##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---



FORM 10-K



|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ------------------------------------------------------------------------------------



FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006



OR



| ̈ |  | 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 of Incorporation)                     |  | (I.R.S. Employer Identification Number)
|1100 Wilson BoulevardSuite 3000Arlington, VA |  | 22209                                  
|(Address of principal executive offices)     |  | (Zip Code)                             



Registrants
telephone number, including area code: 703-247-7500



Securities registered pursuant to Section 12(b) of the Act:



|                                        |  |                                          
|--------------------------------------- |  | -----------------------------------------
|Title of Each Class                     |  | Name of Each Exchange On Which Registered
|Common Stock, par value $0.01 per share |  | The NASDAQ Global Select Market          



Securities
registered pursuant to Section 12(g) of the Act:None



Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ̈No  x.



Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.  Yes ̈No  x.



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 ̈.



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x



Indicate by check mark whether
the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. Large Accelerated Filer  x    Accelerated Filer ̈Non-accelerated
Filer ̈.



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes ̈No  x .



The aggregate market value of common stock held by non-affiliates of the Registrant as of June 30, 2006 was
approximately $826,695,155 based on the closing price on the NASDAQ Global Select Market. For purposes of this computation, shares held by certain stockholders and by directors and executive officers of the Registrant have been excluded. Such
exclusion of shares held by such persons is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the Registrant. There were 58,700,108 shares of the Registrants common stock outstanding as of
February 26, 2007.



Documents Incorporated by Reference



Portions of the Registrants definitive Proxy
Statement relating to the 2007 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III of this Annual Report on Form 10-K as indicated herein.



---



---

##### Table of Contents

MCG CAPITAL CORPORATION



2006 FORM 10-K ANNUAL REPORT



TABLE OF CONTENTS



|           |  |                                                                                                              |  |     
|---------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|           |  |                                                                                                              |  | PAGE
|           |  | PART I                                                                                                       |  |     
|Item 1.    |  | Business                                                                                                     |  | 1   
|Item 1A.   |  | Risk Factors                                                                                                 |  | 19  
|Item 1B.   |  | Unresolved Staff Comments                                                                                    |  | 25  
|Item 2.    |  | Properties                                                                                                   |  | 25  
|Item 3.    |  | Legal Proceedings                                                                                            |  | 25  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                          |  | 25  
|           |  |                                                                                                             
|           |  | PART II                                                                                                      |  |     
|Item 5.    |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 26  
|Item 6.    |  | Selected Financial Data                                                                                      |  | 29  
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 29  
|Item 7A.   |  | Quantitative and Qualitative Disclosures about Market Risk                                                   |  | 57  
|Item 8.    |  | Financial Statements and Supplementary Data                                                                  |  | 58  
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 101 
|Item 9A.   |  | Controls and Procedures                                                                                      |  | 101 
|Item 9B.   |  | Other Information                                                                                            |  | 101 
|           |  |                                                                                                             
|           |  | PART III                                                                                                     |  |     
|Item 10.   |  | Directors, Executive Officers, and Corporate Governance                                                      |  | 102 
|Item 11.   |  | Executive Compensation                                                                                       |  | 102 
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 102 
|Item 13.   |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 102 
|Item 14.   |  | Principal Accountant Fees and Services                                                                       |  | 102 
|           |  |                                                                                                             
|           |  | PART IV                                                                                                      |  |     
|Item 15.   |  | Exhibits and Financial Statement Schedules                                                                   |  | 103 
|           | 
|Signatures |  | 113                                                                                                         



---

##### Table of Contents

PART I



In this Annual Report
on Form 10-K, or Annual Report, the Company, MCG, we, us and our refer to MCG Capital Corporation and its wholly owned subsidiaries (including its affiliated securitization trusts) unless
the context otherwise requires.



Item 1.Business



GENERAL



We are a solutions-focused commercial finance company providing capital and advisory services to middle market companies throughout the United States. We make debt and equity investments primarily in companies with annual revenue of $20
million to $200 million and earnings before interest, taxes, depreciation and amortization (EBITDA) of $3 million to $25 million, which we refer to as middle market companies. Our capital is generally used by our portfolio
companies to finance acquisitions, recapitalizations, buyouts, organic growth and working capital. We identify and source new customers through multiple channels, including private equity sponsors, investment bankers, brokers, fund-less sponsors,
institutional syndication partners, other club lenders and owner operators. We originate most of our investments directly with our customers, although from time to time we do participate in loan syndications or other deals. We have controlling
equity positions in certain of our portfolio companies. We base our investment decisions on extensive analyses of potential customers business operations and asset valuations. We utilize specialized risk management methods, pricing tools, due
diligence methodologies and data management processes that are designed to help us assess risk, establish appropriate pricing, and maximize our return on investment.



Our primary business objectives are to increase our earnings and net asset value by investing in debt and equity securities
of middle market companies. Our investment objective is to achieve current income and capital gains. We earn current income, in the form of interest, dividends, and fees, from our investments in debt and equity securities and achieve capital gains
through appreciation in the value of our equity investments. To meet our investment objectives, we selectively invest in companies which present opportunities for favorable risk-adjusted returns. In addition, we maintain a flexible approach to
funding that permits adjustments to transaction terms, including pricing terms, to accommodate the shifting corporate development needs of our customers.



We have built our portfolio with disciplined asset acquisition through our underwriting and investment approval processes and active portfolio management.
We believe that our core competencies include risk assessment and risk management, and we have developed expertise which is reflected in our underwriting and compliance processes. We generally make investments of up to $75 million utilizing three
core products: our one-stop solution, institutional subordinated debt, and control investing. Our debt investments include senior and subordinated securities, substantially all of which include a security interest. Our loans typically
mature in four to eight years, and require monthly or quarterly interest payments at fixed rates or variable rates based on the prime rate or LIBOR, plus a margin. We price our debt securities based upon our credit analysis and risk assessment. Our
equity investments are often made in companies in which we have also made debt investments. Our equity investments include preferred stock, common stock, and warrants and, in many cases, will include the right to board representation. We may invest
across the capital structure of our portfolio companies using a combination of debt and equity investments to meet our customers needs and optimize our returns.



CORPORATE HISTORY AND OFFICES



We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company under
the Investment Company Act of 1940 or the 1940 Act. As a business development company, we are required to meet various regulatory tests, which include investing at



1



---

##### Table of Contents

least 70% of our total assets in private or thinly traded public U.S.-based companies and meeting a coverage ratio of total net assets to total senior
securities, which include all of our borrowings (including accrued interest payable) and any preferred stock we may issue in the future, of at least 200%. See Regulation as a Business Development Company. In addition, we have elected to
be treated for federal income tax purposes as a regulated investment company, or RIC, under the Internal Revenue Code. In order to continue to qualify as a RIC for federal income tax purposes, we must meet certain requirements, including
certain minimum distribution requirements. See Certain U.S. Federal Income Tax Considerations.



Our business began in 1990 as a division of Signet Bank known as the media communications group. Signet Banking Corporation, the parent of Signet Bank,
was acquired by First Union Corporation (now Wachovia Corporation) on November 27, 1997. We were formed in 1998 by certain members of our management and affiliates of Goldman, Sachs & Co. to purchase a loan portfolio and certain other
assets from First Union National Bank (now Wachovia Bank, National Association) in a management buyout. MCG was organized as a Delaware corporation on March 18, 1998 at which time we changed our name from MCG, Inc. to MCG Credit Corporation. On
June 14, 2001, we changed our name from MCG Credit Corporation to MCG Capital Corporation.



Our executive offices are located at 1100 Wilson Boulevard, Suite 3000, Arlington, Virginia 22209 and our telephone number is (703) 247-7500. We also
have an office in Richmond, Virginia. Our Internet site address is www.mcgcapital.com. Information contained on our web site is not incorporated by reference into this Annual Report and you should not consider information contained on our web
site to be part of this Annual Report. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and our current reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our website as soon as
reasonably practicable after we file them with, or furnish them to, the Securities and Exchange Commission (SEC).



MARKET OPPORTUNITY



We believe that the middle market is a significant, growing segment of the U.S. economy that has increasing demand for, and less access to, high-quality
differentiated corporate financial services, and that this trend is likely to continue given the on-going consolidation in the financial services industry. We also believe that the middle market offers attractive rates of return and that middle
market companies have distinct capital and servicing requirements. Our ability to structure transactions to meet these capital and servicing requirements for middle market companies across a diverse industry base enhances our market opportunity.



In order to continue to service our middle market customers,
we enhance our knowledge of the middle market through continuous engagement with existing and prospective customers and by conducting ongoing market research. We use this information to enhance the quality of our investment analysis. We write and
distribute Transactions, a periodic newsletter which focuses on merger and acquisition activity, to portfolio companies, prospective customers, investors, and others to facilitate a dialogue and to provide our perspective on a variety of
topics. We believe that our extensive knowledge and research capabilities differentiate us in the marketplace because we are able to demonstrate our expertise and knowledge of the middle market and share it with our customers.



STRATEGY



We seek to achieve favorable risk-adjusted rates of return in the form of current income and capital appreciation, while
maintaining credit and investment quality in our asset portfolio. We believe our financial performance is a product of our knowledge and insight, effectiveness in targeting potential customers, exceptional customer service, risk-based pricing
techniques, and effective risk management. We apply well established credit processes to the assessment of risk, and we structure and price our investments accordingly. We have developed proprietary analytics, data and knowledge to support our
business activities.



2



---

##### Table of Contents

Our investment process is designed to achieve the following strategic objectives:



| |  |  | generate favorable risk-adjusted rates of return by delivering capital and strategic insight to increase our customers enterprise value;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | maintain sound credit and investment discipline and pricing practices, regardless of market conditions, to avoid adverse investment selection;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | manage risk by utilizing an integrated team approach to business development, underwriting, and investment servicing.
| | - |  | ---------------------------------------------------------------------------------------------------------------------



INVESTMENTS



Our debt investments include senior and subordinated securities,
substantially all of which include a security interest. Our loans typically mature in four to eight years, and require monthly or quarterly interest payments at fixed rates or variable rates based on the prime rate or LIBOR, plus a margin. We price
our debt securities based upon our credit analysis and risk assessment. Our equity investments are often made in companies in which we have also made debt investments. Our equity investments include preferred stock, common stock, and warrants and,
in many cases, will include the right to board representation. We may invest across the capital structure of our portfolio companies using a combination of debt and equity investments to meet our customers needs and optimize our returns. In
order to execute our strategy we utilize three core products: our one-stop solution, institutional sub debt, and control investing.



One-stop Solution.    Our one-stop solution, which refers to our ability to invest throughout
the capital structure of a company, enables our customers to satisfy multiple financing needs from a single capital provider. In a typical one-stop transaction, we provide a combination of senior and subordinated debt to our customer
and, in certain cases, also acquire an equity interest in the customer. The overall transaction size and product mix are based upon our customers needs. In some cases our one-stop solution results in a product mix that meets our
customers needs but which we believe is not the most efficient use of our capital. In these cases, we may sell portions of some of the securities in order to achieve a more optimal mix. Typically, when we sell portions of one of our
investments, we continue to service the investment and thus these sales are seamless to our customers. One-stop transactions generally provide current interest income on our loans and the opportunity to achieve capital gains on our
equity investment, as well as fee income generated through syndication of portions of the investment.



Institutional Subordinated Debt.    We provide institutional subordinated debt in the form of junior, yielding capital,
as a sole or club investor. These loans are payable in full at maturity and generally provide attractive yields. Our institutional sub debt customers are generally larger businesses supported by institutional equity capital that reduces the risk
profile of these investments.



Control
Investments.    Control investments are those for which we take a majority ownership position and, in most cases, control the board of directors of a portfolio company. Control investments are long-term investments in
which we expect to achieve the majority of our returns through capital appreciation. Our control investments typically include investments across the entire capital structure of the portfolio company. We believe control investments generally provide
a reliable income stream and an opportunity to generate capital gains on our investment.



Other Investments and Services.    In addition to our core products we also make other investments, such as senior loans and investments in broadly syndicated assets. These other
investments help balance our portfolio. In addition to capital, we also offer managerial assistance to our portfolio companies. This assistance typically involves strategic advice, evaluation of business plans, financial modeling assistance and
industry research and insights. We believe that providing assistance to our portfolio companies enables us to maximize our value proposition for our customers which, in turn, helps us maximize our investment returns.



3



---

##### Table of Contents

OPERATIONS



We engage our markets with expertise and superior responsiveness, which enables us to originate and manage a diverse portfolio of investments that
produce current income and capital gains in order to create consistent, high quality and sustainable dividends for our stockholders. To achieve our goal of being a leading provider of solutions-focused financial services to middle market companies,
we have established a credit and business culture that strives to identify and attract new customers and provide excellent customer service, while protecting our capital and generating favorable risk-adjusted returns through current income on our
loans and equity investments and capital gains on our equity investments.



Business Development



MCG and its
predecessors have been active investors in the middle market since 1990 and have invested over $5.1 billion in approximately 480 transactions. We believe that our experience in middle market investing is a meaningful competitive advantage that we
use to develop our business. We identify and source new customers through multiple channels, including private equity sponsors, investment bankers, brokers, fund-less sponsors, institutional syndication partners, other club lenders and owner
operators. We also market to prospective customers identified through various data services, customized internet searches, and relationships with investment bankers, accountants, lawyers and other professionals. From time to time we also purchase
investments through syndicated or other deals. Members of our professional staff engage in other marketing initiatives on a national scale, including attending and presenting at industry forums, conferences and meetings and participating in industry
associations. Of our investments in new customers during 2006, approximately 62% were in deals sponsored by private equity investors, 24% were in syndicated or other deals, and 14% were direct investments in owner operators.



Once we identify a prospective customer, we review its financial reports,
corporate activities, and other relevant information which we gather from third-party databases, industry reports, trade and consumer magazines, newspapers and newsletters. We focus on a companys fundamental performance against industry
conditions and operational benchmarks. We work with our current and prospective customers to understand their business, costs and benefits of their corporate development initiatives, opportunities, competition, and acceptable risks and returns. This
understanding allows us to support our customers corporate development decisions, even in some cases where short-term financial ratios or other metrics may temporarily decline. We believe this approach differentiates us from most other lenders
and investors and enables us to make investments and achieve returns based on the value we help create rather than solely on the basis of our cost of capital. This approach has been successful in attracting new customers and in gaining additional
business from current customers as they execute their long term growth strategies.



Underwriting and Risk Management



Our
underwriting philosophy places primary emphasis on credit and risk analysis. Our underwriting function is initiated during the business development process. Our underwriting team consists of investment professionals who perform due diligence and
financial analyses, deal teams who are responsible for originating and managing the transaction, a member of our credit committee and a member of our legal team. Our underwriting processes, which have been developed over more than 15 years, include
standard due diligence on a prospective customers financial performance as well as customized analyses of a prospective customers operations, systems, accounting policies, human resources and legal and regulatory environment. Our
underwriting team works to gain an understanding of the relationships among the customers business plan, operations and financial performance. We frequently engage external experts to supplement and assist in the underwriting process.



In addition to gaining an in-depth understanding of our
customers and prospective customers, our research and due diligence provide expert perspectives on industry wide operational, strategic, and valuation issues and support our business development and risk management processes by identifying
attractive industries, emerging



4



---

##### Table of Contents

trends, and competitive threats. We continually update our investment perspectives and develop investment hypotheses for new industries. The knowledge and
insight we obtain through our research are valuable to our customers who may draw on our industry expertise to refine their strategic plans, identify acquisition opportunities, and set appropriate financial and operational goals.



As part of our evaluation of a proposed investment, the underwriting team
prepares an investment memorandum for presentation to the credit committee and, in some instances, the investment committee. The investment memorandum generally consists of:



| |  |  | a business description;
| | - |  | -----------------------



| |  |  | historical financial analysis, projections and scenario modeling;
| | - |  | -----------------------------------------------------------------



| |  |  | a risk evaluation specific to the prospective portfolio companys business, considering the anticipated use of proceeds of our investment, and industry;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an enterprise valuation to assess the underlying value of the customer, both as an ongoing operation and its value relative to comparable public and private
companies; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a description of the capital structure and the investment risk and return characteristics.
| | - |  | ------------------------------------------------------------------------------------------



Risk Analysis.    We review the prospective
portfolio companys history, organization and product lines, and we analyze the prospective portfolio companys industry, competition and market share, obsolescence and substitution risk, markets served, legal and regulatory environment
and technology. In particular, we analyze the following risks:



| |  |  | Industry Risks.    We analyze the specific vulnerability to industry risk, such as maturity, cyclicality, and seasonality.
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | Competitive Risks.    We analyze the strengths and weaknesses of the prospective portfolio company relative to its competitors in terms
of its pricing, product quality, customer loyalty, substitution and switching costs, brand positioning and capitalization. We also assess the defensibility of a prospects market position and its opportunity for increasing market share.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regulatory Risks.    We follow regulatory developments in the industries in which we invest and assess the risks that are presented by
existing and proposed regulations.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Customer Concentration and Market Risks.    We evaluate the stability of the prospective portfolio companys customer base by
analyzing the number and size of its customers and their attrition rates, the potential impact of above average customer attrition and low renewals, and the risk due to loss of its significant customers.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Technology Risks.    We follow technological advancements in the industries in which we invest and analyze the positive or negative
impacts these advancements may have on the prospective portfolio company.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We also assess other attributes of a potential transaction. We evaluate managements track record, their business plan, their judgments about their products and other characteristics that may significantly affect
the risk of a transaction. Quantitative attributes that we evaluate include industry-specific comparisons such as cash flow margins, product and cash flow diversification, revenue growth rates, cost structure and other operating benchmarks that are
derived from historical financial statements. Qualitative attributes we evaluate may include management skill and depth, industry risk, substitution risk, cyclicality, geographic diversification, facilities infrastructure, administration
requirements and product quality and ranking.



Enterprise
Valuation.    To assess the risk of a potential investment and to quantify the underlying value of the enterprise in which we are investing, we employ a series of valuation techniques. We primarily derive enterprise
valuations through analyses of comparative public and private market transactions using our database



5



---

##### Table of Contents

of transactions. We also generally prepare discounted cash flow models based on our projections of the future free cash flows of the business and industry
derived capital costs. Finally, we look to comparable public companies to benchmark the value of the enterprise using public market data. We generally base enterprise value on current and projected market conditions. Using these methods provides us
with multiple views of the value of the enterprise and allows us to calculate certain metrics that we use in both risk assessment and product pricing, such as loan-to-value ratios for our debt investments.



Investment Structure.    We evaluate our
customers needs and utilize our product mix to structure investments that meet their capital requirements and business plans and protect our capital while generating favorable risk-adjusted returns through current income on our loans and
equity investments and capital gains on our equity investments. We structure our investments to mitigate risk by requiring appropriate financial and collateral coverage thresholds. When structuring our investments, we evaluate key components,
including payment priority, collateral or asset value, and financial support from guarantors and other credit enhancements. Since our investments typically include loans and our loans are typically cash flow loans, rather than asset backed loans,
liquidation value of assets is a factor in our credit decisions. In the majority of our loans, we receive a security interest in our customers tangible and intangible assets, which entitles us to a preferred position on payments in the event
of liquidation, and a pledge of the equity by the equity owners. In addition, our loan covenants generally include affirmative covenants that require the customer to provide periodic financial information, notification of material events and
compliance with laws, as well as restrictive covenants that prevent customers from taking a range of significant actions, such as incurring additional indebtedness or making acquisitions without our consent. We also generally include covenants
requiring the customer to maintain or achieve specified financial ratios, such as cash flow leverage, interest charge coverage and total charge coverage, and, in certain cases, operating covenants requiring them to maintain certain operational
benchmarks.



Investment Approval Process



All of our investments are approved by our credit
committee, whose members include Steven F. Tunney, our President and Chief Executive Officer; Robert J. Merrick, our Chief Investment Officer; B. Hagen Saville, our Executive Vice President of Business Development; William B. Ford, a Senior Vice
President and Managing Director; and Robert L. Marcotte, a Senior Vice President and Managing Director. In addition, certain investments based on asset type and investment size must also be approved by the investment committee of our board of
directors, whose members include Messrs. Tunney, Saville and Merrick and independent directors Kenneth J. OKeefe, Kim D. Kelly, and Edward S. Civera.



Investment Servicing



After an investment is approved and funded, the deal sponsor and underwriting team, along with the investment administration group and the compliance and
valuation group, monitor covenant compliance and financial performance on an ongoing basis. Our deal teams maintain primary responsibility for the performance of their investments throughout the life of the investment.



Investment Administration Group.    This
group maintains our investment transaction records and is responsible for:



| |  |  | funding the investments in accordance with credit committee and, if applicable, investment committee approval;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | recording the investments into our accounting system;
| | - |  | -----------------------------------------------------



| |  |  | billing and collecting;
| | - |  | -----------------------



| |  |  | reporting and collecting on past due accounts; and
| | - |  | --------------------------------------------------



| |  |  | maintaining the collateral that is in our possession.
| | - |  | -----------------------------------------------------



6



---

##### Table of Contents

Compliance and Valuation Group.    This group monitors investment
compliance and ensures that all investments adhere to our internal policies and procedures. This group is responsible for:



| |  |  | reviewing the investment agreement to ensure that the final documents reflect the terms approved by the credit committee and, if applicable, the investment
committee and advising of any deviations;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ensuring that the portfolio company compliance package is prepared in accordance with the loan covenant requirements;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | entering the portfolio companys financial statements into our tracking system and entering the loan covenants into our covenant tracking system;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ensuring the mathematical accuracy of applicable covenant requirements;
| | - |  | -----------------------------------------------------------------------



| |  |  | reviewing the portfolio companys financial statements to ensure that the portfolio company performs in accordance with our expectations and to identify any
changes in risk;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reporting all covenant violations, loan amendments and covenant waivers to the credit committee; and
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | preparing quarterly portfolio valuations for review by the valuation committee of our Board of Directors.
| | - |  | ---------------------------------------------------------------------------------------------------------



Investment Monitoring and Restructuring
Procedures.    We continually monitor the status and financial performance for each individual customer in order to evaluate overall portfolio quality. We closely monitor compliance with all covenants and take appropriate
action on all exceptions. We do not believe that all contract exceptions, such as breaches of contractual covenants or late delivery of financial statements, are necessarily an indication of deterioration in the credit quality or the need to pursue
remedies or an active workout of a portfolio investment.



When
our attempts to collect past due principal and interest on a loan are unsuccessful, we will perform an analysis to determine the appropriate course of action. In some cases, we may consider restructuring the investment to better reflect the current
financial performance of the customer. Such a restructuring may, among other items, involve deferring payments of principal and interest, adjusting interest rates or warrant positions, imposing additional fees, amending financial or operating
covenants or converting debt to equity. In connection with a restructuring, we generally receive appropriate compensation from the customer for any increased risk. During the process of monitoring a loan in default, we will generally send a notice
of non-compliance outlining the specific defaults that have occurred and preserving our remedies, and initiate a review of the collateral, if any. When a restructuring is not the most appropriate course of action, we generally pursue remedies
available to us that minimize any potential losses, including initiating foreclosure and/or liquidation proceedings.



When a loan becomes 90 days or more past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will,
as a general matter, place the loan on non-accrual status and will generally cease recognizing interest income until all past due principal and interest has been paid or otherwise restructured such that the interest income is determined to be
collectible. We may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection.



Investment Funding



We fund our investments using cash that we receive in exchange for a combination of debt and equity instruments that we issue from time to time. Our debt
obligations include both secured and unsecured obligations. As a business development company we are required to meet a coverage ratio of total assets to total senior securities, which include all of our borrowings and any preferred stock we may
issue in the future, of at least 200%. Our equity is publicly traded on the NASDAQ Global Select Market under the symbol MCGC.



7



---

##### Table of Contents

Portfolio Valuation



We determine the value of each investment in our portfolio on a quarterly basis, and record changes in value as unrealized
appreciation or depreciation in our statement of operations. Value, as defined in Section 2(a)(41) of 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other
securities and assets, fair value is as determined in good faith by the board of directors. Since there is typically no readily ascertainable market value for the investments in our portfolio, we value substantially all of our investments at fair
value as determined in good faith by the board of directors pursuant to a valuation policy and a consistent valuation process. At December 31, 2006 and December 31, 2005, approximately 95% and 88%, respectively, of our total assets
represented investments of which approximately 97% and 94%, respectively, are valued at fair value and approximately 3% and 6%, are valued at market value based on readily ascertainable public market quotes, respectively. Because of the inherent
uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the board of directors may differ significantly from the values that would have
been used had a ready market existed for the investments, and the differences could be material. See further discussion in Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting
Policies.



Portfolio Overview



As of December 31, 2006, our investment portfolio consisted of
approximately 72% of debt investments and 28% of equity investments. Approximately 97% of our debt investments as of that date had security interests.



Our debt instruments provide for a contractual interest rate generally ranging from 10% to 16%, a portion of which may be payment-in-kind
(PIK) which we typically do not collect until maturity. At December 31, 2006, approximately 64% of the debt investments in our portfolio, based on amounts outstanding at fair value, were at variable rates determined on the basis of
LIBOR or prime rate, and approximately 36% were at fixed rates. In addition, approximately 31% of our debt investment portfolio has floors of between 1.50% and 3.00% on the LIBOR base index. Our loans have stated maturities at origination that
generally range from four to eight years. Our customers typically pay an origination fee based on a percentage of the commitment amount and also often pay a fee on any undrawn commitments.



8



---

##### Table of Contents

The following table shows statistics of our portfolio as of December 31, 2006 and 2005, and activity
for the years then ended:



|                                                                                                       |  |      |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|(dollars in millions)                                                                                  |  | 2006 |         |   | 2005 |  
|Portfolio by type at fair value:                                                                       |  |      |         |   |      |   |         |  
|Senior secured debt                                                                                    |  | $    | 389.7   |   |      | $ | 543.0   |  
|Subordinated debt                                                                                      |  |      |         |   |      |   |         |  
|Secured                                                                                                |  |      | 495.0   |   |      |   | 329.5   |  
|Unsecured                                                                                              |  |      | 24.7    |   |      |   | 61.6    |  
|                                                                                                       |  |      |         |   |      |   |         |  
|Total debt investments                                                                                 |  |      | 909.4   |   |      |   | 934.1   |  
|                                                                                                       |  |      |         |   |      |   |         |  
|Preferred equity                                                                                       |  |      | 285.1   |   |      |   | 126.7   |  
|Common equity or common equity equivalents                                                             |  |      | 63.1    |   |      |   | 36.8    |  
|                                                                                                       |  |      |         |   |      |   |         |  
|Total equity investments                                                                               |  |      | 348.2   |   |      |   | 163.5   |  
|                                                                                                       |  |      |         |   |      |   |         |  
|Total portfolio                                                                                        |  | $    | 1,257.6 |   |      | $ | 1,097.6 |  
|                                                                                                       |  |      |         |   |      |   |         |  
|Portfolio by type at fair value as a percentage of total portfolio:                                    |  |      |         |   |      |   |         |  
|Senior secured debt                                                                                    |  |      | 31.0    | % |      |   | 49.5    | %
|Subordinated debt                                                                                      |  |      |         |   |      |   |         |  
|Secured                                                                                                |  |      | 39.3    | % |      |   | 30.0    | %
|Unsecured                                                                                              |  |      | 2.0     | % |      |   | 5.6     | %
|                                                                                                       |  |      |         |   |      |   |         |  
|Total debt investments                                                                                 |  |      | 72.3    | % |      |   | 85.1    | %
|                                                                                                       |  |      |         |   |      |   |         |  
|Preferred equity                                                                                       |  |      | 22.7    | % |      |   | 11.5    | %
|Common equity or common equity equivalents                                                             |  |      | 5.0     | % |      |   | 3.4     | %
|                                                                                                       |  |      |         |   |      |   |         |  
|Total equity investments                                                                               |  |      | 27.7    | % |      |   | 14.9    | %
|                                                                                                       |  |      |         |   |      |   |         |  
|Total portfolio                                                                                        |  |      | 100.0   | % |      |   | 100.0   | %
|                                                                                                       |  |      |         |   |      |   |         |  
|Average investment balance per customer                                                                |  | $    | 15.2    |   |      | $ | 12.1    |  
|Yield on average loan portfolio at fair value                                                          |  |      | 12.9    | % |      |   | 11.9    | %
|Average LIBOR                                                                                          |  |      | 5.2     | % |      |   | 3.6     | %
|Impact of fee accelerations of unearned fees on paid loans                                             |  |      | 0.3     | % |      |   | 0.7     | %
|Spread to average LIBOR on average loan portfolio at fair value                                        |  |      | 7.4     | % |      |   | 7.6     | %
|Total yield on average loan portfolio at fair value                                                    |  |      | 12.9    | % |      |   | 11.9    | %
|Loans on non-accrual status as a percentage of total debt investments                                  |  |      | 3.9     | % |      |   | 1.4     | %
|Loans on non-accrual status as a percentage of total investments                                       |  |      | 2.8     | % |      |   | 1.2     | %
|Loans greater than 90 days past due as a percentage of total debt investments                          |  |      | 2.4     | % |      |   | 1.8     | %
|Loans greater than 90 days past due as a percentage of total investments                               |  |      | 1.7     | % |      |   | 1.5     | %
|Loans on non-accrual status or greater than 90 days past due as a percentage of total debt investments |  |      | 4.1     | % |      |   | 2.8     | %
|Loans on non-accrual status or greater than 90 days past due as a percentage of total investments      |  |      | 3.0     | % |      |   | 2.4     | %
|% of loans with fixed interest rates                                                                   |  |      | 36.2    | % |      |   | 29.2    | %
|% of loans with floating interest rates                                                                |  |      | 63.8    | % |      |   | 70.8    | %
|Portfolio company data:                                                                                |  |      |         |   |      |   |         |  
|Number of portfolio companies                                                                          |  |      | 83      |   |      |   | 91      |  
|Average annual revenue of portfolio companies                                                          |  | $    | 103.3   |   |      | $ | 154.4   |  
|Average annual revenue of portfolio companies (excluding broadly syndicated portfolio companies)       |  | $    | 51.6    |   |      | $ | 45.9    |  
|Average annual EBITDA of portfolio companies                                                           |  | $    | 11.6    |   |      | $ | 19.6    |  
|Average annual EBITDA of portfolio companies (excluding broadly syndicated portfolio companies)        |  | $    | 7.1     |   |      | $ | 8.5     |  
|Average loan to value (excluding broadly syndicated portfolio companies)                               |  |      | 51.0    | % |      |   | 49.0    | %



9



---

##### Table of Contents

The following table shows our portfolio of investments by industry at fair value, as of December 31,
2006 and 2005:



|                                                               |  |                         |         |                             |                   |   |                             |   |                                 |  |       |  
|-------------------------------------------------------------- |  | ----------------------- | ------- | --------------------------- | ----------------- | - | --------------------------- | - | ------------------------------- |  | ----- | -
|                                                               |  | December 31, 2006       |         |                             | December 31, 2005 |  
|(dollars in millions)                                          |  | Investmentsat FairValue |         | Percentageof TotalPortfolio |                   |   | Investmentsat FairValue (a) |   | Percentageof TotalPortfolio (a) | 
|TelecommunicationsCLECs (competitive local exchange carriers) |  | $                       | 274.1   |                             | 21.8              | % |                             | $ | 213.4                           |  | 19.4  | %
|Other Communications                                           |  |                         | 84.0    |                             | 6.7               |   |                             |   | 68.8                            |  | 6.3   |  
|Healthcare                                                     |  |                         | 106.5   |                             | 8.5               |   |                             |   | 91.1                            |  | 8.4   |  
|Newspaper                                                      |  |                         | 90.6    |                             | 7.2               |   |                             |   | 112.8                           |  | 10.3  |  
|Publishing                                                     |  |                         | 68.0    |                             | 5.4               |   |                             |   | 72.3                            |  | 6.6   |  
|Laboratory Instruments                                         |  |                         | 58.4    |                             | 4.6               |   |                             |   | 52.1                            |  | 4.7   |  
|Plastic Products                                               |  |                         | 57.1    |                             | 4.5               |   |                             |   |                                |  |      |  
|Home Furnishings                                               |  |                         | 52.5    |                             | 4.2               |   |                             |   | 18.9                            |  | 1.7   |  
|Business Services                                              |  |                         | 51.2    |                             | 4.1               |   |                             |   | 22.2                            |  | 2.1   |  
|Information Services                                           |  |                         | 47.4    |                             | 3.8               |   |                             |   | 75.4                            |  | 6.9   |  
|Broadcasting                                                   |  |                         | 39.9    |                             | 3.2               |   |                             |   | 31.9                            |  | 2.9   |  
|Cable                                                          |  |                         | 38.7    |                             | 3.1               |   |                             |   | 33.3                            |  | 3.0   |  
|Technology                                                     |  |                         | 36.2    |                             | 2.9               |   |                             |   | 66.1                            |  | 6.0   |  
|Education                                                      |  |                         | 31.0    |                             | 2.5               |   |                             |   | 19.5                            |  | 1.8   |  
|DVD Rental                                                     |  |                         | 28.6    |                             | 2.3               |   |                             |   |                                |  |      |  
|Sporting Goods                                                 |  |                         | 26.9    |                             | 2.1               |   |                             |   |                                |  |      |  
|Electronics                                                    |  |                         | 24.8    |                             | 2.0               |   |                             |   | 34.1                            |  | 3.1   |  
|Other Media                                                    |  |                         | 24.1    |                             | 1.9               |   |                             |   | 33.9                            |  | 3.1   |  
|Food Services                                                  |  |                         | 21.2    |                             | 1.7               |   |                             |   |                                |  |      |  
|Retail                                                         |  |                         | 19.4    |                             | 1.5               |   |                             |   | 20.5                            |  | 1.9   |  
|Auto Parts                                                     |  |                         | 17.2    |                             | 1.4               |   |                             |   | 17.0                            |  | 1.5   |  
|Drugs                                                          |  |                         | 15.6    |                             | 1.2               |   |                             |   | 28.7                            |  | 2.6   |  
|Leisure Activities                                             |  |                         | 14.3    |                             | 1.1               |   |                             |   | 13.4                            |  | 1.2   |  
|Photographic Studio                                            |  |                         | 12.9    |                             | 1.0               |   |                             |   |                                |  |      |  
|Cosmetics                                                      |  |                         | 6.3     |                             | 0.5               |   |                             |   | 11.3                            |  | 1.0   |  
|Car Rental                                                     |  |                         |        |                             |                  |   |                             |   | 13.5                            |  | 1.2   |  
|Other (b)                                                      |  |                         | 10.7    |                             | 0.8               |   |                             |   | 47.4                            |  | 4.3   |  
|                                                               |  |                         |         |                             |                   |   |                             |   |                                 |  |       |  
|                                                               |  | $                       | 1,257.6 |                             | 100.0             | % |                             | $ | 1,097.6                         |  | 100.0 | %
|                                                               |  |                         |         |                             |                   |   |                             |   |                                 |  |       |  

---

|(a) |  | Certain amounts have been reclassified into different industries to conform to the current period industry classification.
|--- |  | --------------------------------------------------------------------------------------------------------------------------

|(b) |  | No individual industry within this category exceeds 1%.
|--- |  | -------------------------------------------------------



Our ten largest portfolio companies represented approximately 41.3% of the total fair value of our investments at December 31, 2006 and accounted for
approximately 37.5% of our operating income during the year ended December 31, 2006. At December 31, 2006, approximately 28.5% of our portfolio at fair value was invested in companies in the communications industry. The communications
industry is a regulated industry. Of the 28.5% in the communications industry, 21.8% represents our investments in CLECs, and 6.7% represents our investments in other communications companies, including telecommunications tower companies, internet
service providers, wireless companies and security alarm companies. Our two largest portfolio companies, Broadview Networks Holdings, Inc. (Broadview) and Cleartel Communications, Inc. (Cleartel) are CLECs. Broadview, our
largest portfolio company and one of our control investments, represented approximately 12.7% of the fair value of our investments at December 31, 2006 and approximately 14.5% of our operating income during the year ended December 31,
2006. Cleartel, our second largest portfolio company and one of our control



10



---

##### Table of Contents

investments, represented approximately 5.8% of the fair value of our investments at December 31, 2006 and approximately 4.8% of our operating income
during the year ended December 31, 2006. See additional discussion of Broadview and Cleartel in Managements Discussion and Analysis of Financial Condition and Results of OperationsPortfolio Composition and Investment
Activity.



Investment Rating System



We use an investment rating system to characterize
and monitor our expected level of return on each investment in our portfolio. We use the following 1 to 5 investment rating scale:



|                 |  |                                                                                                                                                                
|---------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|InvestmentRating |  | Summary Description                                                                                                                                            
|1                |  | Capital gain expected or realized                                                                                                                              
|2                |  | Full return of principal and interest or dividend expected with customer performing in accordance with plan                                                    
|3                |  | Full return of principal and interest or dividend expected but customer requires closer monitoring                                                             
|4                |  | Some loss of interest or dividend expected but still expecting an overall positive internal rate of return on the investment                                   
|5                |  | Loss of interest or dividend and some loss of principal investment expected which would result in an overall negative internal rate of return on the investment



We monitor and, when
appropriate, recommend changes to investment ratings. The valuation committee of our board of directors reviews managements recommendations and affirms or changes the investment ratings quarterly. In most cases, where we hold multiple
securities in a portfolio company, the investment rating is the same for each security in that portfolio company.



The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as of December 31, 2006 and 2005:



|                     |  |                          |         |     |                              |       |   |                          |   |         |                              |  |       |  
|-------------------- |  | ------------------------ | ------- | --- | ---------------------------- | ----- | - | ------------------------ | - | ------- | ---------------------------- |  | ----- | -
|(dollars inmillions) |  | December 31, 2006        |         |     | December 31, 2005            |      
|Investment Rating    |  | Investments atFair Value |         |     | Percentage ofTotal Portfolio |       |   | Investments atFair Value |   |         | Percentage ofTotal Portfolio | 
|1                    |  |                          | 785.3   | (a) |                              | 62.4  | % |                          |   | 459.0   | (a)                          |  | 41.8  | %
|2                    |  |                          | 285.5   |     |                              | 22.7  |   |                          |   | 429.9   |                              |  | 39.2  |  
|3                    |  |                          | 158.2   |     |                              | 12.6  |   |                          |   | 128.0   |                              |  | 11.7  |  
|4                    |  |                          | 23.6    |     |                              | 1.9   |   |                          |   | 77.4    |                              |  | 7.0   |  
|5                    |  |                          | 5.0     |     |                              | 0.4   |   |                          |   | 3.3     |                              |  | 0.3   |  
|                     |  |                          |         |     |                              |       |   |                          |   |         |                              |  |       |  
|                     |  | $                        | 1,257.6 |     |                              | 100.0 | % |                          | $ | 1,097.6 |                              |  | 100.0 | %
|                     |  |                          |         |     |                              |       |   |                          |   |         |                              |  |       |  

---

|(a) |  | At December 31, 2006 and 2005, approximately $447.4 million and $348.4 million, respectively, of our investments with an investment rating of 1 were loans to
companies in which we also hold equity securities or for which we have already realized a gain on our equity investment.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



COMPETITION



In general, we compete for investments with a large number of financial services companies, including commercial finance companies, commercial banks,
private mezzanine and equity funds, investment banks and other investment funds such as hedge funds. These include lending subsidiaries of investment banks, other business development companies, and finance subsidiaries of large industrial
corporations.



11



---

##### Table of Contents

We do not seek to compete primarily based on the interest rates we offer, and we believe that some of our
competitors make loans with interest rates that are comparable to or lower than the rates we offer. We generally compete by using our insight and knowledge of our customers business needs, derived from our research, analysis, and interaction
of our professional staff with our customers, to offer the appropriate product mix coupled with a range of corporate finance services and information that enhances our customers business prospects.



OUR SUBSIDIARIES



We conduct some of our activities through wholly owned financing
subsidiaries. These subsidiaries are bankruptcy remote, special purpose entities to which we transfer certain loans. Each financing subsidiary in turn transfers the loans to a Delaware statutory trust. As of December 31, 2006, we had
established MCG Finance I, LLC, MCG Finance V, LLC, MCG Finance VII, LLC and MCG Finance VIII, LLC as financing subsidiaries. The transfers of the loans to the Delaware statutory trusts are structured as on-balance sheet securitizations for
accounting purposes.



On December 13, 2004, we formed a
subsidiary, Solutions Capital I, LP, which has applied to the United States Small Business Administration (SBA) for a license to operate as a small business investment company (SBIC) under the Small Business Investment Act of
1958, as amended. At the same time we organized another wholly owned subsidiary, Solutions Capital GP, LLC, as a Delaware limited liability company. Solutions Capital GP, LLC will act as the general partner of Solutions Capital I, LP, while we will
be the sole limited partner. We are currently in the pre-licensure phase of the licensing process and anticipate completion of the licensing process during the spring of 2007. Upon receipt of the SBA license, we intend to apply for exemptive relief
from the SEC to permit us to exclude senior securities issued by the SBA to Solutions Capital I, LP from our consolidated asset coverage ratio, which will enable us to fund more investments with debt capital. There can be no assurance that we will
be granted an SBIC license or receive the requested exemptive relief from the SEC.



We also use wholly owned subsidiaries, all of which are structured as Delaware corporations, to hold the assets of one or more of our portfolio companies. As of December 31, 2006, we had established Crystal Media
Network, Inc., IH NPS Holdings, LLC, IH NYL, Inc., IH Sunshine, Inc., and MCG IH Holdings, Inc. to hold assets of certain of our portfolio companies. Some of these subsidiaries have wholly owned subsidiaries, all of which are Delaware corporations,
that hold the assets of certain of our portfolio companies.



INVESTMENT POLICIES



Our investment policies
provide that we will not:



| |  |  | act as an underwriter of securities of other issuers, except to the extent that we may be deemed an underwriter of securities (i) purchased by us
that must be registered under the Securities Act of 1933 before they may be offered or sold to the public, or (ii) in connection with offerings of securities by our portfolio companies;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | purchase or sell real estate or interests in real estate or real estate investment trusts, except that we may purchase and sell real estate or interests in real
estate in connection with the orderly liquidation of or pursuit of remedies with respect to investments and we may own the securities of companies or participate in a partnership or partnerships that are in the business of buying, selling or
developing real estate or we may own real estate for our own uses;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | sell securities short in an uncovered position;
| | - |  | -----------------------------------------------



| |  |  | write or buy uncovered put or call options, except to the extent of options, warrants or conversion privileges in connection with our loans or other investments,
and rights to require the issuers of such investments or their affiliates to repurchase them under certain circumstances;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



12



---

##### Table of Contents

| |  |  | engage in the purchase or sale of commodities or commodity contracts, including futures contracts, except for purposes of hedging in the ordinary course of business
or where necessary in working out distressed loan or investment situations; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | acquire more than 3% of the voting stock of, or invest more than 5% of our total assets in any securities issued by, any other investment company, except if we
acquire them as part of a merger, consolidation or acquisition of assets or if they result from a sale of a portfolio company, or otherwise as permitted under the 1940 Act.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



All of the above policies and the investment and lending guidelines set by
our board of directors or any committees, including our investment objective to achieve current income and capital gains, are not fundamental as defined under the 1940 Act. Therefore, our board may change them without notice to or
approval by our stockholders, but any change may require the consent of our lenders.



Other than the restrictions pertaining to the issuance of senior securities under the Investment Company Act of 1940, the percentage restrictions on investments generally apply at the time a transaction is effected. A
subsequent change in a percentage resulting from market fluctuations or any cause other than an action by us will not require us to dispose of portfolio securities or to take other action to satisfy the percentage restriction.



We intend to conduct our business so as to retain our status as a business
development company. In order to retain our status as a business development company, we may not acquire any assets, other than non-investment assets necessary and appropriate to our operations as a business development company, if after giving
effect to such acquisition the value of our qualifying assets is less than 70% of the value of our total assets.



EMPLOYEES



As of December 31, 2006, we employed 85 employees, including investment and portfolio management professionals, underwriting, compliance, accounting,
finance and human resources professionals, in-house legal counsel, and administrative staff. We believe that our relations with our employees are good.



INVESTMENT ADVISER



We have no investment adviser and are internally managed by our executive officers under the supervision of the board of directors. Our investment
decisions are made by our officers, directors and senior investment professionals who serve on our credit and investment committees, as discussed under OperationsInvestment Approval Process above. None of our executive
officers or other employees has the authority to individually approve any investment.



CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS



We elected to be treated as a regulated investment company or RIC under Subchapter M of the Internal Revenue Code with the filing of our federal corporate income tax return for 2002, which
election was effective as of January 1, 2002. As a RIC, we generally do not have to pay corporate taxes on any income we distribute to our stockholders as dividends, which allows us to reduce or eliminate our corporate-level tax liability.



Taxation as a Regulated Investment Company



If we:



| |  |  | qualify as a RIC, and
| | - |  | ---------------------



| |  |  | distribute each year to stockholders at least 90% of our investment company taxable income (which is defined in the Internal Revenue Code generally as
ordinary income plus realized net short-term capital
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



13



---

##### Table of Contents

| | gains in excess of realized net long-term capital losses), and 90% of any ordinary pre-RIC built-in gains we recognize between January 1, 2002 and
December 31, 2011, less our taxes due on those gains (collectively, the 90% Distribution Requirement),
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



we will be entitled to deduct, and therefore will not be subject to U.S. federal income tax on, the portion of our income we distribute or are deemed to distribute to
stockholders (other than any built-in gain recognized between January 1, 2002 and December 31, 2011). We will be subject to U.S. federal income tax at the regular corporate rate on any income not distributed (or deemed distributed) to our
stockholders. We will be subject to a 4% nondeductible U.S. federal excise tax to the extent we do not distribute (actually or on a deemed basis) in a timely manner 98% of our ordinary income for each calendar year, 98% of our capital gain net
income for each calendar year, and any income realized but not distributed in prior calendar years.



In order to qualify as a RIC for federal income tax purposes, we must, among other things:



| |  |  | continue to qualify as a business development company under the 1940 Act at all times during each taxable year;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | 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 (known as the
90% Income Test); and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | diversify our holdings so that at the end of each quarter of the taxable year:
| | - |  | ------------------------------------------------------------------------------



| |  |  | at least 50% of the value of our assets consists 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
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 (known as the Diversification Tests).
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount,
we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We also may have to include in
income other amounts that we have not yet received in cash, such as payment-in-kind interest and deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. Because any
original issue discount or other amounts accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a cash distribution to our stockholders in the amount of that non-cash income in order to
satisfy the 90% Distribution Requirement, even though we will not have received any cash representing such income.



If we fail to satisfy the 90% Distribution Requirement or fail to qualify as a RIC in any taxable year, we will be subject to tax in that year on all of
our taxable income, regardless of whether we make any distributions to our stockholders. In that case, all of our income will be subject to corporate-level tax, reducing the amount available to be distributed to our stockholders, and all of our
distributions to our stockholders will be characterized as ordinary dividends (to the extent of our current and accumulated earnings and profits). Such dividends generally would be subject to tax to non-corporate U.S. Stockholders at a maximum rate
of 15 percent.



14



---

##### Table of Contents

Treatment of Pre-Conversion Built-in Gain



Through December 31, 2001, we were subject to tax as an ordinary
corporation under Subchapter C of the Internal Revenue Code. As of January 1, 2002, we held substantial assets (including intangible assets not reflected on the balance sheet, such as goodwill) with built-in gain (i.e., with a fair
market value in excess of tax basis). Under a special tax rule that applies to corporations that convert from taxation under Subchapter C of the Internal Revenue Code to taxation as a RIC, we are required to pay corporate level tax on the amount of
any net built-in gains we recognize within ten years after the effective date of our election to be treated as a RIC. Any such corporate level tax will be payable at the time those gains are recognized (which, generally, will be the years in which
we sell or dispose of the built-in gain assets in a taxable transaction). Based on the assets that we hold as of December 31, 2006 that we currently anticipate selling within the ten-year period beginning January 1, 2002 and ending
December 31, 2011, we expect we may have to pay a built-in gain tax of up to $0.4 million at current corporate tax rates. The amount of this tax will vary depending on the assets that are actually sold by us in this ten-year period and
applicable tax rates. Under Treasury Regulations, recognized built-in gains (or losses) will generally retain their character as capital gain or ordinary income (or capital or ordinary losses). Recognized built-in gains that are ordinary in
character will be included in our investment company taxable income, and we must distribute to our stockholders at least 90% of any such built-in gains recognized within the ten-year period, net of the corporate taxes paid by us on the built-in
gains. Any such amount distributed will be taxable to stockholders as ordinary income. Recognized built-in gains within the ten-year period, net of taxes, that are capital gains will be distributed or deemed distributed to our stockholders. Any such
amount distributed or deemed distributed will be taxable to stockholders as a capital gain.



REGULATION AS A BUSINESS DEVELOPMENT COMPANY



A business development company is regulated by the 1940 Act. A business development company must be organized in the United States for the purpose of investing in or lending to primarily private companies and making
managerial assistance available to them. A business development company may use capital provided by public shareholders and from other sources to invest in long-term, private investments in businesses. A business development company provides
stockholders the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits, if any, of investing in primarily privately owned companies.



As a business development company, we may not acquire any asset other than qualifying assets unless, at the time
we make the acquisition, the value of our qualifying assets represents at least 70% of the value of our total assets. The principal categories of qualifying assets relevant to our business are:



| |  |  | Securities of an eligible portfolio company that are purchased in transactions not involving any public offering. An eligible portfolio company is defined under the
1940 Act to include any issuer that:
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | is organized and has its principal place of business in the U.S.;
| | - |  | -----------------------------------------------------------------



| |  |  | is not an investment company or a company operating pursuant to certain exemptions under the 1940 Act, other than a small business investment company wholly owned
by a business development company; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | does not have any class of publicly traded securities with respect to which a broker may extend margin credit;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | does not have a class of securities listed on a national securities exchange;
| | - |  | -----------------------------------------------------------------------------



| |  |  | Securities received in exchange for or distributed with respect to securities described in the bullet above or pursuant to the exercise of options, warrants, or
rights relating to those securities; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Cash, cash items, government securities, or high quality debt securities (as defined in the 1940 Act), maturing in one year or less from the time of investment.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



15



---

##### Table of Contents

To include certain securities described above as qualifying assets for the purpose of the 70% test, a
business development company must offer to make available to the issuer of those securities significant managerial assistance such as providing guidance and counsel concerning the management, operations, or business objectives and policies of a
portfolio company. We offer to provide managerial assistance to each portfolio company.



As a business development company, we are required to meet a coverage ratio of the value of total assets to total senior securities, which include all of our borrowings and any preferred stock we may issue in the
future, of at least 200%. We may also be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our directors who are not interested persons and, in some cases, prior
approval by the SEC.



Our board of directors has appointed a
chief compliance officer pursuant to the requirements of the 1940 Act. We are subject to periodic examination by the SEC for compliance with the 1940 Act.



As with other companies regulated by the 1940 Act, a business development company must adhere to certain substantive regulatory requirements. A majority
of our directors must be persons who are not interested persons, as that term is defined in the 1940 Act. Additionally, we are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect the business
development company. Furthermore, as a business development company, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of such persons office.



As a business development company under the 1940 Act, we are entitled to provide and have previously provided loans to our employees in connection with the purchase of shares of our common stock. However, as a result
of certain provisions of the Sarbanes-Oxley Act of 2002, we are prohibited from making new loans to, or materially modifying existing loans with, our executive officers for that purpose.



