase in interest receivable		(97	)		(1,054	)
(Increase) decrease in accrued payment-in-kind interest and dividends		3,373			(4,108	)
Decrease in unearned income		(2,008	)		(1,192	)
(Increase) decrease in other assets		(4,127	)		397
Decrease in interest payable		(298	)		(341	)
Increase (decrease) in other liabilities		803			(881	)

Net cash provided by operating activities		14,193			8,555

Investing activities
Originations, draws and advances on loans		(58,763	)		(1,494	)
Principal payments on loans		50,090			35,952
Purchase of equity investments		(7,261	)		(3,167	)
Proceeds from sales of equity investments		4,281			—
Purchase of premises, equipment and software		(186	)		(419	)

Net cash (used in) provided by investing activities		(11,839	)		30,872

Financing activities
Net payments on borrowings		(14,851	)		(8,674	)
Decrease in cash—securitization accounts for paydown of principal on debt		7,431			10,576
Payment of financing costs		(1,045	)		—
Dividends paid		(16,267	)		(13,129	)
Issuance of common stock, net of costs		28			—
Repayment of loans granted to officers/shareholders		140			15

Net cash used in financing activities		(24,564	)		(11,212	)

(Decrease) increase in cash and cash equivalents		(22,210	)		28,215
Cash and cash equivalents at beginning of period		60,072			9,389

Cash and cash equivalents at end of period	$	37,862		$	37,604

Supplemental disclosures
Interest paid	$	2,064		$	2,440
Income taxes paid		2			4

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)

March 31, 2004

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

March 31, 2004

Cost

Fair Value

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

21st Century Newspapers, Inc.

Newspaper

Subordinated Debt

22,604

Common Stock

1.4

696

903

The Adrenaline Group, Inc. (8)

Technology

Common Stock

2.7

—

American Consolidated Media Inc. (1)

Newspaper

Senior Debt

19,125

Auto Europe, LLC

Equipment Leasing

Senior Debt

9,525

Badoud Enterprises, Inc. (1)

Newspaper

Senior Debt

7,500

Boucher Communications, Inc. (1)

Publishing

Senior Debt

1,100

Stock Appreciation Rights

—

365

Builders First Source, Inc.

Building & Development

Senior Debt

5,000

5,069

Cambridge Information Group, Inc. (1)

Information Services

Senior Debt

14,088

CCG Consulting, LLC

Business Services

Senior Debt

1,443

Warrants to purchase membership interest in LLC

19.9

—

Communications & Power Industries, Inc.

Aerospace & Defense

Senior Debt

2,000

2,030

Community Media Group, Inc. (1)

Newspaper

Senior Debt

10,345

Connective Corp. (8)

Leisure Goods

Common Stock

0.1

Creative Loafing, Inc. (1)

Newspaper

Senior Debt

13,650

Crescent Publishing Company LLC (1)

Newspaper

Senior Debt

13,771

Cruz Bay Publishing, Inc. (1)

Publishing

Senior Debt

6,247

Subordinated Debt

9,739

Dakota Imaging, Inc.

Technology

Senior Debt

6,640

Warrants to purchase Common Stock

9.4

1,586

1,917

dick clark productions, inc.

Broadcasting

Subordinated Debt

16,777

Warrants to purchase Common Stock

5.6

858

725

Common Stock

0.4

150

Dowden Health Media, Inc.

Publishing

Senior Debt

600

The e-Media Club, LLC (8)

Investment Fund

LLC Interest

0.8

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

March 31, 2004

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

March 31, 2004

Cost

Fair Value

FTI Technologies Holdings,

Technology

Senior Debt

22,125

18,000

Inc. (1)

Warrants to purchase Common Stock

4.2

—

Graycom, LLC (8)

Telecommunications

Warrants to purchase membership interest in LLC

27.8

Hometown Telephone, LLC (8)

Telecommunications

Warrants to purchase membership interest in LLC

27.8

—

I-55 Internet Services, Inc.

Telecommunications

Senior Debt

2,388

Warrants to purchase Common Stock

20.0

366

423

IDS Telcom LLC

Telecommunications

Senior Debt

18,823

Warrants to purchase membership interest in LLC

27.8

2,693

3,310

Images.com, Inc.

Information Services

Senior Debt

3,237

2,996

Information Today, Inc. (1)

Information Services

Senior Debt

8,792

Jeffrey A. Stern (8)

Other

Senior Debt

The Joseph F. Biddle Publishing Company (1)

Newspaper

Senior Debt

9,905

Joseph C. Millstone

Telecommunications

Senior Debt

500

Knowledge Learning Corporation

Healthcare

Senior Debt

7,377

7,537

The Korea Times Los Angeles, Inc.

Newspaper

Senior Debt

10,602

Manhattan Telecommunications

Telecommunications

Senior Debt

13,925

Corporation (1)

Subordinated Debt

12,328

Preferred Stock

100.0

1,854

1,908

Warrants to purchase Common Stock

28.0

2,805

4,214

McGinnis-Johnson Consulting, LLC (1)

Newspaper

Unsecured Note

1,000

MedAssets, Inc.

Healthcare

Senior Debt

5,000

5,013

Subordinated Debt

2,500

2,519

The Meow Mix Company

Food Products

Senior Debt

4,938

4,981

Midwest Towers Partners,
LLC (1)

Telecommunications

Senior Debt

17,009

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

March 31, 2004

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

March 31, 2004

Cost

Fair Value

Miles Media Group, Inc. (1)

Publishing

Senior Debt

7,929

Warrants to purchase Common Stock

12.3

Minnesota Publishers, Inc. (1)

Newspaper

Senior Debt

14,250

MultiPlan, Inc.

Insurance

Senior Debt

5,000

5,063

NALCO Company

Ecological Services

Senior Debt

4,872

5,043

New Century Companies, Inc. (8)

Industrial

Common Stock

2.3

157

Equipment

Warrants to purchase Common Stock

0.4

—

New Vision Broadcasting, LLC (1)

Broadcasting

Senior Debt

16,033

New Wave Communications, LLC (1)

Cable

Senior Debt

8,848

nii communications, inc. (1)

Telecommunications

Senior Debt

7,445

Common Stock

3.0

400

154

Warrants to purchase Common Stock

38.6

1,218

1,696

Powercom Corporation (1)

Telecommunications

Senior Debt

2,144

Warrants to purchase Class A Common Stock

20.0

278

187

R.R. Bowker LLC (1)

Information Services

Senior Debt

9,125

Warrants to purchase membership interest in LLC

14.0

882

1,676

Robert N. Snyder

Information Services

Senior Debt

1,300

Sheridan Healthcare, Inc.

Healthcare

Senior Debt

3,000

3,034

Solo Cup Company

Containers & Glass

Senior Debt

3,500

3,563

Stonebridge Press, Inc. (1)

Newspaper

Senior Debt

5,335

SXC Health Solutions, Inc. (1) (16)

Technology

Senior Debt

7,600

Talk America Holdings, Inc. (8)

Telecommunications

Common Stock

0.8

499

1,783

Warrants to purchase Common Stock

0.7

312

TGI Group, LLC

Information Services

Senior Debt

6,272

Warrants to purchase membership interest in LLC

5.0

126

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

March 31, 2004

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

March 31, 2004

Cost

Fair Value

Tower Resource Management, Inc.

Telecommunications

Senior Debt

1,267

Warrants to purchase Common Stock

8.9

—

VS&A-PBI Holding LLC (8)

Publishing

LLC Interest

0.8

500

—

Wicks Business Information, LLC

Publishing

Unsecured Note

200

Wiesner Publishing Company,

Publishing

Senior Debt

5,365

LLC (1)

Subordinated Debt

5,532

Warrants to purchase membership interest in LLC

15.0

406

365

WirelessLines II, Inc.

Telecommunications

Senior Debt

409

Witter Publishing Co., Inc.

Publishing

Senior Debt

2,413

Warrants to purchase Common Stock

12.9

101

Wyoming Newspapers, Inc. (1)

Newspapers

Senior Debt

15,000

Total Non-affiliate investments

449,310

450,197

Affiliate investments (12):

All Island Media, Inc.

Newspaper

Senior Debt

7,700

Common Stock

9.1

500

Country Media, Inc.

Newspaper

Senior Debt

7,176

Common Stock

6.3

100

135

Executive Enterprise Institute,
LLC (8)

Business Services

LLC Interest

10.0

301

—

Netplexus Corporation (1) (8)

Technology

Senior Debt

1,817

170

Preferred Stock

51.0

766

—

Warrants to purchase Class A
Common Stock

4.8

—

Sunshine Media Delaware, LLC (1)

Publishing

Senior Debt

12,933

11,186

Class A LLC Interest

12.8

564

—

Warrants to purchase Class B LLC interest

100.0

—

ViewTrust Technology (8)

Technology

Common Stock

7.5

Total Affiliate investments

31,858

26,871

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

March 31, 2004

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

March 31, 2004

Cost

Fair Value

Control investments: Non-majority-owned (11):

Creatas, L.L.C. (1)

Information Services

Senior Debt

17,904

Investor Class LLC Interest Guaranty ($501)

100.0

1,273

3,184

ETC Group, LLC (13)

Publishing

Senior Debt

1,200

Series A LLC Interest

100.0

650

Series C LLC Interest

100.0

100

—

Fawcette Technical

Publishing

Senior Debt

12,240

Publications Holding (1)

Subordinated Debt

3,937

Series A Preferred Stock

100.0

2,569

1,195

Common Stock

36.0

—

National Systems Integration,

Security Alarm

Senior Debt

575

Inc. (3) (4) (7)

Class B-2 Preferred Stock

100.0

4,409

2,578

Common Stock

46.0

—

Platinum Wireless, Inc.

Telecommunications

Senior Debt

875

Common Stock

37.0

4,640

4,646

Options to purchase Common Stock

1.5

272

104

Total Control investments: Non-majority-owned

50,644

48,440

Control investments: Majority-owned (10):

AMI Telecommunications

Telecommunications

Senior Debt

3,100

247

Corporation (1) (8)

Series A-1 Preferred Stock

82.3

700

—

Series A-2 Preferred Stock

100.0

1,995

—

Series A-3 Preferred Stock

37.5

1,100

—

Common Stock

5.1

200

—

Bridgecom Holdings,

Telecommunications

Senior Debt

22,114

Inc. (1) (14)

Preferred Stock

100.0

37,511

Common Stock

100.0

—

ClearTel Communications,

Telecommunications

Senior Debt

22,000

Inc. (1) (17)

Subordinated Debt

5,498

Preferred Stock

100.0

4,864

—

Common Stock

100.0

540

—

Guaranty ($200)

Copperstate Technologies,

Security Alarm

Senior Debt

985

Inc. (3)

Class A Common Stock

93.0

2,000

1,274

Class B Common Stock

0.0

—

Warrants to purchase
Class B Common Stock

97.3

—

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

March 31, 2004

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

March 31, 2004

Cost

Fair Value

Corporate Legal Times

Publishing

Senior Debt

4,626

4,429

L.L.C.

Subordinated Debt

1,338

—

LLC Interest

90.6

313

—

Crystal Media Network, LLC (5)

Broadcasting

LLC Interest

100.0

6,132

5,149

Daily Telegram Holdings,

Newspaper

Senior Debt

6,605

LLC (1)

LLC Interest

100.0

1,461

1,496

Interactive Business

Security Alarm

Senior Debt

Solutions, Inc. (4)

Common Stock

100.0

2,750

717

Superior Publishing

Newspaper

Senior Debt

20,760

Corporation. (1) (15)

Subordinated Debt

20,405

Preferred Stock

100.0

7,999

8,242

Common Stock

100.0

Telecomm South, LLC (2) (8)

Telecommunications

Senior Debt

3,183

1,653

LLC Interest

100.0

—

UMAC, Inc. (8)

Publishing

Common Stock

100.0

10,268

285

Working Mother Media,

Publishing

Senior Debt

7,526

Inc. (8)

Class A Preferred Stock

99.1

10,497

7,031

Class B Preferred Stock

100.0

—

Class C Preferred Stock

100.0

—

Common Stock

51.0

—

Guaranty ($1,429)

Total Control investments: Majority-owned

206,560

174,055

Total Investments

738,372

699,563

Unearned income

(14,990

)

(14,990

)

Total Investments net of unearned income

723,382

684,573

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)

December 31, 2003

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

December 31, 2003

Cost

Fair Value

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

21st Century Newspapers, Inc.

