UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-Q


(Mark One)


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


For the quarterly period ended March 31, 2013


OR


o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from ______ to ______


___________________


Commission file number 0-33377


MCG CAPITAL CORPORATION


(Exact name of registrant as specified in its charter)


Delaware54-1889518(State or other jurisdictionof incorporation or organization)(I.R.S. EmployerIdentification No.)1001 19th Street North, 10th FloorArlington, VA(Address of principal executive offices)22209(Zip Code)


(703) 247-7500


(Registrant's telephone number, including area code)





None


(Former name, former address and former fiscal year, if changed since last report)


Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x No o


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes o No o


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated fileroAccelerated filerxNon-accelerated fileroSmaller reporting companyo(Do not check if a smaller reporting company)


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


As of April 26, 2013, there wer e 71,211,636 shares of the registrant’s $0.01 par value Common Stock outstanding.







---



MCG CAPITAL CORPORATION


FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2013


TABLE OF CONTENTS








PART I. FINANCIAL INFORMATION1ITEM 1. FINANCIAL STATEMENTS1CONSOLIDATED BALANCE SHEETS1CONSOLIDATED STATEMENTS OF OPERATIONS2CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS3CONSOLIDATED STATEMENTS OF CASH FLOWS4CONSOLIDATED SCHEDULE OF INVESTMENTS5NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)12REVIEW REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM31ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS32ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK53ITEM 4. CONTROLS AND PROCEDURES54PART II. OTHER INFORMATION55ITEM 1. LEGAL PROCEEDINGS55ITEM 1A. RISK FACTORS55ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS55ITEM 3. DEFAULTS UPON SENIOR SECURITIES56ITEM 4. MINE SAFETY DISCLOSURES56ITEM 5. OTHER INFORMATION56ITEM 6. EXHIBITS57SIGNATURES58







---



PART I. FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS


MCG Capital Corporation


Consolidated Balance Sheets


(in thousands, except per share amounts)March 31, 2013December 31, 2012(unaudited)AssetsCash and cash equivalents$98,894$73,588Cash, securitization accounts33,14416,980Cash, restricted57,17154,838Investments at fair valueNon-affiliate investments (cost of$475,678and $534,389, respectively)301,833365,639Affiliate investments (cost of$55,061and $69,500, respectively)56,74762,079Control investments (cost of$65,548and$64,898, respectively)50,44250,006Total investments (cost of$596,287and $668,787, respectively)409,022477,724Interest receivable4,2822,700Other assets4,4804,946Total assets$606,993$630,776LiabilitiesBorrowings (maturing within one year of$28,088and $15,038, respectively)$233,015$248,053Interest payable8592,496Other liabilities4,4478,499Total liabilities238,321259,048Stockholders’ equityPreferred stock, par value $0.01, authorized 1 share, none issued and outstanding——Common stock, par value $0.01, authorized 200,000 shares on March 31, 2013 and December 31, 2012,71,212issued and outstanding on March 31, 2013 and 71,721issued and outstanding on December 31, 2012712717Paid-in capital982,567984,468Distributions in excess of earnings(427,343)(422,395)Net unrealized depreciation on investments(187,264)(191,062)Total stockholders’ equity368,672371,728Total liabilities and stockholders’ equity$606,993$630,776Net asset value per common share at end of period$5.18$5.18





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


---



MCG Capital Corporation


Consolidated Statements of Operations


(unaudited)


Three months endedMarch 31(in thousands, except per share amounts)20132012RevenueInterest and dividend incomeNon-affiliate investments (less than 5% owned)$9,848$13,781Affiliate investments (5% to 25% owned)1,6271,760Control investments (more than 25% owned)1,3011,755Total interest and dividend income12,77617,296Advisory fees and other incomeNon-affiliate investments (less than 5% owned)458236Control investments (more than 25% owned)1227Total advisory fees and other income470263Total revenue13,24617,559Operating expenseInterest expense2,3825,202Employee compensationSalaries and benefits1,4073,875Amortization of employee restricted stock awards375478Total employee compensation1,7824,353General and administrative expense1,0323,936Restructuring expense726Total operating expense5,20313,517Net operating income before net investment loss, loss on extinguishment of debt and income tax provision8,0434,042Net realized (loss) gain on investmentsNon-affiliate investments (less than 5% owned)(497)16,370Affiliate investments (5% to 25% owned)(3,424)—Control investments (more than 25% owned)(110)8Total net realized (loss) gain on investments(4,031)16,378Net unrealized appreciation (depreciation) on investmentsNon-affiliate investments (less than 5% owned)(5,095)(16,594)Affiliate investments (5% to 25% owned)9,107(1,426)Control investments (more than 25% owned)(214)(846)Derivative and other fair value adjustments—(5)Total net unrealized appreciation (depreciation) on investments3,798(18,871)Net investment loss before income tax provision(233)(2,493)Loss on extinguishment of debt before income tax provision—(174)Income tax provision5818Net income$7,752$1,357Income per basic and diluted common share$0.11$0.02Cash distributions declared per common share$0.125$0.17Weighted-average common shares outstanding—basic and diluted71,50777,050


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


---






MCG Capital Corporation


Consolidated Statements of Changes in Net Assets


(unaudited)


Three months endedMarch 31(in thousands, except per share amounts)20132012Increase in net assets from operationsNet operating income before net investment loss, loss on extinguishment of debt and income tax provision$8,043$4,042Net realized (loss) gain on investments(4,031)16,378Net unrealized appreciation (depreciation) on investments3,798(18,871)Loss on extinguishment of debt before income tax provision—(174)Income tax provision(58)(18)Net income7,7521,357Distributions to stockholdersDistributions declared(8,902)(13,050)Net decrease in net assets resulting from stockholder distributions(8,902)(13,050)Capital share transactionsRepurchase of common stock(2,272)(5,085)Amortization of restricted stock awardsEmployee awards accounted for as employee compensation375478Non-employee director awards accounted for as general and administrative expense1417Common stock withheld to pay taxes applicable to the vesting of restricted stock(23)(184)Net decrease in net assets resulting from capital share transactions(1,906)(4,774)Total decrease in net assets(3,056)(16,467)Net assetsBeginning of period371,728434,952End of period$368,672$418,485Net asset value per common share at end of period$5.18$5.45Common shares outstanding at end of period71,21276,762





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


---



MCG Capital Corporation


Consolidated Statements of Cash Flows


(unaudited)


Three months endedMarch 31(in thousands)20132012Cash flows from operating activitiesNet income$7,752$1,357Adjustments to reconcile net income to net cash provided by operating activitiesInvestments in portfolio companies(14,406)(4,367)Principal collections related to investment repayments or sales83,01575,520Decrease (increase) in interest receivable, accrued payment-in-kind interest and dividends(1,673)1,280Amortization of restricted stock awardsEmployee375478Non-employee director1417Decrease in cash—securitization accounts from interest collections664292Decrease in restricted cash—escrow accounts1921,122Depreciation and amortization3652,757Decrease in other assets102401Decrease in other liabilities(5,739)(2,342)Realized loss (gain) on investments4,031(16,378)Net change in unrealized (appreciation) depreciation on investments(3,798)18,871Loss on extinguishment of debt—174Net cash provided by operating activities70,89479,182Cash flows from financing activitiesRepurchase of common stock(2,272)(5,085)Payments on borrowings(15,038)(49,010)Proceeds from borrowings—21,400Decrease (increase) in cash in restricted and securitization accountsSecuritization accounts for repayment of principal on debt(16,828)4,634Restricted cash(2,525)(35,437)Payment of financing costs—(1,030)Distributions paid(8,902)(13,092)Common stock withheld to pay taxes applicable to the vesting of restricted stock(23)(184)Net cash used in financing activities(45,588)(77,804)Net increase in cash and cash equivalents25,3061,378Cash and cash equivalentsBeginning balance73,58858,563Ending balance$98,894$59,941Supplemental disclosure of cash flow informationInterest paid$3,672$4,318Income taxes (received) paid(53)12Paid-in-kind interest collected1,959333Dividend income collected2443,465


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


---



MCG Capital Corporation


Consolidated Schedule of Investments


March 31, 2013 (unaudited)


(dollars in thousands)


Interest Rate(8)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostControl Investments(4):GMC Television Broadcasting, LLC(2)BroadcastingSenior Debt (Due 12/16)(1)4.3%—4.3%$17,570$15,157$15,743Subordinated Debt (Due 12/16)(6)2.5%—2.5%11,3736,975—Class B Voting Units (8.0%, 86,700 units)(5)9,071—Jet Plastica Investors, LLC(2)(10)Plastic ProductsSenior Debt A (Due 3/15)(1)(6)0.3%7.0%7.3%5,0503,897—RadioPharmacy  Investors, LLC(2)HealthcareSenior Debt (Due 12/16)(1)7.5%—7.5%7,6407,6407,640Subordinated Debt (Due 12/16)(1)12.0%3.0%15.0%10,60010,59610,596Preferred LLC Interest (19.7%, 70,000 units)12,21216,463Total control investments (represents 12.3% of total investments at fair value)65,54850,442Affiliate Investments(3):C7 Data Centers, Inc.Business ServicesSenior Debt (Due 9/17)(1)9.5%—9.5%9,8509,5299,676Series B Preferred Units (10.0%, 7,142,857 units)2,1022,452Contract Datascan Holdings, Inc.Business ServicesSubordinated Debt (Due 3/16)(1)12.0%2.0%14.0%8,6188,1408,135Series A Preferred Stock (10.0%, 2,313 shares)(1)(5)2,3872,710Series B Preferred Stock (10.0%, 358 shares)(1)(5)307420Common Stock (8,519 shares)(1)(5)53853IDOC, LLCHealthcareSenior Debt (Due 8/17)(1)9.8%—9.8%15,00014,71714,717Limited Partner Interests (8.0%)(1)(2)1,0521,125Miles Media Group, LLC(2)Business ServicesSenior Debt (Due 6/16)(1)12.5%—12.5%16,36316,16616,166Warrants to purchase Class A Units (expire 3/21)(1)(5)1231,293Total affiliate investments (represents 13.9% of total investments at fair value)55,06156,747





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


---



MCG Capital Corporation


Consolidated Schedule of Investments


March 31, 2013 (unaudited)


(dollars in thousands)


Interest Rate(8)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostNon-Affiliate Investments (less than 5% owned):Accurate Group Holdings, Inc.(2)Business ServicesSubordinated Unsecured Debt (Due 6/18)(1)12.5%—12.5%$10,000$9,804$9,804Series A Preferred Stock (974,805 shares)(5)2,0002,015Advanced Sleep  Concepts, Inc.(2)Home FurnishingsSenior Debt (Due 9/13 to 1/14)(1)10.3%—10.3%7,5597,5457,225Subordinated Debt (Due 1/14)(1)(6)—%10.0%10.0%3,4963,352—BarBri, Inc.PublishingSenior Debt (Due 6/17)(1)6.0%—6.0%6,0996,0476,063Broadview Networks Holdings, Inc.CommunicationsCommon Stock (132,779 shares)(5)159,5791,106Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)——Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)——Chase Industries, Inc.ManufacturingSubordinated Unsecured Debt (Due 5/18)(1)11.5%—11.5%16,80016,48116,481Color Star Growers of Colorado, Inc.AgricultureSubordinated Debt (Due 11/16)(1)12.0%3.0%15.0%13,65513,40513,405Construction Trailer Specialists, Inc.(2)Auto PartsSenior Debt (Due 6/13)(1)8.6%6.3%14.9%6,4436,4406,440Cruz Bay Publishing, Inc.PublishingSubordinated Debt (Due 3/15)(1)5.0%7.3%12.3%20,36920,31620,316CWP/RMK Acquisition Corp.(2)Home FurnishingsSenior Debt (Due 12/16)(6)6.8%—6.8%600519597Education Management, Inc.EducationSenior Debt (Due 6/15)(1)9.3%—9.3%23,50023,33923,013Gans Communications,L.P.(2)CableSenior Debt (Due 10/17)(1)5.0%—5.0%5,0155,0025,062G&L Investment Holdings, LLC(2)InsuranceSubordinated Debt (Due 5/14)(1)10.7%4.3%15.0%18,86518,69918,699Series A Preferred Shares (14.0%, 5,000,000 shares)(5)8,1917,665Class C Shares (621,907 shares)(5)529—Golden Knight II CLO, Ltd.Diversified Financial ServicesIncome Notes (Due 4/19)2,8383,055Hammond's Candies Since 1920 II, LLCManufacturingSubordinated Debt (Due 9/18)(1)10.0%4.0%14.0%9,0988,9248,924Huron Inc.ManufacturingSubordinated Unsecured Debt (Due 8/18)(1)10.0%4.0%14.0%13,05512,80012,800Jenzabar, Inc.(9)TechnologySubordinated Preferred Stock (109,800 shares)(5)1,098988Legacy Cabinets Holdings II, Inc.Home FurnishingsClass B-1 Common Stock (2,000 shares)(5)2,185—Mailsouth, Inc.PublishingSenior Debt (Due 12/16)(1)6.8%—6.8%4,0924,0504,009Maverick HealthcareEquity, LLCHealthcarePreferred Units (10.0%, 1,250,000 units)1,9722,130Class A Common Units (1,250,000 units)(5)—323Midwest Technical Institute, Inc.EducationSenior Debt (Due 10/17)(1)9.5%—9.5%16,62516,27316,449Oceans Acquisition, Inc.HealthcareSenior Debt (Due 12/17)(1)10.8%—10.8%16,21015,90215,902


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


---



MCG Capital Corporation


Consolidated Schedule of Investments


March 31, 2013 (unaudited)


(dollars in thousands)


Interest Rate(8)PrincipalCostFair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalRita’s Water Ice Franchise Company, LLCRestaurantsSenior Debt (Due 11/16)(1)14.0%—14.0%$9,375$9,306$9,306Sagamore Hill Broadcasting, LLC(2)BroadcastingSenior Debt (Due 8/14)(1)10.5%—10.5%9,7009,6479,647SC Academy Holdings, Inc.EducationSubordinated Debt (Due 7/16)(1)12.0%—12.0%13,50013,42013,420Softlayer Technologies, Inc.Business ServicesSenior Debt (Due 11/16)(1)7.3%—7.3%13,68513,58213,676South Bay Mental Health Center, Inc.HealthcareSubordinated Debt (Due 10/17)(1)12.0%2.5%14.5%18,44718,11518,306Summit Business Media Parent Holding Company LLCInformation ServicesClass E Series I Units (636 units)(1)(5)4,120439Class E Series II Units (276 units)(1)(5)1,78813The e-Media Club I, LLCInvestment FundLLC Interest (74 units)(5)8811The Gavilon Group, LLCAgricultureSenior Debt (Due 12/16)(1)6.0%—6.0%8,2508,1748,179Virtual Radiologic CorporationHealthcareSenior Debt (Due 12/16)(1)7.8%—7.8%13,74013,6049,573Visant CorporationConsumer ProductsSenior Debt (Due 12/16)(1)5.3%—5.3%4,7114,7224,597West World Media, LLCInformation ServicesSenior Debt (Due 9/15)(1)11.0%3.0%14.0%11,49910,99711,227Class A Membership Units (25,000 units)(1)(5)1349Warrant to purchase Class A Membership Units  (expire 9/15)(1)(5)324378Xpressdocs Holdings, Inc.Business ServicesSeries A Preferred Stock (161,870 shares)(5)500241Total non-affiliate investments (represents 73.8% of total investments at fair value)475,678301,833Total Investments$596,287$409,022





