Attached files

file filename
EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-31263014.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-31163014.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-32263014.htm
EX-15.1 - LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION FROM ERNST & YOUNG - MCG CAPITAL CORPex-15163014.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-32163014.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
OR
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
___________________
Commission file number 0-33377
MCG CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
54-1889518
(State or other jurisdiction
of incorporation or organization)
(I.R.S. Employer
Identification No.)
1001 19th Street North, 10th Floor
Arlington, VA
(Address of principal executive offices)
22209
(Zip Code)

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

None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer    o
Accelerated filer    x
Non-accelerated filer    o
Smaller reporting company    o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act).    Yes o No x
As of August 1, 2014, there were 49,501,096 shares of the registrant’s $0.01 par value Common Stock outstanding.




MCG CAPITAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2014
TABLE OF CONTENTS


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




PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MCG Capital Corporation
Consolidated Balance Sheets
(in thousands, except per share amounts)
June 30,
2014
December 31,
2013

(unaudited)

Assets


Cash and cash equivalents
$
69,379

$
91,598

Cash, restricted
131,630

33,895

Cash, securitization accounts

13,906

Investments at fair value




Non-affiliate investments (cost of $296,637 and $444,217, respectively)
122,713

268,173

Affiliate investments (cost of $57,459 and $59,470, respectively)
38,437

56,792

Control investments (cost of $59,796 and $62,751, respectively)
34,925

43,908

Total investments (cost of $413,892 and $566,438, respectively)
196,075

368,873

Interest receivable
1,008

2,087

Other assets
2,981

3,634

Total assets
$
401,073

$
513,993

Liabilities




Borrowings (maturing within one year of $0 and $25,172, respectively)
$
150,000

$
175,172

Secured financing at fair value (cost of $4,513 and $0, respectively)
4,513


Interest payable
2,174

2,345

Other liabilities
4,597

2,522

Total liabilities
161,284

180,039

Commitments and contingencies (Note 11)
 
 
Stockholders’ equity




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


Common stock, par value $0.01, authorized 200,000 shares on June 30, 2014 and December 31, 2013, 54,252 issued and outstanding on June 30, 2014 and 70,510 issued and outstanding on December 31, 2013
543

705

Paid-in capital
924,222

980,930

Distributions in excess of earnings
(466,856
)
(449,915
)
Net unrealized depreciation on investments
(218,120
)
(197,766
)
Total stockholders’ equity
239,789

333,954

Total liabilities and stockholders’ equity
$
401,073

$
513,993

Net asset value per common share at end of period
$
4.42

$
4.74



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


MCG Capital Corporation
Consolidated Statements of Operations
(unaudited)

Three months ended
Six months ended

June 30
June 30
(in thousands, except per share amounts)
2014
2013
2014
2013
Revenue




Interest and dividend income




Non-affiliate investments (less than 5% owned)
$
6,985

$
9,008

$
14,723

$
18,856

Affiliate investments (5% to 25% owned)
1,076

1,694

1,889

3,321

Control investments (more than 25% owned)
702

1,872

1,406

3,173

Total interest and dividend income
8,763

12,574

18,018

25,350

Advisory fees and other income








Non-affiliate investments (less than 5% owned)
750

316

828

774

Control investments (more than 25% owned)
12


25

12

Total advisory fees and other income
762

316

853

786

Total revenue
9,525

12,890

18,871

26,136

Operating expense








Interest expense
1,866

2,305

3,856

4,687

Employee compensation








Salaries and benefits
1,773

1,559

2,861

2,966

Amortization of employee restricted stock awards
1,248

379

1,554

754

Total employee compensation
3,021

1,938

4,415

3,720

General and administrative expense
4,087

1,086

5,726

2,118

Restructuring expense

5


12

Total operating expense
8,974

5,334

13,997

10,537

Net operating income before net investment (loss) gain and income tax provision
551

7,556

4,874

15,599

Net realized gain (loss) on investments








Non-affiliate investments (less than 5% owned)
(4,346
)
(109
)
(8,834
)
(4,191
)
Affiliate investments (5% to 25% owned)

2,877


2,877

Control investments (more than 25% owned)
114


114

51

Total net realized (loss) gain on investments
(4,232
)
2,768

(8,720
)
(1,263
)
Net unrealized (depreciation) appreciation on investments








Non-affiliate investments (less than 5% owned)
(1,127
)
(274
)
2,120

(5,369
)
Affiliate investments (5% to 25% owned)
(834
)
(672
)
(16,344
)
8,435

Control investments (more than 25% owned)
359

(810
)
(6,028
)
(1,024
)
Other fair value adjustments
15


(102
)

Total net unrealized (depreciation) appreciation on investments
(1,587
)
(1,756
)
(20,354
)
2,042

Net investment (loss) gain before income tax provision
(5,819
)
1,012

(29,074
)
779

Income tax provision (benefit)

(6
)
4

52

Net (loss) income
$
(5,268
)
$
8,574

$
(24,204
)
$
16,326

Income (loss) per basic and diluted common share
$
(0.09
)
$
0.12

$
(0.37
)
$
0.23

Cash distributions declared per common share
$
0.07

$
0.125

$
0.195

$
0.25

Weighted-average common shares outstanding—basic and diluted
61,221

71,217

65,286

71,361


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



MCG Capital Corporation
Consolidated Statements of Changes in Net Assets
(unaudited)