On April 4, 2006 we received an exemptive order of the SEC to permit us to issue restricted shares of our common stock
as part of the compensation packages for certain of our employees and directors. We believe that the particular characteristics of our business, the dependence we have on key personnel to conduct our business effectively and the highly competitive
environment in which we operate require the use of equity-based compensation for our personnel in the form of restricted stock. The issuance of restricted shares of our common stock requires the approval of our stockholders. Our stockholders
approved our 2006 Employee Restricted Stock Plan and our 2006 Non-employee Restricted Stock Plan in June 2006.



As required by the 1940 Act, we maintain a code of ethics that establishes procedures for personal investments and restricts certain transactions by our
personnel. Our code of ethics generally does not permit investments by our employees in securities that may be purchased or held by us. You may read and copy the code of ethics at the Securities and Exchange Commissions Public Reference Room
in Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. In addition, the code of ethics is available on the EDGAR Database on the Securities
and Exchange Commissions Internet site at http://www.sec.gov. You may obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following Email address: publicinfo@sec.gov, or by writing the Securities
and Exchange Commissions Public Reference Room, 100 F Street NE, Washington, D.C. 20549.



We may not change the nature of our business so as to cease to be, or withdraw our election as, a business development company unless authorized by vote of a majority of the outstanding voting securities, as required
by the 1940 Act. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (i) 67% or more of such companys shares present at a meeting if more than 50% of the outstanding shares of such
company are present or represented by proxy, or (ii) more than 50% of the outstanding shares of such company. We do not anticipate any substantial change in the nature of our business.



16



---

##### Table of Contents

In addition, as a publicly held company we are subject to compliance with the Sarbanes-Oxley Act of 2002.
The Sarbanes-Oxley Act of 2002, as well as the rules and regulations promulgated thereunder, imposed a wide variety of regulatory requirements on publicly held companies and their insiders, which affect us. For example:



| |  |  | Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the 1934 Act), our chief executive officer and chief financial officer must
certify the accuracy of the financial statements contained in our periodic reports;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pursuant to Item 307 of Regulation S-K, our periodic reports must disclose our conclusions about the effectiveness of our disclosure controls and procedures;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pursuant to Rule 13a-15 of the 1934 Act, our management must prepare a report regarding its assessment of our internal control over financial reporting, which must
be audited by our independent registered public accounting firm; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pursuant to Item 308 of Regulation S-K, our periodic reports must disclose whether there were significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Sarbanes-Oxley Act requires us to review our current policies and
procedures to determine whether we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We will continue to monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and will take actions
necessary to ensure that we are in compliance therewith.



During 2006, a special committee of the independent members of our board of directors (the Independent Committee) was formed after the timeliness of reimbursements of certain tax withholding payments was brought to the attention
of the Audit Committee by our executive officers. The Independent Committee conducted a review of the timeliness of certain loan payments and tax withholding reimbursements involving six of our current and former executive officers and has reported
these matters to the staff of the Securities and Exchange Commission (the SEC Staff). On September 21, 2006, we reported that the review by the Independent Committee had been substantially completed, although the SEC Staff has requested
that we furnish additional information. The Independent Committee believes it has fully cooperated with the SEC Staff and it will continue to do so. The SEC Staff may also require additional information in the future, the nature and scope of which
cannot be determined at this time. As part of its review, the Independent Committee considered whether there were any violations of the Companys code of business conduct and ethics and the federal securities laws, including but not limited to,
Section 402 of the Sarbanes-Oxley Act of 2002 (Section 13(k) of the Securities Exchange Act of 1934). Based upon its review, the Independent Committee concluded that certain violations of our code of business conduct and ethics did occur and reached
no conclusion regarding Section 402 of the Sarbanes-Oxley Act of 2002. We continue to believe that there will be no impact on previously reported earnings as a result of these matters. We have instituted procedures to ensure concurrent payment to
the Company of all future obligations of executive officers resulting from tax withholding paid by the Company on behalf of its executive officers, and we have taken certain other actions as previously disclosed.



In addition, we have adopted certain policies and procedures intended to
comply with the NASDAQ Global Select Markets corporate governance rules. We will continue to monitor our compliance with all future listing standards that are approved by the SEC and will take actions necessary to ensure that we are in
compliance therewith.



QUARTERLY DETERMINATION OF NET ASSET
VALUE



We determine the net asset value per share of our
common stock quarterly. The net asset value per share is equal to the value of our total assets minus liabilities and any preferred stock outstanding divided by the total number of shares of common stock outstanding. At the time of this filing, we
do not have any preferred stock outstanding.



17



---

##### Table of Contents

DETERMINATIONS OF NET ASSET VALUE IN CONNECTION WITH OFFERINGS



We are not generally able to issue and sell our common stock at a price below
net asset value per share. We may, however, sell our common stock, at a price below the current net asset value of the common stock, or sell warrants, options or rights to acquire such common stock, at a price below the current net asset value of
the common stock if our board of directors determines that such sale is in the best interests of the Company and our stockholders, and our stockholders approve our policy and practice of making such sales. In any such case, the price at which our
securities are to be issued and sold may not be less than a price which, in the determination of our board of directors, closely approximates the market value of such securities (less any distributing commission or discount).



In connection with each offering of shares of our common stock, our board of
directors or a committee thereof is required to make the determination that we are not selling shares of our common stock at a price below the then current net asset value of our common stock at the time at which the sale is made. Our board of
directors considers the following factors, among others, in making such determination:



| |  |  | the net asset value of our common stock disclosed in the most recent periodic report we filed with the SEC;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | our managements assessment of whether any material change in the net asset value of our common stock has occurred (including through the realization of gains
on the sale of our portfolio securities) from the period beginning on the date of the most recently disclosed net asset value of our common stock to the period ending two days prior to the date of the sale of our common stock; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the magnitude of the difference between the net asset value of our common stock disclosed in the most recent periodic report we filed with the SEC and our
managements assessment of any material change in the net asset value of our common stock since the date of the most recently disclosed net asset value of our common stock, and the offering price of the shares of our common stock in the
proposed offering.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Importantly, this
determination does not require that we calculate the net asset value of our common stock in connection with each offering of shares of our common stock, but instead it involves the determination by our board of directors or a committee thereof that
we are not selling shares of our common stock at a price below the then current net asset value of our common stock at the time at which the sale is made.



To the extent that there is even a remote possibility that we may issue shares of our common stock at a price below the then current net asset value of
our common stock at the time at which the sale is made, then the board of directors will elect either to postpone the offering until such time that there is no longer the possibility of the occurrence of such event or to undertake to determine the
net asset value of our common stock within two days prior to any such sale to ensure that such sale will not be below our then current net asset value. Moreover, to the extent that there is even a remote possibility that we may trigger the
undertaking (which we provided to the SEC in our registration statements) to suspend the offering of shares of our common stock if the net asset value of our common stock fluctuates by certain amounts in certain circumstances until the prospectus is
amended, then the board of directors will elect to comply with such undertaking or to undertake to determine the net asset value of our common stock to ensure that such undertaking has not been triggered.



18



---

##### Table of Contents

Item 1A.Risk Factors



Investing in our common stock involves a high degree of risk. You should consider carefully the risks described below and all other information
contained in this Annual Report, including our financial statements and the related notes and the schedules and exhibits to this Annual Report.



Because there is generally no established market from which to value most of our investments, our board of directors determination of the value of our
investments may differ materially from the values that a ready market or third party would attribute to these investments.



Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value as
determined by our board. We are not permitted to maintain a general reserve for anticipated loan losses. Instead, we are required by the 1940 Act to specifically value each individual investment and to record any unrealized depreciation for any
asset that we believe has decreased in value. Because there is typically no public market for the securities of the companies in which we invest, our board will determine the fair value of these securities on a quarterly basis pursuant to our
valuation policy. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the board of directors may differ
significantly from the values that would have been used had a ready market existed for the investments and the differences could be material.



We primarily make investments in privately owned middle market companies, which may default on their loans or fail to perform as we expect, thereby reducing or
eliminating the return on our investments.



Our
portfolio primarily consists of debt and equity investments in privately owned middle market businesses. Compared to larger publicly owned companies, these middle market companies may be more vulnerable to economic downturns, may have more limited
access to capital and higher funding costs, may have a weaker financial position, and may need more capital to expand or compete. These businesses also may experience substantial variations in operating results. They may face intense competition,
including from companies with greater financial, technical and marketing resources. Typically, their success depends on the management talents and efforts of an individual or a small group of persons. The death, disability or resignation of any of
their key employees could harm their financial condition. Furthermore, some of these companies do business in regulated industries and could be affected by changes in government regulation. Accordingly, these factors could impair their cash flow or
result in other events, such as bankruptcy, which could limit their ability to repay their obligations to us, and may adversely affect the return on, or the recovery of, our investment in these businesses. Deterioration in a borrowers
financial condition and prospects may be accompanied by deterioration in any collateral for the loan.



Some of these companies may be unable to obtain financing from public capital markets or from traditional credit sources, such as commercial banks.
Accordingly, advances made to these types of customers may entail a higher risk of loss than advances made to customers who are able to utilize traditional credit sources, including the risk that our loans may not be repaid.



Furthermore, there is generally no publicly available information about such
companies and we must rely on the diligence of our employees to obtain information in connection with our investment decisions. If we are unable to uncover all material information about these companies, we may not make a fully informed investment
decision and we may lose money on our investments.



If the industries in
which we invest on a recurring basis, including the communications industry, experience adverse economic or business conditions, our operating results may be negatively impacted.



From time to time we target specific industries in which to invest on a recurring basis, which could cause a high
concentration of our portfolio in a specific industry. At December 31, 2006, approximately 28.5% of our portfolio at fair value was invested in companies in the communications industry. Of the 28.5% in the



19



---

##### Table of Contents

communications industry, 21.8% represents our investments in CLECs, and 6.7% represents our investments in other communications companies. If our customers
in the communications industry, or any other industry in which our portfolio is or may become concentrated, suffer due to adverse business conditions or due to economic slowdowns or downturns, we will be more vulnerable to losses in our portfolio
and our operating results may be negatively impacted.



Our financial
results could be negatively affected if Broadview Networks Holdings, Inc. fails to perform as expected.



At December 31, 2006, our largest portfolio investment was Broadview Networks Holdings, Inc. (Broadview), which totaled $159.8 million at
fair value, or 12.7% of the fair value of our investments, and accounted for approximately $22.3 million, or 14.5% of our operating income during 2006. We own preferred securities of Broadview, which entitle us to a preferred claim of approximately
$237.7 million, plus dividends, which accumulate at an annual rate of 12%, compounded quarterly, on our preferred claim. We currently recognize these dividends as income on a quarterly basis; however, our ability to record income related to these
accumulating dividends will be dependent upon the performance and value of Broadview. Our financial results could be negatively affected if this portfolio company fails to perform as expected or if we are unable to recognize these dividends as
income on a quarterly basis.



Economic downturns or recessions could
impair our customers financial position and operating results, which could, in turn, harm our operating results and reduce our volume of new investments.



Many of the companies in which we have made or will make investments may be susceptible to economic downturns or recessions.
An economic downturn or recession may affect the ability of a company to repay our loans or engage in a liquidity event, such as a sale, recapitalization or initial public offering. Therefore, our non-performing assets are likely to increase and the
value of our portfolio is likely to decrease during these periods. Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments. Economic downturns or recessions could lead
to financial losses in our portfolio and decreases in revenue, net income and assets.



An economic downturn could disproportionately impact the industries in which we invest, causing us to be more vulnerable to losses in our portfolio, which could negatively impact our financial results.



Unfavorable economic conditions also could increase our funding costs, limit
our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing our investment originations and negatively impact our financial results.



If we fail to qualify as a regulated investment company, we will have to pay
corporate-level taxes on our income and our income available for distribution would be reduced.



We have elected to be taxed for federal income tax purposes as a regulated investment company under Subchapter M of the Internal Revenue Code. If we can
meet certain requirements, including source of income, asset diversification and distribution requirements, as well as if we continue to qualify as a business development company, we will qualify to be a regulated investment company and will not
have to pay corporate-level taxes on any income we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level tax liability. Covenants and provisions in our credit facilities limit the ability
of our subsidiaries and our securitization trusts to make distributions to us, which could affect our ability to make distributions to our stockholders and to maintain our status as a regulated investment company. In addition, we may have difficulty
meeting the requirement to make distributions to our stockholders because in certain cases we may recognize income before or without receiving cash representing such income. If we fail to qualify as a regulated investment company, we will have to
pay corporate-level taxes on all of our income whether or not we distribute it, which would substantially reduce the amount of income available for distribution to our stockholders. Even if



20



---

##### Table of Contents

we qualify as a regulated investment company, we generally will be subject to a corporate-level income tax on the income we do not distribute. Moreover, if
we do not distribute at least 98% of our income, we generally will be subject to a 4% excise tax. See Regulation as a Business Development Company and Certain U.S. Federal Income Tax ConsiderationsTaxation as a Regulated
Investment Company.



Because we will distribute substantially all
of our income to our stockholders, we will continue to need additional capital to finance our growth. If additional capital is unavailable or not available on favorable terms, our ability to grow will be impaired.



In order to satisfy the requirements applicable to a regulated investment
company, we intend to distribute to our stockholders substantially all of our income. We may elect to make deemed distributions to our stockholders of certain net capital gains. In addition, as a business development company, we generally will be
required to meet a coverage ratio of total assets to total senior securities, which includes all of our borrowings and any preferred stock we may issue in the future, of at least 200%. This requirement limits the amount that we may borrow. Because
we will continue to need capital to grow our loan and investment portfolio, this limitation may prevent us from incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so. Additional financing may not
be available on favorable terms, if at all, or may be restricted by the terms of our debt facilities. If additional funds are not available to us, we could be forced to curtail or cease our new lending and investment activities, and our net asset
value could decrease.



We have substantial indebtedness and servicing our
indebtedness could reduce funds available to grow our business or make new investments.



As of December 31, 2006, we had $521.9 million of outstanding borrowings under our debt facilities. As of December 31, 2006, the weighted
average annual interest rate on all of our outstanding borrowings was 6.22%, excluding the amortization of deferred debt issuance costs. In order for us to make our annual interest payments on indebtedness, we must achieve annual returns on our
December 31, 2006 total assets of at least 2.46%. Our ability to service our debt depends largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures.



In addition, our subsidiaries have sold some of our loans to trusts that
serve as the vehicles for our securitization facilities, and these trusts, which are bankruptcy remote, hold legal title to these assets. However, we bear losses of principal and interest from defaults on these loans held by the trusts up to the
amount of our retained interest in the trusts, which was approximately $213.5 million as of December 31, 2006.



Our securitization facilities impose financial and operating covenants that restrict our business activities, including limitations that could hinder our
ability to finance additional loans and investments or to make the distributions required to maintain our status as a regulated investment company under Subchapter M of the Internal Revenue Code. In addition, some of our debt facilities, including
our unsecured notes, contain cross-default provisions, whereby a default under one of our debt facilities could constitute a default under other debt facilities. In addition, if any of Steven F. Tunney, our President and Chief Executive Officer, B.
Hagen Saville, one of our Executive Vice Presidents, and Robert J. Merrick, our Chief Investment Officer ceases to be actively involved in our management, the lender under one of our warehouse financing facilities could, absent a waiver or cure,
replace us as the servicer of the loans and declare a default. In addition, if either of Mr. Tunney or Mr. Saville ceases to be an executive officer of MCG actively involved in our management, the lender of our $100.0 million revolving
unsecured credit facility could, absent a waiver or cure, declare a default.



Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. Leverage is generally considered a
speculative investment technique. If the value of our consolidated assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more than it otherwise would have had we not utilized leverage.
Conversely, if the value of our consolidated assets decreases, leveraging would cause net asset value attributable to our common stock to decline more than it otherwise would have had we not utilized



21



---

##### Table of Contents

leverage. Similarly, any increase in our consolidated revenue in excess of consolidated interest expense on our borrowed funds would cause our net income to
increase more than it would without the use of leverage. Any decrease in our consolidated revenue would cause net income to decline more than it would have had we not borrowed funds and could negatively affect our ability to make distributions on
our common stock.



As a business development company, we
generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings and any preferred stock we may issue in the future, of at least 200%. If this ratio declines below
200%, we may not be able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions. At December 31, 2006, this ratio was
approximately 239%.



In addition, because substantially all of
our assets and liabilities are priced using various short-term rate indices, including one-month to six-month LIBOR, commercial paper rates and the prime rate, the timing of changes in market interest rates or in the relationship between interest
rate indices could affect the interest rates earned on interest-earning assets differently than the interest rates paid on interest-bearing liabilities, which could result in a decrease in net income.



If we are not able to refinance our debt or able to do so on favorable terms, we would
not be able to operate our business in the ordinary course.



Our Revolving Unsecured Credit Facility is scheduled to expire on June 18, 2007. Our Commercial Loan Funding Trust Facility $250.0 million warehouse financing facility through Three Pillars Funding, LLC is scheduled to terminate on
November 7, 2007, but is subject to annual renewal by the lender and may be extended under certain circumstances. The next renewal date for this facility is July 27, 2007.



We cannot assure you that we will be able to extend the terms of these facilities or obtain sufficient funds to repay any
amounts outstanding under these facilities before they expire or terminate either from a replacement facility or alternative debt or equity financing. If we are unable to repay amounts outstanding under these facilities and are declared in default
or are unable to refinance these facilities, we would not be able to operate our business in the regular course. Even if we are able to refinance our debt, we may not be able to do so on favorable terms.



When we are a debt or minority equity investor in a portfolio company, we may not be in
a position to control the entity, and management of the company may make decisions that could decrease the value of our portfolio holdings.



We make both debt and minority equity investments. For these investments we are subject to the risk that a portfolio company may make business decisions
with which we disagree, and the stockholders and management of that company may take risks or otherwise act in ways that do not serve our interests. As a result, a portfolio company may make decisions that could decrease the value of our portfolio
holdings.



Investments in equity securities involve a substantial degree
of risk.



We may purchase common stock and other
equity securities, including warrants. Although equity securities have historically generated higher average total returns than debt securities over the long term, equity securities may experience more volatility in those returns than debt
securities. The equity securities we acquire may fail to appreciate and may decline in value or lose all value, and our ability to recover our investment will depend on our portfolio companys success. Investments in equity securities involve a
number of significant risks, including the risk of further dilution as a result of additional issuances. Investments in preferred securities involve special risks, such as the risk of deferred distributions, illiquidity and limited voting rights.



You may not receive distributions.



We intend to make distributions on a quarterly basis to our stockholders. 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



22



---

##### Table of Contents

distributions from time to time. In addition, due to the asset coverage test applicable to us as a business development company, we may be limited in our
ability to make distributions. See Regulation as a Business Development Company. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a
regulated investment company. See Certain U.S. Federal Income Tax ConsiderationsTaxation as a Regulated Investment Company. We cannot assure you that you will receive any distributions or distributions at a particular level.



We may have difficulty paying our required distributions if we recognize
income before or without receiving cash representing such income.



In accordance with generally accepted accounting principles and tax regulations, we include in income certain amounts that we have not yet received in cash, such as contractual payment-in-kind interest, which
represents contractual interest added to the loan balance and due at the end of the loan term. The increases in loan balances as a result of contracted payment-in-kind arrangements are included in income in advance of receiving cash payment, and are
separately identified on our consolidated statements of cash flows. Since we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our investment
company taxable income to maintain regulated investment company tax treatment. See Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies and Certain U.S.
Federal Income Tax ConsiderationsTaxation as a Regulated Investment Company.



If we fail to manage our growth, our financial results could be adversely affected.



We have expanded our operations significantly since purchasing our business from First Union National Bank in 1998. Our growth has placed and could
continue to place significant strain on our management systems and resources. We must continue to refine and expand our marketing capabilities, our management of the investment process, our access to financing resources and our technology. As we
grow, we must continue to hire, train, supervise and manage new employees. We may not develop sufficient lending and administrative personnel and management and operating systems to manage our expansion effectively. If we are unable to manage our
growth, our operations could be adversely affected and our financial results could be adversely affected.



If we need to sell any of our investments, we may not be able to do so at a favorable price and, as a result, we may suffer losses.



Our investments are usually subject to contractual or legal restrictions on resale or are otherwise illiquid because there
is usually no established trading market for such investments. The illiquidity of most of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses. In addition, if we were forced to
immediately liquidate some or all of the investments in our portfolio, the proceeds of such liquidation could be significantly less than the current value of such investments. We may be required to liquidate some or all of our portfolio to meet our
debt service obligations or to maintain our qualification as a business development company and as a regulated investment company if we do not satisfy one or more of the applicable criteria under the respective regulatory frameworks.



Our business depends on our key personnel.



We depend on the continued services of our executive officers and other key
management personnel. The loss of any of our executive officers or key management personnel could result in inefficiencies in our operations and lost business opportunities, which could have a negative impact on our business.



Fluctuations in interest rates could adversely affect our income.



Because we sometimes borrow to make investments, our net income is
dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. A significant increase in market interest rates could harm our ability to attract new customers and originate new loans and
investments,



23



---

##### Table of Contents

our non-performing assets could increase and the value of our portfolio could decrease because our floating-rate loan customers may be unable to meet higher
payment obligations. Due to the nature of the portfolio companies to which we provide fixed rate financing, fluctuations in market rates have a limited impact on rates charged. As a result, an increase in market interest rates would generally have
no effect on the existing fixed rate loans in our portfolio. Conversely, a significant decrease in interest rates would reduce our net income, all other things being equal. A decrease in interest rates may reduce net income despite the increased
demand for our capital that the decrease in interest rates may produce. Approximately 63% of the loans in our portfolio, based on amounts outstanding at cost as of December 31, 2006, were at variable rates determined on the basis of a benchmark
LIBOR or prime rate and approximately 37% were at fixed rates. From January 1, 2004 to December 31, 2006, the three-month LIBOR has increased from 1.15% to 5.36%.



Regulations governing our operation as a business development company will affect our ability to, and the way in which we, raise
additional capital.



We have issued debt securities
and may issue debt securities and/or borrow money from banks or other financial institutions, which we refer to collectively as senior securities, up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act,
we are permitted, as a business development company, to issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities. If the value of our assets
declines, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be
disadvantageous.



We are not generally able to issue and sell
our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the current net asset value of the common stock if our board of
directors determines that such sale is in the best interests of MCG and its stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in
the determination of our board of directors, closely approximates the market value of such securities (less any distributing commission or discount).



Any change in regulation of our business could negatively affect the profitability of our operations.



Changes in the laws, regulations or interpretations of the laws and
regulations that govern business development companies, regulated investment companies or non-depository commercial lenders could significantly affect our operations and our cost of doing business. We are subject to federal, state and local laws and
regulations and are subject 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 more stringent requirements than those
in which we currently conduct business, we may have to incur significant expenses in order to comply or we might have to restrict our operations.



Interpretations of the staff of the Securities and Exchange Commission regarding the appropriateness of the consolidation of certain of our subsidiaries may have an
impact on our financial statements.



The staff of the
Securities and Exchange Commission (the Staff) is reviewing the appropriateness of the consolidation of certain types of subsidiaries on an industry wide basis under generally accepted accounting principles (GAAP) and Rule
6-03 of Regulation S-X. In connection with such review, the Staff is in the process of reviewing the appropriateness of our consolidation of certain of our subsidiaries (the Subsidiaries). In the event that the Staff disagrees with our
position with respect to the appropriateness of consolidation of any of the Subsidiaries, then we will make such additional disclosures and prospective changes in accounting methods as the Staff requires on a prospective basis which will be
discussed and reviewed with us.



Although we believe that our
consolidation of the Subsidiaries conforms with GAAP, there can be no assurance that the Staff will ultimately concur with our position. Such events could have a material impact on our future reported results.



24



---

##### Table of Contents

Certain loan payments and tax withholding reimbursements involving six of our current and former executive officers
may have violated Section 402 of the Sarbanes-Oxley Act of 2002.



As previously reported, the independent members of our Board of Directors (the Independent Committee) have reviewed the timeliness of certain loan payments and tax withholding reimbursements involving six
of our current and former executive officers and have reported these matters to the staff of the Securities and Exchange Commission (the SEC Staff).



Section 402 of the Sarbanes-Oxley Act of 2002, which became effective on June 30, 2002, prohibits us from directly or indirectly extending or
maintaining credit, arranging for the extension of credit, or renewing an extension of credit, in the form of a personal loan to or for any of our directors or executive officers. An extension of credit maintained by us on June 30, 2002 is not
subject to these prohibitions so long as there is no renewal or material modification to any such loan after that date.



The Independent Committee has reported these matters to the staff of the Securities and Exchange Commission (the SEC Staff) and has also
reported the results of the review to date to the SEC Staff. The review by the Independent Committee has now been substantially completed, although the SEC Staff has requested that we furnish additional information. Based upon the facts known to the
Independent Committee as of the present date, the Independent Committee has concluded that certain violations of our code of business conduct and ethics did occur and reached no conclusion regarding Section 402 of Sarbanes-Oxley. The
Independent Committee believes that it has fully cooperated with the SEC Staff and will continue to do so. The SEC Staff may also require further information in the future, the nature and scope of which cannot be determined at this time.



As a result of our internal review, we may become subject to SEC
investigations and/or litigation, which may not be resolved favorably and will require significant management time and attention, and we could incur costs, which could negatively affect our business, results of operations and cash flows. There are
no assurances that an investigation or litigation will not commence, and if commenced, that it will result in the same conclusions as those reached in the Independent Committees review.



Item 1B.Unresolved SEC Staff
 Comments



None.



Item 2.Properties



Neither we nor any of our
subsidiaries own any real estate or other physical properties materially important to our operation or any of our subsidiaries. Currently, we lease approximately 30,000 square feet of office space in Arlington, Virginia for our corporate
headquarters. In addition, we have amended our lease of office space for our headquarters in Arlington, Virginia to provide for an additional 11,500 square feet which we anticipate to commence in late 2007. We also lease office space in Richmond,
Virginia.



Item 3.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 the outcome of these legal proceedings cannot at
this time be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.



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



None.



25



---

##### Table of Contents

PART II



|Item 5. | Market
 for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | -------------------------------------------------------------------------------------------------------------



PRICE RANGE OF COMMON STOCK



Our common stock is traded on the NASDAQ Global Select Market under the symbol MCGC. The following table sets forth the range of high and
low closing prices of our common stock as reported on the NASDAQ Global Select Market for each of the quarterly periods during 2006 and 2005.





|                   |  |             |       |     |   |      
|------------------ |  | ----------- | ----- | --- | - | -----
|                   |  | Price Range
|Quarter Ended      |  | High        |       | Low
|March 31, 2005     |  | $           | 17.57 |     | $ | 15.05
|June 30, 2005      |  |             | 17.20 |     |   | 15.08
|September 30, 2005 |  |             | 18.42 |     |   | 16.85
|December 31, 2005  |  |             | 16.85 |     |   | 14.07
|March 31, 2006     |  |             | 16.19 |     |   | 14.06
|June 30, 2006      |  |             | 15.98 |     |   | 13.85
|September 30, 2006 |  |             | 17.02 |     |   | 15.28
|December 31, 2006  |  |             | 20.80 |     |   | 16.00



As of
February 26, 2007, we had approximately 137 shareholders of record. Such number of shareholders of record does not reflect shareholders who beneficially own common stock in nominee or street name.



SALES OF UNREGISTERED SECURITIES



During the year ended December 31, 2006, we issued a total of 14,588
shares of common stock under our dividend reinvestment plan pursuant to an exemption from the registration requirements of the Securities Act of 1933. The aggregate offering price for the shares of common stock sold under the dividend reinvestment
plan was approximately $218 thousand.



ISSUER PURCHASES OF
EQUITY SECURITIES



We did not repurchase any shares of our
common stock during the three months ended December 31, 2006.



26



---

##### Table of Contents

DISTRIBUTION POLICY



We intend to make distributions on a quarterly basis to our stockholders of substantially all of our income. We may elect to
make deemed distributions to our stockholders of certain net capital gains.



As a business development company that has elected to be treated as a regulated investment company, we generally are required to (1) distribute at least 90% of our investment company taxable income and 90% of any
ordinary pre-RIC built in gains that we recognize in order to deduct distributions made (or deemed made) to our shareholders and (2) distribute (actually or on a deemed basis) at least 98% of our income (both ordinary income and net capital
gains) in order to avoid an excise tax.



Through
December 31, 2006, we have made distributions in excess of our earnings of approximately $90.4 million, which excludes our net unrealized appreciation on our investments of $14.9 million. We may not be able to achieve operating results that
will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage requirements applicable to us
as a business development company 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 regulated investment company tax treatment. We
cannot assure shareholders that they will receive any distributions or distributions at a particular level.



The following table summarizes our distributions declared since January 1, 2005:



|                  |  |                   |  |                  |  |        |     
|----------------- |  | ----------------- |  | ---------------- |  | ------ | ----
|Date Declared     |  | Record Date       |  | Payment Date     |  | Amount
|February 15, 2007 |  | March 15, 2007    |  | April 27, 2007   |  | $      | 0.44
|October 26, 2006  |  | November 22, 2006 |  | January 30, 2007 |  |        | 0.42
|July 27, 2006     |  | August 24, 2006   |  | October 30, 2006 |  |        | 0.42
|April 27, 2006    |  | May 25, 2006      |  | July 28, 2006    |  |        | 0.42
|February 16, 2006 |  | March 16, 2006    |  | April 27, 2006   |  |        | 0.42
|October 26, 2005  |  | November 23, 2005 |  | January 30, 2006 |  |        | 0.42
|July 27, 2005     |  | August 25, 2005   |  | October 28, 2005 |  |        | 0.42
|April 27, 2005    |  | May 26, 2005      |  | July 28, 2005    |  |        | 0.42
|February 23, 2005 |  | March 14, 2005    |  | April 28, 2005   |  |        | 0.42



Since December 2001,
we have declared distributions totaling $9.75 per share. For 2007, we currently estimate that our dividends will be at least $1.76 per share. This estimate takes into consideration our estimates of distributable net operating income (which is equal
to net operating income excluding long-term incentive compensation), net income, capital gains, and taxable income for 2007.



Each year a statement on Form 1099-DIV identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the
sale of securities, and/or a return of paid-in-capital surplus which is a nontaxable distribution) is mailed to our stockholders. To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of
those distributions may be deemed a tax return of capital to our stockholders.



The table below shows the detail of our distributions for the years ended December 31, 2006 and 2005:



|                                    |  |      |      |  |       |   |  |   |      |  |       |  
|----------------------------------- |  | ---- | ---- |  | ----- | - |  | - | ---- |  | ----- | -
|                                    |  | 2006 |      |  | 2005  |  
|Ordinary income (a)                 |  | $    | 1.01 |  | 60.1  | % |  | $ | 1.31 |  | 78.0  | %
|Capital gains (a)                   |  |      |     |  |      |   |  |   | 0.15 |  | 9.0   | %
|Return of capital (b)               |  |      | 0.67 |  | 39.9  | % |  |   | 0.22 |  | 13.0  | %
|                                    |  |      |      |  |       |   |  |   |      |  |       |  
|Total reported on tax Form 1099-DIV |  | $    | 1.68 |  | 100.0 | % |  | $ | 1.68 |  | 100.0 | %
|                                    |  |      |      |  |       |   |  |   |      |  |       |  

---

|(a) |  | Ordinary income is reported on Form 1099-DIV as either qualified or non-qualified and capital gains are reported on Form 1099-DIV in various sub-categories which have differing tax
treatments to shareholders. Those subcategories have not been shown here.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



27



---

##### Table of Contents

|(b) |  | Return of capital refers to those amounts reported as nontaxable distributions on Form 1099-DIV.
|--- |  | ------------------------------------------------------------------------------------------------



On a tax basis, distributions to stockholders in 2006 were approximately $53.0 million ordinary income and $35.2 million of
return of capital, and in 2005 were approximately $61.6 million of ordinary income, $7.1 million of capital gain, and $10.2 million of return of capital.



The following table is a reconciliation of GAAP net income to taxable net income for the years ended December 31, 2006 and 2005:



|                                                                                               |  |      |         |   |      |   |        |  
|---------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------ | -
|(dollars in thousands)                                                                         |  | 2006 |         |   | 2005 |  
|Net income                                                                                     |  | $    | 100,949 |   |      | $ | 68,193 |  
|Net loss of subsidiary not consolidated for tax purposes                                       |  |      |        |   |      |   | 1,744  |  
|Net change in unrealized (appreciation) depreciation on investments not taxable until realized |  |      | (34,604 | ) |      |   | 1,343  |  
|Timing difference related to deductability of long-term incentive compensation                 |  |      | 2,468   |   |      |   | 3,262  |  
|Interest income on nonaccrual loans that is taxable                                            |  |      | 3,612   |   |      |   | 2,437  |  
|Dividend income accrued for GAAP purposes which is not yet taxable                             |  |      | (21,612 | ) |      |   | (6,516 | )
|Federal tax expense                                                                            |  |      | 2,661   |   |      |   | (595   | )
|Other, net                                                                                     |  |      | (93     | ) |      |   | (2,594 | )
|                                                                                               |  |      |         |   |      |   |        |  
|Taxable income before deductions for distributions                                             |  | $    | 53,381  |   |      | $ | 67,274 |  
|                                                                                               |  |      |         |   |      |   |        |  



STOCK PERFORMANCE
GRAPH



This graph compares the return on our common stock
with that of the Russell 2000 Index and the NASDAQ Financial 100 Index, for the period December 31, 2001 through December 31, 2006. The graph assumes that, on December 31, 2001, a person invested $100 in each of our common stock, the Russell
2000 Index, and the NASDAQ Financial 100 Index. The graph measures total shareholder return, which takes into account both changes in stock price and dividends. It assumes that dividends paid are reinvested in like securities.



LOGO



28



---

##### Table of Contents

Item 6.Selected Financial Data



The following selected financial data, excluding the Other data (at period end), is derived from our audited consolidated financial
statements. This selected financial data should be read in conjunction with our Managements Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and notes thereto.



|                                                                                           |  |                         |           |      |   |           |  |      |           |      |   |         |  |   |        
|------------------------------------------------------------------------------------------ |  | ----------------------- | --------- | ---- | - | --------- |  | ---- | --------- | ---- | - | ------- |  | - | -------
|                                                                                           |  | Year Ended December 31,
|(dollars in thousands except per share and other data)                                     |  | 2006                    |           | 2005 |   | 2004      |  | 2003 |           | 2002
|Income Statement Data:                                                                     |  |                         |           |      |   |           |  |      |           |      |   |         |  |   |        
|Operating income                                                                           |  | $                       | 154,393   |      | $ | 119,545   |  | $    | 93,117    |      | $ | 80,690  |  | $ | 76,933 
|Net operating income before investment gains and losses                                    |  |                         | 83,644    |      |   | 60,515    |  |      | 45,090    |      |   | 47,595  |  |   | 44,751 
|Net income                                                                                 |  |                         | 100,949   |      |   | 68,193    |  |      | 47,647    |      |   | 41,975  |  |   | 3,215  
|                                                                                           |  |                         |           |      |  
|Per Common Share Data:                                                                     |  |                         |           |      |   |           |  |      |           |      |   |         |  |   |        
|Earnings per common sharebasic (a)                                                        |  |                         | 1.86      |      |   | 1.42      |  |      | 1.16      |      |   | 1.28    |  |   | 0.11   
|Earnings per common sharediluted (a)                                                      |  |                         | 1.86      |      |   | 1.42      |  |      | 1.15      |      |   | 1.28    |  |   | 0.11   
|Net operating income before investment gains and losses per common share basic and diluted |  |                         | 1.54      |      |   | 1.26      |  |      | 1.09      |      |   | 1.45    |  |   | 1.57   
|Net asset value per common share (b)                                                       |  |                         | 12.83     |      |   | 12.48     |  |      | 12.22     |      |   | 11.98   |  |   | 11.56  
|Cash dividends declared per common share                                                   |  |                         | 1.68      |      |   | 1.68      |  |      | 1.68      |      |   | 1.65    |  |   | 1.76   
|                                                                                           |  |                         |           |      |  
|Selected Period-End Balances:                                                              |  |                         |           |      |   |           |  |      |           |      |   |         |  |   |        
|Total investment portfolio                                                                 |  |                         | 1,257,612 |      |   | 1,097,560 |  |      | 880,400   |      |   | 698,942 |  |   | 688,870
|Total assets                                                                               |  |                         | 1,319,268 |      |   | 1,244,487 |  |      | 1,053,511 |      |   | 790,915 |  |   | 744,993
|Borrowings                                                                                 |  |                         | 521,883   |      |   | 541,119   |  |      | 467,400   |      |   | 304,131 |  |   | 363,838
|                                                                                           |  |                         |           |      |  
|Other data (at period-end):                                                                |  |                         |           |      |   |           |  |      |           |      |   |         |  |   |        
|Number of portfolio companies                                                              |  |                         | 83        |      |   | 91        |  |      | 97        |      |   | 81      |  |   | 79     
|Number of employees (c)                                                                    |  |                         | 85        |      |   | 128       |  |      | 112       |      |   | 53      |  |   | 56     

---

|(a) |  | See Note 10 to our Consolidated Financial Statements under Item 8.
|--- |  | ------------------------------------------------------------------

|(b) |  | Based on common shares outstanding at period-end.
|--- |  | -------------------------------------------------

|(c) |  | The number of employees at December 31, 2005 and December 31, 2004 include 51 and 47 employees, respectively, of our former subsidiary Kagan Research, LLC.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



Item 7.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 Other Data, and
our Consolidated Financial Statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K.



This Annual Report on Form 10-K, 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 and projections about our industry, our beliefs, and our
assumptions. Words such as anticipates, expects, intends, plans, believes, seeks, and estimates and variations of these words and similar expressions are intended to
identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results
to differ materially from those expressed or forecasted in the forward-looking statements, including without limitation:



| |  |  | economic downturns or recessions may impair our customers ability to repay our loans and increase our non-performing assets;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | economic downturns or recessions may disproportionately impact the industries in which we invest, and such conditions may cause us to suffer losses in our portfolio
and experience diminished demand for capital in these industries;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



29



---

##### Table of Contents

| |  |  | a contraction of available credit and/or an inability to access the equity markets could impair our lending and investment activities and adversely impact our
financial results;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | interest rate volatility could adversely affect our results;
| | - |  | ------------------------------------------------------------



| |  |  | the risks associated with the possible disruption in our operations due to terrorism; and
| | - |  | -----------------------------------------------------------------------------------------



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



Although we believe
that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. In
light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Annual Report on Form 10-K 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 Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.



Overview



MCG Capital Corporation is a solutions-focused commercial
finance company providing capital and advisory services to middle market companies throughout the United States. We make debt and equity investments primarily in companies with annual revenue of $20 million to $200 million and earnings before
interest, taxes, depreciation and amortization (EBITDA) of $3 million to $25 million, which we refer to as middle market companies. Our capital is generally used by our portfolio companies to finance acquisitions,
recapitalizations, buyouts, organic growth and working capital. We primarily acquire new customers directly through our contacts with owner operators and other investors, such as private equity sponsors.



We are an internally managed, non-diversified, closed-end investment company
that has elected to be regulated as a business development company under the Investment Company Act of 1940 or the 1940 Act. As a business development company, we are required to meet various regulatory tests which include investing at
least 70% of our total assets in private or thinly traded public U.S.-based companies and meeting a coverage ratio of total net assets to total senior securities, which include all of our borrowings (including accrued interest payable) and any
preferred stock we may issue in the future, of at least 200%. 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, we must meet certain requirements, including certain minimum distribution requirements. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income
we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level tax liability. 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 that the taxable event becomes probable.



Portfolio Composition and Investment Activity



The total value of our investment portfolio, exclusive of unearned income, was $1,257.6 million and $1,097.6 million at December 31, 2006 and
December 31, 2005, respectively. During the year ended December 31, 2006, we originated investments in 35 portfolio companies (some of which were new customers and some of which were existing customers) and made advances to existing
customers pursuant to contractual terms. Our gross originations and advances totaled $595.8 million and $578.3 million during the years ended



30



---

##### Table of Contents

December 31, 2006 and 2005, respectively. During the year ended December 31, 2006, the total value of newly originated investments, additional
investments in existing portfolio companies, accrual of payment-in-kind interest and dividends, and net unrealized appreciation on investments, net of sales and repayments of securities, resulted in a $160.0 million increase in the total portfolio
value of our investments, exclusive of unearned income.



Total
portfolio investment activity (exclusive of unearned income) for the years ended December 31, 2006 and 2005 was as follows:



|                                                    |  |      |         |   |      |   |         |  
|--------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|(dollars in millions)                               |  | 2006 |         |   | 2005 |  
|Beginning investment portfolio                      |  | $    | 1,097.6 |   |      | $ | 880.4   |  
|Originations and advances                           |  |      | 595.8   |   |      |   | 578.3   |  
|Gross payments/reductions/sales of securities/other |  |      | (455.6  | ) |      |   | (368.8  | )
|Net unrealized gains                                |  |      | 23.6    |   |      |   | 5.1     |  
|Net realized (losses) gains                         |  |      | (14.6   | ) |      |   | 9.0     |  
|Reversals of unrealized depreciation (appreciation) |  |      | 10.8    |   |      |   | (6.4    | )
|                                                    |  |      |         |   |      |   |         |  
|Ending investment portfolio                         |  | $    | 1,257.6 |   |      | $ | 1,097.6 |  
|                                                    |  |      |         |   |      |   |         |  



During 2006, we
continued to diversify our investment portfolio on an industry basis. We also reduced our investments in secured senior debt while we increased our investments in subordinated debt and equity. During the year ended December 31, 2006, our
increase in equity investments was primarily driven by the increase in our investments in control companies. At December 31, 2006, our control investments totaled approximately $526.1 million, compared to approximately $305.6 million at
December 31, 2005. Another component of the increase in equity investments during the year ended December 31, 2006 was the conversion of our subordinated unsecured debt in Broadview to preferred shares in Broadview.



The following table shows our portfolio of investments by security type at
December 31, 2006 and 2005:



|                                 |  |                           |         |                               |                   |   |                           |   |                               |  |       |  
|-------------------------------- |  | ------------------------- | ------- | ----------------------------- | ----------------- | - | ------------------------- | - | ----------------------------- |  | ----- | -
|                                 |  | December 31, 2006         |         |                               | December 31, 2005 |  
|(dollars in millions)            |  | Investments at Fair Value |         | Percentage of Total Portfolio |                   |   | Investments at Fair Value |   | Percentage of Total Portfolio | 
|Secured senior debt              |  | $                         | 389.7   |                               | 31.0              | % |                           | $ | 543.0                         |  | 49.5  | %
|Subordinated debt                |  |                           |         |                               |                   |   |                           |   |                               |  |       |  
|Secured                          |  |                           | 495.0   |                               | 39.3              |   |                           |   | 329.5                         |  | 30.0  |  
|Unsecured                        |  |                           | 24.7    |                               | 2.0               |   |                           |   | 61.6                          |  | 5.6   |  
|                                 |  |                           |         |                               |                   |   |                           |   |                               |  |       |  
|Total debt investments           |  |                           | 909.4   |                               | 72.3              |   |                           |   | 934.1                         |  | 85.1  |  
|                                 |  |                           |         |                               |                   |   |                           |   |                               |  |       |  
|Preferred equity                 |  |                           | 285.1   |                               | 22.7              |   |                           |   | 126.7                         |  | 11.5  |  
|Common/common equivalents equity |  |                           | 63.1    |                               | 5.0               |   |                           |   | 36.8                          |  | 3.4   |  
|                                 |  |                           |         |                               |                   |   |                           |   |                               |  |       |  
|Total equity investments         |  |                           | 348.2   |                               | 27.7              |   |                           |   | 163.5                         |  | 14.9  |  
|                                 |  |                           |         |                               |                   |   |                           |   |                               |  |       |  
|Total portfolio                  |  | $                         | 1,257.6 |                               | 100.0             | % |                           | $ | 1,097.6                       |  | 100.0 | %
|                                 |  |                           |         |                               |                   |   |                           |   |                               |  |       |  



The following table
shows our gross originations and advances during 2006 and 2005 by security type:



|                                 |  |      |       |      |   |      
|-------------------------------- |  | ---- | ----- | ---- | - | -----
|(dollars in millions)            |  | 2006 |       | 2005
|Secured senior debt              |  | $    | 176.0 |      | $ | 245.1
|Subordinated debt                |  |      | 256.7 |      |   | 249.0
|Preferred equity                 |  |      | 154.2 |      |   | 66.2 
|Common/common equivalents equity |  |      | 8.9   |      |   | 18.0 
|                                 |  |      |       |      |   |      
|Total                            |  | $    | 595.8 |      | $ | 578.3
|                                 |  |      |       |      |   |      



31



---

##### Table of Contents

The following table shows our gross payments, reductions, and sales of securities during 2006 and 2005 by
security type:



|                      |  |      |       |      |   |      
|--------------------- |  | ---- | ----- | ---- | - | -----
|(dollars in millions) |  | 2006 |       | 2005
|Secured senior debt   |  | $    | 307.5 |      | $ | 281.1
|Subordinated debt     |  |      | 135.6 |      |   | 39.2 
|Equity                |  |      | 12.5  |      |   | 48.5 
|                      |  |      |       |      |   |      
|Total                 |  | $    | 455.6 |      | $ | 368.8
|                      |  |      |       |      |   |      



During the year ended
December 31, 2006, gross originations and advances and gross repayments and sales of equity securities by security type included $51.1 million of Broadview unsecured debt which was converted to preferred equity during the third quarter 2006.



During the years ended December 31, 2006 and 2005, our
gross payments, reductions and sales of securities by transaction type included:



|                                                       |  |      |       |      |   |      
|------------------------------------------------------ |  | ---- | ----- | ---- | - | -----
|(dollars in millions)                                  |  | 2006 |       | 2005
|Scheduled principal amortization                       |  | $    | 35.9  |      | $ | 77.0 
|Secured senior loan sales                              |  |      | 102.7 |      |   | 25.6 
|Principal repayments                                   |  |      | 286.5 |      |   | 210.3
|Payment of accrued paid-in-kind interest and dividends |  |      | 19.9  |      |   | 7.4  
|Sales of equity investments                            |  |      | 10.6  |      |   | 48.5 
|                                                       |  |      |       |      |   |      
|Total                                                  |  | $    | 455.6 |      | $ | 368.8
|                                                       |  |      |       |      |   |      



The majority of our
senior loan sales during the year ended December 31, 2006 were due to our efforts to reduce the percentage of the portfolio that is comprised of secured senior debt.



32



---

##### Table of Contents

The following table shows our portfolio of investments by industry at fair value, as of December 31,
2006 and December 31, 2005 (excluding unearned income):



|                                                               |  |                           |         |                               |                   |   |                               |   |                                   |  |       |  
|-------------------------------------------------------------- |  | ------------------------- | ------- | ----------------------------- | ----------------- | - | ----------------------------- | - | --------------------------------- |  | ----- | -
|                                                               |  | December 31, 2006         |         |                               | December 31, 2005 |  
|                                                               |  | Investments at Fair Value |         | Percentage of Total Portfolio |                   |   | Investments at Fair Value (a) |   | Percentage of Total Portfolio (a) | 
|(dollars in millions)                                          |  |                           |         |                              
|TelecommunicationsCLECs (competitive local exchange carriers) |  | $                         | 274.1   |                               | 21.8              | % |                               | $ | 213.4                             |  | 19.4  | %
|Other Communications                                           |  |                           | 84.0    |                               | 6.7               |   |                               |   | 68.8                              |  | 6.3   |  
|Healthcare                                                     |  |                           | 106.5   |                               | 8.5               |   |                               |   | 91.1                              |  | 8.4   |  
|Newspaper                                                      |  |                           | 90.6    |                               | 7.2               |   |                               |   | 112.8                             |  | 10.3  |  
|Publishing                                                     |  |                           | 68.0    |                               | 5.4               |   |                               |   | 72.3                              |  | 6.6   |  
|Laboratory Instruments                                         |  |                           | 58.4    |                               | 4.6               |   |                               |   | 52.1                              |  | 4.7   |  
|Plastic Products                                               |  |                           | 57.1    |                               | 4.5               |   |                               |   |                                  |  |      |  
|Home Furnishings                                               |  |                           | 52.5    |                               | 4.2               |   |                               |   | 18.9                              |  | 1.7   |  
|Business Services                                              |  |                           | 51.2    |                               | 4.1               |   |                               |   | 22.2                              |  | 2.1   |  
|Information Services                                           |  |                           | 47.4    |                               | 3.8               |   |                               |   | 75.4                              |  | 6.9   |  
|Broadcasting                                                   |  |                           | 39.9    |                               | 3.2               |   |                               |   | 31.9                              |  | 2.9   |  
|Cable                                                          |  |                           | 38.7    |                               | 3.1               |   |                               |   | 33.3                              |  | 3.0   |  
|Technology                                                     |  |                           | 36.2    |                               | 2.9               |   |                               |   | 66.1                              |  | 6.0   |  
|Education                                                      |  |                           | 31.0    |                               | 2.5               |   |                               |   | 19.5                              |  | 1.8   |  
|DVD Rental                                                     |  |                           | 28.6    |                               | 2.3               |   |                               |   |                                  |  |      |  
|Sporting Goods                                                 |  |                           | 26.9    |                               | 2.1               |   |                               |   |                                  |  |      |  
|Electronics                                                    |  |                           | 24.8    |                               | 2.0               |   |                               |   | 34.1                              |  | 3.1   |  
|Other Media                                                    |  |                           | 24.1    |                               | 1.9               |   |                               |   | 33.9                              |  | 3.1   |  
|Food Services                                                  |  |                           | 21.2    |                               | 1.7               |   |                               |   |                                  |  |      |  
|Retail                                                         |  |                           | 19.4    |                               | 1.5               |   |                               |   | 20.5                              |  | 1.9   |  
|Auto Parts                                                     |  |                           | 17.2    |                               | 1.4               |   |                               |   | 17.0                              |  | 1.5   |  
|Drugs                                                          |  |                           | 15.6    |                               | 1.2               |   |                               |   | 28.7                              |  | 2.6   |  
|Leisure Activities                                             |  |                           | 14.3    |                               | 1.1               |   |                               |   | 13.4                              |  | 1.2   |  
|Photographic Studio                                            |  |                           | 12.9    |                               | 1.0               |   |                               |   |                                  |  |      |  
|Cosmetics                                                      |  |                           | 6.3     |                               | 0.5               |   |                               |   | 11.3                              |  | 1.0   |  
|Car Rental                                                     |  |                           |        |                               |                  |   |                               |   | 13.5                              |  | 1.2   |  
|Other (b)                                                      |  |                           | 10.7    |                               | 0.8               |   |                               |   | 47.4                              |  | 4.3   |  
|                                                               |  |                           |         |                               |                   |   |                               |   |                                   |  |       |  
|                                                               |  | $                         | 1,257.6 |                               | 100.0             | % |                               | $ | 1,097.6                           |  | 100.0 | %
|                                                               |  |                           |         |                               |                   |   |                               |   |                                   |  |       |  

---

|(a) |  | Certain amounts have been reclassified into different industries to conform to the current period industry classification.
|--- |  | --------------------------------------------------------------------------------------------------------------------------

|(b) |  | No individual industry within this category exceeds 1%.
|--- |  | -------------------------------------------------------





33



---

##### Table of Contents

At December 31, 2006, our ten largest portfolio companies represented approximately 41.3% of the
total fair value of our investments. These ten customers accounted for approximately 37.5% of our operating income during the year ended December 31, 2006. At December 31, 2006, approximately 28.5% of our portfolio at fair value was
invested in companies in the communications industry, of which 21.8% were in CLECs. Our two largest portfolio companies, Broadview Networks Holdings, Inc. (Broadview) and Cleartel Communications, Inc. (Cleartel) are CLECs.
Our remaining investments in the communications industry include telecommunications tower companies, Internet service providers, wireless companies and security alarm companies.



