MCG CAPITAL CORP - FORM 10-Q - October 29, 2014

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EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-31293014.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-32193014.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-31193014.htm
EX-15.1 - LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION FROM ERNST & YOUNG - MCG CAPITAL CORPex-15193014.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-32293014.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 October 27, 2014, there were 43,506,621 shares of the registrant’s $0.01 par value Common Stock outstanding.


MCG CAPITAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 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)
September 30,
2014
December 31,
2013

(unaudited)

Assets


Cash and cash equivalents
$
114,569

$
91,598

Cash, restricted
1,633

33,895

Cash, securitization accounts
—

13,906

Investments at fair value




Non-affiliate investments (cost of $218,005 and $444,217, respectively)
56,232

268,173

Affiliate investments (cost of $999 and $59,470, respectively)
1,512

56,792

Control investments (cost of $54,471 and $62,751, respectively)
35,826

43,908

Total investments (cost of $273,475 and $566,438, respectively)
93,570

368,873

Interest receivable
952

2,087

Other assets
488

3,634

Total assets
$
211,212

$
513,993

Liabilities




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

$
175,172

Interest payable
—

2,345

Other liabilities
5,244

2,522

Total liabilities
5,244

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 September 30, 2014 and December 31, 2013, 45,965 issued and outstanding on September 30, 2014 and 70,510 issued and outstanding on December 31, 2013
460

705

Paid-in capital
891,536

980,930

Distributions in excess of earnings
(506,121
)
(449,915
)
Net unrealized depreciation on investments
(179,907
)
(197,766
)
Total stockholders’ equity
205,968

333,954

Total liabilities and stockholders’ equity
$
211,212

$
513,993

Net asset value per common share at end of period
$
4.48

$
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
Nine months ended

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




Interest and dividend income




Non-affiliate investments (less than 5% owned)
$
3,664

$
10,060

$
18,387

$
28,915

Affiliate investments (5% to 25% owned)
926

1,238

2,815

4,560

Control investments (more than 25% owned)
683

1,289

2,089

4,462

Total interest and dividend income
5,273

12,587

23,291

37,937

Advisory fees and other income








Non-affiliate investments (less than 5% owned)
378

570

1,206

1,344

Control investments (more than 25% owned)
13

13

38

25

Total advisory fees and other income
391

583

1,244

1,369

Total revenue
5,664

13,170

24,535

39,306

Operating expense








Interest expense
3,483

2,316

7,339

7,003

Employee compensation








Salaries and benefits
996

644

3,857

3,610

Amortization of employee restricted stock awards
127

420

1,681

1,174

Total employee compensation
1,123

1,064

5,538

4,784

General and administrative expense
2,034

1,824

7,760

3,942

Restructuring expense
—

2

—

14

Total operating expense
6,640

5,206

20,637

15,743

Net operating (loss) income before net investment gain (loss) and income tax (benefit) provision
(976
)
7,964

3,898

23,563

Net realized (loss) gain on investments








Non-affiliate investments (less than 5% owned)
(13,905
)
109

(22,739
)
(658
)
Affiliate investments (5% to 25% owned)
(18,827
)
(7
)
(18,827
)
(554
)
Control investments (more than 25% owned)
(3,372
)
—

(3,258
)
51

Total net realized (loss) gain on investments
(36,104
)
102

(44,824
)
(1,161
)
Net unrealized appreciation (depreciation) on investments








Non-affiliate investments (less than 5% owned)
12,151

(5,005
)
14,271

(10,374
)
Affiliate investments (5% to 25% owned)
19,535

71

3,191

8,506

Control investments (more than 25% owned)
6,226

217

198

(807
)
Other fair value adjustments
301

(1
)
199

(1
)
Total net unrealized appreciation (depreciation) on investments
38,213

(4,718
)
17,859

(2,676
)
Net investment gain (loss) before income tax provision
2,109

(4,616
)
(26,965
)
(3,837
)
Income tax (benefit) provision
(152
)
59

(148
)
111

Net income (loss)
$
1,285

$
3,289

$
(22,919
)
$
19,615

Income (loss) per basic and diluted common share
$
0.03

$
0.05

$
(0.38
)
$
0.28

Cash distributions declared per common share
$
0.05

$
0.125

$
0.245

$
0.38

Weighted-average common shares outstanding—basic and diluted
49,805

71,208

59,942

71,313


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


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

Nine months ended

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


Net operating income before net investment loss and income tax provision
$
3,898

$
23,563

Net realized loss on investments
(44,824
)
(1,161
)
Net unrealized appreciation (depreciation) on investments
17,859

(2,676
)
Income tax benefit (provision)
148

(111
)
Net income (loss)
(22,919
)
19,615

Distributions to stockholders


Distributions declared from net operating income
(5,147
)
(20,158
)
Distributions declared in excess of net operating income
(10,281
)
(6,548
)
Net decrease in net assets resulting from stockholder distributions
(15,428
)
(26,706
)
Capital share transactions




Repurchase of common stock
(90,720
)
(2,272
)
Amortization of restricted stock awards




Employee awards accounted for as employee compensation
1,681

1,174

Non-employee director awards accounted for as general and administrative expense
40

43

Common stock withheld to pay taxes applicable to the vesting of restricted stock
(640
)
(81
)
Net decrease in net assets resulting from capital share transactions
(89,639
)
(1,136
)
Total decrease in net assets
(127,986
)
(8,227
)
Net assets




Beginning of period
333,954

371,728

End of period
$
205,968

$
363,501

Net asset value per common share at end of period
$
4.48

$
5.10

Common shares outstanding at end of period
45,965

71,212



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

MCG Capital Corporation
Consolidated Statements of Cash Flows
(unaudited)

Nine months ended

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


Net (loss) income
$
(22,919
)
$
19,615

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




Investments in portfolio companies
(8,944
)
(85,029
)
Principal collections related to investment repayments or sales
247,825

167,724

Increase (decrease) in interest receivable, accrued payment-in-kind interest and dividends
10,591

(5,948
)
Amortization of restricted stock awards




Employee
1,681

1,174

Non-employee director
40

43

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

2,431

(Increase) decrease in restricted cash—escrow accounts
(637
)
5,881

Depreciation and amortization
2,908

1,019

Decrease in other assets
238

500

Increase (decrease) in other liabilities
379

(7,702
)
Realized loss on investments
44,824

1,161

Net unrealized (appreciation) depreciation on investments
(17,859
)
2,676

Net cash provided by operating activities
259,526

103,545

Cash flows from financing activities




Repurchase of common stock
(90,720
)
(2,272
)
Payments on borrowings
(179,685
)
(68,879
)
Proceeds from borrowings
4,513

—

Decrease in cash in restricted and securitization accounts




Securitization accounts for repayment of principal on debt
12,479

6,756

Restricted cash
32,926

10,549

Payment of financing costs
—

(116
)
Distributions paid
(15,428
)
(26,706
)
Common stock withheld to pay taxes applicable to the vesting of restricted stock
(640
)
(81
)
Net cash used in financing activities
(236,555
)
(80,749
)
Net increase in cash and cash equivalents
22,971

22,796

Cash and cash equivalents




Beginning balance
91,598

73,588

Ending balance
$
114,569

$
96,384

Supplemental disclosure of cash flow information




Interest paid
$
6,804

$
7,802

Income taxes paid
—

158

Paid-in-kind interest accrued
2,775

1,644

Paid-in-kind interest collected
12,135

2,161

Dividend income collected
747

680


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

MCG Capital Corporation
Consolidated Schedule of Investments
September 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

$
7,869

$
9,165

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

2.5
%
11,814

6,975

—

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

—

RadioPharmacy
Investors, LLC(2)
Healthcare
Senior Debt (Due 12/16)
9.5
%
—

9.5
%
17,195

17,192

17,192

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

9,469

Total control investments (represents 38.3% of total investments at fair value)
 
 
 
 
54,471

35,826

Affiliate Investments(3):
 
 
 
 
 
 
 
IDOC, LLC
Healthcare
Limited Partner Interests(2)(5)
 
 
 
 
999

1,512

Total affiliate investments (represents 1.6% of total investments at fair value)
 
 
 
 
999

1,512

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

12.5
%
10,000

9,848

9,848

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

1,247

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

266

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

—

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

—

C7 Data Centers, Inc.
Business Services
Senior Debt (Due 9/19)
9.5
%
—

9.5
%
14,850

14,672

14,672

Community Investors, Inc.
Business Services
Preferred Stock (10.0%, 271,169 shares)
 
 
 
 
271

206

Series A-1 Preferred Stock (10.0%, 126,928 shares)
 
 
 
 
298

226

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

—

Golden Knight II CLO, Ltd.(8)(10)
Diversified Financial Services
Income Notes (Due 4/19)(5)
 
 
 
 
2,029

1,600

Industrial Safety Technologies, LLC
Manufacturing
Subordinated Debt (Due 6/19)
9.5
%
2.0
%
11.5
%
10,188

10,056

10,056

Intrafusion Holding Corp.
Healthcare
Subordinated Debt (Due 6/18)
13.7
%
—

13.7
%
8,500

8,367

8,367

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

883

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

—

South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt (Due 10/17)
12.0
%
2.5
%
14.5
%
8,974

8,861

8,861

Total non-affiliate investments (represents 60.1% of total investments at fair value)
 
 
 
 
218,005

56,232

Total Investments
 
 
 
 
 
 
$
273,475

$
93,570



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

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
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
 
 
 
 
 
 
 
 
 
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
7

MCG Capital Corporation
Consolidated Schedule of Investments

(1) 
Some or all of this security was 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 October 2014, we sold our income notes in Golden Knight II CLO, Ltd. for $1.6 million.


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

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:
Taxable Subsidiaries—We currently qualify as a regulated investment company, or RIC, for federal income tax purposes and, therefore, are not required to pay corporate income taxes on any income or gains that we distribute to our stockholders. We have certain wholly owned taxable subsidiaries, or Taxable Subsidiaries, each of which holds one or more portfolio investments listed on our Consolidated Schedules of Investments. The purpose of these Taxable Subsidiaries is to permit us to hold portfolio companies organized as limited liability companies, or LLCs, or other forms of pass-through entities and still satisfy the RIC tax requirement that at least 90% of our gross revenue for income tax purposes must consist of investment income. Absent the Taxable Subsidiaries, a portion of the gross income of any LLC or other pass-through entity portfolio investment would flow through directly to us, and be included in the calculation of the 90% test. To the extent that such income did not consist of investment income, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes. The income of the LLCs or other pass-through entities owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries and does not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages. We do not consolidate the Taxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries’ ownership of the portfolio companies. We reflect any such income tax expense on our Consolidated Statements of Operations.
Small Business Investment Subsidiary—We own Solutions Capital I, L.P., or Solutions Capital, a wholly owned subsidiary that, until September 19, 2014, had been licensed by the United States Small Business Administration, or SBA, and operated 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, MCG also established another wholly owned subsidiary, Solutions Capital G.P., LLC, to act as the general partner of Solutions Capital, while MCG is the sole limited partner.
Wholly Owned Special-Purpose Financing Subsidiary—This subsidiary was a bankruptcy remote, special-purpose entity to which we transferred certain loans. The financing subsidiary, in turn, transferred 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 September 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

9

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. 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
 
September 30, 2014
December 31, 2013
September 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
$
39,732

14.6
%
$
190,783

33.7
%
$
41,029

43.8
%
$
185,524

50.3
%
Subordinated debt
 
 
 
 
 
 
 
 
Secured
34,259

12.5

118,632

20.9

27,283

29.2

108,338

29.4

Unsecured
9,848

3.6

42,452

7.5

9,848

10.5

42,452

11.5

Total debt investments
83,839

30.7

351,867

62.1

78,160

83.5

336,314

91.2

Equity investments
 
 
 
 
 
 
 
 
Preferred
29,055

10.6

44,956

8.0

13,632

14.6

28,390

7.7

Common/common equivalents
160,581

58.7

169,615

29.9

1,778

1.9

4,169

1.1

Total equity investments
189,636

69.3

214,571

37.9

15,410

16.5

32,559

8.8

Total investments
$
273,475

100.0
%
$
566,438

100.0
%
$
93,570

100.0
%
$
368,873

100.0
%
Our debt instruments bear contractual interest rates ranging from 2.5% to 14.5%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of September 30, 2014, approximately 63.4% 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 36.6% of the fair value of our loan portfolio had fixed interest rates. As of September 30, 2014, approximately 51.5% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 2.0% on a LIBOR-based index or prime

10

floors between 2.8% and 4.5%. 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
 
September 30, 2014
December 31, 2013
September 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
$
—

—
%
$
3,897

1.11
%
$
—

—
%
$
—

—
%
Total loans greater than 90 days past due
$
—

—
%
$
3,897

1.11
%
$
—

—
%
$
—

—
%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
6,975

8.32
%
$
17,531

4.98
%
$
—

—
%
$
4,493

1.34
%
Greater than 90 days past due
—

—

3,897

1.11

—

—

—

—

Total loans on non-accrual status
$
6,975

8.32
%
$
21,428

6.09
%
$
—

—
%
$
4,493

1.34
%
The following table summarizes our investment portfolio by industry at fair value:
 
September 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
$
46,284

49.5
%
$
84,922

23.0
%
Business services
26,200

28.0

64,108

17.4

Manufacturing
10,056

10.7

51,735

14.0

Broadcasting
9,165

9.8

12,252

3.3

Diversified financial services
1,600

1.7

3,298

0.9

Education
—

—

57,905

15.7

Publishing
—

—

25,312

6.9

Insurance
—

—

23,620

6.4

Restaurants
—

—

23,010

6.2

Information services
—

—

12,552

3.4

Home furnishings
—

—

4,730

1.3

Consumer products
—

—

4,657

1.3

Other(a)
265

0.3

772

0.2

Total
$
93,570

100.0
%
$
368,873

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

11

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)
Nine months ended
 
September 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

2,774

4,174

Total debt
—

6,317

2,774

9,091

Equity
 
 
 
 
Other (< $1 million)
—

298

547

845

Total Equity
—

298

547

845

Total originations and advances
$
—

$
6,615

$
3,321

$
9,936

As of September 30, 2014, we have commitments to invest an additional $2.0 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.

12

Assets Measured at Fair Value on a Recurring Basis
The following table presents the assets that we report at fair value on our Consolidated Balance Sheets by fair value hierarchy:
 
September 30, 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
$
—

$
14,672

$
14,672

Subordinated secured debt
—

27,283

27,283

Unsecured subordinated debt
—

9,848

9,848

Preferred equity
1,600

2,563

4,163

Common/common equivalents
266

—

266

Total non-affiliate investments
1,866

54,366

56,232

Affiliate investments
 
 


Common/common equivalents
—

1,512

1,512

Total affiliate investments
—

1,512

1,512

Control investments
 
 


Senior secured debt
—

26,357

26,357

Preferred equity
—

9,469

9,469

Total control investments
—

35,826

35,826

Total assets at fair value
$
1,866

$
91,704

$
93,570

As of September 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 September 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 38.3% of our investment portfolio as of September 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.
•
Non-Control Investments—Non-control investments comprise 61.7% of our investment portfolio as of September 30, 2014. Quoted prices are not available for 96.8% of our non-control investments as of September 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

13

interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.
•
Thinly Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly-traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of September 30, 2014, these securities represented 2.0% 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 September 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 99.1% of our investment portfolio, calculated on a fair value basis.
The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs. We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses.
Our board of directors sets our valuation policies and procedures and determines the fair value of our investments. The investment and valuation committee of our board of directors meets at least quarterly with our executive management to review management’s recommendations of fair value of our investments. Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments.
Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and such differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to differ from the valuations currently assigned.
Changes in Level 3 Fair Value Measurements
We classify securities in the Level 3 valuation hierarchy based on the significance of the unobservable factors to the overall fair value measurement. Our fair value approach for Level 3 securities primarily uses unobservable inputs, but may also include observable, actively quoted components derived from external sources. Accordingly, the gains and losses in the table below include fair value changes due, in part, to observable factors. Additionally, we transfer investments in and out of Level 1, 2 and 3 securities as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period. During the three and nine months ended September 30, 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 nine months ended September 30, 2013, there were no transfers in or out of Level 1, 2 or 3.