Six months ended

June 30
(in thousands, except per share amounts)
2014
2013
Increase (decrease) in net assets from operations


Net operating income before net investment loss and income tax provision
$
4,874

$
15,599

Net realized loss on investments
(8,720
)
(1,263
)
Net unrealized (depreciation) appreciation on investments
(20,354
)
2,042

Income tax provision
(4
)
(52
)
Net (loss) income
(24,204
)
16,326

Distributions to stockholders


Distributions declared from net operating income
(8,578
)
(13,176
)
Distributions declared in excess of net operating income
(4,513
)
(4,628
)
Net decrease in net assets resulting from stockholder distributions
(13,091
)
(17,804
)
Capital share transactions




Repurchase of common stock
(57,818
)
(2,272
)
Amortization of restricted stock awards




Employee awards accounted for as employee compensation
1,554

754

Non-employee director awards accounted for as general and administrative expense
28

26

Common stock withheld to pay taxes applicable to the vesting of restricted stock
(634
)
(49
)
Net decrease in net assets resulting from capital share transactions
(56,870
)
(1,541
)
Total decrease in net assets
(94,165
)
(3,019
)
Net assets




Beginning of period
333,954

371,728

End of period
$
239,789

$
368,709

Net asset value per common share at end of period
$
4.42

$
5.18

Common shares outstanding at end of period
54,252

71,222



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


MCG Capital Corporation
Consolidated Statements of Cash Flows
(unaudited)

Six months ended

June 30
(in thousands)
2014
2013
Cash flows from operating activities


Net (loss) income
$
(24,204
)
$
16,326

Adjustments to reconcile net (loss) income to net cash provided by operating activities




Investments in portfolio companies
(8,008
)
(82,160
)
Principal collections related to investment repayments or sales
143,788

106,841

Increase in interest receivable, accrued payment-in-kind interest and dividends
9,023

(3,421
)
Amortization of restricted stock awards




Employee
1,554

754

Non-employee director
28

26

Decrease in cash—securitization accounts from interest collections
1,399

1,592

Decrease (increase) in restricted cash—escrow accounts
(934
)
4,912

Depreciation and amortization
523

660

Decrease in other assets
130

155

Decrease in other liabilities
1,905

(4,371
)
Realized loss on investments
8,720

1,263

Net unrealized depreciation (appreciation) on investments
20,354

(2,042
)
Net cash provided by operating activities
154,278

40,535

Cash flows from financing activities




Repurchase of common stock
(57,818
)
(2,272
)
Payments on borrowings
(25,172
)
(43,126
)
Proceeds from borrowings
4,513


Decrease (increase) in cash in restricted and securitization accounts




Securitization accounts for repayment of principal on debt
12,479

(1,360
)
Restricted cash
(96,774
)
41,863

Payment of financing costs

(116
)
Distributions paid
(13,091
)
(17,804
)
Common stock withheld to pay taxes applicable to the vesting of restricted stock
(634
)
(49
)
Net cash used in financing activities
(176,497
)
(22,864
)
Net (decrease) increase in cash and cash equivalents
(22,219
)
17,671

Cash and cash equivalents




Beginning balance
91,598

73,588

Ending balance
$
69,379

$
91,259

Supplemental disclosure of cash flow information




Interest paid
$
3,522

$
4,127

Income taxes paid (received)

46

Paid-in-kind interest accrued
2,526

1,430

Paid-in-kind interest collected
10,473

2,026

Dividend income collected
326

459


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


MCG Capital Corporation
Consolidated Schedule of Investments
June 30, 2014 (unaudited)
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate(7)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
 
 
 
 
 
 
 
 
 
Control Investments(4):
 
 
 
 
 
 
 
GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)
4.2
%

4.2
%
$
10,203

$
7,864

$
9,117

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

2.5
%
11,739

6,975


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


Jet Plastica
Investors, LLC
(2)
Plastic Products
Senior Debt A (Due 3/15)(1)(6)
2.2
%
7.0
%
9.2
%
5,515

3,897


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

7.5
%
7,620

7,620

7,620

 
Subordinated Debt (Due 12/16)
12.0
%
3.0
%
15.0
%
11,009

11,005

11,005

 
 
Preferred LLC Interest (19.7%, 70,000 units)(5)
 
 
 
 
13,364

7,183

Total control investments (represents 17.8% of total investments at fair value)
 
 
 
 
59,796

34,925

Affiliate Investments(3):
 
 
 
 
 
 
 
C7 Data Centers, Inc.
Business Services
Senior Debt (Due 9/17)(1)
11.5
%

11.5
%
16,850

16,631

16,631

Series B Preferred Stock (7,142,857 shares)(5)
 
 
 
 
2,000

3,275

Education Management, Inc.(11)
Education
Senior Debt (Due 12/15)(6)
6.0
%
5.7
%
11.7
%
20,598

19,189

3,379

 
Series C Preferred Stock (9.0%, 16,910 shares)(5)
 