ASSET QUALITY



Asset quality is generally a function of portfolio company performance, economic conditions, and our underwriting and ongoing management of our investment
portfolio. In addition to various risk management and monitoring tools, we also use an investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio. We use the following 1 to 5 investment
rating scale:



|                  |  |                                                                                                                                                                
|----------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|Investment Rating |  | Summary Description                                                                                                                                            
|1                 |  | Capital gain expected or realized                                                                                                                              
|2                 |  | Full return of principal and interest or dividend expected with customer performing in accordance with plan                                                    
|3                 |  | Full return of principal and interest or dividend expected but customer requires closer monitoring                                                             
|4                 |  | Some loss of interest or dividend expected but still expecting an overall positive internal rate of return on the investment                                   
|5                 |  | Loss of interest or dividend and some loss of principal investment expected which would result in an overall negative internal rate of return on the investment



The following table
shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as of December 31, 2006 and December 31, 2005:



|                      |  |                          |         |     |                              |       |   |                          |   |         |                              |  |       |  
|--------------------- |  | ------------------------ | ------- | --- | ---------------------------- | ----- | - | ------------------------ | - | ------- | ---------------------------- |  | ----- | -
|(dollars in millions) |  | December 31, 2006        |         |     | December 31, 2005            |      
|Investment Rating     |  | Investments at FairValue |         |     | Percentage of TotalPortfolio |       |   | Investments at FairValue |   |         | Percentage of TotalPortfolio | 
|1                     |  |                          | 785.3   | (a) |                              | 62.4  | % |                          |   | 459.0   | (a)                          |  | 41.8  | %
|2                     |  |                          | 285.5   |     |                              | 22.7  |   |                          |   | 429.9   |                              |  | 39.2  |  
|3                     |  |                          | 158.2   |     |                              | 12.6  |   |                          |   | 128.0   |                              |  | 11.7  |  
|4                     |  |                          | 23.6    |     |                              | 1.9   |   |                          |   | 77.4    |                              |  | 7.0   |  
|5                     |  |                          | 5.0     |     |                              | 0.4   |   |                          |   | 3.3     |                              |  | 0.3   |  
|                      |  |                          |         |     |                              |       |   |                          |   |         |                              |  |       |  
|                      |  | $                        | 1,257.6 |     |                              | 100.0 | % |                          | $ | 1,097.6 |                              |  | 100.0 | %
|                      |  |                          |         |     |                              |       |   |                          |   |         |                              |  |       |  

---

|(a) |  | At December 31, 2006 and 2005, approximately $447.4 million and $348.4 million, respectively, of our investments with an investment rating of 1 were loans to
companies in which we also hold equity securities or for which we have already realized a gain on our equity investment.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



34



---

##### Table of Contents

When one of our loans becomes 90 days or more past due, or if we otherwise do not expect the customer to
be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and will generally cease recognizing interest income on that loan until all past due principal and interest has been paid or
otherwise restructured such that the interest income is determined to be collectible. We may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. The following table summarizes loans on
non-accrual status and loans greater than 90 days past due, at fair value, at December 31, 2006 and December 31, 2005:



|                                                             |  |                   |      |                   |                   |   |                    |      |   |           |   |                   |  |      |                    |  |      |  
|------------------------------------------------------------ |  | ----------------- | ---- | ----------------- | ----------------- | - | ------------------ | ---- | - | --------- | - | ----------------- |  | ---- | ------------------ |  | ---- | -
|                                                             |  | December 31, 2006 |      |                   | December 31, 2005 |  
|(dollars in millions)                                        |  | FairValue         |      | % ofLoanPortfolio |                   |   | % ofTotalPortfolio |      |   | FairValue |   | % ofLoanPortfolio |  |      | % ofTotalPortfolio | 
|Loans greater than 90 days past due                          |  |                   |      |                   |                   |   |                    |      |   |           |   |                   |  |      |                    |  |      |  
|On non-accrual status                                        |  | $                 | 20.1 |                   | 2.21              | % |                    | 1.60 | % |           | $ | 3.2               |  | 0.34 | %                  |  | 0.29 | %
|Not on non-accrual status                                    |  |                   | 1.8  |                   | 0.20              | % |                    | 0.14 | % |           |   | 13.6              |  | 1.45 | %                  |  | 1.23 | %
|                                                             |  |                   |      |                   |                   |   |                    |      |   |           |   |                   |  |      |                    |  |      |  
|Total loans greater than 90 days past due                    |  | $                 | 21.9 |                   | 2.41              | % |                    | 1.74 | % |           | $ | 16.8              |  | 1.79 | %                  |  | 1.52 | %
|                                                             |  |                   |      |                   |                   |   |                    |      |   |           |   |                   |  |      |                    |  |      |  
|Loans on non-accrual status                                  |  |                   |      |                   |                   |   |                    |      |   |           |   |                   |  |      |                    |  |      |  
|0 to 90 days past due                                        |  | $                 | 15.3 |                   | 1.68              | % |                    | 1.21 | % |           | $ | 9.5               |  | 1.02 | %                  |  | 0.87 | %
|Greater than 90 days past due                                |  |                   | 20.1 |                   | 2.21              | % |                    | 1.60 | % |           |   | 3.2               |  | 0.34 | %                  |  | 0.29 | %
|                                                             |  |                   |      |                   |                   |   |                    |      |   |           |   |                   |  |      |                    |  |      |  
|Total loans on non-accrual status                            |  | $                 | 35.4 |                   | 3.89              | % |                    | 2.81 | % |           | $ | 12.7              |  | 1.36 | %                  |  | 1.16 | %
|                                                             |  |                   |      |                   |                   |   |                    |      |   |           |   |                   |  |      |                    |  |      |  
|Loans on non-accrual status or greater than 90 days past due |  | $                 | 37.2 |                   | 4.09              | % |                    | 2.95 | % |           | $ | 26.3              |  | 2.81 | %                  |  | 2.39 | %



The increase in loans
on non-accrual status from $12.7 million at December 31, 2005 to $35.4 million at December 31, 2006 is primarily due to one portfolio company that we placed on non-accrual status during the year ended December 31, 2006.



Results of Operations



Comparison of the Years Ended December 31, 2006 and 2005



The following table shows the components of our net income
for the years ended December 31, 2006 and 2005:



|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|----------------------------------------------------------------------------------------------- |  | ---- | ----- | ---- | - | ------ |  | - | ---------------- | - |  | --- | --
|(dollars in millions)                                                                           |  | 2006 |       | 2005 |   | Change |  |   | PercentageChange |  
|Operating income                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Interest and dividend income                                                                    |  | $    | 132.9 |      | $ | 96.7   |  | $ | 36.2             |   |  | 37  | % 
|Loan fees                                                                                       |  |      | 6.0   |      |   | 9.6    |  |   | (3.6             | ) |  | (38 | )%
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total interest and dividend income                                                              |  |      | 138.9 |      |   | 106.3  |  |   | 32.6             |   |  | 31  | % 
|Advisory fees and other income                                                                  |  |      | 15.5  |      |   | 13.2   |  |   | 2.3              |   |  | 17  | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total operating income                                                                          |  |      | 154.4 |      |   | 119.5  |  |   | 34.9             |   |  | 29  | % 
|Operating expenses                                                                              |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Interest expense                                                                                |  |      | 36.3  |      |   | 23.1   |  |   | 13.2             |   |  | 57  | % 
|Employee compensation:                                                                          |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Salaries and benefits                                                                           |  |      | 20.3  |      |   | 19.3   |  |   | 1.0              |   |  | 5   | % 
|Long-term incentive compensation                                                                |  |      | 4.5   |      |   | 6.5    |  |   | (2.0             | ) |  | (31 | )%
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total employee compensation                                                                     |  |      | 24.8  |      |   | 25.8   |  |   | (1.0             | ) |  | (4  | )%
|General and administrative expense                                                              |  |      | 9.7   |      |   | 10.1   |  |   | (0.4             | ) |  | (4  | )%
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total operating expenses                                                                        |  |      | 70.8  |      |   | 59.0   |  |   | 11.8             |   |  | 20  | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Net operating income before investment gains and provision for income taxes on investment gains |  |      | 83.6  |      |   | 60.5   |  |   | 23.1             |   |  | 38  | % 
|Net investment gains before taxes                                                               |  |      | 20.0  |      |   | 7.7    |  |   | 12.3             |   |  | 160 | % 
|Provision for income taxes on investment gains                                                  |  |      | 2.7   |      |   |       |  |   | 2.7              |   |  | 100 | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Net income                                                                                      |  | $    | 100.9 |      | $ | 68.2   |  | $ | 32.7             |   |  | 48  | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   



35



---

##### Table of Contents

Total Operating Income



Total operating income includes interest and dividend income, loan fees and advisory fees and other income. The level of interest income is directly
related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average yield varies from period to period based on the current stated interest rate on
interest-bearing investments and the amounts of loans for which interest is not accruing. Dividend income results from dividends earned on our equity investments or from dividends declared and paid by our portfolio companies. Dividend income will
vary from period to period depending upon the level of yield on our equity investments and the amount of equities outstanding, as well as the value of the underlying securities.



Total interest and dividend income, which includes loan fees, increased $32.6 million for the year ended December 31,
2006 compared to the year ended December 31, 2005. Interest income, exclusive of loan fees increased approximately $24.8 million during the year ended December 31, 2006 compared to the year ended December 31, 2005, due to the increase
in LIBOR, which had an impact of approximately $13.9 million, the growth in the size of our loan portfolio, which had an impact of approximately $11.0 million, and an decrease in the spread to LIBOR in our loan portfolio, which had an impact of
approximately $(0.1) million. We include in interest income certain amounts that we have not received in cash, such as contractual paid-in-kind (PIK) interest. PIK interest represents contractually deferred interest that is added to the loan balance
and which may be prepaid either by contract or the portfolio companys choice, but is generally paid at the end of the loan term. For the year ended December 31, 2006, PIK interest income totaled $14.7 million, compared to $12.7 million
for the year ended December 31, 2005. At December 31, 2006 our total PIK loan balance represented $11.1 million, or 0.9% of our portfolio of investments, compared to $13.5 million, or 1.2%, of our portfolio of investments as of
December 31, 2005. The following table shows the PIK related activity for the years ended December 31, 2006 and 2005:





|                                        |  |      |       |   |      |   |       |  
|--------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|(dollars in millions)                   |  | 2006 |       |   | 2005 |  
|Beginning PIK loan balance              |  | $    | 13.5  |   |      | $ | 17.3  |  
|PIK interest earned during the period   |  |      | 14.7  |   |      |   | 12.7  |  
|Principal payments of cash on PIK loans |  |      | (13.8 | ) |      |   | (10.4 | )
|PIK loans converted to other securities |  |      | (9.9  | ) |      |   | (5.7  | )
|Interest receivable converted to PIK    |  |      | 7.2   |   |      |   |      |  
|Realized loss                           |  |      | (0.6  | ) |      |   | (0.4  | )
|                                        |  |      |       |   |      |   |       |  
|Ending PIK loan balance                 |  | $    | 11.1  |   |      | $ | 13.5  |  
|                                        |  |      |       |   |      |   |       |  



Dividend income
increased approximately $11.4 million for the year ended December 31, 2006 compared to the year ended December 31, 2005, due to an increase in dividends declared by our portfolio companies and an increase in accruing preferred dividends.
Certain of our equity investments have stated accruing dividend rates, for which we accrue dividends as they are earned to the extent we believe they will ultimately be paid. The accrued dividend balance at December 31, 2006 was approximately
$33.6 million, or 2.7% of our portfolio of investments, compared to $12.4 million, or 1.1%, of our portfolio of investments at December 31, 2005. Our dividend activity for the years ended December 31, 2006 and 2005 was as follows:



|                                                |  |      |      |   |      |   |      |  
|----------------------------------------------- |  | ---- | ---- | - | ---- | - | ---- | -
|(dollars in millions)                           |  | 2006 |      |   | 2005 |  
|Beginning accrued dividend balance              |  | $    | 12.4 |   |      | $ | 5.4  |  
|Dividend income earned during the period        |  |      | 23.9 |   |      |   | 12.4 |  
|Payment of previously accrued dividends         |  |      | (2.7 | ) |      |   |     |  
|Accrued dividends converted to other securities |  |      |     |   |      |   | (5.4 | )
|                                                |  |      |      |   |      |   |      |  
|Ending accrued dividend balance                 |  | $    | 33.6 |   |      | $ | 12.4 |  
|                                                |  |      |      |   |      |   |      |  



36



---

##### Table of Contents

Loan fees include origination fees on loans that are deferred and amortized into interest income over the
life of the loan. When repayments or restructurings with other than minor modifications occur, we accelerate the recognition of previously unamortized loan origination fees into loan fee income. These accelerations have the effect of increasing
current period income and may reduce future amortizable income. Because these repayments and restructurings may vary from period to period, the amount of loan origination fees that are recognized as interest income may also vary from period to
period. Loan fees for the years ended December 31, 2006 and 2005, were approximately $6.0 million and $9.6 million, respectively.



The following table shows our loan fee activity during the years ended December 31, 2006 and 2005:



|                                  |  |      |      |   |      |   |      |  
|--------------------------------- |  | ---- | ---- | - | ---- | - | ---- | -
|(dollars in millions)             |  | 2006 |      |   | 2005 |  
|Beginning unearned income balance |  | $    | 9.1  |   |      | $ | 12.5 |  
|Additional deferred fees          |  |      | 6.4  |   |      |   | 6.2  |  
|Unearned income recognized        |  |      | (6.0 | ) |      |   | (9.6 | )
|                                  |  |      |      |   |      |   |      |  
|Ending unearned income balance    |  | $    | 9.5  |   |      | $ | 9.1  |  
|                                  |  |      |      |   |      |   |      |  



The total yield on our
debt portfolio at fair value for the years ended December 31, 2006 and 2005 was 12.9% and 11.9%, respectively. The average LIBOR for the year ended December 31, 2006 was 5.2%, an increase of 1.6% from 3.6% for the year ended
December 31, 2005. The average spread to LIBOR for the years ended December 31, 2006 was 7.7%, a decrease of approximately 0.6% from 8.3% for the year ended December 31, 2005, primarily due to an increase in the level of fixed rate
loans as well as a decrease in amortizing fee income and fee accelerations.



Advisory fees and other income primarily include fees related to advisory and management services, equity structuring fees, syndication fees, prepayment fees, bank interest and other income. Advisory fees and other
income are generally related to specific transactions or services and therefore may vary from period to period depending on the level and types of services provided. The increase in fees and other income of $2.3 million for the year ended
December 31, 2006 as compared to the year ended December 31, 2005 was primarily due to increases in equity structuring fees of $3.5 million, advisory and management fees of $0.8 million, prepayment fees of $3.0 million, and bank interest
and other fees of approximately $0.2 million, partially offset by a decrease in research fees of ($5.3) million due to the deconsolidation of Kagan Research, LLC effective January 1, 2006.



For the year ended December 31, 2006, our largest portfolio company,
Broadview, accounted for approximately $22.3 million, or 14.5%, of our total operating income compared to approximately $17.5 million, or 14.6%, of our total operating income for the year ended December 31, 2005. During the year ended
December 31, 2006, our operating income from our Broadview investment was comprised of interest and dividend income. During the third quarter of 2006, we converted all our debt investments in Broadview to preferred equity. As of December 31,
2006, our preferred equity investments in Broadview entitle us to a preferred claim of approximately $237.7 million, prior to claims by Broadview common shareholders. We are also entitled to accumulating dividends on our preferred stock investment,
which accumulate and compound quarterly at an annual rate of 12% on $237.7 million but are not payable in cash on a current basis. Based on our current investments in Broadview our future earnings will all be in the form of accumulating dividend
income. Further, because accumulating dividends are typically not considered part of taxable income until they are received in cash, it is possible that our GAAP earnings may exceed our taxable earnings by a significant amount until such time as
this investment is liquidated.



For the year ended December 31,
2006, our second largest portfolio company, Cleartel, accounted for $7.5 million, or 4.8% of our total operating income, compared to $3.7 million, or 3.1%, of our total operating income for the year ended December 31, 2005. During the year ended
December 31, 2006, our operating income from our Cleartel investment was comprised of interest and fee income. A portion of the interest income for the year ended December 31, 2006 was in the form of payment-in-kind interest; however, the debt was
restructured during the year and is currently current pay interest.



Our ability to recognize income from our investments in Broadview and Cleartel on an ongoing basis will be dependent upon the performance and value of each company.



37



---

##### Table of Contents

Total Operating Expenses



Operating expenses include interest, employee compensation and general and administrative expenses. The increase in interest expense of approximately
$13.2 million during the year ended December 31, 2006 as compared to the year ended December 31, 2005, is primarily attributable to an increase of $8.1 million due to increases in LIBOR, an increase of $1.7 million due to increases in the
spread to LIBOR, and an increase of $3.4 million due to higher average borrowings. Of the $1.7 million increase due to increases in the spread to LIBOR, $0.5 million is attributable to the amortization of deferred debt issuance costs. The increase
in deferred debt issuance cost amortization is primarily attributable to the expenses associated with the redemption of our Series 2004-1 Notes during the third quarter of 2006.



Employee compensation includes base salaries and benefits, variable annual incentive compensation, and long-term incentive
compensation. The increase in salaries and benefits expense of $1.0 million during the year ended December 31, 2006 as compared to the year ended December 31, 2005 is primarily due to an increase of approximately $3.7 million in salaries
and benefits and $1.5 million of severance costs related to our former CEO, partially offset by a decrease of approximately $4.2 million due to the deconsolidation of Kagan Research, LLC. Long-term incentive compensation expense is made up of
non-cash amortization of restricted stock awards granted in 2001 and 2006 and dividends on shares securing employee loans. Long-term incentive compensation decreased $2.0 million for the year ended December 31, 2006 as compared to the year
ended December 31, 2005 due to a decrease in the lapsing of forfeiture provisions on shares of restricted stock and fewer dividends on shares securing employee loans during the year ended December 31, 2006 compared to the year ended
December 31, 2005, partially offset by a charge of $0.7 million related to the accelerated vesting of certain restricted shares held by our former CEO.



General and administrative expenses include legal and accounting fees, insurance premiums, rent and various other expenses. General and administrative
expenses decreased approximately $0.4 million during the year ended December 31, 2006 compared to the year ended December 31, 2005, due to a decrease of approximately $2.8 million due to the deconsolidation of Kagan Research LLC, partially
offset by professional fees of approximately $1.4 million incurred in conjunction with the independent review of certain tax withholding reimbursements and loan repayments by our current and former executive officers, as previously disclosed, an
increase in directors fees of approximately $0.3 million and an increase in recruiting and other general and administrative costs of approximately $0.7 million.



Net Operating Income Before Investment Gains and Losses and Provision For Income Taxes on Investment Gains



Net operating income before investment gains and losses and provision for
income taxes on investment gains for the year ended December 31, 2006 totaled $83.6 million, an increase of approximately $23.1 million compared with $60.5 million for the year ended December 31, 2005. This increase is due to the items
discussed above. During the year ended December 31, 2005, our wholly owned subsidiary, Kagan Research, LLC, accounted for losses of approximately ($1.7) million. Effective January 1, 2006, Kagan Research, LLC no longer qualified as a
consolidated subsidiary of the Company.



38



---

##### Table of Contents

Net Investment Gains and Losses Before Income Taxes on Investment Gains



Net investment gains before income taxes on investment gains totaled
approximately $20.0 million for the year ended December 31, 2006, compared to $7.7 million for the year ended December 31, 2005. These amounts represent the total of net realized gains and losses, net unrealized appreciation and
depreciation and reversals of unrealized appreciation and depreciation. Reversals of unrealized appreciation and depreciation occur when a gain or loss becomes realized.



The following table summarizes our gains and (losses) on investments and the change in our unrealized appreciation and
depreciation on investments for the year ended December 31, 2006:





|                                                |  |                     |  |               |  |                              |         |   |                       |   |         |                                  |  |   |                |   |  |   |         |  
|----------------------------------------------- |  | ------------------- |  | ------------- |  | ---------------------------- | ------- | - | --------------------- | - | ------- | -------------------------------- |  | - | -------------- | - |  | - | ------- | -
|                                                |  |                     |  |               |  | Year Ended December 31, 2006 |        
|(dollars in thousands)  Portfolio Company       |  | Industry            |  | Type          |  | RealizedGain/(Loss)          |         |   | UnrealizedGain/(Loss) |   |         | Reversal ofUnrealized(Gain)/Loss |  |   | NetGain/(Loss) |  
|Broadview Network Holdings, Inc.                |  | Communications      |  | Control       |  | $                            |        |   |                       | $ | 38,064  |                                  |  | $ |               |   |  | $ | 38,064  |  
|Jenzabar, Inc.                                  |  | Technology          |  | Non-affiliate |  |                              |        |   |                       |   | 9,550   |                                  |  |   |               |   |  |   | 9,550   |  
|Metropolitan Telecommunications Holding Company |  | Communications      |  | Non-affiliate |  |                              | 583     |   |                       |   | 4,423   |                                  |  |   |               |   |  |   | 5,006   |  
|dick clark productions, inc.                    |  | Broadcasting        |  | Non-affiliate |  |                              |        |   |                       |   | 4,363   |                                  |  |   |               |   |  |   | 4,363   |  
|Midwest Tower Partners, LLC                     |  | Communications      |  | Control       |  |                              |        |   |                       |   | 3,882   |                                  |  |   |               |   |  |   | 3,882   |  
|Stratford Schools Holdings, Inc.                |  | Education           |  | Non-affiliate |  |                              |        |   |                       |   | 3,771   |                                  |  |   |               |   |  |   | 3,771   |  
|RadioPharmacy Investors, LLC                    |  | Healthcare          |  | Control       |  |                              |        |   |                       |   | 3,135   |                                  |  |   |               |   |  |   | 3,135   |  
|SXC Health Solutions, Inc.                      |  | Healthcare          |  | Non-affiliate |  |                              | 4,054   |   |                       |   | 1,940   |                                  |  |   | (3,334         | ) |  |   | 2,660   |  
|Wiesner Publishing Company, LLC                 |  | Publishing          |  | Non-affiliate |  |                              |        |   |                       |   | 1,615   |                                  |  |   |               |   |  |   | 1,615   |  
|Miles Media Holding, Inc.                       |  | Publishing          |  | Non-affiliate |  |                              |        |   |                       |   | 1,282   |                                  |  |   |               |   |  |   | 1,282   |  
|Working Mother Media, Inc.                      |  | Publishing          |  | Control       |  |                              |        |   |                       |   | 828     |                                  |  |   |               |   |  |   | 828     |  
|Superior Publishing Corporation                 |  | Newspaper           |  | Control       |  |                              |        |   |                       |   | 700     |                                  |  |   |               |   |  |   | 700     |  
|I-55 Internet Services, Inc.                    |  | Communications      |  | Non-affiliate |  |                              |        |   |                       |   |        |                                  |  |   | 606            |   |  |   | 606     |  
|Crystal Media Network, LLC                      |  | Broadcasting        |  | Control       |  |                              | (2,245  | ) |                       |   | (39     | )                                |  |   | 2,561          |   |  |   | 277     |  
|Telecomm South, LLC                             |  | Communications      |  | Control       |  |                              | (1,493  | ) |                       |   |         |                                  |  |   | 1,493          |   |  |   |        |  
|Copperstate Technologies, Inc.                  |  | Security Alarm      |  | Control       |  |                              | (1,483  | ) |                       |   |        |                                  |  |   | 1,053          |   |  |   | (430    | )
|iVerify, US Inc.                                |  | Communications      |  | Affiliate     |  |                              |        |   |                       |   | (578    | )                                |  |   |               |   |  |   | (578    | )
|West Coast WirelessLines                        |  | Publishing          |  | Control       |  |                              | (781    | ) |                       |   | (586    | )                                |  |   | 586            |   |  |   | (781    | )
|Home Interiors & Gifts, Inc.                    |  | HomeFurnishings     |  | Non-affiliate |  |                              |        |   |                       |   | (807    | )                                |  |   |               |   |  |   | (807    | )
|Platinum Wireless, Inc.                         |  | Communications      |  | Control       |  |                              |        |   |                       |   | (839    | )                                |  |   |               |   |  |   | (839    | )
|Jupitermedia Corporation                        |  | InformationServices |  | Non-affiliate |  |                              |        |   |                       |   | (908    | )                                |  |   |               |   |  |   | (908    | )
|GoldenSource Holdings, Inc.                     |  | Technology          |  | Non-affiliate |  |                              | (3,363  | ) |                       |   |        |                                  |  |   |               |   |  |   | (3,363  | )
|Fawcette Technical Publications Holding         |  | Publishing          |  | Control       |  |                              | (10,059 | ) |                       |   | (2,197  | )                                |  |   | 8,319          |   |  |   | (3,937  | )
|Total Sleep Holdings, Inc.                      |  | Healthcare          |  | Non-affiliate |  |                              |        |   |                       |   | (3,971  | )                                |  |   |               |   |  |   | (3,971  | )
|Cleartel Communications, Inc.                   |  | Communications      |  | Control       |  |                              |        |   |                       |   | (40,072 | )                                |  |   |               |   |  |   | (40,072 | )
|Other                                           |  |                     |  |               |  |                              | 200     |   |                       |   | 67      |                                  |  |   | (303           | ) |  |   | (36     | )
|                                                |  |                     |  |               |  |                              |         |   |                       |   |         |                                  |  |   |                |   |  |   |         |  
|Total                                           |  |                     |  |               |  | $                            | (14,587 | ) |                       | $ | 23,623  |                                  |  | $ | 10,981         |   |  | $ | 20,017  |  
|                                                |  |                     |  |               |  |                              |         |   |                       |   |         |                                  |  |   |                |   |  |   |         |  



39



---

##### Table of Contents

Our board of directors is responsible for determining the fair value of our portfolio investments on a
quarterly basis. In connection with our process for determining fair value as of December 31, 2006, we retained two independent valuation firms to perform independent valuations of certain of our portfolio companies. Independent valuations were
obtained for eleven portfolio companies including all companies in which we hold equity positions with fair value greater than $10.0 million as of December 31, 2006. These valuations were considered by our board of directors in their
determination of fair value. The following table summarizes the independent valuations performed:



|                                                                                           |  |                      |         |   |                       |   |       |  
|------------------------------------------------------------------------------------------ |  | -------------------- | ------- | - | --------------------- | - | ----- | -
|(dollars in millions)                                                                      |  | TotalInvestmentValue |         |   | EquityInvestmentValue |  
|Total portfolio value at December 31, 2006                                                 |  | $                    | 1,257.6 |   |                       | $ | 348.2 |  
|Number of companies for which independent enterprise valuations were obtained              |  |                      | 11      |   |                       |   | 10    |  
|Total value of companies for which independent enterprise valuations were obtained         |  | $                    | 486.0   |   |                       | $ | 267.0 |  
|% of portfolio value for which independent enterprise valuations were obtained             |  |                      | 39      | % |                       |   | 77    | %
|% of loans on non-accrual status for which independent enterprise valuations were obtained |  |                      | 62      | % |                       |   | N/A   |  



Broadview, our largest
portfolio company, serves primarily business customers. At December 31, 2006, our investment in Broadview had a fair value of approximately $159.8 million, or 12.7% of the value of our total portfolio, compared to $95.1 million, or 8.7% at December
31, 2005. During the year ended December 31, 2006, there was an unrealized gain on our Broadview investment of approximately $38.1 million. This increase in fair value is primarily due to an increase in valuations in comparable industry transactions
during the fourth quarter of 2006 and enhanced value associated with Broadviews acquisition of ATX Communications, Inc. (ATX). On September 29, 2006, Broadview completed the acquisition of ATX, an integrated communications provider
serving business customers in the Mid-Atlantic region. Broadview financed the ATX acquisition using a portion of the proceeds from a $210.0 million offering of 11 3/8% Senior Secured Notes due 2012, which were offered through Rule 144A under the
Securities Act of 1933, as amended (the Bond Offering). The Bond Offering closed on August 23, 2006. At the time of the Bond Offering, we invested an additional $5.5 million into Broadview and converted all of our subordinated debt
investments, which at that time had a fair value of approximately $51.1 million, to preferred equity. Broadview was one of the portfolio companies for which an independent valuation was obtained as of December 31, 2006.



Cleartel, our second largest portfolio company, is a Florida-based CLEC that
serves primarily residential customers. At December 31, 2006, Cleartel represented approximately 5.8% of the fair value of our investments compared to 7.2% of the fair value of our investments at December 31, 2005. At December 31, 2006, we held
subordinated debt with a fair value of $72.0 million and preferred equity with a fair value of $0.6 million, which included unrealized depreciation of approximately $40.1 million. This decrease in fair value is largely due to a decrease in
valuations in comparable residential CLEC industry transactions that occurred during the fourth quarter of 2006. During October 2006, Cleartel acquired Supra Telecom, a Florida-based CLEC. In conjunction with this acquisition, we invested an
additional $19.8 million in Cleartel in the form of subordinated debt and restructured our existing debt investments in Cleartel by extending the maturity dates and modifying the interest rates. Cleartel was one of the portfolio companies for which
an independent valuation was obtained as of December 31, 2006.



40



---

##### Table of Contents

The following table summarizes our gains and (losses) on investments and the change in our unrealized
appreciation and depreciation on investments for the year ended December 31, 2005:



|                                                |  |                      |  |               |  |                              |         |   |                       |   |        |                                  |  |   |                |   |  |   |        |  
|----------------------------------------------- |  | -------------------- |  | ------------- |  | ---------------------------- | ------- | - | --------------------- | - | ------ | -------------------------------- |  | - | -------------- | - |  | - | ------ | -
|                                                |  |                      |  |               |  | Year Ended December 31, 2005 |        
|(dollars in thousands)  Portfolio Company       |  | Industry             |  | Type          |  | RealizedGain/(Loss)          |         |   | UnrealizedGain/(Loss) |   |        | Reversal ofUnrealized(Gain)/Loss |  |   | NetGain/(Loss) |  
|Jenzabar, Inc.                                  |  | Technology           |  | Non-affiliate |  | $                            |        |   |                       | $ | 6,506  |                                  |  | $ |               |   |  | $ | 6,506  |  
|Sunshine Media Delaware, LLC                    |  | Publishing           |  | Affiliate     |  |                              |        |   |                       |   | 4,001  |                                  |  |   |               |   |  |   | 4,001  |  
|Jupitermedia Corporation                        |  | Information Services |  | Non-affiliate |  |                              | 2,321   |   |                       |   |       |                                  |  |   | (425           | ) |  |   | 1,896  |  
|Metropolitan Telecommunications Holding Company |  | Communications       |  | Non-affiliate |  |                              | 2,038   |   |                       |   | 534    |                                  |  |   | (989           | ) |  |   | 1,583  |  
|Wiesner Publishing Company, LLC                 |  | Publishing           |  | Non-affiliate |  |                              |        |   |                       |   | 1,514  |                                  |  |   |               |   |  |   | 1,514  |  
|SXC Health Solutions, Inc.                      |  | Healthcare           |  | Non-affiliate |  |                              |        |   |                       |   | 1,342  |                                  |  |   |               |   |  |   | 1,342  |  
|Midwest Tower Partners, LLC                     |  | Communications       |  | Control       |  |                              |        |   |                       |   | 1,131  |                                  |  |   |               |   |  |   | 1,131  |  
|On Target Media, LLC                            |  | Publishing           |  | Affiliate     |  |                              |        |   |                       |   | 1,103  |                                  |  |   |               |   |  |   | 1,103  |  
|Telecomm South, LLC                             |  | Communications       |  | Control       |  |                              |        |   |                       |   | 619    |                                  |  |   |               |   |  |   | 619    |  
|Boucher Communications, Inc.                    |  | Publishing           |  | Non-affiliate |  |                              | 930     |   |                       |   |       |                                  |  |   | (409           | ) |  |   | 521    |  
|ETC Group, LLC                                  |  | Publishing           |  | Control       |  |                              |        |   |                       |   | 503    |                                  |  |   |               |   |  |   | 503    |  
|Talk America Holdings, Inc.                     |  | Communications       |  | Non-affiliate |  |                              | 1,354   |   |                       |   |       |                                  |  |   | (892           | ) |  |   | 462    |  
|National Systems Integration, Inc.              |  | Security Alarm       |  | Control       |  |                              | (5,177  | ) |                       |   |       |                                  |  |   | 5,319          |   |  |   | 142    |  
|Interactive Business Solutions, Inc.            |  | Security Alarm       |  | Control       |  |                              | (1,750  | ) |                       |   |       |                                  |  |   | 1,826          |   |  |   | 76     |  
|Witter Publishing Co. Inc.                      |  | Publishing           |  | Non-affiliate |  |                              | (721    | ) |                       |   | (127   | )                                |  |   | 874            |   |  |   | 26     |  
|All Island Media, Inc                           |  | Newspaper            |  | Affiliate     |  |                              | 390     |   |                       |   |       |                                  |  |   | (390           | ) |  |   |       |  
|UMAC, Inc.                                      |  | Publishing           |  | Control       |  |                              | (10,062 | ) |                       |   |       |                                  |  |   | 10,062         |   |  |   |       |  
|nii communications, inc.                        |  | Communications       |  | Non-affiliate |  |                              | 900     |   |                       |   |       |                                  |  |   | (901           | ) |  |   | (1     | )
|Corporate Legal Times                           |  | Publishing           |  | Control       |  |                              | (367    | ) |                       |   |       |                                  |  |   | 339            |   |  |   | (28    | )
|IDS Telcom LLC                                  |  | Communications       |  | Non-affiliate |  |                              |        |   |                       |   | (692   | )                                |  |   | 583            |   |  |   | (109   | )
|Bridgecom Holdings, Inc. after acquisition      |  | Communications       |  | Control       |  |                              |        |   |                       |   |       |                                  |  |   | (497           | ) |  |   | (497   | )
|Cleartel                                        |  | Communications       |  | Control       |  |                              |        |   |                       |   | (733   | )                                |  |   |               |   |  |   | (733   | )
|Copperstate Technologies, Inc.                  |  | Security Alarm       |  | Control       |  |                              |        |   |                       |   | (876   | )                                |  |   |                |   |  |   | (876   | )
|Superior Publishing Corporation                 |  | Newspaper            |  | Control       |  |                              |        |   |                       |   | (924   | )                                |  |   |               |   |  |   | (924   | )
|CCG Consulting, LLC                             |  | Business Services    |  | Non-affiliate |  |                              | (1,258  | ) |                       |   | (1,269 | )                                |  |   | 1,269          |   |  |   | (1,258 | )
|Working Mother Media, Inc.                      |  | Publishing           |  | Control       |  |                              |        |   |                       |   | (1,604 | )                                |  |   |               |   |  |   | (1,604 | )
|Creatas, L.L.C.                                 |  | Information Services |  | Control       |  |                              | 20,431  |   |                       |   |       |                                  |  |   | (22,138        | ) |  |   | (1,707 | )
|Fawcette Technical Publications Holding         |  | Publishing           |  | Control       |  |                              |        |   |                       |   | (3,553 | )                                |  |   |               |   |  |   | (3,553 | )
|Crystal Media Network, LLC                      |  | Broadcasting         |  | Control       |  |                              |        |   |                       |   | (3,704 | )                                |  |   |               |   |  |   | (3,704 | )
|Other                                           |  |                      |  |               |  |                              | (8      | ) |                       |   | 1,330  |                                  |  |   | (75            | ) |  |   | 1,247  |  
|                                                |  |                      |  |               |  |                              |         |   |                       |   |        |                                  |  |   |                |   |  |   |        |  
|Total                                           |  |                      |  |               |  | $                            | 9,021   |   |                       | $ | 5,101  |                                  |  | $ | (6,444         | ) |  | $ | 7,678  |  
|                                                |  |                      |  |               |  |                              |         |   |                       |   |        |                                  |  |   |                |   |  |   |        |  



Provision for Income Taxes on
Investment Gains



During the year ended December 31,
2006, we recorded a $2.7 million provision for income taxes. This tax provision is primarily related to unrealized gains on one of our investments.



Net Income



Net income totaled approximately $100.9 million for the year ended December 31, 2006, compared to $68.2 million for the year ended December 31,
2005. The increase in net income is due to the items discussed above.



41



---

##### Table of Contents

Comparison of the Years Ended December 31, 2005 and 2004



The following table shows the components of our net operating income for the
years ended December 31, 2005, and 2004:



|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|----------------------------------------------------------------------------------------------- |  | ---- | ----- | ---- | - | ------ |  | - | ---------------- | - |  | --- | --
|(dollars in millions)                                                                           |  | 2005 |       | 2004 |   | Change |  |   | PercentageChange |  
|Operating income                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Interest and dividend income                                                                    |  | $    | 96.7  |      | $ | 69.1   |  | $ | 27.6             |   |  | 40  | % 
|Loan fees                                                                                       |  |      | 9.6   |      |   | 8.8    |  |   | 0.8              |   |  | 9   | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total interest and dividend income                                                              |  |      | 106.3 |      |   | 77.9   |  |   | 28.4             |   |  | 36  | % 
|Advisory fees and other income                                                                  |  |      | 13.2  |      |   | 15.2   |  |   | (2.0             | ) |  | (13 | %)
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total operating income                                                                          |  |      | 119.5 |      |   | 93.1   |  |   | 26.4             |   |  | 28  | % 
|Operating expenses                                                                              |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Interest expense                                                                                |  |      | 23.1  |      |   | 10.5   |  |   | 12.6             |   |  | 120 | % 
|Employee compensation:                                                                          |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Salaries and benefits                                                                           |  |      | 19.3  |      |   | 15.7   |  |   | 3.6              |   |  | 23  | % 
|Long-term incentive compensation                                                                |  |      | 6.5   |      |   | 11.7   |  |   | (5.2             | ) |  | (44 | %)
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total employee compensation                                                                     |  |      | 25.8  |      |   | 27.4   |  |   | (1.6             | ) |  | (6  | %)
|General and administrative expense                                                              |  |      | 10.1  |      |   | 10.1   |  |   |                 |   |  | 0   | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Total operating expenses                                                                        |  |      | 59.0  |      |   | 48.0   |  |   | 11.0             |   |  | 23  | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Net operating income before investment gains and provision for income taxes on investment gains |  |      | 60.5  |      | $ | 45.1   |  |   | 15.4             |   |  | 34  | % 
|Net investment gains before taxes                                                               |  |      | 7.7   |      |   | 2.5    |  |   | 5.2              |   |  | 208 | % 
|Provision for income taxes on investment gains                                                  |  |      |      |      |   |       |  |   |                 |   |  | 0   | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   
|Net income                                                                                      |  | $    | 68.2  |      | $ | 47.6   |  | $ | 20.6             |   |  | 43  | % 
|                                                                                                |  |      |       |      |   |        |  |   |                  |   |  |     |   



Total Operating Income



Total operating income includes interest and dividend
income, loan fees and fees and other income. The level of interest income, which includes interest paid in cash and in kind, is directly related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by
the weighted average yield. The weighted average yield varies from period to period based on the current stated interest rate on interest-bearing investments and the amounts of loans for which interest is not accruing. Dividend income results from
dividends earned on our yielding equity investments. Dividend income will vary from period to period depending upon the level of yield on our equity investments and the amount of yielding equities outstanding, as well as the value of the underlying
securities.



The increase in interest and dividend income for
the year ended December 31, 2005, as compared to the year ended December 31, 2004, is due to growth in average loans, which had an impact of $14.5 million, an increase in LIBOR, which had an impact of $13.2 million and an increase in
dividend income, which had an impact of $7.2 million, primarily attributable to our preferred stock of Broadview Networks Holdings, Inc. These increases were partially offset by a decrease in the spread to LIBOR in our loan portfolio, which had an
impact of ($7.2) million. The majority of the decrease in the spread to LIBOR is related to holding fixed rate loans and loans with LIBOR floors in a rising interest rate environment, as well as fluctuations due to payoff and origination activity.
The total yield on our total investment portfolio, at cost, for the years ended December 31, 2005 and 2004 was 11.1% and 10.0%, respectively.



During the year ended December 31, 2005, our investments in Bridgecom Holdings, Inc. and Broadview accounted for approximately $17.5 million, or
14.6%, of our total operating income. Our operating income



42



---

##### Table of Contents

related to Bridgecom and Broadview related to interest and dividends on our loan and equity investments in these entities. Our preferred stock investment in
Broadview, which had a fair value of $52.1 million as of December 31, 2005, entitles us to a preferred claim of approximately $90 million plus accrued dividends, which accumulate at an annual rate of 12% on our preferred claim. We currently
expect that our Broadview investment will continue to comprise a significant component of our operating income. In future periods, our ability to record income related to the accumulating dividends on our preferred securities will be dependent upon
the performance and value of Broadview.



Loan fees for the
years ended December 31, 2005 and 2004, included fees relating to the following:



|                                |  |      |     |      |   |    
|------------------------------- |  | ---- | --- | ---- | - | ---
|(dollars in millions)           |  | 2005 |     | 2004
|Amortizing and other fee income |  | $    | 3.7 |      | $ | 5.6
|Fee accelerations               |  |      | 5.9 |      |   | 3.1
|                                |  |      |     |      |   |    
|Total loan fees                 |  | $    | 9.6 |      | $ | 8.7
|                                |  |      |     |      |   |    



Loan fees include
origination fees on loans that are capitalized and amortized into interest income over the life of the loan. When repayments or restructurings with other than minor modifications occur, we will accelerate the recognition into loan fee income of
previously unamortized loan origination fees. These accelerations have the effect of increasing current period income and reducing future amortizable income. Because these repayments and restructurings may vary from period to period, the amount of
loan origination fees that are recognized as interest income may also vary from period to period. The decrease in amortizing fee income for the year ended December 31, 2005 as compared to the year ended December 31, 2004 is related
primarily to the volume of fee accelerations in 2005 and a decrease in our average origination fees on new loans.



Fees and other income primarily include fees related to advisory and management services, prepayment fees, research revenues, bank interest and other
income. Fees and other income are generally related to specific transactions or services and therefore may vary from period to period depending on the level and types of services provided. The decrease in fees and other income of $2.0 million for
the year ended December 31, 2005 as compared to the year ended December 31, 2004 was primarily due to $4.5 million of management fees earned in 2004 from one of our control investments, Bridgecom Holdings, Inc., prior to its merger with
Broadview, versus none earned during 2005, and a decrease in other income of $0.7 million. These decreases were partially offset by increases in advisory fees of $0.4 million, prepayment fees of $0.2 million, research revenues from our wholly owned
subsidiary Kagan Research, LLC of $0.9 million, and bank interest income of $1.7 million. The increase in bank interest income is due to higher cash balances, primarily in our cash, securitization accounts, due to higher principal and interest
payments on loans held as collateral for our securitization facilities. Cash from principal and interest payments that occur in our securitization facilities are accumulated in trust accounts until monthly or quarterly disbursements are made from
trust accounts. These balances are reflected as Cash, securitization accounts on the balance sheet. The portion of payments that represent principal payments are primarily used to repay debt.



Total Operating Expenses



Operating expenses include interest, employee compensation and general and
administrative expenses. The increase in interest expense during the year ended December 31, 2005 as compared to the year ended December 31, 2004, is primarily attributable to an increase of $7.8 million due to increases in LIBOR, an
increase of $1.7 million due to the spread to LIBOR, and an increase of $3.1 million due to higher average borrowings.



Employee compensation includes base salaries and benefits, variable annual incentive compensation, and long-term incentive compensation. The increase in
salaries and benefits expense during the year ended December 31, 2005 as compared to the year ended December 31, 2004 is primarily due to increased staffing,



43



---

##### Table of Contents

which is part of an ongoing effort to expand our infrastructure in order to support our plans for future growth. Long-term incentive compensation expense is
made up of non-cash amortization of restricted stock awards granted in 2001 and dividends on performance based restricted shares and shares securing employee loans. Long-term incentive compensation totaled $6.5 million for the year ended
December 31, 2005 compared to $11.7 million for the year ended December 31, 2004. During the first quarter of 2004, our compensation committee waived the performance-based forfeiture restrictions and modified the time-based forfeiture
provisions that were applicable to restricted stock of certain of our executive officers which resulted in an expense of $4.0 million. During the third quarter of 2005, the performance-based forfeiture restrictions and time-based forfeiture
provisions that were applicable to restricted stock of certain non-executive officers lapsed which resulted in a $0.6 million increase in long-term incentive compensation expense and a $0.4 million increase in salaries and benefits expense.



General and administrative expenses include legal and
accounting fees, insurance premiums, rent and various other expenses. General and administrative expenses were approximately $10.1 million for the years ended December 31, 2005 and 2004.



Net Operating Income before Investment Gains and Losses and Provision for Income Taxes on
Investment Gains



Net operating income before investment
gains and losses and provision for income taxes on investment gains for the year ended December 31, 2005 totaled $60.5 million, an increase of 34.2% compared with $45.1 million for the year ended December 31, 2004. Our wholly owned
subsidiary, Kagan Research, LLC, accounted for losses of $(1.9) million and $(0.7) during the years ended December 31, 2005 and 2004, respectively. The changes in net operating income are the result of the items described above.



Net Investment Gains and Losses before Income Taxes on Investment Gains



Net investment gains before income taxes on investment gains totaled
approximately $7.7 million for the year ended December 31, 2005, compared to $2.6 million for the year ended December 31, 2004. These amounts represent the total of net realized gains and losses, net unrealized appreciation and
depreciation and reversals of unrealized appreciation and depreciation. Reversals of unrealized appreciation and depreciation occur when a gain or loss becomes realized.



44



---

##### Table of Contents

The following table summarizes our gains and (losses) on investments and the change in our unrealized
appreciation and depreciation on investments for the year ended December 31, 2005:



|                                                |  |                      |  |               |  |                              |         |   |                       |   |        |                                  |  |   |                |   |  |   |        |  
|----------------------------------------------- |  | -------------------- |  | ------------- |  | ---------------------------- | ------- | - | --------------------- | - | ------ | -------------------------------- |  | - | -------------- | - |  | - | ------ | -
|                                                |  |                      |  |               |  | Year Ended December 31, 2005 |        
|(dollars in thousands) Portfolio
Company        |  | Industry             |  | Type          |  | RealizedGain/(Loss)          |         |   | UnrealizedGain/(Loss) |   |        | Reversal ofUnrealized(Gain)/Loss |  |   | NetGain/(Loss) |  
|Jenzabar, Inc.                                  |  | Technology           |  | Non-affiliate |  | $                            |        |   |                       | $ | 6,506  |                                  |  | $ |               |   |  | $ | 6,506  |  
|Sunshine Media Delaware, LLC                    |  | Publishing           |  | Affiliate     |  |                              |        |   |                       |   | 4,001  |                                  |  |   |               |   |  |   | 4,001  |  
|Jupitermedia Corporation                        |  | Information Services |  | Non-affiliate |  |                              | 2,321   |   |                       |   |       |                                  |  |   | (425           | ) |  |   | 1,896  |  
|Metropolitan Telecommunications Holding Company |  | Communications       |  | Non-affiliate |  |                              | 2,038   |   |                       |   | 534    |                                  |  |   | (989           | ) |  |   | 1,583  |  
|Wiesner Publishing Company, LLC                 |  | Publishing           |  | Non-affiliate |  |                              |        |   |                       |   | 1,514  |                                  |  |   |               |   |  |   | 1,514  |  
|SXC Health Solutions, Inc.                      |  | Healthcare           |  | Non-affiliate |  |                              |        |   |                       |   | 1,342  |                                  |  |   |               |   |  |   | 1,342  |  
|Midwest Tower Partners, LLC                     |  | Communications       |  | Control       |  |                              |        |   |                       |   | 1,131  |                                  |  |   |               |   |  |   | 1,131  |  
|On Target Media, LLC                            |  | Publishing           |  | Affiliate     |  |                              |        |   |                       |   | 1,103  |                                  |  |   |               |   |  |   | 1,103  |  
|Telecomm South, LLC                             |  | Communications       |  | Control       |  |                              |        |   |                       |   | 619    |                                  |  |   |               |   |  |   | 619    |  
|Boucher Communications, Inc.                    |  | Publishing           |  | Non-affiliate |  |                              | 930     |   |                       |   |       |                                  |  |   | (409           | ) |  |   | 521    |  
|ETC Group, LLC                                  |  | Publishing           |  | Control       |  |                              |        |   |                       |   | 503    |                                  |  |   |               |   |  |   | 503    |  
|Talk America Holdings, Inc.                     |  | Communications       |  | Non-affiliate |  |                              | 1,354   |   |                       |   |       |                                  |  |   | (892           | ) |  |   | 462    |  
|National Systems Integration, Inc.              |  | Security Alarm       |  | Control       |  |                              | (5,177  | ) |                       |   |       |                                  |  |   | 5,319          |   |  |   | 142    |  
|Interactive Business Solutions, Inc.            |  | Security Alarm       |  | Control       |  |                              | (1,750  | ) |                       |   |       |                                  |  |   | 1,826          |   |  |   | 76     |  
|Witter Publishing Co. Inc.                      |  | Publishing           |  | Non-affiliate |  |                              | (721    | ) |                       |   | (127   | )                                |  |   | 874            |   |  |   | 26     |  
|All Island Media, Inc                           |  | Newspaper            |  | Affiliate     |  |                              | 390     |   |                       |   |       |                                  |  |   | (390           | ) |  |   |       |  
|UMAC, Inc.                                      |  | Publishing           |  | Control       |  |                              | (10,062 | ) |                       |   |       |                                  |  |   | 10,062         |   |  |   |       |  
|nii communications, inc.                        |  | Communications       |  | Non-affiliate |  |                              | 900     |   |                       |   |       |                                  |  |   | (901           | ) |  |   | (1     | )
|Corporate Legal Times                           |  | Publishing           |  | Control       |  |                              | (367    | ) |                       |   |       |                                  |  |   | 339            |   |  |   | (28    | )
|IDS Telcom LLC                                  |  | Communications       |  | Non-affiliate |  |                              |        |   |                       |   | (692   | )                                |  |   | 583            |   |  |   | (109   | )
|Bridgecom Holdings, Inc. after acquisition      |  | Communications       |  | Control       |  |                              |        |   |                       |   |       |                                  |  |   | (497           | ) |  |   | (497   | )
|Cleartel                                        |  | Communications       |  | Control       |  |                              |        |   |                       |   | (733   | )                                |  |   |               |   |  |   | (733   | )
|Copperstate Technologies, Inc.                  |  | Security Alarm       |  | Control       |  |                              |        |   |                       |   | (876   | )                                |  |   |                |   |  |   | (876   | )
|Superior Publishing Corporation                 |  | Newspaper            |  | Control       |  |                              |        |   |                       |   | (924   | )                                |  |   |               |   |  |   | (924   | )
|CCG Consulting, LLC                             |  | Business Services    |  | Non-affiliate |  |                              | (1,258  | ) |                       |   | (1,269 | )                                |  |   | 1,269          |   |  |   | (1,258 | )
|Working Mother Media, Inc.                      |  | Publishing           |  | Control       |  |                              |        |   |                       |   | (1,604 | )                                |  |   |               |   |  |   | (1,604 | )
|Creatas, L.L.C.                                 |  | Information Services |  | Control       |  |                              | 20,431  |   |                       |   |       |                                  |  |   | (22,138        | ) |  |   | (1,707 | )
|Fawcette Technical Publications Holding         |  | Publishing           |  | Control       |  |                              |        |   |                       |   | (3,553 | )                                |  |   |               |   |  |   | (3,553 | )
|Crystal Media Network, LLC                      |  | Broadcasting         |  | Control       |  |                              |        |   |                       |   | (3,704 | )                                |  |   |               |   |  |   | (3,704 | )
|Other                                           |  |                      |  |               |  |                              | (8      | ) |                       |   | 1,330  |                                  |  |   | (75            | ) |  |   | 1,247  |  
|                                                |  |                      |  |               |  |                              |         |   |                       |   |        |                                  |  |   |                |   |  |   |        |  
|Total                                           |  |                      |  |               |  | $                            | 9,021   |   |                       | $ | 5,101  |                                  |  | $ | (6,444         | ) |  | $ | 7,678  |  
|                                                |  |                      |  |               |  |                              |         |   |                       |   |        |                                  |  |   |                |   |  |   |        |  



The net realized gains
for the year ended December 31, 2005 were primarily attributable to a $20.4 million realized gain on the sale of our Creatas equity investment, partially offset by a $10.1 million realized loss on the sale of our investment in UMAC, Inc. The
reversal of unrealized appreciation on the Creatas investment totaled ($22.1) million, and the reversal of unrealized depreciation on the UMAC investment totaled $10.1 million.