14

The following table provides a reconciliation of fair value changes during the three months ended September 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 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

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
875

82

568

1,525

Preferred equity
13

725

2,286

3,024

Common/common equivalents equity
(840
)
—

—

(840
)
Total realized/unrealized gain
48

807

2,854

3,709

Issuances
 
 
 
 
Senior secured debt
15,033

(14,439
)
10,197

10,791

Subordinated secured debt
407

—

(10,108
)
(9,701
)
Unsecured subordinated debt
95

—

—

95

Preferred equity
322

—

—

322

Total issuances
15,857

(14,439
)
89

1,507

Settlements
 
 
 
 
Senior secured debt
(46,404
)
(15,831
)
(1,145
)
(63,380
)
Subordinated secured debt
(9,508
)
—

(897
)
(10,405
)
Unsecured subordinated debt
(13,068
)
—

—

(13,068
)
Preferred equity
(361
)
—

—

(361
)
Common/common equivalents equity
(41
)
—

—

(41
)
Total settlements
(69,382
)
(15,831
)
(2,042
)
(87,255
)
Sales








Senior secured debt
(4,513
)
(3,462
)
—

(7,975
)
Subordinated secured debt
(6,000
)
—

—

(6,000
)
Preferred equity
—

(4,000
)
—

(4,000
)
Common/common equivalents equity
(711
)
—

—

(711
)
Total sales
(11,224
)
(7,462
)
—

(18,686
)
Fair value as of September 30, 2014
 
 
 
 
Senior secured debt
14,672

—

26,357

41,029

Subordinated secured debt
27,283

—

—

27,283

Unsecured subordinated debt
9,848

—

—

9,848

Preferred equity
2,563

—

9,469

12,032

Common/common equivalents equity
—

1,512

—

1,512

Total fair value as of September 30, 2014
$
54,366

$
1,512

$
35,826

$
91,704

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

15

The following table provides a reconciliation of fair value changes during the three-month period ended September 30, 2013 for all investments for which we determine fair value using unobservable (Level 3) factors:
(in thousands)
Fair value measurements using unobservable inputs (Level 3)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Fair value as of June 30, 2013
 
 
 
 
Senior secured debt
$
166,355

$
31,489

$
19,191

$
217,035

Subordinated secured debt
94,127

8,217

10,676

113,020

Unsecured subordinated debt
39,244

—

—

39,244

Preferred equity
12,706

7,261

16,220

36,187

Common/common equivalents equity
2,475

—

—

2,475

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

46,967

46,087

407,961

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

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

—

(372
)
Preferred equity
(3,134
)
105

211

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

—

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

216

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

35

6

2,193

Subordinated secured debt
1,363

80

82

1,525

Unsecured subordinated debt
462

—

—

462

Preferred equity
8

72

579

659

Total issuances
3,985

187

667

4,839

Settlements
 
 
 
 
Senior secured debt
(6,348
)
6

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

—

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

(5
)
(23,282
)
Sales
 
 
 
 
Senior secured debt
(9,880
)
—

—

(9,880
)
Total sales
(9,880
)
—

—

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

31,489

19,197

201,698

Subordinated secured debt
95,118

8,297

10,758

114,173

Unsecured subordinated debt
22,771

—

—

22,771

Preferred equity
9,580

7,438

17,010

34,028

Common/common equivalents equity
2,367

—

—

2,367

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

$
47,224

$
46,965

$
375,037

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

16

Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the three months ended September 30, 2014 and 2013:
 
Three months ended September 30, 2014
Three months ended September 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
$
3,885

$
15,809

$
3,940

$
23,634

$
(1,379
)
$
(35
)
$
5

$
(1,409
)
Subordinated secured debt
3,352

—

—

3,352

(372
)
—

—

(372
)
Preferred equity
13

3,725

2,286

6,024

(3,134
)
106

211

(2,817
)
Common/common equivalents equity
6,502

—

—

6,502

(108
)
—

—

(108
)
Total change in unrealized appreciation (depreciation) on Level 3 investments
$
13,752

$
19,534

$
6,226

$
39,512

$
(4,993
)
$
71

$
216

$
(4,706
)

17

The following table provides a reconciliation of fair value changes during the nine months ended September 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

$
177,037

Subordinated secured debt
97,497

—

10,841

108,338

Unsecured subordinated debt
42,452

—

—

42,452

Preferred equity
8,261

3,656

13,175

25,092

Common/common equivalents equity
2,504

1,665

—

4,169

Total fair value as of December 31, 2013
256,388

56,792

43,908

357,088

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(297
)
(15,727
)
532

(15,492
)
Subordinated secured debt
(4,070
)
—

—

(4,070
)
Preferred equity
(1,177
)
344

(3,706
)
(4,539
)
Common/common equivalents equity
(871
)
(153
)
—

(1,024
)
Total realized/unrealized (loss)
(6,415
)
(15,536
)
(3,174
)
(25,125
)
Issuances
 
 
 
 
Senior secured debt
21,732

(13,869
)
10,224

18,087

Subordinated secured debt
2,263

—

(9,944
)
(7,681
)
Unsecured subordinated debt
1,011

—

—

1,011

Preferred equity
643

—

—

643

Total issuances
25,649

(13,869
)
280

12,060

Settlements
 
 
 
 
Senior secured debt
(62,432
)
(18,413
)
(4,291
)
(85,136
)
Subordinated secured debt
(52,873
)
—

(897
)
(53,770
)
Unsecured subordinated debt
(33,615
)
—

—

(33,615
)
Preferred equity
(425
)
—

—

(425
)
Common/common equivalents equity
(41
)
—

—

(41
)
Total settlements
(149,386
)
(18,413
)
(5,188
)
(172,987
)
Sales
 
 
 
 
Senior secured debt
(50,005
)
(3,462
)
—

(53,467
)
Subordinated secured debt
(15,534
)
—

—

(15,534
)
Preferred equity
(4,739
)
(4,000
)
—

(8,739
)
Common/common equivalents equity
(1,117
)
—

—

(1,117
)
Total sales
(71,395
)
(7,462
)
—

(78,857
)
Transfers
 
 
 
 
Common/common equivalents equity
(475
)
—

—

(475
)
Total transfers
(475
)
—

—

(475
)
Fair value as of September 30, 2014
 
 
 
 
Senior secured debt
14,672

—

26,357

41,029

Subordinated secured debt
27,283

—

—

27,283

Unsecured subordinated debt
9,848

—

—

9,848

Preferred equity
2,563

—

9,469

12,032

Common/common equivalents equity
—

1,512

—

1,512

Total fair value as of September 30, 2014
$
54,366

$
1,512

$
35,826

$
91,704

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

18

The following table provides a reconciliation of fair value changes during the nine months ended September 30, 2013 for all investments for which we determine fair value using unobservable (Level 3) factors:
(in thousands)
Fair value measurements using unobservable inputs (Level 3)
Non-affiliate
Investments
Affiliate
Investments
Control
Investments
Total
Fair value December 31, 2012
 
 
 
 
Senior secured debt
$
163,125

$
48,060

$
23,376

$
234,561

Subordinated secured debt
96,585

7,880

10,518

114,983

Unsecured subordinated debt
26,274

—

—

26,274

Preferred equity
16,561

6,038

16,112

38,711

Common/common equivalents equity
3,048

101

—

3,149

Total fair value December 31, 2012
305,593

62,079

50,006

417,678

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

11

38

Subordinated secured debt
(473
)
190

—

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

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

—

2,218

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

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

(9,020
)
49

78,186

Subordinated secured debt
8,416

237

240

8,893

Unsecured subordinated debt
13,432

—

—

13,432

Preferred equity
406

211

1,718

2,335

Common/common equivalents equity
3

—

—

3

Total issuances
109,414

(8,572
)
2,007

102,849

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

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

—

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

—

(17,230
)
Preferred equity
(4,098
)
—

—

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

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

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

31,489

19,197

201,698

Subordinated secured debt
95,118

8,297

10,758

114,173

Unsecured subordinated debt
22,771

—

—

22,771

Preferred equity
9,580

7,438

17,010

34,028

Common/common equivalents equity
2,367

—

—

2,367

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

$
47,224

$
46,965

$
375,037


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

19

Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the nine months ended September 30, 2014 and 2013:
 
Nine months ended September 30, 2014
Nine months ended September 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
$
2,539

$
—

$
3,903

$
6,442

$
(252
)
$
174

$
11

$
(67
)
Subordinated secured debt
3,319

—

—

3,319

1,560

190

—

1,750

Preferred equity
2,741

3,344

(3,706
)
2,379

(3,086
)
1,189

(820
)
(2,717
)
Common/common equivalents equity
7,008

(153
)
—

6,855

1,022

23

—

1,045

Total change in unrealized appreciation (depreciation) on Level 3 investments
$
15,607

$
3,191

$
197

$
18,995

$
(756
)
$
1,576

$
(809
)
$
11

Significant Unobservable Inputs
Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with distinct contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and complex, often factoring in numerous different inputs, including the historical and forecasted financial and operational performance of the portfolio company, projected cash flows, market multiples, comparable market transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews and other inputs too numerous to list quantitatively herein.
The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2014:
 
 
 
 
 
 
 
($ in thousands)
Fair Value
Valuation Techniques
Unobservable
Inputs
Range
Weighted Average
 
Minimum
Maximum
Senior debt
$
41,029

Discounted cash flow
Market interest rate
7.8
%
7.8
%
7.8
%



Pending transactions/Letters of intent
Discount
—
%
—
%
—
%



Market comparable companies
EBITDA multiple(a)
6.0x

6.0x

6.0x

Subordinated debt
37,131

Discounted cash flow
Market interest rate
7.8
%
14.5
%
11.7
%



Pending transactions/Letters of intent
Discount
—
%
—
%
—
%
Preferred and common equity
13,544

Market comparable companies
EBITDA multiple(a)
6.0x

10.0x

6.7x

 
Pending transactions/Letters of intent
Discount
—
%
—
%
—
%
 
$
91,704

 
 
 
 
 

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

20

NOTE 4—CONCENTRATIONS OF INVESTMENT RISK
During the nine months ended September 30, 2014, we had concentrations in certain industries, including the healthcare, business services, and manufacturing industries. The following table summarizes our fair value and revenue concentrations in each of those industries:
 
Investments at fair value
Revenue for the nine months ended
 
September 30, 2014
December 31, 2013
September 30, 2014
September 30, 2013
(dollars in thousands)
Amount
% of Total Portfolio
Amount
% of Total Portfolio
Amount
% of Total Revenue
Amount
% of Total Revenue
Industry
 
 
 
 
 
 
 
 
Healthcare
$
46,284

49.5
%
$
84,922

23.0
%
$
6,476

26.4
%
$
10,189

25.9
%
Business services
26,200

28.0

64,108

17.4

6,116

24.9

6,073

15.4

Manufacturing
10,056

10.7

51,735

14.0

5,241

21.4

4,424

11.3

Total
$
82,540

88.2

$
200,765

54.4

$
17,833

72.7

$
20,686

52.6

NOTE 5—BORROWINGS
As of September 30, 2014, we had no outstanding borrowings or borrowing facilities. The following table summarizes our borrowing facilities, the facility amounts and amounts outstanding.
 
 
September 30, 2014
December 31, 2013
(dollars in thousands)
Maturity Date
Total
Facility/
Program
Amount
Outstanding
Total
Facility/
Program
Amount
Outstanding
SBIC(a)
 
 
 
 
 
2008-10B
September 2018
$
—

$
—

$
2,600

$
2,600

2009-10A
March 2019
—

—

12,000

12,000

2009-10B
September 2019
—

—

13,000

13,000

2010-10B
September 2020
—

—

27,500

27,500

2011-10A
March 2021
—

—

53,500

53,500

2012-10A
March 2022
—

—

41,400

41,400

MCG Commercial Loan Trust 2006-1(b)
 




 
 
Series 2006-1 Class D Notes
April 2018
—

—

40,016

25,172

Bank of America Unsecured Revolver(c)
 




 
 
Unsecured Revolving Note
November 2014
—

—

20,000

—

Total borrowings
 
$
—

$
—

$
210,016

$
175,172

__________ 
(a) 
In September 2014, the SBIC Debentures were repaid in full.
(b) 
In January 2014, the Class D Notes were repaid in full.
(c) 
In April 2014, we terminated the undrawn Bank of America Unsecured Revolver.
On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense. In addition, on April 21, 2014, based on our assessment of our excess liquidity, we terminated our undrawn unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or the Bank of America Unsecured Revolver.
As a BDC, we are not permitted to incur indebtedness or issue senior securities, including preferred stock, unless immediately after such borrowing we have an asset coverage for total borrowings (which excluded our SBIC debentures) of at least 200%. In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have an asset coverage ratio of at least 200% after deducting the amount of such dividend, distribution or purchase price. If we are unable to meet this asset coverage requirement, we may not be able to incur additional debt. In October 2008, we received exemptive relief from the SEC which allowed us to exclude debt issued by Solutions Capital from the calculation of our consolidated BDC asset coverage ratio. As of September 30, 2014, there were no senior securities outstanding.

21

Each of our borrowing facilities had certain financial covenants and non-financial covenants. We were in compliance with the covenants as of December 31, 2013.
We had funded our secured borrowing debt facility through a bankruptcy remote, special-purpose, wholly owned subsidiary. Therefore, this subsidiary’s assets were not available to our creditors. While the secured borrowing was in place, we continued to service those portfolio investments that we used as collateral in our secured borrowing facility.
SBIC Debentures
In September 2014, we prepaid in full the $150 million of SBIC debentures owed to the SBA by Solutions Capital, using excess restricted cash. After repayment, Solutions Capital surrendered its SBIC license to the SBA’s Office of SBIC Operations. As of December 31, 2013, Solutions Capital had borrowed $150.0 million from the SBA. We were permitted to use these funds to provide debt and equity capital to qualifying small businesses. However, we were not permitted to use these funds to provide working capital to MCG, Solutions Capital's parent company.
As of December 31, 2013, we had $207.0 million of investments in Solutions Capital and we had $32.5 million, of restricted cash which could be used for additional investments by Solutions Capital.
Bank of America Unsecured Revolver
In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million. On April 21, 2014, we terminated our Bank of America Unsecured Revolver.
MCG Commercial Loan Trust 2006-1
In April 2006, we completed a $500.0 million debt securitization through the MCG Commercial Loan Trust 2006-1, or 2006-1 Trust, a wholly owned subsidiary. The 2006-1 Trust issued six classes of notes with interest rates ranging from LIBOR plus 0.33% to LIBOR plus 2.25%. The reinvestment period for the 2006-1 Trust ended on July 20, 2011 and all subsequent principal collections or monetization proceeds that we received from collateral used to securitize this 2006-1 Trust were applied to the outstanding balance of that facility. As of December 31, 2013, we had $25.2 million of securitized Class D Notes outstanding under the 2006-1 Trust, which was secured by $76.3 million of loans and equity investments and $13.9 million of cash. We retained all of the equity in the securitization. In November 2013, we directed the trustee to redeem the remaining notes on the next quarterly payment date and, on January 21, 2014, we repaid the Class D Notes in full and the loan and equity investments held by the 2006-1 Trust were transferred back to MCG, the parent.
Note 6—SECURED FINANCING
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 would receive 100% of the payments related to the loan, including interest and principal, until the total payments received exceeded the purchase price plus any additional advances funded by the purchaser to Advanced Sleep and certain expenses incurred by the purchaser. Thereafter, the purchaser would receive 95% and we would receive 5% of any payments received from Advanced Sleep. Under the terms of the sale, the purchaser had no recourse to us for any payments. We continued to service the Advanced Sleep loans on behalf of the purchaser.
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 did not meet the definition of a participating interest under ASC 860 resulting in the loans remaining on our Consolidated Balance Sheets and the proceeds from the sale being recorded as a secured financing. In September 2014, we sold the remaining participation interest in our senior and subordinated loans. The sale of the remaining interest resulted in the derecognition of the loans to Advanced Sleep and the liability for the secured financing and the realization of a loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million on our Consolidated Income Statement. In addition, we no longer service the loans on behalf of the purchaser.

22

NOTE 7—CAPITAL STOCK
We have one class of common stock and one class of preferred stock authorized. Our board of directors is authorized to provide for the issuance of shares of preferred stock in one or more series, establish the number of shares to be included in each such series and establish the designations, voting powers, preferences and rights of the shares of each such series, and any qualifications, limitations or restrictions thereof, subject to the 1940 Act.
STOCK REPURCHASE PROGRAM
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million. On October 25, 2013, our board of directors authorized a second stock repurchase program of up to $25.0 million. On February 28, 2014, our board of directors increased the second stock repurchase program to $35.0 million. On April 25, 2014, our board of directors terminated the second stock repurchase program effective as of May 2, 2014 and authorized a third stock repurchase program of up to $50.0 million effective as of May 5, 2014. On August 5, 2014, our board of directors terminated the third stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014. Under the new program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases are made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. The following table summarizes our stock repurchases for the three and nine months ended September 30, 2014.
 