 
 
 
5,000


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

9.8
%
13,832

13,640

13,640

 
 
Limited Partner Interests(1)(2)(5)
 
 
 
 
999

1,512

Total affiliate investments (represents 19.6% of total investments at fair value)
 
 
 
 
57,459

38,437

Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
Accurate Group Holdings, Inc.(2)
Business Services
Subordinated Unsecured Debt (Due 8/18)(1)
12.5
%

12.5
%
10,000

9,841

9,841

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

1,167

Advanced Sleep
Concepts, Inc.
(2)(10)
Home Furnishings
Senior Debt (Due 8/14 to 12/15)(6)
10.3
%

10.3
%
7,309

6,907

4,513

Subordinated Debt (Due 12/15)(6)
12.0
%
3.0
%
15.0
%
3,828

3,352


Broadview Networks Holdings, Inc.(9)
Communications
Common Stock (132,779 shares)(5)
 
 
 
 
159,579

252

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


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


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

9.8
%
13,792

13,568

13,568

Preferred Stock (10.0%, 271,169 shares)(1)
 
 
 
 
303

303

 
 
Series A-1 Preferred Stock (10.0%, 126,928 shares)(1)
 
 
 
 
306

306

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

119

Golden Knight II CLO, Ltd.(8)
Diversified Financial Services
Income Notes (Due 4/19)
 
 
 
 
2,208

3,394

Hammond's Candies Since 1920 II, LLC
Manufacturing
Subordinated Debt (Due 9/18)(1)
10.0
%
3.0
%
13.0
%
9,472

9,328

9,328

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

12,980

12,980

Industrial Safety Technologies, LLC
Manufacturing
Subordinated Debt (Due 6/19)
9.5
%
2.0
%
11.5
%
10,136

9,999

9,999

Intrafusion Holding Corp.
Healthcare
Subordinated Debt (Due 6/18)(1)
11.7
%

11.7
%
11,500

11,310

11,310

Legacy Cabinets Holdings II, Inc.(12)
Home Furnishings
Class B-1 Common Stock (2,000 shares)(5)
 
 
 
 
2,185

520

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

813

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


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

12.5
%
18,462

18,342

18,342

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

10.8
%
14,964

14,748

13,257


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


MCG Capital Corporation
Consolidated Schedule of Investments
June 30, 2014 (unaudited)
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate(7)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
 
 
 
 
 
 
 
 
 
South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt (Due 10/17)(1)
12.0
%
2.5
%
14.5
%
11,909

11,748

11,748

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

544

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

59

West World Media, LLC
Information Services
Class A Membership Units (25,000 units)(1)(5)
 
 
 
 
1

350

Total non-affiliate investments (represents 62.6% of total investments at fair value)
 
 
 
 
296,637

122,713

Total Investments
 
 
 
 
 
 
$
413,892

$
196,075



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


MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2013
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate(7)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
 
 
 
 
 
 
 
 
 
Control Investments(4):
 
 
 
 
 
 
 
GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)(1)
4.3
%

4.3
%
$
13,329

$
10,963

$
12,252

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

2.5
%
11,593

6,975


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


Jet Plastica
Investors, LLC
(2)
Plastic Products
Senior Debt A (Due 3/15)(1)(6)
2.4
%
7.5
%
9.9
%
5,326

3,897


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

7.5
%
7,640

7,640

7,640

 
Subordinated Debt (Due 12/16)(1)
12.0
%
3.0
%
15.0
%
10,845

10,841

10,841

 
 
Preferred LLC Interest (19.7%, 70,000 units)(5)
 
 
 
 
13,364

13,175

Total control investments (represents 11.9% of total investments at fair value)
 
 
 
 
62,751

43,908

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

9.5
%
17,350

17,092

17,092

Series B Preferred Stock (7,142,857 shares)(5)
 
 
 
 
2,000

3,482

Education Management, Inc.
Education
Senior Debt (Due 12/15)(1)
3.0
%
8.7
%
11.7
%
19,723

19,617

19,617

 
Series C Preferred Stock (9.0%, 16,910 shares)(5)
 
 
 
 
5,000

174

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

9.8
%
15,000

14,762

14,762

 
 
Limited Partner Interests(1)(2)(5)
 
 
 
 
999

1,665

Total affiliate investments (represents 15.4% of total investments at fair value)
 
 
 
 
59,470

56,792

Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
Accurate Group Holdings, Inc.(2)
Business Services
Subordinated Unsecured Debt (Due 8/18)(1)
12.5
%

12.5
%
10,000

9,827

9,827

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

1,731

Advanced Sleep
Concepts, Inc.
(2)
Home Furnishings
Senior Debt (Due 1/14 to 8/14)(1)(6)
10.3
%

10.3
%
7,409

7,204

4,493

Subordinated Debt (Due 1/14)(6)
%
10.0
%
10.0
%
3,771

3,352


Broadview Networks Holdings, Inc.(9)
Communications
Common Stock (132,779 shares)(5)
 
 
 
 
159,579

761

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


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


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

9.8
%
12,300

12,079

12,079

Preferred Stock (10.0%, 297,436 shares)(1)
 