During 2005, our investment with the largest unrealized depreciation was Crystal Media Network, LLC. Certain events occurred
at Crystal Media during 2005 that caused us to record unrealized losses on our equity investment of approximately $3.7 million. These unrealized losses, along with unrealized losses recorded on this investment prior to 2005, have reduced our
estimated fair value of our equity investment in Crystal Media to approximately $1.1 million, which is approximately $5.0 million less than our cost basis in this investment. We currently expect to convert this unrealized loss to a realized loss in
a future period.



45



---

##### Table of Contents

The following table summarizes our gains and (losses) on investments and the change in our unrealized
appreciation and depreciation on investments for the year ended December 31, 2004:



|                                                |  |                      |  |               |  |                              |        |   |                       |   |        |                                  |  |   |                |   |  |   |        |  
|----------------------------------------------- |  | -------------------- |  | ------------- |  | ---------------------------- | ------ | - | --------------------- | - | ------ | -------------------------------- |  | - | -------------- | - |  | - | ------ | -
|                                                |  |                      |  |               |  | Year Ended December 31, 2004 |       
|(dollars in thousands) Portfolio
Company        |  | Industry             |  | Type          |  | RealizedGain/(Loss)          |        |   | UnrealizedGain/(Loss) |   |        | Reversal ofUnrealized(Gain)/Loss |  |   | NetGain/(Loss) |  
|Creatas, L.L.C.                                 |  | Information Services |  | Control       |  | $                            |       |   |                       | $ | 20,459 |                                  |  | $ |               |   |  | $ | 20,459 |  
|21st Century Newspapers, Inc.                   |  | Newspaper            |  | Non-affiliate |  |                              | 2,478  |   |                       |   |       |                                  |  |   | (215           | ) |  |   | 2,263  |  
|R.R. Bowker LLC                                 |  | Information Services |  | Non-affiliate |  |                              | 2,268  |   |                       |   | 242    |                                  |  |   | (794           | ) |  |   | 1,716  |  
|Corporate Legal Times                           |  | Publishing           |  | Control       |  |                              |       |   |                       |   | 1,637  |                                  |  |   |               |   |  |   | 1,637  |  
|Images.com, Inc.                                |  | Information Services |  | Non-affiliate |  |                              |       |   |                       |   | 1,466  |                                  |  |   |               |   |  |   | 1,466  |  
|Metropolitan Telecommunications Holding Company |  | Communications       |  | Non-affiliate |  |                              |       |   |                       |   | 1,239  |                                  |  |   |               |   |  |   | 1,239  |  
|Superior Publishing Corporation                 |  | Newspaper            |  | Control       |  |                              |       |   |                       |   | 1,104  |                                  |  |   |               |   |  |   | 1,104  |  
|nii communications, inc.                        |  | Communications       |  | Non-affiliate |  |                              |       |   |                       |   | 925    |                                  |  |   |               |   |  |   | 925    |  
|Jenezabar, Inc.                                 |  | Technology           |  | Non-affiliate |  |                              |       |   |                       |   | 703    |                                  |  |   |               |   |  |   | 703    |  
|NOW Communications, Inc.                        |  | Communications       |  | Non-affiliate |  |                              |       |   |                       |   |       |                                  |  |   | 658            |   |  |   | 658    |  
|Bridgecom Holdings, Inc.                        |  | Communications       |  | Control       |  |                              | 2,158  |   |                       |   | 497    |                                  |  |   | (2,242         | ) |  |   | 413    |  
|Netplexus Corporation                           |  | Technology           |  | Affiliate     |  |                              | (2,531 | ) |                       |   |       |                                  |  |   | 2,413          |   |  |   | (118   | )
|AMI Telecommunications Corporation              |  | Communications       |  | Control       |  |                              | (6,989 | ) |                       |   |       |                                  |  |   | 6,858          |   |  |   | (131   | )
|Witter Publishing Co. Inc.                      |  | Publishing           |  | Non-affiliate |  |                              |       |   |                       |   | (602   | )                                |  |   |               |   |  |   | (602   | )
|Fawcette Technical Publications Holding         |  | Publishing           |  | Control       |  |                              |       |   |                       |   | (718   | )                                |  |   |               |   |  |   | (718   | )
|ETC Group, LLC                                  |  | Publishing           |  | Control       |  |                              |       |   |                       |   | (750   | )                                |  |   |               |   |  |   | (750   | )
|Interactive Business Solutions, Inc.            |  | Security Alarm       |  | Control       |  |                              |       |   |                       |   | (919   | )                                |  |   |               |   |  |   | (919   | )
|Telecomm South, LLC                             |  | Communications       |  | Control       |  |                              |       |   |                       |   | (1,019 | )                                |  |   |               |   |  |   | (1,019 | )
|Talk America Holdings, Inc.                     |  | Communications       |  | Non-affiliate |  |                              |       |   |                       |   | (1,302 | )                                |  |   |               |   |  |   | (1,302 | )
|Copperstate Technologies, Inc.                  |  | Security Alarm       |  | Control       |  |                              |       |   |                       |   | (1,681 | )                                |  |   |               |   |  |   | (1,681 | )
|Sunshine Media Delaware, LLC                    |  | Publishing           |  | Affiliate     |  |                              |       |   |                       |   | (3,678 | )                                |  |   |               |   |  |   | (3,678 | )
|Working Mother Media, Inc.                      |  | Publishing           |  | Control       |  |                              |       |   |                       |   | (4,012 | )                                |  |   |               |   |  |   | (4,012 | )
|National Systems Integration, Inc.              |  | Security Alarm       |  | Control       |  |                              |       |   |                       |   | (4,743 | )                                |  |   |               |   |  |   | (4,743 | )
|Cleartel Communications, Inc.                   |  | Communications       |  | Control       |  |                              | (669   | ) |                       |   | (4,332 | )                                |  |   |               |   |  |   | (5,001 | )
|FTI Technologies Holdings, Inc.                 |  | Technology           |  | Non-affiliate |  |                              | (5,125 | ) |                       |   | (5,125 | )                                |  |   | 5,125          |   |  |   | (5,125 | )
|Other                                           |  |                      |  |               |  |                              | 160    |   |                       |   | (121   | )                                |  |   | (266           | ) |  |   | (227   | )
|                                                |  |                      |  |               |  |                              |        |   |                       |   |        |                                  |  |   |                |   |  |   |        |  
|Total                                           |  |                      |  |               |  | $                            | (8,250 | ) |                       | $ | (730   | )                                |  | $ | 11,537         |   |  | $ | 2,557  |  
|                                                |  |                      |  |               |  |                              |        |   |                       |   |        |                                  |  |   |                |   |  |   |        |  



Net Income



Net income totaled $68.2 million for the year ended December 31, 2005,
compared to $47.6 for the year ended December 31, 2004. The increase in net income is due to the items discussed above.



Financial Condition, Liquidity and Capital Resources



Cash and Cash Equivalents, Cash, Securitization Accounts, and Cash, Restricted



At December 31, 2006 and December 31, 2005, we had $21.7 million and $45.6 million, respectively, in cash and cash
equivalents. In addition, at December 31, 2006 and December 31, 2005, we had $15.9 million and $82.1 million, respectively, in cash, securitization accounts. We also had $2.6 million and $2.0 million of restricted cash as of
December 31, 2006 and December 31, 2005, respectively. We primarily invest cash on hand in interest bearing deposit accounts. Cash, securitization accounts include principal and interest payments received on securitized loans, which in
certain cases are held in designated bank accounts until monthly or quarterly disbursements are made from the securitization trusts. In certain cases, we are required to use a portion of these amounts to pay interest expense, reduce borrowings, or
pay other amounts in accordance with the related securitization agreements, while in other cases we are permitted to use these amounts to acquire new loans into the securitization trusts. Cash in securitization accounts negatively impacts our
earnings since the interest we pay on borrowings typically exceeds the rate of return that we are able to earn on temporary cash investments. Our objective is to maintain sufficient cash on hand to cover current funding requirements and operational
needs.



46



---

##### Table of Contents

For the year ended December 31, 2006, net cash provided by operating activities totaled $69.9
million, an increase of approximately $19.3 million from $50.6 million for the year ended December 31, 2005. This increase was due primarily to an increase in net income, partially offset by an increase in the portion of net income attributable
to net gains on investments and an increase in paid-in-kind interest and dividends. Cash used in investing activities decreased approximately $81.5 million to $115.9 million for the year ended December 31, 2006 from $197.5 million for the year
ended December 31, 2005. This change is primarily the result of an increase in principal payments on loans and a decrease in originations, draws and advances on loans, partially offset by an increase in purchases of equity investments and a
decrease in proceeds from sales of equity investments. Cash provided by financing activities decreased approximately $87.7 million to $22.1 million for the year ended December 31, 2006, from $109.7 million for the year ended December 31,
2005. This change is mainly due to fewer proceeds raised through the issuance of common stock and the net proceeds from borrowings during 2006 compared to 2005 and to higher dividends paid during 2006 compared to 2005.



Liquidity and Capital Resources



We expect our cash on hand and cash generated from operations, including the
portion of the cash in securitization accounts that will be released to us or used to purchase additional loans, will be adequate to meet our cash needs at our current level of operations. In order to fund new originations, we intend to use cash on
hand, advances under our borrowing facilities and equity issuances. Our secured borrowing facilities generally contain collateral requirements, including, but not limited to, asset mix, minimum diversity and rating and limitations on loan size.
These limitations limit our ability to fund certain new originations with advances under such facilities, in which case we fund originations using unsecured debt or equity financings.



During the year ended December 31, 2006 we raised $72.5 million of gross proceeds by selling 4,600,000 shares of newly
issued common stock. During the year ended December 31, 2005 we raised $123.1 million of gross proceeds by selling 8,029,500 shares of newly issued common stock.



In order to satisfy the requirements applicable to a regulated investment company, we intend to distribute to our
stockholders substantially all of our income. In addition, as a business development company, we generally will be required to meet a coverage ratio of total assets to total senior securities, which include all of our borrowings and any preferred
stock we may issue in the future, of at least 200%. As of December 31, 2006, this ratio was 239%. This requirement limits the amount that we may borrow.



To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity
markets and various debt markets. We intend to maintain a current shelf registration statement pursuant to which we may issue common stock from time to time.



Off-Balance Sheet Arrangements



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



Commitments to extend
credit include the unused portions of commitments that obligate us to extend credit in the form of loans, participations in loans or similar transactions. 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.



47



---

##### Table of Contents

As of December 31, 2006, we had unused commitments to extend credit to our customers of $71.6
million, which are not reflected on our balance sheet. From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies. As of December 31, 2006, we had guarantees and standby letters of credit of
approximately $9.5 million.



Contractual Obligations



The following table shows our contractual obligations as
of December 31, 2006:



|                                                  |  |                        |       |                  |   |           |  |           |     |               |   |      |  |   |      
|------------------------------------------------- |  | ---------------------- | ----- | ---------------- | - | --------- |  | --------- | --- | ------------- | - | ---- |  | - | -----
|                                                  |  | Payments Due by Period
|(dollars in millions) Contractual
Obligations (a) |  | Total                  |       | Less than 1 year |   | 1-3 years |  | 4-5 years |     | After 5 years
|Borrowings (b)                                    |  | $                      | 521.9 |                  | $ | 168.0     |  | $         |    |               | $ | 50.0 |  | $ | 303.9
|Future minimum rental obligations                 |  |                        | 11.7  |                  |   | 1.6       |  |           | 3.9 |               |   | 4.1  |  |   | 2.1  
|                                                  |  |                        |       |                  |   |           |  |           |     |               |   |      |  |   |      
|Total contractual obligations                     |  | $                      | 533.6 |                  | $ | 169.6     |  | $         | 3.9 |               | $ | 54.1 |  | $ | 306.0
|                                                  |  |                        |       |                  |   |           |  |           |     |               |   |      |  |   |      

| | 
| | 

| | (a) |  | This excludes the unused commitments to extend credit to our customers of $71.6 million as discussed above.
| | --- |  | -----------------------------------------------------------------------------------------------------------

| | (b) |  | Borrowings under the MCG Commercial Loan Funding Trust Facility, the Commercial Loan Trust 2006-2 and the Revolving Unsecured Credit Facility are listed based on the contractual
maturity of the respective facility due to the revolving nature of the facilities.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Borrowings



The following table shows the facility amounts and outstanding borrowings at December 31, 2006 and December 31, 2005:



|                                           |  |                   |       |                    |   |                 |  |                    |       |  |   |      
|------------------------------------------ |  | ----------------- | ----- | ------------------ | - | --------------- |  | ------------------ | ----- |  | - | -----
|                                           |  | December 31, 2006 |       | December 31, 2005 
|                                           |  | Facility amount   |       | Amount outstanding |   | Facility amount |  | Amount outstanding
|(dollars in millions)                      |  |                   |       |                   
|Unsecured Notes                            |  | $                 | 50.0  |                    | $ | 50.0            |  | $                  | 50.0  |  | $ | 50.0 
|Commercial Loan Trust 2005-2               |  |                   |      |                    |   |                |  |                    | 250.0 |  |   | 159.2
|Commercial Loan Trust 2006-2               |  |                   | 200.0 |                    |   | 84.0            |  |                    |       |  |   |      
|Commercial Loan Funding Trust Facility     |  |                   | 250.0 |                    |   | 84.0            |  |                    | 250.0 |  |   | 160.0
|Term Securitizations                       |  |                   |       |                    |   |                 |  |                    |       |  |   |      
|Series 2004-1 Class A-1 Asset Backed Bonds |  |                   |      |                    |   |                |  |                    | 81.1  |  |   | 81.1 
|Series 2004-1 Class A-2 Asset Backed Bonds |  |                   |      |                    |   |                |  |                    | 31.5  |  |   | 31.5 
|Series 2004-1 Class B Asset Backed Bonds   |  |                   |      |                    |   |                |  |                    | 43.5  |  |   | 43.5 
|Series 2004-1 Class C Asset Backed Bonds   |  |                   |      |                    |   |                |  |                    | 15.8  |  |   | 15.8 
|Series 2006-1 Class A-1 Notes              |  |                   | 106.2 |                    |   | 106.2           |  |                    |      |  |   |     
|Series 2006-1 Class A-2 Notes              |  |                   | 50.0  |                    |   | 11.4            |  |                    |      |  |   |     
|Series 2006-1 Class A-3 Notes              |  |                   | 85.0  |                    |   | 35.0            |  |                    |      |  |   |     
|Series 2006-1 Class B Notes                |  |                   | 58.8  |                    |   | 58.8            |  |                    |      |  |   |     
|Series 2006-1 Class C Notes                |  |                   | 45.0  |                    |   | 45.0            |  |                    |      |  |   |     
|Series 2006-1 Class D Notes                |  |                   | 47.5  |                    |   | 47.5            |  |                    |      |  |   |     
|Revolving Unsecured Credit Facility        |  |                   | 100.0 |                    |   |                |  |                    | 50.0  |  |   |     
|                                           |  |                   |       |                    |   |                 |  |                    |       |  |   |      
|Total                                      |  | $                 | 992.5 |                    | $ | 521.9           |  | $                  | 771.9 |  | $ | 541.1
|                                           |  |                   |       |                    |   |                 |  |                    |       |  |   |      



48



---

##### Table of Contents

For the above borrowings, the fair value of the borrowings approximates cost. 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 the year ended
December 31, 2006 and 2005:



|                                             |  |      |       |   |      |   |       |  
|-------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                             |  | 2006 |       |   | 2005 |  
|Weighted average borrowings                  |  | $    | 507.5 |   |      | $ | 439.0 |  
|Weighted average interest rate on borrowings |  |      | 7.1   | % |      |   | 5.3   | %
|Average LIBOR                                |  |      | 5.2   | % |      |   | 3.6   | %
|Average spread to LIBOR                      |  |      | 1.9   | % |      |   | 1.7   | %



The increase of
approximately 1.8% in the weighted average interest rate for the year ended December 31, 2006 compared to the year ended December 31, 2005 was primarily attributable to an increase in average LIBOR of 1.6%, as well as an increase in the
average spread to LIBOR of 0.2%.



All of our debt facilities,
except the Revolving Unsecured Credit Facility and the Unsecured Notes, are funded through our bankruptcy remote, special purpose, wholly owned subsidiaries and, therefore, their assets may not be available to our creditors. In some cases, advances
under our debt facilities are subject to certain other covenants, including having sufficient levels of collateral and various restrictions on which loans we may leverage as collateral. We borrow directly, as well as indirectly, through credit
facilities maintained by our subsidiaries.



Unsecured
Notes.    On October 11, 2005, we issued $50.0 million of investment grade five-year unsecured notes in a private placement. The notes were rated BBB- by Fitch Ratings, Inc. and have a fixed interest rate of
6.73% per year payable semi-annually. Bayerische Hypo-Und Vereinsbank, AG, New York Branch (HVB) acted as the placement agent for the issuance.



Commercial Loan Trust 2006-2.    On May 2, 2006 we established, through MCG Commercial Loan Trust 2006-2, a $200.0
million warehouse credit facility with Merrill Lynch Capital Corp. The warehouse credit facility allows MCG Commercial Loan Trust 2006-2 to acquire up to $250.0 million of commercial loans with borrowings of up to $200.0 million subject to certain
covenants, concentration limitations and other restrictions. The warehouse credit facility is primarily secured by the assets of MCG Commercial Loan Trust 2006-2, including the commercial loans purchased by the trust from us. Under the terms of the
credit and warehouse agreement, the loans may be senior secured loans, second lien loans or unsecured loans, as defined in the agreement, subject to certain limitations. Up to 60% of the collateral in this warehouse facility may be non-senior
secured loans, and the remaining 40% must be senior secured loans.



We use this warehouse credit facility to fund the origination of loans that will collateralize a future term securitization. Advances under the facility, equal to 80% of the value of commercial loans purchased by the trust, bear interest
based on LIBOR plus 0.75% and interest is payable monthly. The facility is scheduled to terminate on the earlier of November 30, 2007 or the completion of a term securitization and may be extended under certain circumstances. As of
December 31, 2006 we had $84.0 million outstanding under this facility.



MCG Commercial Loan Funding Trust.    On November 10, 2004, we established, through MCG Commercial Loan Funding Trust, a $150.0 million warehouse financing facility funded through Three
Pillars Funding LLC, an asset-backed commercial paper conduit administered by SunTrust Capital Markets, Inc. The warehouse financing facility operates like a revolving credit facility that is primarily secured by the assets of MCG Commercial Loan
Funding Trust, including commercial loans sold by us to the trust. The pool of commercial loans in the trust must meet certain requirements, including, but not limited to, term, average life, investment rating, agency rating and industry diversity
requirements. There are also certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and



49



---

##### Table of Contents

charge-offs. Such limitations, requirements, and associated defined terms are as provided for in the documents governing the facility. Through July 29,
2005, advances under the facility bore interest based on a commercial paper rate plus 1.15%.



On July 29, 2005, we amended the MCG Commercial Loan Funding Trust facility. Pursuant to this amendment, the total facility amount was increased from $150.0 million to $250.0 million, the interest rate was
changed from commercial paper rate plus 1.15% to commercial paper rate plus 0.95%, the concentration criteria were modified to allow, among other things, for an increase in the allowable percentage of certain secured subordinated loans in the
collateral pool from 25% to 35%, and other minor modifications were made. On April 17, 2006 we again amended this facility to allow, among other things, for an increase in the allowable percentage of certain secured subordinated loans in the
collateral pool from 35% to 50% and the inclusion of additional industry segments. The facility is scheduled to terminate on November 7, 2007, but is subject to annual renewal and may be extended under certain circumstances. During July 2006,
the facility was renewed until July 27, 2007. As of December 31, 2006, we had $84.0 million outstanding under this credit facility. See Recent Developments for further discussion.



Commercial Loan Trust 2006-1.    On April 18,
2006, we completed a $500.0 million debt securitization through MCG Commercial Loan Trust 2006-1, our wholly owned subsidiary. The 2006-1 Trust issued $106.2 million of Class A-1 Notes rated AAA / Aaa, $50.0 million of Class A-2 Notes
rated AAA / Aaa, $85.0 million of Class A-3 Notes rated AAA / Aaa, $58.8 million of Class B Notes rated AA / Aa2, $45.0 million of Class C Notes rated A / A2 and $47.5 million of Class D Notes rated BBB / Baa2 as rated by Moodys and
S&P, respectively. The Series 2006-1 Class A-1 Notes, Class A-2 Notes, Class A-3 Notes, Class B Notes, Class C Notes and Class D Notes bear interest of LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%, respectively.



We retained all of the equity in the securitization. The
securitization includes a reinvestment period of five years, during which principal collections received on the underlying collateral may be used to purchase new collateral from us. Under the terms of the securitization, up to 55% of the collateral
may be non-senior secured commercial loans and the remaining 45% must be senior secured commercial loans.



The Class A-1, Class B, Class C and Class D Notes are term notes. The Class A-2 Notes are a revolving class of secured notes and have a
revolving period of five years. The Class A-3 Notes are a delayed draw class of secured notes and are required to be drawn by April 2007. All of the notes are secured by the assets of MCG Commercial Loan Trust 2006-1, including commercial loans
totaling $408.6 million as of December 31, 2006, which were purchased by the trust from us. Additional commercial loans will be purchased by the trust from us primarily using the proceeds from the Class A-3 delayed draw notes and the
Class A-2 revolving notes. The pool of commercial loans in the trust must meet certain requirements, including, but not limited to, asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector
diversity requirements. As of December 31, 2006, we had $303.9 million of these notes outstanding.



Revolving Unsecured Credit Facility.    This facility was established on September 20, 2005 as a result of an amendment to
our Senior Secured Credit facility with Bayerische Hypo-Und Vereinsbank, AG, New York Branch (HVB). Pursuant to that amendment the facility was no longer secured by our assets and was committed up to $50.0 million. On June 19, 2006,
we made a second amendment to this facility. Pursuant to this amendment, the aggregate revolving commitment under this credit facility was increased from $50.0 million to $60.0 million, the maturity date was extended from September 19, 2006 to
June 18, 2007, and an additional lender was added to the facility. Other minor modifications were also made to the facility. HVB maintained its $50.0 million commitment, and the additional $10.0 million was committed by Chevy Chase Bank. On
August 7, 2006, we again amended this facility. Pursuant to this amendment, the aggregate revolving commitment under this facility was increased from $60.0 million to $75.0 million and an additional lender was added to the facility. HVB and
Chevy Chase Bank maintained their $50.0 million and $10.0 million commitments, respectively, and the additional $15.0 million was committed by Sovereign Bank. On November 29, 2006, we again amended this



50



---

##### Table of Contents

facility. Pursuant to this amendment, the aggregate revolving commitment under this facility was increased from $75.0 million to $100.0 million and an
additional lender was added to the facility. HVB, Chevy Chase Bank, and Sovereign Bank maintained their $50.0 million, $10.0 million, and $15 million commitments, respectively, and the additional $25.0 million was committed by Royal Bank of Canada.



This credit facility is unsecured and is committed up to
$100.0 million on a revolving basis. In addition, this Revolving Unsecured Credit Facility allows for additional lenders with HVB acting as the agent. Advances under this credit facility bear interest at LIBOR plus 2.00% or the prime rate plus
0.50%, and there is a commitment fee of 0.25% per annum on undrawn amounts. The credit facility contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting, minimum
stockholders equity, minimum asset coverage ratio, and minimum cash net investment income. The credit facility also contains customary events of default with customary cure and notice, including, without limitation, nonpayment,
misrepresentation in a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change of control, change of management, and material adverse change. As of December 31, 2006, the Company had no amounts outstanding
under this credit facility.



Commercial Loan Trust
2005-2.    On June 9, 2005, we established, through MCG Commercial Loan Trust 2005-2, a $250.0 million warehouse credit facility with Merrill Lynch Capital Corp. On April 18, 2006, this facility terminated in
connection with our Term Securitization 2006-1. The warehouse credit facility allowed MCG Commercial Loan Trust 2005-2 to borrow up to $250.0 million subject to certain covenants, concentration limitations and other restrictions. The warehouse
credit facility was primarily secured by the assets of MCG Commercial Loan Trust 2005-2, including cash and commercial loans transferred by us to the trust. Under the terms of the credit and warehouse agreement, the loans could be senior secured
loans, second lien loans or unsecured loans, as defined in the agreement, subject to certain limitations, including the requirement that at least 50% of the overall warehouse facility amount be senior secured commercial loans. Advances under the
facility bore interest based on LIBOR plus 0.75% and interest was payable monthly.



Term Securitization 2004-1.    On September 30, 2004, we established MCG Commercial Loan Trust 2004-1 (the 2004-1 Trust), which issued three classes of series 2004-1 Notes.
The facility was structured to hold up to $397.7 million of loans. The facility was secured by all of the 2004-1 Trusts commercial loans and cash in securitization accounts, which totaled $228.0 million as of December 31, 2005. On
July 20, 2006 we repaid the 2004-1 Notes using approximately $61.9 million of cash from the Commercial Loan Trust 2004-1 and our Commercial Loan Trust 2006-1 securitization and $15.0 million of new borrowings from our Commercial Loan Trust
2006-1 securitization. This facility was scheduled to terminate July 20, 2016 or sooner upon the full repayment of the Class A-1, Class A-2, Class B and Class C Notes.



The 2004-1 Trust issued $250.5 million of Class A-1 Notes rated Aaa/AAA, $31.5 million of Class A-2 Notes rated
Aa1/AAA, $43.5 million of Class B Notes rated A2/A and $15.8 million of Class C Notes rated Baa2/BBB as rated by Moodys and Fitch, respectively. On June 1, 2005, we sold the Class C securities, which had previously been retained by MCG.
The Series 2004-1 Class A-1 Notes, Class A-2 Notes, Class B Notes and Class C Notes bore interest of LIBOR plus 0.43%, 0.65%, 1.30%, and 2.50%, respectively.



On December 13, 2004, we formed a subsidiary, Solutions Capital I, LP, which has applied to the United States Small
Business Administration (SBA) for a license to operate as a small business investment company (SBIC) under the Small Business Investment Act of 1958, as amended. We are currently in the pre-licensure phase of the licensing
process and anticipate completion of the licensing process during the spring of 2007. Upon receipt of the SBA license, we intend to apply for exemptive relief from the SEC to permit us to exclude senior securities issued by the SBA to Solutions
Capital I, LP from our consolidated asset coverage ratio, which will enable us to fund more investments with debt capital. There can be no assurance that we will be granted an SBIC license or receive the exemptive relief from the SEC.



51



---

##### Table of Contents

Distributions



We intend to make distributions on a quarterly basis to our stockholders of substantially all of our income. We may make deemed distributions to our
stockholders of certain net capital gains.



As a business
development company that has elected to be treated as a RIC, we generally are required to (1) distribute at least 90% of our investment company taxable income and 90% of any ordinary pre-RIC built in gains that we recognize in order to deduct
distributions made (or deemed made) to our shareholders and (2) distribute (actually or on a deemed basis) at least 98% of our income (both ordinary income and net capital gains) in order to avoid an excise tax.



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



The following table summarizes our distributions declared since January 1, 2005:



|                  |  |                   |  |                  |  |        |     
|----------------- |  | ----------------- |  | ---------------- |  | ------ | ----
|Date Declared     |  | Record Date       |  | Payment Date     |  | Amount
|February 15, 2007 |  | March 15, 2007    |  | April 27, 2007   |  | $      | 0.44
|October 26, 2006  |  | November 22, 2006 |  | January 30, 2007 |  |        | 0.42
|July 27, 2006     |  | August 24, 2006   |  | October 30, 2006 |  |        | 0.42
|April 27, 2006    |  | May 25, 2006      |  | July 28, 2006    |  |        | 0.42
|February 16, 2006 |  | March 16, 2006    |  | April 27, 2006   |  |        | 0.42
|October 26, 2005  |  | November 23, 2005 |  | January 30, 2006 |  |        | 0.42
|July 27, 2005     |  | August 25, 2005   |  | October 28, 2005 |  |        | 0.42
|April 27, 2005    |  | May 26, 2005      |  | July 28, 2005    |  |        | 0.42
|February 23, 2005 |  | March 14, 2005    |  | April 28, 2005   |  |        | 0.42



Since December 2001,
we have declared distributions totaling $9.75 per share. For 2007, we currently estimate that our dividends will be at least $1.76 per share. This estimate takes into consideration our estimates of distributable net operating income (which is equal
to net operating income excluding long-term incentive compensation), net income, capital gains and taxable income for 2007.



Each year a statement on Form 1099-DIV identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the
sale of securities, and/or a return of paid-in-capital surplus which is a nontaxable distribution) is mailed to our stockholders. To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of
those distributions may be deemed a tax return of capital to our stockholders.



The table below shows the detail of our distributions for the years ended December 31, 2006 and 2005:



|                                    |  |      |      |  |       |   |  |   |      |  |       |  
|----------------------------------- |  | ---- | ---- |  | ----- | - |  | - | ---- |  | ----- | -
|                                    |  | 2006 |      |  | 2005  |  
|Ordinary income (a)                 |  | $    | 1.01 |  | 60.1  | % |  | $ | 1.31 |  | 78.0  | %
|Capital gains (a)                   |  |      |     |  |      |   |  |   | 0.15 |  | 9.0   | %
|Return of capital (b)               |  |      | 0.67 |  | 39.9  | % |  |   | 0.22 |  | 13.0  | %
|                                    |  |      |      |  |       |   |  |   |      |  |       |  
|Total reported on tax Form 1099-DIV |  | $    | 1.68 |  | 100.0 | % |  | $ | 1.68 |  | 100.0 | %
|                                    |  |      |      |  |       |   |  |   |      |  |       |  

| | 
| | 

| | (a) |  | Ordinary income is reported on Form 1099-DIV as either qualified or non-qualified and capital gains are reported on Form 1099-DIV in various sub-categories which have differing tax
treatments to shareholders. Those subcategories have not been shown here.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



52



---

##### Table of Contents

| | (b) |  | Return of capital refers to those amounts reported as nontaxable distributions on Form 1099-DIV.
| | --- |  | ------------------------------------------------------------------------------------------------



On a tax basis, distributions to stockholders in 2006 were $53,020 of ordinary income and $35,204 of return of capital, and
in 2005 were $61,582 of ordinary income, $7,136 of capital gain, and $10,221 of return of capital.



The following table is a reconciliation of GAAP net income to taxable net income for the years ended December 31, 2006 and 2005:



|                                                                                               |  |      |         |   |      |   |        |  
|---------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------ | -
|(dollars in thousands)                                                                         |  | 2006 |         |   | 2005 |  
|Net income                                                                                     |  | $    | 100,949 |   |      | $ | 68,193 |  
|Net loss of subsidiary not consolidated for tax purposes                                       |  |      |        |   |      |   | 1,744  |  
|Net change in unrealized (appreciation) depreciation on investments not taxable until realized |  |      | (34,604 | ) |      |   | 1,343  |  
|Timing difference related to deductibility of long-term incentive compensation                 |  |      | 2,468   |   |      |   | 3,262  |  
|Interest income on nonaccrual loans that is taxable                                            |  |      | 3,612   |   |      |   | 2,437  |  
|Dividend income accrued for GAAP purposes which is not yet taxable                             |  |      | (21,612 | ) |      |   | (6,516 | )
|Federal tax expense                                                                            |  |      | 2,661   |   |      |   | (595   | )
|Other, net                                                                                     |  |      | (93     | ) |      |   | (2,594 | )
|                                                                                               |  |      |         |   |      |   |        |  
|Taxable income before deductions for distributions                                             |  | $    | 53,381  |   |      | $ | 67,274 |  
|                                                                                               |  |      |         |   |      |   |        |  



Critical Accounting
Policies



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



Income Recognition



Interest and Dividend Income



Interest income
is recorded on the accrual basis to the extent that such amounts are expected to be collected. When a loan becomes 90 days or more past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will,
as a general matter, place the loan on non-accrual status and cease recognizing interest income on that loan until all principal has been paid. However, we may make exceptions to this policy if the investment has sufficient collateral value and is
in the process of collection.



Dividend income on equity
investments that have stated accruing dividend rates is recorded on the accrual basis to the extent that such amounts are expected to be collected. Dividend income on common equity investments is recorded when declared and paid.



Contractual paid-in-kind (PIK) interest, which represents contractually
deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We will generally cease accruing PIK if there is
insufficient value to support the accrual or we do not expect the customer to be able to pay all principal and interest due.



Loan origination fees are capitalized and then amortized into interest income using the effective interest rate method. In certain loan arrangements,
warrants or other equity interests are received from the borrower as additional origination fees. The borrowers granting these interests are typically non-publicly traded companies. We record the financial instruments received at fair value as
determined by our board of directors. Fair values are determined using various valuation models which estimate the underlying value of the associated entity. These



53



---

##### Table of Contents

models are then applied to our ownership share considering any discounts for transfer restrictions or other terms which impact the value. Changes in these
values are recorded through our statement of operations. Any resulting discount on the loan from recordation of warrant and other equity instruments are accreted into income over the term of the loan.



Other Fee Income



Other fee income is related to advisory and management services, equity
structuring fees, prepayment fees, research revenues, bank interest, and other fees. Advisory and management services fees are recognized when earned. Equity structuring fees are recognized as earned, which is generally when the investment
transaction closes. Prepayment fees are recognized upon receipt.



Valuation
of Investments



We determine the value of each investment
in our portfolio on a quarterly basis. Value, as defined in Section 2(a)(41) of the Investment Company Act of 1940, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other
securities and assets, fair value is as determined in good faith by the board of directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our investments at fair value
as determined in good faith by the board of directors pursuant to a valuation policy and a consistent valuation process. At December 31, 2006, approximately 95% of our total assets represented investments of which approximately 97% are valued
at fair value and approximately 3% are valued at market value based on readily ascertainable public market quotes at December 31, 2006. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily
available market value, the fair value of our investments determined in good faith by the board of directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could
be material.



There is no single standard for determining fair
value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment. Unlike banks, we are not permitted to provide a general reserve for anticipated loan
losses. Instead, we determine the fair value of each individual investment on a quarterly basis and record changes in fair value as unrealized appreciation or depreciation on investments in our statement of operations.



As a business development company, we invest primarily in illiquid securities
including debt and equity securities of private companies. The structure of each debt and equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We generally include many terms governing interest
rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership and corporate governance parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. In some cases, our loan
agreements also allow for increases in the spread to the base index rate if the financial or operational performance of the customer deteriorates or shows negative variances from the customers business plan and, in some cases, allow for
decreases in the spread if financial or operational performance improves or exceeds the customers plan. Our investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type
of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial
condition and market changing events that impact valuation.



We
base the fair value of our investments on the enterprise value of the portfolio companies in which we invest. The enterprise value is the value at which an enterprise could be sold in a transaction between two willing parties other than through a
forced or liquidation sale. Typically, private companies are bought and sold based on multiples of EBITDA, cash flows, net income, revenues, or in limited cases, book value. There is no single methodology for determining enterprise value and for any
one portfolio company enterprise value is generally described as a range of values from which we derive a single estimate of enterprise value. In determining the



54



---

##### Table of Contents

enterprise value of a portfolio company, we analyze its historical and projected financial results. We generally prepare discounted cash flow models based on
our projections of the future free cash flows of the business and industry derived capital costs. We review external events, including private mergers and acquisitions, and include these events in our enterprise valuation process. We also use
industry valuation benchmarks and review public market comparables. In certain cases, we retain independent valuation firms to perform valuations that we consider as part of our determination of portfolio company value. When an external event such
as a purchase transaction, public offering, or subsequent debt or equity sale occurs, the pricing indicated by the external event may be used to corroborate our estimate of enterprise value.



Using the estimated enterprise value of the portfolio company, we estimate
the value of each investment we own in the portfolio company. For our loans and debt securities, if there is adequate enterprise value to support the repayment of our debt then the fair value of our loan or debt security typically corresponds to
cost unless the borrowers condition or other factors lead to a determination of fair value at a different amount. The fair value of our equity investments is determined based on various factors including the enterprise value remaining for
equity holders after the repayment of the portfolio companys debt and other preference capital, as well as other pertinent factors such as recent offers to purchase a portfolio company, recent sales of the portfolio companys equity
securities, recent liquidation events or other events. The investment value is discounted if it is illiquid in nature and/or a minority, non-control position.



During the fourth quarter of 2006, in connection with our process for determining fair value as of December 31, 2006, we retained two independent
valuation firms to perform independent valuations of certain of our portfolio companies. These valuations were considered by our Board of Directors in their determination of fair value. We intend to continue to utilize independent valuation firms to
obtain additional support in the preparation of our internal valuation analyses each quarter.



Securities that are traded in the over-the-counter market or on a stock exchange generally will be valued at the prevailing bid price on the date of the relevant period end. However, restricted or thinly traded public
securities may be valued at discounts from the public market value due to the restrictions on sale.



Share-based Compensation



Prior to January 1, 2006, we accounted for share based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Effective January 1, 2006, we adopted
the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (SFAS No. 123R) using the modified prospective method. The adoption of SFAS
No. 123R did not impact our net operating income before investment gains and losses, net income, cash flows from operations, cash flows from financing activities, or basic and diluted earnings per share during that period. See Note 9 to the
Consolidated Financial Statements for further discussion of our share-based compensation.



Securitization Transactions



Periodically, we transfer pools of loans to bankruptcy remote, special purpose entities for use in securitization transactions. These transfers of loans are treated as secured borrowing financing arrangements in accordance with FASB SFAS
No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. These on-balance sheet securitization transactions comprise a significant source of our overall funding, with the total face
amount of the assets assumed by our consolidated bankruptcy remote special purpose entities equaling $677.4 million at December 31, 2006 and $596.9 million at December 31, 2005.



Recent Accounting Pronouncements



In June 2006, the FASB issued FASB Interpretation No. 48 (FIN No. 48), Accounting for
Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in



55



---

##### Table of Contents

income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN
No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 will be effective as of the last day of the first reporting period beginning after December 15, 2006, which is
March 31, 2007.



We have conducted a review of all open
tax years income recognition and expense deduction filing positions and income tax returns filed (federal and state) for determination of any uncertain tax positions that may require recognition of a tax liability. This review encompassed an
analysis of all book/tax difference adjustments as well as the timing of income and expense recognition for all tax years still open under the statute of limitations. As a result, we have determined that it is more likely than not that each tax
position taken on a previously filed return or to be taken on current tax returns will be sustained on examination based on the technical merits of the positions and therefore, no recognition of a tax liability on an uncertain tax position for FIN
No. 48 purposes is anticipated.



In September 2006, the
FASB issued SFAS No. 157 (SFAS No. 157), Fair Value Measurements. Among other requirements, SFAS No. 157 defines fair value and establishes a framework for measuring fair value and also expands disclosure about
the use of fair value to measure assets and liabilities. SFAS No. 157 is effective for the first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of SFAS No. 157 on its financial position
and results of operations.



Recent Developments



On January 9, 2007, the performance criteria for
200,000 restricted shares to certain executives were determined by the board of directors and those executives, therefore those awards are considered granted for GAAP purposes on that date. The total compensation cost of those awards is
approximately $3.9 million, based on the closing price of MCGs common stock on that date, and will be recognized as compensation expense over the requisite service periods which run through February 2010.



In January 2007, one of our majority owned control companies, Midwest Tower
Partners, LLC (MTP), sold substantially all of its assets and repaid its outstanding debt with those proceeds. MTP is currently in the process of making distributions to its equity holders. As of December 31, 2006, we had debt and
equity investments in MTP with a fair value of $34.9 million which includes unrealized appreciation of $5.0 million. In connection with this transaction, we expect to realize the December 31, 2006 unrealized pre-tax gain of approximately $5.0
million which will have no significant impact on first quarter 2007 earnings.



On February 1, 2007, we entered into the fifth amendment to our MCG Commercial Loan Funding Trust facility, funded by Three Pillars Funding LLC (Three Pillars), an asset-backed commercial paper
conduit administered by SunTrust Capital Markets, Inc. Pursuant to this amendment, the $250.0 million facility provided by Three Pillars has been divided and will be funded through two separate Variable Funding Certificates (VFCs), a
$218.8 million Class A VFC and a $31.2 million Class B VFC. The Class A VFC will maintain the same advance rate, of up to 70% of eligible collateral, and the same interest rate, the commercial paper rate plus 0.95%, as was in effect
immediately prior to this amendment. The Class B VFC has an advance rate of 10% of eligible collateral and bears interest at the commercial paper rate plus 1.75%. This amendment effectively increases our overall borrowing advance rate by 10% from a
maximum of 70% of eligible collateral to a maximum of 80% of eligible collateral, which will allow us to borrow up to $250.0 million under the facility using less collateral than previously required. Other minor modifications were also made to this
facility.



In February 2007, Broadview Networks Holdings, Inc.,
our largest portfolio company, signed a definitive agreement to acquire InfoHighway Communications Corp., a New York-based integrated provider of hosted and managed communications solutions serving more than 12,000 business customers in the
Mid-Atlantic and



56



---

##### Table of Contents

Northeast regions of the U.S. We do not expect to be required to provide additional funding to Broadview to facilitate this transaction. The transaction is
expected to close in the second quarter of 2007 and is subject to regulatory approvals and other closing conditions.



During the first quarter of 2007, our board of directors approved the issuance of 777,600 shares of restricted stock to our employees pursuant to the MCG
Capital Corporation 2006 Employee Restricted Stock Plan, which will generally be expensed over four years.



Item 7A.Quantitative and Qualitative Disclosures about Market Risk



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 December 31, 2006, approximately 63% of our loan portfolio, at cost, bears interest at a spread to LIBOR, and 36% at a fixed rate. As
of December 31, 2006, approximately 31% of our loan portfolio, at cost, has LIBOR floors between 1.50% and 3.00% on the LIBOR base index.



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. At December 31,
2006, we were not a party to any hedging arrangements. Certain of our interest bearing investments contain LIBOR floors between 1.50% and 3.00% on the LIBOR base index to minimize our exposure to significant decreases in interest rates.



The following table shows a comparison of the interest rate base for our
interest bearing cash, outstanding commercial loans and our outstanding borrowings at December 31, 2006 and December 31, 2005:



|                          |  |                                          |       |                   |   |                                          |  |            |         |  |   |      
|------------------------- |  | ---------------------------------------- | ----- | ----------------- | - | ---------------------------------------- |  | ---------- | ------- |  | - | -----
|                          |  | December 31, 2006                        |       | December 31, 2005
|(dollars in millions)     |  | Interest BearingCash andCommercial Loans |       | Borrowings        |   | Interest BearingCash andCommercial Loans |  | Borrowings
|Repurchase Agreement Rate |  | $                                        | 37.5  |                   | $ |                                         |  | $          | 120.7   |  | $ |     
|Money Market Rate         |  |                                          | 2.6   |                   |   |                                         |  |            | 2.0     |  |   |     
|Prime Rate                |  |                                          | 0.4   |                   |   |                                         |  |            | 36.1    |  |   |     
|30-Day LIBOR              |  |                                          | 14.5  |                   |   |                                         |  |            | 36.0    |  |   |     
|60-Day LIBOR              |  |                                          | 0.8   |                   |   |                                         |  |            |        |  |   |     
|90-Day LIBOR              |  |                                          | 522.0 |                   |   | 388.0                                    |  |            | 562.6   |  |   | 331.1
|180-Day LIBOR             |  |                                          | 42.6  |                   |   |                                         |  |            | 30.9    |  |   |     
|9 month LIBOR             |  |                                          | 1.3   |                   |   |                                         |  |            |        |  |   |     
|Commercial Paper          |  |                                          |      |                   |   | 83.9                                     |  |            |        |  |   | 160.0
|Fixed Rate                |  |                                          | 334.8 |                   |   | 50.0                                     |  |            | 273.5   |  |   | 50.0 
|                          |  |                                          |       |                   |   |                                          |  |            |         |  |   |      
|Total                     |  | $                                        | 956.5 |                   | $ | 521.9                                    |  | $          | 1,061.8 |  | $ | 541.1
|                          |  |                                          |       |                   |   |                                          |  |            |         |  |   |      



Based on our
December 31, 2006 balance sheet, the following table shows the impact to net income of base rate changes in interest rates assuming no changes in our investment and borrowing structure:



|                                         |  |                |       |   |                 |   |       |           |  |   |      |  
|---------------------------------------- |  | -------------- | ----- | - | --------------- | - | ----- | --------- |  | - | ---- | -
|(dollars in millions) Basis Point
Change |  | InterestIncome |       |   | InterestExpense |   |       | NetIncome | 
|(300)                                    |  | $              | (18.3 | ) |                 | $ | (14.2 | )         |  | $ | (4.1 | )
|(200)                                    |  |                | (12.4 | ) |                 |   | (9.4  | )         |  |   | (3.0 | )
|(100)                                    |  |                | (6.2  | ) |                 |   | (4.7  | )         |  |   | (1.5 | )
|100                                      |  |                | 6.2   |   |                 |   | 4.7   |           |  |   | 1.5  |  
|200                                      |  |                | 12.4  |   |                 |   | 9.4   |           |  |   | 3.0  |  
|300                                      |  |                | 18.7  |   |                 |   | 14.2  |           |  |   | 4.5  |  



57



---

##### Table of Contents

Item 8.Financial Statements and Supplementary Data



Index to Financial Statements



|                                                                                                       |  |   
|------------------------------------------------------------------------------------------------------ |  | --
|Managements Report on Internal Control Over Financial Reporting                                       |  | 59
|Reports of Independent Registered Public Accounting Firm                                               |  | 60
|Consolidated Balance Sheets as of December 31, 2006 and 2005                                           |  | 62
|Consolidated Statements of Operations for the years ended December 31, 2006, 2005, and 2004            |  | 63
|Consolidated Statements of Changes in Net Assets for the years ended December 31, 2006, 2005, and 2004 |  | 64
|Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005, and 2004            |  | 65
|Consolidated Schedule of Investments as of December 31, 2006                                           |  | 66
|Consolidated Schedule of Investments as of December 31, 2005                                           |  | 71
|Notes to Consolidated Financial Statements                                                             |  | 79



58



---

##### Table of Contents

MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING



The management of MCG Capital Corporation (the Company) is responsible for establishing and maintaining adequate internal control over
financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by the SEC, internal control over financial reporting is a process designed under the supervision of the Companys
principal executive, principal financial and principal accounting officers, and effected by the Companys board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements in accordance with generally accepted accounting principles.



The Companys internal control over financial reporting is supported by written policies and procedures, that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Companys assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Companys management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.



Management of the
Company conducted an assessment of the effectiveness of the Companys internal control over financial reporting as of December 31, 2006 based on criteria established in Internal ControlIntegrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the COSO Framework). Based on this assessment, management has concluded that the Companys internal control over financial reporting was effective as of December 31, 2006.



Managements assessment of the effectiveness of the
Companys internal control over financial reporting as of December 31, 2006, has been audited by Ernst & Young LLP, the registered public accounting firm that audited the Companys financial statements, as stated in their
report, a copy of which is included in this Annual Report on Form 10-K.





59



---

##### Table of Contents

Report of Independent Registered Public Accounting Firm



Board of Directors and Shareholders

MCG Capital Corporation



We
have audited managements assessment, included in the accompanying Managements Report on Internal Control over Financial Reporting,that MCG Capital Corporation maintained effective internal control over financial
reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). MCG Capital Corporations
management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements
assessment and an opinion on the effectiveness of the companys internal control over financial reporting based on our audit.



We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial
reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.



A companys
internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions
and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



In our opinion, managements assessment that MCG Capital Corporation
maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, MCG Capital Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.



We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets
of MCG Capital Corporation, including the consolidated schedules of investments, as of December 31, 2006 and 2005 and the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the
period ended December 31, 2006 and the financial highlights for each of the five years ended December 31, 2006 of MCG Capital Corporation and our report dated February 26, 2007 expressed an unqualified opinion thereon.



/s/ Ernst & Young LLP



McLean, Virginia

February 26, 2007



60



---

##### Table of Contents

Report of Independent Registered Public Accounting Firm



Board of Directors and Shareholders

MCG Capital Corporation



We have audited the accompanying consolidated balance sheets of MCG Capital Corporation, including the consolidated schedules of investments, as of
December 31, 2006 and 2005 and the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2006 and the financial highlights for each of the five
years ended December 31, 2006. Our audit also included the financial statement schedule listed in the Index at Item 15. These financial statements, financial highlights and the schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements, financial highlights and schedule based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements and financial highlights. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our
procedures included verification by examination of securities held and confirmation of securities held by the custodians. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the consolidated financial position of MCG Capital Corporation at December 31, 2006 and 2005, and the consolidated results of its operations, its cash flows and the changes in its net assets for
each of the three years in the period ended December 31, 2006 and the financial highlights for each of the five years ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.



We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of MCG Capital Corporations internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2007 expressed an unqualified opinion thereon.