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


---



MCG Capital Corporation


Consolidated Schedule of Investments


December 31, 2012


(dollars in thousands)


Interest Rate(8)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostControl Investments(4):GMC Television Broadcasting, LLC(2)BroadcastingSenior Debt (Due 12/16)(1)4.3%—4.3%$17,570$15,150$15,736Subordinated Debt (Due 12/16)(6)2.5%—2.5%11,3036,976—Class B Voting Units (8.0%, 86,700 units)(5)9,071—Jet Plastica Investors, LLC(2)(10)Plastic ProductsSenior Debt A (Due 3/15)(1)(6)2.3%7.0%9.3%4,9633,897—RadioPharmacy  Investors, LLC(2)HealthcareSenior Debt (Due 12/16)(1)7.5%—7.5%7,6407,6407,640Subordinated Debt (Due 12/16)(1)12.0%3.0%15.0%10,52110,51810,518Preferred LLC Interest (19.7%, 70,000 units)11,64616,112Total control investments (represents 10.5% of total investments at fair value)64,89850,006Affiliate Investments(3):Advanced SleepConcepts, Inc.(2)Home FurnishingsSenior Debt (Due 1/14)(1)12.9%—12.9%$7,559$7,539$7,199Subordinated Debt (Due 1/14)(1)(6)12.0%4.0%16.0%5,8735,38510Series A Preferred Stock (20.0%, 49 shares)(5)344—Series B Preferred Stock (1,000 shares)(5)——Common Stock (423 shares)(5)524—Warrants to purchase Common Stock (expire 10/16)(5)348—C7 Data Centers, Inc.Business ServicesSenior Debt (Due 9/17)(1)9.5%—9.5%10,0009,6599,659Series B Preferred Units (10.0%, 7,142,857 units)2,0532,421Contract Datascan Holdings, Inc.Business ServicesSubordinated Debt (Due 3/16)(1)12.0%2.0%14.0%8,5758,0597,870Series A Preferred Stock (10.0%, 2,313 shares)(1)(5)2,3872,203Series B Preferred Stock (10.0%, 358 shares)(1)(5)307341Common Stock (8,519 shares)(1)(5)538—IDOC, LLCHealthcareSenior Debt (Due 8/17)(1)9.8%—9.8%15,00014,70714,707Limited Partner Interests (8.0%)(1)(2)1,0321,073Miles Media Group, LLC(2)Business ServicesSenior Debt (Due 6/16)(1)12.5%—12.5%16,73816,49516,495Warrants to purchase Class A Units (expire 3/21)(1)(5)123101Total affiliate investments (represents 13.0% of total investments at fair value)69,50062,079





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


---



MCG Capital Corporation


Consolidated Schedule of Investments


December 31, 2012


(dollars in thousands)


Interest Rate(8)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostNon-Affiliate Investments (less than 5% owned):Accurate Group Holdings, Inc.(2)Business ServicesSubordinated Unsecured Debt (Due 6/18)(1)12.5%—12.5%$10,000$9,802$9,802Series A Preferred Stock (974,805 shares)(5)2,0002,000BarBri, Inc.PublishingSenior Debt (Due 6/17)(1)6.0%—6.0%6,0996,0466,110Broadview Networks Holdings, Inc.CommunicationsCommon Stock (132,779 shares)(5)159,5791,087Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)——Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)——Capstone Logistics, LLC(12)LogisticsSenior Debt (Due 9/16)(1)10.5%—10.5%27,34727,23727,237Chase Industries, Inc.ManufacturingSubordinated Unsecured Debt (Due 5/18)(1)11.5%—11.5%16,80016,47216,472Color Star Growers of Colorado, Inc.AgricultureSubordinated Debt (Due 11/16)(1)12.0%3.0%15.0%13,55313,29213,292Construction Trailer Specialists, Inc.(2)Auto PartsSenior Debt (Due 6/13)(1)8.6%6.3%14.9%6,4456,4346,434Cruz Bay Publishing, Inc.PublishingSubordinated Debt (Due 3/15)(1)(7)5.0%7.3%12.3%20,00019,94219,942CWP/RMK Acquisition Corp.(2)Home FurnishingsSenior Debt (Due 12/16)(6)6.8%—6.8%600519597Education Management, Inc.EducationSenior Debt (Due 6/15)(1)9.3%—9.3%26,65426,45925,260Gans Communications,L.P.(2)CableSenior Debt (Due 10/17)(1)5.0%—5.0%5,0154,9965,061G&L Investment Holdings, LLC(2)InsuranceSubordinated Debt (Due 5/14)(1)10.7%4.3%15.0%18,66718,46218,462Series A Preferred Shares (14.0%, 5,000,000 shares)(5)8,1918,067Class C Shares (621,907 shares)(5)529—Golden Knight II CLO, Ltd.Diversified Financial ServicesIncome Notes (Due 4/19)2,9892,847Hammond's Candies Since 1920 II, LLCManufacturingSenior Debt (Due 12/17)(1)8.5%—8.5%3,5003,4273,427Subordinated Debt (Due 6/18)(1)10.0%4.0%14.0%9,0088,8298,829Jenzabar, Inc.(9)TechnologySubordinated Preferred Stock (109,800 shares)1,098988Legacy Cabinets Holdings II, Inc.Home FurnishingsClass B-1 Common Stock (2,000 shares)(5)2,185—Mailsouth, Inc.PublishingSenior Debt (Due 12/16)(1)6.8%—6.8%4,6404,5904,594Maverick HealthcareEquity, LLCHealthcarePreferred Units (10.0%, 1,250,000 units)1,9252,078Class A Common Units (1,250,000 units)(5)—444Midwest Technical Institute, Inc.EducationSenior Debt (Due 10/17)(1)9.5%—9.5%17,06316,68216,682NDSSI Holdings,LLC(2)ElectronicsSenior Debt (Due 12/12)(1)12.8%1.0%13.8%30,17530,17430,174Series D Preferred Units (30.0%, 2,000,000 units)(5)2,0003,000Series A Preferred Units (516,691 units)(5)718—Series B Convertible Preferred Units (165,003 units)(5)142187Class A Common Units (1,000,000 units)(5)333—Oceans Acquisition, Inc.HealthcareSenior Debt (Due 12/17)(1)10.8%—10.8%23,71023,23723,237


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


---



MCG Capital Corporation


Consolidated Schedule of Investments


December 31, 2012


(dollars in thousands)


Interest Rate(8)PrincipalCostFair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalOrbitz Worldwide, Inc.Personal TransportationSenior Debt (Due 7/14)(1)3.2%—3.2%$2,808$2,728$2,702Rita’s Water Ice Franchise Company, LLCRestaurantsSenior Debt (Due 11/16)(1)14.0%—14.0%9,3759,3019,301Sagamore Hill Broadcasting, LLC(2)BroadcastingSenior Debt (Due 8/14)(1)10.5%—10.5%9,7009,6369,636SC Academy Holdings, Inc.EducationSubordinated Debt (Due 7/16)(1)12.0%—12.0%18,00017,84117,841Softlayer Technologies, Inc.Business ServicesSenior Debt (Due 11/16)(1)7.3%—7.3%13,72013,60613,814South Bay Mental Health Center, Inc.HealthcareSubordinated Debt (Due 10/17)(1)12.0%2.5%14.5%18,33317,98418,219Summit Business Media Parent Holding Company LLCInformation ServicesClass E Series I Units (636 units)(1)(5)4,120439Class E Series II Units (276 units)(1)(5)1,78813Sunshine Media Group, Inc.(2)PublishingWarrants to purchase Common Stock (expire 1/21)(5)——The e-Media Club I, LLCInvestment FundLLC Interest (74 units)(5)8811The Gavilon Group, LLCAgricultureSenior Debt (Due 12/16)(1)6.0%—6.0%8,5008,4098,489Virtual Radiologic CorporationHealthcareSenior Debt (Due 12/16)(1)7.8%—7.8%13,74013,59112,091Visant CorporationConsumer ProductsSenior Debt (Due 12/16)(1)5.3%—5.3%4,7604,7724,338VS&A-PBI Holding LLCPublishingLLC Interest(5)500—West World Media, LLCInformation ServicesSenior Debt (Due 9/15)(1)11.0%3.0%14.0%11,46210,91111,140Class A Membership Units (25,000 units)(1)(5)1335Warrant to purchase Class A Membership Units  (expire 9/15)(1)(5)324719Xpressdocs Holdings, Inc.Business ServicesSeries A Preferred Stock (161,870 shares)(5)500241Total non-affiliate investments (represents 76.5% of total investments at fair value)534,389365,639Total Investments$668,787$477,724





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


---



MCG Capital Corporation


Consolidated Schedule of Investments


December 31, 2012


(dollars in thousands)


|    |                                                                                                                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Some or all of this security is held by our SBIC subsidiary or one of our other financing subsidiaries and may have been pledged as collateral in connection therewith.  SeeNote 5—Borrowingsto the Condensed Consolidated Financial Statements.

|    |                                                                                 
|--- | --------------------------------------------------------------------------------
|(2) | Includes securities issued by one or more of the portfolio company’s affiliates.

|    |                                                                                                                                           
|--- | ------------------------------------------------------------------------------------------------------------------------------------------
|(3) | Affiliate investments represent companies in which we own at least 5%, but not more than 25% of the portfolio company’s voting securities.

|    |                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------
|(4) | Control investments represent companies in which we own more than 25% of the portfolio company’s voting securities.

|    |                                                       
|--- | ------------------------------------------------------
|(5) | Equity security is non-income producing at period-end.

|    |                                                
|--- | -----------------------------------------------
|(6) | Loan or debt security is on non-accrual status.

|    |                                                                                                                                                                                                                                           
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(7) | We did not recognize paid-in-kind, or PIK, interest or accretion income because the fair value of our investment was below its cost basis.  However, we continue to accrue interest that is receivable in cash from the portfolio company.

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(8) | Interest rates represent the weighted-average annual stated interest rate on debt securities, presented by nature of indebtedness for a single issuer.  PIK interest represents contractually deferred interest that is added to the principal balance of the debt security and compounded if not paid on a current basis.  PIK may be prepaid by either contract or the portfolio company's choice, but generally is paid at the end of the loan term.  Rates on preferred stock and preferred LLC interests, where applicable, represent the contractual rate.

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(9) | In February 2012, we accepted $23.7 million for our senior preferred stock and warrant position in Jenzabar.  The consideration received also settled any and all direct claims and counterclaims asserted in the litigation by and among the Company, Jenzabar and certain Jenzabar officers and directors.  We will receive the balance of the payment for our position in Jenzabar in the amount of $990,000 for our subordinated preferred stock and will exchange those shares upon the final dismissal of the litigation, including the dismissal of the derivative claims.

|     |                                                                                                                                                                                                                              
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | In the three months ended June 30, 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets.  Including the proceeds from the liquidation, we have received $11.0 million of payments on our senior debt.
















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


---



MCG Capital Corporation


Notes to the Condensed Consolidated Financial Statements (Unaudited)


NOTE 1—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION


These Condensed  Consolidated Financial Statements present the results of operations, financial position and cash flows of MCG Capital Corporation and its consolidated subsidiaries.  The terms “we,” “our,” “us” and “MCG” refer to MCG Capital Corporation and its consolidated subsidiaries.


We are a solutions-focused commercial finance company that provides capital and advisory services to middle-market companies throughout the United States.  We are an internally managed, non-diversified, closed-end investment company that elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940 , as amended, or the 1940 Act.  Our organization includes the following categories of subsidiaries:


Wholly Owned Special-Purpose Financing Subsidiary —This subsidiary is a bankruptcy remote, special-purpose entity to which we transfer certain loans.  The financing subsidiary, in turn, transfers the loans to a Delaware statutory trust.  For accounting purposes, the transfers of the loans to the Delaware statutory trust is structured as an on-balance sheet securitization.


Small Business Investment Subsidiaries —We own Solutions Capital I, L.P., or Solutions Capital, a wholly owned subsidiary licensed by the United States Small Business Administration, or SBA, which operates as a small business investment company, or SBIC, under the Small Business Investment Act of 1958 , as amended, or SBIC Act.  In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L. P. in order to apply for a second SBIC license.  In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013.  Receipt of such an invitation from the SBA does not assure an applicant that the SBA will grant the additional license in any specified time period or at all.  MCG is also the sole member of Solutions Capital G.P., LLC, which acts as the general partner of Solutions Capital and Solutions Capital II, L.P.


Taxable Subsidiaries — We currently qualify as a regulated investment company, or RIC, for federal income tax purposes and, therefore, are not required to pay corporate income taxes on any income or gains that we distribute to our stockholders.  We have certain wholly owned taxable subsidiaries, or Taxable Subsidiaries, each of which holds one or more portfolio investments listed on our Consolidated Schedules of Investments .  The purpose of these Taxable Subsidiaries is to permit us to hold portfolio companies organized as limited liability companies, or LLCs, or other forms of pass-through entities and still satisfy the RIC tax requirement that at least 90% of our gross revenue for income tax purposes must consist of investment income.  Absent the Taxable Subsidiaries, a portion of the gross income of any LLC or other pass-through entity portfolio investment would flow through directly to us, and be included in the calculation of the 90% test.  To the extent that such income did not consist of investment income, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes.  The income of the LLCs or other pass-through entities owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries and does not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages.  We do not consolidate the Taxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries’ ownership of the portfolio companies.  We reflect any such income tax expense on our Consolidated Statements of Operations .


The accompanying financial statements reflect the consolidated accounts of MCG and the following subsidiaries:  Solutions Capital; Solutions Capital II, L.P.; Solutions Capital G.P., LLC; and MCG’s special-purpose financing subsidiary, MCG Finance VII, LLC.


BASIS OF PRESENTATION AND USE OF ESTIMATES


These unaudited financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America and conform to Regulation S-X under the Securities  Exchange Act of 1934 , as amended.  We believe we have made all necessary adjustments so that the financial statements are presented fairly and that all such adjustments are of a normal recurring nature.  We eliminated all significant intercompany balances.  In accordance with Article 6 of Regulation S-X of the Securities Act of 1933 , as amended, and the Securities Exchange Act of 1934 , as amended, we do not consolidate portfolio company investments, including those in which we have a controlling interest.  Certain prior period information has been reclassified to conform to current year presentation.  Further, in connection with the preparation of these Condensed Consolidated Financial


12


---



Statements , we have evaluated subsequent events that occurred after the balance sheet date as of March 31, 2013 through the date these financial statements were issued.


Preparing financial statements requires us to make estimates and assumptions that affect the amounts reported on our Condensed Consolidated Financial Statements and accompanying notes.  Although we believe the estimates and assumptions used in preparing these Condensed Consolidated Financial Statements and related notes are reasonable, actual results could differ materially.


Interim results are not necessarily indicative of results for a full year.  You should read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.