 
 
 
317

317

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

124

Cruz Bay Publishing, Inc.
Publishing
Subordinated Debt (Due 3/15)(1)
5.0
%
7.3
%
12.3
%
21,521

21,483

21,483

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

9.5
%
10,000

9,867

9,867

G&L Investment Holdings, LLC(2)
Insurance
Subordinated Debt (Due 5/14)(1)
11.2
%
4.3
%
15.5
%
19,484

19,423

19,423

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

4,196

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


Golden Knight II CLO, Ltd.(8)
Diversified Financial Services
Income Notes (Due 4/19)
 
 
 
 
2,491

3,298

Hammond's Candies Since 1920 II, LLC
Manufacturing
Subordinated Debt (Due 9/18)(1)
10.0
%
4.0
%
14.0
%
9,379

9,221

9,221

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

12,958

12,958

Industrial Safety Technologies, LLC
Manufacturing
Subordinated Debt (Due 6/19)
9.7
%
2.0
%
11.7
%
10,035

9,888

9,888

Intrafusion Holding Corp.
Healthcare
Subordinated Debt (Due 6/18)(1)
11.9
%

11.9
%
11,500

11,290

11,290

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

237

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

6.8
%
3,921

3,888

3,830


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


MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2013
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate(7)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
 
 
 
 
 
 
 
 
 
Maverick Healthcare
Equity, LLC
Healthcare
Preferred Units (10.0%, 1,250,000 units)(5)
 
 
 
 
2,021

1,474

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


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

9.5
%
13,813

13,575

13,670

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

12.5
%
19,063

18,913

18,913

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

10.8
%
12,710

12,460

12,460

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

14.0
%
9,375

9,320

9,320

SC Academy Holdings, Inc.
Education
Subordinated Debt (Due 7/16)(1)
%
14.0
%
14.0
%
14,641

14,577

14,577

South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt (Due 10/17)(1)
12.0
%
2.5
%
14.5
%
11,761

11,581

11,614

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

563

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

67

TCFI CP LLC
Manufacturing
Subordinated Unsecured Debt (Due 4/19)(1)
10.0
%
3.0
%
13.0
%
20,010

19,667

19,667

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

9.5
%
14,000

13,691

13,691

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

11

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

5.3
%
4,711

4,711

4,657

West World Media, LLC
Information Services
Senior Debt (Due 9/15)(1)
11.0
%
3.0
%
14.0
%
11,467

11,105

11,182

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

362

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

379

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

543

Total non-affiliate investments (represents 72.7% of total investments at fair value)
 
 
 
 
444,217

268,173

Total Investments
 
 
 
 
 
 
$
566,438

$
368,873




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


MCG Capital Corporation
Consolidated Schedule of Investments

(1) 
Some or all of this security is held by our SBIC subsidiary or one of our other financing subsidiaries and may have been pledged as collateral in connection therewith. See Note 5—Borrowings to the Condensed Consolidated Financial Statements.
(2) 
Includes securities issued by one or more of the portfolio company’s affiliates.
(3) 
Affiliate investments represent companies in which we own at least 5%, but not more than 25% of the portfolio company’s voting securities.
(4) 
Control investments represent companies in which we own more than 25% of the portfolio company’s voting securities.
(5) 
Equity security is non-income producing at period-end.
(6) 
Loan or debt security is on non-accrual status.
(7) 
Interest rates represent the weighted-average annual stated interest rate on debt securities, presented by nature of indebtedness for a single issuer. PIK interest represents contractually deferred interest that is generally added to the principal balance of the debt security and compounded if contractually required and not paid on a current basis. PIK may be prepaid by either contract or the portfolio company's choice, but generally is paid at the end of the loan term. Rates on preferred stock and preferred LLC interests, where applicable, represent the contractual rate.
(8) 
Investment is not a qualifying asset under section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of total assets at the time of acquisition of any additional non-qualifying assets.
(9) 
Broadview Networks Holdings, Inc.’s financial statements are currently publicly available and may be accessed on-line using either the Company’s website (www.broadviewnet.com) or using the EDGAR System available on the SEC’s website (www.sec.gov)
(10) 
In June 2014, we monetized substantially all of our investment in Advanced Sleep Concepts, Inc., or Advanced Sleep, through the sale of a 95% participation interest in our senior and subordinated loans. Under the terms of the sale, the purchaser will receive 100% of the payments related to the loan, including interest and principal, until the total payments received exceeds the purchase price plus any additional advances funded by the purchaser to Advanced Sleep and certain expenses incurred by the purchaser. Thereafter, the purchaser will receive 95% and we will receive 5% of any payments received from Advanced Sleep. Under the terms of the sale, the purchaser will have no recourse to us for any payments.
We follow the guidance in Accounting Standard Codification Topic 860—Transfers and Servicing, or ASC 860, when accounting for loan participations and other partial loan sales. Such guidance requires a participation or other partial loan sale to meet the definition of a “participating interest,” as defined in the guidance, in order for sale treatment to be allowed. Due to the non-pro-rata allocation of payments, the sale of the interest in Advanced Sleep's loans does not meet the definition of a participating interest under ASC 860 and the loans remain on our Consolidated Balance Sheets and the proceeds from the sale are recorded as a secured financing until all the criteria for sale accounting are met.
(11) 
On June 30, 2014, we entered into a binding trade agreement to sell the senior debt and preferred stock of Education Management, Inc., which settled in July 2014.
(12) 
In July 2014, we sold our investment in the class B-1 common stock of Legacy Cabinets Holdings II, Inc.