Three months ended September 30, 2014
Nine months ended September 30, 2014
Dollar amount repurchased (in thousands)
$
32,902

$
90,720

Shares repurchased
8,285,836

24,358,596

Average price per share
$
3.97

$
3.72

Discount to quarterly weighted average net asset value per share
10.2
%
15.9
%
We requested and received the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engage in a stock repurchase program and agree not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans. Although as of September 30, 2014, there were 1,426,811 shares of our common stock available for issuance under our Third Amended and Restated 2006 Employee Restricted Stock Plan, or 2006 Plan, no shares of restricted stock could be issued under our 2006 Plan or our Third Amended and Restated 2006 Non-Employee Director Restricted Stock Plan, or 2006 Non-Employee Plan, because the 10% threshold set forth in the SEC's order had been reached due to shares we repurchased under our stock repurchase program.
DISTRIBUTIONS
The following table summarizes our distributions per share declared since January 1, 2013:
Date Declared
Record Date
Payment Date
Amount
August 5, 2014
August 20, 2014
August 29, 2014
$
0.050

April 25, 2014
May 9, 2014
May 30, 2014
$
0.070

February 28, 2014
March 14, 2014
March 28, 2014
$
0.125

October 25, 2013
November 8, 2013
November 22, 2013
$
0.125

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

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

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


23

NOTE 8—SHARE-BASED COMPENSATION
EMPLOYEE SHARE-BASED COMPENSATION
Third Amended and Restated 2006 Employee Restricted Stock Plan
From time to time, we have awarded shares of restricted common stock to employees under our 2006 Plan, which our stockholders initially approved in June 2006. In May 2010, our stockholders approved an amendment to the 2006 Plan increasing the number of shares we may award from 3,500,000 to 6,050,000 shares. Shares of restricted common stock awarded under the 2006 Plan may be subject to the employees' meeting service or performance conditions specified at the time of award. The award date is the date on which the shares are awarded by the Compensation Committee of our board of directors, while the fair value of the respective stock award is based on the closing price of our common stock on the NASDAQ Global Select Market on the award date. We amortize restricted stock awards on a straight-line basis over the requisite service period and report this expense as amortization of employee restricted stock awards on our Consolidated Statements of Operations.
During each of the nine months ended September 30, 2014 and 2013, no shares of restricted stock were issued under the 2006 Plan.
During the nine months ended September 30, 2014, we recognized $1.7 million of compensation expense related to share-based compensation awards including $1.1 million of compensation costs associated with the retirement of our former chief executive officer and other employee terminations. During the nine months ended September 30, 2013, we recognized $1.2 million of compensation expense related to share-based compensation awards. As of September 30, 2014, all the restricted share awards for which forfeiture provisions had not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares. As of September 30, 2014, we had $0.6 million of unrecognized compensation cost related to restricted common stock awarded to employees. We expect to recognize the remaining costs over the remaining weighted-average requisite service period of 1.43 years.
Non-Employee Director Share-Based Compensation
During June 2006, our stockholders initially approved the 2006 Non-Employee Plan which was subsequently amended and restated. In May 2010, our stockholders approved an amendment to the 2006 Non-Employee Plan that increased the number of shares we may award to non-employee members of our board of directors from 100,000 to 150,000 shares. During the nine months ended September 30, 2014, no shares of restricted stock were issued to non-employee directors. Our board of directors has waived the right to an automatic award of 7,500 shares of restricted stock, previously awarded to non-employee directors upon the commencement of each three-year term of board service.  During the nine months ended September 30, 2013, we awarded 15,000 shares of restricted common stock to non-employee directors. During each of the nine months ended September 30, 2014 and 2013, we recognized less than $0.1 million of compensation costs related to share-based awards to non-employee directors. We include this compensation cost in general and administrative expense on our Consolidated Statements of Operations. As of September 30, 2014, we had less than $0.1 million of unrecognized compensation cost related to restricted common stock awarded to non-employee directors, which we expect to recognize over the remaining weighted-average requisite service period of 1.3 years.
SUMMARY OF EMPLOYEE AND NON-EMPLOYEE DIRECTOR SHARE-BASED COMPENSATION
The following table summarizes our restricted stock award activity during the nine months ended September 30, 2014:
 
Shares
Weighted-Average
Grant Date
Fair Value per Share
Subject to forfeiture provisions as of December 31, 2013
895,740

$
4.55

Awarded
—

$
—

Forfeiture provision satisfied
(521,855
)
$
4.60

Forfeited
(1,805
)
$
6.97

Subject to forfeiture provisions as of September 30, 2014
372,080

$
4.48


24

NOTE 9—INCOME TAXES
As a RIC, we are taxed under Subchapter M of the Internal Revenue Code. As such, our income generally is not taxable to the extent we distribute it to stockholders and we meet certain qualification tests as outlined in the Internal Revenue Code. However, income from certain investments owned by our wholly owned subsidiaries is subject to federal, state and local income taxes. On a continuing basis, we monitor distribution requirements in order to comply with Subchapter M of the Internal Revenue Code. To qualify as a RIC for federal income tax purposes, we must, among other things:
1.
continue to qualify as a BDC under the 1940 Act at all times during each taxable year;
2.
derive in each taxable year at least 90% of our gross income from (1) dividends, interest, payments with respect to certain securities, loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities and (2) net income derived from an interest in a “qualified publicly traded partnership;” and
3.
diversify our holdings so that at the end of each quarter of the taxable year:
a.
at least 50% of the value of our assets consist of cash, cash items, U.S. government securities, securities of other RICs, and other securities, if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and
b.
no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of (i) one issuer, (ii) two or more issuers that are controlled, as determined under applicable Internal Revenue Code rules, by us and are engaged in the same or similar or related trades or businesses or (iii) one or more “qualified publicly traded partnerships.”
If we fail to satisfy the distribution requirement or fail to qualify as a RIC in any taxable year, we would be subject to tax in that year on all of our taxable income at regular corporate rates, regardless of whether we make any distributions to our stockholders. Distributions would not be required, and any distributions made in taxable years beginning on or after January 1, 2014 would be taxable to our stockholders as ordinary dividend income that, subject to certain limitations, may be eligible for the 15% or 20% maximum tax rate (depending on income thresholds) to the extent of our current and accumulated earnings and profits. Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends-received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain.
We use the asset and liability method to account for our Taxable Subsidiaries' income taxes. Using this method, we recognize deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and the tax basis of assets and liabilities. In addition, we recognize deferred tax benefits associated with net operating carryforwards that we may use to offset future tax obligations. We measure deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences. During the nine months ended September 30, 2014, we recorded an income tax benefit of $0.1 million, which was primarily attributable to an NOL carryback and lower than expected flow-through taxable income on certain investments held by our subsidiaries. During the nine months ended September 30, 2013, we recorded an income tax provision of $0.1 million, which was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.
From December 2001 through September 30, 2014, we declared aggregate per share distributions of $14.13. Each year, we mail statements on Form 1099-DIV to our stockholders that identify whether we made distributions from ordinary income, net capital gains on the sale of securities, each of which are taxable distributions, and/or a return of paid-in-capital surplus, which is a nontaxable distribution. A portion of our distributions may represent a return of capital to our stockholders, to the extent that the total distributions paid in a given year exceed current and accumulated taxable earnings and profits. All or a portion of the distributions that we paid to stockholders during fiscal years 2013, 2012, 2011, 2008, 2006, 2005, 2004 and 2003 represented a return of capital.
We determine the tax attributes of our distributions as of the end of our fiscal year based upon our taxable income for the full year and distributions paid during the full year. Therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year. If we determined the tax attributes of our distributions as of September 30, 2014, 33% would be from ordinary income and 67% would be a return of capital. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.

25

On December 22, 2010, the Regulated Investment Company Modernization Act of 2010, or the Modernization Act, was enacted, which changed various technical rules governing the tax treatment of RICs. The changes are generally effective for taxable years beginning after the date of enactment. One of the more prominent changes addresses capital loss carryforwards. Under the Modernization Act, each RIC will be permitted to carry forward capital losses incurred in taxable years beginning after the date of enactment for an unlimited period. However, any losses incurred during those subsequent taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to expire unused. Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short-term as permitted under previous regulation. For the tax years ended December 31, 2013, 2012 and 2011, we have total net capital losses of $120.5 million which have no expiration and will be carried forward indefinitely to offset future net capital gains. Capital loss carryforwards from tax years 2009 of $54.2 million and 2010 of $5.2 million will expire December 31, 2017 and December 31, 2018, respectively, unless utilized to offset future net capital gains prior to those expiration dates to the extent permitted by federal tax law.
Taxable income differs from net income recognized in accordance with accounting principles generally accepted in the United States, or GAAP, because of temporary and permanent differences in income and expense recognition.
Taxable income generally excludes unrealized gains and losses from appreciation or depreciation of our investments, which are included in GAAP net income. Further, amounts recognized for financial reporting purposes may differ from amounts included in taxable income due to the accrued dividends on preferred stock, which increase the book basis but not the tax basis of our investments, and non-accrual interest on loans, which increase the tax basis but not book basis.

26

NOTE 10—EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted income per common share for the three and nine months ended September 30, 2014 and 2013:
(dollars in thousands, except per share amounts)
Three months ended September 30,
Nine months ended September 30,
 
2014
2013
2014
2013
Numerator for basic and diluted earnings per share
 
 
 
 
Net income (loss)
$
1,285

$
3,289

$
(22,919
)
$
19,615

Less: Dividends declared—common and restricted shares
(2,337
)
(8,902
)
(15,428
)
(26,706
)
Undistributed loss
(1,052
)
(5,613
)
(38,347
)
(7,091
)
Percentage allocated to common shares(a)
99.2
%
98.4
%
100.0
%
98.4
%
Undistributed earnings—common shares
(1,044
)
(5,523
)
(38,347
)
(6,978
)
Add: Dividends declared—common shares
2,318

8,760

15,428

26,284

Numerator for common shares outstanding excluding participating shares
1,274

3,237

(22,919
)
19,306

Numerator for participating unvested shares only
11

52

—

309

Numerator for basic and diluted earnings per share—total
$
1,285

$
3,289

$
(22,919
)
$
19,615

Denominator for basic and diluted weighted-average shares outstanding
 
 
 
 
Common shares outstanding
49,428

70,109

59,942

70,189

Participating unvested shares(b)
377

1,109

—

1,124

Basic and diluted weighted-average common shares outstanding—total
49,805

71,218

59,942

71,313

Earnings (loss) per share—basic and diluted
 
 
 
 
Excluding participating unvested shares
$
0.03

$
0.05

$
(0.38
)
$
0.28

Including participating unvested shares
$
0.03

$
0.05

$
(0.38
)
$
0.28

 
 
 
 
 
 
(a) Basic and diluted weighted-average common shares:
 
 
 
 
Weighted-average common shares outstanding
49,428

70,109

59,942

70,189

Weighted-average restricted shares(b)
377

1,109

—

1,124

Total basic and diluted weighted-average common shares
49,805

71,218

59,942

71,313

Percentage allocated to common shares
99.2
%
98.4
%
100.0
%
98.4
%
(b)     For the nine months ended September 30, 2014, we excluded 592 weighted-average shares of restricted common stock from the calculation of diluted loss per share because the inclusion of these shares would have had an anti-dilutive impact on the calculation of loss per share.
Holders of unvested shares of our issued and outstanding restricted common stock are eligible to receive non-forfeitable dividends. As such, these unvested shares are participating securities requiring the two-class method of computing earnings per share in periods with net income. Pursuant to the two-class method, we report basic and diluted loss per share both inclusive and exclusive of the impact of the participating securities.
NOTE 11—COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
We are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations.
FINANCIAL INSTRUMENTS
During the normal course of business, we are party to certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments. We conduct extensive due diligence and, when appropriate, obtain collateral to limit our credit risk. Generally, these commitments have fixed expiration dates or other termination clauses, which may require payment of a fee by the counterparty. We expect many of these commitments

27

will not be fully used before they expire; therefore, the total commitment amounts do not necessarily represent future cash requirements.
We do not report the unused portions of these commitments on our Consolidated Balance Sheets. As of September 30, 2014 and December 31, 2013, we had $2.0 million and $18.1 million, respectively, of outstanding unused loan commitments. We estimate that as of each of September 30, 2014 and December 31, 2013, the fair value of these commitments was less than $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. As of September 30, 2014 and December 31, 2013, we had no outstanding guarantees or standby letters of credit.
LEASE OBLIGATIONS
The lease on our headquarters in Arlington, Virginia has a term from October 2012 through November 2014 with a base rent of $0.4 million per year. The base rent will not increase during the term of the lease. In February 2014, we entered into a new lease for our headquarters in Arlington, Virginia which has a term from December 2014 through December 2015. We have an option to extend the new lease for one additional one year period, which may be exercised prior to December 31, 2014. The base rent for the new lease is $0.7 million per year with a $0.2 million rent credit. The base rent will not increase during the term of the new lease. As of September 30, 2014, our obligations for the remaining term of the lease is $0.6 million, of which $0.5 million will be payable during the next twelve months.

28

NOTE 12—FINANCIAL HIGHLIGHTS
The following schedule summarizes our financial highlights for the nine months ended September 30, 2014 and 2013:
 
Nine months ended
(in thousands, except per share amounts)
September 30
 
2014
2013
Per share data
 
 
Net asset value at beginning of period(a)
$
4.74

$
5.18

Net (loss) income(b)


 
Net operating income before net investment gain (loss) and income tax provision
0.07

0.33

Net realized loss on investments
(0.75
)
(0.02
)
Net unrealized appreciation (depreciation) on investments
0.30

(0.03
)
Income tax provision
—

—

Net income (loss)
(0.38
)
0.28

Net decrease in net assets resulting from distributions
 
 
Distributions declared from net operating income
(0.08
)
(0.29
)
Distributions declared in excess of net operating income
(0.17
)
(0.09
)
Net decrease in net assets resulting from distributions
(0.25
)
(0.38
)
Net increase in net assets relating to stock-based transactions


 
Repurchase of common stock(b)
0.31

—

Net increase in stockholders’ equity from restricted stock amortization(b)
0.03

0.02

Net increase in stockholders’ equity from other stock transactions(b)
0.03

—

Net increase in net assets relating to stock-based transactions
0.37

0.02

Net asset value at end of period(a)
4.48

5.10

Market price per share

 
Beginning of period
$
4.26

$
4.60

End of period
$
3.52

$
5.04

Total Return(c)
-11.62
 %
17.72
%
Shares of Common Stock Outstanding


 
Weighted-average—basic and diluted
59,942

71,313

End of period
45,965

71,212

Net assets


 
Average
$
270,486

$
367,445

End of period
$
205,968

$
363,501

Ratios (annualized)


 
Operating expenses to average net assets
10.20
 %
5.74
%
Net operating income to average net assets
1.93
 %
8.60
%
General and administrative expense to average net assets
3.84
 %
1.44
%
Return on average equity
-11.33
 %
7.16
%
__________________
(a) Based on total number of shares outstanding.
 
 
(b) Based on weighted-average number of shares outstanding.
 
 
(c) Total return = [(ending market price per share – beginning market price per share + dividends paid per share) / beginning market price per share].
NOTE 13—SIGNIFICANT SUBSIDIARY
We have determined that for the nine months ended September 30, 2014, RadioPharmacy Investors, LLC, or RadioPharmacy, is an unconsolidated portfolio company that meets the conditions of a significant subsidiary and therefore, we are presenting unaudited summarized financial information of RadioPharmacy as of the most recent periods for which data is available. RadioPharmacy is a private company, which has prepared financial statements in accordance with GAAP but not in accordance with Regulation S-X.