NOTE 2—INVESTMENT PORTFOLIO


The following table summarizes the composition of our investment portfolio at cost and fair value:


COST BASISFAIR VALUE BASISMarch 31, 2013December 31, 2012March 31, 2013December 31, 2012(dollars in thousands)Investments at Cost% of Total PortfolioInvestments at Cost% of Total PortfolioInvestments at Fair Value% of Total PortfolioInvestments at Fair Value% of Total PortfolioDebt InvestmentsSenior secured debt$222,25537.3%$297,84244.6%$214,90752.5%$291,76061.1%Subordinated debtSecured121,94220.4127,28819.0111,80127.3114,98324.1Unsecured39,0856.626,2743.939,0859.626,2745.4Total debt investments383,28264.3451,40467.5365,79389.4433,01790.6Equity investmentsPreferred43,7307.346,4036.939,2649.641,5588.7Common/common equivalents169,27528.4170,98025.63,9651.03,1490.7Total equity investments213,00535.7217,38332.543,22910.644,7079.4Total investments$596,287100.0%$668,787100.0%$409,022100.0%$477,724100.0%


Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0% , a portion of which may be in the form of paid-in-kind interest, or PIK.  As of March 31, 2013 , approximately 69.4% of the fair value of our loan portfolio had variable interest rates, based on a London Interbank Offer Rate, or LIBOR, benchmark or the prime rate, and 30.6% of the fair value of our loan portfolio had fixed interest rates.  As of March 31, 2013 , approximately 59.4% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR-based index and prime floors between 2.5% and 6.0% .  At origination, our loans generally have four- to six-year stated maturities.  Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.


When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and generally will cease recognizing interest income on that loan until all principal and interest has been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible.  However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection.  If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.


13


---



The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status:


COST BASISFAIR VALUE BASISMarch 31, 2013December 31, 2012March 31, 2013December 31, 2012(dollars in thousands)Investments at Cost% of Loan PortfolioInvestments at Cost% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioLoans greater than 90 days past dueOn non-accrual status$3,8971.02%$3,8970.86%$——%$——%Not on non-accrual status————————Total loans greater than 90 days past due$3,8971.02%$3,8970.86%$——%$——%Loans on non-accrual status0 to 90 days past due$10,8462.83%$12,8802.85%$5970.16%$6070.14%Greater than 90 days past due3,8971.023,8970.86————Total loans on non-accrual status$14,7433.85%$16,7773.71%$5970.16%$6070.14%


The following table summarizes our investment portfolio by industry at fair value :


March 31, 2013December 31, 2012(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioHealthcare$96,77523.7%$106,11922.2%Business services66,64116.364,94713.6Education52,88212.959,78312.5Manufacturing38,2059.328,7286.0Publishing30,3887.430,6466.4Insurance26,3646.526,5295.6Broadcasting25,3906.225,3725.3Agriculture21,5845.321,7814.6Information services12,4063.012,6462.7Restaurants9,3062.39,3011.9Home furnishings7,8221.97,8061.6Auto parts6,4401.66,4341.3Cable5,0621.25,0611.1Consumer products4,5971.14,3380.9Electronics——33,3617.0Logistics——27,2375.7Other(a)5,1601.37,6351.6Total$409,022100.0%$477,724100.0%______________________(a)No individual industry within this category exceeds 1%.


14


---



NOTE 3—FAIR VALUE MEASUREMENT


We account for our investments in portfolio companies under Accounting Standard Codification Topic 820—Fair Value Measurements and Disclosures, or ASC 820.  ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value.  ASC 820 defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.


Fair Value Hierarchy


ASC 820 establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:


ASC 820 Fair Value HierarchyInputs to Fair Value MethodologyLevel 1Quoted prices in active markets for identical assets or liabilitiesLevel 2Quoted prices for similar assets or liabilities; quoted markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the financial instrument; inputs other than quoted prices that are observable for the asset or liability; or inputs that are derived principally from, or corroborated by, observable market informationLevel 3Pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption is unobservable or when the estimation of fair value requires significant management judgment


We categorize a financial instrument in the fair value hierarchy based on the lowest level of input that is significant to its fair value measurement.  In the event that transfers between these levels were to occur in the future, we would recognize those transfers as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.


15


---



Assets Measured at Fair Value on a Recurring Basis


The following table presents the assets that we report at fair value on our Consolidated Balance Sheets by fair value hierarchy:


March 31, 2013(in thousands)Internal Models with SignificantTotal Fair Value  Reported in  Consolidated  Balance SheetObservable Market Parameters(Level 2)Unobservable  Market Parameters(Level 3)Non-affiliate investmentsSenior secured debt$51,159$99,806$150,965Subordinated secured debt—93,07093,070Unsecured subordinated debt—39,08539,085Preferred equity3,05513,03916,094Common/common equivalents—2,6192,619Total non-affiliate investments54,214247,619301,833Affiliate investmentsSenior secured debt—40,55940,559Subordinated secured debt—8,1358,135Preferred equity—6,7076,707Common/common equivalents—1,3461,346Total affiliate investments—56,74756,747Control investmentsSenior secured debt—23,38323,383Subordinated secured debt—10,59610,596Preferred equity—16,46316,463Total control investments—50,44250,442Total assets at fair value$54,214$354,808$409,022


As of March 31, 2013 , we had no investments that had quoted market prices in active markets which we would categorize as Level 1 investments under ASC 820.  Cash and cash equivalents are carried at cost which approximates fair value and are Level 1 assets.


Valuation Methodologies and Procedures


As required by the 1940 Act, we classify our investments by level of control.  Control investments include both majority-owned control investments and non-majority owned control investments.  A majority-owned control investment represents a security in which we own more than 50% of the voting interest of the portfolio company and generally control its board of directors.  A non-majority owned control investment represents a security in which we own 25% to 50% of the portfolio company’s voting equity.  As of each of March 31, 2013 and December 31, 2012 , our portfolio contained zero non-majority control investments.  Non-control investments represent both affiliate and non-affiliate securities for which we do not have a controlling interest.  Affiliate investments represent securities in which we own 5% to 25% of the portfolio company’s equity.  Non-affiliate investments represent securities in which we own less than 5% of the portfolio company’s equity.


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Majority-Owned Control Investments—Majority-owned control investments comprised12.3%of our investment portfolio as ofMarch 31, 2013.  Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value.  Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value.  Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question.  Also, in a limited number of cases, we use income approaches to determine fair value, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs.  Our valuation approaches for majority-owned investments estimate the value upon a hypothetical sale or exit and then allocates such value to the investment's securities in order of their relative liquidation preference.  In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par.  These valuation approaches consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.

16


---



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Non-Control Investments—Non-control investments comprised87.7%of our investment portfolio as ofMarch 31, 2013.  Quoted prices were not available for84.9%of our non-control investments as ofMarch 31, 2013.  For our non-control equity investments, we use the same market and income approaches used to value our control investments.  For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates.  We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower.  In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Thinly Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end.  However, we may apply a discount to the market value of restricted or thinly-traded public securities to reflect the impact that these restrictions have on the value of these securities.  We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2).  As ofMarch 31, 2013, these securities represented13.3%of our investment portfolio.  We utilize independent pricing services to arrive at certain of our fair value estimates.  The majority of our level 2 investments are senior debt investments that are secured and collateralized.  To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.

Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales.  Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks.  We also use independent valuation firms to provide additional data points for our quarterly valuation analyses.  Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months.  In total, as of March 31, 2013 , we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve-month period for 98.8% of our investment portfolio, calculated on a fair value basis.


The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs.  We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses.


Our board of directors sets our valuation policies and procedures and determines the fair value of our investments.  The investment and valuation committee of our board of directors meets at least quarterly with our executive management to review management’s recommendations of fair value of our investments.  Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments.


Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and such differences could be material.  In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to differ from the valuations currently assigned.


Changes in Level 3 Fair Value Measurements


We classify securities in the Level 3 valuation hierarchy based on the significance of the unobservable factors to the overall fair value measurement.  Our fair value approach for Level 3 securities primarily uses unobservable inputs, but may also include observable, actively quoted components derived from external sources.  Accordingly, the gains and losses in the table below include fair value changes due, in part, to observable factors.  Additionally, we transfer investments in and out of Level 1, 2 and 3 securities as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.  During the three months ended March 31, 2013 and 2012 , there were no transfers in or out of Level 1, 2 or 3.


17


---



The following table provides a reconciliation of fair value changes during the three months ended March 31, 2013 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value December 31, 2012Senior secured debt$163,125$48,060$23,376$234,561Subordinated secured debt96,5857,88010,518114,983Unsecured subordinated debt26,274——26,274Preferred equity16,5616,03816,11238,711Common/common equivalents equity3,048101—3,149Total fair value December 31, 2012305,59362,07950,006417,678Realized/unrealized gain (loss)Senior secured debt1,070146—1,216Subordinated secured debt(55)185—130Preferred equity(460)600(215)(75)Common/common equivalents equity741,245—1,319Total realized/unrealized gain (loss)6292,176(215)2,590IssuancesSenior secured debt8,4857778,569Subordinated secured debt5,95080786,108Unsecured subordinated debt12,811——12,811Preferred equity4769566682Total issuances27,29322665128,170SettlementsSenior secured debt(65,524)(7,724)—(73,248)Subordinated secured debt(9,410)(10)—(9,420)Common/common equivalents equity(500)——(500)Total settlements(75,434)(7,734)—(83,168)SalesSenior secured debt(7,350)——(7,350)Preferred equity(3,109)——(3,109)Common/common equivalents equity(3)——(3)Total sales(10,462)——(10,462)Fair value as of March 31, 2013Senior secured debt99,80640,55923,383163,748Subordinated secured debt93,0708,13510,596111,801Unsecured subordinated debt39,085——39,085Preferred equity13,0396,70716,46336,209Common/common equivalents equity2,6191,346—3,965Total fair value as of March 31, 2013$247,619$56,747$50,442$354,808


There were no purchases of level 3 investments during the three months ended March 31, 2013 .


18


---



The following table provides a reconciliation of fair value changes during the three -month period ended March 31, 2012 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value December 31, 2011Senior secured debt$280,371$40,572$62,615$383,558Subordinated secured debt100,96712,96710,355124,289Unsecured subordinated debt12,203——12,203Preferred equity28,97812,45346,29387,724Common/common equivalents equity18,6453,610—22,255Total fair value December 31, 2011441,16469,602119,263630,029Realized/unrealized gain (loss)Senior secured debt658(1,082)3,9373,513Subordinated secured debt(228)46—(182)Unsecured subordinated debt81—889Preferred equity(1,633)190(4,783)(6,226)Common/common equivalents equity1(577)—(576)Total realized/unrealized gain (loss)(1,121)(1,423)(838)(3,382)IssuancesSenior secured debt1,4013,494354,930Subordinated secured debt37312981583Unsecured subordinated debt69——69Preferred equity27228478778Total issuances2,1153,6515946,360SettlementsSenior secured debt(18,510)(2,050)(1,080)(21,640)Subordinated secured debt(12,541)—(79)(12,620)Unsecured subordinated debt——(8)(8)Preferred equity(6,908)——(6,908)Common/common equivalents equity(16,791)——(16,791)Total settlements(54,750)(2,050)(1,167)(57,967)Fair value as of March 31, 2012Senior secured debt263,92040,93465,507370,361Subordinated secured debt88,57113,14210,357112,070Unsecured subordinated debt12,353——12,353Preferred equity20,70912,67141,98875,368Common/common equivalents equity1,8553,033—4,888Total fair value as of March 31, 2012$387,408$69,780$117,852$575,040


There were no purchases or sales of level 3 investments during the three months ended March 31, 2012 .


19


---



Unrealized (Depreciation) Appreciation of Level 3 Investments


The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the three months ended March 31, 2013 and 2012 :


Three months ended March 31, 2013Three months ended March 31, 2012(in thousands)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalNon-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalChange in unrealized appreciation (depreciation)Senior secured debt$1,070$147$—$1,217$658$(1,082)$3,937$3,513Subordinated secured debt1,978185—2,163(90)46—(44)Unsecured subordinated debt————81——81Preferred equity(366)598(215)17(1,633)190(4,783)(6,226)Common/common equivalents equity1,2771,246—2,52368(577)—(509)Total change in unrealized appreciation (depreciation) on Level 3 investments$3,959$2,176$(215)$5,920$(916)$(1,423)$(846)$(3,185)


Significant Unobservable Inputs


Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs.  Rather, the majority of our investment portfolio is composed of complex debt and equity securities with distinct contract terms and conditions.  As such, our valuation of each investment in our portfolio is unique and complex, often factoring in numerous different inputs, including the historical and forecasted financial and operational performance of the portfolio company, projected cash flows, market multiples, comparable market transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews and other inputs too numerous to list quantitatively herein.


The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of March 31, 2013 :


($ in thousands)Fair ValueValuation TechniquesUnobservable InputsRangeWeighted AverageMinimumMaximumSenior debt$163,748Discounted cash flowMarket interest rate6.8%12.8%9.4%Discounted cash flowDiscount rate4.0%4.0%4.0%Market comparable companiesEBITDA multiple(a)7.5x7.5x7.5xSubordinated debt150,886Discounted cash flowMarket interest rate11.5%15.0%13.3%Market comparable companiesRevenue multiple0.2x0.2x0.2xMarket comparable companiesEBITDA multiple(a)7.5x7.5x7.5xPreferred and common equity40,174Market comparable companiesEBITDA multiple(a)4.4x10.0x7.4xDiscount for minority interest—%25.0%1.9%Pending transactions/Letters of intentDiscount—%—%—%Residual assetsDiscount25.0%25.0%25.0%$354,808


________________


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

20


---



NOTE 4—CONCENTRATIONS OF INVESTMENT RISK


During the three months ended March 31, 2013 , we had concentrations in certain industries, including the healthcare, business services and education industries.  The following table summarizes our fair value and revenue concentrations in each of those industries:


Investments at fair valueRevenue for the three months endedMarch 31, 2013December 31, 2012March 31, 2013March 31, 2012(dollars in thousands)Amount% of Total PortfolioAmount% of Total PortfolioAmount% of Total RevenueAmount% of Total RevenueIndustryHealthcare$96,77523.7%$106,11922.2%$3,05323.0%$2,70615.4%Business services66,64116.364,94713.61,80113.62,04311.6Education52,88212.959,78312.51,56411.81,3897.9


NOTE 5—BORROWINGS


As of March 31, 2013 , we reported $233.0 million of borrowings on our Consolidated Balance Sheets at cost.  The following table summarizes our borrowing facilities, the facility amounts and amounts outstanding.


March 31, 2013December 31, 2012(dollars in thousands)Maturity DateTotal Facility/ ProgramAmount OutstandingTotal Facility/ ProgramAmount OutstandingSBIC2008-10BSeptember 2018$2,600$2,600$2,600$2,6002009-10AMarch 201912,00012,00012,00012,0002009-10BSeptember 201913,00013,00013,00013,0002010-10BSeptember 202027,50027,50027,50027,5002011-10AMarch 202153,50053,50053,50053,5002012-10AMarch 202241,40041,40041,40041,400MCG Commercial Loan Trust 2006-1Series 2006-1 Class B Notes(a)April 2018(b)22,11322,11337,15137,151Series 2006-1 Class C Notes(c)April 2018(b)45,00032,00045,00032,000Series 2006-1 Class D Notes(d)April 2018(b)45,94528,90245,94528,902Bank of America Unsecured RevolverUnsecured Revolving NoteNovember 201420,000—20,000—Total borrowings$283,058$233,015$298,096$248,053__________(a)In April 2013, the Class B Notes were repaid in full.(b)Borrowings under the MCG Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt.(c)Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.(d)Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.


We estimate that the fair value of these borrowings as of March 31, 2013 was approximately $235.9 million, based on market data and current interest rates.  This fair value is estimated from market quotes in an inactive market provided by an independent pricing service for $78.8 million of our borrowings (level 2) and a market-yield approach for $157.1 million (level 3) of our borrowings.