Newspaper

Subordinated Debt

22,266

Common Stock

1.0

453

667

aaiPharma Inc.

Drugs

Senior Debt

4,875

The Adrenaline Group, Inc. (8)

Technology

Common Stock

2.7

—

American Consolidated Media Inc. (1)

Newspaper

Senior Debt

19,300

Auto Europe, LLC

Equipment Leasing

Senior Debt

10,000

Badoud Enterprises, Inc. (1)

Newspaper

Senior Debt

7,675

Barcom Electronic Inc.

Security Alarm

Senior Debt

3,393

Boucher Communications,

Publishing

Senior Debt

1,400

Inc. (1)

Stock Appreciation Rights

—

340

Bridgecom Holdings,

Telecommunications

Senior Debt

22,114

Inc. (1) (14)

Warrants to purchase Common Stock

13.0

2,122

4,364

Brookings Newspapers,
L.L.C. (1)

Newspaper

Senior Debt

2,700

Cambridge Information Group, Inc. (1)

Information Services

Senior Debt

15,450

CCG Consulting, LLC

Business Services

Senior Debt

1,451

Warrants to purchase membership interest in LLC

21.5

—

Community Media Group,
Inc. (1)

Newspaper

Senior Debt

10,345

Connective Corp. (8)

Leisure Goods

Common Stock

0.2

Creative Loafing, Inc. (1)

Newspaper

Senior Debt

14,050

Crescent Publishing Company LLC (1)

Newspaper

Senior Debt

14,304

Cruz Bay Publishing, Inc. (1)

Publishing

Senior Debt

6,200

Subordinated Debt

4,035

Dakota Imaging, Inc.

Technology

Senior Debt

7,062

Warrants to purchase Common Stock

9.4

1,586

1,671

dick clark productions, inc.

Broadcasting

Subordinated Debt

16,479

Warrants to purchase Common Stock

5.6

858

639

Common Stock

0.4

150

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

December 31, 2003

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

December 31, 2003

Cost

Fair Value

Dowden Health Media, Inc.

Publishing

Senior Debt

700

The e-Media Club, LLC (8)

Investment Fund

LLC Interest

0.8

FTI Technologies Holdings,

Technology

Senior Debt

22,450

Inc. (1)

Warrants to purchase Common Stock

4.2

—

Graycom, LLC (8)

Telecommunications

Warrants to purchase membership interest in LLC

27.8

Hometown Telephone, LLC (8)

Telecommunications

Warrants to purchase membership interest in LLC

27.8

—

I-55 Internet Services, Inc.

Telecommunications

Senior Debt

2,301

Warrants to purchase Common Stock

7.5

103

156

IDS Telcom LLC

Telecommunications

Senior Debt

18,823

Warrants to purchase membership interest in LLC

27.8

2,693

3,101

Images.com, Inc.

Information Services

Senior Debt

3,188

1,722

Information Today, Inc. (1)

Information Services

Senior Debt

9,192

Jeffrey A. Stern (8)

Other

Senior Debt

The Joseph F. Biddle Publishing Company (1)

Newspaper

Senior Debt

10,305

Joseph C. Millstone

Telecommunications

Senior Debt

500

The Korea Times Los Angeles, Inc.

Newspaper

Senior Debt

10,602

Manhattan Telecommunications

Telecommunications

Senior Debt

13,925

Corporation (1)

Subordinated Debt

12,328

Preferred Stock

100.0

1,800

1,854

Warrants to purchase Common Stock

28.0

2,805

4,021

Marketron International,
Inc. (6) (8)

Business Services

Warrants to purchase Common Stock

1.5

—

McGinnis-Johnson Consulting, LLC (1)

Newspaper

Subordinated Debt

10,531

The Meow Mix Company

Food Products

Senior Debt

4,969

Midwest Towers Partners,
LLC (1)

Telecommunications

Senior Debt

17,009

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

December 31, 2003

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

December 31, 2003

Cost

Fair Value

Miles Media Group, Inc. (1)

Publishing

Senior Debt

7,906

Warrants to purchase Common Stock

12.4

Minnesota Publishers, Inc. (1)

Newspaper

Senior Debt

14,250

New Century Companies, Inc. (8)

Industrial

Common Stock

2.3

157

144

Equipment

Warrants to purchase Common Stock

0.4

—

New Vision Broadcasting, LLC (1)

Broadcasting

Senior Debt

13,367

New Wave Communications, LLC (1)

Cable

Senior Debt

8,804

nii communications, inc. (1)

Telecommunications

Senior Debt

7,353

Common Stock

3.0

400

137

Warrants to purchase Common Stock

38.5

1,218

1,501

NOW Communications, Inc. (1)

Telecommunications

Senior Debt

4,783

4,125

Warrants to purchase Common Stock

10.0

—

Pacific-Sierra Publishing, Inc.

Newspaper

Senior Debt

25,734

Powercom Corporation (1)

Telecommunications

Senior Debt

2,160

Warrants to purchase Class A
Common Stock

18.6

263

211

R.R. Bowker LLC (1)

Information Services

Senior Debt

9,500

Warrants to purchase membership interest in LLC

14.0

882

1,434

Robert N. Snyder

Information Services

Senior Debt

1,300

Stonebridge Press, Inc. (1)

Newspaper

Senior Debt

5,466

SXC Health Solutions, Inc. (1) (16)

Technology

Senior Debt

7,600

Talk America Holdings, Inc. (8)

Telecommunications

Common Stock

0.8

499

2,484

Warrants to purchase Common Stock

0.8

474

TGI Group, LLC

Information Services

Senior Debt

6,225

Warrants to purchase membership interest in LLC

5.0

126

—

Tower Resource Management, Inc.

Telecommunications

Senior Debt

1,503

Warrants to purchase Common Stock

8.9

—

VS&A-PBI Holding LLC (8)

Publishing

LLC Interest

0.8

500

—

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

December 31, 2003

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

December 31, 2003

Cost

Fair Value

Wicks Business Information, LLC

Publishing

Unsecured Note

200

Wiesner Publishing Company,

Publishing

Senior Debt

5,461

LLC (1)

Subordinated Debt

5,623

Warrants to purchase membership interest in LLC

15.0

406

398

WirelessLines II, Inc.

Telecommunications

Senior Debt

437

Witter Publishing Co., Inc.

Publishing

Senior Debt

2,340

Warrants to purchase Common Stock

10.5

Wyoming Newspapers, Inc. (1)

Newspaper

Senior Debt

10,378

Total Non-affiliate investments

477,732

482,112

Affiliate investments (12):

All Island Media, Inc.

Newspaper

Senior Debt

8,000

Common Stock

9.1

500

Country Media, Inc.

Newspaper

Senior Debt

7,176

Common Stock

6.3

100

134

Creatas, L.L.C. (1)

Information Services

Senior Debt

17,735

Investor Class LLC Interest Guaranty ($501)

100.0

1,273

2,951

Executive Enterprise Institute, LLC (8)

Business Services

LLC Interest

10.0

301

—

Netplexus Corporation (1) (8)

Technology

Senior Debt

1,817

170

Preferred Stock

51.0

766

—

Warrants to purchase Class A Common Stock

4.8

—

Sunshine Media Delaware,

Publishing

Senior Debt

12,839

12,516

LLC (1)

Class A LLC Interest

12.8

564

—

Warrants to purchase

Class B LLC interest

100.0

—

ViewTrust Technology (8)

Technology

Common Stock

7.5

Total Affiliate investments

51,072

49,183

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

December 31, 2003

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

December 31, 2003

Cost

Fair Value

Control investments: Non-majority-owned (11):

ETC Group, LLC (13)

Publishing

Senior Debt

1,200

Series A LLC Interest

100.0

650

Series C LLC Interest

100.0

100

Fawcette Technical Publications

Publishing

Senior Debt

12,160

Holding (1)

Subordinated Debt

3,906

Series A Preferred Stock

100.0

2,569

718

Common Stock

36.0

—

National Systems Integration,

Security Alarm

Senior Debt

500

Inc. (3) (4) (7)

Class B-2 Preferred Stock

100.0

4,409

3,833

Common Stock

46.0

—

Platinum Wireless, Inc.

Telecommunications

Senior Debt

875

Common Stock

37.0

4,640

4,519

Options to purchase Common Stock

1.5

272

Total Control investments: Non-majority-owned

31,281

28,559

Control investments: Majority-owned (10):

AMI Telecommunications

Telecommunications

Senior Debt

3,100

237

Corporation (1) (8)

Series A-1 Preferred Stock

82.3

700

—

Series A-2 Preferred Stock

100.0

1,995

—

Series A-3 Preferred Stock

37.5

1,100

—

Common Stock

5.1

200

—

Biznessonline.com, Inc. (1) (17)

Telecommunications

Senior Debt

18,556

Preferred Stock

100.0

4,864

—

Common Stock

73.2

540

—

Copperstate Technologies, Inc. (3)

Security Alarm

Senior Debt

910

Class A Common Stock

93.0

2,000

2,160

Class B Common Stock

0.1

—

Warrants to purchase Class B Common Stock

99.9

—

1,343

Corporate Legal Times L.L.C.

Publishing

Senior Debt

4,624

4,302

Subordinated Debt

1,340

—

LLC Interest

90.6

313

—

Crystal Media Network, LLC (5)

Broadcasting

LLC Interest

100.0

6,132

5,149

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

December 31, 2003

(Dollars in thousands)

Portfolio Company

Industry

Title of Securities
Held by the
Company

Percentage of
Class Held on
a Fully
Diluted Basis

(9)

December 31, 2003

Cost

Fair Value

Interactive Business Solutions,

Security Alarm

Senior Debt

Inc. (4)

Common Stock

100.0

2,750

1,351

Superior Publishing

Newspaper

Senior Debt

20,760

Corporation. (1) (15)

Subordinated Debt

28,000

Preferred Stock

100.0

7,999

Common Stock

100.0

Telecomm North Corp. (14)

Telecommunications

Preferred Stock

100.0

31,856

Common Stock

100.0

—

Telecomm South, LLC (2) (8)

Telecommunications

Senior Debt

3,292

2,210

LLC Interest

100.0

—

UMAC, Inc. (8)

Publishing

Common Stock

100.0

10,375

344

Working Mother Media, Inc. (8)

Publishing

Senior Debt

8,026

Class A Preferred Stock

98.8

8,497

5,808

Class B Preferred Stock

100.0

—

Class C Preferred Stock

100.0

—

Common Stock

51.0

—

Total Control investments: Majority-owned

168,018

139,088

Total Investments

728,103

698,942

Unearned income

(16,416

)

(16,416

)

Total Investments net of unearned income

711,687

682,526

(1)

Some of the securities listed are issued by affiliate(s) of the listed portfolio company.

(2)

In July 2002, we acquired the assets of ValuePage Holdings, Inc. in satisfaction of debt and transferred them to Telecomm South, LLC, which at the time was a wholly owned subsidiary of MCG Finance I, LLC.

(3)

In August 2002, we acquired the Arizona division of Intellisec Holdings, Inc. in partial satisfaction of debt and transferred it to Copperstate Technologies, Inc., which at the time was a wholly owned subsidiary of MCG Finance I, LLC.