29

RadioPharmacy is a nuclear compounding pharmacy for regional hospitals and imaging centers. During the nine months ended September 30, 2014, we recognized $1.7 million of total revenue from our investment in RadioPharmacy. The following table sets forth summarized balance sheet information for RadioPharmacy as of September 30, 2014 and December 31, 2013.
(in thousands)
September 30, 2014
December 31, 2013
 
(unaudited)
(unaudited)
Assets:
 
 
Total current assets
$
5,782

$
6,573

Total non-current assets
19,364

19,409

Total assets
$
25,146

$
25,982

 
 
 
Liabilities and Stockholders' Equity:
 
 
Current liabilities
$
3,932

$
3,351

Long-term liabilities
18,374

20,411

Preferred stock
1

1

Other stockholders' equity
2,839

2,219

Total liabilities and stockholders' equity
$
25,146

$
25,982

The following table sets forth summarized income statement information for RadioPharmacy for the nine months ended September 30, 2014 and 2013.
 
Nine months ended September 30,
(in thousands)
2014
2013
 
(unaudited)
(unaudited)
Sales
$
20,227

$
19,894

Gross margin
$
12,195

$
11,753

Net income (loss)
$
620

$
151

NOTE 14—SUBSEQUENT EVENTS
Tender Offer
On October 29, 2014, we announced that we expected to commence a modified “Dutch Auction” tender offer to purchase up to $75.0 million of our common stock at a price per share not less than $3.25 and not greater than $3.75. The tender offer is expected to commence on November 3, 2014, and will expire on December 3, 2014, unless extended. Until the expiration of the tender offer, we have suspended our previously announced stock repurchase program.



30

Review Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
MCG Capital Corporation
We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation, including the consolidated schedule of investments, as of September 30, 2014, the related consolidated statements of operations for the three- and nine- month periods ended September 30, 2014 and 2013, and the related consolidated statements of changes in net assets, cash flows and financial highlights for the nine-month periods ended September 30, 2014 and 2013. These financial statements are the responsibility of MCG Capital Corporation’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of MCG Capital Corporation as of December 31, 2013, including the consolidated schedule of investments, and the related consolidated statements of operations, changes in net assets, cash flows, and financial highlights for the year then ended (not presented herein), and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated March 5, 2014. In our opinion, the accompanying consolidated balance sheet as of December 31, 2013, including the consolidated schedule of investments, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ ERNST & YOUNG LLP
McLean, Virginia
October 29, 2014


31

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information contained in this section should be read in conjunction with the Selected Financial Data and our Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management including, without limitation: our expectations regarding our results of operations, including revenues, net operating income, net investment losses and general and administrative expenses and the factors that may affect such results; our intentions to commence, and the potential impact of, a self-tender offer for up to $75 million of our common stock when there can be no assurance that we will complete such an offer at such amounts or price levels or at all; our future intentions to repurchase shares of our common stock under our stock repurchase program subject to applicable law; our expectations regarding future monetizations of our investment portfolio; potential future transactions involving the Company, including a sale, a restructuring, a recapitalization, a special dividend to stockholders, a liquidation or other transaction or series of transactions, when there can be no assurance that we will engage in any such transaction, that any such transaction will be successfully consummated or of the value of such transaction if consummated; the sufficiency of liquidity to meet 2014 operating requirements, new origination opportunities, potential dividend distributions and any stock repurchases under our tender offer or under our stock repurchase program; our expectations regarding the full use before expiration of certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments; our decisions to make dividend distributions after taking into account our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio; the use of our available liquidity to pay dividends to our stockholders and to repurchase our common stock in our planned tender offer and in the open market under our stock repurchase program; our use of independent valuation firms to provide additional support for our internal analyses; our expectations regarding the outcome of legal proceedings incidental to our business; general market conditions; the state of the economy and other factors. Forward-looking statements can be identified by terminology such as “anticipate,” “believe,” “could,” “could increase the likelihood,” “hope,” “target,” “project,” “goals,” “potential,” “predict,” “might,” “estimate,” “expect,” “intend,” “is planned,” “may,” “should,” “will,” “will enable,” “would be expected,” “look forward,” “may provide,” “would” or similar terms, variations of such terms or the negative of those terms. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those risk factors discussed in Item IA of Part II of this Quarterly Report on Form 10-Q.
Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report on Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
DESCRIPTION OF BUSINESS
We are a solutions-focused commercial finance company that provides capital and advisory services to lower middle-market companies throughout the United States. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, refinance existing debt, buyouts, organic growth, working capital and other general corporate purposes.
We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. As a BDC we must meet various regulatory tests, which include investing at least 70% of our total assets in private or thinly traded public U.S.-based companies and limitations on our ability to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt generally may not exceed 50% of the value of our assets).
In addition, we have elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code. In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements. If we satisfy these requirements, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders as distributions, allowing us to substantially reduce or eliminate our

32

corporate-level tax liability. From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities. In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.
RECENT DEVELOPMENTS — Q3 2014
•
Strategic Exit of SBIC Fund - In September 2014, we prepaid in full the $150 million of SBIC debentures owed to the United States Small Business Administration, or SBA, by Solutions Capital I, L.P., or Solutions Capital, using excess restricted cash. After repayment, Solutions Capital surrendered its small business investment company, or SBIC, license to the SBA’s Office of SBIC Operations. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense. From 2005-2014, Solutions Capital invested $468 million in 36 U.S. small businesses generating an approximate 12% IRR on its portfolio investments based on the total amounts invested and amounts received through the exit of the investments.
•
Open-Market Purchases of Our Stock - During the quarter ended September 30, 2014, we repurchased 8,285,836 shares of our common stock at a weighted average purchase price of $3.97 equal to an 11.4% discount to our September 30, 2014 Net Asset Value, or NAV, per share. We acquired these shares in open market transactions. We retire these shares upon settlement, thereby reducing the number of shares issued and outstanding. From January 1, 2014 to October 16, 2014, we repurchased 26,816,896 shares of our common stock at a weighted average purchase price of $3.71 equal to a 17.2% discount to our September 30, 2014 NAV per share.
•
Originations and Advances - We made $0.6 million in advances to existing portfolio companies, principally paid-in-kind interest, or PIK, interest and dividends, a majority of which we collected in the same quarter ended September 30, 2014.
•
Loan Monetizations - We received $100.8 million in loan payoffs and amortization payments. We exited nine loans and sold a portion of three investments to reduce our per investment concentration and to maintain our qualification as a regulated investment company.
•
Equity Monetizations - We received $5.3 million in proceeds principally from the sale of our preferred stock in C7 Data Centers, Inc., Legacy Cabinets Holdings II, Inc. and Summit Business Media Parent Holding Company LLC.
•
Loans on Non-Accrual - We exited all of our non-accrual loans with a fair value greater than zero and we put no new loans on non-accrual during the quarter. We have one subordinated loan to GMC Broadcasting, LLC on non-accrual at $7.0 million cost (8.3% of the total loan portfolio) and zero at fair value (0.0% of the total loan portfolio).
•
Operating Costs - Our total operating costs, excluding interest expense, were $3.2 million, or 1.5% of total assets of $211.2 million. We incurred $0.4 million in salaries and benefits related to successful Solutions Capital investment exits that occurred during the quarter, $0.1 million in amortization of employee restricted stock awards, $0.5 million in general and administrative expense associated with contractual payments due our former CEO tied to successful Solutions Capital investment exits that occurred during the quarter and employee severance costs and $0.6 million in general and administrative expense related to our lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., all of which we include in total operating costs.
OUTLOOK
We continued to take steps in the third quarter ended September 30, 2014 to strengthen our balance sheet by selling assets that, in our judgment, did not produce adequate compensation for the assumed risk relative to purchasing our stock in open-market transactions, which we acquired at an 11.4% discount to our NAV per share at September 30, 2014. In October 2014, we continued to buy back our stock in the open market and we purchased 2,458,300 shares at an average price of $3.52, which we anticipate will result in an additional $0.05 per share accretion to our NAV in the fourth quarter.

33

As we stated previously, we believe that current market conditions in our primary lending markets are consistent with a peak of a credit cycle. We believe that we have successfully monetized challenging investments into a very liquid market, improving the quality of our assets and our cash position and resulting in a stronger balance sheet. We also elected to use excess cash to repay all of our outstanding debt and to repurchase our stock in the open market. As a result of these capital allocation decisions, we have meaningfully reduced the size of our balance sheet and our net earning assets. Though we continue to take steps to rationalize our cost infrastructure and to strengthen our balance sheet, we do not have sufficient net earning assets to generate positive net operating income at this time.
Our board of directors has decided not to declare a dividend for the quarter ended September 30, 2014. Future distributions, if any, will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.
Based on the volume of shares that we have been able to acquire at prices significantly below our NAV, we believe that a significant number of our shareholders are seeking liquidity in our stock. To that end, in November 2014 we intend to commence a tender offer for up to $75 million of our stock in the price range of $3.25 to $3.75 per share. We intend to use unencumbered cash to fund the repurchase of our shares acquired through this tender offer. Upon completion or termination of the self-tender offer and subject to applicable law, we may reinstitute the open market share purchase program that we initiated in August 2014, which is presently suspended until the termination of the tender offer.
We expect to continue to monetize our investment portfolio in the ordinary course of business, which may include a sale of any or all of our investments to a third party. We may receive offers or engage in a transaction in the ordinary course which may ultimately result in a sale of any or all of our investments at, above or below the fair value of the investment on our balance sheet at that time. We may also consider a variety of extraordinary transactions, such as a sale of the Company, a restructuring, a recapitalization, a special dividend to stockholders, a liquidation or other transaction or series of transactions. Any such transaction could result in proceeds to stockholders at that time above the tender offer price and/or above the book value of our investments, although there is no assurance (i) that we will engage in any such transaction, (ii) that any such transaction will be successfully consummated or (iii) that the value of such transaction if consummated will be at or above the tender offer price or book value.
ACCESS TO CAPITAL AND LIQUIDITY
At September 30, 2014, we had $114.6 million of cash and cash equivalents available for general corporate purposes and $1.6 million of restricted cash held in escrow.
On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.
On January 21, 2014, we repaid and terminated our MCG Commercial Loan Trust 2006-1, or 2006-1 Trust. As of December 31, 2013, we had $25.2 million of securitized Class D Notes outstanding under the 2006-1 Trust, which was secured by $76.3 million of loans and equity investments and $13.9 million of cash. Upon termination, the assets of the 2006-1 Trust were transferred to MCG, the parent.
PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY
As of September 30, 2014, the fair value of our investment portfolio was $93.6 million, which represents a $275.3 million, or 74.6%, decrease from the $368.9 million fair value as of December 31, 2013. The following sections describe the composition of our investment portfolio as of September 30, 2014 and key changes in our portfolio during the nine months ended September 30, 2014.

34

Portfolio Composition
The following table summarizes the composition of our investment portfolio at fair value:
 
September 30, 2014
December 31, 2013
(dollars in thousands)
Investments at
Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Debt investments
 
 
 
 
Senior secured debt
41,029

43.8
%
$
185,524

50.3
%
Subordinated debt
 
 
 
 
Secured
27,283

29.2

108,338

29.4

Unsecured
9,848

10.5

42,452

11.5

Total debt investments
78,160

83.5

336,314

91.2

Equity investments
 
 
 
 
Preferred equity
13,632

14.6

28,390

7.7

Common/common equivalents equity
1,778

1.9

4,169

1.1

Total equity investments
15,410

16.5

32,559

8.8

Total investments
$
93,570

100.0
%
$
368,873

100.0
%
Our debt instruments bear contractual interest rates ranging from 2.5% to 14.5%, a portion of which may be in the form of PIK. As of September 30, 2014, approximately 63.4% of the fair value of our loan portfolio had variable interest rates, based on either the London Interbank Offer Rate, or LIBOR, or the prime rate, and 36.6% of the fair value of our loan portfolio had fixed interest rates. As of September 30, 2014, approximately 51.5% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 2.0% on a LIBOR-based index or prime floors between 2.8% and 4.5%. At origination, our loans generally have four- to six-year stated maturities. Borrowers typically pay an origination fee based on a percentage of the total commitment and a fee on undrawn commitments.
The following table summarizes our investment portfolio by industry at fair value:
 
September 30, 2014
December 31, 2013
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
46,284

49.5
%
$
84,922

23.0
%
Business services
26,200

28.0

64,108

17.4

Manufacturing
10,056

10.7

51,735

14.0

Broadcasting
9,165

9.8

12,252

3.3

Diversified financial services
1,600

1.7

3,298

0.9

Education
—

—

57,905

15.7

Publishing
—

—

25,312

6.9

Insurance
—

—

23,620

6.4

Restaurants
—

—

23,010

6.2

Investment fund
—

—

12,552

3.4

Home furnishings
—

—

4,730

1.3

Consumer products
—

—

4,657

1.3

Other(a)
265

0.3

772

0.2

Total
$
93,570

100.0
%
$
368,873

100.0
%
______________________
(a)    No individual industry within this category exceeds 1%.
 
 
 
 
As of September 30, 2014, our ten largest portfolio companies represented approximately 99.3% of the total fair value of our investments. These ten companies accounted for 38.21% of our total revenue during the nine months ended September 30, 2014.

35

During the nine months ended September 30, 2014, we had concentrations in certain industries, including the healthcare, business services, and manufacturing industries. The following table summarizes our fair value and revenue concentrations in each of those industries:
 
Investments at fair value
Revenue for the nine months ended
 
September 30, 2014
December 31, 2013
September 30, 2014
September 30, 2013
(dollars in thousands)
Amount
% of Total Portfolio
Amount
% of Total Portfolio
Amount
% of Total Revenue
Amount
% of Total Revenue
Industry
 
 
 
 
 
 
 
 
Healthcare
$
46,284

49.5
%
$
84,922

23.0
%
$
6,476

26.4
%
$
10,189

25.9
%
Business services
26,200

28.0

64,108

17.4

6,116

24.9

6,073

15.4

Manufacturing
10,056

10.7

51,735

14.0

5,241

21.4

4,424

11.3

Total
$
82,540

88.2

$
200,765

54.4

$
17,833

72.7

$
20,686

52.6

Changes in Investment Portfolio
The following table summarizes our total portfolio investment activity during the nine months ended September 30, 2014 and 2013:
 
Nine months ended
(in thousands)
September 30
 
2014
2013
Beginning investment portfolio
$
368,873

$
477,724

Originations and advances
9,936

91,032

Gross payments, reductions and sales of securities
(260,707
)
(170,566
)
Net realized loss
(44,522
)
(961
)
Unrealized depreciation
(24,327
)
(5,286
)
Reversals of unrealized depreciation
41,987

2,610

Origination fees and amortization of unearned income
2,330

979

Ending investment portfolio
$
93,570

$
395,532

Originations and Advances
The following table shows our originations and advances during the nine months ended September 30, 2014 and 2013 by security type:
 
Nine months ended September 30,
 
2014
2013
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
Senior secured debt
$
6,451

64.9
%
$
71,178

78.2
%
Subordinated debt
 
 
 
 
Secured
2,089

21.0

3,570

3.9

Unsecured
551

5.5

13,322

14.6

Total debt investments
9,091

91.4

88,070

96.7

Equity investments
 
 
 
 
Preferred equity
845

8.6

2,959

3.3

Common/common equivalents equity
—

—

3

—

Total equity investments
845

8.6

2,962

3.3

Total originations and advances
$
9,936

100.0
%
$
91,032

100.0
%

36

The following table shows our significant originations and advances:
(in thousands)
Nine months ended
 
September 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

2,774

4,174

Total debt
—

6,317

2,774

9,091

Equity
 
 
 
 
Other (< $1 million)
—

298

547

845

Total Equity
—

298

547

845

Total originations and advances
$
—

$
6,615

$
3,321

$
9,936

Repayments, Sales and Other Reductions of Investment Portfolio
The following table shows our gross payments, reductions and sales of securities during the nine months ended September 30, 2014 and 2013 by security type:
 
Nine months ended September 30,
 
2014
2013
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
Senior secured debt
$
146,802

56.3
%
$
141,011

82.7
%
Subordinated debt
 
 
 
 
Secured
69,303

26.6

4,500

2.6

Unsecured
33,616

12.9

16,935

9.9

Total debt investments
249,721

95.8

162,446

95.2

Equity investments
 
 
 
 
Preferred equity
9,829

3.8

5,117

3.0

Common/common equivalents equity
1,157

0.4

3,003

1.8

Total equity investments
10,986

4.2

8,120

4.8

Total gross payments, reductions and sales of securities
$
260,707

100.0
%
$
170,566

100.0
%
During the nine months ended September 30, 2014 and 2013, our gross payments, reductions and sales of securities by transaction type included:  
 
Nine months ended September 30,
(in thousands)
2014
2013
Principal repayments, reductions and loan sales
$
213,869