As a BDC, we are not permitted to incur indebtedness or issue senior securities, including preferred stock, unless immediately after such borrowing we have an asset coverage for total borrowings (excluding borrowings by our SBIC facility) of at least 200%.  In addition, we may not be permitted to declare any cash dividend or other distribution on


21


---



our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have an asset coverage ratio of at least 200% after deducting the amount of such dividend, distribution or purchase price.  If we are unable to meet this asset coverage requirement, we may not be able to incur additional debt.  As of March 31, 2013 , our ratio of total assets to total borrowings and other senior securities was 542% .


Each of our borrowing facilities has certain financial covenants and non-financial covenants.  We were in compliance with the covenants as of March 31, 2013 and 2012 .


We have funded our current secured borrowing debt facility through a bankruptcy remote, special-purpose, wholly owned subsidiary.  Therefore, this subsidiary’s assets may not be available to our creditors.  We continue to service those portfolio investments that we use as collateral in our secured borrowing facility.


The following table summarizes repayments of our borrowings based on the final legal maturity or the contractual principal collections of the outstanding loans that comprise the collateral, where applicable.  Actual repayments could differ significantly due to future prepayments by our borrowers, modifications of our borrowers’ existing loan agreements, and monetizations.


(in thousands)March 31, 20132013(a)$28,0882014—2015—2016—2017—Thereafter204,927Total$233,015


____________


|    |                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Reflects repayments we are required to make in connection with principal collections from collateral loans in our MCG Commercial Loan Trust 2006-1.

SBIC Debentures


In December 2004, we formed a wholly owned subsidiary Solutions Capital.  Solutions Capital has a license from the SBA to operate as an SBIC under the SBIC Act.  The license permits Solutions Capital to borrow up to $150.0 million from the SBA, which is the maximum amount of outstanding leverage available to single-license SBIC companies.


In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L. P. in order to apply for a second SBIC license.  In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013.  There is no assurance that the SBA will grant the additional license in any specified time period or at all.  Currently, a second SBIC license would grant us the ability to borrow up to an additional $75 million from the SBA, or two times the amount of statutory equity capital we invest in Solutions Capital II, L.P.  If approved and depending on available capital, we intend to fund the entire $37.5 million using unrestricted cash.


To realize the full $150.0 million in borrowings for which we have received approval to date under the SBIC program, we have funded a total of $75.0 million to Solutions Capital.  As of each of March 31, 2013 and December 31, 2012 , Solutions Capital had borrowed $150.0 million.  We are permitted to use these funds to provide debt and equity capital to qualifying small businesses.  However, we may not use these borrowings to provide additional financing to certain companies that are currently in our portfolio without SBA approval.  In addition, we may not use these funds to provide working capital to MCG, Solutions Capital's parent company.


As of March 31, 2013 and December 31, 2012 , we had $186.3 million and $187.9 million, respectively, of investments in our SBIC and we had $50.5 million and $48.3 million, respectively, of restricted cash to be used for additional investments in our SBIC.


22


---



As of March 31, 2013 , Solutions Capital had borrowings outstanding as summarized in the following table:


Amount Outstanding(dollars in thousands)March 31, 2013December 31, 2012RateTranche2008-10B$2,600$2,6006.44%Fixed2009-10A12,00012,0005.34%Fixed2009-10B13,00013,0004.95%Fixed2010-10B27,50027,5003.93%Fixed2011-10A53,50053,5004.80%Fixed2012-10A41,40041,4003.38%FixedTotal$150,000$150,0004.33%


In October 2008, we received exemptive relief from the SEC which allows us to exclude debt issued by Solutions Capital from the calculation of our consolidated BDC asset coverage ratio.


MCG Commercial Loan Trust 2006-1


In April 2006, we completed a $500.0 million debt securitization through the MCG Commercial Loan Trust 2006-1, or 2006-1 Trust, a wholly owned subsidiary.  The 2006-1 Trust issued $106.25 million of Class A-1 Notes, $50.0 million of Class A-2 Notes, $85.0 million of Class A-3 Notes, $58.75 million of Class B Notes, $45.0 million of Class C Notes and $47.5 million of Class D Notes.  The respective classes of notes were issued with interest at LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%.  As of March 31, 2013 , we have repaid all of the Class A notes.


All of the notes are secured by the assets of the 2006-1 Trust. The following table summarizes the fair value of the assets securitized under this facility as of March 31, 2013 and December 31, 2012 :


(dollars in thousands)March 31, 2013December 31, 2012Amount%Amount%Securitized assetsSenior secured debt$104,39062.1%$136,51374.2%Subordinated secured debt30,00017.930,02516.3Common Equity4520.34520.3Total securitized assets134,84280.3166,99090.8Cash, securitization accounts33,14419.716,9809.2Total collateral$167,986100.0%$183,970100.0%


We retain all of the equity in the securitization.  The securitization included a five-year reinvestment period, which ended in July 2011.


The outstanding Class B, Class C and Class D Notes are term notes.  The Class A-2 Notes initially provided for a five-year revolving period, which has expired.  Therefore, we may not draw on the Class A-2 Notes.  The Class A-3 Notes were a delayed draw class of secured notes, which were drawn in full between July 2006 and April 2007.  The pool of commercial loans in the trust must meet certain requirements, such as asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.


Bank of America Unsecured Revolver


In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or Bank of America Unsecured Revolver.  Advances under the Bank of America Unsecured Revolver will bear interest at LIBOR plus 3.5% per annum and will expire in November 2014.  As of March 31, 2013 , there were no borrowings outstanding on the Bank of America Unsecured Revolver.


23


---



The Bank of America Unsecured Revolver is subject to certain collateral requirements and financial covenants.  Included among them are requirements that we maintain a ratio of all unencumbered assets to outstanding amounts under the Bank of America Unsecured Revolver of at least four-to-one, as well as a ratio of unencumbered cash and senior portfolio loans to outstanding amounts under the Bank of America Unsecured Revolver of at least three-to-one.  The Bank of America Unsecured Revolver may be prepaid at any time, and is required to be paid in full for a period of at least five consecutive calendar days during each quarter.


NOTE 6—CAPITAL STOCK


We have one class of common stock and one class of preferred stock authorized.  Our board of directors is authorized to provide for the issuance of shares of preferred stock in one or more series, establish the number of shares to be included in each such series and establish the designations, voting powers, preferences and rights of the shares of each such series, and any qualifications, limitations or restrictions thereof, subject to the 1940 Act.


STOCK REPURCHASE PROGRAM


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million and we have provided our stockholders with notice of our intention to repurchase shares of our common stock in accordance with 1940 Act requirements.  Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.  During the three months ended March 31, 2013 , we repurchased 504,639 shares of our common stock at a weighted average purchase price of $4.50 per share, which was a 13.1% discount from our quarterly net asset value per share.


We have received an exemptive order from 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.  Awards under the Third Amended and Restated 2006 Employee Restricted Stock Plan (discussed in Note 7—Share-Based Compensation below) must comply with all aspects of the SEC's order, including the following:


|  |                                                                                    
|- | -----------------------------------------------------------------------------------
|• | no one person may be granted awards totaling more than 25% of the shares available;

|  |                                                                                                         
|- | --------------------------------------------------------------------------------------------------------
|• | in any fiscal year, no person may be granted awards in excess of 500,000 shares of our common stock; and

|  |                                                                                                                                                                                                                         
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | the total number of shares that may be outstanding as restricted shares under all of our compensation plans may not exceed 10% of the total number of our shares of common stock authorized and outstanding at any time.

We have requested the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engage in a stock repurchase program and agree not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans.  We have received no assurance or indication from the SEC that we will receive such relief, or of the timeframe in which we would receive any relief, should it ultimately be granted.  As of December 31, 2012 and March 31, 2013, an aggregate of 1,079,253 and 574,614 shares of restricted stock, respectively, could be issued under our Third Amended and Restated 2006 Employee Restricted Stock Plan and our Third Amended and Restated 2006 Non-Employee Director Restricted Stock Plan before reaching the 10% threshold set forth in the SEC's order.  The decrease in shares that could be issued under the restricted stock plans is attributable to the shares we repurchased under our stock repurchase program.


24


---



DISTRIBUTIONS


The following table summarizes our distributions per share declared since January 1, 2012:


Date DeclaredRecord DatePayment DateAmountApril 26, 2013May 10, 2013May 31, 2013$0.125March 1, 2013March 15, 2013March 29, 2013$0.125October 26, 2012November 16, 2012November 30, 2012$0.125July 27, 2012August 17, 2012August 31, 2012$0.140April 27, 2012June 13, 2012July 13, 2012$0.140February 24, 2012April 13, 2012May 15, 2012$0.170


NOTE 7—SHARE-BASED COMPENSATION


EMPLOYEE SHARE-BASED COMPENSATION


Third Amended and Restated 2006 Employee Restricted Stock Plan


From time to time, we award shares of restricted common stock to employees under our Third  Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, which our stockholders initially approved in June 2006.  In May 2010, our stockholders approved an amendment to the 2006 Plan increasing the number of shares we may award from 3,500,000 to 6,050,000 shares.  Shares of restricted common stock awarded under the 2006 Plan may be subject to the employees' meeting service or performance conditions specified at the time of award.  The award date is the date on which the shares are awarded by the Compensation Committee of our board of directors, while the fair value of the respective stock award is based on the closing price of our common stock on the NASDAQ Global Select Market on the award date.  We amortize restricted stock awards on a straight-line basis over the requisite service period and report this expense as amortization of employee restricted stock awards on our Consolidated Statements of Operations .


During the three months ended March 31, 2013 , no shares of restricted stock were issued under the 2006 Plan.  During three months ended March 31, 2012 , we issued 1,000,000 shares of restricted stock under the 2006 Plan with a weighted-average fair value per share of common stock at the award date of $4.43.


During the three months ended March 31, 2013 and 2012 , we recognized $0.4 million and $0.5 million, respectively, of compensation expense related to share-based compensation awards.  As of March 31, 2013 , all the restricted share awards for which forfeiture provisions had not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares.  As of March 31, 2013 , we had $4.0 million of unrecognized compensation cost related to restricted common stock awarded to employees.  We expect to recognize these costs over the remaining weighted-average requisite service period of 2.8 years.


Non-Employee Director Share-Based Compensation


During June 2006, our stockholders initially approved the 2006 Non-Employee Director Restricted Stock Plan, which was subsequently amended and restated and which we refer to as the 2006 Non-Employee Plan.  In May 2010, our stockholders approved an amendment to the 2006 Non-Employee Plan that increased the number of shares we may award to non-employee members of our board of directors from 100,000 to 150,000 shares.  During the three months ended March 31, 2013 and 2012 , no shares of restricted stock were issued under the 2006 Plan.  During the three months ended March 31, 2013 and 2012 , we recognized less than $0.1  million of compensation costs related to share-based awards to non-employee directors.  We include this compensation cost in general and administrative expense on our Consolidated Statements of Operations .  As of March 31, 2013 , we had less than $0.1 million of unrecognized compensation cost related to restricted common stock awarded to non-employee directors, which we expect to recognize over the remaining weighted-average requisite service period of 1.7 years.


25


---



SUMMARY OF EMPLOYEE AND NON-EMPLOYEE DIRECTOR SHARE-BASED COMPENSATION


The following table summarizes our restricted stock award activity during the three months ended March 31, 2013 :


SharesWeighted-Average Grant Date Fair Value per ShareSubject to forfeiture provisions as of December 31, 20121,142,020$4.69Forfeiture provision satisfied(25,075)$4.09Subject to forfeiture provisions as of March 31, 20131,116,945$4.65


NOTE 8—CORPORATE RESTRUCTURING


On August 1, 2011, our board of directors approved a plan to reduce our workforce by 42%, including 22 current employees and 5 resignations.  Affected employees received severance pay, continuation of benefits and, for employees who had been awarded restricted stock, additional lapsing of restrictions associated with restricted stock awards.  We have accounted for these costs in accordance with ASC 420-10-Exit or Disposal Cost Obligations .


During the three months ended March 31, 2013 , we incurred $7,000 of restructuring expenses related to severance obligations, which we reported as a separate line item on our Consolidated Statements of Operations .


We included liabilities associated with our restructuring in other liabilities on our Consolidated Balance Sheets .  The following table summarizes changes in the balance of our restructuring liabilities from January 1, 2013 through March 31, 2013 :


(in thousands)SeveranceBenefitsOtherTotalBalance as of December 31, 2012$648$21$669Additions—(10)(10)Accretion7—7Cash payments(220)(8)(228)Balance as of March 31, 2013$435$3$438


NOTE 9—INCOME TAXES


As a RIC, we are taxed under Subchapter M of the Internal Revenue Code.  As such, our income generally is not taxable to the extent we distribute it to stockholders and we meet certain qualification tests as outlined in the Internal Revenue Code.  However, income from certain investments owned by our wholly owned subsidiaries is subject to federal, state and local income taxes.  On a continuing basis, we monitor distribution requirements in order to comply with Subchapter M of the Internal Revenue Code.


We use the asset and liability method to account for our Taxable Subsidiaries' income taxes.  Using this method, we recognize deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and the tax basis of assets and liabilities.  In addition, we recognize deferred tax benefits associated with net operating carryforwards that we may use to offset future tax obligations.  We measure deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences.  During each of the three months ended March 31, 2013 and 2012 , we recorded income tax provisions of less than $0.1 million, which were primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


From December 2001 through March 31, 2013 , we declared distributions per share of $13.51 in the aggregate.  Each year, we mail statements on Form 1099-DIV to our stockholders that identify whether we made distributions from ordinary income, net capital gains on the sale of securities, which are each taxable distributions, and/or a return of paid-in-capital surplus, which is a nontaxable distribution.  A portion of our distributions may represent a return of capital to our stockholders, to the extent that the total distributions paid in a given year exceed current and accumulated taxable earnings and profits.  All or a portion of the distributions that we paid to stockholders during fiscal years 2012, 2011, 2008, 2006, 2005, 2004 and 2003 represented a return of capital.


26


---



We determine the tax attributes of our distributions as of the end of our fiscal year based upon our taxable income for the full year and distributions paid during the full year.  Therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.  If we determined the tax attributes of our distributions as of March 31, 2013 , 49% would be from ordinary income and 51% would be a return of capital.  Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.


On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 , or the Modernization Act, was enacted, which changed various technical rules governing the tax treatment of regulated investment companies.  The changes are generally effective for taxable years beginning after the date of enactment.  One of the more prominent changes addresses capital loss carryforwards.  Under the Modernization Act, each RIC will be permitted to carry forward capital losses incurred in taxable years beginning after the date of enactment for an unlimited period.  However, any losses incurred during those subsequent taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date.  As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to expire unused.  Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short-term as permitted under previous regulation.


Taxable income differs from net income recognized in accordance with accounting principles generally accepted in the United States, or GAAP, because of temporary and permanent differences in income and expense recognition.


Taxable income generally excludes unrealized gains and losses from appreciation or depreciation of our investments, which are included in GAAP net income.  Further, amounts recognized for financial reporting purposes may differ from amounts included in taxable income due to the accrued dividends on preferred stock, which increase the book basis but not the tax basis of our investments, and non-accrual interest on loans, which increase the tax basis but not book basis.