/s/ Ernst & Young LLP



McLean, Virginia

February 26, 2007



61



---

##### Table of Contents

MCG Capital Corporation

Consolidated Balance Sheets

(in thousands, except per share data)



|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | --------- | - | ---- | - | --------- | -
|                                                                                                                                                                                                 |  | December 31, |          
|                                                                                                                                                                                                 |  | 2006         |           |   | 2005 |  
|Assets                                                                                                                                                                                           |  |              |           |   |      |   |           |  
|Cash and cash equivalents                                                                                                                                                                        |  | $            | 21,691    |   |      | $ | 45,626    |  
|Cash, securitization accounts                                                                                                                                                                    |  |              | 15,931    |   |      |   | 82,107    |  
|Cash, restricted                                                                                                                                                                                 |  |              | 2,587     |   |      |   | 1,977     |  
|Investments at fair value                                                                                                                                                                        |  |              |           |   |      |   |           |  
|Non-affiliate investments (cost of $629,849 and $733,717, respectively)                                                                                                                          |  |              | 659,441   |   |      |   | 745,757   |  
|Affiliate investments (cost of $71,589 and $46,168, respectively)                                                                                                                                |  |              | 72,031    |   |      |   | 46,156    |  
|Control investments (cost of $541,267 and $337,372, respectively)                                                                                                                                |  |              | 526,140   |   |      |   | 305,647   |  
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Total investments (cost of $1,242,705 and $1,117,257, respectively)                                                                                                                              |  |              | 1,257,612 |   |      |   | 1,097,560 |  
|Unearned income on commercial loans                                                                                                                                                              |  |              | (9,539    | ) |      |   | (9,062    | )
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Total investments net of unearned income                                                                                                                                                         |  |              | 1,248,073 |   |      |   | 1,088,498 |  
|Interest receivable                                                                                                                                                                              |  |              | 10,451    |   |      |   | 10,602    |  
|Other assets                                                                                                                                                                                     |  |              | 20,535    |   |      |   | 15,677    |  
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Total assets                                                                                                                                                                                     |  | $            | 1,319,268 |   |      | $ | 1,244,487 |  
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Liabilities                                                                                                                                                                                      |  |              |           |   |      |   |           |  
|Borrowings (maturing within one year of $167,983 and $362,435, respectively)                                                                                                                     |  | $            | 521,883   |   |      | $ | 541,119   |  
|Interest payable                                                                                                                                                                                 |  |              | 5,198     |   |      |   | 5,904     |  
|Dividends payable                                                                                                                                                                                |  |              | 24,652    |   |      |   | 20,967    |  
|Other liabilities                                                                                                                                                                                |  |              | 14,398    |   |      |   | 10,410    |  
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Total liabilities                                                                                                                                                                                |  |              | 566,131   |   |      |   | 578,400   |  
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Stockholders equity                                                                                                                                                                             |  |              |           |   |      |   |           |  
|Preferred stock, par value $.01, authorized 1 share, none issued and outstanding                                                                                                                 |  |              |          |   |      |   |          |  
|Common stock, par value $.01, authorized 200,000 shares on December 31, 2006 and 2005, 58,694 issued and outstanding on December 31, 2006 and
53,372 issued and outstanding on December 31, 2005 |  |              | 587       |   |      |   | 534       |  
|Paid-in capital                                                                                                                                                                                  |  |              | 828,795   |   |      |   | 758,433   |  
|Distributions in excess of earnings:                                                                                                                                                             |  |              |           |   |      |   |           |  
|Paid-in capital                                                                                                                                                                                  |  |              | (78,072   | ) |      |   | (39,219   | )
|Other                                                                                                                                                                                            |  |              | (12,365   | ) |      |   | (26,784   | )
|Net unrealized appreciation (depreciation) on investments                                                                                                                                        |  |              | 14,907    |   |      |   | (19,697   | )
|Stockholder loans                                                                                                                                                                                |  |              | (715      | ) |      |   | (3,624    | )
|Unearned compensationrestricted stock                                                                                                                                                           |  |              |          |   |      |   | (3,556    | )
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Total stockholders equity                                                                                                                                                                       |  |              | 753,137   |   |      |   | 666,087   |  
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Total liabilities and stockholders equity                                                                                                                                                       |  | $            | 1,319,268 |   |      | $ | 1,244,487 |  
|                                                                                                                                                                                                 |  |              |           |   |      |   |           |  
|Net asset value per common share at period end                                                                                                                                                   |  | $            | 12.83     |   |      | $ | 12.48     |  



See notes to
consolidated financial statements



62



---

##### Table of Contents

MCG Capital Corporation

Consolidated Statements of Operations

(in thousands, except per share data)



|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|---------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                                           |  | Year Ended December 31, |        
|                                                                                                           |  | 2006                    |         |   | 2005 |   |         | 2004 | 
|Operating income                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Interest and dividend income                                                                               |  |                         |         |   |      |   |         |      |  |   |        |  
|Non-affiliate investments (less than 5% owned)                                                             |  | $                       | 85,569  |   |      | $ | 69,760  |      |  | $ | 51,898 |  
|Affiliate investments (5% to 25% owned)                                                                    |  |                         | 6,015   |   |      |   | 5,745   |      |  |   | 3,999  |  
|Control investments (more than 25% owned)                                                                  |  |                         | 47,261  |   |      |   | 30,761  |      |  |   | 21,954 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Total interest and dividend income                                                                         |  |                         | 138,845 |   |      |   | 106,266 |      |  |   | 77,851 |  
|Advisory fees and other income                                                                             |  |                         |         |   |      |   |         |      |  |   |        |  
|Non-affiliate investments (less than 5% owned)                                                             |  |                         | 7,537   |   |      |   | 12,317  |      |  |   | 9,306  |  
|Affiliate investments (5% to 25% owned)                                                                    |  |                         | 1,621   |   |      |   |        |      |  |   | 495    |  
|Control investments (more than 25% owned)                                                                  |  |                         | 6,390   |   |      |   | 962     |      |  |   | 5,465  |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Total advisory fees and other income                                                                       |  |                         | 15,548  |   |      |   | 13,279  |      |  |   | 15,266 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Total operating income                                                                                     |  |                         | 154,393 |   |      |   | 119,545 |      |  |   | 93,117 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Operating expenses                                                                                         |  |                         |         |   |      |   |         |      |  |   |        |  
|Interest expense                                                                                           |  |                         | 36,240  |   |      |   | 23,100  |      |  |   | 10,509 |  
|Employee compensation:                                                                                     |  |                         |         |   |      |   |         |      |  |   |        |  
|Salaries and benefits                                                                                      |  |                         | 20,274  |   |      |   | 19,331  |      |  |   | 15,693 |  
|Long-term incentive compensation                                                                           |  |                         | 4,514   |   |      |   | 6,523   |      |  |   | 11,683 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Total employee compensation                                                                                |  |                         | 24,788  |   |      |   | 25,854  |      |  |   | 27,376 |  
|General and administrative expense                                                                         |  |                         | 9,721   |   |      |   | 10,076  |      |  |   | 10,142 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Total operating expenses                                                                                   |  |                         | 70,749  |   |      |   | 59,030  |      |  |   | 48,027 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Net operating income before investment gains and losses and provision for income taxes on investment gains |  |                         | 83,644  |   |      |   | 60,515  |      |  |   | 45,090 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Net realized gains (losses) on investments                                                                 |  |                         |         |   |      |   |         |      |  |   |        |  
|Non-affiliate investments (less than 5% owned)                                                             |  |                         | 1,619   |   |      |   | 5,741   |      |  |   | 1,939  |  
|Affiliate investments (5% to 25% owned)                                                                    |  |                         | 9       |   |      |   | 205     |      |  |   | (2,531 | )
|Control investments (more than 25% owned)                                                                  |  |                         | (16,215 | ) |      |   | 3,075   |      |  |   | (7,658 | )
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Total net realized gains (losses) on investments                                                           |  |                         | (14,587 | ) |      |   | 9,021   |      |  |   | (8,250 | )
|Net unrealized appreciation (depreciation) on investments                                                  |  |                         |         |   |      |   |         |      |  |   |        |  
|Non-affiliate investments (less than 5% owned)                                                             |  |                         | 17,549  |   |      |   | 7,279   |      |  |   | 378    |  
|Affiliate investments (5% to 25% owned)                                                                    |  |                         | 455     |   |      |   | 5,289   |      |  |   | (1,186 | )
|Control investments (more than 25% owned)                                                                  |  |                         | 16,600  |   |      |   | (13,911 | )    |  |   | 11,615 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Total net unrealized appreciation (depreciation) on investments                                            |  |                         | 34,604  |   |      |   | (1,343  | )    |  |   | 10,807 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Net investment gains before income taxes on investment gains                                               |  |                         | 20,017  |   |      |   | 7,678   |      |  |   | 2,557  |  
|Provision for income taxes on investment gains                                                             |  |                         | 2,712   |   |      |   |        |      |  |   |       |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Net income                                                                                                 |  | $                       | 100,949 |   |      | $ | 68,193  |      |  | $ | 47,647 |  
|                                                                                                           |  |                         |         |   |      |   |         |      |  |   |        |  
|Earnings per common sharebasic                                                                            |  | $                       | 1.86    |   |      | $ | 1.42    |      |  | $ | 1.16   |  
|Earnings per common sharediluted                                                                          |  | $                       | 1.86    |   |      | $ | 1.42    |      |  | $ | 1.15   |  
|Cash dividends declared per common share                                                                   |  | $                       | 1.68    |   |      | $ | 1.68    |      |  | $ | 1.68   |  
|Weighted average common shares outstanding                                                                 |  |                         | 54,227  |   |      |   | 48,109  |      |  |   | 41,244 |  
|Weighted average common shares outstanding and dilutive common stock equivalents                           |  |                         | 54,264  |   |      |   | 48,131  |      |  |   | 41,298 |  



See notes to
consolidated financial statements





63



---

##### Table of Contents

MCG Capital Corporation

Consolidated Statements of Changes in Net Assets

(in thousands, except per share amounts)



|                                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                     |  | Year Ended December 31, |        
|                                                                     |  | 2006                    |         |   | 2005 |   |         | 2004 | 
|Operations:                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Net operating income                                                 |  | $                       | 83,644  |   |      | $ | 60,515  |      |  | $ | 45,090  |  
|Net realized (loss) gain on investments                              |  |                         | (14,587 | ) |      |   | 9,021   |      |  |   | (8,250  | )
|Net unrealized appreciation (depreciation) of investments            |  |                         | 34,604  |   |      |   | (1,343  | )    |  |   | 10,807  |  
|Provision for income taxes on investment gains                       |  |                         | (2,712  | ) |      |   |        |      |  |   |        |  
|                                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Net increase in net assets resulting from operations                 |  |                         | 100,949 |   |      |   | 68,193  |      |  |   | 47,647  |  
|Shareholder distributions:                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Distributions from net investment income                             |  |                         | (51,926 | ) |      |   | (59,519 | )    |  |   | (46,191 | )
|Distributions from capital gains                                     |  |                         |        |   |      |   | (9,021  | )    |  |   |        |  
|Return of capital distributions                                      |  |                         | (38,853 | ) |      |   | (10,221 | )    |  |   | (21,187 | )
|                                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Net decrease in net assets resulting from shareholder distributions  |  |                         | (90,779 | ) |      |   | (78,761 | )    |  |   | (67,378 | )
|Capital share transactions:                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Issuance of common stock                                             |  |                         | 70,211  |   |      |   | 117,015 |      |  |   | 100,034 |  
|Issuance of common stock under dividend reinvestment plan            |  |                         | 218     |   |      |   | 127     |      |  |   | 97      |  
|Repayment of stockholder loans                                       |  |                         | 2,909   |   |      |   | 879     |      |  |   | 462     |  
|Amortization of restricted stock awards                              |  |                         | 3,542   |   |      |   | 4,421   |      |  |   | 9,401   |  
|                                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Net increase in net assets resulting from capital share transactions |  |                         | 76,880  |   |      |   | 122,442 |      |  |   | 109,994 |  
|                                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Total increase in net assets                                         |  |                         | 87,050  |   |      |   | 111,874 |      |  |   | 90,263  |  
|Net assets at beginning of period                                    |  |                         | 666,087 |   |      |   | 554,213 |      |  |   | 463,950 |  
|                                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Net assets at end of period                                          |  | $                       | 753,137 |   |      | $ | 666,087 |      |  | $ | 554,213 |  
|                                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Net asset value per common share                                     |  | $                       | 12.83   |   |      | $ | 12.48   |      |  | $ | 12.22   |  
|                                                                     |  |                         |        
|Common shares outstanding at end of period                           |  |                         | 58,694  |   |      |   | 53,372  |      |  |   | 45,342  |  





See notes to consolidated financial statements.



64



---

##### Table of Contents

MCG Capital Corporation

Consolidated Statements of Cash Flows

(in thousands)



|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------------------------------ |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                     |  | Year Ended December 31, |         
|                                                                                     |  | 2006                    |          |   | 2005 |   |          | 2004 | 
|Operating activities                                                                 |  |                         |          |   |      |   |          |      |  |   |          |  
|Net income                                                                           |  | $                       | 100,949  |   |      | $ | 68,193   |      |  | $ | 47,647   |  
|Adjustments to reconcile net income to net cash provided by operating activities:    |  |                         |          |   |      |   |          |      |  |   |          |  
|Depreciation and amortization                                                        |  |                         | 316      |   |      |   | 756      |      |  |   | 1,021    |  
|Amortization of restricted stock awards                                              |  |                         | 3,542    |   |      |   | 4,421    |      |  |   | 9,401    |  
|Amortization of deferred debt issuance costs                                         |  |                         | 4,122    |   |      |   | 3,646    |      |  |   | 1,558    |  
|Net realized losses (gains) on investments                                           |  |                         | 14,587   |   |      |   | (9,021   | )    |  |   | 8,250    |  
|Net unrealized (appreciation) depreciation on investments                            |  |                         | (34,604  | ) |      |   | 1,343    |      |  |   | (10,807  | )
|Decrease (increase) in cashsecuritization accounts from interest collections        |  |                         | 2,650    |   |      |   | (943     | )    |  |   | (1,348   | )
|Increase in interest receivable                                                      |  |                         | (6,993   | ) |      |   | (5,674   | )    |  |   | (773     | )
|Increase in accrued payment-in-kind interest and dividends                           |  |                         | (22,128  | ) |      |   | (13,936  | )    |  |   | (3,239   | )
|Decrease in unearned income                                                          |  |                         | (70      | ) |      |   | (3,730   | )    |  |   | (6,207   | )
|Decrease in other assets                                                             |  |                         | 1,722    |   |      |   | 2        |      |  |   | 424      |  
|(Decrease) increase in interest payable                                              |  |                         | (706     | ) |      |   | 2,979    |      |  |   | 1,740    |  
|Increase in other liabilities                                                        |  |                         | 6,546    |   |      |   | 2,584    |      |  |   | 5,264    |  
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash provided by operating activities                                            |  |                         | 69,933   |   |      |   | 50,620   |      |  |   | 52,931   |  
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Investing activities                                                                 |  |                         |          |   |      |   |          |      |  |   |          |  
|Originations, draws and advances on loans                                            |  |                         | (410,874 | ) |      |   | (465,232 | )    |  |   | (339,102 | )
|Principal payments on loans                                                          |  |                         | 373,923  |   |      |   | 274,743  |      |  |   | 168,340  |  
|Purchase of equity investments                                                       |  |                         | (80,984  | ) |      |   | (31,664  | )    |  |   | (16,026  | )
|Proceeds from sales of equity investments                                            |  |                         | 2,683    |   |      |   | 24,956   |      |  |   | 13,861   |  
|Purchase of premises, equipment and software                                         |  |                         | (677     | ) |      |   | (258     | )    |  |   | (665     | )
|Other acquisitions                                                                   |  |                         |         |   |      |   |         |      |  |   | (2,208   | )
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash used in investing activities                                                |  |                         | (115,929 | ) |      |   | (197,455 | )    |  |   | (175,800 | )
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Financing activities                                                                 |  |                         |          |   |      |   |          |      |  |   |          |  
|Net proceeds from borrowings                                                         |  |                         | 15,355   |   |      |   | 82,866   |      |  |   | 120,314  |  
|Decrease (increase) in cashsecuritization accounts for paydown of principal on debt |  |                         | 28,933   |   |      |   | (10,839  | )    |  |   | (1,736   | )
|Payment of financing costs                                                           |  |                         | (7,342   | ) |      |   | (1,378   | )    |  |   | (6,758   | )
|Dividends paid                                                                       |  |                         | (88,223  | ) |      |   | (78,941  | )    |  |   | (66,884  | )
|Issuance of common stock, net of costs                                               |  |                         | 70,429   |   |      |   | 117,142  |      |  |   | 100,131  |  
|Repayment of stockholder loans                                                       |  |                         | 2,909    |   |      |   | 879      |      |  |   | 462      |  
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash provided by financing activities                                            |  |                         | 22,061   |   |      |   | 109,729  |      |  |   | 145,529  |  
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|(Decrease) increase in cash and cash equivalents                                     |  |                         | (23,935  | ) |      |   | (37,106  | )    |  |   | 22,660   |  
|Cash and cash equivalents at beginning of period                                     |  |                         | 45,626   |   |      |   | 82,732   |      |  |   | 60,072   |  
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash and cash equivalents at end of period                                           |  | $                       | 21,691   |   |      | $ | 45,626   |      |  | $ | 82,732   |  
|                                                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Supplemental disclosures                                                             |  |                         |          |   |      |   |          |      |  |   |          |  
|Interest paid                                                                        |  | $                       | 32,824   |   |      | $ | 16,475   |      |  | $ | 7,210    |  
|Income taxes paid (received)                                                         |  |                         | 298      |   |      |   |         |      |  |   | (98      | )



See notes to
consolidated financial statements





65



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments

December 31, 2006

(in thousands,
except share data)



|                                                                                                |  |                      |  |                                              |  |           |        |      |         |           |  |   |       
|----------------------------------------------------------------------------------------------- |  | -------------------- |  | -------------------------------------------- |  | --------- | ------ | ---- | ------- | --------- |  | - | ------
|Portfolio Company                                                                               |  | Industry             |  | Investment (8)                               |  | Principal |        | Cost |         | FairValue
|Control investments: Majority-owned (5):                                                        |  |                      |  |                                              |  |           |        |      |         |           | 
|Broadview Networks Holdings,                                                                    |  | Communications-CLEC  |  | Series A Preferred Stock (87,254 shares)     |  |           |        |      | $       | 64,318    |  | $ | 74,165
|Inc.(2)(13)                                                                                     |  |                      |  | Series A-1 Preferred Stock (100,702 shares)  |  |           |        |      |         | 57,380    |  |   | 85,597
|                                                                                                |  |                      |  | Common Stock (4,698,987 shares)              |  |           |        |      |         |          |  |   |      
|Chesapeake Tower Holdings,                                                                      |  | Communications-Other |  | Senior Debt (11.4%, Due 5/10)                |  | $         | 400    |      |         | 400       |  |   | 400   
|LLC                                                                                             |  |                      |  | Preferred LLC Interest (3,139 units)         |  |           |        |      |         | 3,139     |  |   | 3,139 
|                                                                                                |  |                      |  | Common LLC Interest (4,000 units)            |  |           |        |      |         |          |  |   |      
|Cleartel Communications,                                                                        |  | Communications-CLEC  |  | Subordinated Debt (14.7%, Due 12/10-12/11)   |  |           | 71,962 |      |         | 71,962    |  |   | 71,962
|Inc.(2)                                                                                         |  |                      |  | Preferred Stock (57,859 shares)              |  |           |        |      |         | 50,613    |  |   | 612   
|                                                                                                |  |                      |  | Common Stock (9 shares)                      |  |           |        |      |         | 540       |  |   |      
|                                                                                                |  |                      |  | Guaranty ($7,125)                            |  |           |        |      |         |           |  |   |       
|Helicon Cable Holdings,                                                                         |  | Cable                |  | Senior Debt (10.4%, Due 12/12)(12)           |  |           | 12,250 |      |         | 12,250    |  |   | 12,250
|LLC(2)                                                                                          |  |                      |  | Subordinated Debt (14.3%, Due 6/13)(12)      |  |           | 7,187  |      |         | 7,187     |  |   | 7,187 
|                                                                                                |  |                      |  | Preferred LLC Interest (82,500 units)        |  |           |        |      |         | 9,180     |  |   | 9,180 
|                                                                                                |  |                      |  | Standby Letter of Credit ($300)              |  |           |        |      |         |           |  |   |       
|IntranMedia, LLC                                                                                |  | Other Media          |  | Senior Debt (9.9%, Due 12/11)(12)            |  |           | 12,000 |      |         | 12,000    |  |   | 12,000
|                                                                                                |  |                      |  | Preferred Units (86,000 units)               |  |           |        |      |         | 8,661     |  |   | 8,661 
|Jet Plastica Investors, LLC(2)                                                                  |  | Plastic Products     |  | Subordinated Debt (14.0%, Due 3/13)(12)      |  |           | 26,159 |      |         | 26,159    |  |   | 26,159
|                                                                                                |  |                      |  | Preferred LLC Interest (301,595 units)       |  |           |        |      |         | 30,893    |  |   | 30,893
|JupiterKagan, Inc.(2)(11)                                                                       |  | Information Services |  | Senior Debt (12.1%, Due 3/10)(12)            |  |           | 5,349  |      |         | 5,349     |  |   | 5,349 
|                                                                                                |  |                      |  | Series A Preferred Stock (100,000 shares)    |  |           |        |      |         | 10,000    |  |   | 10,000
|                                                                                                |  |                      |  | Common Stock (770,000 shares)                |  |           |        |      |         |          |  |   |      
|                                                                                                |  |                      |  | Standby Letter of Credit ($225)              |  |           |        |      |         |           |  |   |       
|                                                                                                |  |                      |  | Guaranty ($1,353)                            |  |           |        |      |         |           |  |   |       
|Midwest Tower Partners,                                                                         |  | Communications-Other |  | Senior Debt (16.4%, 8/07)                    |  |           | 9,781  |      |         | 9,781     |  |   | 9,781 
|LLC(2)                                                                                          |  |                      |  | Subordinated Debt (14.3%, Due 2/08)(12)      |  |           | 17,485 |      |         | 17,485    |  |   | 17,485
|                                                                                                |  |                      |  | Preferred LLC Interest (17,563 units)        |  |           |        |      |         | 2,438     |  |   | 2,438 
|                                                                                                |  |                      |  | Common LLC Interest (79,117 Units)           |  |           |        |      |         | 201       |  |   | 5,213 
|RadioPharmacy Investors,                                                                        |  | Healthcare           |  | Senior Debt ( 9.9%, Due 12/10) (12)          |  |           | 7,000  |      |         | 7,000     |  |   | 7,000 
|LLC(2)                                                                                          |  |                      |  | Subordinated Debt (15.0%, Due 12/11)(12)     |  |           | 9,258  |      |         | 9,258     |  |   | 9,258 
|                                                                                                |  |                      |  | Preferred LLC Interest (70,000 units)        |  |           |        |      |         | 7,522     |  |   | 10,657
|Superior Industries Investors,                                                                  |  | Sporting Goods       |  | Subordinated Debt (14.0%, Due 3/13-3/15)(12) |  |           | 14,083 |      |         | 14,083    |  |   | 14,083
|LLC (2)                                                                                         |  |                      |  | Preferred LLC Interest (125,400 units)       |  |           |        |      |         | 12,837    |  |   | 12,837
|Superior Publishing                                                                             |  | Newspaper            |  | Subordinated Debt (20.0%, Due 10/10)(12)     |  |           | 20,731 |      |         | 19,022    |  |   | 19,022
|Corporation(2)                                                                                  |  |                      |  | Preferred Stock (7,999 shares)               |  |           |        |      |         | 7,999     |  |   | 9,244 
|                                                                                                |  |                      |  | Common Stock (100 shares)                    |  |           |        |      |         | 365       |  |   |      
|Working Mother Media, Inc.(6)                                                                   |  | Publishing           |  | Senior Debt (8.8%, Due 12/08)                |  |           | 17,869 |      |         | 11,546    |  |   | 11,546
|                                                                                                |  |                      |  | Class A Preferred Stock (12,497 shares)      |  |           |        |      |         | 12,497    |  |   | 5,019 
|                                                                                                |  |                      |  | Class B Preferred Stock (1 share)            |  |           |        |      |         | 1         |  |   |      
|                                                                                                |  |                      |  | Class C Preferred Stock (1 share)            |  |           |        |      |         | 1         |  |   |      
|                                                                                                |  |                      |  | Common Stock (510 shares)                    |  |           |        |      |         | 1         |  |   |      
|                                                                                                |  |                      |  | Guaranty ($476)                              |  |           |        |      |         |           |  |   |       
|Total Control investments: Majority-owned (represents 39.1% of total investments at
fair value) |  |                      |  |                                              |  | 502,068   |        |      | 491,137



See notes to
consolidated financial statements



66



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2006

(in thousands, except share data)



|                                                                                                   |  |                        |  |                                               |  |           |        |      |         |           |  |   |       
|-------------------------------------------------------------------------------------------------- |  | ---------------------- |  | --------------------------------------------- |  | --------- | ------ | ---- | ------- | --------- |  | - | ------
|Portfolio Company                                                                                  |  | Industry               |  | Investment (8)                                |  | Principal |        | Cost |         | FairValue
|Control Investments: Non-majority owned (4):                                                       |  |                        |  |                                               |  |           |        |      |        
|Crystal Media Network,                                                                             |  | Broadcasting           |  | LLC Interest                                  |  |           |        |      | $       | 3,060     |  | $ | 547   
|LLC(1)(6)                                                                                          |  |                        |  |                                               |  |           |        |      |         |           |  |   |       
|National Product Services,                                                                         |  | Business Services      |  | Senior Debt (13.2%, Due 6/09)                 |  | $         | 12,316 |      |         | 5,710     |  |   | 12,365
|Inc.(2)                                                                                            |  |                        |  | Subordinated Debt (16.0%, Due 6/09)           |  |           | 11,594 |      |         | 10,225    |  |   | 3,035 
|                                                                                                   |  |                        |  | Common Stock (995,428 shares)                 |  |           |        |      |         |          |  |   |      
|Platinum Wireless, Inc. (6)                                                                        |  | Communications-Other   |  | Common Stock (2,937 shares)                   |  |           |        |      |         | 4,640     |  |   | 3,764 
|                                                                                                   |  |                        |  | Option to purchase Common Stock               |  |           |        |      |         | 272       |  |   |      
|                                                                                                   |  |                        |  | (expire 12/31/13)                             |  |           |        |      |         |           |  |   |       
|PremierGarage Holdings,                                                                            |  | Home Furnishings       |  | Senior Debt (10.1%, Due 6/10-12/10)           |  |           | 10,700 |      |         | 10,700    |  |   | 10,700
|LLC(2)                                                                                             |  |                        |  | Preferred LLC Units (445 Units)               |  |           |        |      |         | 4,592     |  |   | 4,592 
|                                                                                                   |  |                        |  | Common LLC Units (356 Units)                  |  |           |        |      |         |           |  |   |       
|Total Control Investments: Non-majority-owned (represents 2.8% of total investments at
fair value) |  |                        |  |                                               |  | 39,199    |        |      | 35,003 
|Total Control Investments: (represents 41.9% of total investments at fair
value)                   |  |                        |  |                                               |  | 541,267   |        |      | 526,140
|Affiliate Investments (3):                                                                         |  |                        |  |                                               |  |           |        |      |         |           | 
|Cherry Hill Holdings, Inc.(2)                                                                      |  | Photographic Studio    |  | Senior Debt (12.9%, Due 8/11)(12)             |  |           | 12,122 |      |         | 12,122    |  |   | 12,122
|                                                                                                   |  |                        |  | Series A Preferred Stock (750 Shares)         |  |           |        |      |         | 775       |  |   | 775   
|iVerify. US Inc. (6)                                                                               |  | Communications-Other   |  | Preferred Stock (54 shares)                   |  |           |        |      |         | 578       |  |   |      
|                                                                                                   |  |                        |  | Common Stock (20 shares)                      |  |           |        |      |         | 550       |  |   |      
|NYL Brands Holdings,                                                                               |  | Clothing & Accessories |  | Subordinated Debt (13.0%, Due 2/11)(12)       |  |           | 10,000 |      |         | 10,000    |  |   | 10,000
|Inc.(2)                                                                                            |  |                        |  | Class A Common Stock (1,500 shares)           |  |           |        |      |         | 1,500     |  |   | 1,500 
|                                                                                                   |  |                        |  | Warrants to purchase Common Stock             |  |           |        |      |         | 331       |  |   | 526   
|                                                                                                   |  |                        |  | (expire 2/3/16)                               |  |           |        |      |         |           |  |   |       
|On Target Media, LLC                                                                               |  | Other Media            |  | Class A LLC Interest                          |  |           |        |      |         | 1,836     |  |   | 1,836 
|                                                                                                   |  |                        |  | Class B LLC Interest                          |  |           |        |      |         |          |  |   | 1,613 
|Sunshine Media Delaware,                                                                           |  | Publishing             |  | Senior Debt (14.7%, Due 12/08)                |  |           | 13,632 |      |         | 12,281    |  |   | 12,281
|LLC(2)                                                                                             |  |                        |  | Class A LLC Interest                          |  |           |        |      |         | 564       |  |   | 329   
|                                                                                                   |  |                        |  | Warrants to purchase Class B LLC interest     |  |           |        |      |         |          |  |   |      
|                                                                                                   |  |                        |  | (expire 1/31/11)                              |  |           |        |      |         |           |  |   |       
|TNR Entertainment Corp                                                                             |  | DVD Rental             |  | Senior Debt (10.4%, Due 7/10)(12)             |  |           | 12,500 |      |         | 12,500    |  |   | 12,500
|LLC(2)                                                                                             |  |                        |  | Subordinated Debt (17.5%, Due 1/11) (12)      |  |           | 13,067 |      |         | 13,067    |  |   | 13,067
|                                                                                                   |  |                        |  | Series D Preferred Stock (1,806,452 shares)   |  |           |        |      |         | 3,000     |  |   | 3,000 
|                                                                                                   |  |                        |  | Warrants to purchase Series D Preferred Stock |  |           |        |      |         |          |  |   |      
|                                                                                                   |  |                        |  | (expire 7/31/16)                              |  |           |        |      |         |           |  |   |       
|XFone, Inc(6)(10)                                                                                  |  | Communications-Other   |  | Common Stock (868,947 shares)                 |  |           |        |      |         | 2,485     |  |   | 2,482 
|                                                                                                   |  |                        |  | Warrants to purchase common stock             |  |           |        |      |         |          |  |   |      
|                                                                                                   |  |                        |  | (expire 3/3/11)                               |  |           |        |      |         |           |  |   |       
|Total Affiliate Investments (represents 5.7% of total investments at fair
value)                   |  |                        |  |                                               |  | 71,589    |        |      | 72,031 



See notes to
consolidated financial statements



67



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2006

(in thousands, except share data)



|                                                |  |                        |  |                                                                                                                                                            |  |           |            |      |   |                  |  |   |                 
|----------------------------------------------- |  | ---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | ---------- | ---- | - | ---------------- |  | - | ----------------
|Portfolio Company                               |  | Industry               |  | Investment (8)                                                                                                                                             |  | Principal |            | Cost |   | FairValue       
|Non-Affiliate Investments (less than 5% owned): |  |                        |  |                                                                                                                                                            |  |           |            |      |  
|Advanced Sleep Concepts, Inc. (2)               |  | Home Furnishings       |  | Senior Debt (13.8%, Due 10/11 ) (12) Subordinated Debt 16.0%, Due 4/12) (12) Common Stock (419
shares) Warrants to Purchase Common Stock (expire 10/12/16) |  | $         | 7,0004,540 |      | $ | 7,0004,540524348 |  | $ | 7,0004,540524348
|Allen's TV Cable Service, Inc.                  |  | Cable                  |  | Senior Debt (12.1%, Due 12/12) (12)                                                                                                                        |  |           | 7,998      |      |   | 7,998            |  |   | 7,998           
|                                                |  |                        |  | Subordinated Debt (12.1%, Due 12/12) (12)                                                                                                                  |  |           | 2,096      |      |   | 2,096            |  |   | 2,096           
|                                                |  |                        |  | Warrants to purchase Common Stock (expire 12/31/15)                                                                                                        |  |           |            |      |   |                 |  |   |                
|Amerifit Nutrition, Inc. (2)                    |  | Drugs                  |  | Senior Debt (12.0%, Due 3/10) (12)                                                                                                                         |  |           | 5,569      |      |   | 5,569            |  |   | 5,569           
|B & H Education, Inc. (2)                       |  | Education              |  | Senior Debt (10.4%, Due 3/10) (12)                                                                                                                         |  |           | 4,000      |      |   | 4,000            |  |   | 4,000           
|                                                |  |                        |  | Preferred Stock ( 5,384 shares)                                                                                                                            |  |           |            |      |   | 1,188            |  |   | 1,540           
|Badoud Enterprises, Inc. (2)                    |  | Newspaper              |  | Senior Debt (10.4%, Due 9/11) (12)                                                                                                                         |  |           | 4,799      |      |   | 4,799            |  |   | 4,799           
|BLI Holdings, Inc. (2)                          |  | Drugs                  |  | Subordinated Debt (13.1%, Due 3/10) (12)                                                                                                                   |  |           | 10,000     |      |   | 10,000           |  |   | 10,000          
|Builders First Source, Inc.                     |  | Building & Development |  | Senior Debt (7.9%, Due 8/11) (12)                                                                                                                          |  |           | 886        |      |   | 886              |  |   | 873             
|Cambridge Information Group, Inc. (2)           |  | Information Services   |  | Subordinated Debt (12.9%, Due 11/11) (12)                                                                                                                  |  |           | 8,500      |      |   | 8,500            |  |   | 8,500           
|CEI Holdings, Inc.                              |  | Cosmetics              |  | Subordinated Debt (13.1%, Due 12/11) (12)                                                                                                                  |  |           | 4,755      |      |   | 4,755            |  |   | 4,755           
|Communications & Power Industries, Inc.         |  | Aerospace & Defense    |  | Senior Debt (7.6%, Due 7/10) (12)                                                                                                                          |  |           | 741        |      |   | 741              |  |   | 744             
|Communicom Broadcasting, LLC (2)                |  | Broadcasting           |  | Senior Debt (12.4%, Due 2/11) (12)                                                                                                                         |  |           | 8,068      |      |   | 8,068            |  |   | 8,068           
|Community Media Group,Inc. (2)                  |  | Newspaper              |  | Senior Debt (9.9%, Due 9/10) (12)                                                                                                                          |  |           | 19,730     |      |   | 19,730           |  |   | 19,730          
|Cornerstone Healthcare Group Holding, Inc.      |  | Healthcare             |  | Subordinated Debt (14.0%, Due 7/12) (12)                                                                                                                   |  |           | 7,206      |      |   | 7,206            |  |   | 7,206           
|Country Road Communications LLC (2)             |  | Communications-Other   |  | Subordinated Debt (13.3%,Due 7/13) (12)                                                                                                                    |  |           | 13,000     |      |   | 13,000           |  |   | 13,000          
|Creative Loafing, Inc. (2)                      |  | Newspaper              |  | Senior Debt (12.0%, Due 6/10) (12)                                                                                                                         |  |           | 18,275     |      |   | 18,275           |  |   | 18,275          
|Crescent Publishing Company LLC (2)             |  | Newspaper              |  | Senior Debt (15.1%, Due 6/09-6/10) (12)                                                                                                                    |  |           | 7,503      |      |   | 7,503            |  |   | 7,503           
|Cruz Bay Publishing, Inc.                       |  | Publishing             |  | Subordinated Debt (12.4%, Due 12/13)                                                                                                                       |  |           | 20,000     |      |   | 20,000           |  |   | 20,000          
|CWP/RMK Acquisition Corp                        |  | Home Furnishings       |  | Senior Debt (8.9%, Due 6/11) (12)                                                                                                                          |  |           | 6,250      |      |   | 6,250            |  |   | 6,250           
|                                                |  |                        |  | Subordinated Debt (13.4%, Due 12/12) (12)                                                                                                                  |  |           | 11,750     |      |   | 11,750           |  |   | 11,750          
|                                                |  |                        |  | Common Stock (500 Shares)                                                                                                                                  |  |           |            |      |   | 500              |  |   | 500             
|Dayton Parts Holdings,LLC (2)                   |  | Auto Parts             |  | Subordinated Debt (12.5%, Due 6/11) (12) Preferred LLC Interest ( 16,371
units) Class A LLC Interest (10,914 units)                                        |  |           | 16,000     |      |   | 16,000589408     |  |   | 16,000589609    
|D&B Towers, LLC                                 |  | Communications-Other   |  | Senior Debt (15.4%, Due 6/08) (12)                                                                                                                         |  |           | 5,412      |      |   | 5,412            |  |   | 5,062           
|dick clark productions, inc. (6)                |  | Broadcasting           |  | Common Stock (235,714 shares)                                                                                                                              |  |           |            |      |   | 210              |  |   | 510             
|                                                |  |                        |  | Warrants to purchase Common Stock (expire 7/25/11)                                                                                                         |  |           |            |      |   | 858              |  |   | 5,049           
|The e-Media Club, LLC (6)                       |  | Investment Fund        |  | LLC Interest                                                                                                                                               |  |           |            |      |   | 88               |  |   | 34              
|EAS Group, Inc.                                 |  | Technology             |  | Subordinated Debt (16.0%, Due 4/11) (12)                                                                                                                   |  |           | 11,529     |      |   | 11,529           |  |   | 11,529          
|Empower IT Holdings, Inc. (2)                   |  | Information Services   |  | Senior Debt (11.9%, Due 5/12) (12)                                                                                                                         |  |           | 7,959      |      |   | 7,959            |  |   | 7,959           
|                                                |  |                        |  | Subordinated Debt (14.5%, Due 6/12) (12)                                                                                                                   |  |           | 5,116      |      |   | 5,116            |  |   | 5,116           
|Equibrand Holding Corporation (2)               |  | Leisure Activities     |  | Senior Debt (12.4%, Due 9/10) (12) Subordinated Debt (15.8%, Due 3/11) (12)                                                                                |  |           | 4,6409,674 |      |   | 4,6409,674       |  |   | 4,6409,674      
|Flexsol Packaging Corp.                         |  | Chemicals/Plastics     |  | Subordinated Debt (13.5%, Due 12/12) (12)                                                                                                                  |  |           | 3,000      |      |   | 3,000            |  |   | 2,955           
|GoldenSource HoldingsInc. (6)                   |  | Technology             |  | Warrants to purchase Common Stock (expire 10/31/08)                                                                                                        |  |           |            |      |   |                 |  |   |                
|Home Interiors & Gifts, Inc.                    |  | Home Furnishings       |  | Senior Debt (10.4%, Due 3/11)                                                                                                                              |  |           | 4,492      |      |   | 4,492            |  |   | 3,308           



See notes to
consolidated financial statements



68



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2006

(in thousands, except share data)



|                                                    |  |                        |  |                                                                                                                                       |  |           |              |      |   |                   |  |   |                  
|--------------------------------------------------- |  | ---------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | ------------ | ---- | - | ----------------- |  | - | -----------------
|Portfolio Company                                   |  | Industry               |  | Investment (8)                                                                                                                        |  | Principal |              | Cost |   | FairValue        
|Jenzabar, Inc. (2)                                  |  | Technology             |  | Preferred Stock (5,000 shares)                                                                                                        |  |           |              |      | $ | 6,381             |  | $ | 6,381            
|                                                    |  |                        |  | Subordinated Preferred Stock (109,800 shares)                                                                                         |  |           |              |      |   | 1,098             |  |   | 1,098            
|                                                    |  |                        |  | Warrants to purchase Common Stock (expire 4/30/16)                                                                                    |  |           |              |      |   | 422               |  |   | 17,180           
|The Joseph F. Biddle Publishing Company (2)         |  | Newspaper              |  | Senior Debt (8.9%, Due 12/11) (12)                                                                                                    |  | $         | 7,050        |      |   | 7,050             |  |   | 7,050            
|Jupitermedia Corporation (6)                        |  | Information Services   |  | Common Stock (148,373 shares)                                                                                                         |  |           |              |      |   | 2,114             |  |   | 1,175            
|Legacy Cabinets, Inc                                |  | Home Furnishings       |  | Subordinated Debt (12.9%, Due 8/13) (12)                                                                                              |  |           | 3,000        |      |   | 3,000             |  |   | 3,000            
|Marietta Intermediate Holding Corporation           |  | Cosmetics              |  | Subordinated Debt (14.8%, Due 12/11) (12)                                                                                             |  |           | 2,000        |      |   | 2,000             |  |   | 1,517            
|MCI Holdings, LLC (2)                               |  | Healthcare             |  | Subordinated Debt (12.7%, Due 3/12-4/13) (12)                                                                                         |  |           | 29,791       |      |   | 29,791            |  |   | 29,791           
|                                                    |  |                        |  | Class A LLC Interest (4,712,042 units)                                                                                                |  |           |              |      |   | 3,000             |  |   | 3,388            
|Metropolitan Telecommunications Holding Company (2) |  | Communications-CLEC    |  | Senior Debt (12.5%, Due 6/010-9/10) (12) Subordinated Debt (16.4%, Due 12/10) (12) Warrants to purchase Common Stock (expire 9/30/13) |  |           | 20,72510,929 |      |   | 20,72510,9291,843 |  |   | 20,72510,9298,320
|MicroCal Holdings, LLC (2)                          |  | Laboratory Instruments |  | Senior Debt (9.9%, Due 3/10-9/10) (12)                                                                                                |  |           | 12,800       |      |   | 12,800            |  |   | 12,800           
|                                                    |  |                        |  | Subordinated Debt (14.5%, Due 3/11) (12)                                                                                              |  |           | 9,115        |      |   | 9,115             |  |   | 9,115            
|MicroDental Laboratories (2)                        |  | Healthcare             |  | Senior Debt (10.7%, Due 5/11-11/11) (12)                                                                                              |  |           | 13,186       |      |   | 13,186            |  |   | 13,186           
|                                                    |  |                        |  | Subordinated Debt (15.0%, Due 5/12) (12)                                                                                              |  |           | 6,999        |      |   | 6,999             |  |   | 6,999            
|Miles Media Holding, LLC (2)                        |  | Publishing             |  | Senior Debt (11.9%, Due 6/12) (12)                                                                                                    |  |           | 9,150        |      |   | 9,150             |  |   | 9,150            
|                                                    |  |                        |  | Subordinated Debt (16.4%, Due 12/12) (12)                                                                                             |  |           | 4,000        |      |   | 4,000             |  |   | 4,000            
|                                                    |  |                        |  | Warrants to purchase Units in LLC (expire 6/30/09)                                                                                    |  |           |              |      |   | 439               |  |   | 2,119            
|National Display Holdings, LLC (2)                  |  | Electronics            |  | Senior Debt (11.4%, Due 12/11) (12)                                                                                                   |  |           | 10,000       |      |   | 10,000            |  |   | 10,000           
|                                                    |  |                        |  | Subordinated Debt (15.0%, Due 12/12) (12)                                                                                             |  |           | 13,682       |      |   | 13,682            |  |   | 13,682           
|                                                    |  |                        |  | Class A LLC Interest (1,000,000 units)                                                                                                |  |           |              |      |   | 1,000             |  |   | 1,152            
|New Century Companies, Inc. (6)                     |  | Industrial Equipment   |  | Warrants to purchase Common Stock (expire 6/30/10)                                                                                    |  |           |              |      |   |                  |  |   |                 
|PartMiner, Inc. (2)                                 |  | Information Services   |  | Senior Debt (14.9%, Due 6/09) (12)                                                                                                    |  |           | 3,341        |      |   | 3,341             |  |   | 3,341            
|Philadelphia Newspapers, LLC                        |  | Newspapers             |  | Subordinated Debt (16.0%, Due 6/14) (12)                                                                                              |  |           | 5,017        |      |   | 5,017             |  |   | 5,017            
|Powercom Corporation (2)                            |  | Communications-CLEC    |  | Senior Debt (12.0%, Due 12/06)                                                                                                        |  |           | 1,798        |      |   | 1,798             |  |   | 1,798            
|                                                    |  |                        |  | Warrants to purchase Class A Common Stock (expire 6/30/14)                                                                            |  |           |              |      |   | 286               |  |   |                 
|Quantum Medical Holdings, LLC (2)                   |  | Laboratory Instruments |  | Senior Debt (11.1%, Due 12/10  5/11) (12)                                                                                            |  |           | 17,500       |      |   | 17,500            |  |   | 17,500           
|                                                    |  |                        |  | Subordinated Debt (15.0%, Due 12/11) (12)                                                                                             |  |           | 18,032       |      |   | 18,032            |  |   | 18,032           
|                                                    |  |                        |  | Preferred LLC Interest (1,000,000 units)                                                                                              |  |           |              |      |   | 421               |  |   | 955              
|Restaurant Technologies, Inc.                       |  | Food Services          |  | Subordinated Debt (16.0%, Due 2/12) (12)                                                                                              |  |           | 20,923       |      |   | 20,923            |  |   | 20,923           
|                                                    |  |                        |  | Series A Preferred Stock (7,813 Shares)                                                                                               |  |           |              |      |   | 281               |  |   | 281              
|Sagamore Hill Broadcasting, LLC (2)                 |  | Broadcasting           |  | Senior Debt (11.4%, Due 11/09) (12)                                                                                                   |  |           | 14,000       |      |   | 14,000            |  |   | 14,000           



See notes to
consolidated financial statements



69



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2006

(in thousands, except share data)



|                                                                                      |  |                      |           |                                                                                                                                                                      |  |           |             |      |   |                 |           |  |   |                       |  
|------------------------------------------------------------------------------------- |  | -------------------- | --------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | ----------- | ---- | - | --------------- | --------- |  | - | --------------------- | -
|Portfolio Company                                                                     |  | Industry             |           | Investment (8)                                                                                                                                                       |  | Principal |             | Cost |   |                 | FairValue | 
|Stratford School Holdings, Inc. (2)                                                   |  | Education            |           | Senior Debt (9.9%, Due 7/11- 9/11) (12) Subordinated Debt (14.0%, Due 12/11) (12) Preferred Stock (10,000 shares) Warrants to purchase Common Stock (expire 5/31/15) |  | $         | 14,5006,924 |      | $ | 14,5006,9246068 |           |  | $ | 14,5006,9242,9971,026 |  
|Summit Business Media Intermediate Holding Company, LLC                               |  | Information Services |           | Subordinated Debt (12.4%, Due 11/13)                                                                                                                                 |  |           | 6,000       |      |   | 6,000           |           |  |   | 6,000                 |  
|Switch & Data Holdings, Inc.                                                          |  | Business Services    |           | Subordinated Debt (12.6%, Due 4/11) (12)                                                                                                                             |  |           | 12,000      |      |   | 12,000          |           |  |   | 12,000                |  
|Team Express, Inc. (2)                                                                |  | Retail               |           | Subordinated Debt (15.0%, Due 6/11) (12)                                                                                                                             |  |           | 7,327       |      |   | 7,327           |           |  |   | 7,327                 |  
|Teleguam Holdings, LLC (2)                                                            |  | Communications-Other |           | Subordinated Debt (12.4%, Due 10/12) (12)                                                                                                                            |  |           | 20,000      |      |   | 20,000          |           |  |   | 20,000                |  
|Total Sleep Holdings, Inc. (2)                                                        |  | Healthcare           |           | Subordinated Debt (16.0%, Due 9/11) (12)                                                                                                                             |  |           | 23,179      |      |   | 23,005          |           |  |   | 19,034                |  
|ValuePage, Inc. (6)                                                                   |  | Communications-Other |           | Senior Debt (12.8%, Due 6/08)                                                                                                                                        |  |           | 1,146       |      |   | 1,095           |           |  |   | 1,095                 |  
|VS&A-PBI Holding LLC (6)                                                              |  | Publishing           |           | LLC Interest                                                                                                                                                         |  |           |             |      |   | 500             |           |  |   |                      |  
|VOX Communications Group Holdings, LLC (2)                                            |  | Broadcasting         |           | Senior Debt (13.6%, Due 12/07-6/10) (12) Convertible Preferred Subordinated Notes (12.4%, Due 6/15-10/16 )                                                           |  |           | 11,0541,317 |      |   | 11,0001,244     |           |  |   | 11,000677             |  
|Wicks Business Information,                                                           |  | Publishing           |           | Unsecured Note (10.3%, Due 2/08)                                                                                                                                     |  |           | 237         |      |   | 237             |           |  |   | 237                   |  
|LLC                                                                                   |  |                      |           |                                                                                                                                                                      |  |           |             |      |   |                 |           |  |   |                       |  
|Wiesner Publishing Company, LLC                                                       |  | Publishing           |           | Warrants to purchase membership interest in LLC (expire 6/30/12)                                                                                                     |  |           |             |      |   | 406             |           |  |   | 3,339                 |  
|Wire Rope Corporation of America, Inc.                                                |  | Industrial Equipment |           | Senior Debt (13.1%, Due 6/11) (12)                                                                                                                                   |  |           | 6,000       |      |   | 6,000           |           |  |   | 6,120                 |  
|WirelessLines II, Inc.                                                                |  | Communications-Other |           | Senior Debt (8.0%, Due 4/07)                                                                                                                                         |  |           | 129         |      |   | 129             |           |  |   | 129                   |  
|Xpressdocs Holdings, Inc (2)                                                          |  | Business Services    |           | Senior Debt (9.3%, Due 7/11) (12)                                                                                                                                    |  |           | 17,255      |      |   | 17,255          |           |  |   | 17,255                |  
|                                                                                      |  |                      |           | Subordinated Debt (14.0%, Due 7/12) (12)                                                                                                                             |  |           | 6,075       |      |   | 6,075           |           |  |   | 6,075                 |  
|                                                                                      |  |                      |           | Series A Preferred Stock (161,870 shares)                                                                                                                            |  |           |             |      |   | 500             |           |  |   | 500                   |  
|Total Non-Affiliate Investments (represents 52.4% of total investments at fair
value) |  |                      | 629,849   |                                                                                                                                                                      |  |           | 659,441     |     
|Total Investments                                                                     |  |                      |           |                                                                                                                                                                      |  |           |             |      |   | 1,242,705       |           |  |   | 1,257,612             |  
|Unearned Income                                                                       |  |                      |           |                                                                                                                                                                      |  |           |             |      |   | (9,539          | )         |  |   | (9,539                | )
|                                                                                      |  |                      |           |                                                                                                                                                                      |  |           |             |      |   |                 |           |  |   |                       |  
|Total Investments Net of Unearned Income                                              |  | $                    | 1,233,166 |                                                                                                                                                                      |  | $         | 1,248,073   |     
|                                                                                      |  |                      |           |                                                                                                                                                                      |  |           |             |      |   |                 |           |  |   |                       |  
|Call Options Written                                                                  |  |                      |           |                                                                                                                                                                      |  |           |             |      |   |                 |           |  |   |                       |  
|Crystal Media Network, LLC (1)                                                        |  | Broadcasting         |           | Call options written                                                                                                                                                 |  |           |             |      | $ |                |           |  | $ |                      |  
|Total Call Options Written                                                            |  |                      |           |                                                                                                                                                                      |  |           |             |      | $ |                |           |  | $ |                      |  
|                                                                                      |  |                      |           |                                                                                                                                                                      |  |           |             |      |   |                 |           |  |   |                       |  