(4)

In October 2002, we acquired the North Carolina division of Intellisec Holdings, Inc. in partial satisfaction of debt and transferred it to Interactive Business Solutions, Inc., which at the time was a wholly owned subsidiary of MCG Finance I, LLC.

(5)

In February 2003, we acquired the assets of NBG Radio Networks, Inc. in satisfaction of debt. The assets are held and operated through a separate portfolio company, Crystal Media Network, LLC, which is a wholly owned indirect subsidiary of MCG Capital Corporation.

(6)

In February 2003, BuyMedia Inc. changed its name to Marketron International, Inc.

(7)

In March 2003, we converted $8,631 of senior debt and $1,262 of debtor in possession financing in Intellisec Holdings, Inc., into preferred and common stock in connection with a plan of reorganization. In March 2003, Intellisec Holdings, Inc. changed its name to National Systems Integration, Inc.

(8)

Non-income producing at the relevant period end.

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Consolidated Schedule of Investments (unaudited)—(Continued)

(9)

The “percentage of class held on a fully diluted basis” represents the percentage of the class of security we may own assuming we exercise our warrants or options (whether or not they are in-the-money) and assuming that warrants, options or convertible securities held by others are not exercised or converted. We have not included any security which is subject to significant vesting contingencies. Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted. The percentage was calculated based on the most current outstanding share information available to us (i) in the case of private companies, provided by that company, and (ii) in the case of public companies, provided in that company’s most recent public filings with the SEC.

(10)

Majority owned investments are generally defined under the Investment Company Act of 1940 as companies in which MCG owns more than 50% of the voting securities of the company.

(11)

Non-majority owned control investments are generally defined under the Investment Company Act of 1940 as companies in which MCG owns more than 25% but not more than 50% of the voting securities of the company.

(12)

Affiliate investments are generally defined under the Investment Company Act of 1940 as companies in which MCG owns at least 5% but not more than 25% of the voting securities of the company.

(13)

In July 2003, we acquired the assets of THE Journal LLC in satisfaction of debt and transferred those assets to a wholly owned subsidiary, ETC Group, LLC. In August 2003, we sold 50% of the equity in ETC Group, LLC to third party investors.

(14)

In December 2003, Telecomm North Corp., a wholly-owned subsidiary and portfolio company, entered into an agreement to merge with another of our portfolio companies, Bridgecom Holdings, Inc. The merger was completed in March 2004.

(15)

In December 2003, Superior Publishing Inc., a wholly-owned subsidiary and portfolio company, purchased the stock of one of our portfolio companies, Murphy McGinnis Media, Inc.

(16)

In July 2003, Systems Xcellence USA, Inc. changed its name to SXC Health Solutions, Inc.

(17)

In February, 2004, BiznessOnline.com, Inc. changed its name to ClearTel Communications, Inc.

See notes to consolidated financial statements (unaudited).

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited)

(in thousands except share and per share amounts)

Note 1. Description of Business and Unaudited Interim Consolidated Financial Statements Basis of Presentation

MCG Capital Corporation (“MCG” or the “Company” or “Parent” or “we” or “us” or “our”) is a solutions-focused financial services company providing financing and advisory services to a variety of small- and medium-sized companies throughout the United States with a focus on growth oriented companies. Currently, our portfolio consists primarily of companies in the communications, information services, media and technology, including software and technology-enabled business services, industry sectors. Our capital is generally used by our portfolio companies to finance acquisitions, recapitalizations, management buyouts, organic growth and working capital. Prior to its name change effective June 14, 2001, the Company’s legal name was MCG Credit Corporation. The Company is a non-diversified internally managed, closed-end investment company that elected to be treated as a business development company under the Investment Company Act of 1940, as amended (“1940 Act”).

On March 3, 2004, MCG filed a Form N-2 Registration Statement with the Securities and Exchange Commission (“SEC”) which will allow MCG or certain selling shareholders named therein to offer, from time to time, up to 18,000,000 shares of common stock in one or more offerings.

Interim consolidated financial statements of MCG are prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year. The interim unaudited consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended December 31, 2003, as filed with the SEC.

The accompanying financial statements reflect the consolidated accounts of MCG, including MCG-Kagan Research, Inc. and MCG’s special purpose financing subsidiaries MCG Finance I, LLC, MCG Finance II, LLC, MCG Finance III, LLC, and MCG Finance IV, LLC with all significant intercompany balances eliminated, and the related consolidated results of operations. In accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, the Company does not consolidate portfolio company investments in which the Company has a controlling interest.

Note 2. Investments

As of March 31, 2004 and December 31, 2003, investments consisted of the following:


	March 31, 2004						December 31, 2003
	Cost			Fair Value			Cost			Fair Value
Commercial loans	$	618,059		$	605,046		$	615,253		$	605,551
Investments in equity securities		120,313			94,517			112,850			93,391
Unearned income		(14,990	)		(14,990	)		(16,416	)		(16,416	)

Total	$	723,382		$	684,573		$	711,687		$	682,526

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited) (continued)

(in thousands except share and per share amounts)

MCG’s customer base includes primarily small- and medium-sized private companies in the communications, information services, media and technology, including software and technology-enabled business services, industry sectors. The proceeds of the loans to these companies are generally used for buyouts, growth, acquisitions, liquidity, refinancings and restructurings. In addition, we have occasionally made loans to individuals who are principals in these companies where the proceeds are used for or in connection with the operations or capitalization of such companies. Our debt instruments generally provide for a contractual variable interest rate generally ranging from approximately 4% to 14%, a portion of which may be deferred. At March 31, 2004, approximately 88% of loans in the portfolio, based on amounts outstanding at fair value, were at variable rates determined on the basis of a benchmark LIBOR or prime rate and approximately 12% were at fixed rates. In addition, approximately 52% of the loan portfolio has floors of between 1.25% and 3% on the LIBOR base index. The Company’s loans generally have stated maturities at origination that range from 2 to 8 years. Customers typically pay an origination fee based on a percentage of the commitment amount. They also often pay a fee based on any undrawn commitments.

At March 31, 2004, approximately 50% of MCG’s loans had detachable warrants or an option to purchase warrants, stock appreciation rights or other equity interests or other provisions designed to provide the Company with an enhanced internal rate of return through the potential recognition of capital gains from the sale of such interests. In lieu of cash for loan origination fees, MCG received warrants valued at $522 and $227 for the quarter ended March 31, 2004 and 2003, respectively. These equity and equity-like instruments generally do not produce a current return, but are held for potential investment appreciation and capital gains. The warrants and options to purchase warrants typically are exercisable immediately and typically remain exercisable for 10 years. The exercise prices on the warrants vary from nominal exercise prices to exercise prices that are at or above the current fair market value of the equity for which we are receiving warrants. In some cases, some or all of the deferred interest on loans may be used to pay the exercise price on the warrants or option to purchase warrants. The equity interests and warrants and options to purchase warrants often include registration rights, which allow us, under certain circumstances, to require the portfolio company to register the underlying securities with the SEC after the portfolio company’s initial public offering. Realized gains and losses on sales of investments, as determined on a specific identification basis, are included in the Consolidated Statements of Operations.

The composition of MCG’s investments as of March 31, 2004 and December 31, 2003 at cost and fair value was as follows (excluding unearned income):


	March 31, 2004				December 31, 2003

	Investments at Cost		Percentage of Total Portfolio		Investments at Cost		Percentage of Total Portfolio

Senior Debt	$	516,201	69.9	%	$	510,545	70.1	%
Subordinated Debt		101,858	13.8	%		104,708	14.4	%
Equity		108,619	14.7	%		99,312	13.6	%
Warrants to Acquire Equity		11,694	1.6	%		13,538	1.9	%
Equity Appreciation Rights		—	0.0	%		—	0.0	%

Total	$	738,372	100.0	%	$	728,103	100.0	%

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited) (continued)

(in thousands except share and per share amounts)


	March 31, 2004				December 31, 2003

	Investments at Fair Value		Percentage of Total Portfolio		Investments at Fair Value		Percentage of Total Portfolio

Senior Debt	$	504,507	72.1	%	$	502,183	71.9	%
Subordinated Debt		100,539	14.4	%		103,368	14.7	%
Equity		78,936	11.3	%		73,467	10.5	%
Warrants to Acquire Equity		15,216	2.1	%		19,584	2.8	%
Equity Appreciation Rights		365	0.1	%		340	0.1	%

Total	$	699,563	100.0	%	$	698,942	100.0	%

Set forth below are tables showing the composition of MCG’s portfolio by industry sector (excluding unearned income) at cost and fair value as of March 31, 2004 and December 31, 2003:



	March 31, 2004				December 31, 2003

	Investments at Cost		Percentage of Total Portfolio		Investments at Cost		Percentage of Total Portfolio

Media
Newspaper	$	216,490	29.3	%	$	250,895	34.5	%
Publishing		108,901	14.7	%		102,045	14.0	%
Broadcasting		48,799	6.6	%		45,790	6.3	%
Telecommunications		205,845	27.9	%		201,272	27.6	%
Information Services		62,999	8.5	%		64,871	8.9	%
Other Diversified Sectors		54,804	7.5	%		21,948	3.0	%
Technology		40,534	5.5	%		41,282	5.7	%

Total	$	738,372	100.0	%	$	728,103	100.0	%


	March 31, 2004				December 31, 2003

	Investments at Fair Value		Percentage of Total Portfolio		Investments at Fair Value		Percentage of Total Portfolio

Media
Newspaper	$	217,062	31.0	%	$	251,143	35.9	%
Publishing		89,073	12.7	%		84,432	12.1	%
Broadcasting		47,588	6.8	%		44,487	6.4	%
Telecommunications		191,162	27.3	%		192,872	27.5	%
Information Services		65,351	9.4	%		65,509	9.4	%
Other Diversified Sectors		54,992	7.9	%		21,541	3.1	%
Technology		34,335	4.9	%		38,958	5.6	%

Total	$	699,563	100.0	%	$	698,942	100.0	%

At March 31, 2004, there were $45 of loans greater than 60 days past due compared to $4,175 of loans at December 31, 2003. At March 31, 2004, there were $9,785 of loans on non-accrual, including all $45 of the loans greater than 60 days past due. At December 31, 2003, there were $14,617 of loans on non-accrual, including $50 of the loans greater than 60 days past due.

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited) (continued)

(in thousands except share and per share amounts)

Note 3. Borrowings

As of June 1, 2000, we, through MCG Master Trust, established a revolving credit facility (the “Revolving Credit Facility”), which allows us to issue up to $200,000 of Series 2000-1 Class A Notes (the “Series 2000-1 Notes” or “Series 2000-1 Class A Asset Backed Securities”). As of March 31, 2004, $114,938 of the Series 2000-1 Notes were outstanding with one investor and as of December 31, 2003, $130,991 were outstanding with one investor. As of March 31, 2004 and December 31, 2003, we had no notes outstanding under a swingline credit facility (the “Swingline Notes”), which is part of the Revolving Credit Facility, that allows us to borrow up to $25,000 as part of the $200,000 total facility limit for a period of up to four days. The Swingline Notes are repaid through the issuance of Series 2000-1 Notes. The Revolving Credit Facility was secured by $180,783 of commercial loans as of March 31, 2004 and $194,308 of commercial loans as of December 31, 2003. We are subject to certain limitations on the amount of Series 2000-1 Notes we may issue at any point in time including the requirement for a minimum amount of unleveraged loans that serve as collateral for the indebtedness. Such amount was a minimum of $75,000 as of July 8, 2002 and thereafter. We are also subject to limitations including restrictions on geographic concentrations, sector concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings as well as regulatory restrictions on leverage which may affect the amount of Series 2000-1 notes we may issue from time to time. There are also certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, violation of which could result in the early amortization of the facility and limit further advances under the facility, and in some cases could be an event of default. Such limitations, requirements, and associated defined terms are as provided for in the documents governing the facility. As noted below, on February 12, 2004, the requirement relating to loan charge-offs was eliminated. The Series 2000-1 Notes’ interest was based on a commercial paper rate plus 3.0% prior to February 12, 2004 at which time it was reduced to LIBOR plus 1.5%, and interest is payable monthly.