27


---



NOTE 10—EARNINGS PER SHARE


The following table sets forth the computation of basic and diluted income per common share for the three months ended March 31, 2013 and 2012 :


(dollars in thousands, except per share amounts)Three months ended March 31, 201320132012Numerator for basic and diluted earnings per shareNet income$7,752$1,357Less: Dividends declared—common and restricted shares(8,902)(13,050)Undistributed loss(1,150)(11,693)Percentage allocated to common shares(a)98.4%99.2%Undistributed earnings—common shares(1,132)(11,599)Add: Dividends declared—common shares8,76012,946Numerator for common shares outstanding excluding participating shares7,6281,347Numerator for participating unvested shares only12410Numerator for basic and diluted earnings per share—total$7,752$1,357Denominator for basic and diluted weighted-average shares outstandingCommon shares outstanding70,36576,443Participating unvested shares1,142607Basic and diluted weighted-average common shares outstanding—total71,50777,050Earnings (loss) per share—basic and dilutedExcluding participating unvested shares$0.11$0.02Including participating unvested shares$0.11$0.02(a)Basic and diluted weighted-average common shares:Weighted-average common shares outstanding70,36576,443Weighted-average restricted shares1,142607Total basic and diluted weighted-average common shares71,50777,050Percentage allocated to common shares98.4%99.2%


Holders of unvested shares of our issued and outstanding restricted common stock are eligible to receive non-forfeitable dividends.  As such, these unvested shares are participating securities requiring the two-class method of computing earnings per share in periods with net income.  Pursuant to the two-class method, we report basic and diluted loss per share both inclusive and exclusive of the impact of the participating securities.


NOTE 11—CONTINGENCIES AND COMMITMENTS


LEGAL PROCEEDINGS


We are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies.  While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations.


FINANCIAL INSTRUMENTS


During the normal course of business, we are party to certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments.  We conduct extensive due diligence and, when appropriate, obtain collateral to limit our credit risk.  Generally, these commitments have fixed expiration dates or other termination clauses, which may require payment of a fee by the counterparty.  We expect many of these commitments will not be fully used before they expire; therefore, the total commitment amounts do not necessarily represent future cash requirements.


28


---



We do not report the unused portions of these commitments on our Consolidated Balance Sheets .  As of March 31, 2013 and December 31, 2012 , we had $18.1 million and $23.0 million, respectively, of outstanding unused loan commitments.  We estimate that as of each of March 31, 2013 and December 31, 2012 , the fair value of these commitments was $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties.  As of March 31, 2013 and December 31, 2012 , we had no outstanding guarantees or standby letters of credit.


LEASE OBLIGATIONS


We lease our headquarters and certain other facilities and equipment under non-cancelable operating and capital leases which expire through 2014.  We have sublet certain of our facilities to third parties.  The lease on our former headquarters in Arlington, Virginia expired in February 2013.  In August 2012, we entered into a lease agreement for new office space in Arlington, Virginia.  The new lease term is from October 2012 to November 2014 with a base rent of $0.4 million per year.  The base rent will not increase during the term of the lease.  In November 2012, we ceased using our old headquarters and recognized the remaining amounts due under that lease in other liabilities on our Consolidated Balance Sheet as of December  31, 2012 .  As of March 31, 2013 , our obligations for the remaining terms of these leases was $0.7 million , of which $0.4 million will be payable during the next twelve months.


29


---



NOTE 12—FINANCIAL HIGHLIGHTS


The following schedule summarizes our financial highlights for the three months ended March 31, 2013 and 2012 : Three months ended(in thousands, except per share amounts)March 3120132012Per share dataNet asset value at beginning of period(a)$5.18$5.65Net income(b)Net operating income before net investment loss, loss on extinguishment of debt and income tax provision0.110.05Net realized (loss) gain on investments(0.06)0.21Net unrealized appreciation (depreciation) on investments0.06(0.24)Loss on extinguishment of debt before income tax provision——Income tax provision——Net income0.110.02Net decrease in net assets resulting from distributions(0.13)(0.17)Net increase (decrease) in net assets relating to stock-based transactionsIssuance of shares of restricted common stock(c)—(0.07)Repurchase of common stock0.010.02Net increase in stockholders’ equity from restricted stock amortization0.01—Net increase (decrease) in net assets relating to share issuances0.02(0.05)Net asset value at end of period(a)5.185.45Market price per shareBeginning of period$4.60$3.99End of period$4.78$4.26Total Return(d)6.63%11.03%Shares of Common Stock Outstanding(d)Weighted-average—basic and diluted71,50777,050End of period71,21276,762Net assetsAverage$372,574$436,919End of period$368,672$418,485Ratios (annualized)Operating expenses to average net assets5.68%12.44%Net operating income to average net assets8.78%3.72%General and administrative expense to average net assets1.13%3.62%Return on average equity8.46%1.25%__________________(a)Based on total number of shares outstanding.(b)Based on weighted-average number of shares outstanding.(c)Represents the effects of shares issued during the period and the lapsing of forfeiture provisions on restricted stock on earnings per share.(d)Total return = [(ending market price per share–beginning market price per share+dividends paid per share)/beginning market price per share].





30


---



Review Report of Independent Registered Public Accounting Firm


The Board of Directors and Stockholders


MCG Capital Corporation


We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation, including the consolidated schedule of investments, as of March 31, 2013 , the related consolidated statements of operations, changes in net assets, cash flows and financial highlights for the three -month periods ended March 31, 2013 and 2012 .  These financial statements are the responsibility of MCG Capital Corporation’s management.


We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.


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


We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of MCG Capital Corporation as of December 31, 2012 , including the consolidated schedule of investments, and the related consolidated statements of operations, changes in net assets, cash flows, and financial highlights for the year then ended (not presented herein), and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated March 5, 2013.  In our opinion, the accompanying consolidated balance sheet as of December 31, 2012 , including the consolidated schedule of investments, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.


/s/ ERNST & YOUNG LLP


McLean, Virginia


April 30, 2013





31


---



ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


The information contained in this section should be read in conjunction with the Selected Financial Data and our Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.


This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties.  These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management including, without limitation: our expectations regarding our results of operations, including revenues, net operating income, net investment losses and general and administrative expenses and the factors that may affect such results; our use of independent valuation firms to provide additional support for our internal analyses; our expectations regarding the approval process for a second SBIC license; our intentions with respect to funding in full our equity portion of a second SBIC license using unrestricted cash; our expectations regarding the full use before expirati on of certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments; our belief that the monetizations of legacy investments and investments that exceed our target hold size are positive events for MCG and for our investors; our expectations regarding monetizations during 2013 and the use proceeds of such monetizations; our expectations with regard to 2013 origination pacing and anticipated aggregate investment levels by year-end; our expectation that we will substantially deploy our cash on-hand in 2013; ou r intentions to repurchase shares of our common stock under our stock repurchase program and purchase debt for cash in open markets purchases and/or privately-negotiated transactions; the sufficiency of liquidity to meet 2013 operating requirements, as well as new origination opportunities and potential dividend distributions; estimated liquidity for repayment of our borrowing facilities from a number of sources, including cash on-hand, the maturity or monetization of our investment portfolio, other borrowing facilities and equity issuances, and from other borrowing arrangements; our decisions to make dividend distributions after taking into account our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio; our expectations regarding the outcome of legal proceedings incidental to our business; general market conditions; the state of the economy and other factors.  Forward-looking statements can be identified by terminology such as “anticipate,” “believe,” “could,” “could increase the likelihood,” “hope,” “target,” “project,” “goals,” “potential,” “predict,” “might,” “estimate,” “expect,” “intend,” “is planned,” “may,” “should,” “will,” “will enable,” “would be expected,” “look forward,” “may provide,” “would” or similar terms, variations of such terms or the negative of those terms.  These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict.  Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements.  Such factors that could cause or contribute to such differences include those risk factors discussed in Item IA of Part II of this Quarterly Report on Form 10-Q.


Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect.  In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report on Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved.  You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q.  We undertake no obligation to update or revise any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.


DESCRIPTION OF BUSINESS


We are a solutions-focused commercial finance company that provides capital and advisory services to middle-market companies throughout the United States. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, refinance existing debt, buyouts, organic growth, working capital and other general corporate purposes.


We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended , or the 1940 Act.  As a BDC we must meet various regulatory tests, which include investing at least 70% of our total assets in private or thinly traded public U.S.-based companies and limitations on our ability to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings (excluding SBIC debt) of at least 200% (i.e., the amount of debt generally may not exceed 50% of the value of our assets).


In addition, we have elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code.  In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements.  If we satisfy these requirements, we generally will not have to pay corporate-level taxes


32


---



on any income we distribute to our stockholders as distributions, allowing us to substantially reduce or eliminate our corporate-level tax liability.  From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities.  In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.


RECENT DEVELOPMENTS — Q1 2013


|  |                                                                                                                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Originations and Advances— We made$15.9 millionin originations and advances to new and existing portfolio companies, principally in the form of loans (94%or$15.0 million), including one new portfolio company.

|  |                                                                                                                                                                                                                                                        
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Loan Monetizations— We received$81.7 millionin loan payoffs and amortization payments: five borrowers repaid $71.3 million in principal at or above par and we received $10.4 million in loan amortization and paid-in-kind interest, or PIK, payments.

|  |                                                                                                                                                                                                                     
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Loans on Non-Accrual —Loans on non-accrual, at cost (remained under 4% of the total loan portfolio) and fair value (under 20 basis points of the total loan portfolio) remained stable in the first quarter of 2013.

|  |                                                                                                                                                                        
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Equity Monetizations and Realizations —We received $3.5 million in proceeds from equity securities, principally from the sale of our investment in NDSSI Holdings, LLC.

|  |                                                                                                                                                                               
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Second SBIC License Update— In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013.

|  |                                                                                                                                                                                                                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Open-Market Purchases of Our Stock— We repurchased 504,639 shares of our common stock at a total cost of $2.3 million, or a weighted average purchase price of $4.50 per share.  We acquired these shares from sellers in open market transactions.  We retire these shares upon settlement, thereby reducing the number of shares issued and outstanding.

|  |                                                                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Operating Costs— Excluding interest expense, our total operating costs were 0.5% of $607 million in total assets (equal to an annualized rate of approximately 2% of total assets).

|  |                                                                                                                                                                                                                                                                                                                                                                                                                  
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Reduced Leverage— From December 31, 2012 to March 31, 2013, we reduced our outstanding borrowings under our MCG Commercial Loan Trust, or 2006-1 Trust, by $15.1 million, reducing our borrowings under our 2006-1 Trust from $98.1 million to $83.0 million as of March 31, 2013.  In April 2013, we further reduced our borrowings under our 2006-1 Trust by $28.1 million from $83.0 million to $54.9 million.

OUTLOOK


Since January 1, 2010, we monetized over $950 million of our investment portfolio.  At March 31, 2013, approximately 64% of our investments, at fair value, had been originated since January 1, 2010.  Though we have seen an acceleration of monetizations, we continue to believe that monetizations of older vintage investments or investments that exceed our target hold size of $15 million are long-term positive events for MCG and for our investors.  However, these monetizations, especially when unplanned, result in short-term pressure to redeploy such capital.


Throughout the remainder of 2013, we anticipate that we will monetize approximately $30 million to $50 million of investments.  In addition, we expect to use part of the proceeds from these monetizations to reduce the borrowings in our 2006-1 Trust to approximately $20 million to $30 million.  We expect to originate new loans and equity co-investments sufficient to end the year with total investments of $500 million to $530 million (calculated at fair value).


At March 31, 2013, using unrestricted cash and restricted cash from our SBIC, we had $148.6 million of cash on-hand to make new investments.  Assuming continued stability in the market, actionable opportunities that meet our underwriting standards, portfolio granularity requirements and no material repayments beyond maturities that we are aware of as of March 31, 2013, we anticipate that we will substantially deploy our cash on-hand in 2013.


Under the $35 million stock repurchase program authorized by our board of directors in January 2012, we continue to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. As of March 31, 2013, we have repurchased and retired an aggregate of 6,686,685 common shares at a weighted average purchase price of $4.40 per share.


33


---



ACCESS TO CAPITAL AND LIQUIDITY


At March 31, 2013 , we had $98.9 million of cash and cash equivalents available for general corporate purposes, as well as $49.7 million of cash in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC and $7.5 million of restricted cash held in escrow.  In addition, we had $33.1 million of cash in securitization accounts, that may only be used to make interest and principal payments on our securitized borrowings or distributions to MCG in accordance with the indenture agreement of the 2006-1 Trust.


At March 31, 2013 , cash in securitization accounts included $29.9 million in the principal collections account of our 2006-1 Trust.  In April 2013, we used $30.5 million of securitized cash, including $0.6 million collected in April 2013, to repay borrowings of our 2006-1 Trust, a pro rata portion of which we received for the principal we own.  The reinvestment period for this facility ended on July 20, 2011 and all subsequent principal collections received have been, and will be, used to repay the securitized debt.  At March 31, 2013 , the outstanding borrowings under the 2006-1 Trust were $83.0 million .


At March 31, 2013 , $150.0 million of United States Small Business Administration, or SBA, borrowings were outstanding, the maximum available under our current SBIC license.


At March 31, 2013 , we had full access to our $20.0 million unsecured revolving credit facility with Bank of America, N.A.


PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY


As of March 31, 2013 , the fair value of our investment portfolio was $409.0 million , which represents a $68.7 million , or 14.4% , decrease from the $477.7 million fair value as of December 31, 2012 .  The following sections describe the composition of our investment portfolio as of March 31, 2013 and key changes in our portfolio during the three months ended March 31, 2013 .


Portfolio Composition


The following table summarizes the composition of our investment portfolio at fair value :


March 31, 2013December 31, 2012(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioDebt investmentsSenior secured debt$214,90752.5%$291,76061.1%Subordinated debtSecured111,80127.3114,98324.1Unsecured39,0859.626,2745.4Total debt investments365,79389.4433,01790.6Equity investmentsPreferred equity39,2649.641,5588.7Common/common equivalents equity3,9651.03,1490.7Total equity investments43,22910.644,7079.4Total investments$409,022100.0%$477,724100.0%


Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0% , a portion of which may be in the form of PIK.  As of March 31, 2013 , approximately 69.4% of the fair value of our loan portfolio had variable interest rates, based on either the London Interbank Offer Rate, or LIBOR, or the prime rate, and 30.6% of the fair value of our loan portfolio had fixed interest rates.  As of March 31, 2013 , approximately 59.4% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR based index and prime floors between 2.5% and 6.0% .  At origination, our loans generally have four- to six-year stated maturities.  Borrowers typically pay an origination fee based on a percentage of the total commitment and a fee on undrawn commitments.


34


---



The following table summarizes our investment portfolio by industry at fair value :


March 31, 2013December 31, 2012(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioHealthcare$96,77523.7%$106,11922.2%Business services66,64116.364,94713.6Education52,88212.959,78312.5Manufacturing38,2059.328,7286.0Publishing30,3887.430,6466.4Insurance26,3646.526,5295.6Broadcasting25,3906.225,3725.3Agriculture21,5845.321,7814.6Information services12,4063.012,6462.7Restaurants9,3062.39,3011.9Home furnishings7,8221.97,8061.6Auto parts6,4401.66,4341.3Cable5,0621.25,0611.1Consumer products4,5971.14,3380.9Electronics——33,3617.0Logistics——27,2375.7Other(a)5,1601.37,6351.6Total$409,022100.0%$477,724100.0%______________________(a)No individual industry within this category exceeds 1%.


As of March 31, 2013 , our ten largest portfolio companies represented approximately 50.1% of the total fair value of our investments.  These ten companies accounted for 46.8% of our total revenue during the three months ended March 31, 2013 .