See notes to
consolidated financial statements



70



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2005

(in thousands, except share data)



|                                                                                                |  |                |                                          |                                                                                                                                         |  |           |             |      |         |                  |  |        |                 
|----------------------------------------------------------------------------------------------- |  | -------------- | ---------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | ----------- | ---- | ------- | ---------------- |  | ------ | ----------------
|Portfolio Company                                                                               |  | Industry       |                                          | Investment (8)                                                                                                                          |  | Principal |             | Cost |         | FairValue       
|Control Investments: Majority-owned (5):                                                        |  |                |                                          |                                                                                                                                         |  |           |             |      |        
|Broadview Networks Holdings, Inc. (2) (7)                                                       |  | Communications |                                          | Subordinated Debt (12.0%, Due 12/09)                                                                                                    |  | $         | 42,993      |      | $       | 42,993           |  | $      | 42,993          
|                                                                                                |  |                | Series A Preferred Stock (89,154 shares) |                                                                                                                                         |  |           |             |      | 52,137  |                  |  | 52,137
|                                                                                                |  |                |                                          | Common Stock (2,228,937 shares)                                                                                                         |  |           |             |      |         |                 |  |        |                
|Cleartel Communications,                                                                        |  | Communications |                                          | Senior Debt (8.3%, Due 6/09)                                                                                                            |  |           | 28,850      |      |         | 28,850           |  |        | 28,850          
|Inc. (2)                                                                                        |  |                |                                          | Subordinated Debt (14.4%, Due 6/09)                                                                                                     |  |           | 9,356       |      |         | 9,356            |  |        | 9,356           
|                                                                                                |  |                |                                          | Preferred Stock (57,859 shares)                                                                                                         |  |           |             |      |         | 50,613           |  |        | 40,684          
|                                                                                                |  |                |                                          | Common Stock (9 shares)                                                                                                                 |  |           |             |      |         | 540              |  |        |                
|                                                                                                |  |                |                                          | Guaranty ($8,092)                                                                                                                       |  |           |             |      |         |                  |  |        |                 
|Copperstate Technologies,                                                                       |  | Security Alarm |                                          | Senior Debt (11.0%, Due 9/07)                                                                                                           |  |           | 1,272       |      |         | 1,272            |  |        | 1,272           
|Inc.                                                                                            |  |                |                                          | Class A Common Stock (20,000 shares)                                                                                                    |  |           |             |      |         | 2,000            |  |        | 946             
|                                                                                                |  |                |                                          | Class B Common Stock (10 shares)                                                                                                        |  |           |             |      |         |                 |  |        |                
|                                                                                                |  |                |                                          | Warrants to purchase Class B Common Stock (expire 12/20/12)                                                                             |  |           |             |      |         |                 |  |        |                
|                                                                                                |  |                |                                          | Standby Letter of Credit ($1,000)                                                                                                       |  |           |             |      |         |                  |  |        |                 
|Crystal Media Network,                                                                          |  | Broadcasting   |                                          | Senior Debt (11.4%, Due 5/06)                                                                                                           |  |           | 1,099       |      |         | 947              |  |        | 947             
|LLC (6)                                                                                         |  |                |                                          | LLC Interest                                                                                                                            |  |           |             |      |         | 6,132            |  |        | 1,097           
|Helicon Cable Holdings, LLC (2)                                                                 |  | Cable          |                                          | Senior Debt (9.2%, Due 12/12) Subordinated Debt (14.3%, Due 6/13) Preferred LLC Interest (82,500 units) Standby Letter of Credit ($300) |  |           | 10,0725,750 |      |         | 10,0725,7508,316 |  |        | 10,0725,7508,316
|Midwest Tower Partners,                                                                         |  | Communications |                                          | Subordinated Debt (14.1%, Due 2/07) (12)                                                                                                |  |           | 16,813      |      |         | 16,813           |  |        | 16,813          
|LLC (2)                                                                                         |  |                |                                          | Preferred LLC Interest                                                                                                                  |  |           |             |      |         | 2,121            |  |        | 2,121           
|                                                                                                |  |                |                                          | Common LLC Interest                                                                                                                     |  |           |             |      |         | 201              |  |        | 1,332           
|Superior Publishing                                                                             |  | Newspaper      |                                          | Senior Debt (9.0%, Due 12/06) (12)                                                                                                      |  |           | 20,759      |      |         | 20,759           |  |        | 20,759          
|Corporation (2)                                                                                 |  |                |                                          | Subordinated Debt (20.0%, Due 12/06) (12)                                                                                               |  |           | 22,692      |      |         | 20,141           |  |        | 20,141          
|                                                                                                |  |                |                                          | Preferred Stock (7,999 shares)                                                                                                          |  |           |             |      |         | 7,999            |  |        | 8,545           
|                                                                                                |  |                |                                          | Common Stock (100 shares)                                                                                                               |  |           |             |      |         | 365              |  |        |                
|Telecomm South, LLC                                                                             |  | Communications |                                          | Senior Debt (13.4%, Due 12/05)                                                                                                          |  |           | 7,996       |      |         | 2,582            |  |        | 1,100           
|                                                                                                |  |                |                                          | LLC Interest                                                                                                                            |  |           |             |      |         | 10               |  |        |                
|West Coast Wireless Lines LLC                                                                   |  | Conferences    |                                          | LLC Interest                                                                                                                            |  |           |             |      |         | 851              |  |        | 851             
|Working Mother Media,                                                                           |  | Publishing     |                                          | Senior Debt (7.5%, Due 6/06)                                                                                                            |  |           | 10,452      |      |         | 8,576            |  |        | 8,576           
|Inc. (6)                                                                                        |  |                |                                          | Class A Preferred Stock (12,497 shares)                                                                                                 |  |           |             |      |         | 12,497           |  |        | 4,192           
|                                                                                                |  |                |                                          | Class B Preferred Stock (1 share)                                                                                                       |  |           |             |      |         | 1                |  |        |                
|                                                                                                |  |                |                                          | Class C Preferred Stock (1 share)                                                                                                       |  |           |             |      |         | 1                |  |        |                
|                                                                                                |  |                |                                          | Common Stock (510 shares)                                                                                                               |  |           |             |      |         | 1                |  |        |                
|                                                                                                |  |                |                                          | Guaranty ($834)                                                                                                                         |  |           |             |      |         |                  |  |        |                 
|Total Control Investments: Majority-owned (represents 26.1% of total investments at
fair value) |  |                |                                          |                                                                                                                                         |  | 311,896   |             |      | 286,850



See notes to
consolidated financial statements



71



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2005

(in thousands,
except share data)



|                                                                                                   |  |                |        |                                                            |  |           |        |      |         |           |  |   |       
|-------------------------------------------------------------------------------------------------- |  | -------------- | ------ | ---------------------------------------------------------- |  | --------- | ------ | ---- | ------- | --------- |  | - | ------
|Portfolio Company                                                                                  |  | Industry       |        | Investment (8)                                             |  | Principal |        | Cost |         | FairValue
|Control Investments: Non-majority owned (4):                                                       |  |                |        |                                                            |  |           |        |      |        
|ETC Group, LLC (6)                                                                                 |  | Publishing     |        | Series A LLC Interest                                      |  |           |        |      | $       | 270       |  | $ | 123   
|                                                                                                   |  |                |        | Series C LLC Interest                                      |  |           |        |      |         | 100       |  |   |      
|Fawcette Technical                                                                                 |  | Publishing     |        | Senior Debt (14.5%, Due 12/06) (12)                        |  | $         | 13,061 |      |         | 12,545    |  |   | 12,545
|Publications Holding (2)                                                                           |  |                |        | Subordinated Debt (14.8%, Due 12/06)                       |  |           | 5,186  |      |         | 4,691     |  |   | 1,137 
|                                                                                                   |  |                |        | Series A Preferred Stock (8,473 shares)                    |  |           |        |      |         | 2,569     |  |   |      
|                                                                                                   |  |                |        | Common Stock (5,010,379 shares)                            |  |           |        |      |         |          |  |   |      
|Platinum Wireless, Inc.                                                                            |  | Communications |        | Senior Debt (8.0%, Due 6/06)                               |  |           | 389    |      |         | 389       |  |   | 389   
|                                                                                                   |  |                |        | Common Stock (2,937 shares)                                |  |           |        |      |         | 4,640     |  |   | 4,505 
|                                                                                                   |  |                |        | Option to purchase Common Stock (expire 12/31/13)          |  |           |        |      |         | 272       |  |   | 98    
|Total Control Investments: Non-majority-owned (represents 1.7% of total investments at
fair value) |  |                |        |                                                            |  | 25,476    |        |      | 18,797 
|Total Control Investments: (represents 27.8% of total investments at fair
value)                   |  |                |        |                                                            |  | 337,372   |        |      | 305,647
|Affiliate Investments (3):                                                                         |  |                |        |                                                            |  |           |        |      |         |           |  |   |       
|iVerify. US Inc.                                                                                   |  | Security Alarm |        | Senior Debt (8.0%, Due 4/06)                               |  |           | 75     |      |         | 75        |  |   | 75    
|                                                                                                   |  |                |        | Common Stock (20 shares)                                   |  |           |        |      |         | 550       |  |   |      
|On Target Media, LLC                                                                               |  | Other Media    |        | Senior Debt (10.5%, Due 9/09) (12)                         |  |           | 20,000 |      |         | 20,000    |  |   | 20,000
|                                                                                                   |  |                |        | Subordinated Debt (17.0%, Due 3/10) (12)                   |  |           | 11,266 |      |         | 11,266    |  |   | 11,266
|                                                                                                   |  |                |        | Class A LLC Interest                                       |  |           |        |      |         | 1,508     |  |   | 2,610 
|                                                                                                   |  |                |        | Class B LLC Interest                                       |  |           |        |      |         |          |  |   |      
|Sunshine Media Delaware,                                                                           |  | Publishing     |        | Senior Debt (13.7%, Due 12/07)                             |  |           | 12,739 |      |         | 12,205    |  |   | 12,205
|LLC (2)                                                                                            |  |                |        | Class A LLC Interest                                       |  |           |        |      |         | 564       |  |   |      
|                                                                                                   |  |                |        | Warrants to purchase Class B LLC interest (expire 1/31/11) |  |           |        |      |         |          |  |   |      
|Total Affiliate Investments (represents 4.2% of total investments at fair
value)                   |  |                | 46,168 |                                                            |  | 46,156   



See notes to
consolidated financial statements



72



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2005

(in thousands, except share data)



|                                                |  |                          |  |                                                     |  |           |        |      |   |           |  |   |       
|----------------------------------------------- |  | ------------------------ |  | --------------------------------------------------- |  | --------- | ------ | ---- | - | --------- |  | - | ------
|Portfolio Company                               |  | Industry                 |  | Investment (8)                                      |  | Principal |        | Cost |   | FairValue
|Non-Affiliate Investments (less than 5% owned):
|Allen's TV Cable Service, Inc.                  |  | Cable                    |  | Senior Debt (13.1%, Due 12/12) (12)                 |  | $         | 7,130  |      | $ | 7,130     |  | $ | 7,130 
|                                                |  |                          |  | Subordinated Debt (12.6%, Due 12/12) (12)           |  |           | 2,007  |      |   | 2,007     |  |   | 2,007 
|                                                |  |                          |  | Warrants to purchase Common Stock (expire 12/31/15) |  |           |        |      |   |          |  |   |      
|Amerifit Nutrition, Inc. (2)                    |  | Drugs                    |  | Senior Debt (13.9%, Due 3/10) (12)                  |  |           | 6,623  |      |   | 6,623     |  |   | 6,623 
|Archway Broadcasting Group, LLC                 |  | Broadcasting             |  | Senior Debt (11.0%, Due 12/08) (12)                 |  |           | 4,900  |      |   | 4,900     |  |   | 4,900 
|Auto Europe, LLC                                |  | Equipment Leasing        |  | Subordinated Debt (11.3%, Due 10/12) (12)           |  |           | 13,500 |      |   | 13,500    |  |   | 13,500
|B & H Education, Inc. (2)                       |  | Education                |  | Senior Debt (10.5%, Due 3/10) (12)                  |  |           | 4,000  |      |   | 4,000     |  |   | 4,000 
|                                                |  |                          |  | Preferred Stock ( 5,384 shares)                     |  |           |        |      |   | 1,060     |  |   | 1,078 
|Badoud Enterprises, Inc. (2)                    |  | Newspaper                |  | Senior Debt (9.7%, Due 9/11)                        |  |           | 5,449  |      |   | 5,449     |  |   | 5,449 
|BLI Holdings, Inc. (2)                          |  | Drugs                    |  | Subordinated Debt (12.2%, Due 3/10) (12)            |  |           | 10,000 |      |   | 10,000    |  |   | 10,000
|Builders First Source, Inc.                     |  | Building & Development   |  | Senior Debt (6.2%, Due 8/11) (12)                   |  |           | 889    |      |   | 889       |  |   | 894   
|Cambridge Information Group, Inc. (2)           |  | Information Services     |  | Senior Debt (8.7%, Due 6/07-6/11) (12)              |  |           | 26,825 |      |   | 26,825    |  |   | 26,825
|CEI Holdings, Inc.                              |  | Cosmetics                |  | Subordinated Debt (11.1%, Due 12/11) (12)           |  |           | 2,377  |      |   | 2,377     |  |   | 2,270 
|Communications & Power Industries, Inc.         |  | Aerospace & Defense      |  | Senior Debt (6.6%, Due 7/10) (12)                   |  |           | 1,778  |      |   | 1,778     |  |   | 1,797 
|Community Media Group, Inc. (2)                 |  | Newspaper                |  | Senior Debt (8.9%, Due 9/10) (12)                   |  |           | 22,365 |      |   | 22,365    |  |   | 22,365
|Cornerstone Healthcare Group Holding, Inc.      |  | Healthcare               |  | Subordinated Debt (14.0%, Due 7/12) (12)            |  |           | 7,060  |      |   | 7,060     |  |   | 7,060 
|Country Road Communications LLC (2)             |  | Communications           |  | Subordinated Debt (11.6%, Due 7/13) (12)            |  |           | 13,000 |      |   | 13,000    |  |   | 13,000
|Creative Loafing, Inc. (2)                      |  | Newspaper                |  | Senior Debt (11.1%, Due 6/10) (12)                  |  |           | 19,400 |      |   | 19,400    |  |   | 19,400
|Crescent Publishing Company LLC (2)             |  | Newspaper                |  | Senior Debt (14.3%, Due 6/09-6/10) (12)             |  |           | 8,942  |      |   | 8,942     |  |   | 8,942 
|Cruz Bay Publishing, Inc. (2)                   |  | Publishing               |  | Senior Debt (12.1%, Due 12/06) (12)                 |  |           | 6,172  |      |   | 6,172     |  |   | 6,172 
|                                                |  |                          |  | Subordinated Debt (20.5%, Due 12/06) (12)           |  |           | 11,417 |      |   | 11,417    |  |   | 11,417
|Dayton Parts Holdings, LLC(2)                   |  | Vehicle Parts & Supplies |  | Subordinated Debt (12.5%, Due 6/11)                 |  |           | 16,000 |      |   | 16,000    |  |   | 16,000
|                                                |  |                          |  | Preferred LLC Interest ( 16,371 units)              |  |           |        |      |   | 602       |  |   | 602   
|                                                |  |                          |  | Class A LLC Interest (10,914 units)                 |  |           |        |      |   | 401       |  |   | 401   



See notes to
consolidated financial statements



73



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2005

(in thousands, except share data)



|                                            |  |                          |  |                                                     |  |           |        |      |   |           |  |   |       
|------------------------------------------- |  | ------------------------ |  | --------------------------------------------------- |  | --------- | ------ | ---- | - | --------- |  | - | ------
|Portfolio Company                           |  | Industry                 |  | Investment (8)                                      |  | Principal |        | Cost |   | FairValue
|D&B Towers, LLC                             |  | Communications           |  | Senior Debt (14.2%, Due 6/08) (12)                  |  | $         | 5,022  |      | $ | 5,022     |  | $ | 5,022 
|dick clark productions, inc.(6)             |  | Broadcasting             |  | Common Stock (235,714 shares)                       |  |           |        |      |   | 210       |  |   | 111   
|                                            |  |                          |  | Warrants to purchase Common Stock (expire 7/25/11)  |  |           |        |      |   | 858       |  |   | 1,085 
|The e-Media Club, LLC (6)                   |  | Investment Fund          |  | LLC Interest                                        |  |           |        |      |   | 89        |  |   | 37    
|EAS Group, Inc.                             |  | Communications Equipment |  | Subordinated Debt (16.0%, Due 4/11) (12)            |  |           | 10,227 |      |   | 10,227    |  |   | 10,227
|Empower IT Holdings, Inc. (2)               |  | Information Services     |  | Senior Debt (11.0%, Due 5/12)                       |  |           | 10,000 |      |   | 10,000    |  |   | 10,000
|                                            |  |                          |  | Subordinated Debt (14.5%, Due 6/12)                 |  |           | 5,067  |      |   | 5,067     |  |   | 5,067 
|Equibrand Holding Corporation(2)            |  | Leisure Activities       |  | Senior Debt (11.5%, Due 3/10-9/10) (12)             |  |           | 4,640  |      |   | 4,640     |  |   | 4,640 
|                                            |  |                          |  | Subordinated Debt (16.0%, Due 3/11) (12)            |  |           | 8,763  |      |   | 8,763     |  |   | 8,763 
|Flexsol Packaging Corp.                     |  | Chemicals/Plastics       |  | Subordinated Debt (10.7%, Due 12/12) (12)           |  |           | 5,000  |      |   | 5,000     |  |   | 5,000 
|GoldenSource Holdings Inc.(2)               |  | Technology               |  | Senior Debt (9.0%, Due 9/08)                        |  |           | 17,000 |      |   | 17,000    |  |   | 17,000
|                                            |  |                          |  | Warrants to purchase Common Stock (expire 10/31/08) |  |           |        |      |   |          |  |   |      
|The Hillman Group, Inc.                     |  | Home Furnishings         |  | Senior Debt (7.7%, Due 3/11) (12)                   |  |           | 5,910  |      |   | 5,910     |  |   | 6,010 
|Home Interiors & Gifts, Inc.                |  | Home Furnishings         |  | Senior Debt (9.4%, Due 3/11) (12)                   |  |           | 4,668  |      |   | 4,668     |  |   | 4,290 
|I-55 Internet Services, Inc. (6)            |  | Communications           |  | Senior Debt (17.5%, Due 12/06)                      |  |           | 1,778  |      |   | 1,778     |  |   | 1,539 
|                                            |  |                          |  | Warrants to purchase Common Stock (expire 4/30/10)  |  |           |        |      |   | 366       |  |   |      
|Images.com, Inc.                            |  | Information Services     |  | Senior Debt (12.5%, Due 12/07) (12)                 |  |           | 2,664  |      |   | 2,664     |  |   | 2,664 
|Information Today, Inc. (2)                 |  | Information Services     |  | Senior Debt (11.0%, Due 9/08) (12)                  |  |           | 6,915  |      |   | 6,915     |  |   | 6,915 
|Instant Web, Inc.                           |  | Direct Mail Advertiser   |  | Senior Debt (7.8%, Due 2/11) (12)                   |  |           | 4,962  |      |   | 4,962     |  |   | 5,037 
|Jenzabar, Inc. (2)                          |  | Technology               |  | Senior Debt (12.5%, Due 4/09) (12)                  |  |           | 12,000 |      |   | 12,000    |  |   | 12,000
|                                            |  |                          |  | Subordinated Debt (18.0%, Due 4/09-4/12) (12)       |  |           | 7,467  |      |   | 7,467     |  |   | 7,467 
|                                            |  |                          |  | Senior Preferred Stock (5,000 shares)               |  |           |        |      |   | 5,831     |  |   | 5,831 
|                                            |  |                          |  | Subordinated Preferred Stock (109,800 shares)       |  |           |        |      |   | 1,098     |  |   | 1,098 
|                                            |  |                          |  | Warrants to purchase Common Stock (expire 4/30/16)  |  |           |        |      |   | 422       |  |   | 7,630 
|The Joseph F. Biddle Publishing Company (2) |  | Newspaper                |  | Senior Debt (7.4%, Due 12/11) (12)                  |  |           | 7,225  |      |   | 7,225     |  |   | 7,225 



See notes to
consolidated financial statements



74



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2005

(in thousands, except share data)



|                                                        |  |                               |  |                                                    |  |           |        |      |   |           |  |   |       
|------------------------------------------------------- |  | ----------------------------- |  | -------------------------------------------------- |  | --------- | ------ | ---- | - | --------- |  | - | ------
|Portfolio Company                                       |  | Industry                      |  | Investment (8)                                     |  | Principal |        | Cost |   | FairValue
|Jupitermedia Corporation                                |  | Information Services          |  | Common Stock (148,373 shares)                      |  |           |        |      | $ | 2,115     |  | $ | 2,084 
|Managed Health Care Associates, Inc.                    |  | Drugs                         |  | Senior Debt (10.3%, Due 6/09-6/10) (12)            |  | $         | 4,380  |      |   | 4,380     |  |   | 4,380 
|MD Beauty, Inc                                          |  | Cosmetics                     |  | Subordinated Debt (11.3%, Due 2/13) (12)           |  |           | 9,000  |      |   | 9,000     |  |   | 9,079 
|MCI Holdings, LLC (2)                                   |  | Management Consulting Service |  | Subordinated Debt (12.5%, Due 3/12)                |  |           | 17,102 |      |   | 17,102    |  |   | 17,102
|                                                        |  |                               |  | Class A LLC Interest (4,712,042 units)             |  |           |        |      |   | 3,000     |  |   | 3,000 
|Metropolitan Telecommunications Holding Company (2) (9) |  | Communications                |  | Senior Debt (11.6%, Due 6/10-9/10) (12)            |  |           | 22,000 |      |   | 22,000    |  |   | 22,000
|                                                        |  |                               |  | Subordinated Debt (15.5%, Due 12/10) (12)          |  |           | 10,929 |      |   | 10,929    |  |   | 10,929
|                                                        |  |                               |  | Warrants to purchase Common Stock (expire 9/30/13) |  |           |        |      |   | 1,843     |  |   | 3,897 
|Michael May                                             |  | Security Alarm                |  | Senior Debt (12.0%, Due 2/08)                      |  |           | 450    |      |   | 450       |  |   | 450   
|MicroCal Holdings, LLC (2)                              |  | Laboratory Instruments        |  | Senior Debt (9.0%, Due 3/10-9/10) (12)             |  |           | 13,900 |      |   | 13,900    |  |   | 13,900
|                                                        |  |                               |  | Subordinated Debt (14.5%, Due 3/11) (12)           |  |           | 9,115  |      |   | 9,115     |  |   | 9,115 
|MicroDental Laboratories (2)                            |  | Healthcare                    |  | Senior Debt (9.8%, Due 5/11-11/11) (12)            |  |           | 11,767 |      |   | 11,767    |  |   | 11,767
|                                                        |  |                               |  | Subordinated Debt (15.0%, Due 5/12) (12)           |  |           | 6,113  |      |   | 6,113     |  |   | 6,113 
|Miles Media Holding, Inc. (2)                           |  | Publishing                    |  | Senior Debt (10.9%, Due 6/12) (12)                 |  |           | 8,287  |      |   | 8,287     |  |   | 8,287 
|                                                        |  |                               |  | Subordinated Debt (15.4%, Due 12/12) (12)          |  |           | 4,000  |      |   | 4,000     |  |   | 4,000 
|                                                        |  |                               |  | Warrants to purchase Common Stock (expire 6/3/15)  |  |           |        |      |   | 439       |  |   | 837   
|Monotype Imaging Holdings Corp. (2)                     |  | Technology                    |  | Senior Debt (8.8%, Due 11/09) (12)                 |  |           | 4,850  |      |   | 4,850     |  |   | 4,850 
|MultiPlan, Inc.                                         |  | Insurance                     |  | Senior Debt (7.0%, Due 3/09) (12)                  |  |           | 3,194  |      |   | 3,194     |  |   | 3,234 
|Nalco Company                                           |  | Ecological Services           |  | Senior Debt (6.3%, Due 11/10) (12)                 |  |           | 4,162  |      |   | 4,162     |  |   | 4,217 
|National Display Holdings, LLC(2)                       |  | Electronics                   |  | Senior Debt (9.7%, Due 12/10-12/11)                |  |           | 20,087 |      |   | 20,087    |  |   | 20,087
|                                                        |  |                               |  | Subordinated Debt (15.0%, Due 12/12)               |  |           | 13,000 |      |   | 13,000    |  |   | 13,000
|                                                        |  |                               |  | Class A LLC Interest (1,000,000 units)             |  |           |        |      |   | 1,000     |  |   | 1,000 
|National Product Services, Inc.                         |  | Business Services             |  | Subordinated Debt (14.0%, Due 6/07) (12)           |  |           | 10,225 |      |   | 10,225    |  |   | 10,225
|New Century Companies, Inc. (6)                         |  | Industrial Equipment          |  | Warrants to purchase Common Stock (expire 6/30/10) |  |           |        |      |   |          |  |   |      



See notes to
consolidated financial statements



75



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2005

(in thousands, except share data)



|                                      |  |                        |  |                                                            |  |           |        |      |   |           |  |   |       
|------------------------------------- |  | ---------------------- |  | ---------------------------------------------------------- |  | --------- | ------ | ---- | - | --------- |  | - | ------
|Portfolio Company                     |  | Industry               |  | Investment (8)                                             |  | Principal |        | Cost |   | FairValue
|OMP, Inc.                             |  | Drugs                  |  | Senior Debt (8.3%, Due 1/10-1/11) (12)                     |  | $         | 7,714  |      | $ | 7,714     |  | $ | 7,714 
|PartMiner, Inc. (2)                   |  | Information Services   |  | Senior Debt (15.0%, Due 6/09) (12)                         |  |           | 5,240  |      |   | 5,240     |  |   | 5,240 
|Powercom Corporation (2)              |  | Communications         |  | Senior Debt (12.0%, Due 12/06) (12)                        |  |           | 1,861  |      |   | 1,861     |  |   | 1,861 
|                                      |  |                        |  | Warrants to purchase Class A Common Stock (expire 6/30/14) |  |           |        |      |   | 286       |  |   | 341   
|Quantum Medical Holdings, LLC (2)     |  | Laboratory Instruments |  | Senior Debt (9.3%, Due 12/10-5/11)                         |  |           | 17,535 |      |   | 17,535    |  |   | 17,535
|                                      |  |                        |  | Subordinated Debt (15.0%, Due 12/11)                       |  |           | 10,502 |      |   | 10,502    |  |   | 10,502
|                                      |  |                        |  | Preferred LLC Interest (1,000,000 units)                   |  |           |        |      |   | 1,001     |  |   | 1,001 
|R.R. Bowker, LLC (2)                  |  | Information Services   |  | Senior Debt (11.4%, Due 12/08-12/09) (12)                  |  |           | 16,650 |      |   | 16,650    |  |   | 16,650
|Republic National Cabinet Corporation |  | Home Furnishings       |  | Senior Debt (9.2%, Due 6/09) (12)                          |  |           | 3,578  |      |   | 3,578     |  |   | 3,578 
|                                      |  |                        |  | Subordinated Debt (13.1%, Due 6/09) (12)                   |  |           | 5,000  |      |   | 5,000     |  |   | 5,000 
|Sagamore Hill Broadcasting, LLC (2)   |  | Broadcasting           |  | Senior Debt (11.9%, Due 11/09) (12)                        |  |           | 12,400 |      |   | 12,400    |  |   | 12,400
|SCI Holdings, Inc                     |  | Communication Services |  | Subordinated Debt (11.5%, Due 11/12) (12)                  |  |           | 7,500  |      |   | 7,500     |  |   | 7,500 
|Sheridan Healthcare, Inc.             |  | Healthcare             |  | Senior Debt (7.5%, Due 11/10) (12)                         |  |           | 2,850  |      |   | 2,850     |  |   | 2,895 
|Sterigenics International, Inc.       |  | Healthcare             |  | Senior Debt (7.5%, Due 6/11) (12)                          |  |           | 4,925  |      |   | 4,925     |  |   | 4,993 
|Stratford School Holdings, Inc.(2)    |  | Education              |  | Senior Debt (9.5%, Due 6/11) (12)                          |  |           | 6,500  |      |   | 6,500     |  |   | 6,500 
|                                      |  |                        |  | Subordinated Debt (14.0%, Due 12/11) (12)                  |  |           | 6,651  |      |   | 6,651     |  |   | 6,651 
|                                      |  |                        |  | Preferred Stock (10,000 shares)                            |  |           |        |      |   | 1,059     |  |   | 1,059 
|                                      |  |                        |  | Warrants to purchase Common Stock (expire 5/31/15)         |  |           |        |      |   | 67        |  |   | 192   
|Survey Sampling International, LLC    |  | Research               |  | Senior Debt (7.3%, Due 5/11) (12)                          |  |           | 3,911  |      |   | 3,911     |  |   | 3,943 
|Switch & Data Holdings, Inc.          |  | Business Services      |  | Subordinated Debt (11.6%, Due 4/11) (12)                   |  |           | 12,000 |      |   | 12,000    |  |   | 12,000
|SXC Health Solutions, Inc. (2)        |  | Technology             |  | Senior Debt (9.0%, Due 12/10) (12)                         |  |           | 13,260 |      |   | 13,260    |  |   | 13,260
|                                      |  |                        |  | Common Stock (1,111,100 shares)                            |  |           |        |      |   | 1,235     |  |   | 2,630 
|Talk America Holdings, Inc. (6)       |  | Communications         |  | Warrants to purchase Common Stock (expire 8/17/063/31/07) |  |           |        |      |   | 25        |  |   | 330   



See notes to
consolidated financial statements



76



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2005

(in thousands, except share data)



|                                                                                        |  |                      |   |                                                                  |   |           |        |      |   |           |           |  |   |           |  
|--------------------------------------------------------------------------------------- |  | -------------------- | - | ---------------------------------------------------------------- | - | --------- | ------ | ---- | - | --------- | --------- |  | - | --------- | -
|Portfolio Company                                                                       |  | Industry             |   | Investment (8)                                                   |   | Principal |        | Cost |   |           | FairValue | 
|Team Express, Inc.                                                                      |  | Specialty Retail     |   | Senior Debt (10.7%, Due 12/09-12/10) (12)                        |   | $         | 13,364 |      | $ | 13,364    |           |  | $ | 13,364    |  
|                                                                                        |  |                      |   | Subordinated Debt (15.0%, Due 6/11) (12)                         |   |           | 7,108  |      |   | 7,108     |           |  |   | 7,108     |  
|Teleguam Holdings, LLC                                                                  |  | Communications       |   | Subordinated Debt (11.4%, Due 10/12) (12)                        |   |           | 20,000 |      |   | 20,000    |           |  |   | 20,000    |  
|Tippmann Sports, LLC                                                                    |  | Leisure Goods        |   | Senior Debt (10.3%, Due 6/09) (12)                               |   |           | 6,550  |      |   | 6,550     |           |  |   | 6,550     |  
|Total Sleep Holdings, Inc. (2)                                                          |  | Healthcare           |   | Subordinated Debt (14.0%, Due 9/11) (12)                         |   |           | 22,220 |      |   | 22,220    |           |  |   | 22,220    |  
|U. S. I. Holdings Corporation                                                           |  | Insurance            |   | Senior Debt (6.7%, Due 8/08) (12)                                |   |           | 2,970  |      |   | 2,970     |           |  |   | 2,982     |  
|VS&A-PBI Holding LLC (6)                                                                |  | Publishing           |   | LLC Interest                                                     |   |           |        |      |   | 500       |           |  |   |          |  
|VOX Communications Group Holdings, LLC (2)                                              |  | Broadcasting         |   | Senior Debt (10.8%, Due 12/07-6/10) (12)                         |   |           | 10,350 |      |   | 10,350    |           |  |   | 10,350    |  
|                                                                                        |  |                      |   | Convertible Preferred Subordinated Notes (12.0%, Due 6/15 )      |   |           | 1,062  |      |   | 1,062     |           |  |   | 1,062     |  
|Wicks Business Information, LLC                                                         |  | Publishing           |   | Unsecured Notes (9.3%, Due 2/08)                                 |   |           | 215    |      |   | 215       |           |  |   | 215       |  
|Wiesner Publishing Company, LLC (2)                                                     |  | Publishing           |   | Warrants to purchase membership interest in LLC (expire 6/30/12) |   |           |        |      |   | 406       |           |  |   | 1,723     |  
|Wire Rope Corporation of America, Inc.                                                  |  | Industrial Equipment |   | Senior Debt (11.9%, Due 6/11) (12)                               |   |           | 6,000  |      |   | 6,000     |           |  |   | 6,180     |  
|WirelessLines II, Inc.                                                                  |  | Communications       |   | Senior Debt (8.0%, Due 4/07)                                     |   |           | 185    |      |   | 185       |           |  |   | 185       |  
|Total Non-Affiliate Investments (represents 68.0% of total investments at fair
value)   |  |                      |  |                                                                  |   | 733,717   |        |      |   | 745,757   |          
|Total Investments                                                                       |  |                      |   |                                                                  |   |           |        |      |   | 1,117,257 |           |  |   | 1,097,560 |  
|Unearned Income                                                                         |  |                      |   |                                                                  |   |           |        |      |   | (9,062    | )         |  |   | (9,062    | )
|                                                                                        |  |                      |   |                                                                  |   |           |        |      |   |           |           |  |   |           |  
|Total Investments Net of Unearned Income                                                |  |                      |   |                                                                  | $ | 1,108,195 |        |      | $ | 1,088,498 |          
|                                                                                        |  |                      |   |                                                                  |   |           |        |      |   |           |           |  |   |           |  
|Call options written (included in Other Liabilities in the Consolidated Balance
Sheets) |  |                      |   |                                                                  |   |           |        |      |   |           |          
|Metropolitan Telecommunications Holding Company (9)                                     |  | Communications       |   | Call options written                                             |   |           |        |      | $ | 575       |           |  | $ | 575       |  
|Total Call Options Written                                                              |  |                      |   |                                                                  |   |           |        |      | $ | 575       |           |  | $ | 575       |  
|                                                                                        |  |                      |   |                                                                  |   |           |        |      |   |           |           |  |   |           |  



See notes to
consolidated financial statements



77



---

##### Table of Contents

MCG Capital Corporation

Consolidated Schedule of Investments(Continued)

December 31, 2006
and 2005

(in thousands, except share data)



---

|(1) |  | In August 2006, MCG sold 50.1% of its equity in Crystal Media Network, LLC (Crystal Media). As part of the same transaction, Crystal Medias outstanding debt was
paid off. At December 31, 2006, MCG had a written call option outstanding on up to a 10% interest in Crystal Media. The option expires January 31, 2008.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Some of the securities listed are issued by affiliate(s) of the listed portfolio company.
|--- |  | -----------------------------------------------------------------------------------------

|(3) |  | Affiliate investments are generally defined under the Investment Company Act of 1940 as companies in which MCG owns at least 5% but not more than 25% of the voting securities of the
company.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Non-majority owned control investments are generally defined under the Investment Company Act of 1940 as companies in which MCG owns more than 25% but not more than 50% of the
voting securities of the company.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Majority owned investments are generally defined under the Investment Company Act of 1940 as companies in which MCG owns more than 50% of the voting securities of the company.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Non-income producing at the relevant period end.
|--- |  | ------------------------------------------------

|(7) |  | In January 2005, MCG IH II, Inc., the sole owner of one of the Companys majority-owned controlled portfolio companies, Bridgecom Holdings, Inc., completed a merger with and
into BV-BC Acquisition Corporation, a wholly-owned subsidiary of Broadview Networks, Inc. The Companys economic ownership in the new merged entity dropped below 50%; however, the Company retained greater than 50% of the voting control of the
merged entity. Accordingly, our investment will continue to be reflected as a majority-owned control portfolio company.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The
maturity dates represent the earliest and the latest maturity dates.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) |  | In June 2005, MCG granted Metropolitan Telecommunication Holding Company an option to repurchase all of the warrants to purchase their common stock currently held by MCG at a
specified price. This option expired on March 31, 2006.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) |  | In March 2006, I-55 Internet Services, Inc. merged with XFone, Inc.
|---- |  | -------------------------------------------------------------------

|(11) |  | In March 2006, a subsidiary of JupiterKagan, Inc., a majority-owned controlled portfolio company, purchased the JupiterResearch division of Jupitermedia Corporation. At
December 31, 2005, Kagan Research, LLC was a consolidated subsidiary of MCG.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) |  | Some or all of this security has been pledged as collateral in one or more of MCGs credit facilities. See Note 3 to the Consolidated Financial Statements.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) |  | In September 2006, Broadview Network Holdings, Inc. (Broadview) acquired ATX Communications, Inc. (ATX). In connection with the acquisition of ATX, MCG
converted its Broadview subordinated debt to Broadview preferred stock. See Note 2 to the Consolidated Financial Statements for more detail on the ATX acquisition and its impact on the Companys investment in Broadview.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



See notes to consolidated financial statements



78



---

##### Table of Contents

MCG Capital Corporation



Notes
to Consolidated Financial Statements



(in thousands,
except per share data)



Note 1Description of Business, Basis of
Presentation, and Summary of Significant Accounting Policies



Description of Business and Basis of Presentation



MCG Capital Corporation (MCG or the Company) is a solutions-focused commercial finance company providing capital and advisory services to middle market companies throughout the United States. The Company is a
non-diversified internally managed, closed-end investment company that elected to be treated as a business development company under the Investment Company Act of 1940, as amended (1940 Act).



The accompanying financial statements reflect the consolidated accounts of
MCG, including Solutions Capital I, LP, Solutions Capital GP, LLC, and MCGs special purpose financing subsidiaries, MCG Finance I, LLC, MCG Finance II, LLC, MCG Finance III, LLC, MCG Finance IV, LLC, MCG Finance V, LLC, MCG Finance VI, LLC,
MCG Finance VII, LLC, and MCG Finance VIII, LLC, with all significant intercompany balances eliminated. In accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, the Company does not
consolidate portfolio company investments, including those in which it has a controlling interest. Prior to January 1, 2006, Kagan Research, LLC was one of the Companys consolidated subsidiaries. During the first quarter of 2006, Kagan
Research, LLC and Jupiter Research, LLC merged to create JupiterKagan, Inc., which is reflected on the Companys schedule of investments.



Use of estimates



The accompanying financial statements are prepared in conformity with accounting principles generally accepted in the United States. This requires
management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.



Summary of Significant Accounting Policies



Income Recognition



Interest and dividend income



Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. When a loan becomes 90 days or more past
due, or if MCG otherwise does not expect the customer to be able to service its debt and other obligations, MCG will, as a general matter, place the loan on non-accrual status and cease recognizing interest income on that loan until all principal
has been paid. However, MCG may make exceptions to this policy if the investment has sufficient collateral value and is in the process of collection.



Dividend income on equity investments that have stated accruing dividend rates is recorded on the accrual basis to the extent that such amounts are
expected to be collected. Dividend income on common equity investments is recorded when declared and paid.



Contractual paid-in-kind (PIK) interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of
the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. MCG will generally cease accruing PIK if there is insufficient value to support the accrual or it does not expect the customer to be
able to pay all principal and interest due.



Loan origination
fees are capitalized and then amortized into interest income using the effective interest rate method. In certain loan arrangements, warrants or other equity interests are received from the borrower as



79



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



additional origination fees. The borrowers granting these interests are typically non-publicly traded companies. MCG records the financial instruments
received at fair value as determined by MCGs board of directors. Fair values are determined using various valuation models which estimate the underlying value of the associated entity. These models are then applied to MCGs ownership
share considering any discounts for transfer restrictions or other terms which impact the value. Changes in these values are recorded through MCGs statement of operations. Any resulting discount on the loan from recordation of warrant and
other equity instruments are accreted into income over the term of the loan.



Other income



Advisory fees and other income
is related to advisory and management services, equity structuring fees, prepayment fees, research revenues, bank interest, and other fees. Advisory and management services fees are recognized when earned. Equity structuring fees are recognized as
earned, which is generally when the investment transaction closes. Prepayment fees are recognized upon receipt.



Securitization Transactions



Periodically, MCG transfers pools of loans to bankruptcy remote, special purpose entities for use in securitization transactions. These transfers of loans
are treated as secured borrowing financing arrangements in accordance with FASB SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.



Cash and Cash Equivalents



Cash and cash equivalents as presented in the balance sheet and the
statement of cash flows includes bank checking accounts, highly liquid investments with original maturities of 90 days or less, and interest bearing deposits collateralized by marketable debt securities.



Cash, Securitization Accounts



Cash, securitization accounts includes amounts held in designated bank
accounts representing principal and interest payments received on securitized loans or other reserved amounts associated with the Companys securitization facilities. The Company is required to use these amounts to pay interest expense, reduce
borrowings, or pay other amounts in accordance with the related securitization agreements.



Cash, Restricted



Cash, restricted includes cash that was received in exchange for the sale of an asset that is currently held in escrow.



Investments



The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, Control Investments are
defined as investments in companies in which MCG owns more than 25% of the voting securities or maintains greater than 50% of the board representation. Under the 1940 Act, Affiliate Investments are defined as those non-control
investments in companies in which MCG owns between 5% and 25% of the voting securities. Under the 1940 Act, Non-affiliate Investments are defined as investments that are neither Control Investments nor Affiliate Investments.



80



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



All investments are carried at fair value with any adjustments recorded in the statement of
operations as investment gains (losses)unrealized. The Company determines the value of each investment in its portfolio on a quarterly basis. Value, as defined in Section 2(a)(41) of the Investment Company Act of 1940, is (i) the
market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the board of directors. Since there is typically no readily available
market value for the investments in the Companys portfolio, the Company values substantially all of its investments at fair value as determined in good faith by the board of directors pursuant to a valuation policy and a consistent valuation
process. At December 31, 2006, approximately 95% of the Companys total assets represented investments of which approximately 97% are valued at fair value and approximately 3% are valued at market value based on readily ascertainable
public market quotes at December 31, 2006. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Companys investments determined in good
faith by the board of directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.



There is no single standard for determining fair value in good faith. As a result, determining fair value requires that
judgment be applied to the specific facts and circumstances of each portfolio investment. Unlike banks, the Company is not permitted to provide a general reserve for anticipated loan losses. Instead, the Company must determine the fair value of each
individual investment on a quarterly basis and record changes in fair value as unrealized appreciation or depreciation on investments in its statement of operations.



As a business development company, the Company invests primarily in illiquid securities including debt and equity securities
of private companies. The structure of each debt and equity security is specifically negotiated to enable us to protect our investment and maximize our returns. The Company generally includes many terms governing interest rate, repayment terms,
prepayment penalties, financial covenants, operating covenants, ownership and corporate governance parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. In some cases, the Companys loan agreements
also allow for increases in the spread to the base index rate if the financial or operational performance of the customer deteriorates or shows negative variances from the customers business plan and, in some cases, allow for decreases in the
spread if financial or operational performance improves or exceeds the customers plan. The Companys investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type of
investments that the Company makes and the nature of its business, the Companys valuation process requires an analysis of various factors. The Companys fair value methodology includes the examination of, among other things, the
underlying investment performance, financial condition and market changing events that impact valuation.



The Company bases the fair value of its investments on the enterprise value of the portfolio companies in which it invests. The enterprise value is the
value at which an enterprise could be sold in a transaction between two willing parties other than through a forced or liquidation sale. Typically, private companies are bought and sold based on multiples of EBITDA, cash flows, net income, revenues,
or in limited cases, book value. There is no single methodology for determining enterprise value and for any one portfolio company enterprise value is generally described as a range of values from which a single estimate of enterprise value is
derived. In determining the enterprise value of a portfolio company, the Company analyzes the portfolio companys historical and projected financial results. The Company generally prepares discounted cash flow models based on its projections of
the future free cash flows of the business and industry derived capital costs. The Company reviews external events, including private mergers and acquisitions, and includes these events in the enterprise valuation process. The Company also uses
industry valuation benchmarks and reviews public market



81



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



comparables. In certain cases, the Company retains independent valuation firms to perform valuations that it considers as part of its determination of
portfolio company value. When an external event such as a purchase transaction, public offering, or subsequent debt or equity sale occurs, the pricing indicated by the external event may be used to corroborate the Companys estimate of
enterprise value.



For loans and debt securities, if there is
adequate enterprise value to support the repayment of the Companys debt then the fair value of its loan or debt security typically corresponds to cost unless the borrowers condition or other factors lead to a determination of fair value
at a different amount. The fair value of the Companys equity investments is determined based on various factors including the enterprise value remaining for equity holders after the repayment of the portfolio companys debt and other
preference capital, as well as other pertinent factors such as recent offers to purchase a portfolio company, recent sales of the portfolio companys equity securities, recent liquidation events or other events. The investment value is
discounted if it is illiquid in nature and/or a minority, non-control position.



During the fourth quarter of 2006, in connection with its process for determining fair value as of December 31, 2006, the Company retained two independent valuation firms to perform independent valuations of
certain of its portfolio companies. These valuations were considered by the board of directors in their determination of fair value. The Company intends to continue to utilize independent valuation consultants to obtain additional support in the
preparation of our internal valuation analyses each quarter.



Securities that are traded in the over-the-counter market or on a stock exchange generally will be valued at the prevailing bid price on the date of the relevant period end. However, restricted or thinly traded public securities may be
valued at discounts from the public market value due to the restrictions on sale.



Debt Issuance Costs



Debt issuance costs represent fees and other direct incremental costs incurred in connection with the Companys borrowings. These costs are amortized into the consolidated statement of operations as interest expense ratably over the
contractual term of the borrowing using the effective interest method.



Share-based Compensation



The Company
recognizes share based compensation in accordance with FASB Statement No. 123 (revised 2004), Share-Based Payment, (SFAS No. 123R), which it adopted effective January 1, 2006 using the modified prospective
method. Effective January 1, 2006, unearned compensation amounts previously recorded as a separate component of equity on the Companys balance sheet are included in paid-in capital. In accordance with FAS 123R, the Company recognizes
compensation cost related to share based awards for which forfeiture provisions are expected to lapse over the requisite service period.



Prior to January 1, 2006, the Company accounted for share based compensation in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees. The adoption of SFAS No. 123R did not impact the Companys net operating income before investment gains and losses, net income, cash flows from operations, cash flows from financing
activities, or basic and diluted earnings per share. See Note 9 for further discussion of the Companys share based compensation.



Income Taxes



The Company currently qualifies as a regulated investment company (a RIC) for federal income tax purposes, which allows it to avoid paying
corporate income taxes on any income or gains that it distributes to its



82



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



shareholders. The Company has distributed and intends to distribute sufficient dividends to eliminate taxable income. The Company may also be subject to
federal excise tax if it does not distribute at least 98% of its investment company taxable income in any calendar year and 98% of its capital gain net income in any calendar year.



The Company has certain wholly owned taxable subsidiaries (the Taxable Subsidiaries), each of which holds one or
more of the Companys portfolio investments that are listed on the Consolidated Schedule of Investments. The Taxable Subsidiaries are consolidated with the Company for GAAP purposes, such that the Companys consolidated financial
statements reflect its investments in the portfolio companies owned by the Taxable Subsidiaries. The purpose of the Taxable Subsidiaries is to permit the Company to hold portfolio companies that are organized as limited liability companies
(LLCs) (or other forms of passthrough entities) and still satisfy the RIC tax requirement that at least 90% of the Companys gross revenue for income tax purposes must consist of investment income. Absent the Taxable
Subsidiaries, a proportionate amount of any gross income of an LLC (or other passthrough entity) portfolio investment would flow through directly to the Company. To the extent that such income did not consist of investment income, it could
jeopardize the ability of the Company to qualify as a RIC and therefore cause the Company to incur significant amounts of federal income taxes. Where the LLCs (or other pass-through entities) are owned by the Taxable Subsidiaries, however, their
income is taxed to the Taxable Subsidiaries and does not flow through to the Company, thereby helping the Company preserve its RIC status and resultant tax advantages. The Taxable Subsidiaries are not consolidated with the Company for income tax
purposes and may generate income tax expense as a result of their ownership of the portfolio companies. This income tax expense, if any, is reflected in the Companys Consolidated Statement of Operations.



Earnings Per Share



Basic earnings per share is computed by dividing net income applicable to
common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share is computed by dividing such net income by the sum of the weighted average number of shares outstanding for the
period and the dilutive impact of restricted stock for which forfeiture provisions have not lapsed.



Goodwill



The Company records goodwill in accordance with FASB Statement No. 142, Goodwill and Other Intangible Assets (SFAS
No. 142). As of December 31, 2006 and December 31, 2005, the balance of goodwill was $3,851 and $6,224, respectively, and is included in other assets on the Consolidated Balance Sheets. In accordance with SFAS No. 142, the
Company has tested its intangible assets with indefinite lives for impairment and determined that there were no impairments as of those dates.



Reclassifications



Certain prior period information has been reclassified to conform to current year presentation.



Recent Accounting Pronouncements



In December 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment (SFAS No. 123R), which replaced SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be
recognized in the financial



83



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



statements based on their fair values. SFAS No. 123R is effective beginning with the first interim period of the fiscal year beginning after
June 15, 2005. MCG adopted SFAS No. 123R effective January 1, 2006. See Note 9, Share Based Compensation.



In June 2006, the FASB issued FASB Interpretation No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxesan
interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes.
FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 will be effective as of the last day of the first reporting period beginning after December 15, 2006, which is
March 31, 2007.



The Company has conducted a review of all
open tax years income recognition and expense deduction filing positions and income tax returns filed (federal and state) for determination of any uncertain tax positions that may require recognition of a tax liability. This review encompassed
an analysis of all book/tax difference adjustments as well as the timing of income and expense recognition for all tax years still open under the statute of limitations. As a result, the Company has determined that it is more likely than not that
each tax position taken on a previously filed return or to be taken on current tax returns will be sustained on examination based on the technical merits of the positions and therefore, no recognition of a tax liability on an uncertain tax position
for FIN No. 48 purposes is anticipated.



In September
2006, the FASB issued SFAS No. 157 (SFAS No. 157), Fair Value Measurements. Among other requirements, SFAS No. 157 defines fair value and establishes a framework for measuring fair value and also expands
disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 is effective for the first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of SFAS No. 157 on its
financial position and results of operations.