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


MCG Capital Corporation
Notes to the Condensed Consolidated Financial Statements (Unaudited)
NOTE 1—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
These Condensed Consolidated Financial Statements present the results of operations, financial position and cash flows of MCG Capital Corporation and its consolidated subsidiaries. The terms “we,” “our,” “us” and “MCG” refer to MCG Capital Corporation and its consolidated subsidiaries.
We are a solutions-focused commercial finance company that provides capital and advisory services to lower middle-market companies throughout the United States. We are an internally managed, non-diversified, closed-end investment company that elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. Our organization includes the following categories of subsidiaries:
Small Business Investment Subsidiaries—We own Solutions Capital I, L.P., or Solutions Capital, a wholly owned subsidiary licensed by the United States Small Business Administration, or SBA, which operates as a small business investment company, or SBIC, under the Small Business Investment Act of 1958, as amended, or SBIC Act. In connection with the formation of Solutions Capital I, L.P., MCG also established another wholly owned subsidiary, Solutions Capital G.P., LLC, to act as the general partner of Solutions Capital I, L.P., while MCG is the sole limited partner.
Taxable SubsidiariesWe currently qualify as a regulated investment company, or RIC, for federal income tax purposes and, therefore, are not required to pay corporate income taxes on any income or gains that we distribute to our stockholders. We have certain wholly owned taxable subsidiaries, or Taxable Subsidiaries, each of which holds one or more portfolio investments listed on our Consolidated Schedules of Investments. The purpose of these Taxable Subsidiaries is to permit us to hold portfolio companies organized as limited liability companies, or LLCs, or other forms of pass-through entities and still satisfy the RIC tax requirement that at least 90% of our gross revenue for income tax purposes must consist of investment income. Absent the Taxable Subsidiaries, a portion of the gross income of any LLC or other pass-through entity portfolio investment would flow through directly to us, and be included in the calculation of the 90% test. To the extent that such income did not consist of investment income, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes. The income of the LLCs or other pass-through entities owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries and does not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages. We do not consolidate the Taxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries’ ownership of the portfolio companies. We reflect any such income tax expense on our Consolidated Statements of Operations.
Wholly Owned Special-Purpose Financing Subsidiary—This subsidiary was a bankruptcy remote, special-purpose entity to which we transfered certain loans. The financing subsidiary, in turn, transfered the loans to a Delaware statutory trust. For accounting purposes, the transfers of the loans to the Delaware statutory trust were structured as an on-balance sheet securitization.
The accompanying financial statements reflect the consolidated accounts of MCG and the following subsidiaries: Solutions Capital; Solutions Capital G.P., LLC; and MCG’s former special-purpose financing subsidiary, MCG Finance VII, LLC.
Basis of Presentation and Use of Estimates
These unaudited financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America and conform to Regulation S-X under the Securities Exchange Act of 1934, as amended. We believe we have made all necessary adjustments so that the financial statements are presented fairly and that all such adjustments are of a normal recurring nature. We eliminated all significant intercompany balances. In accordance with Article 6 of Regulation S-X of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, we do not consolidate portfolio company investments, including those in which we have a controlling interest. Further, in connection with the preparation of these Condensed Consolidated Financial Statements, we have evaluated subsequent events that occurred after the balance sheet date as of June 30, 2014 through the date these financial statements were issued.
Preparing financial statements requires us to make estimates and assumptions that affect the amounts reported on our Condensed Consolidated Financial Statements and accompanying notes. Although we believe the estimates and

10


assumptions used in preparing these Condensed Consolidated Financial Statements and related notes are reasonable, actual results could differ materially.
Interim results are not necessarily indicative of results for a full year. You should read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2013.
Recent Accounting Pronouncement
In June 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2013-08, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, or ASU 2013-08. This update changes the approach to the assessment of whether a company is an investment company, clarifies the characteristics of an investment company, provides comprehensive guidance for the investment company assessment and contains certain disclosure requirements. ASU 2013-08 is effective for interim and annual reporting periods in fiscal years that began after December 15, 2013. Earlier application is prohibited. We adopted this standard update beginning January 1, 2014. The implementation of this standard update did not have a material impact on our consolidated financial statements.
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), or ASU 2014-09. This update supersedes the revenue recognition requirements in Accounting Standards Update No. 2011-230: Revenue Recognition (Topic 605), and most industry-specific guidance throughout the industry topics of the codification. The core principal of the update is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to exchange for those goods or services. In applying the revenue model to contracts within its scope, an entity should identify the contract(s) with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. We are currently evaluating the potential impact the adoption of this update will have on our consolidated financial statements.
NOTE 2—INVESTMENT PORTFOLIO
The following table summarizes the composition of our investment portfolio at cost and fair value:
 