During the three months ended March 31, 2013 , we had concentrations in certain industries, including the healthcare, business services and education industries.  The following table summarizes our fair value and revenue concentrations in each of those industries:


Investments at fair valueRevenue for the three months endedMarch 31, 2013December 31, 2012March 31, 2013March 31, 2012(dollars in thousands)Amount% of Total PortfolioAmount% of Total PortfolioAmount% of Total RevenueAmount% of Total RevenueIndustryHealthcare$96,77523.7%$106,11922.2%$3,05323.0%$2,70615.4%Business services66,64116.364,94713.61,80113.62,04311.6Education52,88212.959,78312.51,56411.81,3897.9


35


---



Changes in Investment Portfolio


During the three months ended March 31, 2013 , we completed $15.9 million of originations and advances compared to $6.2 million of originations and advances during the three months ended March 31, 2012 .  The following table summarizes our total portfolio investment activity during the three months ended March 31, 2013 and 2012 :


Three months ended(in thousands)March 3120132012Beginning investment portfolio$477,724$741,166Originations and advances15,8946,213Gross payments, reductions and sales of securities(85,218)(79,318)Net (loss) gain(3,832)16,378Unrealized appreciation (depreciation)15(2,351)Reversals of unrealized (appreciation) depreciation3,783(16,515)Origination fees and amortization of unearned income656567Ending investment portfolio$409,022$666,140


Originations and Advances


The following table shows our originations and advances during the three months ended March 31, 2013 and 2012 by security type:


Three months ended March 31,20132012(dollars in thousands)Amount% of TotalAmount% of TotalDebt investmentsSenior secured debt$9455.9%$4,56473.5%Subordinated debtSecured9966.35038.1Unsecured13,05582.1691.1Total debt investments14,99694.35,13682.7Equity investmentsPreferred equity8985.71,07717.3Common/common equivalents equity————Total equity investments8985.71,07717.3Total originations and advances$15,894100.0%$6,213100.0%


The following table shows our significant originations and advances:


(in thousands)Three months endedMarch 31, 2013CompanyOriginationsDraws/ AdvancesPIK Advances/ DividendsTotalDebtHuron, Inc.$13,000$—$55$13,055Other (< $1 million)—7501,1911,941Total debt13,0007501,24614,996EquityOther (< $1 million)——898898Total Equity——898898Total originations and advances$13,000$750$2,144$15,894


36


---



Repayments, Sales and Other Reductions of Investment Portfolio


The following table shows our gross payments, reductions and sales of securities during the three months ended March 31, 2013 and 2012 by security type:


Three months ended March 31,20132012(dollars in thousands)Amount% of TotalAmount% of TotalDebt investmentsSenior secured debt$77,24090.6%$42,68253.8%Subordinated debtSecured4,5005.312,62015.9Unsecured——8—Total debt investments81,74095.955,31069.7Equity investmentsPreferred equity3,4754.17,2169.1Common/common equivalents equity3—16,79221.2Total equity investments3,4784.124,00830.3Total gross payments, reductions and sales of securities$85,218100.0%$79,318100.0%


During the three months ended March 31, 2013 and 2012 , our gross payments, reductions and sales of securities by transaction type included:


Three months ended March 31,(in thousands)20132012Principal repayments, reductions and loan sales$63,011$48,135Sale of equity investments3,23420,542Scheduled principal amortization16,7706,843Collection of accrued paid-in-kind interest and dividends2,2033,798Total gross payments, reductions and sales of securities$85,218$79,318


As shown in the following table, during the three months ended March 31, 2013 , we monetized all, or part of, 9 portfolio investments with proceeds totaling $67.0 million:


Three months endedMarch 31, 2013(in thousands)Principal Repayments and Proceeds from Loan SalesSale or Settlement of Equity InvestmentsPIK Interest and Dividend PrepaymentsTotalMonetizationsNDSSI Holdings, LLC$29,356$3,237$831$33,424Capstone Logistics, LLC27,347——27,347Other < 5 Million6,308(125)—6,183Total monetizations63,0113,11283166,954Other scheduled payments16,7701221,37218,264Total gross payments, sales and other reductions of investment portfolio$79,781$3,234$2,203$85,218


The proceeds from these monetizations correlated closely with the most recently reported fair value of the associated investments.


37


---



ASSET QUALITY


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


Investment RatingSummary Description1Capital gain expected or realized2Full return of principal and interest or dividend expected with customer performing in accordance with plan3Full return of principal and interest or dividend expected, but customer requires closer monitoring4Some loss of interest or dividend expected, but still expect an overall positive internal rate of return on the investment5Loss of interest or dividend and some loss of principal investment expected, which would result in an overall negative internal rate of return on the investment


The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of March 31, 2013 and December 31, 2012 :


(dollars in thousands)March 31, 2013December 31, 2012Investment RatingInvestments at Fair Value% of Total PortfolioInvestments at Fair Value% of Total  Portfolio1(a)$89,88322.0%$146,58930.7%2185,72145.4209,01643.73110,69527.096,93220.3420,3165.022,7894.852,4070.62,3980.5Total$409,022100.0%$477,724100.0%


_________________________


|    |                                                                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | As ofMarch 31, 2013andDecember 31, 2012, Investment Rating “1” included $63.7 million and $81.9 million, respectively, of loans to companies in which we also hold equity securities.

When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place all or a portion of the loan on non-accrual status and will cease recognizing interest income on that loan until all principal and interest have been brought current through payment or a restructuring such that the interest income is deemed to be collectible.  However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection.  If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.


38


---



The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status:


COST BASISFAIR VALUE BASISMarch 31, 2013December 31, 2012March 31, 2013December 31, 2012(dollars in thousands)Investments at Cost% of Loan PortfolioInvestments at Cost% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioLoans greater than 90 days past dueOn non-accrual status$3,8971.02%$3,8970.86%$——%$——%Not on non-accrual status————————Total loans greater than 90 days past due$3,8971.02%$3,8970.86%$——%$——%Loans on non-accrual status0 to 90 days past due$10,8462.83%$12,8802.85%$5970.16%$6070.14%Greater than 90 days past due3,8971.023,8970.86————Total loans on non-accrual status$14,7433.85%$16,7773.71%$5970.16%$6070.14%


The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2012 through March 31, 2013 :


Three months endedMarch 31, 2013(In thousands)CostFair ValueNon-accrual loan balance as of December 31, 2012$16,777$607Change in unrealized gain (loss) on non-accrual loans—(10)Reversal of previously recognized unrealized loss on non-accrual loans(a)—2,034Realized loss on non-accrual loans(a)(2,034)(2,034)Total change in non-accrual loans(2,034)(10)Non-accrual loan balance as of March 31, 2013$14,743$597


_________________________


|    |                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Represents the reversal of previously recognized unrealized loss and recognition of realized loss on the non-accrual loan attributed to Advanced Sleep Concepts, Inc.




39


---



Results of Operations


The following section compares our results of operations for the three months ended March 31, 2013 to the three months ended March 31, 2012 .


COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2013 AND 2012


The following table summarizes the components of our net income for the three months ended March 31, 2013 and 2012 :


Three months ended March 31,Variance(dollars in thousands)20132012$PercentageRevenueInterest and dividend incomeInterest income$11,085$15,596$(4,511)(28.9)%Dividend income8981,077(179)(16.6)Loan fees79362317027.3Total interest and dividend income12,77617,296(4,520)(26.1)Advisory fees and other income47026320778.7Total revenue13,24617,559(4,313)(24.6)Operating expensesInterest expense2,3825,202(2,820)(54.2)Employee compensationSalaries and benefits1,4073,875(2,468)(63.7)Amortization of employee restricted stock375478(103)(21.5)Total employee compensation1,7824,353(2,571)(59.1)General and administrative expense1,0323,936(2,904)(73.8)Restructuring expense726(19)(73.1)Total operating expense5,20313,517(8,314)(61.5)Net operating income before net investment loss, loss on extinguishment of debt and income tax provision8,0434,0424,00199.0Net investment loss before income tax provision(233)(2,493)2,260NMLoss on extinguishment of debt before income tax provision—(174)174(100.0)Income tax provision581840222.2Net income$7,752$1,357$6,395471.3NM=Not Meaningful


TOTAL REVENUE


Total revenue includes interest and dividend income, loan fees, advisory fees and other income.  The following sections describe the reasons for the variances in each major component of our revenue during the three months ended March 31, 2013 from the three months ended March 31, 2012 .


INTEREST INCOME


The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments.  During the three months ended March 31, 2013 , the total yield on our average debt portfolio at fair value was 12.1% compared to 10.9% during the three months ended March 31, 2012 .  The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.


40


---



The following table shows the various components of the total yield on our average debt portfolio at fair value for the three months ended March 31, 2013 and 2012 :


Three months ended March 31,20132012Average 90-day LIBOR0.3%0.5%Spread to average LIBOR on average loan portfolio11.710.6Impact of fee accelerations of unearned fees on paid/restructured loans0.10.2Impact of non-accrual loans—(0.4)Total yield on average loan portfolio12.1%10.9%


During the three months ended March 31, 2013 , interest income was $11.1 million , compared to $15.6 million during the three months ended March 31, 2012 , which represented a $4.5 million , or 28.9% , decrease .  This decrease reflected a $5.6 million decrease resulting from a 33.7% decrease in our average loan balance, a decrease of $0.4 million due to interest rate floors, a $0.3 million decrease in interest income related to the decrease in LIBOR and a $0.2 million decrease resulting from the net impact of loans that had been on non-accrual status during the three months ended March 31, 2013 that were accruing interest during the three months ended March 31, 2012 .  These decreases were partially offset by a $2.1 million increase in interest income resulting from a 1.2% increase in our net spread to LIBOR.


PIK Income


Interest income includes certain amounts that we have not received in cash, such as PIK interest.  PIK interest represents contractually deferred interest that is added to the principal balance of the loan and compounded if not paid on a current basis.  Borrowers may, in some instances, be required to prepay PIK because of certain contractual provisions or they may choose to prepay; however, more typically, PIK is paid at the end of the loan term.  The following table shows the PIK-related activity for the three months ended March 31, 2013 and 2012 , at cost :


Three months ended March 31,(in thousands)20132012Beginning PIK loan balance$9,043$15,653PIK interest earned during the period1,2461,336Payments received from PIK loans(1,959)(333)Realized loss(357)—Ending PIK loan balance$7,973$16,656


As of March 31, 2013 all of our PIK loans were accruing interest and, as of March 31, 2012 , we were not accruing interest on $8.9 million of the PIK loans, at cost, shown in the preceding table.  During the three months ended March 31, 2013 , the payments received from PIK loans included $1.0 million collected in conjunction with the partial repayment of our investment in Education Management, Inc., as well as $0.8 million collected in conjunction with the repayment in full of our investment in NDSSI Holdings, LLC.


DIVIDEND INCOME


We accrete dividends on equity investments with stated dividend rates as they are earned, to the extent that we believe the dividends will be paid ultimately and the associated portfolio company has sufficient value to support the accretion.  We recognize dividends on our other equity investments when we receive the dividend payment.  Our dividend income varies from period to period because of changes in the size and composition of our equity investments, the yield from the investments in our equity portfolio and the ability of the portfolio companies to declare and pay dividends.  During the three months ended March 31, 2013 and 2012 , we recognized dividend income of $0.9 million and $1.1 million , respectively.  In addition, during the three months ended March 31, 2013 and 2012 , we received payments on accrued dividends of $0.2 million and $3.5 million, respectively.  As of March 31, 2013 , the balance of accrued dividends was $9.9 million.


ADVISORY FEES AND OTHER INCOME


Advisory fees and other income primarily include fees related to prepayment, advisory and management services, equity structuring, syndication, bank interest and other income.  Generally, advisory fees and other income relate to specific transactions or services and, therefore, may vary from period to period depending on the level and types of


41


---



services provided.  During the three months ended March 31, 2013 , we earned $0.5 million of advisory fees and other income, which represented a $0.2 million , or 78.7% , increase from the three months ended March 31, 2012 .  This increase resulted from an increase in prepayment fees related to loan prepayments in the first quarter of 2013.


TOTAL OPERATING EXPENSES


Total operating expenses include interest, employee compensation and general and administrative expenses.  The reasons for these variances are discussed in more detail below.


INTEREST EXPENSE


During the three months ended March 31, 2013 , we incurred $2.4 million of interest expense, which represented a $2.8 million , or 54.2% , decrease from the same period in 2012 .  During these respective periods, our average cost to borrow decreased from 5.0% to 4.0% , principally due to a decrease in the amortization of deferred financing costs (from $2.5 million to $0.3 million ) offset by the repayment of securitized debt of our 2006-1 Trust (which carries interest rates ranging from L+0.33% to L+2.25%) and additional borrowings under the SBIC debenture program (which carries a weighted average fixed rate of 4.33%).


During the three months ended March 31, 2013 , our averaging borrowings declined to approximately $235.6 million from an average of approximately $419.6 million for the same period in 2012 , which accounted for a $1.6 million reduction in our interest expense.  In addition, interest expense decreased by $2.1 million related to decreased amortization of debt issuance costs and $0.2 million due to a decrease in the average LIBOR rate from 0.52% to 0.29% .  These decreases were offset by $1.1 million attributable to the spread to LIBOR increasing from approximately 2.08% to 3.17% .


We recognized $0.3 million in deferred financing costs during the three months ended March 31, 2013 , down $2.1 million from the same period in 2012 .  The decrease is primarily attributable to $1.5 million in accelerated deferred financing fees related to the termination of our SunTrust Warehouse financing facility in the first quarter of 2012.


EMPLOYEE COMPENSATION


Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards.  During the three months ended March 31, 2013 , our employee compensation expense was $1.8 million , which represented a $2.6 million , or 59.1% , decrease from the same period in March 31, 2012 .  Our salaries and benefits decreased by $2.5 million , or 63.7% , due to a $1.7 million decrease in incentive compensation and a $0.8 million decrease in salaries and benefits primarily resulting from our operational realignment, which is now substantially complete.  As of March 31, 2013 , we had 20 employees compared to 33 employees as of March 31, 2012 .


GENERAL AND ADMINISTRATIVE


During the three months ended March 31, 2013 , general and administrative expense was $1.0 million , which represented a $2.9 million , or 73.8% , decrease compared to the same period in 2012 .  In the first quarter of 2012, general and administrative expense included $1.1 million in severance costs and $0.3 million of legal expenses related to investment monetizations.  In addition, general and administrative expense decreased $0.5 million due to reduced occupancy costs for our new corporate office space.


42


---



NET INVESTMENT LOSS BEFORE INCOME TAX PROVISION


During the three months ended March 31, 2013 , we incurred $0.2 million of net investment losses before income tax provision, compared to $2.5 million during the same period in 2012 .  These amounts represent the total of net realized gains and losses, net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation.  We reverse unrealized (appreciation) depreciation at the time that we realize the gain or loss.  The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended March 31, 2013 :


Three months ended March 31, 2013(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyVirtual Radiologic CorporationHealthcareNon-Affiliate$—$(2,531)$—$(2,531)Miles Media Group, LLCBusiness ServicesAffiliate—1,192—1,192Advanced Sleep Concepts, Inc.Home FurnishingsAffiliate(3,424)103,249(165)Other (< $1 million net gain (loss))(607)1,3455331,271Total$(4,031)$16$3,782$(233)


|  |                                                                                                                                                                                                         
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | In the first quarter of 2013, we recorded$2.5 millionof unrealized depreciation on our investment inVirtual Radiologic Corporationto reflect a decrease in the indicated market price for that security.

|  |                                                                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | We also recorded$1.2 millionof unrealized appreciation on our investment inMiles Media Group, LLCto reflect an improvement in that portfolio company's operating performance.

|  |                                                                                                                                                                                                                                                                           
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | In addition, during the three months endedMarch 31, 2013, we wrote off our preferred and common equity investments inAdvanced Sleep Concepts, Inc.resulting in a realized loss of$3.4 millionand a reversal of previously recorded unrealized depreciation of$3.2 million.