Note 2Investments



The composition of MCGs investments as of
December 31, 2006 and 2005, at cost, was as follows, excluding unearned income:



|                                 |  |                    |           |                              |                   |   |                    |   |                              |  |       |  
|-------------------------------- |  | ------------------ | --------- | ---------------------------- | ----------------- | - | ------------------ | - | ---------------------------- |  | ----- | -
|                                 |  | December 31, 2006  |           |                              | December 31, 2005 |  
|                                 |  | Investments atCost |           | Percentage ofTotal Portfolio |                   |   | Investments atCost |   | Percentage ofTotal Portfolio | 
|Secured senior debt              |  | $                  | 384,490   |                              | 30.9              | % |                    | $ | 544,449                      |  | 48.7  | %
|Subordinated debt                |  |                    |           |                              |                   |   |                    |   |                              |  |       |  
|Secured                          |  |                    | 506,681   |                              | 40.8              |   |                    |   | 333,080                      |  | 29.8  |  
|Unsecured                        |  |                    | 25,233    |                              | 2.0               |   |                    |   | 61,557                       |  | 5.5   |  
|                                 |  |                    |           |                              |                   |   |                    |   |                              |  |       |  
|Total debt investments           |  |                    | 916,404   |                              | 73.7              |   |                    |   | 939,086                      |  | 84.0  |  
|                                 |  |                    |           |                              |                   |   |                    |   |                              |  |       |  
|Preferred equity                 |  |                    | 296,942   |                              | 23.9              |   |                    |   | 146,905                      |  | 13.1  |  
|Common/Common equivalents equity |  |                    | 29,359    |                              | 2.4               |   |                    |   | 31,266                       |  | 2.9   |  
|                                 |  |                    |           |                              |                   |   |                    |   |                              |  |       |  
|Total equity investments         |  |                    | 326,301   |                              | 26.3              |   |                    |   | 178,171                      |  | 16.0  |  
|                                 |  |                    |           |                              |                   |   |                    |   |                              |  |       |  
|Total                            |  | $                  | 1,242,705 |                              | 100.0             | % |                    | $ | 1,117,257                    |  | 100.0 | %
|                                 |  |                    |           |                              |                   |   |                    |   |                              |  |       |  



84



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



The composition of MCGs investments as of December 31, 2006 and 2005, at fair value, was
as follows, excluding unearned income:



|                                 |  |                          |           |                              |                   |   |                          |   |                              |  |       |  
|-------------------------------- |  | ------------------------ | --------- | ---------------------------- | ----------------- | - | ------------------------ | - | ---------------------------- |  | ----- | -
|                                 |  | December 31, 2006        |           |                              | December 31, 2005 |  
|                                 |  | Investments atFair Value |           | Percentage ofTotal Portfolio |                   |   | Investments atFair Value |   | Percentage ofTotal Portfolio | 
|Secured senior debt              |  | $                        | 389,721   |                              | 31.0              | % |                          | $ | 542,981                      |  | 49.5  | %
|Subordinated debt                |  |                          |           |                              |                   |   |                          |   |                              |  |       |  
|Secured                          |  |                          | 494,992   |                              | 39.3              |   |                          |   | 329,498                      |  | 30.0  |  
|Unsecured                        |  |                          | 24,666    |                              | 2.0               |   |                          |   | 61,557                       |  | 5.6   |  
|                                 |  |                          |           |                              |                   |   |                          |   |                              |  |       |  
|Total debt investments           |  |                          | 909,379   |                              | 72.3              |   |                          |   | 934,036                      |  | 85.1  |  
|                                 |  |                          |           |                              |                   |   |                          |   |                              |  |       |  
|Preferred equity                 |  |                          | 285,150   |                              | 22.7              |   |                          |   | 126,664                      |  | 11.5  |  
|Common/Common equivalents equity |  |                          | 63,083    |                              | 5.0               |   |                          |   | 36,860                       |  | 3.4   |  
|                                 |  |                          |           |                              |                   |   |                          |   |                              |  |       |  
|Total equity investments         |  |                          | 348,233   |                              | 27.7              |   |                          |   | 163,524                      |  | 14.9  |  
|                                 |  |                          |           |                              |                   |   |                          |   |                              |  |       |  
|Total                            |  | $                        | 1,257,612 |                              | 100.0             | % |                          | $ | 1,097,560                    |  | 100.0 | %
|                                 |  |                          |           |                              |                   |   |                          |   |                              |  |       |  



The Companys
debt instruments generally provide for a contractual variable interest rate generally ranging from approximately 10% to 16%, a portion of which may be deferred. At December 31, 2006, approximately 64% of loans in the portfolio, based on amounts
outstanding at fair value, were at variable rates determined on the basis of a benchmark LIBOR or prime rate and approximately 36% were at fixed rates. In addition, at December 31, 2006, approximately 31% of the loan portfolio has floors of
between 1.50% and 3.0% on the LIBOR base index. The Companys loans generally have stated maturities at origination that range from four to eight years. Customers typically pay an origination fee based on a percentage of the commitment amount.
They also often pay a fee based on any undrawn commitments.



When one of the Companys loans becomes 90 days or more past due, or if the Company otherwise does not expect the customer to be able to service its debt and other obligations, the Company will, as a general matter, place the loan on
non-accrual status and will generally cease recognizing interest income on that loan until all past due principal and interest has been paid or otherwise restructured such that the interest income is determined to be collectible. The Company may
make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. The following table summarizes our loans greater than 90 days past due and loans on non-accrual status, at fair value, at
December 31, 2006 and December 31, 2005:



|                                                             |  |                   |        |                    |                   |   |                     |      |   |           |   |                    |  |      |                     |  |      |  
|------------------------------------------------------------ |  | ----------------- | ------ | ------------------ | ----------------- | - | ------------------- | ---- | - | --------- | - | ------------------ |  | ---- | ------------------- |  | ---- | -
|                                                             |  | December 31, 2006 |        |                    | December 31, 2005 |  
|                                                             |  | FairValue         |        | % of LoanPortfolio |                   |   | % of TotalPortfolio |      |   | FairValue |   | % of LoanPortfolio |  |      | % of TotalPortfolio | 
|Loans greater than 90 days past due                          |  |                   |        |                    |                   |   |                     |      |   |           |   |                    |  |      |                     |  |      |  
|On non-accrual status                                        |  | $                 | 20,129 |                    | 2.21              | % |                     | 1.60 | % |           | $ | 3,218              |  | 0.34 | %                   |  | 0.29 | %
|Not on non-accrual status                                    |  |                   | 1,798  |                    | 0.20              | % |                     | 0.14 | % |           |   | 13,553             |  | 1.45 | %                   |  | 1.23 | %
|                                                             |  |                   |        |                    |                   |   |                     |      |   |           |   |                    |  |      |                     |  |      |  
|Total loans greater than 90 days past due                    |  | $                 | 21,927 |                    | 2.41              | % |                     | 1.74 | % |           | $ | 16,771             |  | 1.79 | %                   |  | 1.52 | %
|                                                             |  |                   |        |                    |                   |   |                     |      |   |           |   |                    |  |      |                     |  |      |  
|Loans on non-accrual status                                  |  |                   |        |                    |                   |   |                     |      |   |           |   |                    |  |      |                     |  |      |  
|0 to 90 days past due                                        |  | $                 | 15,259 |                    | 1.68              | % |                     | 1.21 | % |           | $ | 9,522              |  | 1.02 | %                   |  | 0.87 | %
|Greater than 90 days past due                                |  |                   | 20,129 |                    | 2.21              | % |                     | 1.60 | % |           |   | 3,218              |  | 0.34 | %                   |  | 0.29 | %
|                                                             |  |                   |        |                    |                   |   |                     |      |   |           |   |                    |  |      |                     |  |      |  
|Total loans on non-accrual status                            |  | $                 | 35,388 |                    | 3.89              | % |                     | 2.81 | % |           | $ | 12,740             |  | 1.36 | %                   |  | 1.16 | %
|                                                             |  |                   |        |                    |                   |   |                     |      |   |           |   |                    |  |      |                     |  |      |  
|Loans on non-accrual status or greater than 90 days past due |  | $                 | 37,186 |                    | 4.09              | % |                     | 2.95 | % |           | $ | 26,293             |  | 2.81 | %                   |  | 2.39 | %



85



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



Set forth below are tables showing the composition of MCGs portfolio by industry (excluding
unearned income) at cost and fair value as of December 31, 2006 and 2005:



|                                                               |  |                    |           |                              |                   |   |                       |   |                                 |  |       |  
|-------------------------------------------------------------- |  | ------------------ | --------- | ---------------------------- | ----------------- | - | --------------------- | - | ------------------------------- |  | ----- | -
|                                                               |  | December 31, 2006  |           |                              | December 31, 2005 |  
|                                                               |  | Investments atCost |           | Percentage ofTotal Portfolio |                   |   | Investments atCost(a) |   | Percentage ofTotal Portfolio(a) | 
|TelecommunicationsCLECs (competitive local exchange carriers) |  | $                  | 280,394   |                              | 22.6              | % |                       | $ | 221,433                         |  | 19.8  | %
|Other Communications                                           |  |                    | 81,605    |                              | 6.6               |   |                       |   | 71,725                          |  | 6.4   |  
|Healthcare                                                     |  |                    | 106,967   |                              | 8.6               |   |                       |   | 89,532                          |  | 8.0   |  
|Newspaper                                                      |  |                    | 89,760    |                              | 7.2               |   |                       |   | 112,645                         |  | 10.1  |  
|Publishing                                                     |  |                    | 71,623    |                              | 5.8               |   |                       |   | 86,307                          |  | 7.7   |  
|Laboratory Instruments                                         |  |                    | 57,868    |                              | 4.6               |   |                       |   | 52,053                          |  | 4.7   |  
|Plastic Products                                               |  |                    | 57,052    |                              | 4.6               |   |                       |   |                                |  |      |  
|Home Furnishings                                               |  |                    | 53,696    |                              | 4.3               |   |                       |   | 19,156                          |  | 1.7   |  
|Business Services                                              |  |                    | 51,765    |                              | 4.2               |   |                       |   | 22,225                          |  | 2.0   |  
|Information Services                                           |  |                    | 48,379    |                              | 3.9               |   |                       |   | 75,476                          |  | 6.8   |  
|Cable                                                          |  |                    | 38,711    |                              | 3.1               |   |                       |   | 33,275                          |  | 3.0   |  
|Broadcasting                                                   |  |                    | 38,440    |                              | 3.1               |   |                       |   | 36,859                          |  | 3.3   |  
|DVD Rental                                                     |  |                    | 28,567    |                              | 2.3               |   |                       |   |                                |  |      |  
|Sporting Goods                                                 |  |                    | 26,920    |                              | 2.2               |   |                       |   |                                |  |      |  
|Education                                                      |  |                    | 26,740    |                              | 2.1               |   |                       |   | 19,337                          |  | 1.7   |  
|Electronics                                                    |  |                    | 24,682    |                              | 2.0               |   |                       |   | 34,087                          |  | 3.0   |  
|Other Media                                                    |  |                    | 22,497    |                              | 1.8               |   |                       |   | 32,774                          |  | 2.9   |  
|Food Services                                                  |  |                    | 21,204    |                              | 1.7               |   |                       |   |                                |  |      |  
|Technology                                                     |  |                    | 19,430    |                              | 1.6               |   |                       |   | 58,895                          |  | 5.3   |  
|Retail                                                         |  |                    | 19,158    |                              | 1.5               |   |                       |   | 20,472                          |  | 1.8   |  
|Auto Parts                                                     |  |                    | 16,997    |                              | 1.4               |   |                       |   | 17,003                          |  | 1.5   |  
|Drugs                                                          |  |                    | 15,569    |                              | 1.2               |   |                       |   | 28,717                          |  | 2.6   |  
|Leisure Activities                                             |  |                    | 14,314    |                              | 1.2               |   |                       |   | 13,403                          |  | 1.2   |  
|Photographic Studio                                            |  |                    | 12,897    |                              | 1.0               |   |                       |   |                                |  |      |  
|Cosmetics                                                      |  |                    | 6,755     |                              | 0.5               |   |                       |   | 11,377                          |  | 1.0   |  
|Car Rental                                                     |  |                    |          |                              |                  |   |                       |   | 13,500                          |  | 1.2   |  
|Other(b)                                                       |  |                    | 10,715    |                              | 0.9               |   |                       |   | 47,006                          |  | 4.3   |  
|                                                               |  |                    |           |                              |                   |   |                       |   |                                 |  |       |  
|                                                               |  | $                  | 1,242,705 |                              | 100.0             | % |                       | $ | 1,117,257                       |  | 100.0 | %
|                                                               |  |                    |           |                              |                   |   |                       |   |                                 |  |       |  

---

|(a) |  | Certain amounts have been reclassified into different industries to conform to the current period industry classification.
|--- |  | --------------------------------------------------------------------------------------------------------------------------

|(b) |  | No individual industry within this category exceeds 1%.
|--- |  | -------------------------------------------------------





86



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



|                                                               |                          |                   |                              |  |                   |                             |  |                                 |           |  |       |  
|-------------------------------------------------------------- | ------------------------ | ----------------- | ---------------------------- |  | ----------------- | --------------------------- |  | ------------------------------- | --------- |  | ----- | -
|                                                               |                          | December 31, 2006 |                              |  | December 31, 2005 |                            
|                                                               | Investments atFair Value |                   | Percentage ofTotal Portfolio |  |                   | Investments atFair Value(a) |  | Percentage ofTotal Portfolio(a) |          
|TelecommunicationsCLECs (competitive local exchange carriers) |                          | $                 | 274,108                      |  | 21.8              | %                           |  | $                               | 213,379   |  | 19.4  | %
|Other Communications                                           |                          |                   | 83,988                       |  | 6.7               |                             |  |                                 | 68,846    |  | 6.3   |  
|Healthcare                                                     |                          |                   | 106,519                      |  | 8.5               |                             |  |                                 | 91,040    |  | 8.4   |  
|Newspaper                                                      |                          |                   | 90,640                       |  | 7.2               |                             |  |                                 | 112,826   |  | 10.3  |  
|Publishing                                                     |                          |                   | 68,020                       |  | 5.4               |                             |  |                                 | 72,280    |  | 6.6   |  
|Laboratory Instruments                                         |                          |                   | 58,402                       |  | 4.6               |                             |  |                                 | 52,052    |  | 4.7   |  
|Plastic Products                                               |                          |                   | 57,052                       |  | 4.5               |                             |  |                                 |          |  |      |  
|Home Furnishings                                               |                          |                   | 52,512                       |  | 4.2               |                             |  |                                 | 18,878    |  | 1.7   |  
|Business Services                                              |                          |                   | 51,230                       |  | 4.1               |                             |  |                                 | 22,225    |  | 2.1   |  
|Information Services                                           |                          |                   | 47,440                       |  | 3.8               |                             |  |                                 | 75,444    |  | 6.9   |  
|Broadcasting                                                   |                          |                   | 39,851                       |  | 3.2               |                             |  |                                 | 31,953    |  | 2.9   |  
|Cable                                                          |                          |                   | 38,711                       |  | 3.1               |                             |  |                                 | 33,275    |  | 3.0   |  
|Technology                                                     |                          |                   | 36,188                       |  | 2.9               |                             |  |                                 | 66,103    |  | 6.0   |  
|Education                                                      |                          |                   | 30,987                       |  | 2.5               |                             |  |                                 | 19,479    |  | 1.8   |  
|DVD Rental                                                     |                          |                   | 28,567                       |  | 2.3               |                             |  |                                 |          |  |      |  
|Sporting Goods                                                 |                          |                   | 26,920                       |  | 2.1               |                             |  |                                 |          |  |      |  
|Electronics                                                    |                          |                   | 24,834                       |  | 2.0               |                             |  |                                 | 34,087    |  | 3.1   |  
|Other Media                                                    |                          |                   | 24,110                       |  | 1.9               |                             |  |                                 | 33,876    |  | 3.1   |  
|Food Services                                                  |                          |                   | 21,204                       |  | 1.7               |                             |  |                                 |          |  |      |  
|Retail                                                         |                          |                   | 19,353                       |  | 1.5               |                             |  |                                 | 20,472    |  | 1.9   |  
|Auto Parts                                                     |                          |                   | 17,198                       |  | 1.4               |                             |  |                                 | 17,003    |  | 1.5   |  
|Drugs                                                          |                          |                   | 15,569                       |  | 1.2               |                             |  |                                 | 28,717    |  | 2.6   |  
|Leisure Activities                                             |                          |                   | 14,314                       |  | 1.1               |                             |  |                                 | 13,403    |  | 1.2   |  
|Photographic Studio                                            |                          |                   | 12,897                       |  | 1.0               |                             |  |                                 |          |  |      |  
|Cosmetics                                                      |                          |                   | 6,272                        |  | 0.5               |                             |  |                                 | 11,349    |  | 1.0   |  
|Car Rental                                                     |                          |                   |                             |  |                  |                             |  |                                 | 13,500    |  | 1.2   |  
|Other(b)                                                       |                          |                   | 10,726                       |  | 0.8               |                             |  |                                 | 47,373    |  | 4.3   |  
|                                                               |                          |                   |                              |  |                   |                             |  |                                 |           |  |       |  
|                                                               |                          | $                 | 1,257,612                    |  | 100.0             | %                           |  | $                               | 1,097,560 |  | 100.0 | %
|                                                               |                          |                   |                              |  |                   |                             |  |                                 |           |  |       |  

---

|(a) |  | Certain amounts have been reclassified into different industries to conform to the current period industry classification.
|--- |  | --------------------------------------------------------------------------------------------------------------------------

|(b) |  | No individual industry within this category exceeds 1%.
|--- |  | -------------------------------------------------------



87



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



Note 3Borrowings



The following is a summary of the borrowings for the years ended December 31, 2006, and 2005:



|                                           |  |                   |         |                   |   |                |  |                   |         |  |   |        
|------------------------------------------ |  | ----------------- | ------- | ----------------- | - | -------------- |  | ----------------- | ------- |  | - | -------
|                                           |  | December 31, 2006 |         | December 31, 2005
|                                           |  | Facilityamount    |         | Amountoutstanding |   | Facilityamount |  | Amountoutstanding
|Unsecured Notes                            |  | $                 | 50,000  |                   | $ | 50,000         |  | $                 | 50,000  |  | $ | 50,000 
|Commercial Loan Trust 2005-2               |  |                   |        |                   |   |               |  |                   | 250,000 |  |   | 159,181
|Commercial Loan Trust 2006-2               |  |                   | 200,000 |                   |   | 84,040         |  |                   |        |  |   |       
|Commercial Loan Funding Trust Facility     |  |                   | 250,000 |                   |   | 83,943         |  |                   | 250,000 |  |   | 160,000
|Term Securitizations                       |  |                   |         |                   |   |                |  |                   |         |  |   |        
|Series 2004-1 Class A-1 Asset Backed Bonds |  |                   |        |                   |   |               |  |                   | 81,138  |  |   | 81,138 
|Series 2004-1 Class A-2 Asset Backed Bonds |  |                   |        |                   |   |               |  |                   | 31,500  |  |   | 31,500 
|Series 2004-1 Class B Asset Backed Bonds   |  |                   |        |                   |   |               |  |                   | 43,500  |  |   | 43,500 
|Series 2004-1 Class C Asset Backed Bonds   |  |                   |        |                   |   |               |  |                   | 15,800  |  |   | 15,800 
|Series 2006-1 Class A-1 Notes              |  |                   | 106,250 |                   |   | 106,250        |  |                   |        |  |   |       
|Series 2006-1 Class A-2 Notes              |  |                   | 50,000  |                   |   | 11,400         |  |                   |        |  |   |       
|Series 2006-1 Class A-3 Notes              |  |                   | 85,000  |                   |   | 35,000         |  |                   |        |  |   |       
|Series 2006-1 Class B Notes                |  |                   | 58,750  |                   |   | 58,750         |  |                   |        |  |   |       
|Series 2006-1 Class C Notes                |  |                   | 45,000  |                   |   | 45,000         |  |                   |        |  |   |       
|Series 2006-1 Class D Notes                |  |                   | 47,500  |                   |   | 47,500         |  |                   |        |  |   |       
|Revolving Unsecured Credit Facility        |  |                   | 100,000 |                   |   |               |  |                   | 50,000  |  |   |       
|                                           |  |                   |         |                   |   |                |  |                   |         |  |   |        
|Total                                      |  | $                 | 992,500 |                   | $ | 521,883        |  | $                 | 771,938 |  | $ | 541,119
|                                           |  |                   |         |                   |   |                |  |                   |         |  |   |        



All of the
Companys debt facilities, except the Revolving Unsecured Credit Facility and the Unsecured Notes, are funded through the Companys bankruptcy remote, special purpose, wholly owned subsidiaries and, therefore, the assets of these
subsidiaries may not be available to the Companys creditors. In some cases, advances under the Companys debt facilities are subject to certain other covenants, including having sufficient levels of collateral and various restrictions on
which loans the Company may leverage as collateral. The Company borrows directly as well as indirectly through credit facilities maintained by its subsidiaries.



Unsecured Notes.    On October 11, 2005, the Company issued $50,000 of investment grade five-year unsecured notes in a
private placement. The notes were rated BBB- by Fitch Ratings, Inc. and have a fixed interest rate of 6.73% per year payable semi-annually. Bayerische Hypo-Und Vereinsbank, AG, New York Branch (HVB) acted as the
placement agent for the issuance.



Commercial Loan Trust
2006-2.    On May 2, 2006 the Company established, through MCG Commercial Loan Trust 2006-2, a $200,000 warehouse credit facility with Merrill Lynch Capital Corp. The warehouse credit facility allows MCG Commercial Loan
Trust 2006-2 to acquire up to $250,000 of commercial loans with borrowings of up to $200,000 subject to certain covenants, concentration limitations and other restrictions. The warehouse credit facility is primarily secured by the assets of MCG
Commercial Loan Trust 2006-2, including the commercial loans purchased by the trust from the Company. Under the terms of the credit and warehouse agreement, the loans may be senior secured loans, second lien loans or unsecured loans, as defined in
the agreement, subject to certain limitations. Up to 60% of the collateral in this warehouse facility may be non-senior secured loans, and the remaining 40% must be senior secured loans.



88



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



The Company uses this facility to fund the origination of loans that will collateralize a future term
securitization. Advances under the facility, equal to 80% of the value of commercial loans purchased by the trust, bear interest based on LIBOR plus 0.75% and interest is payable monthly. The facility is scheduled to terminate on the earlier of
November 30, 2007 or the completion of a term securitization and may be extended under certain circumstances. As of December 31, 2006 the Company had $84,040 outstanding under this facility.



MCG Commercial Loan Funding Trust.    On
November 10, 2004, the Company established, through MCG Commercial Loan Funding Trust, a $150,000 warehouse financing facility funded through Three Pillars Funding LLC, an asset-backed commercial paper conduit administered by SunTrust Capital
Markets, Inc. The warehouse financing facility operates like a revolving credit facility that is primarily secured by the assets of MCG Commercial Loan Funding Trust, including commercial loans sold by the Company to the trust. The pool of
commercial loans in the trust must meet certain requirements, including, but not limited to, term, average life, investment rating, agency rating and industry diversity requirements. There are also certain requirements relating to portfolio
performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs. Such limitations, requirements, and associated defined terms are as provided for in the documents governing the facility. Through July 29,
2005, advances under the facility bore interest based on a commercial paper rate plus 1.15%.



On July 29, 2005, the Company amended the MCG Commercial Loan Funding Trust facility. Pursuant to this amendment, the total facility amount was increased from $150,000 to $250,000, the interest rate was changed
from commercial paper rate plus 1.15% to commercial paper rate plus 0.95%, the concentration criteria were modified to allow, among other things, for an increase in the allowable percentage of certain secured subordinated loans in the collateral
pool from 25% to 35%, and other minor modifications were made. On April 17, 2006 the Company again amended this facility to allow, among other things, for an increase in the allowable percentage of certain secured subordinated loans in the
collateral pool from 35% to 50% and the inclusion of additional industry segments. The facility is scheduled to terminate on November 7, 2007, but is subject to annual renewal and may be extended under certain circumstances. During July 2006,
the facility was renewed until July 27, 2007. As of December 31, 2006, the Company had $83,943 outstanding under this credit facility. See Note 13  Subsequent Events for further discussion.



Commercial Loan Trust 2006-1.    On April 18,
2006, the Company completed a $500,000 debt securitization through MCG Commercial Loan Trust 2006-1, its wholly owned subsidiary. The 2006-1 Trust issued $106,250 of Class A-1 Notes rated AAA / Aaa, $50,000 of Class A-2 Notes rated AAA /
Aaa, $85,000 of Class A-3 Notes rated AAA / Aaa, $58,750 of Class B Notes rated AA / Aa2, $45,000 of Class C Notes rated A / A2 and $47,500 of Class D Notes rated BBB / Baa2 as rated by Moodys and S&P, respectively. The Series 2006-1
Class A-1 Notes, Class A-2 Notes, Class A-3 Notes, Class B Notes, Class C Notes and Class D Notes bear interest of LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%, respectively.



The Company retains all of the equity in the securitization. The
securitization includes a reinvestment period of five years, during which principal collections received on the underlying collateral may be used to purchase new collateral from the Company. Under the terms of the securitization, up to 55% of the
collateral may be non-senior secured commercial loans and the remaining 45% must be senior secured commercial loans.



The Class A-1, Class B, Class C and Class D Notes are term notes. The Class A-2 Notes are a revolving class of secured notes and have a
revolving period of five years. The Class A-3 Notes are a delayed draw class of secured notes and are required to be drawn by April 2007. All of the notes are secured by the assets of MCG Commercial Loan Trust 2006-1, including commercial loans
totaling $408,562 as of December 31, 2006, which



89



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



were purchased by the trust from the Company. Additional commercial loans will be purchased by the trust from the Company primarily using the proceeds from
the Class A-3 delayed draw notes and the Class A-2 revolving notes. The pool of commercial loans in the trust must meet certain requirements, including, but not limited to, asset mix and concentration, collateral coverage, term, agency
rating, minimum coupon, minimum spread and sector diversity requirements. As of December 31, 2006, a total of $303,900 of these notes were outstanding.



Revolving Unsecured Credit Facility.    This facility was established on September 20, 2005 as a result of an amendment to
the Companys Senior Secured Credit facility with Bayerische Hypo-Und Vereinsbank, AG, New York Branch (HVB). Pursuant to that amendment the facility was no longer secured by the Companys assets and was committed up to
$50,000. On June 19, 2006, the Company made a second amendment to this facility. Pursuant to this amendment, the aggregate revolving commitment amount under this credit facility was increased from $50,000 to $60,000, the maturity date was
extended from September 19, 2006 to June 18, 2007, and an additional lender was added to this facility. Other minor modifications were also made to this facility. HVB maintained its $50,000 commitment, and the additional $10,000 was
committed by Chevy Chase Bank. On August 7, 2006, the Company again amended this facility. Pursuant to this amendment, the aggregate revolving commitment amount under this credit facility was increased from $60,000 to $75,000, and an additional
lender was added to this facility. HVB and Chevy Chase Bank maintained their $50,000 and $10,000 commitments, respectively, and the additional $15,000 was committed by Sovereign Bank. On November 29, 2006, the Company again amended this
facility. Pursuant to this amendment, the aggregate revolving commitment amount under this credit facility was increased from $75,000 to $100,000, and an additional lender was added to this facility. HVB, Chevy Chase Bank, and Sovereign Bank
maintained their $50,000, $10,000, and $15,000 commitments, respectively, and the additional $25,000 was committed by Royal Bank of Canada.



This credit facility is unsecured and is committed up to $100,000 on a revolving basis. In addition, this Revolving Unsecured Credit Facility allows for
additional lenders with HVB acting as the agent. Advances under this credit facility bear interest at LIBOR plus 2.00% or the prime rate plus 0.50%, and there is a commitment fee of 0.25% per annum on undrawn amounts. The credit facility
contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting, minimum stockholders equity, minimum asset coverage ratio, and minimum cash net investment income. The
credit facility also contains customary events of default with customary cure and notice, including, without limitation, nonpayment, misrepresentation in a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change
of control, change of management, and material adverse change. As of December 31, 2006, the Company had no amounts outstanding under this credit facility.



Commercial Loan Trust 2005-2.    On June 9, 2005, the Company established, through MCG Commercial Loan Trust 2005-2, a
$250,000 warehouse credit facility with Merrill Lynch Capital Corp. On April 18, 2006, this facility terminated in connection with the Companys Term Securitization 2006-1. The warehouse credit facility allowed MCG Commercial Loan Trust
2005-2 to borrow up to $250,000 subject to certain covenants, concentration limitations and other restrictions. The warehouse credit facility was primarily secured by the assets of MCG Commercial Loan Trust 2005-2, including cash and commercial
loans transferred by us to the trust. Under the terms of the credit and warehouse agreement, the loans could be senior secured loans, second lien loans or unsecured loans, as defined in the agreement, subject to certain limitations, including the
requirement that at least 50% of the overall warehouse facility amount be senior secured commercial loans. Advances under the facility bore interest based on LIBOR plus 0.75% and interest was payable monthly.



Term Securitization 2004-1.    On
September 30, 2004, the Company established MCG Commercial Loan Trust 2004-1 (the 2004-1 Trust), which issued three classes of series 2004-1 Notes. The facility was structured



90



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



to hold up to $397,700 of loans. The facility was secured by all of the 2004-1 Trusts commercial loans and cash in securitization accounts, which
totaled approximately $228,047 as of December 31, 2005. On July 20, 2006, the Company repaid the 2004-1 Notes using approximately $61,868 of cash from the Commercial Loan Trust 2004-1 and its Commercial Loan Trust 2006-1 securitization and
$15,000 of new borrowings from its Commercial Loan Trust 2006-1 securitization. This facility was scheduled to terminate July 20, 2016 or sooner upon the full repayment of the Class A-1, Class A-2, Class B and Class C Notes.



The 2004-1 Trust issued $250,500 of Class A-1 Notes rated
Aaa/AAA, $31,500 of Class A-2 Notes rated Aa1/AAA, $43,500 of Class B Notes rated A2/A and $15,800 of Class C Notes rated Baa2/BBB as rated by Moodys and Fitch, respectively. On June 1, 2005, the Company sold the Class C securities,
which had previously been retained by the Company. The Series 2004-1 Class A-1 Notes, Class A-2 Notes, Class B Notes and Class C Notes bore interest of LIBOR plus 0.43%, 0.65%, 1.30%, and 2.50%, respectively.



Borrowing repayments based on the contractual principal collections of the
loans which comprise the collateral would be:



|                    |  |   |        
|------------------- |  | - | -------
|2007                |  | $ | 167,983
|2008                |  |   |       
|2009                |  |   |       
|2010                |  |   | 50,000 
|2011 and thereafter |  |   | 303,900
|                    |  |   |        
|Total               |  | $ | 521,883
|                    |  |   |        



Actual repayments
could differ significantly due to prepayments by our borrowers and modifications of our borrowers existing loan agreements.



Borrowings outstanding, by interest rate benchmark, as of December 31, 2006 and December 31, 2005 were as follows:



|                      |  |                  |         |                  |   |        
|--------------------- |  | ---------------- | ------- | ---------------- | - | -------
|                      |  | December 31,2006 |         | December 31,2005
|90-day LIBOR          |  | $                | 387,940 |                  | $ | 331,119
|Commercial paper rate |  |                  | 83,943  |                  |   | 160,000
|Fixed Rate            |  |                  | 50,000  |                  |   | 50,000 
|                      |  |                  |         |                  |   |        
|                      |  | $                | 521,883 |                  | $ | 541,119
|                      |  |                  |         |                  |   |        



Note 4Capital Stock



MCG has one class of common stock and one class of
preferred stock authorized. The Companys board of directors is authorized to provide for the issuance of shares of preferred stock in one or more series, to establish the number of shares to be included in each such series, and to fix 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.



In 2006, MCG raised $68,642 of net proceeds by selling 4,600 shares of newly issued common stock. In 2005, MCG raised
$117,015 of net proceeds by selling 8,030 shares of newly issued common stock.





91



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



The following table summarizes MCGs distributions declared since January 1, 2005:



|                  |  |                   |  |                  |  |        |     
|----------------- |  | ----------------- |  | ---------------- |  | ------ | ----
|Date Declared     |  | Record Date       |  | Payment Date     |  | Amount
|February 15, 2007 |  | March 15, 2007    |  | April 27, 2007   |  | $      | 0.44
|October 26, 2006  |  | November 22, 2006 |  | January 30, 2007 |  |        | 0.42
|July 27, 2006     |  | August 24, 2006   |  | October 30, 2006 |  |        | 0.42
|April 27, 2006    |  | May 25, 2006      |  | July 28, 2006    |  |        | 0.42
|February 16, 2006 |  | March 16, 2006    |  | April 27, 2006   |  |        | 0.42
|October 26, 2005  |  | November 23, 2005 |  | January 30, 2006 |  |        | 0.42
|July 27, 2005     |  | August 25, 2005   |  | October 28, 2005 |  |        | 0.42
|April 27, 2005    |  | May 26, 2005      |  | July 28, 2005    |  |        | 0.42
|February 23, 2005 |  | March 14, 2005    |  | April 28, 2005   |  |        | 0.42



A return of capital
for federal income tax purposes, which MCG calls a tax return of capital, of $0.67 per share, $0.22 per share and $0.53 per share occurred with respect to the fiscal years ended December 31, 2006, 2005 and 2004, respectively. Each year a
statement on Form 1099-DIV identifying the source of the dividend (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of paid-in-capital surplus which is a nontaxable distribution) is mailed to
MCGs stockholders. To the extent MCGs taxable earnings fall below the total amount of MCGs distributions for that fiscal year, a portion of those distributions may be deemed a tax return of capital to MCGs stockholders. See
Note 6  Income Taxes for further discussion.



Note
5Employee Benefit Plans



MCG sponsors a contributory
savings plan (The Plan). The Plan allows all full-time and part-time employees who work at least one thousand hours per year to participate beginning on the first day of the calendar quarter following an employees date of hire. MCG
matches a portion of the contribution made by employees, which is based upon a percent of defined compensation, to the savings plan. Expenses related to the Plan were $236, $265, and $692 for the years ended December 31, 2006, 2005, and 2004,
respectively.



MCG has created a deferred compensation plan for
certain executives that allows them to defer a portion of their salary and bonuses to an unfunded deferred compensation plan managed by MCG. Contributions to the plan earn interest at a rate of 2.00% over MCGs internal cost of funds rate, as
defined by the plan. Expenses related to the Plan were $46, $56, and $35 for the years ended December 31, 2006, 2005, and 2004, respectively.



Note 6Income Taxes



Through December 31, 2001 the Company was taxed under Subchapter C of the Internal Revenue Code. Effective January 1, 2002 the Company elected
to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code. The Companys taxable income therefore generally will not be subject to Federal taxation to the extent such taxable income is distributed to
stockholders and the Company annually meets certain qualification and minimum distribution requirements. During the year ended December 31, 2006, the Company recorded a tax provision of approximately $2,712. This tax provision is primarily
related to unrealized gains on the Companys investments.



Deferred income taxes subsequent to conversion to a business development company reflect taxes on built-in gains on equity investments, which amounted to $377, $377, and $989 at December 31, 2006, 2005, and 2004, respectively.



92



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



The tax cost basis of the Companys investments as of December 31, 2006, 2005, and 2004
approximates the book cost basis. In addition, the components of stockholders equity on a tax basis are not materially different from components of stockholders equity on a book basis for the years ended December 31, 2006, 2005, and
2004.



For income tax purposes, distributions paid to
shareholders are reported as ordinary income, return of capital, capital gains, or a combination thereof. Distributions paid per common share for the years ended December 31, 2006, 2005, and 2004 were taxable as follows:



|                                                                                                   |  |      |       |   |      |       |   |      |   |       |   |  |       |   |  |   |       |   |  |       |  
|-------------------------------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | ----- | - | ---- | - | ----- | - |  | ----- | - |  | - | ----- | - |  | ----- | -
|                                                                                                   |  | 2006 |       |   | 2005 |       |   | 2004 |  
|Dividends declared during the year                                                                 |  | $    | 1.68  |   |      |       |   |      | $ | 1.68  |   |  |       |   |  | $ | 1.68  |   |  |       |  
|Dividends declared in 2003 but treated as taxable in 2004 as required by the Internal Revenue Code |  |      |      |   |      |       |   |      |   |      |   |  |       |   |  |   | 0.42  |   |  |       |  
|Dividends declared in 2004 but treated as taxable in 2005 as required by the Internal Revenue Code |  |      |      |   |      |       |   |      |   | 0.42  |   |  |       |   |  |   | (0.42 | ) |  |       |  
|Dividends declared in 2005 but treated as taxable in 2006 as required by the Internal Revenue Code |  |      | 0.42  |   |      |       |   |      |   | (0.42 | ) |  |       |   |  |   |      |   |  |       |  
|Dividends declared in 2006 but treated as taxable in 2007 as required by the Internal Revenue Code |  |      | (0.42 | ) |      |       |   |      |   |      |   |  |       |   |  |   |      |   |  |       |  
|                                                                                                   |  |      |       |   |      |       |   |      |   |       |   |  |       |   |  |   |       |   |  |       |  
|Dividends paid for tax purposes                                                                    |  | $    | 1.68  |   |      |       |   |      | $ | 1.68  |   |  |       |   |  | $ | 1.68  |   |  |       |  
|                                                                                                   |  |      |       |   |      |       |   |      |   |       |   |  |       |   |  |   |       |   |  |       |  
|Ordinary income (a)                                                                                |  |      | 1.01  |   |      | 60.1  | % |      |   | 1.31  |   |  | 78.0  | % |  |   | 1.09  |   |  | 64.6  | %
|Capital gains (a)                                                                                  |  |      |      |   |      |      |   |      |   | 0.15  |   |  | 9.0   |   |  |   | 0.06  |   |  | 3.7   |  
|Return of capital (b)                                                                              |  |      | 0.67  |   |      | 39.9  |   |      |   | 0.22  |   |  | 13.0  |   |  |   | 0.53  |   |  | 31.7  |  
|                                                                                                   |  |      |       |   |      |       |   |      |   |       |   |  |       |   |  |   |       |   |  |       |  
|Total reported on tax Form 1099-DIV                                                                |  | $    | 1.68  |   |      | 100.0 | % |      | $ | 1.68  |   |  | 100.0 | % |  | $ | 1.68  |   |  | 100.0 | %
|                                                                                                   |  |      |       |   |      |       |   |      |   |       |   |  |       |   |  |   |       |   |  |       |  

---

|(a) |  | For 2006, 2005 and 2004, ordinary income is reported on Form 1099-DIV as either qualified or non-qualified and capital gains are reported on Form 1099-DIV in various sub-categories
which have differing tax treatments to shareholders. Those subcategories have not been shown here.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) |  | Return of capital refers to those amounts reported as nontaxable distributions on Form 1099-DIV.
|--- |  | ------------------------------------------------------------------------------------------------



On a tax basis, distributions to stockholders in 2006 were $53,020 of ordinary income and $35,204 of return of capital, and
in 2005 were $61,582 of ordinary income, $7,136 of capital gain, and $10,221 of return of capital.



The following table is a reconciliation of GAAP net income to taxable net income for the years ended December 31, 2006 and 2005:



|                                                                                               |  |      |         |   |      |   |        |  
|---------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------ | -
|(dollars in thousands)                                                                         |  | 2006 |         |   | 2005 |  
|Net income                                                                                     |  | $    | 100,949 |   |      | $ | 68,193 |  
|Net loss of subsidiary not consolidated for tax purposes                                       |  |      |        |   |      |   | 1,744  |  
|Net change in unrealized (appreciation) depreciation on investments not taxable until realized |  |      | (34,604 | ) |      |   | 1,343  |  
|Timing difference related to deductibility of long- term incentive compensation                |  |      | 2,468   |   |      |   | 3,262  |  
|Interest income on nonaccrual loans that is taxable                                            |  |      | 3,612   |   |      |   | 2,437  |  
|Dividend income accrued for GAAP purposes which is not yet taxable                             |  |      | (21,612 | ) |      |   | (6,516 | )
|Federal tax expense                                                                            |  |      | 2,661   |   |      |   | (595   | )
|Other, net                                                                                     |  |      | (93     | ) |      |   | (2,594 | )
|                                                                                               |  |      |         |   |      |   |        |  
|Taxable income before deductions for distributions                                             |  | $    | 53,381  |   |      | $ | 67,274 |  
|                                                                                               |  |      |         |   |      |   |        |  



93



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



Note 7Commitments and Contingencies



MCG is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial
needs of 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. MCG attempts to limit its credit risk by conducting
extensive due diligence and obtaining collateral where appropriate.



Commitments to extend credit include the unused portions of commitments that obligate the Company to extend credit in the form of loans, participations in loans or similar transactions. Commitments to extend credit would also include loan
proceeds the Company is 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.



The balance of unused commitments to extend credit was $71,581 and $37,330 at December 31, 2006 and 2005, respectively.
The estimated fair value of these commitments reflects the amount MCG would have to pay a counterparty to assume these obligations and was $358 and $187 at December 31, 2006 and 2005, respectively. These amounts were estimated as the amount of
fees currently charged to enter into similar agreements, taking into account the present creditworthiness of the counterparties.



From time to time, the Company provides guarantees or standby letters of credit on behalf of its portfolio companies. As of December 31, 2006 and
2005, the Company had guarantees and standby letters of credit of approximately $9,480 and $10,226, respectively.



Certain premises are leased under agreements which expire at various dates through 2013. Total rent expense amounted to $1,541, $1,758, and $1,725 during
the years ended December 31, 2006, 2005, and 2004, respectively.



Future minimum rental commitments as of December 31, 2006 for all non-cancelable operating leases with initial or remaining terms of one year or more were as follows:



|                    |  |   |       
|------------------- |  | - | ------
|2007                |  | $ | 1,607 
|2008                |  |   | 1,939 
|2009                |  |   | 2,004 
|2010                |  |   | 2,070 
|2011 and thereafter |  |   | 4,070 
|                    |  |   |       
|Total               |  | $ | 11,690
|                    |  |   |       



The Company is also a
party to certain legal proceedings incidental to the normal course of its business including the enforcement of its rights under contracts with its portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted
with certainty, the Company does not expect that these proceedings will have a material effect upon the Companys financial condition or results of operations.



Note 8Concentrations of Credit Risk



At December 31, 2006, the Companys ten largest customers represented approximately 41.3% of the total fair value of the Companys
investments and accounted for approximately 37.5% of the Companys operating



94



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



income during the year ended December 31, 2006. At December 31, 2006, approximately 28.5% of the Companys portfolio at fair value was
invested in companies in the communications industry, of which 21.8% were in competitive local exchange carriers, or CLECs. The Companys two largest customers, Broadview Networks Holdings, Inc. (Broadview) and Cleartel
Communications, Inc. (Cleartel) are CLECs. The Companys remaining investments in the communications industry include telecommunications tower companies, rural local exchange carriers, Internet service providers, wireless
companies and security alarm companies.



At December 31,
2006, the Company holds preferred stock in Broadview which had an aggregate fair value of $159,762. The preferred stock is convertible into common stock and represents a 58% ownership of the preferred stock and a 52% ownership interest on an as-if
converted basis. As of December 31, 2006, the Companys preferred stock investment entitles it to aggregate claims of approximately $237,685, prior to any claims by Broadview common shareholders. The Company is also entitled to
accumulating dividends on its preferred stock investment, which accumulate and compound quarterly at an annual rate of 12% on $237,685. On September 29, 2006, Broadview completed the acquisition of ATX, an integrated communications provider serving
business customers in the Mid-Atlantic region. Broadview financed the ATX acquisition using a portion of the proceeds from a $210.0 million offering of 11 3/8% Senior Secured Notes due 2012, which were offered through Rule 144A under the Securities
Act of 1933, as amended (the Bond Offering). Any amounts outstanding on the Bond Offering and Broadviews $25,000 revolving credit facility from a third party, which Broadview also obtained during the third quarter of 2006, are
payable prior to any payments of preferred claims. At December 31, 2006, the Company did not hold any debt investments in Broadview.



At December 31, 2006, the Companys Broadview investment represented approximately 12.7% of the fair value of its total investments compared to
8.7% of the fair value of its total investments at December 31, 2005. Additionally, the Companys investment in Broadview accounted for $22,345, or 14.5%, of its total operating income for the year ended December 31, 2006, compared to
$17,460, or 14.6%, of its total operating income for the year ended December 31, 2005.



At December 31, 2006, the Companys Cleartel investment represented approximately 5.8% of the fair value of its total investments compared to 7.2% of the fair value of its total investments at
December 31, 2005. Additionally, the Companys investment in Cleartel accounted for $7,473, or 4.8%, of its total operating income for the year ended December 31, 2006, compared to $3,681, or 3.1%, of its total operating income for
the year ended December 31, 2005.



Note 9Share Based Compensation



Prior to January 1, 2006, the Company accounted for
share based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Effective January 1, 2006, the Company adopted the FASB Statement No. 123 (revised 2004),
Share-Based Payment, (SFAS No. 123R) using the modified prospective method. The adoption of SFAS No. 123R did not impact the Companys net operating income before investment gains and losses, net income, cash
flows from operations, cash flows from financing activities, or basic and diluted earnings per share. Effective January 1, 2006, unearned compensation amounts previously recorded as a separate component of equity on the Companys balance
sheet are included in paid-in capital.



In accordance with FAS
123R, the Company recognizes compensation cost related to share based awards for which forfeiture provisions are expected to lapse. The Company uses its historical forfeiture rate as a basis for



95



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



its estimate of awards for which forfeiture provisions will lapse. The grant date is generally the date on which MCG and the employee reach a mutual
understanding of the key terms and conditions of a share based award. The grant date fair value of the restricted share awards is based on the closing price of the Companys common stock as reported on the NASDAQ Global Select Market on that
date. For those awards subject to service conditions, the Company uses the straight line method over the entire service period. During June 2006, the 2006 Employee Restricted Stock Plan (2006 Plan) was approved by the Companys
shareholders. The Company may issue up to 3,500 shares under the 2006 Plan. Awards granted under the 2006 Plan may be subject to service, performance, or market conditions as specified in the award agreements.



In 2001, MCG terminated its stock option plan and the option grants made
thereunder. In connection with the termination of its stock option plan, MCG issued approximately 1,540 shares of restricted stock, for which forfeiture provisions have not lapsed with respect to approximately 206 as of December 31, 2005.
During 2006, the Company granted 483 restricted shares under the 2006 Plan. Of these 483 restricted shares, forfeiture provisions lapsed with respect to 83 immediately upon issuance, and forfeiture provisions will lapse with respect to 300 on a
quarterly basis from December 31, 2006 through December 31, 2009, subject to service conditions of continued employment with the Company, while forfeiture provisions will lapse with respect to the other 100 annually on September 1,
2007 and September 1, 2008, subject to service conditions of continued employment with the Company.



During the years ended December 31, 2006 and 2005, the Company recognized compensation expense related to share-based awards in the amount of $4,514
and $6,523, respectively. Included in this amount are dividends of approximately $1,045 and $2,102 that were paid on shares securing non-recourse employee loans. At December 31, 2006, all the restricted share awards for which forfeiture
provisions have not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares. Dividends paid on restricted shares for which forfeiture provisions are expected to lapse are charged to retained earnings while dividends
paid on restricted shares for which forfeiture provisions are not expected to lapse are charged to compensation expense. During the year ended December 31, 2006, no dividends paid on restricted stock for which forfeiture provisions have not
lapsed were charged to compensation expense as forfeiture provisions are expected to lapse with respect to all such shares. At December 31, 2006, total unrecognized compensation cost related to restricted stock granted to employees was
approximately $6,589 and is expected to be recognized over a weighted average remaining requisite service period of approximately 2.4 years.



Additionally, pursuant to employment agreements with certain executives dated September 18, 2006, the Company will grant to these executives 200
restricted shares, under the 2006 Plan, that will be subject to both service and performance conditions. Forfeiture provisions will lapse with respect to these 200 restricted shares annually each February 28 from 2007 to 2010. As of
December 31, 2006, these 200 shares are not yet considered granted under FAS 123R because the performance conditions had not yet been established. Therefore, the Company has not recorded any compensation expense related to these 200 shares. See
Note 13  Subsequent Events for additional discussion regarding the 200 restricted shares with performance conditions and for additional discussion of share based compensation.



Non-Employee Director Share Based Compensation



During June 2006, the 2006 Non-Employee Director Restricted Stock Plan
(2006 Non-Employee Plan) was approved by the Companys shareholders. The Company may issue up to 100 shares under the 2006 Non-Employee Plan. During the year ended December 31, 2006, the Company granted 25 restricted shares
under the 2006 Non-Employee Plan to certain non-employee directors. Forfeiture provisions will lapse with respect to



96



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



these restricted shares annually each March 31 from 2007 to 2009. This compensation cost is considered part of the general compensation to these
non-employee directors and, therefore, is included as a component of general and administrative expenses on the Companys Consolidated Statement of Operations for the year ended December 31, 2006. At December 31, 2006, total
unrecognized compensation cost related to restricted stock granted to non-employee directors was approximately $400 and is expected to be recognized over a weighted average remaining requisite service period of approximately 2.2 years.



The following table summarizes the Companys restricted stock award
activity during the year ended December 31, 2006:



|                                                      |  |        |   |  |                                               |      
|----------------------------------------------------- |  | ------ | - |  | --------------------------------------------- | -----
|                                                      |  | Shares |   |  | Weighted AverageGrant DateFair Valueper Share
|Subject to forfeiture provisions at December 31, 2005 |  | 206    |   |  | $                                             | 17.01
|Granted                                               |  | 508    |   |  |                                               | 16.83
|Not subject to forfeiture provisions                  |  | (256   | ) |  |                                               | 17.56
|Forfeited                                             |  |       |   |  |                                               |     
|                                                      |  |        |   |  |                                               |      
|Subject to forfeiture provisions at December 31, 2006 |  | 458    |   |  | $                                             | 16.50
|                                                      |  |        |   |  |                                               |      



Note 10Earnings Per Share



The following table sets forth the computation of basic
and diluted earnings per common share for the years ended December 31, 2006, 2005, and 2004:



|                                                                                                     |  |                         |         |      |   |        |  |   |       
|---------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------ |  | - | ------
|                                                                                                     |  | Year Ended December 31,
|                                                                                                     |  | 2006                    |         | 2005 |   | 2004  
|Basic                                                                                                |  |                         |         |      |   |        |  |   |       
|Net income                                                                                           |  | $                       | 100,949 |      | $ | 68,193 |  | $ | 47,647
|Weighted average common shares outstanding                                                           |  |                         | 54,227  |      |   | 48,109 |  |   | 41,244
|Earnings per common share-basic                                                                      |  | $                       | 1.86    |      | $ | 1.42   |  | $ | 1.16  
|Diluted                                                                                              |  |                         |         |      |   |        |  |   |       
|Net income                                                                                           |  | $                       | 100,949 |      | $ | 68,193 |  | $ | 47,647
|Weighted average common shares outstanding                                                           |  |                         | 54,227  |      |   | 48,109 |  |   | 41,244
|Dilutive effect of stock options and restricted stock on which forfeiture provisions have not lapsed |  |                         | 37      |      |   | 22     |  |   | 54    
|                                                                                                     |  |                         |         |      |   |        |  |   |       
|Weighted average common shares and common stock equivalents                                          |  |                         | 54,264  |      |   | 48,131 |  |   | 41,298
|Earnings per common share-diluted                                                                    |  | $                       | 1.86    |      | $ | 1.42   |  | $ | 1.15  



For purposes of
calculating earnings per common share, shares of restricted common stock for which forfeiture provisions have not lapsed and are solely based on passage of time are included in diluted earnings per common share based on the treasury stock method.
Shares of restricted common stock for which forfeiture provisions have not lapsed and are based on performance criteria are included in diluted earnings per common share when it becomes probable such criteria will be met and is calculated using the
treasury stock method.