COST BASIS
FAIR VALUE BASIS
 
June 30, 2014
December 31, 2013
June 30, 2014
December 31, 2013
(dollars in thousands)
Investments
at Cost
% of Total
Portfolio
Investments
at Cost
% of Total
Portfolio
Investments
at Fair Value
% of Total
Portfolio
Investments
at Fair Value
% of Total
Portfolio
Debt Investments
 
 
 
 
 
 
 
 
Senior secured debt
$
122,406

29.5
%
$
190,783

33.7
%
$
100,068

51.1
%
$
185,524

50.3
%
Subordinated debt




 
 




 
 
Secured
63,717

15.4

118,632

20.9

53,389

27.2

108,338

29.4

Unsecured
22,821

5.5

42,452

7.5

22,821

11.6

42,452

11.5

Total debt investments
208,944

50.4

351,867

62.1

176,278

89.9

336,314

91.2

Equity investments




 
 




 
 
Preferred
36,274

8.8

44,956

8.0

16,441

8.4

28,390

7.7

Common/common equivalents
168,674

40.8

169,615

29.9

3,356

1.7

4,169

1.1

Total equity investments
204,948

49.6

214,571

37.9

19,797

10.1

32,559

8.8

Total investments
$
413,892

100.0
%
$
566,438

100.0
%
$
196,075

100.0
%
$
368,873

100.0
%
Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of June 30, 2014, approximately 63.1% of the fair value of our loan portfolio had variable interest rates, based on a London Interbank Offer Rate, or LIBOR, benchmark or the prime rate, and 36.9% of the fair value of our loan portfolio had fixed interest rates. As of June 30, 2014, approximately 57.9% of our loan portfolio, at fair value, had LIBOR floors between 1.3% and 3.0% on a LIBOR-based index or prime floors between

11


2.8% and 6.0%. At origination, our loans generally have four- to six-year stated maturities. Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and generally will cease recognizing interest income on that loan until all principal and interest has been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status.
 
COST BASIS
FAIR VALUE BASIS
 
June 30, 2014
December 31, 2013
June 30, 2014
December 31, 2013
(dollars in thousands)
Investments
at Cost
% of Loan
Portfolio
Investments
at Cost
% of Loan
Portfolio
Investments
at Fair Value
% of Loan
Portfolio
Investments
at Fair Value
% of Loan
Portfolio
Loans greater than 90 days past due
 
 
 
 
 
 
 
On non-accrual status
$
14,156

6.78
%
$
3,897

1.11
%
$
4,513

2.54
%
$

%
Not on non-accrual status








Total loans greater than 90 days past due
$
14,156

6.78
%
$
3,897

1.11
%
$
4,513

2.54
%
$

%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
26,164

12.52
%
$
17,531

4.98
%
$
3,379

1.90
%
$
4,493

1.34
%
Greater than 90 days past due
14,156

6.78

3,897

1.11

4,513

2.54



Total loans on non-accrual status
$
40,320

19.30
%
$
21,428

6.09
%
$
7,892

4.44
%
$
4,493

1.34
%
The following table summarizes our investment portfolio by industry at fair value:
 
June 30, 2014
December 31, 2013
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
78,087

39.8
%
$
84,922

23.0
%
Business services
63,554

32.4

64,108

17.4

Manufacturing
32,306

16.5

51,735

14.0

Broadcasting
9,117

4.6

12,252

3.3

Home furnishings
5,033

2.6

4,730

1.3

Diversified financial services
3,394

1.7

3,298

0.9

Education
3,379

1.7

57,905

15.7

Publishing


25,312

6.9

Insurance


23,620

6.4

Restaurants


23,010

6.2

Consumer products


4,657

1.3

Other(a)
1,205

0.7

13,324

3.6

Total
$
196,075

100.0
%
$
368,873

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

12


We provide financial support to our portfolio companies for investment purposes in the form of originations or draws and advances. Originations represent financial support for which we have not been previously contractually required to provide and draws and advances represent financial support for which we have been previously contractually required to provide. The following table shows our significant originations and advances:
(in thousands)
Six months ended
 
June 30, 2014
Company
Originations
Draws/
Advances
PIK Advances/ Dividends
Total
Debt
 
 
 
 
Oceans Acquisition, Inc.
$

$
3,250

$

$
3,250

Community Investors, Inc.

1,667


1,667

Other (< $1 million)

1,400

2,526

3,926

Total debt

6,317

2,526

8,843

Equity
 
 
 
 
Other (< $1 million)

298

225

523

Total Equity

298

225

523

Total originations and advances
$

$
6,615

$
2,751

$
9,366

As of June 30, 2014, we have commitments to invest an additional $5.0 million to our portfolio companies. See Note 11—Commitments and Contingencies.
NOTE 3—FAIR VALUE MEASUREMENT
We account for our investments in portfolio companies under Accounting Standard Codification Topic 820—Fair Value Measurements and Disclosures, or ASC 820. ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820 defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.
Fair Value Hierarchy
ASC 820 establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:
ASC 820
Fair Value Hierarchy
Inputs to Fair Value Methodology
Level 1
Quoted prices in active markets for identical assets or liabilities
Level 2
Quoted prices for similar assets or liabilities; quoted markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the financial instrument; inputs other than quoted prices that are observable for the asset or liability; or inputs that are derived principally from, or corroborated by, observable market information
Level 3
Pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption is unobservable or when the estimation of fair value requires significant management judgment
We categorize a financial instrument in the fair value hierarchy based on the lowest level of input that is significant to its fair value measurement. In the event that transfers between these levels were to occur in the future, we would recognize those transfers as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.