The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from the change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.


The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended March 31, 2012 :


Three months ended March 31, 2012(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyRadioPharmacy Investors, LLCHealthcareControl$—$(2,053)$—$(2,053)Orbitel Holdings, LLCCableControl—(1,966)—(1,966)Miles Media Group, LLCBusiness ServicesNon-Affiliate—(1,575)—(1,575)Jenzabar, Inc.TechnologyNon-Affiliate16,370(1)(16,435)(66)Jet Plastica Investors, LLCPlastic ProductsControl—3,175—3,175Other (< $1 million net gain (loss))864(80)(8)Total$16,378$(2,356)$(16,515)$(2,493)


|  |                                                                                                                                                                                                                                     
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | During the quarter ended March 31, 2012, we recorded $2.0 million of unrealized depreciation on our investment in Orbitel Holdings, LLC due to a reduction in the multiple used to value that company based on estimated exit value.

|  |                                                                                                                                                                                               
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | We also recorded unrealized depreciation on our investments in Miles Media Group, LLC and RadioPharmacy Investors, LLC  to reflect decreases in the operating performances of those companies.

43


---



|  |                                                                                                                                                                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | In April 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets.  Including the proceeds from the liquidation, we received a $10.2 million payment on our senior debt resulting in a $3.2 million unrealized appreciation in the first quarter of 2012.

|  |                                                                                                                                                                                                                                                
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | In February 2012, we accepted $23.7 million for our senior preferred stock and warrant position in Jenzabar, Inc. which resulted in a $16.4 million reversal of previously unrealized appreciation and the realization of a $16.4 million gain.

INCOME TAX PROVISION


During the three months ended March 31, 2013 , we incurred a $58,000 income tax provision compared to an $18,000 income tax provision during the three months ended March 31, 2012 .  The income tax provision for both periods was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES


Our financial liquidity principally comes from our cash on hand and the spread we earn on our investments (principally loans, over our cost to borrow) and gains and losses on our investments.  We may also use our available liquidity to pay dividends to our stockholders and to repurchase our common stock in the open market under our stock repurchase program.  For the three months ended March 31, 2013 , we declared 12.5 cents per share in dividends and paid $8.9 million in total dividends.  We also repurchased 504,639 shares of our common stock for $2.3 million at a weighted average price of $4.50 per share.


For the three months ended March 31, 2013 , we earned 12.1% on our average loan portfolio at fair value of $398.8 million and our weighted average cost to borrow was 4.0% on average borrowings of $235.6 million .  Including dividend income and fee income, we earned $10.9 million of financial income, or total revenue less interest expense, $8.0 million of net operating income and $7.8 million of net income.


At March 31, 2013 , we had $98.9 million in cash and cash equivalents available for general corporate purposes, $49.7 million of cash in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC and $0.8 million of restricted cash held in escrow.  In addition, we had $33.1 million in securitization accounts that may only be used to make interest and principal payments on our securitized borrowings or distributions to MCG in accordance with the indenture agreement for the 2006-1 Trust.  We also have access to the full principal amount under our $20 million unsecured revolving credit facility that we may use for general corporate purposes.


In order to reduce future cash interest payments under our borrowings, as well as future amounts due at maturity or upon redemption under our borrowings, we may, from time to time, purchase debt for cash in open market purchases and/or privately negotiated transactions, if attractive pricing can be identified.  We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity and prospects for future access to capital.  The amounts involved in any such transactions, individually or in the aggregate, may be material.


Although there can be no assurance, we believe we have sufficient liquidity to meet our operating requirements for the remainder of 2013, as well as liquidity for new origination opportunities and potential dividend distributions.


CASH AND CASH EQUIVALENTS, CASH, SECURITIZATION ACCOUNTS AND CASH, RESTRICTED


Our Consolidated Balance Sheets and our Consolidated Statements of Cash Flows reflect three categories of cash:  cash and cash equivalents; cash, securitization accounts; and cash, restricted.  Each of these categories is described more fully below:


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Cash and cash equivalentsrepresent unrestricted cash, including checking accounts, interest bearing deposits collateralized by marketable debt securities and highly liquid investments with original maturities of 90 days or less.  As ofMarch 31, 2013andDecember 31, 2012, we had$98.9 millionand $73.6 million, respectively, in cash and cash equivalents.  As ofMarch 31, 2013, our cash and cash equivalents included$63.1 millionthat was held in interest-bearing accounts.

44


---



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Cash, securitization accountsinclude principal and interest payments received on securitized loans, which, are held in designated bank accounts until monthly or quarterly disbursements are made from the securitization trusts.  We are generally required to use a portion of these amounts to pay interest expense, reduce borrowings or pay other amounts in accordance with the related securitization agreements.  Cash in securitization accounts has a negative impact on our earnings since the interest we pay on borrowings typically exceeds the rate of return that we are able to earn on temporary cash investments.  Our objective is to maintain sufficient cash-on-hand and availability under our debt facilities to cover current funding requirements.  As ofMarch 31, 2013andDecember 31, 2012, we had$33.1 millionand $17.0 million, respectively, in cash, securitization accounts.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Cash, restrictedincludes cash held for regulatory purposes and cash held in escrow.  The largest component of restricted cash was represented by cash held by Solutions Capital I, L.P., or Solutions Capital, a wholly owned subsidiary licensed as a small business investment company, or SBIC, under theSmall Business Investment Act of 1958, as amended, or SBIC Act, which generally is restricted to the origination of new loans by Solutions Capital.  As ofMarch 31, 2013andDecember 31, 2012, we had$57.2 millionand $54.8 million respectively, of restricted cash.

During the three months ended March 31, 2013 , our operating activities provided $70.9 million of cash and cash equivalents, and our financing activities used $45.6 million of cash and cash equivalents.


LIQUIDITY AND CAPITAL RESOURCES—BORROWINGS


As of March 31, 2013 , we reported $233.0 million of borrowings on our Consolidated Balance Sheets at cost.  The following table summarizes our borrowing facilities, the facility amounts and the amounts outstanding.


March 31, 2013December 31, 2012(dollars in thousands)Maturity DateTotal Facility/ ProgramAmount OutstandingTotal Facility/ ProgramAmount OutstandingSBIC2008-10BSeptember 2018$2,600$2,600$2,600$2,6002009-10AMarch 201912,00012,00012,00012,0002009-10BSeptember 201913,00013,00013,00013,0002010-10BSeptember 202027,50027,50027,50027,5002011-10AMarch 202153,50053,50053,50053,5002012-10AMarch 202241,40041,40041,40041,400MCG Commercial Loan Trust 2006-1Series 2006-1 Class B Notes(a)April 2018(b)22,11322,11337,15137,151Series 2006-1 Class C Notes(c)April 2018(b)45,00032,00045,00032,000Series 2006-1 Class D Notes(d)April 2018(b)45,94528,90245,94528,902Bank of America Unsecured RevolverUnsecured Revolving NoteNovember 201420,000—20,000—Total borrowings$283,058$233,015$298,096$248,053______________________(a)In April 2013, the Class B Notes were repaid in full.(b)Borrowings under the MCG Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt.(c)Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.(d)Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.


As of March 31, 2013 , our asset coverage ratio was 542% .  This ratio does not include our SBIC debt which the SEC has permitted us to exclude from the asset coverage ratio requirements pursuant to an exemptive order.


Our access to current and future liquidity from our borrowing facilities depends on several factors, including, but not limited to:  the credit quality of our investment portfolio, including those investments used to collateralize borrowing facilities; the magnitude of our investments in individual companies and the industries in which they operate; our compliance with specific covenants in each borrowing agreement; and the specific provisions of our borrowing facilities.


45


---



As our borrowing facilities mature, it is important that we have sufficient liquidity available to repay our borrowing obligations.  We may obtain the liquidity for repayment of our borrowing facilities from a number of sources, including cash on-hand, the maturity or monetization of our investment portfolio, other borrowing facilities and equity issuances, and from other borrowing arrangements.


We have funded our current secured borrowing debt facility through a bankruptcy remote, special-purpose, wholly owned subsidiary.  Therefore, this subsidiary’s assets may not be available to our creditors.  We continue to service those portfolio investments that we use as collateral in our secured borrowing facility.


SBIC DEBENTURES


In December 2004, we formed a wholly owned subsidiary, Solutions Capital.  Solutions Capital has a license from the SBA to operate as an SBIC under the SBIC Act.  The license gave Solutions Capital the ability to borrow from the SBA up to $150.0 million, which is the maximum amount of outstanding leverage available to single-license SBIC companies.


In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L. P. in order to apply for a second SBIC license.  In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013.  There is no assurance that the SBA will grant the additional license in any specified time period or at all.  Currently, a second SBIC license would grant us the ability to borrow up to an additional $75 million from the SBA, or two times the amount of statutory equity capital we invest in Solutions Capital II, L.P.  If approved and depending on available capital, we intend to fund the entire $37.5 million using unrestricted cash.


To realize the full $150.0 million borrowing for which we have received approval under the SBIC program, we have funded a total of $75.0 million to Solutions Capital.  As of each of March 31, 2013 and December 31, 2012 , Solutions Capital had borrowed $150.0 million.  We are permitted to use these funds to provide debt and equity capital to qualifying small businesses.  However, we may not use these borrowings to provide additional financing to certain companies that are currently in our portfolio without SBA approval.  In addition, we may not use these funds for MCG’s, the parent company’s, working capital.


SBICs are subject to regulation and oversight by the SBA, including requirements to maintain certain minimum financial ratios and other covenants.  Receipt of an SBIC license does not assure that an SBIC will receive SBA-guaranteed debenture funding, which is dependent upon continued compliance with SBA regulations and policies.  The SBA, as a creditor, will have superior claim to Solutions Capital’s assets over our stockholders in the event we liquidate Solutions Capital or the SBA exercises its remedies upon an event of default under the SBA-guaranteed debentures issued by Solutions Capital.


The following table sets forth the maturity of Solutions Capital debentures, as well as the maturity of the investments and the current balance of restricted cash in Solutions Capital as of March 31, 2013 .


Maturities(in thousands)TotalLess than 1 year1-3 years4-5 yearsAfter 5 yearsBorrowings$150,000$—$—$—$150,000CollateralFair value of debt investments181,2012,81319,292111,08848,008Fair value of equity investments(a)5,143———5,143Cash, restricted account50,54350,543———Total collateral$236,887$53,356$19,292$111,088$53,151


____________


(a) Equity investments do not have a stated maturity date.


MCG COMMERCIAL LOAN TRUST 2006-1


As of March 31, 2013 , we had $83.0 million of securitized debt outstanding under the 2006-1 Trust, which matures in April 2018.  We retain all of the equity in the securitization.  The pool of commercial loans in the trust must meet certain requirements, such as asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.  The securitization included a five-year reinvestment period, during


46


---



which the trust was permitted to use principal collections received on the underlying collateral to purchase new collateral from us.


The following table sets forth the maturity of this facility, as well as the maturity of the securitized assets and the current balance of securitized cash in this borrowing facility.


Maturities(in thousands)TotalLess than 1 year1-3 years4-5 yearsAfter 5 yearsBorrowings(a)$83,015$28,088$—$—$54,927CollateralFair value of debt investments134,3909,85039,87384,667—Fair value of equity investments(b)452———452Cash, securitization account33,14433,144———Total collateral$167,986$42,994$39,873$84,667$452


_____________


|    |                                                                                                                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Borrowings under the MCG Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and all future principal collections from collateral in the facility have been and will be used to repay the securitized debt.

|    |                                                       
|--- | ------------------------------------------------------
|(b) | Equity investments do not have a stated maturity date.

We were able to use the cash in the securitized account, as well as proceeds from principal collections of securitized investments, to originate new loans until July 20, 2011.  The reinvestment period ended on July 20, 2011 and all subsequent principal collections or monetization proceeds that we receive from collateral used to securitize this 2006-1 Trust must be applied to the outstanding balance of that facility.  Upon maturity of this facility, any remaining balance must be repaid, otherwise all or part of the associated collateral may be forfeited.  As shown in the above table, repayments of principal of the collateral held by this facility are expected to permit the repayment of 2006-1 Trust prior to its April 2018 maturity.


BANK OF AMERICA UNSECURED REVOLVER


In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or Bank of America Unsecured Revolver.  Advances under the Bank of America Unsecured Revolver will bear interest at LIBOR plus 3.5% per annum and will expire in November 2014.  As of March 31, 2013 , there were no borrowings outstanding on the Bank of America Unsecured Revolver.


The Bank of America Unsecured Revolver is subject to certain collateral requirements and financial covenants.  Included among them are requirements that we maintain a ratio of all unencumbered assets to outstanding amounts under the Bank of America Unsecured Revolver of at least four-to-one, as well as a ratio of unencumbered cash and senior portfolio loans to outstanding amounts under the Bank of America Unsecured Revolver of at least three-to-one.  The Bank of America Unsecured Revolver may be prepaid at any time, and is required to be paid in full for a period of at least five consecutive calendar days during each quarter.


WEIGHTED-AVERAGE BORROWINGS AND COST OF FUNDS


The following table shows our weighted-average borrowings, the weighted-average interest rate on all of our borrowings, including amortization of deferred debt issuance costs and commitment fees, the average LIBOR, and the average spread to LIBOR for 2013 and 2012 :


For the three months ended(dollars in thousands)March 31, 2013March 31, 2012Weighted-average borrowings$235,605$419,597Average LIBOR0.29%0.52%Average spread to LIBOR, excluding amortization of deferred debt issuance costs3.172.08Impact of amortization of deferred debt issuance costs0.592.40Total cost of funds4.05%5.00%


47


---



LIQUIDITY AND CAPITAL RESOURCES—COMMON STOCK


We are a closed-end investment company that has elected to be regulated as a BDC under the 1940 Act.  The 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value of such stock, except in limited circumstances, including approval by our stockholders of such a sale and certain determinations by our board of directors.


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million and we have provided our stockholders with notice of our intention to repurchase shares of our common stock in accordance with 1940 Act requirements.  Under the program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.  During the three months ended March 31, 2013 , we repurchased 504,639 shares of our common stock at a weighted average purchase price of $4.50 per share, which was a 13.1% discount from our quarterly net asset value per share.


OFF-BALANCE SHEET ARRANGEMENTS


FINANCIAL INSTRUMENTS


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


Commitments to extend credit include the unused portions of commitments that obligate us to extend credit in the form of loans, participations in loans, guarantees, letters of credit and other financial commitments.  Commitments to extend credit would also include loan proceeds we are obligated to advance, such as loan draws, rotating or revolving credit arrangements, or similar transactions.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the counterparty.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.


We do not report the unused portions of these commitments on our Consolidated Balance Sheets.  As of March 31, 2013 , we had $18.1 million of outstanding unused loan commitments, as shown in the table below.  We believe that our operations, monetizations, revolving credit facility and unrestricted cash will provide sufficient liquidity to fund, as necessary, requests to draw on these unfunded commitments.  We estimate that the fair value of these commitments was $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties.  From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies.  As of March 31, 2013 , we had no outstanding guarantees or standby letters of credit.