On February 12, 2004, we entered into an agreement with Wachovia Bank, National Association to amend the revolving credit facility that we had established through MCG Master Trust. The amendment to the Revolving Credit Facility, among other things, provides for the following:

•

a decrease in our borrowing capacity from $200.0 million to $130.0 million, which will further be reduced to $115.0 million on June 30, 2004 and to $100.0 million by September 30, 2004;

•

an extension of the revolving period to September 30, 2004;

•

permits recourse to MCG Capital Corporation itself in the event that the interest and principal payments from the loans we transferred to MCG Master Trust in connection with the Revolving Credit Facility are insufficient to repay the outstanding amount due under the Revolving Credit Facility;

•

eliminates a requirement relating to loan charge-offs at the servicer level that we were previously required to seek a waiver from in February 2003;

•

changes the date on which the holder of the notes issued by MCG Master Trust receives final payment on such notes from June 2020 to September 2009; and

•

reduces the interest rate payable under the Revolving Credit Facility from the commercial paper rate plus 3.0% to LIBOR plus 1.5%.

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited) (continued)

(in thousands except share and per share amounts)

As discussed above, there are certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, violation of which could result in the early amortization of the facility and limit further advances under the facility, and in some cases could be an event of default. In February 2003, we amended the Revolving Credit Facility agreements. Prior to the February 2003 amendment, the Revolving Credit Facility required us among other things to maintain an average trailing twelve-month portfolio charged-off ratio (as defined in the Revolving Credit Facility agreements) of 3% or less. The amendment increased this ratio to 7% for any date prior to and including June 30, 2003 and decreased this ratio to 3% thereafter. This amendment also included a waiver with respect to the applicability of the charged-off ratio for periods prior to February 2003. Additionally, this amendment required us to increase the amount of collateral held by the noteholders by pledging the MCG Commercial Loan Trust 2001-1 Class C Notes, which we own. As noted above, on February 12, 2004, the requirement relating to loan charge-offs was eliminated.

On January 29, 2004, our wholly owned, bankruptcy remote, special purpose indirect subsidiary, MCG Commercial Loan Trust 2003-1 entered into a $200 million secured warehouse credit facility with an affiliate of UBS AG. As of March 31, 2004, $15,000 was outstanding under this facility. We will use the warehouse credit facility to fund our origination and purchase of a diverse pool of loans, including broadly syndicated rated loans, that we intend to securitize using an affiliate of the lender as the exclusive structurer and underwriter or placement agent. Advances under the credit facility bear interest at LIBOR plus 0.50%. The warehouse credit facility operates much like a revolving credit facility that is primarily secured by the loans acquired with the advances under the credit facility. In addition, the lender will have recourse to MCG Capital Corporation itself in a maximum aggregate amount of $72,000 in the event that the principal and interest payments from the loans transferred to MCG Commercial Loan Trust 2003-1 are insufficient to repay the outstanding amount due to the lender. The warehouse credit facility is cancelable by the lender for cause at any time and has an expiration term of September 24, 2004. The warehouse credit facility is a short-term commitment of capital. If we are unable to consummate the securitization transaction or otherwise arrange for new financing on terms acceptable to us, we will have to curtail our loan origination activities.

On December 27, 2001, we established the MCG Commercial Loan Trust 2001-1 (the “Trust”), which issued two classes of Series 2001-1 Notes to 15 institutional investors. The facility is secured by all of the Trust’s existing assets, totaling $231,156 as of March 31, 2004 and $247,490 as of December 31, 2003. This facility is scheduled to terminate on February 20, 2013 or sooner upon full repayment of the Class A and Class B Notes. The Class A and Class B Notes are scheduled to be repaid as we receive principal collections on the underlying collateral. As of March 31, 2004, $159,297 of the Series 2001-1 Notes were outstanding and $173,140 were outstanding as of December 31, 2003. The Series 2001-1 Class A Asset Backed Bonds bear interest of LIBOR plus 0.60% and Series 2001-1 Class B Asset Backed Bonds bear interest of LIBOR plus 1.75%, and interest on both is payable quarterly.

The Trust and the Revolving Credit Facility are both funded through bankruptcy remote, special purpose, wholly owned subsidiaries of ours and, therefore, their assets may not be available to our creditors.

Amounts outstanding under the Revolving Credit Facility, the Warehouse Credit Facility and the Trust Notes as of March 31, 2004 and December 31, 2003 by interest rate benchmark were as follows:


	March 31, 2004		December 31, 2003
30-day LIBOR	$	129,938	$	—
90-day LIBOR		159,297		173,140
Commercial Paper Rate		—		130,991

	$	289,235	$	304,131

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited) (continued)

(in thousands except share and per share amounts)

The following is a summary of the borrowings for the three months ended March 31, 2004 and 2003:


(dollars in thousands)	Maximum Outstanding		Average Outstanding		Weighted Average Interest Rate		Interest Rate at Period-End
As of March 31, 2004 and the three months then ended
Trust Notes	$	173,140	$	162,187	2.0	%	2.0	%
Revolving Credit Facility		130,991		115,896	2.6		2.7
Warehouse Credit Facility		15,000		330	1.6		1.6
Swingline Notes		—		—	—		—

As of March 31, 2003 and the three months then ended
Trust Notes	$	240,120	$	214,447	2.3	%	2.2	%
Revolving Credit Facility		148,325		135,388	2.6		2.5
Swingline Notes		—		—	—		—

Subject to certain minimum equity restrictions and other covenants, including restrictions on which loans the Company may leverage as collateral, the unused amount under the Revolving Credit Facility totaled $15,062 and $69,009 at March 31, 2004 and December 31, 2003, respectively. Subject to certain minimum equity restrictions and other covenants, including restrictions on which loans the Company may leverage as collateral, the unused amount under the Warehouse Credit Facility totaled $185,000 at March 31, 2004.

Note 4. Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per common share for the three months ended March 31, 2004 and 2003:


	Three Months Ended March 31,
	2004		2003
Basic
Net increase in stockholders’ equity resulting from earnings/net income	$	2,097	$	8,897
Weighted average common shares outstanding		37,823		30,067
Earnings per common share-basic	$	0.06	$	0.30
Diluted
Net increase in stockholders’ equity resulting from earnings/net income	$	2,097	$	8,897
Weighted average common shares outstanding		37,823		30,067
Dilutive effect of restricted stock on which forfeiture provisions have not lapsed		105		—

Weighted average common shares and common stock equivalents		37,928		30,067

Earnings per common share-diluted	$	0.06	$	0.30

For purposes of calculating earnings per common share, unvested restricted common stock whose forfeiture provisions are solely based on passage of time are included in diluted earnings per common share based on the treasury stock method. Unvested restricted common stock whose forfeiture provisions are based on performance criteria are included in diluted earnings per common share when it becomes probable such criteria will be met and is calculated using the treasury stock method.

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited) (continued)

(in thousands except share and per share amounts)

Note 5. Employee Stock Plans

During the first quarter of 2004, as part of our review of executive compensation, our compensation committee waived the performance-based forfeiture restrictions and modified the time-based forfeiture provisions associated with the Tier III shares of certain of our executive officers through their respective amended and restated restricted stock agreements. As a result, we recorded additional paid-in-capital and unearned compensation—restricted stock of $11,570 and $(11,570), respectively, and we also recorded long-term incentive compensation expense of $4,003 during the quarter. The net effect of these modifications was to decrease stockholders’ equity by $4,003.

In addition, our compensation committee agreed to allow the restrictions on certain shares of restricted stock to lapse. As a result, the Tier I and Tier II shares held by certain of our executive officers will vest immediately upon full repayment of the loans that are secured by the restricted stock. As of March 31, 2004, none of these executives had repaid these loans and, therefore, there was no additional expense recorded during the quarter related to these modifications.

MCG Capital Corporation

Notes To Consolidated Financial Statements (unaudited) (continued)

(in thousands except share and per share amounts)

Note 6. Financial Highlights

The following is a schedule of financial highlights for the three months ended March 31, 2004 and 2003:


	Three Months Ended March 31,
	2004			2003
Per Share Data:
Net asset value at beginning of period (1)	$	11.98		$	11.56
Net operating income before investment gains and losses (2)		0.26			0.36
Net realized gains (losses) on investments (2)		0.05			(0.65	)
Net change in unrealized appreciation (depreciation) on investments (2)		(0.25	)		0.59

Net income		0.06			0.30
Dividends declared		(0.42	)		(0.40	)
Antidilutive effect of distributions recorded as compensation expense (2)		0.02			0.02

Net decrease in stockholders’ equity resulting from distributions		(0.40	)		(0.38	)
Dilutive effect of share issuances and unvested restricted stock		(0.01	)		(0.02	)
Net increase in stockholders’ equity from restricted stock amortization (2)		0.13			0.03

Net increase in stockholders’ equity relating to share issuances		0.12			0.01

Net asset value at end of period (1)	$	11.76		$	11.49

Per share market value at end of period	$	20.18		$	9.99
Total return (3)		5.16	%		-3.34	%
Shares outstanding at end of period		38,733			31,259
Ratio/Supplemental Data:
Net assets at end of period	$	455,497		$	359,184
Ratio of operating expenses to average net assets (annualized)		10.53	%		8.28	%
Ratio of net operating income to average net assets (annualized)		8.38	%		11.94	%

(1)

Based on total shares outstanding.

(2)

Based on average shares outstanding.

(3)

For 2004, total return equals the increase of the ending market value over the December 31, 2003 price of $19.59 per share plus dividends paid ($0.42 per share), divided by the beginning price. For 2003, total return equals the decrease of the ending market value over the December 31, 2002 price of $10.77 per share plus dividends paid ($0.42 per share), divided by the beginning price. Total return is not annualized.

Independent Accountants’ Review Report

Board of Directors and Shareholders

MCG Capital Corporation

We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation as of March 31, 2004, including the consolidated schedule of investments, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the three-month periods ended March 31, 2004 and 2003. These financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.

We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated balance sheet of MCG Capital Corporation as of December 31, 2003, including the consolidated schedules of investments, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated March 10, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, including the consolidated schedules 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

April 29, 2004

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 Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report.

This Quarterly Report, including the 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 and projections about our industry, our beliefs, and our assumptions. Words such as “anticipates”, “expects”, “intends”, “plans”, “believes”, “seeks”, and “estimates” and variations of these words and similar expressions are intended to identify forward-looking statements. 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 and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements including without limitation:

•

economic downturns or recessions may impair our customers’ ability to repay our loans and increase our non-performing assets,

•

economic downturns or recessions may disproportionately impact certain sectors in which we concentrate, and such conditions may cause us to suffer losses in our portfolio and experience diminished demand for capital in these industry sectors,

•

a contraction of available credit and/or an inability to access the equity markets could impair our lending and investment activities,

•

interest rate volatility could adversely affect our results,

•

the risks associated with the possible disruption in the Company’s operations due to terrorism and

•

the risks, uncertainties and other factors we identify from time to time in our filings with the Securities and Exchange Commission, including our Form 10-Ks, Form 10-Qs and Form 8-Ks.

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 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. We undertake no obligation to update such statements to reflect subsequent events.

Overview

MCG Capital Corporation is a solutions-focused financial services company providing financing and advisory services to a variety of small and medium-sized companies throughout the United States with a focus on growth oriented companies. Currently, our portfolio consists primarily of companies in the communications, information services, media, and technology, including software and technology-enabled business services, industry sectors. Our capital is generally used by our portfolio companies to finance acquisitions, recapitalizations, management buyouts, organic growth and working capital. On December 4, 2001, we completed an initial public offering and became an internally managed, non-diversified, closed-end investment company that elected to be treated as a business development company under the Investment Company Act of 1940. MCG Capital Corporation elected to be treated for federal income tax purposes as a regulated investment company under the Internal Revenue Code with the filing of its federal corporate income tax return for 2002, which election was effective as of January 1, 2002. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level tax liability.