97



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



Note 11Selected Quarterly Data (Unaudited)



The following tables set forth certain quarterly financial information for
each of the eight quarters ended with the quarter ended December 31, 2006. This information was derived from our unaudited consolidated financial statements. Results for any quarter are not necessarily indicative of results for the full year or
for any future quarter.



|                                                        |  |       |        |       |   |        |  |       |        |  |   |       
|------------------------------------------------------- |  | ----- | ------ | ----- | - | ------ |  | ----- | ------ |  | - | ------
|                                                        |  | 2006 
|                                                        |  | Qtr 1 |        | Qtr 2 |   | Qtr 3  |  | Qtr 4
|Operating income                                        |  | $     | 37,637 |       | $ | 35,270 |  | $     | 40,864 |  | $ | 40,622
|Net operating income before investment gains and losses |  |       | 20,764 |       |   | 18,885 |  |       | 20,064 |  |   | 23,931
|Net income                                              |  |       | 26,402 |       |   | 22,910 |  |       | 22,116 |  |   | 29,521
|Earnings per common sharebasic and diluted             |  | $     | 0.50   |       | $ | 0.43   |  | $     | 0.42   |  | $ | 0.52  
|                                                        | 
|                                                        |  | 2005 
|                                                        |  | Qtr 1 |        | Qtr 2 |   | Qtr 3  |  | Qtr 4
|Operating income                                        |  | $     | 28,115 |       | $ | 30,158 |  | $     | 28,374 |  | $ | 32,898
|Net operating income before investment gains and losses |  |       | 14,491 |       |   | 16,430 |  |       | 12,887 |  |   | 16,707
|Net income                                              |  |       | 13,058 |       |   | 19,880 |  |       | 16,695 |  |   | 18,560
|Earnings per common sharebasic and diluted             |  | $     | 0.29   |       | $ | 0.42   |  | $     | 0.34   |  | $ | 0.37  



98



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



Note 12Financial Highlights



Following is a schedule of financial highlights for the years ended December 31, 2006, 2005, 2004, 2003 and 2002:



|                                                                                                                           |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -- |  | ---- | ------- | - |  | - | ------- | -
|                                                                                                                           |  | Year Ended December 31, |        
|                                                                                                                           |  | 2006                    |         |   | 2005 |   |         | 2004 |  |   | 2003    |    |  | 2002 |        
|Per Share Data:                                                                                                            |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net asset value at beginning of period (a)                                                                                 |  | $                       | 12.48   |   |      | $ | 12.22   |      |  | $ | 11.98   |    |  | $    | 11.56   |   |  | $ | 12.46   |  
|Net operating income before investment gains and losses (b)                                                                |  |                         | 1.54    |   |      |   | 1.26    |      |  |   | 1.10    |    |  |      | 1.45    |   |  |   | 1.57    |  
|Net realized (losses) gains on investments (b)                                                                             |  |                         | (0.27   | ) |      |   | 0.19    |      |  |   | (0.20   | )  |  |      | (0.60   | ) |  |   | (0.34   | )
|Net change in unrealized appreciation (depreciation) on investments (b)                                                    |  |                         | 0.64    |   |      |   | (0.03   | )    |  |   | 0.26    |    |  |      | 0.43    |   |  |   | (1.12   | )
|Provision for income taxes on investment gains                                                                             |  |                         | (0.05   | ) |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|                                                                                                                           |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net income                                                                                                                 |  |                         | 1.86    |   |      |   | 1.42    |      |  |   | 1.16    |    |  |      | 1.28    |   |  |   | 0.11    |  
|Distributions from net investment income                                                                                   |  |                         | (1.01   | ) |      |   | (1.27   | )    |  |   | (1.15   | )  |  |      | (1.40   | ) |  |   | (1.76   | )
|Distributions from capital gains                                                                                           |  |                         |        |   |      |   | (0.19   | )    |  |   |        |    |  |      |        |   |  |   |        |  
|Distributions from return of capital                                                                                       |  |                         | (0.67   | ) |      |   | (0.22   | )    |  |   | (0.53   | )  |  |      | (0.25   | ) |  |   |        |  
|Effect on distributions of stock offerings after record dates (c)                                                          |  |                         | 0.12    |   |      |   | 0.16    |      |  |   | 0.10    |    |  |      | 0.23    |   |  |   | 0.08    |  
|Effect of distributions recorded as compensation expense (b)                                                               |  |                         | 0.02    |   |      |   | 0.04    |      |  |   | 0.06    |    |  |      | 0.06    |   |  |   | 0.09    |  
|                                                                                                                           |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net decrease in stockholders equity resulting from distributions                                                          |  |                         | (1.54   | ) |      |   | (1.48   | )    |  |   | (1.52   | )  |  |      | (1.36   | ) |  |   | (1.59   | )
|Net increase in shareholders equity resulting from reduction in employee loans                                            |  |                         | 0.05    |   |      |   | 0.02    |      |  |   | 0.01    |    |  |      | 0.01    |   |  |   | 0.03    |  
|Issuance of shares                                                                                                         |  |                         | 2.45    |   |      |   | 2.35    |      |  |   | 3.13    |    |  |      | 3.06    |   |  |   | 4.29    |  
|Dilutive effect of share issuances, issuance of restricted stock and restricted stock subject to forfeiture provisions (d) |  |                         | (2.54   | ) |      |   | (2.14   | )    |  |   | (2.77   | )  |  |      | (2.68   | ) |  |   | (3.88   | )
|Net increase in stockholders equity from restricted stock amortization (b)                                                |  |                         | 0.07    |   |      |   | 0.09    |      |  |   | 0.23    |    |  |      | 0.11    |   |  |   | 0.14    |  
|                                                                                                                           |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net increase in stockholders' equity relating to share issuances                                                           |  |                         | 0.03    |   |      |   | 0.32    |      |  |   | 0.60    |    |  |      | 0.50    |   |  |   | 0.58    |  
|                                                                                                                           |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net asset value at end of period (a)                                                                                       |  | $                       | 12.83   |   |      | $ | 12.48   |      |  | $ | 12.22   |    |  | $    | 11.98   |   |  | $ | 11.56   |  
|                                                                                                                           |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Per share market value at end of period                                                                                    |  | $                       | 20.32   |   |      | $ | 14.59   |      |  | $ | 17.13   |    |  | $    | 19.59   |   |  | $ | 10.77   |  
|Total return (e)                                                                                                           |  |                         | 50.79   | % |      |   | (5.02   | )%   |  |   | (3.98   | )% |  |      | 97.21   | % |  |   | (27.13  | )
|Shares outstanding at end of period                                                                                        |  |                         | 58,694  |   |      |   | 53,372  |      |  |   | 45,342  |    |  |      | 38,732  |   |  |   | 31,259  |  
|Ratio/Supplemental Data:                                                                                                   |  |                         |         |   |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net assets at end of period                                                                                                |  | $                       | 753,137 |   |      | $ | 666,087 |      |  | $ | 554,213 |    |  | $    | 463,950 |   |  | $ | 361,250 |  
|Ratio of operating expenses to average net assets (annualized)                                                             |  |                         | 10.40   | % |      |   | 9.94    | %    |  |   | 9.43    | %  |  |      | 8.31    | % |  |   | 8.56    | %
|Ratio of net operating income to average net assets (annualized)                                                           |  |                         | 12.30   | % |      |   | 10.19   | %    |  |   | 8.85    | %  |  |      | 11.95   | % |  |   | 11.91   | %

---

|(a) |  | Based on total shares outstanding.
|--- |  | ----------------------------------

|(b) |  | Based on average shares outstanding.
|--- |  | ------------------------------------

|(c) |  | The effect on distributions of stock offerings after record dates represents the effect on net asset value of issuing additional shares after the record date of a distribution.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



99



---

##### Table of Contents

MCG Capital Corporation



Notes to Consolidated Financial Statements(Continued)



(in thousands, except per share data)



|(d) |  | The Dilutive effect of share issuances, issuance of restricted stock and restricted stock subject to forfeiture provision represents the effects of shares issued during the period
and the lapsing of forfeiture provisions on restricted stock on earnings per share.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(e) |  | Total return equals the change in the ending market value over the beginning of period price per share plus dividends paid per share during the period, divided by the beginning
price.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Note 13Subsequent Events



On January 9, 2007, the performance criteria for 200 restricted shares
to certain executives were determined by the board of directors, therefore those awards are considered granted for GAAP purposes on that date. The total compensation cost of those awards is $3,874, based on the closing price of MCGs common
stock on that date, and will be recognized as compensation expense over the requisite service periods which run through February 2010.



In January 2007, one of the Companys majority owned control companies, Midwest Tower Partners, LLC (MTP), sold substantially all of its
assets and repaid its outstanding debt with those proceeds. MTP is currently in the process of making distributions to its equity holders. As of December 31, 2006, the Company had debt and equity investments in MTP with a fair value of $34,917
which includes unrealized appreciation of $5,012. In connection with this transaction, the Company expects to realize the December 31, 2006 unrealized pre-tax gain of approximately $5,012 which will have no significant impact on first quarter
2007 earnings.



On February 1, 2007, the Company entered
into the fifth amendment to its MCG Commercial Loan Funding Trust facility, funded by Three Pillars Funding LLC ("Three Pillars"), an asset-backed commercial paper conduit administered by SunTrust Capital Markets, Inc. Pursuant to this amendment,
the $250.0 million facility provided by Three Pillars has been divided and will be funded through two separate Variable Funding Certificates ("VFCs"), a $218.8 million Class A VFC and a $31.2 million Class B VFC. The Class A VFC will
maintain the same advance rate, of up to 70% of eligible collateral, and the same interest rate, the commercial paper rate plus 0.95%, as was in effect immediately prior to this amendment. The Class B VFC has an advance rate of 10% of eligible
collateral and bears interest at the commercial paper rate plus 1.75%. This amendment effectively increases the Companys overall borrowing advance rate by 10% from a maximum of 70% of eligible collateral to a maximum of 80% of eligible
collateral, which will allow the Company to borrow up to $250.0 million under the facility using less collateral than previously required. Other minor modifications were also made to this facility.



In February 2007, Broadview Networks Holdings, Inc., the Companys
largest portfolio company, signed a definitive agreement to acquire InfoHighway Communications Corp., a New York-based integrated provider of hosted and managed communications solutions serving more than 12,000 business customers in the Mid-Atlantic
and Northeast regions of the U.S. MCG does not expect to be required to provide additional funding to Broadview to facilitate this transaction. The transaction is expected to close in the second quarter of 2007 and is subject to regulatory approvals
and other closing conditions.



During the first quarter of
2007, the Companys board of directors approved the issuance of 778 shares of restricted stock to the Companys employees pursuant to the MCG Capital Corporation 2006 Employee Restricted Stock Plan, which will generally be expensed over
four years.



100



---

##### Table of Contents

Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure



None.



Item 9A.Controls and Procedures



|1. |  | Disclosure Controls and Procedures
|-- |  | ----------------------------------



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



|2. |  | Internal Control Over Financial Reporting
|-- |  | -----------------------------------------



| | a. |  | Managements Annual Report on Internal Control Over Financial Reporting
| | -- |  | -----------------------------------------------------------------------



Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such
term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934 and for the assessment of the effectiveness of internal control over financial reporting.



Managements assessment of the effectiveness of our internal control over financial reporting as of December 31,
2006, has been audited by Ernst & Young LLP, the independent registered public accounting firm that audited our financial statements, as stated in their report which is included in this Annual Report on Form 10-K.



Managements report on internal control over financial reporting and
the attestation report of Ernst & Young LLP, an independent registered public accounting firm, thereon are set forth under the headings Managements Report on Internal Control over Financial Reporting and Report of
Independent Registered Public Accounting Firm on Internal Control over Financial Reporting in this Annual Report.



| | b. |  | Attestation Report of the Registered Public Accounting Firm
| | -- |  | -----------------------------------------------------------



Our independent registered public accounting firm, Ernst & Young LLP has issued an attestation report concurring with managements
assessment, which is included at the beginning of Part II, Item 8 of this Annual Report on Form 10-K.



| | c. |  | Changes in Internal Control Over Financial Reporting
| | -- |  | ----------------------------------------------------



There have been no changes in MCGs internal control over financial reporting that occurred during the quarter ended December 31, 2006 that have
materially affected, or are reasonably likely to materially affect, MCGs internal control over financial reporting.



Item 9B.Other Information



None.



101



---

##### Table of Contents

PART III



Item 10.Directors, Executive Officers and Corporate Governance



The information with respect to our directors, executive officers and corporate governance matters is contained under the captions Proposal I :
Election of Directors, Information about Executive Officers who are not Directors and Certain Relationships and Transactions, in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated in this Annual Report by reference in response to this item.



We have adopted a code of business conduct and ethics that applies to
directors, officers and employees. The code of business conduct and ethics is available on our website at http://www.mcgcapital.com. We will report any amendments to or waivers of a required provision of the code of business conduct and ethics on
our website or in a Form 8-K.



Item 11.Executive Compensation



The information with respect to compensation of executives and directors is contained under the caption Compensation of Executive Officers and
Directors in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated in this
Annual Report by reference in response to this item.



Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters



The information with respect to security ownership of certain beneficial owners and management is contained under the
captions Security Ownership of Certain Beneficial Owners and Management and Compensation of Executive Officers and Directors in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated in this Annual Report by reference in response to this item.



Item 13.Certain Relationships and Related Transactions, and Director Independence



The information with respect to certain relationships and related transactions is contained under the caption Certain
Relationships and Transactions and the caption Proposal I: Election of Directors in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A under the Securities Exchange Act and is incorporated in this Annual Report by reference in response to this item.



Item 14.Principal Accountant Fees and Services



The information with respect to principal accountant fees and services is contained under the captions Principal Accountant Fees and Services
and Proposal II: Ratification of Selection of Independent Auditors in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the
Securities Exchange Act of 1934 and is incorporated in this Annual Report by reference to this item.





102



---

##### Table of Contents

PART IV



Item 15.Exhibits and Financial Statement Schedules



|   |  |                                                                                                                         |  |   
|-- |  | ----------------------------------------------------------------------------------------------------------------------- |  | --
|1. |  | The following financial statements are filed herewith                                                                   |  |   
|   |  | Managements Report on Internal Control over Financial Reporting                                                        |  | 59
|   |  | Reports of Independent Registered Public Accounting Firm                                                                |  | 60
|   |  | Consolidated Balance Sheets as of December 31, 2006 and 2005                                                            |  | 62
|   |  | Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004                              |  | 63
|   |  | Consolidated Statements of Changes in Net Assets for the years ended December 31, 2006, 2005 and 2004                   |  | 64
|   |  | Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004                              |  | 65
|   |  | Consolidated Schedule of Investments as of December 31, 2006                                                            |  | 66
|   |  | Consolidated Schedule of Investments as of December 31, 2005                                                            |  | 71
|   |  | Notes to Consolidated Financial Statements                                                                              |  | 79
|2. |  | The following financial statement schedules are filed herewithSchedule 12-14 Investments in and Advances to Affiliates. |  |   
|3. |  | Exhibits required to be filed by Item 601 of Regulation S-K.                                                            |  |   





103



---

##### Table of Contents

Schedule 12-14

MCG Capital Corporation

Schedule of Investments in and Advances to Affiliates



|                                                             |  |                                               |  |                                                    |        |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        
|------------------------------------------------------------ |  | --------------------------------------------- |  | -------------------------------------------------- | ------ | ------------------------------- | - | ------------------ |  | ------------------- | ------ |  | ------------------------------- | ------- | - |  | - | -------
|                                                             |  |                                               |  | Year EndedDecember 31,2006                         |        |                                 |   |                    |  |                     |        |  |                                
|Portfolio Company (in
thousands)                             |  | Investment (1)                                |  | Amount ofInterest orDividendsCredited toIncome (5) |        | As ofDecember 31,2005Fair Value |   | GrossAdditions (2) |  | GrossReductions (3) |        |  | As ofDecember 31,2006Fair Value
|Control Investments                                          |  |                                               |  |                                                    |        |                                 |   |                    |  |                     |        |  |                                 |         |   | 
|Broadview Networks Holdings, Inc.                            |  | Debt                                          |  | $                                                  | 3,692  |                                 | $ | 42,993             |  | $                   | 8,121  |  | $                               | (51,114 | ) |  | $ |       
|                                                             |  | Series A Preferred Stock                      |  |                                                    | 12,180 |                                 |   | 52,137             |  |                     | 32,377 |  |                                 |         |   |  |   | 84,514 
|                                                             |  | Series A-1 Preferred Stock                    |  |                                                    | 5,383  |                                 |   |                   |  |                     | 75,248 |  |                                 |         |   |  |   | 75,248 
|                                                             |  | Common Stock                                  |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Chesapeake Tower Holdings, LLC                               |  | Debt                                          |  |                                                    | 31     |                                 |   |                   |  |                     | 400    |  |                                 |         |   |  |   | 400    
|                                                             |  | Preferred LLC Interest                        |  |                                                    |       |                                 |   |                   |  |                     | 3,139  |  |                                 |         |   |  |   | 3,139  
|                                                             |  | Common C LLC Interest                         |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Cleartel Communications, Inc.                                |  | Debt                                          |  |                                                    | 6,723  |                                 |   | 38,206             |  |                     | 33,756 |  |                                 |         |   |  |   | 71,962 
|                                                             |  | Preferred Stock                               |  |                                                    |       |                                 |   | 40,684             |  |                     |        |  |                                 | (40,072 | ) |  |   | 612    
|Crystal Media Network, LLC                                   |  | Debt (4)                                      |  |                                                    |       |                                 |   | 947                |  |                     |        |  |                                 | (947    | ) |  |   |       
|                                                             |  | LLC Interest                                  |  |                                                    |       |                                 |   | 1,097              |  |                     | 38     |  |                                 | (588    | ) |  |   | 547    
|Helicon Cable Holdings, LLC                                  |  | Debt                                          |  |                                                    | 2,021  |                                 |   | 15,822             |  |                     | 3,615  |  |                                 |         |   |  |   | 19,437 
|                                                             |  | Preferred LLC Interest                        |  |                                                    | 864    |                                 |   | 8,316              |  |                     | 864    |  |                                 |         |   |  |   | 9,180  
|IntranMedia, LLC                                             |  | Debt                                          |  |                                                    | 92     |                                 |   |                   |  |                     | 12,000 |  |                                 |         |   |  |   | 12,000 
|                                                             |  | Preferred Units                               |  |                                                    | 61     |                                 |   |                   |  |                     | 8,661  |  |                                 |         |   |  |   | 8,661  
|Jet Plastica Investors, LLC                                  |  | Debt                                          |  |                                                    | 1,136  |                                 |   |                   |  |                     | 26,159 |  |                                 |         |   |  |   | 26,159 
|                                                             |  | Preferred LLC Interest                        |  |                                                    | 734    |                                 |   |                   |  |                     | 30,893 |  |                                 |         |   |  |   | 30,893 
|JupiterKagan, Inc.                                           |  | Debt                                          |  |                                                    | 416    |                                 |   |                   |  |                     | 5,349  |  |                                 |         |   |  |   | 5,349  
|                                                             |  | Series A Preferred Stock                      |  |                                                    |       |                                 |   |                   |  |                     | 10,000 |  |                                 |         |   |  |   | 10,000 
|                                                             |  | Common Stock                                  |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Midwest Tower Partners, LLC                                  |  | Debt                                          |  |                                                    | 3,024  |                                 |   | 16,813             |  |                     | 10,487 |  |                                 | (34     | ) |  |   | 27,266 
|                                                             |  | Preferred LLC Interest                        |  |                                                    | 317    |                                 |   | 2,121              |  |                     | 317    |  |                                 |         |   |  |   | 2,438  
|                                                             |  | Common LLC Interest                           |  |                                                    |       |                                 |   | 1,332              |  |                     | 7,565  |  |                                 | (3,684  | ) |  |   | 5,213  
|National Product Services, Inc.                              |  | Debt (4)                                      |  |                                                    | 602    |                                 |   |                   |  |                     | 15,834 |  |                                 | (434    | ) |  |   | 15,400 
|                                                             |  | Common Stock                                  |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Platinum Wireless, Inc.                                      |  | Debt                                          |  |                                                    | 10     |                                 |   | 389                |  |                     |        |  |                                 | (389    | ) |  |   |       
|                                                             |  | Common Stock                                  |  |                                                    |       |                                 |   | 4,505              |  |                     | 201    |  |                                 | (942    | ) |  |   | 3,764  
|                                                             |  | Option to purchase                            |  |                                                    |       |                                 |   | 98                 |  |                     | 8      |  |                                 | (106    | ) |  |   |       
|PremierGarage Holdings, LLC                                  |  | Debt                                          |  |                                                    | 471    |                                 |   |                   |  |                     | 11,000 |  |                                 | (300    | ) |  |   | 10,700 
|                                                             |  | Preferred LLC Interest                        |  |                                                    | 142    |                                 |   |                   |  |                     | 4,592  |  |                                 |         |   |  |   | 4,592  
|                                                             |  | Common LLC Interest                           |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|RadioPharmacy Investors, LLC                                 |  | Debt                                          |  |                                                    | 1,965  |                                 |   |                   |  |                     | 16,258 |  |                                 |         |   |  |   | 16,258 
|                                                             |  | Preferred LLC Interest                        |  |                                                    | 522    |                                 |   |                   |  |                     | 10,657 |  |                                 |         |   |  |   | 10,657 
|Superior Industries Investors, LLC                           |  | Debt                                          |  |                                                    | 594    |                                 |   |                   |  |                     | 14,083 |  |                                 |         |   |  |   | 14,083 
|                                                             |  | Preferred LLC Interest                        |  |                                                    | 297    |                                 |   |                   |  |                     | 12,837 |  |                                 |         |   |  |   | 12,837 
|Superior Publishing Corporation                              |  | Debt                                          |  |                                                    | 5,927  |                                 |   | 40,900             |  |                     | 2,392  |  |                                 | (24,270 | ) |  |   | 19,022 
|                                                             |  | Preferred Stock                               |  |                                                    |       |                                 |   | 8,545              |  |                     | 832    |  |                                 | (133    | ) |  |   | 9,244  
|                                                             |  | Common Stock                                  |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Working Mother Media, Inc.                                   |  | Debt (4)                                      |  |                                                    |       |                                 |   | 8,576              |  |                     | 2,970  |  |                                 |         |   |  |   | 11,546 
|                                                             |  | Class A Preferred Stock                       |  |                                                    |       |                                 |   | 4,192              |  |                     | 827    |  |                                 |         |   |  |   | 5,019  
|                                                             |  | Class B Preferred Stock                       |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|                                                             |  | Class C Preferred Stock                       |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|                                                             |  | Common Stock                                  |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Income from Control Investmentsdisposed of during the year   |  |                                               |  |                                                    | 57     |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        
|                                                             |  |                                               |  |                                                    |        |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        
|Total Control Investments                                    |  |                                               |  | $                                                  | 47,261 |                                 |   |                    |  |                     |        |  |                                 |         |   |  | $ | 526,140
|                                                             |  |                                               |  |                                                    |        |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        
|Affiliate Investments                                        |  |                                               |  |                                                    |        |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        
|Cherry Hill Holdings Inc.                                    |  | Debt                                          |  | $                                                  | 548    |                                 | $ |                   |  | $                   | 13,122 |  | $                               | (1,000  | ) |  | $ | 12,122 
|                                                             |  | Series A Preferred Stock                      |  |                                                    | 25     |                                 |   |                   |  |                     | 775    |  |                                 |         |   |  |   | 775    
|iVerify, US Inc.                                             |  | Debt                                          |  |                                                    |       |                                 |   | 75                 |  |                     |        |  |                                 | (75     | ) |  |   |       
|                                                             |  | Preferred Stock                               |  |                                                    |       |                                 |   |                   |  |                     | 578    |  |                                 | (578    | ) |  |   |       
|                                                             |  | Common Stock                                  |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|NYL Brands Holdings, Inc.                                    |  | Debt                                          |  |                                                    | 1,581  |                                 |   |                   |  |                     | 18,000 |  |                                 | (8,000  | ) |  |   | 10,000 
|                                                             |  | Class A Common Stock                          |  |                                                    |       |                                 |   |                   |  |                     | 1,501  |  |                                 | (1      | ) |  |   | 1,500  
|                                                             |  | Warrants to purchase Common Stock             |  |                                                    |       |                                 |   |                   |  |                     | 526    |  |                                 |         |   |  |   | 526    
|On Target Media, LLC                                         |  | Debt                                          |  |                                                    | 285    |                                 |   | 31,266             |  |                     | 14     |  |                                 | (31,280 | ) |  |   |       
|                                                             |  | Class A LLC Interest                          |  |                                                    | 328    |                                 |   | 2,610              |  |                     | 408    |  |                                 | (1,182  | ) |  |   | 1,836  
|                                                             |  | Class B LLC Interest                          |  |                                                    |       |                                 |   |                   |  |                     | 1,628  |  |                                 | (15     | ) |  |   | 1,613  
|Sunshine Media Delaware, LLC                                 |  | Debt                                          |  |                                                    | 1,896  |                                 |   | 12,205             |  |                     | 229    |  |                                 | (153    | ) |  |   | 12,281 
|                                                             |  | Class A LLC Interest                          |  |                                                    |       |                                 |   |                   |  |                     | 329    |  |                                 |         |   |  |   | 329    
|TNR Entertainment Corp LLC                                   |  | Debt                                          |  |                                                    | 1,352  |                                 |   |                   |  |                     | 25,606 |  |                                 | (39     | ) |  |   | 25,567 
|                                                             |  | Class D Preferred Stock                       |  |                                                    |       |                                 |   |                   |  |                     | 3,000  |  |                                 |         |   |  |   | 3,000  
|                                                             |  | Warrants to purchase Series D Preferred Stock |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Xfone, Inc.                                                  |  | Common Stock                                  |  |                                                    |       |                                 |   |                   |  |                     | 2,803  |  |                                 | (321    | ) |  |   | 2,482  
|                                                             |  | Warrants to purchase Common Stock             |  |                                                    |       |                                 |   |                   |  |                     |        |  |                                 |         |   |  |   |       
|Income from Affiliate Investmentsdisposed of during the year |  |                                               |  |                                                    |       |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        
|                                                             |  |                                               |  |                                                    |        |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        
|Total Affiliate Investments                                  |  |                                               |  | $                                                  | 6,015  |                                 |   |                    |  |                     |        |  |                                 |         |   |  | $ | 72,031 
|                                                             |  |                                               |  |                                                    |        |                                 |   |                    |  |                     |        |  |                                 |         |   |  |   |        



104



---

##### Table of Contents

This schedule should be read in conjunction with the Companys Consolidated Financial Statements, including the
Consolidated Statement of Investments and Note 2 to the Consolidated Financial Statements.



(1) Common stock, warrants, options, and equity interests are generally non-income producing and restricted. In some cases, preferred stock may also be non-income producing. The principal amount for debt and the
number of shares of common stock and preferred stock is shown in the Consolidated Schedule of Investments as of December 31, 2006.



(2) Gross additions include increases in investments resulting from new portfolio company investments, paid-in-kind interest or dividends, the amortization of discounts
and fees, and the exchange of one or more existing securities for one or more new securities. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation.



(3) Gross reductions include decreases in investments resulting from principal collections
related to investment repayments or sales and the exchange of one or more existing securities for one or more new securities. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation.



(4) Debt is on non-accrual status at December 31, 2006, and is therefore
considered non-income producing.



(5) Represents the total amount of interest
or dividends credited to income for the portion of the year an investment was a control investment (more than 25% owned) or an affiliate investment (5% to 25% owned), respectively.



** Information related to the amount of equity in the net profit and loss for the period for the investments listed has not been included in
this schedule. This information is not considered to be meaningful due to the complex capital structures of the portfolio companies, with different classes of equity securities outstanding with different preferences in liquidation. These investments
are not consolidated, nor are they accounted for under the equity method of accounting.





105



---

##### Table of Contents

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



|               |  |                                                                                                                                                                                                                                                                                                                                         
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                                                                                                                                                 
|               | 
|3.1            |  | Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 filed with MCG Capitals Current Report on Form 8-K
filed on May 31, 2005).                                                                                                                                                                             
|               | 
|3.2            |  | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 filed with MCG Capitals Current Report on Form 8-K filed on
March 28, 2005).                                                                                                                                                                                     
|               | 
|4.1            |  | Specimen Common Stock Certificate (incorporated by reference to Exhibit D.1 to Pre-effective Amendment No. 2 to MCG Capitals
registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 1, 2001).                                                                           
|               | 
|10.1           |  | Third Amended and Restated Registration Rights Agreement by and among MCG Capital Corporation and certain stockholders (incorporated by
reference to Exhibit 10.1 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                             
|               | 
|10.2           |  | Sale and Servicing Agreement by and among MCG Commercial Loan Trust 2001-1, MCG Finance III, LLC, MCG Capital Corporation and Wells Fargo
Bank Minnesota, National Association, dated as of December 1, 2001 (incorporated by reference to Exhibit 10.13 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).      
|               | 
|10.3           |  | Note Purchase Agreement among MCG Commercial Loan Trust 2001-1, MCG Capital Corporation, MCG Finance III, LLC and Wachovia Securities, Inc.
(formerly First Union Securities, Inc.), dated as of December 19, 2001 (incorporated by reference to Exhibit 10.14 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).
|               | 
|10.4           |  | Trust Agreement between MCG Finance III, LLC and Wilmington Trust Company, dated as of December 1, 2001 (incorporated by reference to
Exhibit 10.15 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                                           
|               | 
|10.5           |  | MCG Commercial Loan Trust 2001-1 Trust Certificate, dated as of December 27, 2001 (incorporated by reference to Exhibit 10.16 filed
with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                                                                 
|               | 
|10.6           |  | MCG Commercial Loan Trust 2001-1 Class A Note, dated as of December 27, 2001 (incorporated by reference to Exhibit 10.17 filed with
MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                                                                      
|               | 
|10.7           |  | MCG Commercial Loan Trust 2001-1 Class B Note, dated as of December 27, 2001 (incorporated by reference to Exhibit 10.18 filed with
MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                                                                      
|               | 
|10.8           |  | MCG Commercial Loan Trust 2001-1 Class C Note issued to MCG Finance III, LLC, dated as of December 27, 2001 (incorporated by reference
to Exhibit 10.19 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                                       
|               | 
|10.9           |  | Indenture between MCG Commercial Loan Trust 2001-1 and Wells Fargo Bank Minnesota, National Association, dated as of December 1, 2001
(incorporated by reference to Exhibit 10.20 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                             
|               | 
|10.10          |  | Commercial Loan Sale Agreement between MCG Capital Corporation and MCG Finance III, LLC, dated as of December 1, 2001 (incorporated by
reference to Exhibit 10.21 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                             
|               | 
|10.11          |  | 401(k) Plan (incorporated by reference to Exhibit i.1 filed with MCG Capitals registration statement on Form N-2 [File No. 333-64596]
filed with the Securities and Exchange Commission on July 5, 2001).                                                                                                                              



106



---

##### Table of Contents

|               |  |                                                                                                                                                                                                                                                                                                         
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                                                                                                                 
|               | 
|10.12          |  | Deferred Compensation Plan (incorporated by reference to Exhibit i.2 filed with MCG Capitals registration statement on Form N-2 [File
No. 333-64596] filed with the Securities and Exchange Commission on July 5, 2001).                                                                               
|               | 
|10.13          |  | Dividend Reinvestment Plan (incorporated by reference to Exhibit e to Pre-effective Amendment No. 2 to MCG Capitals registration
statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 1, 2001).                                                    
|               | 
|10.14          |  | Form of Restricted Stock Agreement for administrative personnel (incorporated by reference to Exhibit i.3 to Pre-effective Amendment No. 3
to MCG Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 6, 2001).             
|               | 
|10.15          |  | Form of Restricted Stock Agreement for staff professionals (incorporated by reference to Exhibit i.4 to Pre-effective Amendment No. 3
to MCG Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 6, 2001).                  
|               | 
|10.16          |  | Form of Restricted Stock Agreement for senior management (incorporated by reference to Exhibit i.6 to Pre-effective Amendment No. 3 to MCG
Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 6, 2001).                    
|               | 
|10.17          |  | Form of Amended and Restated Restricted Stock Agreement for senior management (incorporated by reference to Exhibit i.26 to MCG
Capitals registration statement on Form N-2 [File No. 333-113236] filed with the Securities and Exchange Commission on March 3, 2004).                                 
|               | 
|10.18          |  | Amended and Restated Restricted Stock Agreement between the Company and Bryan J. Mitchell, dated March 1, 2004 (incorporated by
reference to Exhibit i.27 to MCG Capitals registration statement on Form N-2 [File No. 333-113236] filed with the Securities and Exchange Commission on March 3, 2004).
|               | 
|10.19          |  | Restricted Stock Agreement between the Company and Robert J. Merrick, dated November 28, 2001 (incorporated by reference to Exhibit
10.30 filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                     
|               | 
|10.20          |  | Amended and Restated Restricted Stock Agreement between the Company and B. Hagen Saville, dated March 1, 2004 (incorporated by
reference to Exhibit i.29 to MCG Capitals registration statement on Form N-2 [File No. 333-113236] filed with the Securities and Exchange Commission on March 3, 2004). 
|               | 
|10.21          |  | Amended and Restated Restricted Stock Agreement between the Company and Steven F. Tunney, dated March 1, 2004 (incorporated by
reference to Exhibit i.28 to MCG Capitals registration statement on Form N-2 [File No. 333-113236] filed with the Securities and Exchange Commission on March 3, 2004). 
|               | 
|10.22          |  | Form of Restricted Stock Agreement for directors (incorporated by reference to Exhibit 99.i.7 to Pre-effective Amendment No. 3 to MCG
Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 6, 2001).                         
|               | 
|10.23          |  | Promissory Note issued to Bryan J. Mitchell, dated as of November 28, 2001 (incorporated by reference to Exhibit 10.34 filed with MCG
Capitals Form 10-K for the year ended December 31, 2001).                                                                                                        
|               | 
|10.24          |  | Promissory Note issued to B. Hagen Saville, dated as of November 28, 2001 (incorporated by reference to Exhibit 10.35 filed with MCG
Capitals Form 10-K for the year ended December 31, 2001).                                                                                                         
|               | 
|10.25          |  | Promissory Note issued to Steven F. Tunney, dated as of November 28, 2001 (incorporated by reference to Exhibit 10.36 filed with MCG
Capitals Form 10-K for the year ended December 31, 2001).                                                                                                         



107



---

##### Table of Contents

|               |  |                                                                                                                                                                                                                                                                                                      
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                                                                                                              
|               | 
|10.26          |  | Form of Promissory Note issued to senior management (incorporated by reference to Exhibit i.8 to Pre-effective Amendment No. 3 to MCG
Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 6, 2001).                      
|               | 
|10.27          |  | Form of Promissory Note issued to employees (incorporated by reference to Exhibit i.9 to Pre-effective Amendment No. 3 to MCG
Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 6, 2001).                              
|               | 
|10.28          |  | Pledge Agreement between the Company and Bryan J. Mitchell, dated as of November 28, 2001 (incorporated by reference to Exhibit 10.39
filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                      
|               | 
|10.29          |  | Pledge Agreement between the Company and B. Hagen Saville, dated as of November 28, 2001 (incorporated by reference to Exhibit 10.40
filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                       
|               | 
|10.30          |  | Pledge Agreement between the Company and Steven F. Tunney, dated as of November 28, 2001 (incorporated by reference to Exhibit 10.41
filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                       
|               | 
|10.31          |  | Form of Pledge Agreement between the Company and employee (incorporated by reference to Exhibit i.10 to Pre-effective Amendment No. 3 to
MCG Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 6, 2001).               
|               | 
|10.32          |  | Form of Amended and Restated Promissory Note issued to senior management (incorporated by reference to Exhibit I.10 to Pre-effective
Amendment No. 2 to MCG Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on November 1, 2001).
|               | 
|10.33          |  | Form of Pledge Agreement between the Company and senior management, dated as of June 24, 1998 (incorporated by reference to Exhibit
i.7 filed with MCG Capitals registration statement on Form N-2 [File No. 333-64596] filed with the Securities and Exchange Commission on July 5, 2001).         
|               | 
|10.34          |  | Custodial Agreement between the Company and Riggs Bank, N.A. (incorporated by reference to Exhibit 10.45 filed with MCG Capitals Form
10-K for the year ended December 31, 2001).                                                                                                                   
|               | 
|10.35          |  | Employment Agreement between the Company and Robert J. Merrick, dated November 28, 2001 (incorporated by reference to Exhibit 10.47
filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                        
|               | 
|10.36          |  | Employment Agreement between the Company and B. Hagen Saville, dated November 28, 2001 (incorporated by reference to Exhibit 10.48
filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                         
|               | 
|10.37          |  | Employment Agreement between the Company and Steven F. Tunney, dated November 28, 2001 (incorporated by reference to Exhibit 10.49
filed with MCG Capitals Form 10-K for the year ended December 31, 2001).                                                                                         
|               | 
|10.38          |  | Deed of Lease by and between Twin Towers II Associates Limited Partnership, as landlord, and MCG Capital Corporation, as tenant, dated as
of September 24, 2002 (incorporated by reference to Exhibit 10.50 filed with MCG Capitals Form 10-Q for the quarter ended September 30, 2002).            
|               | 
|10.39          |  | Amended and Restated Employment Agreement between MCG Capital Corporation and Bryan J. Mitchell dated November 3, 2002 (incorporated
by reference to Exhibit 10.51 filed with MCG Capitals Form 10-Q for the quarter ended September 30, 2002).                                                     



108



---

##### Table of Contents

|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                                                                                                                                                                                                                                                         
|               | 
|10.40          |  | MCG Capital Corporation Swingline Note issued to Wachovia Bank, National Association (formerly First Union National Bank), dated as of
February 12, 2004 (incorporated by reference to Exhibit f.27 to MCG Capitals registration statement on Form N-2 [File No. 333-113236] filed with the Securities and Exchange Commission on March 3, 2004).                                                                                              
|               | 
|10.41          |  | Employment Agreement between the Company and Michael R. McDonnell, dated July 14, 2004 (incorporated by reference to Exhibit 10.65
filed with MCG Capitals Form 10-Q for the quarter ended June 30, 2004).                                                                                                                                                                                                                                     
|               | 
|10.42          |  | Sale and Servicing Agreement by and among MCG Commercial Loan Trust 2004-1, MCG Finance IV, LLC, MCG Capital Corporation and Wells Fargo
Bank, National Association, dated as of September 30, 2004 (incorporated by reference to Exhibit 10.66 filed with MCG Capitals Form 10-Q for quarter ended September 30, 2004).                                                                                                                       
|               | 
|10.43          |  | Indenture between MCG Commercial Loan Trust 2004-1 and Wells Fargo Bank, National Association, dated as of September 30, 2004
(incorporated by reference to Exhibit 10.67 filed with MCG Capitals Form 10-Q for quarter ended September 30, 2004).                                                                                                                                                                                             
|               | 
|10.44          |  | Sale and Servicing Agreement by and among MCG Capital Corporation, MCG Commercial Loan Funding Trust, Three Pillars Funding, LLC, SunTrust
Capital Markets, Inc. and Wells Fargo Bank, National Association, dated as of November 10, 2004 (incorporated by reference to Exhibit f.37 filed with MCG Capitals registration statement on Form N-2 [File No. 333-121358] filed with the
Securities and Exchange Commission on December 17, 2004).
|               | 
|10.45          |  | Credit and Warehouse Agreement, dated as of April 21, 2005, among UBS AG, Stamford Branch, MCG Commercial Loan Trust 2005-1 and MCG
Capital Corporation (incorporated by reference to Exhibit 10.71 filed with MCG Capitals Form 10-Q for the quarter ended March 31, 2005).                                                                                                                                                                   
|               | 
|10.46          |  | Pledge, Security and Custody Agreement by and among MCG Commercial Loan Trust 2005-1, MCG Finance VI, LLC, MCG Capital Corporation, UBS AG,
Stamford Branch, and Wells Fargo Bank, National Association, dated as of April 21, 2005 (incorporated by reference to Exhibit 10.72 filed with MCG Capitals Form 10-Q for the quarter ended March 31, 2005).                                                                                       
|               | 
|10.47          |  | Master Conveyance Assignment, dated as of April 21, 2005, among MCG Capital Corporation, MCG Finance VI, LLC, and MCG Commercial Loan
Trust 2005-1 (incorporated by reference to Exhibit 10.73 filed with MCG Capitals Form 10-Q for the quarter ended March 31, 2005).                                                                                                                                                                        
|               | 
|10.48          |  | First Amendment to Sale and Servicing Agreement by and among MCG Commercial Loan Funding Trust, MCG Capital Corporation, Three Pillars
Funding LLC, SunTrust Capital Markets, Inc. and Wells Fargo Bank, National Association, dated as of May 2, 2005 (incorporated by reference to Exhibit 10.74 filed with MCG Capitals Form 10-Q for the quarter ended March 31,
2005).                                                                    
|               | 
|10.49          |  | Credit and Warehouse Agreement, dated as of June 9, 2005, among Merrill Lynch Capital Corp., MCG Commercial Loan Trust 2005-2 and MCG
Capital Corporation (incorporated by reference to Exhibit 99.1 filed with MCG Capitals Current Report on Form 8-K filed on June 9, 2005).                                                                                                                                                                
|               | 
|10.50          |  | Second Amendment to Sale and Servicing Agreement, dated as of July 29, 2005 among MCG Commercial Loan Funding Trust, MCG Capital
Corporation, Three Pillars Funding LLC, SunTrust Capital Markets, Inc., and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.76 filed with MCG Capitals Form 10-Q for the quarter ended June 30,
2005).                                                                        
|               | 
|10.51          |  | Amended and Restated Revolving Credit Agreement dated as of September 20, 2005 among MCG Capital Corporation, Bayerische Hypo-Und
Vereinsbank, AG, New York Branch and Various Lenders (incorporated by reference to Exhibit 99.1 filed with MCG Capitals Current Report on Form 8-K filed on September 21, 2005).                                                                                                                             



109



---

##### Table of Contents

|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                                                                                                                                                                                                                                                         
|               | 
|10.52          |  | Note Purchase Agreement, dated October 11, 2005 (incorporated by reference to Exhibit 99.1 filed with MCG Capitals Current
Report on Form 8-K filed on October 12, 2005).                                                                                                                                                                                                                                                                      
|               | 
|10.53          |  | Third Amendment to Sale and Servicing Agreement, dated as of December 7, 2005 among MCG Commercial Loan Funding Trust, MCG Capital
Corporation, Three Pillars Funding LLC, SunTrust Capital Markets, Inc., and Wells Fargo Bank, National Association (incorporated by reference Exhibit 99.1 filed with MCG Capitals Current Report on Form 8-K filed on December 13,
2005).                                                                  
|               | 
|10.54          |  | Fourth Amendment to Sale and Servicing Agreement, dated as of April 17, 2006, among MCG Commercial Loan Funding Trust, MCG Capital
Corporation, Three Pillars Funding LLC, SunTrust Capital Markets, Inc., and Wells Fargo, National Association (incorporated by reference to Exhibit f.23 filed with MCG Capitals registration statement on Form N-2 [File No. 333-133669] filed
with the Securities and Exchange Commission on May 1, 2006).
|               | 
|10.55          |  | Indenture by and between MCG Commercial Loan Trust 2006-1 and Wells Fargo Bank, National Association, dated as of April 18, 2006
(incorporated by reference to Exhibit f.24 filed with MCG Capitals registration statement on Form N-2 [File No. 333-133669] filed with the Securities and Exchange Commission on May 1, 2006).                                                                                                                
|               | 
|10.56          |  | Collateral Management Agreement, dated as of April 18, 2006, by and between MCG Commercial Loan Trust 2006-1 and MCG Capital
Corporation (incorporated by reference to Exhibit f.25 filed with MCG Capitals registration statement on Form N-2 [File No. 333-133669] filed with the Securities and Exchange Commission on May 1, 2006).                                                                                                        
|               | 
|10.57          |  | Class A-2 Note Purchase Agreement, dated as of April 18, 2006, among MCG Commercial Loan Trust 2006-1 and Wells Fargo Bank, National
Association (incorporated by reference to Exhibit f.26 filed with MCG Capitals registration statement on Form N-2 [File No. 333-133669] filed with the Securities and Exchange Commission on May 1, 2006).                                                                                                
|               | 
|10.58          |  | Class A-3 Note Purchase Agreement, dated as of April 18, 2006, by and among MCG Commercial Loan Trust 2006-1, North Sea Funding Europe
Asset Purchasing Company No. 1 B.V. and Wells Fargo Bank, National Association (incorporated by reference to Exhibit f.27 filed with MCG Capitals registration statement on Form N-2 [File No. 333-133669] filed with the Securities and Exchange
Commission on May 1, 2006).                           
|               | 
|10.59          |  | Class A-3 Note Purchase Agreement, dated as of April 18, 2006 by and among MCG Commercial Loan Trust 2006-1, Barclays Bank PLC and
Wells Fargo Bank, National Association (incorporated by reference to Exhibit f.28 filed with MCG Capitals registration statement on Form N-2 [File No. 333-133669] filed with the Securities and Exchange Commission on May 1,
2006).                                                                       
|               | 
|10.60          |  | Credit and Warehouse Agreement, dated as of May 2, 2006, among Merrill Lynch Capital Corp., MCG Commercial Loan Trust 2006-2 and MCG
Capital Corporation (incorporated by reference to exhibit 10.60 filed with MCG Capitals Form 10-Q for the quarter ended March 31, 2006).                                                                                                                                                                  
|               | 
|10.61          |  | Custody Agreement, dated as of May 2, 2006, among MCG Capital Corporation, MCG Finance VIII, LLC, MCG Commercial Loan Trust 2006-2,
Wells Fargo Bank, National Association and Merrill Lynch Capital Corp. (incorporated by reference to exhibit 10.61 filed with MCG Capitals Form 10-Q for the quarter ended March 31, 2006).                                                                                                                
|               | 
|10.62          |  | MCG Capital Corporation 2006 Non-Employee Director Restricted Stock Plan. (incorporated by reference to exhibit 10.62 filed with MCG
Capitals Form 10-Q for the quarter ended June 30, 2006).                                                                                                                                                                                                                                                  
|               | 
|10.63          |  | MCG Capital Corporation 2006 Employee Restricted Stock Plan. (incorporated by reference to exhibit 10.63 filed with MCG Capitals Form
10-Q for the quarter ended June 30, 2006).                                                                                                                                                                                                                                                               



110



---

##### Table of Contents

|               |  |                                                                                                                                                                                                                                                                                                                                                                             
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                                                                                                                                                                                     
|10.64          |  | Amendment No. 1 to the Second Amended and Restated Revolving Credit Agreement, dated as of August 7, 2006, by and among MCG Capital
Corporation, Bayerische Hypo-Und Vereinsbank AG, New York Branch and various lenders. (incorporated by reference to exhibit 10.64 filed with MCG Capitals Form 10-Q for the quarter ended June 30, 2006).                              
|10.65          |  | Severance Agreement and Release by and between Bryan J. Mitchell and MCG Capital Corporation, dated as of August 24, 2006
(incorporated by reference to exhibit 10.1 filed with MCG Capitals Current Report on Form 8-K filed on August 28, 2006).                                                                                                                         
|10.66          |  | Employment Agreement by and between MCG Capital Corporation and Steven F. Tunney, dated as of September 18, 2006 (incorporated by
reference to exhibit 10.1 filed with MCG Capitals Current Report on Form 8-K filed on September 19, 2006).                                                                                                                               
|10.67          |  | Employment Agreement by and between MCG Capital Corporation and B. Hagen Saville, dated as of September 18, 2006 (incorporated by
reference to exhibit 10.2 filed with MCG Capitals Current Report on Form 8-K filed on September 19, 2006).                                                                                                                               
|10.68          |  | Employment Agreement by and between MCG Capital Corporation and Robert J. Merrick, dated as of September 18, 2006 (incorporated by
reference to exhibit 10.3 filed with MCG Capitals Current Report on Form 8-K filed on September 19, 2006).                                                                                                                              
|10.69          |  | Amended and Restated Employment Agreement by and between MCG Capital Corporation and Michael R. McDonnell, dated as of September 18,
2006 (incorporated by reference to exhibit 10.4 filed with MCG Capitals Current Report on Form 8-K filed on September 19, 2006).                                                                                                      
|10.70          |  | MCG Capital Corporation Supplemental Non-Qualified Retirement Plan Amended and Restated as of January 1, 2005 (incorporated by
reference to exhibit 10.70 filed with MCG Capitals Form 10-Q for the quarter ended September 30, 2006).                                                                                                                                     
|10.71          |  | Third Amended and Restated Revolving Credit Agreement dated as of November 29, 2006 among MCG Capital Corporation, Bayerische Hypo Und
Vereinsbank, AG, New York Branch and Various Lenders (incorporated by reference to Exhibit 99.1 filed with MCG Capitals Current Report on Form 8-K filed on November 30, 2006).                                                     
|10.72          |  | Fifth Amendment to Sale and Servicing Agreement, dated as of February 1, 2007, among MCG Commercial Loan Funding Trust, MCG Capital
Corporation, Three Pillars Funding LLC, SunTrust Capital Markets, Inc., and Wells Fargo, National Association (incorporated by reference to Exhibit 99.1 filed with MCG Capitals Current Report on Form 8-K filed on February 1,
2007).
|10.73++        |  | First Amendment to Deed of Lease by and between Twin Towers II Property Associates, LLC, as landlord and MCG Capital Corporation, as
tenant, dated as of November 30, 2006.                                                                                                                                                                                                 
|               | 
|10.74++        |  | Employment Agreement by and between MCG Capital Corporation and Samuel G. Rubenstein, dated as of March 1, 2007.                                                                                                                                                                                                                                                            
|               | 
|10.75++        |  | Form of Restricted Stock Agreement for Non-Employee Directors Pursuant to 2006 Non-Employee Director Restricted Stock
Plan.                                                                                                                                                                                                                                                 
|               | 
|10.76++        |  | Form of Restricted Stock Agreement for Employees Pursuant to 2006 Employee Restricted Stock Plan.                                                                                                                                                                                                                                                                           
|11             |  | Statement regarding computation of per share earnings is included in Note 10 to the Companys Notes to the Consolidated Financial
Statements.                                                                                                                                                                                                                               
|21++           |  | Subsidiaries of the Company and jurisdiction of incorporation/organization.                                                                                                                                                                                                                                                                                                 
|23++           |  | Consent of Ernst & Young LLP                                                                                                                                                                                                                                                                                                                                                
|31.1++         |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.                                                                                                                                                                                                                                                              
|31.2++         |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.                                                                                                                                                                                                                                                              
|31.3++         |  | Certification of Chief Accounting Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.                                                                                                                                                                                                                                                             



111



---

##### Table of Contents

|               |  |                                                                                                                        
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                
|32.1++         |  | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350). 
|32.2++         |  | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350). 
|32.3++         |  | Certification of Chief Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C.
1350).

---

|++ |  | Filed Herewith
|-- |  | --------------



112



---

##### Table of Contents

SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on February 28, 2007.



MCG CAPITAL CORPORATIONBy:

/S/    STEVEN F.
TUNNEYSteven F. Tunney Chief Executive Officer




Pursuant to the
requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the Registrant in the capacities, and on the dates indicated.



|                                                |  |                                                                    |  |                  
|----------------------------------------------- |  | ------------------------------------------------------------------ |  | -----------------
|Signature                                       |  | Title                                                              |  | Date             
|                                                |  |                                                                   
|/s/    STEVEN F.
TUNNEYSteven F. Tunney         |  | Director and Chief Executive Officer (Principal Executive Officer) |  | February 28, 2007
|                                                |  |                                                                   
|/s/    MICHAEL R.
MCDONNELLMichael R.
McDonnell |  | Chief Financial Officer (Principal Financial Officer)              |  | February 28, 2007
|                                                |  |                                                                   
|/s/    JOHN C. WELLONSJohn C. Wellons           |  | Chief Accounting Officer (Principal Accounting Officer)            |  | February 28, 2007
|                                                |  |                                                                   
|/s/    B. HAGEN
SAVILLEB. Hagen Saville         |  | Director and ExecutiveVice President                               |  | February 28, 2007
|                                                |  |                                                                   
|/s/    ROBERT J.
MERRICKRobert J. Merrick       |  | Director and Chief Investment Officer                              |  | February 28, 2007
|                                                |  |                                                                   
|/s/    KENNETH J.
OKEEFEKenneth J.
OKeefe     |  | Chairman of the Board and Director                                 |  | February 28, 2007
|                                                |  |                                                                   
|/s/    EDWARD S.
CIVERAEdward S. Civera         |  | Director                                                           |  | February 28, 2007
|                                                |  |                                                                   
|/s/    JEFFREY M.
BUCHERJeffrey M. Bucher       |  | Director                                                           |  | February 28, 2007
|                                                |  |                                                                   
|/s/    WALLACE B.
MILLNERWallace B.
Millner     |  | Director                                                           |  | February 28, 2007
|                                                |  |                                                                   
|/s/    KIM D. KELLYKim D. Kelly                 |  | Director                                                           |  | February 28, 2007