$
136,932

Sale of equity investments
10,239

7,440

Scheduled principal amortization
23,717

23,352

Collection of accrued paid-in-kind interest and dividends
12,882

2,842

Total gross payments, reductions and sales of securities
$
260,707

$
170,566


37

As shown in the following table, during the nine months ended September 30, 2014, we monetized 25 portfolio investments with proceeds totaling $234.7 million:
 
Nine months ended
 
September 30, 2014
(in thousands)
Principal Repayments and Proceeds from Loan Sales
Sale or Settlement of Equity Investments
PIK Interest and Dividend Prepayments
Total
Monetizations
 
 
 
 
TCFI CP LLC
$
20,000

$
—

$
282

$
20,282

Miles Media Group, LLC
18,463

—

—

18,463

G&L Investment Holdings, LLC
17,500

4,196

2,060

23,756

Cruz Bay Publishing, Inc.
16,857

—

5,345

22,202

Ted's Café Escondido Holdings, Inc.
14,306

—

—

14,306

Oceans Acquisition, Inc.
14,251

—

—

14,251

IDOC, LLC
13,832

—

—

13,832

Huron Inc.
12,868

—

200

13,068

Midwest Technical Institute, Inc.
12,251

—

—

12,251

West World Media LLC
10,576

446

919

11,941

Dorsey's School of Business Holdings, Inc.
9,653

—

—

9,653

SC Academy Holdings, Inc.
9,534

—

1,530

11,064

Rita's Water Ice Franchise Company, LLC
9,282

—

—

9,282

Hammond's Candies Since 1920 II, LLC
9,000

—

508

9,508

Community Investors, Inc.
8,292

—

—

8,292

Visant Corporation
4,670

—

—

4,670

Advanced Sleep Concepts, Inc.
4,518

—

—

4,518

C7 Data Centers, Inc.
—

4,000

—

4,000

Education Management, Inc.
3,962

—

—

3,962

Mailsouth, Inc.
3,529

—

—

3,529

Other < 1 Million
525

1,254

57

1,836

Total monetizations
213,869

9,896

10,901

234,666

Other scheduled payments
23,717

343

1,981

26,041

Total gross payments, sales and other reductions of investment portfolio
$
237,586

$
10,239

$
12,882

$
260,707

The proceeds from these monetizations correlated closely with the most recently reported fair value of the associated investments.
Secured Financing
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 would receive 100% of the payments related to the loan, including interest and principal, until the total payments received exceeded the purchase price plus any additional advances funded by the purchaser to Advanced Sleep and certain expenses incurred by the purchaser. Thereafter, the purchaser would receive 95% and we would receive 5% of any payments received from Advanced Sleep. Under the terms of the sale, the purchaser had no recourse to us for any payments. We continued to service the Advanced Sleep loans on behalf of the purchaser.
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 did not meet the definition of a participating interest under ASC 860 resulting in the loans remaining on our Consolidated Balance Sheets and the proceeds from the sale being recorded as a secured financing. In September 2014, we sold the remaining participation interest in our senior and subordinated loans. The sale of the remaining interest resulted in the derecognition of the loans to Advanced Sleep and the liability for the secured financing and the realization of a loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million on our Consolidated Income Statement. In addition, we no longer service the loans on behalf of the purchaser.
ASSET QUALITY
Asset quality is generally a function of portfolio company performance and economic conditions, as well as our underwriting and ongoing management of our investment portfolio. In addition to various risk management and monitoring tools, we use the following investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio:
Investment
Rating
Summary Description
1
Capital gain expected or realized
2
Full return of principal and interest or dividend expected with customer performing in accordance with plan
3
Full return of principal and interest or dividend expected, but customer requires closer monitoring
4
Some loss of interest or dividend expected, but still expect an overall positive internal rate of return on the investment
5
Loss of interest or dividend and some loss of principal investment expected, which would result in an overall negative internal rate of return on the investment
The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of September 30, 2014 and December 31, 2013:
(dollars in thousands)
September 30, 2014
December 31, 2013
Investment
Rating
Investments at
Fair Value
% of Total
Portfolio
Investments at
Fair Value
% of Total 
Portfolio
1(a)
$
1,945

2.1
%
$
104,657

28.4
%
2
43,555

46.5

137,586

37.3

3
36,205

38.7

94,102

25.5

4
10,716

11.5

25,976

7.0

5
1,149

1.2

6,552

1.8

Total
$
93,570

100.0
%
$
368,873

100.0
%
_________________________
(a) 
As of December 31, 2013, Investment Rating “1” included $83.4 million of loans to companies in which we also hold equity securities.
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place all or a portion of the loan on non-accrual status and will cease recognizing interest income on that loan until all principal and interest have been brought current through payment or a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.

38

The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status.
 
COST BASIS
FAIR VALUE BASIS
 
September 30, 2014
December 31, 2013
September 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
$
—

—
%
$
3,897

1.11
%
$
—

—
%
$
—

—
%
Total loans greater than 90 days past due
$
—

—
%
$
3,897

1.11
%
$
—

—
%
$
—

—
%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
6,975

8.32
%
$
17,531

4.98
%
$
—

—
%
$
4,493

1.34
%
Greater than 90 days past due
—

—

3,897

1.11

—

—

—

—

Total loans on non-accrual status
$
6,975

8.32
%
$
21,428

6.09
%
$
—

—
%
$
4,493

1.34
%
The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2013 through September 30, 2014:
 
Nine months ended
 
September 30, 2014
(In thousands)
Cost
Fair Value
Non-accrual loan balance as of December 31, 2013
$
21,428

$
4,493

Additional loan on non-accrual status
19,856

4,879

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

(515
)
Payments received from loans on non-accrual status
(9,469
)
(9,469
)
Reversal of previously recognized unrealized loss on non-accrual loans
—

25,452

Realized loss on non-accrual loans
(24,840
)
(24,840
)
Total change in non-accrual loans
(14,453
)
(4,493
)
Non-accrual loan balance as of September 30, 2014
$
6,975

$
—


39

Results of Operations
The following section compares our results of operations for the three months ended September 30, 2014 to the three months ended September 30, 2013.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
The following table summarizes the components of our net income for the three months ended September 30, 2014 and 2013:
 
Three months ended September 30,
Variance
(dollars in thousands)
2014
2013
$
Percentage
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Interest income
$
4,010

$
10,717

$
(6,707
)
(62.6
)%
Dividend income
322

847

(525
)
(62.0
)
Loan fees
941

1,023

(82
)
(8.0
)
Total interest and dividend income
5,273

12,587

(7,314
)
(58.1
)
Advisory fees and other income
391

583

(192
)
(32.9
)
Total revenue
5,664

13,170

(7,506
)
(57.0
)
Operating expenses
 
 
 
 
Interest expense
3,483

2,316

1,167

50.4

Employee compensation








Salaries and benefits
996

644

352

54.7

Amortization of employee restricted stock
127

420

(293
)
(69.8
)
Total employee compensation
1,123

1,064

59

5.5

General and administrative expense
2,034

1,824

210

11.5

Restructuring expense
—

2

(2
)
(100.0
)
Total operating expense
6,640

5,206

1,434

27.5

Net operating (loss) income before net investment gain (loss) and income tax (benefit) provision
(976
)
7,964

(8,940
)
NM

Net investment gain (loss) before income tax provision
2,109

(4,616
)
6,725

NM

Income tax (benefit) provision
(152
)
59

(211
)
NM

Net income (loss)
$
1,285

$
3,289

$
(2,004
)
(60.9
)
NM=Not Meaningful
 
 
 
 
TOTAL REVENUE
Total revenue includes interest and dividend income, loan fees, advisory fees and other income. The following sections describe the reasons for the variances in each major component of our revenue during the three months ended September 30, 2014 from the three months ended September 30, 2013.
INTEREST INCOME
The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments. During the three months ended September 30, 2014, the total yield on our average debt portfolio at fair value was 13.3% compared to 12.4% during the three months ended September 30, 2013. The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.

40

The following table shows the various components of the total yield on our average debt portfolio at fair value for the three months ended September 30, 2014 and 2013:
 
Three months ended September 30,
 
2014
2013
Average 90-day LIBOR
0.2
 %
0.3
 %
Spread to average LIBOR on average loan portfolio
12.4

12.0

Impact of fee accelerations of unearned fees on paid/restructured loans
1.4

0.6

Impact of non-accrual loans
(0.7
)
(0.5
)
Total yield on average loan portfolio
13.3
 %
12.4
 %
During the three months ended September 30, 2014, interest income was $4.0 million, compared to $10.7 million during the three months ended September 30, 2013, which represented a $6.7 million, or 62.6%, decrease. This decrease reflected a $6.2 million decrease in interest income resulting from a 60.7% decrease in our average loan balance, a decrease of $0.9 million resulting from loans that were on non-accrual status during the three months ended September 30, 2014, but that had been accruing interest during the three months ended September 30, 2013, and a $0.1 million decrease due to interest rate floors. These decreases were partially offset by a $0.4 million increase in interest income attributable to an increase in our net spread to LIBOR.
PIK Income
Interest income includes certain amounts that we have not received in cash, such as PIK interest. PIK interest represents contractually deferred interest that is added to the principal balance of the loan and compounded if not paid on a current basis. Borrowers may, in some instances, be required to prepay PIK because of certain contractual provisions or they may choose to prepay; however, more typically, PIK is paid at the end of the loan term. The following table shows the PIK-related activity for the three months ended September 30, 2014 and 2013, at cost:
 
Three months ended September 30,
(in thousands)
2014
2013
Beginning PIK loan balance
$
4,056

$
9,336

PIK interest earned during the period
248

1,644

Payments received from PIK loans
(1,662
)
(135
)
Realized loss
(1,023
)
—

Ending PIK loan balance
$
1,619

$
10,845

As of each of September 30, 2014 and September 30, 2013, all of our PIK loans were accruing interest. During the three months ended September 30, 2014, the payments received from PIK loans included $0.9 million in payments on our loan to RadioPharmacy Investors, LLC and $0.5 million collected in conjunction with the repayment of our loan to Hammond's Candies Since 1920 II, LLC.
DIVIDEND INCOME
We accrete dividends on equity investments with stated dividend rates as they are earned, to the extent that we believe the dividends will be paid ultimately and the associated portfolio company has sufficient value to support the accretion. Dividend accretion is included in the cost basis of the related equity instrument on our Consolidated Balance Sheets and Consolidated Schedule of Investments. We recognize dividends on other equity investments when we receive the dividend payment. Our dividend income varies from period to period because of changes in the size and composition of our equity investments, the yield from the investments in our equity portfolio and the ability of the portfolio companies to declare and pay dividends. During the three months ended September 30, 2014 and 2013, we recognized $0.3 million and $0.8 million, respectively, of dividend income. In addition, during the three months ended September 30, 2014 and 2013, we received payments on accrued dividends of $0.4 million and $0.2 million, respectively. As of September 30, 2014, the balance of accrued dividends was $7.5 million, which was principally comprised of $6.4 million related to our investment in RadioPharmacy Investors, LLC and $0.8 million related to our investment in Maverick Healthcare Equity, LLC.

41

ADVISORY FEES AND OTHER INCOME
Advisory fees and other income primarily include fees related to prepayment, advisory and management services, equity structuring, syndication, bank interest and other income. Generally, advisory fees and other income relate to specific transactions or services and, therefore, may vary from period to period depending on the level and types of services provided. During the three months ended September 30, 2014, we earned $0.4 million of advisory fees and other income, which represented a $0.2 million, or 32.9%, decrease from the three months ended September 30, 2013. This decrease resulted principally from decreased loan prepayment fees in the third quarter of 2014.
TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the three months ended September 30, 2014, we incurred $3.5 million of interest expense, which represented a $1.2 million, or 50.4%, increase from the same period in 2013. On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital, which had a cost of funds, including the amortization of deferred financing costs, of 4.6%. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense. As of September 30, 2014, we had no outstanding borrowings or borrowing facilities.
During the three months ended September 30, 2014, our average borrowings declined to approximately $125.5 million from an average of approximately $183.5 million for the same period in 2013, which accounted for a $0.5 million reduction in our interest expense. In addition, interest expense decreased by $0.3 million attributable to the spread to LIBOR decreasing from approximately 3.95% to 3.22%. These decreases were offset by $2.0 million related to the increased amortization of debt issuance costs.
EMPLOYEE COMPENSATION
Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards. During the three months ended September 30, 2014, our employee compensation expense was $1.1 million, which represented a $0.1 million, or 5.5%, increase from the same period in September 30, 2013. Our salaries and benefits expense increased by $0.4 million, or 54.7%, due to a $0.7 million increase in incentive compensation, which consisted of $0.4 million tied to successful Solutions Capital investment exits that occurred during the third quarter of 2014 and the reversal, in the third quarter of 2013, of $0.3 million of previously accrued incentive compensation. The increase in incentive compensation was partially offset by a $0.4 million decrease in base salaries and benefits. As of September 30, 2014, we had 11 employees compared to 17 employees as of September 30, 2013. Amortization of employee stock awards decreased $0.3 million, or 69.8%.
GENERAL AND ADMINISTRATIVE
During the three months ended September 30, 2014, general and administrative expense was $2.0 million, which represented a $0.2 million, or 11.5%, increase compared to the same period in 2013.
•
General and administrative expense increased $0.6 million due to an increase in legal fees related to our lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., Vast, Inc. and Color Star LLC.
•
General and administrative expense also increased $0.3 million due to an increase in professional services fees. Professional services fees expense for the three months ended September 30, 2014 included $0.3 million paid under the consulting agreement with our former chief executive officer and incentive compensation tied to successful Solutions Capital investment exits that occurred during the quarter due to our former chief executive officer.
•
These increases in general and administrative expense were offset by a decrease of $0.6 million in severance related to employee terminations.

42

NET INVESTMENT GAIN (LOSS) BEFORE INCOME TAX PROVISION
During the three months ended September 30, 2014, we recorded $2.1 million of net investment gain before income tax (benefit) provision, compared to $4.6 million of net investment loss during the same period in 2013. These amounts represent the total of net realized gains and (losses), net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation. We reverse unrealized (appreciation) depreciation at the time that we realize the gain or (loss). The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2014:
 
 
 
Three months ended September 30, 2014
(in thousands)
 
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Note
RadioPharmacy Investors, LLC
1
Healthcare
Control
$
—

$
2,286

$
—

$
2,286

Golden Knight II CLO, Ltd.
2
Diversified Financial Services
Non-Affiliate
—

(1,614
)
—

(1,614
)
C7 Data Centers, Inc.
3
Broadcasting
Affiliate
2,000

—

(1,275
)
725

Jet Plastica Investors, LLC
4
Plastic Products
Control
(3,371
)
—

3,897

526

Summit Business Media Parent Holding Company LLC
5
Information Services
Non-Affiliate
(5,717
)
—

5,305

(412
)
Education Management, Inc.
6
Education
Affiliate
(20,727
)
—

20,810

83

Advanced Sleep Concepts, Inc.
7
Home Furnishings
Non-Affiliate
(5,741
)
—

5,746

5

Legacy Cabinets Holdings II, Inc.
8
Home Furnishings
Non-Affiliate
(1,665
)
—

1,665

—

Other (< $1.0 million net gain (loss))
 
 
 
(883
)
(50
)
1,443

510

Total
 
 
 
$
(36,104
)
$
622

$
37,591

$
2,109

_______________________
1.
We recorded $2.3 million of unrealized appreciation on our investment in RadioPharmacy Investors, LLC to reflect improvement in that portfolio company's operating performance.
2.
In October 2014, we sold our investment in Golden Knight II CLO, Ltd. for proceeds of $1.6 million. The September 30, 2014 value of that investment reflects the market price indicated by the sale.
3.
We sold our equity investment in C7 Data Centers, Inc. for net proceeds of $4.0 million resulting in a realized gain of $2.0 million and the reversal of previously recorded unrealized appreciation of $1.3 million.
4.
We received the final proceeds for the sale of the assets of Jet Plastica Investors, LLC of $0.5 million resulting in a realized loss of $3.4 million and the reversal of previously recorded unrealized depreciation of $3.9 million.
5.
We sold our equity investment in Summit Business Media Parent Holding Company LLC for net proceeds of $0.2 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.3 million.
6.
We sold our senior debt and preferred stock investment in Education Management, Inc. for net proceeds of $3.5 million resulting in a realized loss of $20.7 million and the reversal of previously recorded unrealized depreciation of $20.8 million.
7.
We sold our senior and subordinated debt investment in Advanced Sleep for net proceeds of $4.5 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million.
8.
We sold our equity investment in Legacy Cabinets Holdings II, Inc. for net proceeds of $0.5 million resulting in a realized loss of $1.7 million and the reversal of previously recorded unrealized depreciation of $1.7 million.
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from the change in the performance of certain of our portfolio companies.