Portfolio Composition and Asset Quality

Our primary business is lending to and investing in growth oriented private businesses, through investments in senior debt, subordinated debt and equity-based investments, including warrants and equity appreciation rights.

The total portfolio value of our investments was $699.6 million and $698.9 million at March 31, 2004 and December 31, 2003, respectively (exclusive of unearned income). During the first quarter of 2004 we made investments in nine new portfolio companies totaling $44.4 million and several follow on investments in existing customers representing $20.8 million. During 2003, our originations of debt included $32.0 million of subordinated debt to two new portfolio companies. The increase in investments during 2003 was primarily due to newly originated debt and equity investments. In addition, during 2003 a higher proportion of our new origination activity was in the form of equity securities, which included new investments of $44.1 million to control companies. Early pay-offs and sales of securities for the first quarter of 2004 were due primarily to pay-offs of $25.8 million from one portfolio company in the newspaper industry and $7.7 million from two portfolio companies in the telecommunications industry. Early pay-offs and sales of securities in 2003 were primarily due to pay-offs of $42.5 million from six companies in the publishing industry and $46.5 million from four companies in the broadcasting industry.

Total portfolio investment activity for the three months ended March 31, 2004 and year ended December 31, 2003, was as follows (exclusive of unearned income):


(dollars in millions)	Three Months Ended March 31, 2004			Year Ended December 31, 2003
Beginning Portfolio	$	698.9		$	688.9
Originations/Draws/Advances on Loans		61.4			115.3
Originations/Warrants Capitalized on Equity (a)		9.7			77.5
Gross Payments/Reductions (a)		(24.7	)		(69.1	)
Early Pay-offs/Sales of Securities		(38.0	)		(108.1	)
Realized Gains		2.2			4.7
Realized (Losses)		(0.3	)		(24.3	)
Unrealized Appreciation on Investments		5.3			35.1
Unrealized Depreciation on Investments		(14.9	)		(21.1	)

Ending Portfolio	$	699.6		$	698.9

(a)

Included in these amounts is the conversion of $0.5 million and $21.4 million of debt to equity in connection with certain restructurings for the three months ended March 31, 2004 and year ended December 31, 2003, respectively.

The following table shows the fair value of our portfolio of investments by asset class as of March 31, 2004 and December 31, 2003 (excluding unearned income):


	March 31, 2004				December 31, 2003

(dollars in millions)	Investments at Fair Value		Percentage of Total Portfolio		Investments at Fair Value		Percentage of Total Portfolio

Senior Debt	$	504.5	72.1	%	$	502.2	71.9	%
Subordinated Debt		100.5	14.4	%		103.4	14.7	%
Equity		79.0	11.3	%		73.4	10.5	%
Warrants to Acquire Equity		15.2	2.1	%		19.6	2.8	%
Equity Appreciation Rights		0.4	0.1	%		0.3	0.1	%

	$	699.6	100.0	%	$	698.9	100.0	%

Set forth below is a table showing the composition of MCG’s portfolio by industry sector at fair value at March 31, 2004 and December 31, 2003 (excluding unearned income):


	March 31, 2004				December 31, 2003

(dollars in millions)	Investments at Fair Value		Percentage of Total Portfolio		Investments at Fair Value		Percentage of Total Portfolio

Media
Newspaper	$	217.1	31.0	%	$	251.1	35.9	%
Publishing		89.1	12.7	%		84.4	12.1	%
Broadcasting		47.6	6.8	%		44.5	6.4	%
Telecommunications		191.2	27.3	%		192.9	27.5	%
Information Services		65.3	9.4	%		65.5	9.4	%
Other Diversified Sectors		55.0	7.9	%		21.5	3.1	%
Technology		34.3	4.9	%		39.0	5.6	%

	$	699.6	100.0	%	$	698.9	100.0	%

Asset Quality

Asset quality is generally a function of economic conditions, our underwriting and ongoing management of our investment portfolio. As a business development company, our loans and equity investments are carried at market value or, in the absence of market value, at fair value as determined by our board of directors in good faith on a quarterly basis. As of March 31, 2004 and December 31, 2003, net unrealized depreciation on investments totaled $38.8 million and $29.2 million, respectively. For additional information on the decrease in unrealized depreciation on investments, see the section entitled “Net Investment Gains and Losses”.

In addition to various risk management and monitoring tools, we also use an investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio. We use the following 1 to 5 investment rating scale. Below is a description of the conditions associated with each investment rating:


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 expecting an overall positive internal rate of return on the investment
5		Loss of interest or dividend and some loss of principal investment expected which would result in an overall negative internal rate of return on the investment

The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as of March 31, 2004 and December 31, 2003 (excluding unearned income):


(dollars in millions)
	March 31, 2004				December 31, 2003

Investment Rating	Investments at Fair Value		Percentage of Total Portfolio		Investments at Fair Value		Percentage of Total Portfolio

1	$	238.1	34.0	%	$	234.5	33.5	%
2		248.9	35.6	%		255.4	36.5	%
3		145.5	20.8	%		161.9	23.2	%
4		61.3	8.8	%		38.8	5.6	%
5		5.8	0.8	%		8.3	1.2	%

	$	699.6	100.0	%	$	698.9	100.0	%

We monitor loan concentrations in our portfolio, both on an individual loan basis and on a sector or industry basis, to manage overall portfolio performance due to specific customer issues or specific industry issues. At March 31, 2004, of the investments with a 5 rating, $2.1 million were loans, all of which were on non-accrual. Of the investments with a 4 rating, $53.1 million were loans, of which $7.6 million were on non-accrual. At December 31, 2003, of the investments with a 5 rating, $2.6 million were loans, all of which were on non-accrual. Of the investments with a 4 rating, $32.3 million were loans, of which $12.0 million were on non-accrual. The increase in investments with a 4 rating is due primarily to the downgrade of one investment in the technology sector.

We monitor individual customer’s financial trends in order to assess the appropriate course of action with respect to each customer and to evaluate overall portfolio quality. We closely monitor the status and performance of each individual investment on a quarterly and, in some cases, a monthly or more frequent basis. Because we are a provider of long-term privately negotiated investment capital to growth-oriented companies and we actively manage our investments through our contract structure and corporate governance rights, we do not believe that contract exceptions such as breaches of contractual covenants or late delivery of financial statements are necessarily an indication of deterioration in the credit quality or the need to pursue remedies or an active workout of a portfolio investment.

When a loan becomes 90 days or more 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 cease recognizing interest income on that loan until all principal has been paid. However, we may make exceptions to this policy if the investment is well secured and in the process of collection.

At March 31, 2004 and December 31, 2003, there were $0.1 million and $4.2 million, respectively, of loans, or approximately 0.01% and 0.6%, respectively, of the investment portfolio, greater than 60 days past due. At March 31, 2004, $9.8 million of loans, including all of the loans greater than 60 days past due, were on non-accrual status, which represented 1.4% of the investment portfolio. At December 31, 2003, $14.6 million of loans, including $0.1 million of the loans greater than 60 days past due, were on non-accrual status, which represented 2.1% of the investment portfolio. The non-accrual and past due loans at March 31, 2004 and December 31, 2003 primarily represented borrowers in the publishing, telecommunications and paging businesses. Portions of the trade publishing industry, which are dependent on financial, technology or telecommunications advertising, experienced sluggish advertising revenue. Certain companies in the telecommunications industry have suffered from competitive pressure from low cost and prepaid cellular calling plans.

At March 31, 2004, of the $149.0 million of loans to our controlled portfolio companies, $9.6 million were on non-accrual status. At December 31, 2003, of the $101.7 million of loans to our controlled portfolio companies, $14.4 million were on non-accrual status. As of March 31, 2004, of the $26.2 million of loans to other affiliates, $0.2 million were on non-accrual status. As of December 31, 2003, of the $45.6 million of loans to other affiliates, $0.2 million were on non-accrual status.

When principal and interest on a loan is not paid within the applicable grace period, we will contact the customer for collection. At that time, we will make a determination as to the extent of the problem, if any. We will then pursue a commitment for immediate payment and if we have not already, we will begin to more actively monitor the investment. We will formulate strategies to optimize the resolution process and will begin the process of restructuring the investment to better reflect the current financial performance of the customer. Such a restructuring may involve deferring payments of principal and interest, adjusting interest rates or warrant positions, imposing additional fees, amending financial or operating covenants or converting debt to equity. In general, in order to compensate us for any enhanced risk, we receive additional compensation from the customer in connection with a restructuring. During the process of monitoring a loan that is out of compliance, we will in appropriate circumstances send a notice of non-compliance outlining the specific defaults that have occurred and preserving our remedies, and initiate a review of the collateral. When a restructuring is not the most appropriate course of action, we may determine to pursue remedies available under our loan documents or at law to minimize any potential losses, including initiating foreclosure and/or liquidation proceedings.

Results of Operations

Comparison of the Three Months Ended March 31, 2004 and 2003

Operating Income

Operating income includes interest income on commercial loans, dividend income, advisory fees and other income. Interest income is comprised of commercial loan interest at contractual rates and upfront fees that are amortized into income over the life of the loan. Most of our loans contain lending features that adjust the rate margin based on the financial and operating performance of the borrower, which generally occurs quarterly.

The change in operating income for the three months ended March 31, 2004 compared to the same period in 2003 is attributable to the following items:


(dollars in thousands)	Three Months Ended March 31, 2004 vs. 2003
Change due to:
Decrease in assets (a)	$	(1,835	)
Change in LIBOR (a)		(344	)
Change in spread (a)		991
Increase in loan fee and dividend income		1,849
Increase in advisory fees and other income		3,005

Total change in operating income	$	3,666

(a)

The change in interest income due to change in LIBOR, change in spread and loan growth has been allocated in proportion to the relationship of the absolute dollar amount of the changes in each.

Total operating income for the first quarter of 2004 was $22.2 million, an increase of $3.7 million or 20% compared to the first quarter of 2003. Loan interest declined $1.2 million from the first quarter of 2003 to the first quarter of 2004. The benefit of an increase in interest spread was more than offset by a decrease in average loans and LIBOR. The majority of the loans are priced as a variable spread to LIBOR and this spread increased by 58 basis points in the first quarter of 2004 compared to the first quarter of 2003, resulting in an addition to income of $1.0 million. The majority of our loan portfolio has floors between 1.25% and 3% on the LIBOR base index. The LIBOR floors have had the effect of increasing our spread because such floors have generally been above current LIBOR rates. For these periods, average loans declined 12%, contributing a $1.8 million decrease in operating income. Average three month LIBOR decreased 21 basis points over these periods from 1.33% to 1.12%, decreasing income by $0.3 million. Loan fees and dividend income increased by $1.8 million from the first quarter of 2003 to the first quarter of 2004 due primarily to dividend income of $1.4 million from Bridgecom Holdings, Inc. Advisory fees and other income increased $3.0 million from the first quarter of 2003 to the first quarter of 2004 due to an increase in advisory services provided to new and existing customers compared to the prior year’s quarter, research revenues from our newly acquired subsidiary Kagan Research, LLC and management fees from one of our control investments, Bridgecom Holdings, Inc.

Operating Expenses

Operating expenses include interest expense on borrowings, including amortization of deferred debt issuance costs, employee compensation, and general and administrative expenses.

The change in operating expenses for the three months ended March 31, 2004 compared to the same period in 2003 is attributable to the following items:


(dollars in thousands)	Three Months Ended March 31, 2004 vs. 2003
Change due to:
Decrease in borrowings (a)	$	(428	)
Change in LIBOR (a)		(186	)
Change in spread (a)		282
Debt cost amortization		(12	)
Salaries and benefits		1,001
Long-term incentive compensation		4,025
General and administrative expense		89

Total change in operating expense	$	4,771

(a)

The change in interest expense due to decrease in borrowings, change in LIBOR, and change in spread has been allocated in proportion to the relationship of the absolute dollar amount of the changes in each.