13


Assets Measured at Fair Value on a Recurring Basis
The following table presents the assets that we report at fair value on our Consolidated Balance Sheets by fair value hierarchy:
 
June 30, 2014
(in thousands)
Internal Models with Significant
Total Fair Value
Reported in
Consolidated
Balance Sheet
Observable Market Parameters  
(Level 2)
Unobservable
Market Parameters
 
(Level 3)
Non-affiliate investments
 
 
 
Senior secured debt
$

$
49,681

$
49,681

Subordinated secured debt

42,384

42,384

Unsecured subordinated debt

22,821

22,821

Preferred equity
3,394

2,589

5,983

Common/common equivalents
252

1,592

1,844

Total non-affiliate investments
3,646

119,067

122,713

Affiliate investments
 
 


Senior secured debt

33,650

33,650

Subordinated secured debt



Preferred equity

3,275

3,275

Common/common equivalents

1,512

1,512

Total affiliate investments

38,437

38,437

Control investments
 
 


Senior secured debt

16,737

16,737

Subordinated secured debt

11,005

11,005

Preferred equity

7,183

7,183

Total control investments

34,925

34,925

Total assets at fair value
$
3,646

$
192,429

$
196,075

As of June 30, 2014, we had no investments that had quoted market prices in active markets which we would categorize as Level 1 investments under ASC 820. Cash and cash equivalents are carried at cost which approximates fair value and are Level 1 assets. Interest receivable is carried at cost which approximates fair value.
Valuation Methodologies and Procedures
As required by the 1940 Act, we classify our investments by level of control. Control investments include both majority-owned control investments and non-majority owned control investments. A majority-owned control investment represents a security in which we own more than 50% of the voting interest of the portfolio company and generally control its board of directors. A non-majority owned control investment represents a security in which we own 25% to 50% of the portfolio company’s voting equity. As of each of June 30, 2014 and December 31, 2013, our portfolio contained zero non-majority control investments. Non-control investments represent both affiliate and non-affiliate securities for which we do not have a controlling interest. Affiliate investments represent securities in which we own 5% to 25% of the portfolio company’s equity. Non-affiliate investments represent securities in which we own less than 5% of the portfolio company’s equity.
Majority-Owned Control Investments—Majority-owned control investments comprise 17.8% of our investment portfolio as of June 30, 2014. Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value. Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value. Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question. Also, in a limited number of cases, we use income approaches to determine fair value, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs. Our valuation approaches for majority-owned investments estimate the value upon a hypothetical sale or exit and then allocates such value to the investment's securities in order of their relative liquidation preference. In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par. These valuation approaches consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.

14


Non-Control Investments—Non-control investments comprise 82.2% of our investment portfolio as of June 30, 2014. Quoted prices are not available for 97.7% of our non-control investments as of June 30, 2014. For our non-control equity investments, we use the same market and income approaches used to value our control investments. For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.
Thinly Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly-traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of June 30, 2014, these securities represented 1.9% of our investment portfolio. We utilize independent pricing services to arrive at certain of our fair value estimates. To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.
Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales. Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks. We also engage independent valuation firms to provide additional data points for our quarterly valuation analyses. Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months. In total, as of June 30, 2014, we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve-month period to calculate 98.9% of our investment portfolio, calculated on a fair value basis.
The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs. We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses.
Our board of directors sets our valuation policies and procedures and determines the fair value of our investments. The investment and valuation committee of our board of directors meets at least quarterly with our executive management to review management’s recommendations of fair value of our investments. Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments.
Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and such differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to differ from the valuations currently assigned.
Changes in Level 3 Fair Value Measurements
We classify securities in the Level 3 valuation hierarchy based on the significance of the unobservable factors to the overall fair value measurement. Our fair value approach for Level 3 securities primarily uses unobservable inputs, but may also include observable, actively quoted components derived from external sources. Accordingly, the gains and losses in the table below include fair value changes due, in part, to observable factors. Additionally, we transfer investments in and out of Level 1, 2 and 3 securities as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period. During the three and six months ended June 30, 2014, our investment in Broadview Networks Holdings, Inc. was transferred from level 3 to level 2, because its common stock began trading in an inactive market. During the three and six months ended June 30, 2013, there were no transfers in or out of Level 1, 2 or 3.