43

The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2013:
 
 
Three months ended September 30, 2013
(in thousands)
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
G&L Investment Holdings, LLC
Insurance
Non-Affiliate
$
—

$
(2,915
)
$
—

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

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

$
(4,630
)
$
(88
)
$
(4,616
)
In the third quarter of 2013, we recorded $2.9 million of unrealized depreciation on our investment in G&L Investment Holdings, LLC to reflect a decrease in that portfolio company's operating performance.
INCOME TAX (BENEFIT) PROVISION
During the three months ended September 30, 2014, we recorded an income tax benefit of $152,000, which was primarily attributable to an NOL carryback and lower than expected flow-through taxable income on certain investments held by our subsidiaries. During the three months ended September 30, 2013, we recorded an income tax provision of $59,000, which was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.

44

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
The following table summarizes the components of our net (loss) income for the nine months ended September 30, 2014 and 2013:
 
Nine months ended September 30,
Variance
(dollars in thousands)
2014
2013
$
Percentage
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Interest income
$
20,325

$
33,023

$
(12,698
)
(38.5
)%
Dividend income
547

2,662

(2,115
)
(79.5
)
Loan fees
2,419

2,252

167

7.4

Total interest and dividend income
23,291

37,937

(14,646
)
(38.6
)
Advisory fees and other income
1,244

1,369

(125
)
(9.1
)
Total revenue
24,535

39,306

(14,771
)
(37.6
)
Operating expenses
 
 
 
 
Interest expense
7,339

7,003

336

4.8

Employee compensation








Salaries and benefits
3,857

3,610

247

6.8

Amortization of employee restricted stock
1,681

1,174

507

43.2

Total employee compensation
5,538

4,784

754

15.8

General and administrative expense
7,760

3,942

3,818

96.9

Restructuring expense
—

14

(14
)
(100.0
)
Total operating expense
20,637

15,743

4,894

31.1

Net operating income before net investment (loss) and income tax (benefit) provision
3,898

23,563

(19,665
)
(83.5
)
Net investment loss before income tax benefit provision
(26,965
)
(3,837
)
(23,128
)
602.8

Income tax (benefit) provision
(148
)
111

(259
)
NM

Net (loss) income
$
(22,919
)
$
19,615

$
(42,534
)
NM

NM=Not Meaningful
 
 
 
 

TOTAL REVENUE
Total revenue includes interest and dividend income, loan fees, advisory fees and other income. The following sections describe the reasons for the variances in each major component of our revenue during the nine months ended September 30, 2014 from the nine months ended September 30, 2013.
INTEREST INCOME
The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments. During the nine months ended September 30, 2014, the total yield on our average debt portfolio at fair value was 12.2% compared to 12.3% during the nine months ended September 30, 2013. The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.

45

The following table shows the various components of the total yield on our average debt portfolio at fair value for the nine months ended September 30, 2014 and 2013:
 
Nine months ended September 30,
 
2014
2013
Average 90-day LIBOR
0.2
 %
0.3
 %
Spread to average LIBOR on average loan portfolio
11.4

11.9

Impact of fee accelerations of unearned fees on paid/restructured loans
0.7

0.3

Impact of non-accrual loans
(0.1
)
(0.2
)
Total yield on average loan portfolio
12.2
 %
12.3
 %
During the nine months ended September 30, 2014, interest income was $20.3 million, compared to $33.0 million during the nine months ended September 30, 2013, which represented a $12.7 million, or 38.5%, decrease. This decrease reflected a $10.9 million decrease in interest income resulting from a 34.9% decrease in our average loan balance, a decrease of $2.6 million resulting from loans that were on non-accrual status during the nine months ended September 30, 2014, but that had been accruing interest during the nine months ended September 30, 2013, a $0.2 million decrease due to interest rate floors, and a $0.1 million decrease related to the decrease in LIBOR. These decreases were partially offset by a $1.1 million increase in interest income attributable to an increase in our net spread to LIBOR.
PIK Income
The following table shows the PIK-related activity for the nine months ended September 30, 2014 and 2013, at cost:
 
Nine months ended September 30,
(in thousands)
2014
2013
Beginning PIK loan balance
$
12,132

$
9,043

PIK interest earned during the period
2,775

4,320

Payments received from PIK loans
(12,135
)
(2,161
)
Realized loss
(1,153
)
(357
)
Ending PIK loan balance
$
1,619

$
10,845

During nine months ended September 30, 2014, the payments received from PIK loans included $5.3 million collected in connection with the repayment of our loan to Cruz Bay Publishing, Inc., $2.1 million related to the repayment in full of our loan to G&L Investment Holdings, LLC, $1.5 million collected in connection with the sale of our loan to SC Academy Holdings, Inc., $0.9 million collected in connection with the repayment of our loan to West World Media, LLC, $0.9 million in payments on our loan to RadioPharmacy Investors, LLC and $0.5 million collected in connection with the repayment of our loan to Hammond's Candies Since 1920 II, LLC. During the nine months ended September 30, 2013, the payments received from PIK loans included $1.0 million collected in connection with the partial repayment of our investment in Education Management, Inc., as well as $0.8 million collected in connection with the repayment in full of our investment in NDSSI Holdings, LLC.
DIVIDEND INCOME
During the nine months ended September 30, 2014 and 2013, we recognized dividend income of $0.5 million and $2.7 million, respectively. In addition, during each of the nine months ended September 30, 2014 and 2013, we received payments on accrued dividends of $0.7 million. As of September 30, 2014, the balance of accrued dividends was $7.5 million.
ADVISORY FEES AND OTHER INCOME
During the nine months ended September 30, 2014, we earned $1.2 million of advisory fees and other income, which represented a $0.1 million, or 9.1%, decrease from the nine months ended September 30, 2013. This decrease resulted principally from decreased prepayment fees in 2014.

46

TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the nine months ended September 30, 2014, we incurred $7.3 million of interest expense, which represented a $0.3 million, or 4.8%, increase from the same period in 2013. During these respective periods, our average cost to borrow increased to 6.8% from 4.4%, principally due to the repayment of securitized debt in our 2006-1 Trust which carried interest rates ranging from L+0.33% to L+2.25%. On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital, which had a cost of funds, including the amortization of deferred financing costs, of 4.6%. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense. In addition, interest expense for the nine months ended September 30, 2014 includes $0.2 million of interest and deferred financing costs associated with our 2006-1 Trust, which we terminated in January 2014. As of September 30, 2014, we had no outstanding borrowings or borrowing facilities.
During the nine months ended September 30, 2014, our average borrowings declined to approximately $143.2 million from an average of approximately $209.4 million for the same period in 2013, which accounted for a $2.1 million reduction in our interest expense. This decreases was offset by increases of $1.9 million related to decreased amortization of debt issuance costs and $0.6 million attributable to the spread to LIBOR increasing from approximately 3.53% to 3.88%.
EMPLOYEE COMPENSATION
Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards. During the nine months ended September 30, 2014, our employee compensation expense was $5.5 million, which represented a $0.8 million, or 15.8%, increase from the same period in 2013. Our salaries and benefits increased by $0.2 million, or 6.8%, due to a $1.1 million increase in incentive compensation tied to successful Solutions Capital investment exits, offset by a $0.9 million decrease in base salaries and benefits. As of September 30, 2014, we had 11 employees compared to 17 employees as of September 30, 2013. Amortization of employee stock awards increased $0.5 million, or 43.2%. Amortization of employee stock awards for the nine months ended September 30, 2014 includes $1.1 million of accelerated amortization related to the retirement of our former chief executive officer and other employee terminations.
GENERAL AND ADMINISTRATIVE
During the nine months ended September 30, 2014, general and administrative expense was $7.8 million, which represented a $3.8 million, or 96.9%, increase compared to the same period in 2013.
•
General and administrative expense increased $2.0 million due to an increase in severance costs. General and administrative expense for the nine months ended September 30, 2014 included $2.8 million in severance related to the retirement of our former chief executive officer and other employee terminations.
•
General and administrative expense increased $1.5 million due to an increase in legal fees related to our lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., Vast, Inc. and Color Star LLC.
•
In addition, general and administrative expense increased $0.3 million due to an increase in professional services fees. Professional services fees expense for the nine months ended September 30, 2014 included $0.4 million paid under the consulting agreement with our former chief executive officer and incentive compensation tied to successful Solutions Capital investment exits due to our former chief executive officer.

47

NET INVESTMENT LOSS BEFORE INCOME TAX PROVISION
During the nine months ended September 30, 2014, we recorded $27.0 million of net investment loss before income tax (benefit) provision, compared to $3.8 million of net investment loss during the same period in 2013. These amounts represent the total of net realized gains and (losses), net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation. We reverse unrealized (appreciation) depreciation at the time that we realize the gain or (loss). The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2014:
 
 
 
Nine months ended September 30, 2014
(in thousands)
 
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Note
Education Management, Inc.
1
Education
Affiliate
$
(20,727
)
$
(15,984
)
$
20,810

$
(15,901
)
SC Academy Holdings, Inc.
2
Education
Non-Affiliate
(4,037
)
—

—

(4,037
)
RadioPharmacy Investors, LLC
3
Healthcare
Control
—

(3,706
)
—

(3,706
)
Golden Knight II CLO, Ltd.
4
Diversified Financial Services
Non-Affiliate
—

(1,236
)
—

(1,236
)
Jet Plastica Investors, LLC
5
Plastic Products
Control
(3,371
)
—

3,897

526

C7 Data Centers, Inc.
6
Business Services
Affiliate
2,000

(207
)
(1,275
)
518

Summit Business Media Parent Holding Company LLC
7
Information Services
Non-Affiliate
(5,717
)
(27
)
5,305

(439
)
Advanced Sleep Concepts, Inc.
8
Home Furnishings
Non-Affiliate
(5,741
)
317

5,746

322

Legacy Cabinets Holdings II, Inc.
9
Home Furnishings
Non-Affiliate
(1,665
)
283

1,665

283

G&L Investment Holdings, LLC
10
Insurance
Non-Affiliate
(4,416
)
—

4,523

107

Other (< $1.0 million net gain (loss))
 
 
 
(1,150
)
(3,869
)
1,617

(3,402
)
Total
 
 
 
$
(44,824
)
$
(24,429
)
$
42,288

$
(26,965
)
____________________________
1.
We sold our senior debt and preferred stock investment in Education Management, Inc. for net proceeds of $3.5 million resulting in a realized loss of $20.7 million and the reversal of previously recorded unrealized depreciation of $20.8 million.
2.
We sold our subordinated debt investment in SC Academy Holdings, Inc. for net proceeds of $11.1 million resulting in a realized loss of $4.0 million.
3.
We recorded $3.7 million of net unrealized depreciation on our investment in RadioPharmacy Investors, LLC due to reducing our valuation multiple in the first quarter of 2014 based on volume, pricing and supply-cost challenges facing the company's core business, offset by improved performance during 2014.
4.
In October 2014, we sold our investment in Golden Knight II CLO, Ltd. for proceeds of $1.6 million. The September 30, 2014 value of that investment reflects the market price indicated by the sale.
5.
We received the final proceeds for the sale of the assets of Jet Plastica Investors, LLC of $0.5 million resulting in a realized loss of $3.4 million and the reversal of previously recorded unrealized depreciation of $3.9 million.
6.
We sold our equity investment in C7 Data Centers, Inc. for net proceeds of $4.0 million resulting in a realized gain of $2.0 million and the reversal of previously recorded unrealized depreciation of $1.3 million.
7.
We sold our equity investment in Summit Business Media Parent Holding Company LLC for net proceeds of $0.2 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.3 million.
8.
We sold our senior and subordinated debt investment in Advanced Sleep for net proceeds of $4.5 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million.
9.
We sold our equity investment in Legacy Cabinets Holdings II, Inc. for net proceeds of $0.5 million resulting in a realized loss of $1.7 million and the reversal of previously recorded unrealized depreciation of $1.7 million.
10.
In addition, we sold our preferred and common equity investments in G&L Investment Holdings, LLC resulting in a realized loss of $4.4 million and a reversal of previously recorded unrealized depreciation of $4.5 million.
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from the change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.

48

The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2013:
 
 
 
Nine months ended September 30, 2013
(in thousands)
 
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Note
Virtual Radiologic Corporation
1
Healthcare
Non-Affiliate
$
—

$
(3,341
)
$
—

$
(3,341
)
G&L Investment Holdings, LLC
2
Insurance
Non-Affiliate
—

(3,133
)
—

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

1,192

(1,170
)
2,899

Advanced Sleep Concepts, Inc.
4
Home Furnishings
Non-Affiliate
(3,424
)
(458
)
3,249

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

530

371

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

$
(3,837
)
________________________
1.
We recorded $3.3 million of unrealized depreciation on our investment in Virtual Radiologic Corporation to reflect a decrease in the indicated market price for that security.
2.
We recorded $3.1 million of unrealized depreciation on our investment in G&L Investment Holdings, LLC, to reflect a decrease in that portfolio company's operating performance.
3.
We received $3.0 million for the sale of our equity investment in Miles Media Group, LLC, which resulted in a $2.9 million realized gain and a reversal of previously unrealized appreciation of $1.2 million.
4.
In addition, during 2013, we wrote off our preferred and common equity investments in Advanced Sleep resulting in a realized loss of $3.4 million and a reversal of previously recorded unrealized depreciation of $3.2 million.
INCOME TAX (BENEFIT) PROVISION
During the nine months ended September 30, 2014, we recorded an income tax benefit of $148,000, which was primarily attributable to an NOL carryback and lower than expected flow-through taxable income on certain investments held by our subsidiaries. During the nine months ended September 30, 2013, we recorded an income tax provision of $111,000, which was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Our financial liquidity principally comes from our cash on hand, portfolio monetizations and net operating income. In addition to making investments in portfolio companies, we may use our available liquidity to pay dividends to our stockholders and to repurchase our common stock in our planned tender offer and in the open market under our stock repurchase program (which is presently suspended until the termination of the tender offer). For the nine months ended September 30, 2014, we declared 24.5 cents per share in dividends and paid $15.4 million in total dividends. We also repurchased 24,358,596 shares of our common stock for $90.7 million at a weighted average price of $3.72 per share representing a 15.9% discount from our quarterly weighted average net asset value per share.
For the nine months ended September 30, 2014, we earned 12.2% on our average loan portfolio at fair value of $249.9 million and our weighted average cost to borrow was 6.8% on average borrowings of $143.2 million. Including dividend income and fee income, we earned $3.9 million of net operating income.
At September 30, 2014, we had $114.6 million in cash and cash equivalents available for general corporate purposes and $1.6 million of restricted cash held in escrow. On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital. On April 21, 2014, based on our assessment of our excess liquidity, we terminated our undrawn unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or the Bank of America Unsecured Revolver, that was set to expire in November 2014.
Although there can be no assurance, we believe we have sufficient liquidity to meet our operating requirements for the remainder of 2014, as well as liquidity for new origination opportunities, potential dividend distributions and any stock repurchases under our tender offer for up to $75.0 million of our common stock that we expect to commence on

49

November 3, 2014 or under our stock repurchase program (which is presently suspended until the termination of the tender offer).
CASH AND CASH EQUIVALENTS, CASH, RESTRICTED AND CASH, SECURITIZATION ACCOUNTS
Our Consolidated Balance Sheets and our Consolidated Statements of Cash Flows reflect three categories of cash: cash and cash equivalents; cash, restricted; and cash, securitization accounts. Each of these categories is described more fully below:
•
Cash and cash equivalents represent unrestricted cash, including checking accounts, interest bearing deposits collateralized by marketable debt securities and highly liquid investments with original maturities of 90 days or less. As of September 30, 2014 and December 31, 2013, we had $114.6 million and $91.6 million, respectively, in cash and cash equivalents. As of September 30, 2014, our cash and cash equivalents included $25.9 million held in interest-bearing accounts.
•
Cash, restricted includes cash held in escrow and previously included cash held for regulatory purposes. The largest component of restricted cash was represented by cash held by Solutions Capital, a wholly owned subsidiary which was licensed as an SBIC under the SBIC Act. Cash held by an SBIC generally is restricted to the origination of new loans by the SBIC. In September, 2014, we prepaid in full the $150 million of SBIC debentures owed to the SBA by Solutions Capital using excess restricted cash, surrendered our SBIC license and closed the investment vehicle, resulting in the reclassification of cash held by Solutions Capital to Cash and cash equivalents on our Consolidated Balance Sheets. As of December 31, 2013, we had $33.9 million of restricted cash.
•
Cash, securitization accounts previously included principal and interest payments received on securitized loans, which, were held in designated bank accounts until monthly or quarterly disbursements were made from the securitization trusts. We were generally required to use a portion of these amounts to pay interest expense, reduce borrowings or pay other amounts in accordance with the related securitization agreements. Cash in securitization accounts had a negative impact on our earnings since the interest we paid on borrowings typically exceeded the rate of return that we were able to earn on temporary cash investments. As of December 31, 2013, we had $13.9 million in cash, securitization accounts. On January 21, 2014, we terminated our 2006-1 Trust and the securitized cash was used to repay principal and interest due on the notes including the notes owned by MCG Capital, the parent.
During the nine months ended September 30, 2014, our operating activities provided $259.5 million of cash and cash equivalents, and our financing activities used $236.6 million of cash and cash equivalents.