Total operating expenses for the three months ended March 31, 2004 increased $4.8 million, or 63%, to $12.4 million when compared to the three months ended March 31, 2003. Interest expense declined by 14% to $2.1 million in the first quarter of 2004 compared to $2.4 million in the first quarter of 2003. The decline in LIBOR, debt amortization costs and average borrowings decreased interest expense by $0.6 million. These decreases were partially offset by the increase in spreads. The increase in spreads increased interest expense by $0.3 million. Salaries and benefits increased $1.0 million primarily due to higher variable annual incentive compensation expense. During the first quarter of 2004, our compensation committee waived the performance-based forfeiture restrictions and modified the time-based forfeiture provisions associated with the Tier III shares of certain of our executive officers through their respective amended and restated restricted stock agreements. As a result, long-term incentive compensation, which is made up of non-cash amortization of restricted stock awards and the treatment of dividends on all shares securing employee loans as compensation, totaled $5.6 million for the first quarter of 2004 compared to $1.5 million for the first quarter of 2003. The increase of $4.1 million is primarily due to these modifications. General and administrative expenses increased less than $0.1 million for the three months ended March 31, 2004 as compared to the same period in 2003.

Net Operating Income Before Investment Gains and Losses

Net operating income before investment gains and losses (NOI) for the quarter ended March 31, 2004 totaled $9.8 million, a decrease of 10% from the same quarter of 2003.

Net Investment Gains and Losses

Net investment losses primarily related to net depreciation in the technology, security alarm, and publishing sectors totaled $7.7 million for the first quarter of 2004 compared to $2.0 million for the first quarter of 2003. These amounts represent the total of net realized gains and losses, net unrealized appreciation and depreciation and reversals of unrealized appreciation and depreciation as summarized in the following tables. Reversals of unrealized appreciation and depreciation occur when a gain or loss becomes realized.

The following table summarizes our realized gains and losses on investments for the three months ended March 31, 2004 and 2003:

MCG Capital Corporation

Summary of Realized Gains and Losses on Investments

(dollars in thousands)


		Three Months Ended March 31,
Portfolio Company	Sector	2004			2003

Realized gains (losses) on loans
VS&A-PBI Holding LLC	Publishing	$	—		$	(7,901	)
National Systems Integration	Security Alarm		—			(5,812	)
AMI Telecommunications Corporation	Telecommunications		—			(5,585	)
NBG Radio Network, Inc.	Broadcasting		—			(398	)
aaiPharma Inc.	Drugs		(291	)		—
Other			37			—

		$	(254	)	$	(19,696	)

Realized gains (losses) on equity investments
Bridgecom Holdings, Inc.	Telecommunications		2,158			—

			2,158			—

Realized gains (losses) on investments		$	1,904			(19,696	)

The following table summarizes the net change in our unrealized appreciation and depreciation on investments for the three months ended March 31, 2004 and 2003:

MCG Capital Corporation

Summary of Net Change in Unrealized Appreciation and Depreciation on Investments

(dollars in thousands)


		Three Months Ended March 31,
Portfolio Company	Sector	2004			2003

Unrealized appreciation on loans
Images.com, Inc.	Information Services	$	1,225		$	—
Other			803			46

			2,028			46

Unrealized appreciation on equity investments
Fawcette Technical Publications Holding	Publishing		477			—
Superior Publishing Corporation	Newspaper		295			—
Bridgecom Holdings, Inc.	Telecommunications		—			690
Creatas, L.L.C.	Information Services		233			298
Talk America Holdings, Inc.	Telecommunications		—			834
Other			1,565			698

			2,570			2,520

Unrealized appreciation on investments			4,598			2,566

Unrealized depreciation on loans
FTI Technologies Holdings, Inc.	Technology		(4,125	)		—
Sunshine Media Deleware, LLC	Publishing		(1,424	)		—
Telecomm South, LLC	Telecommunications		(448	)		—
Images.com, Inc.	Information Services		—			(384	)
Other			—			(190	)

			(5,997	)		(574	)

Unrealized depreciation on equity investments
Copperstate Technologies, Inc.	Security Alarm		(2,230	)		—
Talk America Holdings, Inc.	Telecommunications		(863	)		—
Working Mother Media, Inc.	Publishing		(777	)		(497	)
ETC Group, LLC	Publishing		(748	)		—
Interactive Business Solutions, Inc.	Security Alarm		(634	)		—
National Systems Integration	Security Alarm		(1,255	)		(317	)
Biznessonline.com, Inc.	Telecommunications		—			(2,001	)
Other			(158	)		(424	)

			(6,665	)		(3,239	)

Unrealized depreciation on investments			(12,662	)		(3,813	)

Reversal of unrealized (appreciation) depreciation*
Bridgecom Holdings, Inc.	Telecommunications		(2,242	)		—
NBG Radio Network, Inc.	Broadcasting		—			574
AMI Telecommunications Corporation	Telecommunications		—			5,143
National Systems Integration	Security Alarm		—			5,276
VS&A-PBI Holding LLC	Publishing		—			7,901
NOW Communications, Inc.	Telecommunications		658			—

Total unrealized (appreciation) depreciation			(1,584	)		18,894

Net change in unrealized depreciation on investments		$	(9,648	)	$	17,647

When a gain or loss becomes realized, the prior unrealized appreciation or depreciation is reversed.

Net Income

Net income totaled $2.1 million for the quarter ended March 31, 2004 compared to $8.9 million for the quarter ended March 31, 2003.

Financial Condition, Liquidity and Capital Resources

Cash, Cash Equivalents and Cash, Securitization Accounts

At March 31, 2004 and December 31, 2003, we had $37.9 million and $60.1 million, respectively, in cash and cash equivalents. In addition, at March 31, 2004 and December 31, 2003, we had $24.8 million and $33.4 million, respectively, in cash, securitization accounts. We invest cash on hand in interest bearing deposit accounts with daily sweep features. We have maintained adequate cash balances to support ongoing origination activity and follow-on investments in portfolio companies. Cash, securitization accounts includes amounts held in designated bank accounts representing payments received on securitized loans. We are required to use a portion of these amounts to pay interest expense, reduce borrowings, or pay other amounts in accordance with the related securitization agreements. Our objective is to maintain sufficient cash on hand to cover current funding requirements, operations and to maintain flexibility as we manage our debt facilities.

For the first quarter of 2004, net cash provided by operating activities totaled $14.2 million, an increase of $5.6 million over the prior year’s first quarter amount. This increase was due primarily to higher cash receipts of previously deferred payment-in-kind interest during the first quarter of 2004 as compared to the first quarter of 2003. Cash used in investing and financing activities totaled $36.4 million compared with a net provision of cash in the first quarter of 2003 of $19.7 million. These changes were principally due to higher investment originations in 2004.

Liquidity and Capital Resources

We expect our cash on hand and cash generated from operations, including the portion of the cash in securitization accounts that will be released to us, to be adequate to meet our cash needs at our current level of operations, including the next twelve months. We generally fund new originations using cash on hand, advances under our credit facilities and equity financings.

On March 3, 2004, we filed a registration statement on Form N-2 with the Securities and Exchange Commission (“SEC”) which will allow us or certain selling shareholders named therein to offer, from time to time, up to 18,000,000 shares of common stock in one or more offerings.

In order to satisfy the requirements applicable to a regulated investment company, we intend to distribute to our stockholders all of our income except for certain net capital gains and adjustments for long-term incentive compensation. In addition, as a business development company, we generally will be required to meet a coverage ratio of total assets to total senior securities, which include all of our borrowings and any preferred stock we may issue in the future, of at least 200%. As of March 31, 2004, this ratio was 263%. This requirement limits the amount that we may borrow. To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets.

Off-Balance Sheet Arrangements

We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. We attempt to limit our credit risk by conducting extensive due diligence and obtaining collateral where appropriate.

As of March 31, 2004, we had unused commitments to extend credit to our customers of $20.5 million, which are not reflected on our balance sheet. At the same time, subject to certain minimum equity restrictions and other covenants and limitations which include restrictions on geographic concentrations, sector concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings as well as regulatory restrictions on leverage which may affect the amounts we can draw on our Revolving Credit Facility and our Warehouse Credit Facility, the unused portion of our borrowing facilities totaled $200.1 million. See “Borrowings” section below for discussion of our borrowing facilities.

Contractual Obligations

The following table shows our significant contractual obligations as of March 31, 2004:


	Payments Due by Period
(dollars in millions) Contractual Obligations (a)	Total		Less than 1 year		1-3 years		4-5 years		After 5 years

Borrowings (b)	$	289.2	$	206.6	$	82.6	$	—	$	—
Future minimum rental obligations		12.1		1.3		2.6		2.6		5.6

Total contractual obligations	$	301.3	$	207.9	$	85.2	$	2.6	$	5.6

(a)

This excludes the unused commitments to extend credit to our customers of $20.5 million as discussed above.

(b)

Borrowings under the Warehouse Credit Facility and the Revolving Credit Facility are listed based on the contractual maturity of the respective facility. Repayments of the Series 2001-1 Notes are based on the contractual principal collections of the loans which comprise the collateral. Actual repayments could differ significantly due to prepayments by our borrowers and modifications of our borrowers’ existing loan agreements.

Borrowings

Term Securitization

On December 27, 2001, we established the MCG Commercial Loan Trust 2001-1 (the “Trust”), which issued two classes of Series 2001-1 Notes to 15 institutional investors. The facility is secured by all of the Trust’s existing assets which were contributed by us and totaled $231.2 million as of March 31, 2004 and $247.5 million as of December 31, 2003. This facility is scheduled to terminate on February 20, 2013 or sooner upon full repayment of the Class A and Class B Notes. The Class A and Class B Notes are scheduled to be repaid as we receive principal collections on the underlying collateral.

The Trust issued $229.8 million of Class A Notes rated AAA/Aaa/AAA, and $35.4 million of Class B Notes rated A/A2/A (the “Series 2001-1 Class A Asset Backed Bonds” and “Series 2001-1 Class B Asset Backed Bonds”) as rated by Standard & Poors, Moody’s and Fitch, respectively. As of March 31, 2004, $159.3 million of the Series 2001-1 Notes were outstanding and $173.1 million were outstanding as of December 31, 2003. The Series 2001-1 Class A Asset Backed Bonds bear interest of LIBOR plus 0.60% and Series 2001-1 Class B Asset Backed Bonds bear interest of LIBOR plus 1.75%, and interest on both is payable quarterly.

Revolving Credit Facility

As of June 1, 2000, we, through MCG Master Trust, established a revolving credit facility (the “Revolving Credit Facility”), which allowed us to issue up to $200.0 million of Series 2000-1 Class A Notes (the “Series 2000-1 Notes” or “Series 2000-1 Class A Asset Backed Securities”). On February 12, 2004, the Revolving Credit Facility was amended (see separate discussion below) under which our borrowing capacity decreased from $200.0 million to $130.0 million. As of March 31, 2004, $114.9 million of the Series 2000-1 Notes were

outstanding with one investor and, as of December 31, 2003, $131.0 million were outstanding with one investor. As of March 31, 2004 and December 31, 2003, we had no notes outstanding under a swingline credit facility (the “Swingline Notes”), which is part of the Revolving Credit Facility, that allows us to borrow up to $25.0 million as part of the $200.0 million total facility limit for a period of up to four days. The Swingline Notes are repaid through the issuance of Series 2000-1 Notes. The Revolving Credit Facility was secured by $180.8 million of commercial loans as of March 31, 2004 and $194.3 million of commercial loans as of December 31, 2003. We are subject to certain limitations on the amount of Series 2000-1 Notes we may issue at any point in time including the requirement for a minimum amount of unleveraged loans that serve as collateral for the indebtedness. Such amount was a minimum of $75.0 million as of July 8, 2002 and thereafter. We are also subject to limitations including restrictions on geographic concentrations, sector concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings as well as regulatory restrictions on leverage which may affect the amount of Series 2000-1 notes we may issue from time to time. There are also certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, violation of which could result in the early amortization of the facility, and limit further advances under the facility, and in some cases could be an event of default. Such limitations, requirements, and associated defined terms are as provided for in the documents governing the facility. As noted below, on February 12, 2004, the requirement relating to loan charge-offs was eliminated. The Series 2000-1 Notes’ interest was based on a commercial paper rate plus 3.0% prior to February 12, 2004 at which time it was reduced to LIBOR plus 1.5%. Interest is payable monthly.