15


The following table provides a reconciliation of fair value changes during the three months ended June 30, 2014 for all investments for which we determine fair value using unobservable (Level 3) factors:
(in thousands)
Fair value measurements using unobservable inputs (Level 3)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Fair value as of March 31, 2014
 
 
 
 
Senior secured debt
$
108,196

$
36,769

$
19,851

$
164,816

Subordinated secured debt
79,205


10,922

90,127

Unsecured subordinated debt
42,761



42,761

Preferred equity
2,880

3,275

6,836

12,991

Common/common equivalents equity
2,271

1,513


3,784

Total fair value as of March 31, 2014
235,313

41,557

37,609

314,479

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(1,278
)
(833
)
13

(2,098
)
Subordinated secured debt
(4,037
)


(4,037
)
Preferred equity
51


347

398

Common/common equivalents equity
202

(1
)

201

Total realized/unrealized gain (loss)
(5,062
)
(834
)
360

(5,536
)
Issuances
 
 
 
 
Senior secured debt
2,197

50

17

2,264

Subordinated secured debt
554


83

637

Unsecured subordinated debt
607



607

Preferred equity
201



201

Total issuances
3,559

50

100

3,709

Settlements
 
 
 
 
Senior secured debt
(13,942
)
(2,336
)
(3,144
)
(19,422
)
Subordinated secured debt
(23,804
)


(23,804
)
Unsecured subordinated debt
(20,547
)


(20,547
)
Total settlements
(58,293
)
(2,336
)
(3,144
)
(63,773
)
Sales








Senior secured debt
(45,492
)


(45,492
)
Subordinated secured debt
(9,534
)


(9,534
)
Preferred equity
(543
)


(543
)
Common/common equivalents equity
(406
)


(406
)
Total sales
(55,975
)


(55,975
)
Transfers
 
 
 
 
Common/common equivalents equity
(475
)


(475
)
Total transfers
(475
)


(475
)
Fair value as of June 30, 2014
 
 
 
 
Senior secured debt
49,681

33,650

16,737

100,068

Subordinated secured debt
42,384


11,005

53,389

Unsecured subordinated debt
22,821



22,821

Preferred equity
2,589

3,275

7,183

13,047

Common/common equivalents equity
1,592

1,512


3,104

Total fair value as of June 30, 2014
$
119,067

$
38,437

$
34,925

$
192,429

There were no purchases of level 3 investments during the three months ended June 30, 2014.

16


The following table provides a reconciliation of fair value changes during the three-month period ended June 30, 2013 for all investments for which we determine fair value using unobservable (Level 3) factors:
(in thousands)
Fair value measurements using unobservable inputs (Level 3)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Fair value as of March 31, 2013
 
 
 
 
Senior secured debt
$
99,806

$
40,559

$
23,383

$
163,748

Subordinated secured debt
93,070

8,135

10,596

111,801

Unsecured subordinated debt
39,085



39,085

Preferred equity
13,039

6,707

16,463

36,209

Common/common equivalents equity
2,619

1,346


3,965

Total fair value as of March 31, 2013
247,619

56,747

50,442

354,808

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
57

62

6

125

Subordinated secured debt
(46
)
5


(41
)
Preferred equity
305

484

(816
)
(27
)
Common/common equivalents equity
(147
)
1,654


1,507

Total realized/unrealized gain (loss)
169

2,205

(810
)
1,564

Issuances
 
 
 
 
Senior secured debt
76,520

(9,132
)
36

67,424

Subordinated secured debt
1,103

77

80

1,260

Unsecured subordinated debt
159



159

Preferred equity
351

70

573

994

Common/common equivalents equity
3



3

Total issuances
78,136

(8,985
)
689

69,840

Settlements
 
 
 
 
Senior secured debt
(10,028
)

(4,234
)
(14,262
)
Total settlements
(10,028
)

(4,234
)
(14,262
)
Sales
 
 
 
 
Preferred equity
(989
)


(989
)
Common/common equivalents equity

(3,000
)

(3,000
)
Total sales
(989
)
(3,000
)

(3,989
)
Fair value as of June 30, 2013
 
 
 
 
Senior secured debt
166,355

31,489

19,191

217,035

Subordinated secured debt
94,127

8,217

10,676

113,020

Unsecured subordinated debt
39,244



39,244

Preferred equity
12,706

7,261

16,220

36,187

Common/common equivalents equity
2,475



2,475

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

$
46,967

$
46,087

$
407,961

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

17


Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the three months ended June 30, 2014 and 2013:
 
Three months ended June 30, 2014
Three months ended June 30, 2013
(in thousands)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Change in unrealized appreciation (depreciation)
 
 
 
 
 
 
 
 
Senior secured debt
$
(1,452
)
$
(833
)
$
12

$
(2,273
)
$
57

$
62

$
6

$
125

Subordinated secured debt




(46
)
5


(41
)
Preferred equity
9


347

356

414

485

(816
)
83

Common/common equivalents equity
209

(1
)

208

(147
)
(1,223
)

(1,370
)
Total change in unrealized appreciation (depreciation) on Level 3 investments
$
(1,234
)
$
(834
)
$
359

$
(1,709
)
$
278

$
(671
)
$
(810
)
$
(1,203
)

18


The following table provides a reconciliation of fair value changes during the six months ended June 30, 2014 for all investments for which we determine fair value using unobservable (Level 3) factors:
(in thousands)
Fair value measurements using unobservable inputs (Level 3)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Fair value as of December 31, 2013
 
 
 
 
Senior secured debt
$
105,674

$
51,471

$
19,892