50

LIQUIDITY AND CAPITAL RESOURCES—BORROWINGS
As of September 30, 2014, we had no outstanding borrowings or borrowing facilities. The following table summarizes our borrowing facilities, the facility amounts and the amounts outstanding.
 
 
September 30, 2014
December 31, 2013
(dollars in thousands)
Maturity Date
Total
Facility/
Program
Amount
Outstanding
Total
Facility/
Program
Amount
Outstanding
SBIC(a)
 
 
 
 
 
2008-10B
September 2018
$
—

$
—

$
2,600

$
2,600

2009-10A
March 2019
—

—

12,000

12,000

2009-10B
September 2019
—

—

13,000

13,000

2010-10B
September 2020
—

—

27,500

27,500

2011-10A
March 2021
—

—

53,500

53,500

2012-10A
March 2022
—

—

41,400

41,400

MCG Commercial Loan Trust 2006-1(b)
 




 
 
Series 2006-1 Class D Notes
April 2018
—

—

40,016

25,172

Bank of America Unsecured Revolver(c)
 




 
 
Unsecured Revolving Note
November 2014
—

—

20,000

—

Total borrowings
 
$
—

$
—

$
210,016

$
175,172

_______________ 
(a) 
In September 2014, the SBIC Debentures were repaid in full.
(b) 
In January 2014, the Class D Notes were repaid in full.
(c) 
In April 2014, we terminated the undrawn Bank of America Unsecured Revolver.
SBIC DEBENTURES
In September, 2014, we prepaid in full the $150 million of SBIC debentures owed to the SBA by Solutions Capital using excess restricted cash. After repayment, Solutions Capital surrendered its SBIC license to the SBA’s Office of SBIC Operations. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense. From 2005-2014, Solutions Capital invested $468 million in 36 U.S. small businesses generating an approximate 12% IRR on its portfolio investments based on the total amounts invested and amounts received through the exit of the investments.
BANK OF AMERICA UNSECURED REVOLVER
In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million. On April 21, 2014, based on our assessment of our excess liquidity, we terminated our undrawn Bank of America Unsecured Revolver.
MCG COMMERCIAL LOAN TRUST 2006-1
As of December 31, 2013, we had $25.2 million of securitized Class D Notes outstanding under the 2006-1 Trust, which was secured by $76.3 million of loans and equity investments and $13.9 million of cash. We retained all of the equity in the securitization. In November 2013, we directed the trustee to redeem the remaining notes on the next quarterly payment date and, on January 21, 2014, we repaid the Class D Notes in full and the loan and equity investments held by the 2006-1 Trust were transferred back to MCG, the parent.

51

WEIGHTED-AVERAGE BORROWINGS AND COST OF FUNDS
The following table shows our weighted-average borrowings, the weighted-average interest rate on all of our borrowings, including amortization of deferred debt issuance costs and commitment fees, the average LIBOR, and the average spread to LIBOR for 2014 and 2013:
 
Nine months ended September 30,
(dollars in thousands)
2014
2013
Weighted-average borrowings
$
143,187

$
209,367

Average LIBOR
0.23
%
0.28
%
Average spread to LIBOR, excluding amortization of deferred debt issuance costs
3.88

3.53

Impact of amortization of deferred debt issuance costs
2.65

0.60

Total cost of funds
6.76
%
4.41
%
SECURED FINANCING
In June 2014, we monetized substantially all of our investment in Advanced Sleep through the sale of a 95% participation interest in our senior and subordinated loans. Under the terms of the sale, the purchaser would receive 100% of the payments related to the loan, including interest and principal, until the total payments received exceeded the purchase price plus any additional advances funded by the purchaser to Advanced Sleep and certain expenses incurred by the purchaser. Thereafter, the purchaser would receive 95% and we would receive 5% of any payments received from Advanced Sleep. Under the terms of the sale, the purchaser had no recourse to us for any payments. We continued to service the Advanced Sleep loans on behalf of the purchaser.
We follow the guidance in 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 did not meet the definition of a participating interest under ASC 860 resulting in the loans remaining on our Consolidated Balance Sheets and the proceeds from the sale being recorded as a secured financing. In September 2014, we sold the remaining participation interest in our senior and subordinated loans. The sale of the remaining interest resulted in the derecognition of the loans to Advanced Sleep and the liability for the secured financing and the realization of a loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million on our Consolidated Income Statement. In addition, we no longer service the loans on behalf of the purchaser.
LIQUIDITY AND CAPITAL RESOURCES—COMMON STOCK
We are a closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. The 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value of such stock, except in limited circumstances, including approval by our stockholders of such a sale and certain determinations by our board of directors.
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million. On October 25, 2013, our board of directors authorized a second stock repurchase program of up to $25.0 million. On February 28, 2014, our board of directors increased the second stock repurchase program to $35.0 million. On April 25, 2014, our board of directors terminated the second stock repurchase program effective as of May 2, 2014 and authorized a third stock repurchase program of up to $50.0 million effective as of May 5, 2014. On August 5, 2014, our board of directors terminated the third stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014. Under the new program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. During the nine months ended September 30, 2014, we repurchased 24,358,596 shares of our common stock at a weighted average purchase price of $3.72 per share, which was a 15.9% discount from our quarterly weighted average net asset value per share.

52

We requested and received the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engage in a stock repurchase program and agree not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans. Although as of September 30, 2014, there were 1,426,811 shares of our common stock available for issuance under our Third Amended and Restated 2006 Employee Restricted Stock Plan, or 2006 Plan, no shares of restricted stock could be issued under our 2006 Plan or our Third Amended and Restated 2006 Non-Employee Director Restricted Stock Plan, because the 10% threshold set forth in the SEC's order had been reached due to shares we repurchased under our stock repurchase program.
On October 29, 2014, we announced that we expected to commence a modified “Dutch Auction” tender offer to purchase up to $75.0 million of our common stock at a price per share not less than $3.25 and not greater than $3.75. The tender offer is expected to commence on November 3, 2014, and will expire on December 3, 2014, unless extended. Until the expiration of the tender offer, we have suspended our previously announced stock repurchase program.
OFF-BALANCE SHEET ARRANGEMENTS
FINANCIAL INSTRUMENTS
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. We attempt to limit our credit risk by conducting extensive due diligence and obtaining collateral where appropriate.
Commitments to extend credit include the unused portions of commitments that obligate us to extend credit in the form of loans, participations in loans, guarantees, letters of credit and other financial commitments. Commitments to extend credit would also include loan proceeds we are obligated to advance, such as loan draws, rotating or revolving credit arrangements, or similar transactions. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the counterparty. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
We do not report the unused portions of these commitments on our Consolidated Balance Sheets. As of September 30, 2014, we had $2.0 million of outstanding unused loan commitments. We believe that our operations, monetizations and unrestricted cash will provide sufficient liquidity to fund, as necessary, requests to draw on these unfunded commitments. We estimate that the fair value of these commitments was less than $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies. As of September 30, 2014, we had no outstanding guarantees or standby letters of credit.
CONTRACTUAL OBLIGATIONS
The following table shows our contractual obligations as of September 30, 2014:
(in thousands)
Payments Due by Period
Contractual Obligations(a)
Total
Less than
1 year
1-3 years
4-5 years
After 5
years
Operating leases
641

470

171

—

—

Severance obligations(b)
2,458

1,829

629

—

—

Total contractual obligations
$
3,099

$
2,299

$
800

$
—

$
—

_______________
(a) 
Excludes the unused commitments to extend credit to our customers of $2.0 million as discussed above.
(b) 
Represents remaining severance payments, employer taxes and incentive payments that we are obligated to pay stemming from the resignation of our former chief executive officer.

53

DISTRIBUTIONS
We currently qualify as a RIC for federal income tax purposes, which generally allows us to avoid paying corporate income taxes on any income or gains that we distribute to our stockholders. Generally, we intend to distribute sufficient dividends to eliminate taxable income and may distribute more than the taxable income, which amount would be considered a return of capital. As a RIC, we are subject to a 4% excise tax to the extent that we do not distribute on an actual or deemed basis: (i) 98.0% of our current year ordinary income; and (ii) 98.2% of our current year net capital gain income.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions. In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of favorable RIC tax treatment. We cannot assure stockholders that they will receive any distributions, or distributions at a particular level. We may make distributions to our stockholders of certain net capital gains. Since December 2001, we have declared aggregate per share distributions of $14.13.
The following table summarizes the distributions that we declared since January 1, 2012:
Date Declared
Record Date
Payable Date
Dividends per Share
August 5, 2014
August 20, 2014
August 29, 2014
$
0.050

April 25, 2014
May 9, 2014
May 30, 2014
$
0.070

February 28, 2014
March 14, 2014
March 28, 2014
$
0.125

October 25, 2013
November 8, 2013
November 22, 2013
$
0.125

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

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

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

October 26, 2012
November 16, 2012
November 30, 2012
$
0.125

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

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

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

If we determined the tax attributes of our distributions as of September 30, 2014, 33% would be from ordinary income and 67% would be a return of capital. A return of capital is a return of stockholder investment, rather than a return of earnings or gains derived from our investment activities. While not immediately taxable to the extent of a stockholder's basis in its shares, a stockholder's basis in the investment will be reduced by the nontaxable amount, which will result in additional gain or a lower loss when the shares are sold. However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year. Therefore, a determination as to the tax attributes of the distributions made on a quarterly basis may not be representative of the actual tax attributes for a full year.  We intend to update stockholders quarterly with an estimated percentage of our distributions that resulted from taxable ordinary income.  The actual tax characteristics of distributions to stockholders will be reported to stockholders annually on a Form 1099-DIV. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.
CRITICAL ACCOUNTING POLICIES
These Condensed Consolidated Financial Statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. The following section describes our accounting policies associated with the valuation of our portfolio of investments. For a full discussion of our other critical accounting policies and estimates, see Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2013.

54

VALUATION OF INVESTMENTS
FAIR VALUE MEASUREMENTS AND DISCLOSURES
We account for our investments at fair value in accordance with Accounting Standard Codification Topic 820—Fair Value Measurements and Disclosures, or ASC 820. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. ASC 820 defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.
ASC 820 establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:
ASC 820
Fair Value Hierarchy
Inputs to Fair Value Methodology
Level 1
Quoted prices in active markets for identical assets or liabilities
Level 2
Quoted prices for similar assets or liabilities; quoted markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the financial instrument; inputs other than quoted prices that are observable for the asset or liability; or inputs that are derived principally from, or corroborated by, observable market information
Level 3
Pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption is unobservable or when the estimation of fair value requires significant management judgment
We categorize a financial instrument in the fair value hierarchy based on the lowest level of input that is significant to its fair value measurement. In the event that transfers between these levels were to occur in the future, we would recognize those transfers as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.
DETERMINATION OF FAIR VALUE IN GOOD FAITH
As a BDC, we invest primarily in illiquid securities, including debt and equity securities of private companies. To protect our investments and maximize our returns, we negotiate the structure of each equity security and the majority of the debt securities in our investment portfolio. Our contracts with our portfolio companies generally include many terms governing interest rate, repayment terms, prepayment premiums, financial covenants, operating covenants, ownership and corporate governance rights, dilution parameters, liquidation preferences, voting rights, and put or call rights. In some cases, our loan agreements also allow for increases in the spread to the base index rate, if the portfolio company’s financial or operational performance deteriorates or shows negative variances from its business plan and, in some cases, allow for decreases in the spread if financial or operational performance improves or exceeds the portfolio company’s plan. Generally, our investments are subject to some restrictions on resale and have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation processes require analyses of numerous market, industry and company-specific factors, including: the performance of the underlying investment; the financial condition of the portfolio company; changing market events; market prices, when available; estimates of market interest rates that would otherwise be made available to our portfolio companies; and other factors relevant to the individual security.
There is no single approach for determining fair value in good faith. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. As a result, for portfolio investments that do not have an active market, we must apply business judgment to the specific facts and circumstances associated with each security to determine fair value.
Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. When such market prices are not available, we use several valuation methodologies to estimate the fair value of our investment portfolio, which generally results in a range of fair values from which we derive a single estimate of fair value. To determine a portfolio company’s fair value, we analyze its historical and projected financial results, as well as key market value factors. In determining

55

a security's fair value, we assume we would exchange it in an orderly transaction at the measurement date. We use the following methods to determine the fair value of investments in our portfolio that are not traded actively:
•
Majority-Owned Control Investments—Majority-owned control investments comprise 38.3% of our investment portfolio at fair value. Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value. Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value. Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question. Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs. Our valuation approaches for majority-owned investments estimate the value upon a hypothetical sale or exit and then allocates such value to the investment's securities in order of their relative liquidation preference. In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par. These valuation approaches also consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.
•
Non-Control Investments—Non-control investments comprise 61.7% of our investment portfolio at fair value. Quoted prices are not available for 96.8% of our non-control investments at fair value. For our non-control equity investments, we use the same market and income approaches used to value our control investments. For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.
•
Thinly-Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly-traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of September 30, 2014, these securities represented 2.0% of our investment portfolio at fair value. 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 September 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 99.1% of the fair value of our investment portfolio.
The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs. We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses.
Our board of directors sets our valuation policies and procedures and determines the fair value of our investments. The investment and valuation committee of our board of directors meets at least quarterly with our executive management to review management’s recommendations of fair value of our investments. Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments.