As discussed above, there are certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, violation of which could result in the early amortization of the facility and limit further advances under the facility, and in some cases could be an event of default. In February 2003, we amended the Revolving Credit Facility agreements. Prior to the February 2003 amendment, the Revolving Credit Facility required us among other things to maintain an average trailing twelve-month portfolio charged-off (as defined in the Revolving Credit Facility agreements) ratio of 3% or less. The amendment increased this ratio to 7% for any date prior to and including June 30, 2003 and decreased this ratio to 3% thereafter. This amendment also included a waiver with respect to the applicability of the charge-off ratio for periods prior to February 2003. Additionally, this amendment required us to increase the amount of collateral held by the noteholders by pledging the MCG Commercial Loan Trust 2001-1 Class C Notes, which we own. As noted below, on February 12, 2004, the requirement relating to loan charge-offs was eliminated.

On February 12, 2004, we entered into an agreement with Wachovia Bank, National Association to amend the Revolving Credit Facility that we had established through MCG Master Trust. The amendment to the Revolving Credit Facility, among other things, provides for the following:

•

a decrease in our borrowing capacity from $200.0 million to $130.0 million, which will further be reduced to $115.0 million on June 30, 2004 and to $100.0 million by September 30, 2004;

•

an extension of the revolving period to September 30, 2004;

•

permits recourse to MCG Capital itself in the event that the interest and principal payments from the loans we transferred to MCG Master Trust in connection with the revolving credit facility are insufficient to repay the outstanding amount due under the Revolving Credit Facility;

•

eliminates a requirement relating to loan charge-offs at the servicer level that we were previously required to seek a waiver from in February 2003;

•

changes the date on which the holder of the notes issued by MCG Master Trust receives final payment on such notes from June 2020 to September 2009; and

•

reduces the interest rate payable under the Revolving Credit Facility from the commercial paper rate plus 3.0% to LIBOR plus 1.5%.

Warehouse Facility

On January 29, 2004, our wholly owned, bankruptcy remote, special purpose indirect subsidiary, MCG Commercial Loan Trust 2003-1 entered into a $200 million secured warehouse credit facility with an affiliate of UBS AG. As of March 31, 2004, $15.0 million was outstanding under this facility. We will use the warehouse credit facility to fund our origination and purchase of a diverse pool of loans, including broadly syndicated rated loans, that we intend to securitize using an affiliate of the lender as the exclusive structurer and underwriter or placement agent. Advances under the credit facility bear interest at LIBOR plus 0.50%. The warehouse credit facility operates much like a revolving credit facility that is primarily secured by the loans acquired with the advances under the credit facility. In addition, the lender will have recourse to MCG Capital Corporation itself in a maximum aggregate amount of $72 million in the event that the principal and interest payments from the loans transferred to MCG Commercial Loan Trust 2003-1 are insufficient to repay the outstanding amount due to the lender. The warehouse credit facility is cancelable by the lender for cause at any time and has an expiration term of September 24, 2004. The warehouse credit facility is a short-term commitment of capital. If we are unable to consummate the securitization transaction or otherwise arrange for new financing on terms acceptable to us, we will have to curtail our loan origination activities.

Outstanding Borrowings

Our $130 million Revolving Credit Facility is scheduled to terminate on September 30, 2009, or sooner upon repayment of our borrowings thereunder after September 30, 2004. Our $265.2 million securitization facility is scheduled to terminate on February 20, 2013 or sooner upon repayment of our borrowings. Our $200 million secured warehouse facility with an affiliate of UBS AG is scheduled to terminate on September 24, 2004.

At March 31, 2004, we had aggregate outstanding borrowings of $289.2 million. The following table shows the facility amounts and outstanding borrowings at March 31, 2004:


(dollars in millions)	Facility amount		Amount outstanding		Interest Rate (a)
Term Securitization
Series 2001-1 Class A Asset Backed Bonds	$	123.9	$	123.9	1.72	%
Series 2001-1 Class B Asset Backed Bonds		35.4		35.4	2.87
Revolving Credit Facilty
Series 2000-1 Class A Asset Backed Securities		130.0		114.9	2.59
Warehouse Facilty
Warehouse Facilty Notes		200.0		15.0	1.62

Total borrowings	$	489.3	$	289.2	2.20	%

(a)

Excludes the cost of commitment fees and other facility fees.

At December 31, 2003, we had aggregate outstanding borrowings of $304.1 million. The following table shows the facility amounts and outstanding borrowings at December 31, 2003:


(dollars in millions)	Facility amount		Amount outstanding		Interest Rate (a)
Term Securitization
Series 2001-1 Class A Asset Backed Bonds	$	137.7	$	137.7	1.77	%
Series 2001-1 Class B Asset Backed Bonds		35.4		35.4	2.92
Revolving Credit Facilty
Series 2000-1 Class A Asset Backed Securities		200.0		131.0	4.12

Total borrowings	$	373.1	$	304.1	2.91	%

(a)

Excludes the cost of commitment fees and other facility fees.

Each of our borrowing facilities is funded through bankruptcy remote, special purpose, wholly-owned subsidiaries of ours and, therefore, their assets may not be available to our creditors. See Note 3 to the Consolidated Financial Statements for further discussion of our borrowings.

Dividends

We have elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code. In order to maintain our status as a regulated investment company, we are required to (i) distribute at least 90% of our investment company taxable income and 90% of any ordinary pre-RIC built in gains we recognize between January 1, 2002 and December 31, 2011, less any taxes due on those gains to avoid corporate level taxes on the amount distributed to stockholders (other than any built in gain recognized between January 1, 2002 and December 31, 2011) and (ii) distribute (actually or on a deemed basis) at least 98% of our income (both ordinary income and net capital gains) to avoid an excise tax. We intend to make distributions on a quarterly basis to our stockholders of all of our income, except for certain net capital gains and adjustments for long-term incentive compensation expense. We intend to make deemed distributions to our stockholders of any retained net capital gains.

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 from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the Investment Company Act of 1940 and due to provisions in our credit facilities. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. We cannot assure shareholders that they will receive any distributions or distributions at a particular level.

The following table summarizes our dividends declared and paid on all shares, including restricted stock, to date:


Date Declared	Record Date	Payment Date	Amount

April 22, 2004	May 7, 2004	July 29, 2004	$	0.42
March 25, 2004	April 6, 2004	April 29, 2004		0.42
December 16, 2003	December 31, 2003	January 29, 2004		0.42
August 6, 2003	August 18, 2003	October 30, 2003		0.42
June 16, 2003	June 23, 2003	July 30, 2003		0.41
March 28, 2003	April 16, 2003	April 29, 2003		0.40
December 18, 2002	December 30, 2002	January 30, 2003		0.42
September 30, 2002	October 16, 2002	October 30, 2002		0.46
June 3, 2002	June 11, 2002	July 31, 2002		0.47
March 28, 2002	April 17, 2002	April 30, 2002		0.41
December 31, 2001	January 22, 2002	January 31, 2002		0.86

Total Declared			$	5.11

The aggregate dividend of $0.86 per share in December 2001 consisted of a dividend of $0.25 per share for the fourth quarter of 2001 and an additional dividend of $0.61 per share representing the distribution of substantially all of our earnings and profits since inception through December 31, 2001. The aggregate dividend of $0.46 declared in September 2002 consisted of a dividend of $0.43 per share for the third quarter of 2002 and an additional dividend of $0.03 per share which represented the remaining distribution of our earnings and profits since inception through December 31, 2001. The aggregate dividend declared in December 2001 along with the $0.03 dividend declared in September, 2002 were required for us to qualify as a regulated investment company.

Related Party Transactions

Prior to election to be regulated as a business development company, we terminated our stock option plan and adopted a restricted stock program under which we issued 1,539,851 shares of restricted common stock to employees and directors. The total number of shares issued for the termination of the option plan was based upon the Black-Scholes option-pricing model and assumptions and approved by our board of directors.

We made cash payments totaling $1.7 million to non-executive employees for the taxes imposed on them associated with the issuance of restricted common stock. The cash payments assumed a combined federal and state tax rate of 48% for each employee.

Additionally, in connection with the termination of our stock option plan, certain executive officers and employees purchased a portion of the 1,539,851 shares of restricted common stock at a per share price of $17.00. Those executive officers and employees issued partially non-recourse notes to us, with an aggregate face value of $5.8 million secured by approximately 1.4 million shares with a value of $23.8 million at the initial public offering price. The notes are payable at the end of a four and a half-year term, subject to acceleration, bear interest at 4.13% payable annually and are secured by all of the restricted common stock held by such employee and for some employees, for a specified time-period, additional shares of our common stock the employee owns. The notes are non-recourse as to the principal amount but recourse as to the interest. Amounts due on these loans are reflected as a reduction of stockholders’ equity in the consolidated balance sheets.

In the first quarter of 2004, as part of a review of our executive compensation, the compensation committee of our Board of Directors agreed with certain of our executive officers to allow the forfeiture restrictions to lapse with respect to their Tier I and Tier II shares immediately upon full repayment of the partially nonrecourse promissory notes that are secured by the restricted stock. In addition, the compensation committee waived the performance-based forfeiture restrictions and modified the time-based forfeiture provisions associated with the Tier III shares through their respective amended and restated restricted stock agreements. The impact of these changes on long-term incentive compensation expense was an increase of approximately $4.1 million for the first quarter of 2004.

Critical Accounting Policies

The consolidated financial statements are based on the selection and application of significant accounting policies, which require management to make significant estimates and assumptions. We believe that the following are some of the more critical judgment areas in the application of our accounting policies that currently affect our financial condition and results of operations.

Income Recognition

Interest on commercial loans is computed by methods that generally result in level rates of return on principal amounts outstanding. When a loan becomes 90 days or more 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 cease recognizing interest income on that loan until all principal has been paid. However, we may make exceptions to this policy if the investment is well secured and in the process of collection.

Paid-in-Kind Interest

In accordance with GAAP, we include in income certain amounts that we have not yet received in cash, such as contractual paid-in-kind (PIK) interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term. However, in certain cases, a customer makes principal payments on its loan prior to making payments to reduce the PIK loan balances and, therefore, the PIK portion of a customer’s loan can increase while the total outstanding amount of the loan to that customer may stay the same

or decrease. PIK loans represented $21.3 million or 3.0% of our portfolio of investments as of March 31, 2004 and $27.3 million or 3.9% of our portfolio of investments as of December 31, 2003.

PIK related activity for the three months ended March 31, 2004 and the year ended December 31, 2003 was as follows:


(in millions)	Three Months Ended March 31, 2004			Year Ended December 31, 2003
Beginning PIK loan balance	$	27.3		$	27.2
PIK interest earned during the period		2.6			18.3
Change in interest receivable on PIK loans		—			0.1
Principal payments of cash on PIK loans		(7.4	)		(7.0	)
PIK loans converted to other securities		(1.2	)		(10.9	)
Realized loss		—			(0.4	)

Ending PIK loan balance	$	21.3		$	27.3

As noted above, in certain cases, a customer may make principal payments on its loan that are contractually applied first to the non-PIK loan balance instead of the PIK loan balance. If all principal payments from these customers had been applied first to any PIK loan balance outstanding at the time of the payment, and any remainder applied to the non-PIK loan balance, an additional $6.2 million of payments would have been applied against the March 31, 2004 PIK loan balance of $21.3 million and an additional $6.6 million of payments would have been applied against the December 31, 2003 PIK loan balance of $27.3 million.