56

Due to the uncertainty inherent in the valuation process, such fair value estimates may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses that we ultimately realize on these investments to differ from the valuations currently assigned.
Significant Unobservable Inputs
Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with distinct contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and complex, often factoring in numerous different inputs, including the historical and forecasted financial and operational performance of the portfolio company, projected cash flows, market multiples, comparable market transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews and other inputs too numerous to list quantitatively herein.
The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2014.
($ in thousands)
Fair Value
Valuation Techniques
Unobservable
Inputs
Range
Weighted Average
 
Minimum
Maximum
Senior debt
$
41,029

Discounted cash flow
Market interest rate
7.8
%
7.8
%
7.8
%



Pending transactions/Letters of intent
Discount
—
%
—
%
—
%



Market comparable companies
EBITDA multiple(a)
6.0x

6.0x

6.0x

Subordinated debt
37,131

Discounted cash flow
Market interest rate
7.8
%
14.5
%
11.7
%



Pending transactions/Letters of intent
Discount
—

—

—

Preferred and common equity
13,544

Market comparable companies
EBITDA multiple(a)
6.0x

10.0x

6.7x




Pending transactions/Letters of intent
Discount
—
%
—
%
—
%
 
$
91,704

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

57

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to financial market risks, including changes in interest rates. In the event of financial downturns affecting the banking system and financial markets, the financial position and results of operations of certain of the middle-market companies in our portfolio could be affected adversely, which ultimately could lead to difficulty in their meeting debt service requirements and an increase in defaults.
Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates. Our net interest income is affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates. As of September 30, 2014, approximately 63.4% of our loan portfolio, at fair value, bore interest at a spread to either the LIBOR or the prime rate, and 36.6% at a fixed interest rate. As of September 30, 2014, approximately 51.5% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 2.0% on a LIBOR-base index or prime floors between 2.8% and 4.5%. The three-month weighted-average LIBOR interest rate was 0.23% as of September 30, 2014. Thus, the LIBOR floors in these loan investments lessen the impact of such historically low LIBOR rates.
We regularly measure exposure to interest rate risk. We assess interest rate risk and we manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates.
The following table shows a comparison of the interest rate base for our interest-bearing cash, outstanding commercial loans, at cost, and our outstanding borrowings as of September 30, 2014 and December 31, 2013:
 
September 30, 2014
December 31, 2013
(in thousands)
Interest Bearing Cash and Commercial Loans
Borrowings
Interest Bearing Cash and Commercial Loans
Borrowings
Money market rate
$
27,578

$
—

$
56,685

$
—

Prime rate
—

—

—

—

LIBOR
 
 
 
 
30-day
19

—

57,725

—

60-day
—

—

—

—

90-day
48,267

—

194,133

25,172

180-day
—

—

—

—

Fixed rate
35,554

—

100,009

150,000

Total
$
111,418

$
—

$
408,552

$
175,172

In addition, as of September 30, 2014, we had $88.6 million of non-interest-bearing cash and cash equivalents.
Based on our September 30, 2014 balance sheet, the following table shows the impact to net income of hypothetical base rate increases in interest rates, assuming no changes in our investment and borrowing structure. The impact to net income of hypothetical base rate decreases in interest rates is not shown in the following table because as of September 30, 2014, the quarterly average LIBOR was 0.23% and a 100-basis point decrease could not occur:
(dollars in thousands) 
 
Basis Point Change
Interest
Income
Interest
Expense
Net Income
100
$
356

$
—

$
356

200
849

—

849

300
1,607

—

1,607


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ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2014. The term “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the foregoing evaluation of our disclosure controls and procedures as of September 30, 2014, our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
INTERNAL CONTROL OVER FINANCIAL REPORTING
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), occurred during the fiscal quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
From time to time, we are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations. During the quarter ended September 30, 2014, there were no new or material developments in legal proceedings.
ITEM 1A. RISK FACTORS.
Investing in our common stock may be speculative and involves a high degree of risk. In addition to the other information contained in this Quarterly Report on Form 10-Q, including our financial statements, the related notes, schedules and exhibits, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, which could materially affect our business, financial condition and/or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and/or operating results.
Other than described below, there have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, which should be read together with the other risk factors and information disclosed elsewhere in this Quarterly Report on Form 10-Q and our other reports filed with the SEC.

59

The following disclosure removes the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2013 titled:
•
"Our wholly owned subsidiary is licensed by the SBA and is subject to SBA regulations. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or revoke or suspend our license"; and
•
"Our wholly-owned SBIC subsidiary may be unable to make distributions to us that will enable us to maintain RIC status, which could result in the imposition of an entity-level tax."
The following disclosure replaces and supplements the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2013 titled:
•
"Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns";
•
"If we fail to qualify as a RIC, we will have to pay corporate-level taxes on our income and our income available for distribution would be reduced significantly or eliminated";
•
"If we fail to service our existing debt arrangements adequately, or to establish new credit facilities on favorable terms, our business could be harmed materially";
•
"Our stock price has been, and continues to be, volatile and purchasers of our common stock could incur substantial losses"; and
•
"Any change in the regulation of our business could have a significant adverse effect on the profitability of our operations and our cost of doing business."
In addition, the following disclosure adds the new risk factor titled:
•
"We cannot assure you that our tender offer or any stock repurchase program will actually result in repurchases of our common stock or enhance long-term stockholder value, and repurchases, if any, could affect our stock price, increase its volatility, will diminish our cash reserves and could impact our RIC status."
Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns.
From time to time, we target specific industries in which to invest on a recurring basis, which may result in significant concentrations in our portfolio. As a consequence, the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of such investments or a substantial write-down of any one investment. Beyond regulatory and income tax diversification requirements, we do not have fixed guidelines for industry concentration. In addition, while we generally decline to make investments in a particular industry or group of industries that would exceed 15.0% of our total assets at the time of closing, it is possible that as the values of our portfolio companies change, one industry or a group of industries may come to exceed such level. As a result, a downturn in an industry in which we have invested a significant portion of our total investments could have a materially adverse effect on us. As of September 30, 2014, due to the number of recent monetizations and loan repayments, 49.5%, 28.0% and 10.7% of our total investments at fair value were invested in healthcare, business services, and manufacturing industries, respectively. Therefore, we are susceptible to the economic circumstances in these industries, and a downturn in any one of these industries could have a material adverse effect on our results of operations and financial condition.
If we fail to qualify as a RIC, we will have to pay corporate-level taxes on our income and our income available for distribution would be reduced significantly or eliminated.
We have elected to be taxed for federal income tax purposes as a RIC, under Subchapter M of the Internal Revenue Code. To qualify as a RIC under the Internal Revenue Code, we must meet certain source-of-income, asset diversification and annual distribution requirements and maintain our status as a BDC, including:
•
Sources of Income. We must obtain at least 90% of our income each year from dividends, interest, gains from the sale of stock or securities or similar sources.
•
Asset Diversification. At the end of each taxable year, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other acceptable

60

securities. No more than 25% of the value of our assets may be invested in the securities, other than U.S. government securities or securities of other RICs, (i) of one issuer, or (ii) of two or more issuers that are controlled, as determined under applicable Internal Revenue Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.”
•
Income Distribution. We must distribute to our stockholders at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, on an annual basis. Because we are subject to an asset coverage ratio requirement under the 1940 Act, and may also be subject to certain financial covenants under any debt financings we may incur, we could, under certain circumstances, be restricted from making the distributions necessary to satisfy the IRS requirement.
As our total assets continue to decline associated with our stock repurchase program and tender offer, dividend distributions to stockholders and other transactions that reduce our total assets, there is an increased risk of non-qualification as a RIC due to the 50% or 25% asset diversification test as outlined in Internal Revenue Code Section 851(b)(3). The 50% diversification test requires at least 50% of the value of a RIC’s total assets be invested in cash, cash items (including receivables), government securities (as defined under the 1940 Act), securities of other RIC’s, or investments in other securities that, with respect to any one issuer, do not represent more than 5 percent of the RIC’s assets or more than 10 percent of the issuer’s voting securities.
The 25% diversification test requires that not more than 25% of the value of the company’s total assets are invested in the securities (other than government securities or the securities of other RIC’s) of any one issuer, or of two or more issuers which the taxpayer controls and which are determined to be engaged in the same or similar trades or businesses. The term “controls” means the ownership of 20% or more of the total combined voting power of all classes of voting stock in a corporation.
The 50% and 25% diversification test must be satisfied at the end of each quarter of a RIC’s taxable year.
Failure to meet the foregoing requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and, therefore, will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in losses. If we fail to qualify as a RIC for any reason we would become subject to corporate-level income tax, substantially reducing our net assets, the amount of income available for distribution and the amount of our distributions. Such a failure would have a material adverse effect on our stockholders and us.
If we fail to establish new credit facilities on favorable terms, our business could be harmed materially.
We cannot be certain that we will be able to establish new borrowing facilities to provide working and investment capital, including for new originations. If we are unable to establish new facilities of a reasonable size, our liquidity will be reduced significantly. Even if we are able to consummate new borrowing facilities, we may not be able to do so on favorable terms.
Our stock price has been, and continues to be, volatile and purchasers of our common stock could incur substantial losses.
The stock market in general, and the market prices for securities of financial services companies in particular, have experienced extreme volatility that often has been unrelated or disproportionate to the operating performance of these companies. If current levels of market volatility continue or worsen, we may continue to experience an adverse effect, possibly material, on our ability to access capital and on our business, financial condition and results of operations.
The market price and the liquidity of the market for our shares may from time to time be affected by a number of factors, which include, but are not limited to, the following:
•
our quarterly results of operations;
•
our origination activity, including the pace of, and competition for, new investment opportunities;
•
price and volume fluctuations in the overall stock market from time to time;
•
investors' general perception of our company, the economy and general market conditions;
•
actual or anticipated changes in our earnings or fluctuations in our operating results or changes in the expectations of securities analysts;
•
the financial performance of the specific industries in which we invest on a recurring basis, including without limitation, our investments in the healthcare, business services and education industries;

61

•
significant transactions or capital commitments by us or our competitors;
•
significant volatility in the market price and trading volume of securities of BDCs or other financial services companies;
•
volatility resulting from trading in derivative securities related to our common stock including puts, calls or short trading positions;
•
potential future sales of debt securities convertible into or exchangeable or exercisable for our common stock or the conversion of such securities;
•
changes in laws or regulatory policies or tax guidelines with respect to BDCs or RICs;
•
loss of RIC status;
•
the inability to secure additional debt or equity capital;
•
our recent announcement and commencement of a tender offer to repurchase up to $75.0 million of shares of our common stock and the expiration of that tender offer;
•
announcements of strategic developments, acquisitions and other material events by us or our competitors;
•
litigation or regulatory actions affecting us or our portfolio companies; and
•
departures of key personnel.
If any of these factors causes an adverse effect on our business, our results of operations or our financial condition, the price of our common stock could fall and investors may not be able to sell their common stock at or above their respective purchase prices.
Any change in the regulation of our business could have a significant adverse effect on the profitability of our operations and our cost of doing business.
Changes in the laws, regulations or interpretations of the laws and regulations that govern BDCs, RICs or non-depository commercial lenders could have a significant adverse effect on our operations and our cost of doing business. We are subject to federal, state and local laws and regulations and also to judicial and administrative decisions that affect our operations. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted requirements that are more stringent than those in which we currently conduct business, we may have to incur significant expenses in order to comply or we may have to restrict our operations.
We cannot assure you that our tender offer or any stock repurchase program will actually result in repurchases of our common stock or enhance long-term stockholder value, and repurchases, if any, could affect our stock price, increase its volatility, will diminish our cash reserves and could impact our RIC status.
On October 28, 2014, our board of directors approved a modified “Dutch Auction” tender offer to repurchase up to $75.0 million of shares of our common stock. The tender offer is scheduled to commence on November 3, 2014 and will expire on December 3, 2014, unless extended. Until the tender offer expires, we will not know the amount of shares that have been tendered for repurchase, or the exact per share price (within the $3.25 to $3.75 range offered) that we will be required to pay to stockholders who tender shares. We cannot provide any assurance that we will repurchase a sufficient number of shares of our common stock through the tender offer to accomplish our stated objectives. Accordingly, we may pursue other strategies to return capital to stockholders, including open market repurchases.
Following the termination of our tender offer, we may resume our previously announced stock repurchase program, the size of which will be determined based upon the results of the tender offer and subject to applicable law. Under the program, we are authorized to repurchase shares of our common stock in open market transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Exchange Act. The timing and actual number of shares repurchased, if any, will depend on a variety of factors, including the price and availability of our shares, trading volume and general market conditions. The program was suspended prior to the announcement of the tender offer, and, if resumed, may be suspended or discontinued at any time in the future without prior notice.
Repurchases pursuant to our tender offer and our stock repurchase program could affect our stock price and increase its volatility. The successful completion of our tender offer, and continued repurchases under our stock repurchase program to the extent available, will reduce the market liquidity for our stock. Additionally, repurchases under our tender offer and any renewed stock repurchase program will diminish our cash reserves, which could impact our ability to pursue possible future strategic opportunities, would result in lower cash available to invest resulting in potentially lower returns on investments and could impact our ability to qualify as a RIC because a reduced asset

62

base would increase the chances that we could fail the asset diversification requirements under the Internal Revenue Code. In addition, any such repurchases will increase the proportional ownership of the stockholders who do not participate, or participate only in part, in the tender offer. There can be no assurance that any stock repurchases will, in fact, occur, or, if they occur, that they will enhance stockholder value because the market price of our common stock may decline below the levels at which we repurchased shares of stock. Although our tender offer and our stock repurchase program are intended to enhance long-term stockholder value, short-term stock price fluctuations could reduce the effectiveness of these programs.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
STOCK REPURCHASE PROGRAM
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million. On October 25, 2013, our board of directors authorized a second stock repurchase program of up to $25.0 million. On February 28, 2014, our board of directors increased the second stock repurchase program to $35.0 million. On April 25, 2014, our board of directors terminated the second stock repurchase program effective as of May 2, 2014 and authorized a third stock repurchase program of up to $50.0 million effective as of May 5, 2014. On August 5, 2014, our board of directors terminated the third stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014. Under the new program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. The following table summarizes our stock repurchases for the three and nine months ended September 30, 2014.
 
Three months ended September 30, 2014
Nine months ended September 30, 2014
Dollar amount repurchased (in thousands)
$
32,902

$
90,720

Shares repurchased
8,285,836

24,358,596

Average price per share
$
3.97

$
3.72

Discount to quarterly weighted average net asset value per share
10.2
%
15.9
%
On October 29, 2014, we announced that we expected to commence a modified “Dutch Auction” tender offer to purchase up to $75.0 million of our common stock at a price per share not less than $3.25 and not greater than $3.75. The tender offer is expected to commence on November 3, 2014, and will expire on December 3, 2014, unless extended. Until the expiration of the tender offer, we have suspended our previously announced stock repurchase program.
NET ISSUANCE OF RESTRICTED STOCK
For certain employees, we may be deemed to have purchased through the net issuance of shares, a portion of the shares of restricted stock previously issued under the 2006 Plan for which the forfeiture provisions have lapsed to satisfy the applicable employee’s income tax withholding obligations. We retire immediately all such shares of common stock that we purchase in connection with such net issuance to employees.
DIVIDEND REINVESTMENT PLAN
As part of our dividend reinvestment plan for our common stockholders, we may direct the plan administrator to purchase shares of our common stock on the open market to satisfy dividend reinvestment requests related to dividends that we pay on outstanding shares of our common stock.

63

The following table summarizes the shares of common stock that we have purchased during the three months ended September 30, 2014:
Period/Purpose
Total number
of shares
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
July 1 – 31, 2014
 
 
 
 
 
Stock repurchase program(a)
4,751,236

$
3.94

 
4,751,236

$
4,441,554

August 1 – 31, 2014
 
 
 
 
 
Stock repurchase program(a)
1,483,800

$
3.98

 
1,483,800

$
45,755,743

Restricted stock vesting(b)
289

$
3.96

(c) 
n/a

n/a

Dividend reinvestment requirements(d)
737

$
4.02

(e) 
n/a

n/a

Total August 1 – 31, 2014
1,484,826

$
3.98

 
1,483,800

$
45,755,743

September 1 – 30, 2014
 
 
 
 
 
Stock repurchase program(a)
2,050,800

$
4.02

 
2,050,800

$
37,503,353

Restricted stock vesting(b)
1,286

$
3.52

(c) 
n/a

n/a

Total September 1 – 30, 2014
2,052,086

$
4.02

 
2,050,800

$
37,503,353

Total
8,288,148

$
3.97

 
8,285,836

$
37,503,353

    
(a) 
On April 25, 2014, our board of directors authorized a stock repurchase program of up to $50.0 million effective as of May 5, 2014. On August 5, 2014, our board of directors terminated the existing stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014.
(b) 
Represents shares repurchased from our employees in connection with the net issuance of shares to satisfy employee tax withholding obligations in connection with the vesting of restricted stock.
(c) 
Based on the weighted-average closing share prices of our common stock on the dates that the forfeiture restrictions lapsed.
(d) 
Represents stock purchased on the open market to satisfy dividend reinvestment requests.
(e) 
Represents the weighted-average purchase price per share, including commissions, for shares purchased pursuant to the terms of our dividend reinvestment plan.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not Applicable.
ITEM 4. MINE SAFETY DISCLOSURES.
Not Applicable.
ITEM 5. OTHER INFORMATION.
Not Applicable.

64

ITEM 6. EXHIBITS.
The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K. All exhibits listed in the following table are incorporated by reference except for those exhibits denoted in the last column.
 
 
Incorporated by Reference
 
Exhibit
No.
Description
Form and SEC
File No.
Filing Date
with SEC
Exhibit No.
Filed with this 10-Q
 
 
 
 
 
 
15.1
Letter regarding unaudited interim financial information from Ernst & Young LLP, independent registered public accounting firm
 
 
 
*
31.1
Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
*
31.2
Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
*
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
†
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
†
*
Filed herewith.
 
 
 
 
†
Furnished herewith.
 
 
 
 


65

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
 
MCG Capital Corporation
 
 
 
 
Date:
October 29, 2014
By:
/s/ KEITH KENNEDY
 
 
 
Keith Kennedy
 
 
 
Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
Date:
October 29, 2014
By:
/s/ BEVERLY JANE ALLEY
 
 
 
Beverly Jane Alley
 
 
 
Chief Financial Officer
(Principal Financial and Accounting Officer)


66

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