As of March 31, 2004, 83% of the $21.3 million of PIK loans outstanding have an investment rating of 3 or better and as of December 31, 2003, 93% of the $27.3 million of PIK loans outstanding had an investment rating of 3 or better. The net increase in loan balances as a result of contracted PIK arrangements are separately identified on our consolidated statements of cash flows.

Loan Origination Fees

Loan origination fees are deferred and amortized as adjustments to the related loan’s yield over the contractual life of the loan. In certain loan arrangements, warrants or other equity interests are received from the borrower as additional origination fees. The borrowers granting these interests are typically non-publicly traded companies. We record the financial instruments received at fair value as determined by our board of directors. Fair values are determined using various valuation models which attempt to estimate the underlying value of the associated entity. These models are then applied to our ownership share considering any discounts for transfer restrictions or other terms which impact the value. Changes in these values are recorded through our statement of operations. Any resulting discount on the loan from recordation of warrant and other equity instruments are accreted into income over the term of the loan. We had $15.0 million and $16.4 million of unearned income as of March 31, 2004 and December 31, 2003, respectively.

Unearned fee activity for the three months ended March 31, 2004 and year ended December 31, 2003 was as follows:


	Three Months Ended March 31,									Year Ended December 31,
	2004									2003
(in millions)	Cash Received			Equity Interest and Future Receivables			Total			Cash Received			Equity Interest and Future Receivables			Total

Beginning unearned income balance	$	5.6		$	10.8		$	16.4		$	8.3		$	4.5		$	12.8
Additional fees		0.3			0.6			0.9			1.8			10.6			12.4
Unearned income recognized		(0.9	)		(1.0	)		(1.9	)		(2.9	)		(4.1	)		(7.0	)
Unearned fees applied against loan balance		(0.4	)		—			(0.4	)		(1.6	)		(0.2	)		(1.8	)

Ending unearned income balance	$	4.6		$	10.4		$	15.0		$	5.6		$	10.8		$	16.4

(a)

When a loan is paid off at an amount below our cost basis, we apply any fees received that have not been recognized as income against the outstanding loan amount to reduce the cost basis, which has the effect of reducing any realized loss.

Other Fees

In certain investment transactions, we perform investment banking and other advisory services. For services that are separately identifiable and external evidence exists to substantiate fair value, income is recognized as earned which is generally when the investment transaction closes.

Valuation of Investments

At March 31, 2004, approximately 91% of our total assets represented investments recorded at fair value. Value, as defined in Section 2(a)(41) of the Investment Company Act of 1940, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the board of directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our investments at fair value as determined in good faith by the board of directors pursuant to a valuation policy and a consistent valuation process. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily ascertainable market value, the fair value of our investments determined in good faith by the board of directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we must determine the fair value of each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has decreased in value, including where collection of a loan or realization of an equity security is doubtful. Conversely, we will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, our investment has also appreciated in value, where appropriate.

As a business development company, we invest primarily in illiquid securities including debt and equity securities of private companies. The structure of each debt and equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We generally include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership and corporate governance parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. In many cases, our loan agreements also allow for increases in the spread to the base index rate if the financial or

operational performance of the customer deteriorates or shows negative variances from the customer’s business plan and, in some cases, allow for decreases in the spread if financial or operational performance improves or exceeds the customer’s plan. Our investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation.

With respect to private debt and equity securities, each investment is valued using industry valuation benchmarks, and, where appropriate, the value is assigned a discount reflecting the illiquid nature of the investment and/or our minority, non-control position. When an external event such as a purchase transaction, public offering, or subsequent debt or equity sale occurs, the pricing indicated by the external event will be used to corroborate our private debt or equity valuation. Securities that are traded in the over-the-counter market or on a stock exchange generally will be valued at the prevailing bid price on the valuation date. However, restricted or thinly traded public securities may be valued at discounts from the public market value due to the restrictions on sale.

Stock-based Compensation

We account for stock-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. For restricted common stock issued to employees for which no return-based criteria apply, compensation expense, equal to the value of the shares at the later of the grant date or the date at which all return-based forfeiture provisions lapsed or were removed, is recorded over the term of the forfeiture provisions. See Note 5 to the Consolidated Financial Statements for further discussion of our employee stock plans.

Securitization Transactions

Periodically, we transfer pools of loans to special purpose entities (SPEs) for use in securitization transactions. These on-balance sheet securitization transactions comprise a significant source of our overall funding, with the total face amount of the outstanding loans and equity investments assumed by third parties equaled $462.1 million at March 31, 2004 and $441.8 million at December 31, 2003. On April 1, 2001, the Company adopted the requirements of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, which applies prospectively to all securitization transactions occurring after March 31, 2001. Adoption of SFAS No. 140 did not have a material impact on our operations or financial position. Transfers of loans have not met the requirements of SFAS No. 140 for sales treatment and are, therefore, treated as secured borrowings, with the transferred loans remaining in investments and the related liability recorded in borrowings.

Recent Development

In the first quarter of 2004, we retained the services of a national executive recruiting firm to assist us with our search for a new Chief Financial Officer. Our current Chief Financial Officer, Janet Perlowski, has indicated her intent to step down as Chief Financial Officer in order to focus on her family. She will continue to serve as our Chief Financial Officer until a replacement is hired.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest rate sensitivity refers to the change in earnings that may result from the 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. Over 87% of our loan portfolio bears interest at a spread to LIBOR, with the remainder bearing interest at a fixed rate or at a spread to a prime rate. Approximately 52% of our loan portfolio has a LIBOR floor, at various levels. Our interest rates on our borrowings are based on LIBOR and commercial paper rates, with the majority based on LIBOR.

We regularly measure exposure to interest rate risk. We have interest rate risk exposure mainly from the portion of the commercial loan portfolio funded using stockholders’ equity. Our board of directors assesses interest rate risk and we manage our interest rate exposure on an ongoing basis. The following table shows a comparison of the interest rate base for our interest bearing cash, outstanding commercial loans and our outstanding borrowings at March 31, 2004 and December 31, 2003:


	March 31, 2004				December 31, 2003

(dollars in millions)	Interest Bearing Cash and Commercial Loans		Borrowings		Interest Bearing Cash and Commercial Loans		Borrowings

Repurchase Agreement Rate	$	61.0	$	—	$	93.0	$	—
Prime Rate		1.3		—		1.3		—
30-Day LIBOR		42.9		129.9		20.9		—
60-Day LIBOR		12.6		—		7.4		—
90-Day LIBOR		473.6		159.3		481.6		173.1
Commercial Paper Rate		—		—		—		131.0
Fixed Rate		74.6		—		94.4		—

Total	$	666.0	$	289.2	$	698.6	$	304.1

Based on our March 31, 2004 balance sheet, the following table shows the impact of base rate changes in interest rates assuming no changes in our investment and borrowing structure. The impact of an additional 100 basis point increase is different from the first 100 basis point increase due to the imposition of LIBOR floors.


(dollars in millions)
Basis Point Change	Interest Income			Interest Expense			Net Income

(100)	$	(2.8	)	$	(2.9	)	$	0.1
100	$	3.1		$	2.9		$	0.2
200	$	7.8		$	5.8		$	2.0
300	$	13.8		$	8.7		$	5.1

Currently, we do not engage in hedging activities because we have determined that the cost of hedging the risks associated with interest rate changes outweighs the risk reduction benefit. We monitor this strategy on an ongoing basis.

Item 4. Controls and Procedures

(a)

As of the end of the period covered by this report, MCG carried out an evaluation, under the supervision and with the participation of MCG’s management, including MCG’s Chief Executive Officer, President and Chief Operating Officer, Chief Financial Officer and Chief Accounting Officer, of the effectiveness of the design and operation of MCG’s disclosure controls and procedures (as defined in Rule 13a-15 of the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer, the President and Chief Operating Officer, the Chief Financial Officer and Chief Accounting Officer have concluded that MCG’s current disclosure controls and procedures are effective in timely alerting them of material information relating to MCG that is required to be disclosed by MCG in the reports it files or submits under the Securities Exchange Act of 1934.

(b)

There have been no changes in MCG’s internal control over financial reporting that occurred during the quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, MCG’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On January 29, 2003, a purported securities class action lawsuit was filed in the United States District Court for the Eastern District of Virginia against us, certain of our officers and the underwriters of our initial public offering. The complaint alleged that the defendants made certain misstatements in violation of Sections 11, 12(a) (2) and 15 of the Securities Act of 1933 and Section 10(b), Rule 10b-5 and Section 20(a) of the Securities Exchange Act of 1934. Specifically, the complaint asserted that members of the plaintiff class purchased our common stock at purportedly inflated prices during the period from November 28, 2001 to November 1, 2002 as a result of certain misstatements regarding the academic degree of our chief executive officer. The complaint sought unspecified compensatory and other damages, along with costs and expenses. On June 16, 2003, a consolidated amended class action complaint was filed in the proceedings captioned In re MCG Capital Corporation Securities Litigation, 1:03cv0114-A. The consolidated amended complaint named only us and certain of our officers and directors as defendants, and alleged violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. We filed a motion to dismiss the consolidated amended class action complaint. On September 12, 2003, the United States District Court for the Eastern District of Virginia dismissed the lawsuit in its entirety. The plaintiffs filed a notice of appeal to seek review of the district court decision by the United States Court of Appeals for the Fourth Circuit, and both parties have now filed briefs. The appeal is pending.

We are also 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 upon our financial condition or results of operations.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

During the three months ended March 31, 2004, MCG issued a total of 1,425 shares of common stock under its dividend reinvestment plan pursuant to an exemption from the registration requirements of the Securities Act of 1933. The aggregate offering proceeds for the shares of common stock sold under the dividend reinvestment plan were approximately $28,000.

We did not repurchase any shares of our common stock during the three months ended March 31, 2004.

Item 3. Defaults Upon Senior Securities

Not Applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not Applicable.

Item 5. Other Information

Not Applicable.

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

Listed below are the exhibits which are filed as part of this report (according to the number assigned to them in Item 601 of Regulation S-K):


Exhibit Number		Description of Document

31.1	*	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2	*	Certification of President and Chief Operating Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.3	*	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.4	*	Certification of Chief Accounting Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1	*	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).

32.2	*	Certification of President and Chief Operating Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).

32.3	*	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).

32.4	*	Certification of Chief Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

Submitted herewith.

(b)

Reports on Form 8-K

On February 12, 2004, we filed a current report on Form 8-K, pursuant to Item 12 reporting the issuance of a press release, announcing our financial results for the three months and year ended December 31, 2003.

On March 26, 2004, we filed a current report on Form 8-K, pursuant to Item 12 reporting the issuance of a press release, announcing we had declared a dividend of $0.42 per share for the quarter ending March 31, 2004.

On April 27, 2004, we filed a current report on Form 8-K, pursuant to Item 12 reporting the issuance of a press release, announcing we had declared a dividend of $0.42 per share for the quarter ending June 30, 2004 and our financial results for the three months ended March 31, 2004.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 on May 7, 2004.


MCG CAPITAL CORPORATION

By:		/s/ BRYAN J. MITCHELL
		Bryan J. Mitchell Chief Executive Officer



By:		/s/ STEVEN F. TUNNEY
		Steven F. Tunney President and Chief Operating Officer



By:		/s/ JANET C. PERLOWSKI
		Janet C. Perlowski Chief Financial Officer



By:		/s/ JOHN C. WELLONS
		John C. Wellons Chief Accounting Officer