48


---



CONTRACTUAL OBLIGATIONS


The following table shows our contractual obligations as of March 31, 2013 :


(in thousands)Payments Due by PeriodContractual Obligations(a)TotalLess than 1 year1-3 years4-5 yearsAfter 5 yearsBorrowingsTerm securitizations(b)$83,015$28,088$—$—$54,927SBIC150,000———150,000Total borrowings233,01528,088——204,927Interest payments on borrowings(c)56,3137,66615,19715,19718,253Operating leases670407263——Severance obligations(d)1,9021,728174——Total contractual obligations$291,900$37,889$15,634$15,197$223,180


_______________


|    |                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------
|(a) | Excludes the unused commitments to extend credit to our customers of$18.1 millionas discussed above.

|    |                                                                                                                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | Borrowings under the MCG Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and all future principal collections from collateral in the facility have been and will be used to repay the securitized debt.

|    |                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(c) | Interest payments are based on contractual maturity and the current outstanding principal balance of our borrowings and assume no changes in interest rate benchmarks.

|    |                                                                                                                                                                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(d) | Represents remaining severance payments, benefits, deferred compensation and employer taxes that we are obligated to pay to employees who were terminated as a result of the corporate restructuring effected in August 2011 and for obligations stemming from the resignations of our former chief executive officer and former chief financial officer.

DISTRIBUTIONS


We currently qualify as a RIC for federal income tax purposes, which generally allows us to avoid paying corporate income taxes on any income or gains that we distribute to our stockholders.  Generally, we intend to distribute sufficient dividends to eliminate taxable income and may distribute more than the taxable income, which amount would be considered a return of capital.  As a RIC, we are subject to a 4% excise tax to the extent that we do not distribute on an actual or deemed basis:  (i) 98.0% of our current year ordinary income; and (ii) 98.2% of our current year net capital gain income.


We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions.  In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act and due to provisions in our credit facilities and SBA regulations.  If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of favorable RIC tax treatment.  We cannot assure stockholders that they will receive any distributions, or distributions at a particular level.  We may make distributions to our stockholders of certain net capital gains.  Since December 2001, we have declared distributions of $13.51 per share in the aggregate.


49


---



The following table summarizes the distributions that we declared since January 1, 2011:


Date DeclaredRecord DatePayable DateDividends per ShareApril 26, 2013May 10, 2013May 31, 2013$0.125March 1, 2013March 15, 2013March 29, 2013$0.125October 26, 2012November 16, 2012November 30, 2012$0.125July 27, 2012August 17, 2012August 31, 2012$0.140April 27, 2012June 13, 2012July 13, 2012$0.140February 24, 2012April 13, 2012May 15, 2012$0.170October 31, 2011December 15, 2011January 13, 2012$0.170August 1, 2011September 14, 2011October 14, 2011$0.170May 5, 2011June 15, 2011July 15, 2011$0.170March 1, 2011March 15, 2011April 15, 2011$0.150


If we determined the tax attributes of our distributions as of March 31, 2013 , 49% would be from ordinary income and 51% would be a return of capital.  A return of capital is a return of stockholder investment, rather than a return of earnings or gains derived from our investment activities.  While not immediately taxable to the extent of a stockholder's basis in its shares, a stockholder's basis in the investment will be reduced by the nontaxable amount, which will result in additional gain or a lower loss when the shares are sold.  However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year.  Therefore, a determination as to the tax attributes of the distributions made on a quarterly basis may not be representative of the actual tax attributes for a full year.  We intend to update shareholders quarterly with an estimated percentage of our distributions that resulted from taxable ordinary income.  The actual tax characteristics of distributions to shareholders will be reported to shareholders annually on a Form 1099-DIV.  Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.


CRITICAL ACCOUNTING POLICIES


These Condensed Consolidated Financial Statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions.  The following section describes our accounting policies associated with the valuation of our portfolio of investments.  For a full discussion of our other critical accounting policies and estimates, see Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2012 .


VALUATION OF INVESTMENTS


FAIR VALUE MEASUREMENTS AND DISCLOSURES


We account for our investments at fair value in accordance with Accounting Standard Codification Topic 820—Fair Value Measurements and Disclosures, or ASC 820.  ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value.  ASC 820 defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.


50


---



ASC 820 establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:


ASC 820 Fair Value HierarchyInputs to Fair Value MethodologyLevel 1Quoted prices in active markets for identical assets or liabilitiesLevel 2Quoted prices for similar assets or liabilities; quoted markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the financial instrument; inputs other than quoted prices that are observable for the asset or liability; or inputs that are derived principally from, or corroborated by, observable market informationLevel 3Pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption is unobservable or when the estimation of fair value requires significant management judgment


We categorize a financial instrument in the fair value hierarchy based on the lowest level of input that is significant to its fair value measurement. In the event that transfers between these levels were to occur in the future, we would recognize those transfers as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.


DETERMINATION OF FAIR VALUE IN GOOD FAITH


As a BDC, we invest primarily in illiquid securities, including debt and equity securities of private companies.  To protect our investments and maximize our returns, we negotiate the structure of each equity security and the majority of the debt securities in our investment portfolio.  Our contracts with our portfolio companies generally include many terms governing interest rate, repayment terms, prepayment premiums, financial covenants, operating covenants, ownership and corporate governance parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights.  In some cases, our loan agreements also allow for increases in the spread to the base index rate, if the portfolio company’s financial or operational performance deteriorates or shows negative variances from its business plan and, in some cases, allow for decreases in the spread if financial or operational performance improves or exceeds the portfolio company’s plan.  Generally, our investments are subject to some restrictions on resale and have no established trading market.  Because of the type of investments that we make and the nature of our business, our valuation processes require analyses of numerous market, industry and company-specific factors, including: the performance of the underlying investment; the financial condition of the portfolio company; changing market events; market prices, when available; estimates of market interest rates that would otherwise be made available to our portfolio companies; and other factors relevant to the individual security.


There is no single approach for determining fair value in good faith.  Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses.  As a result, for portfolio investments that do not have an active market, we must apply business judgment to the specific facts and circumstances associated with each security to determine fair value.


Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end.  When such market prices are not available, we use several valuation methodologies to estimate the fair value of our investment portfolio, which generally results in a range of fair values from which we derive a single estimate of fair value.  To determine a portfolio company’s fair value, we analyze its historical and projected financial results, as well as key market value factors.  In determining a security's fair value, we assume we would exchange it in an orderly transaction at the measurement date.  We use the following methods to determine the fair value of investments in our portfolio that are not traded actively:


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Majority-Owned Control Investments—Majority-owned control investments comprised12.3%of our investment portfolio at fair value.  Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value.  Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value.  Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question.  Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs.  Our valuation approaches for majority-owned investments estimate the value

51


---



upon a hypothetical sale or exit and then allocates such value to the investment's securities in order of their relative liquidation preference.  In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par.  These valuation approaches also consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Non-Control Investments—Non-control investments comprised87.7%of our investment portfolio at fair value.  Quoted prices were not available for84.9%of our non-control investments at fair value.  For our non-control equity investments, we use the same market and income approaches used to value our control investments.  For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates.  We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower.  In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Thinly-Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end.  However, we may apply a discount to the market value of restricted or thinly-traded public securities to reflect the impact that these restrictions have on the value of these securities.  We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2).  As ofMarch 31, 2013, these securities represented13.3%of our investment portfolio at fair value.  We utilize independent pricing services to arrive at certain of our fair value estimates.  The majority of our level 2 investments are senior debt investments that are secured and collateralized.  To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.

Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales.  Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks.  We also engage independent valuation firms to provide additional data points for our quarterly valuation analyses.  Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months.  In total, as of March 31, 2013 , we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve month period to calculate 98.8% of the fair value of our investment portfolio.


The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs.  We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses.


Our board of directors sets our valuation policies and procedures and determines the fair value of our investments.  The investment and valuation committee of our board of directors meets at least quarterly with our executive management to review management’s recommendations of fair value of our investments.  Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments.


Due to the uncertainty inherent in the valuation process, such fair value estimates may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material.  In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses that we ultimately realize on these investments to differ from the valuations currently assigned.


Significant Unobservable Inputs


Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs.  Instead, the majority of our investment portfolio is composed of complex debt and equity securities with distinct contract terms and conditions.  As such, our valuation of each investment in our portfolio is unique and


52


---



complex, often factoring in numerous different inputs, including the historical and forecasted financial and operational performance of the portfolio company, projected cash flows, market multiples, comparable market transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews and other inputs too numerous to list quantitatively herein.


The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of March 31, 2013 .


($ in thousands)Fair ValueValuation TechniquesUnobservable InputsRangeWeighted AverageMinimumMaximumSenior debt$163,748Discounted cash flowMarket interest rate6.8%12.8%9.4%Discounted cash flowDiscount rate4.0%4.0%4.0%Market comparable companiesEBITDA multiple(a)7.5x7.5x7.5xSubordinated debt150,886Discounted cash flowMarket interest rate11.5%15.0%13.3%Market comparable companiesRevenue multiple0.2x0.2x0.2xMarket comparable companiesEBITDA multiple(a)7.5x7.5x7.5xPreferred and common equity40,174Market comparable companiesEBITDA multiple(a)4.4x10.0x7.4xDiscount for minority interest—%25.0%1.9%Pending transactions/Letters of intentDiscount—%—%—%Residual assetsDiscount25.0%25.0%25.0%$354,808


______________


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




ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


There were a number of indicators of modest growth in the United States' economy during the first quarter of 2013.  However, certain leading and lagging indicators suggest continuing risk.  In the event of renewed financial turmoil affecting the banking system and financial markets, the financial position and results of operations of certain of the middle-market companies in our portfolio could be affected adversely, which ultimately could lead to difficulty in their meeting debt service requirements and an increase in defaults.


Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates.  Our net interest income is affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates.  As of March 31, 2013 , approximately 69.4% of our loan portfolio, at fair value, bore interest at a spread to either the LIBOR or the  prime rate, and 30.6% at a fixed interest rate.  As of March 31, 2013 , approximately 59.4% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR base index and prime floors between 2.5% and 6.0% .  The three-month weighted-average LIBOR interest rate was 0.29% as of March 31, 2013 .  Thus, the LIBOR floors in these loan investments lessen the impact of such historically low LIBOR rates.


We regularly measure exposure to interest rate risk.  We assess interest rate risk and we manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities.  Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates.


53


---



The following table shows a comparison of the interest rate base for our interest-bearing cash, outstanding commercial loans, at cost, and our outstanding borrowings as of March 31, 2013 and December 31, 2012 :


March 31, 2013December 31, 2012(in thousands)Interest Bearing Cash and Commercial LoansBorrowingsInterest Bearing Cash and Commercial LoansBorrowingsMoney market rate$63,144$—$43,291$—Prime rate13,616—13,603—LIBOR30-day24,330—18,635—60-day————90-day214,02083,015294,77498,053180-day9,305—9,301—Commercial paper————Fixed rate122,011150,000115,091150,000Total$446,426$233,015$494,695$248,053


Based on our March 31, 2013 balance sheet, the following table shows the impact to net income of hypothetical base rate increases in interest rates, assuming no changes in our investment and borrowing structure.  The impact to net income of hypothetical base rate decreases in interest rates is not shown in the following table because as of March 31, 2013 , the quarterly average LIBOR was 0.29% and a 100-basis point decrease could not occur:


(dollars in thousands)Basis Point ChangeInterest IncomeInterest ExpenseNet Income (Loss)100$1,200$830$3702003,3561,6601,6963006,3502,4903,860


ITEM 4.  CONTROLS AND PROCEDURES


DISCLOSURE CONTROLS AND PROCEDURES


Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2013 .  The term “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.


Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on the foregoing evaluation of our disclosure controls and procedures as of March 31, 2013 , our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.


54


---



INTERNAL CONTROL OVER FINANCIAL REPORTING


No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), occurred during the fiscal quarter ended March 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


PART II.  OTHER INFORMATION





ITEM 1.  LEGAL PROCEEDINGS.


From time to time, we are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies.  While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations.  During the quarter ended March 31, 2013 , there were no new or material developments in legal proceedings.


ITEM 1A.  RISK FACTORS.


Investing in our common stock may be speculative and involves a high degree of risk.  In addition to the other information contained in this Quarterly Report on Form 10-Q, including our financial statements, the related notes, schedules and exhibits, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 , which could materially affect our business, financial condition and/or operating results.  The risks described in our Annual Report on Form 10-K are not the only risks facing our Company.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and/or operating results.


There have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012 , which should be read together with the other risk factors and information disclosed elsewhere in this Quarterly Report on Form 10-Q and our other reports filed with the SEC.


ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.


STOCK REPURCHASE PROGRAM


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million and we have provided our stockholders with notice of our intention to repurchase shares of our common stock in accordance with 1940 Act requirements.  Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases are made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.  We retire immediately all such shares of common stock that we purchase in connection with the stock repurchase program.


NET ISSUANCE OF RESTRICTED STOCK


For certain employees, we may be deemed to have purchased through the net issuance of shares, a portion of the shares of restricted stock previously issued under our Third Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, for which the forfeiture provisions have lapsed to satisfy the respective employee’s income


55


---



tax withholding obligations.  We retire immediately all such shares of common stock that we purchase in connection with such net issuance to employees.


DIVIDEND REINVESTMENT PLAN


As part of our dividend reinvestment plan for our common stockholders, we may direct the plan administrator to purchase shares of our common stock on the open market to satisfy dividend reinvestment requests related to dividends that we pay on outstanding shares of our common stock.


The following table summarizes the shares of common stock that we have purchased during the three months ended March 31, 2013 :


Period/PurposeTotal number  of sharesAverage Price Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsMaximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or ProgramsJanuary 1 – 31, 2012Stock repurchase program(a)254,638$4.50254,638$6,681,954February 1 – 28, 2012Stock repurchase program(a)24,197$4.5224,197$6,572,667March 1 – 31, 2012Stock repurchase program(a)225,804$4.50225,8045,556,186Restricted stock vesting(b)4,934$4.78(c)n/an/aDividend reinvestment requirements(d)1,114$4.79(e)n/an/aTotal March 1 – 31, 2012231,852$4.51225,804$5,556,186Total510,687$4.50504,639$5,556,186


____________________


|    |                                                                                                                                
|--- | -------------------------------------------------------------------------------------------------------------------------------
|(a) | On January 17, 2012, we announced that our board of directors had authorized a stock repurchase program of up to $35.0 million.

|    |                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | Represents shares repurchased from our employees in connection with the net issuance of shares to satisfy employee tax withholding obligations in connection with the vesting of restricted stock.

|    |                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------
|(c) | Based on the weighted-average closing share prices of our common stock on the dates that the forfeiture restrictions lapsed.

|    |                                                                                         
|--- | ----------------------------------------------------------------------------------------
|(d) | Represents stock purchased on the open market to satisfy dividend reinvestment requests.

|    |                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|(e) | Represents the weighted-average purchase price per share, including commissions, for shares purchased pursuant to the terms of our dividend reinvestment plan.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.


Not Applicable.


ITEM 4.  MINE SAFETY DISCLOSURES.


Not Applicable.


ITEM 5.  OTHER INFORMATION.


Not Applicable.





56


---



ITEM 6.  EXHIBITS.


The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K.  All exhibits listed in the following table are incorporated by reference except for those exhibits denoted in the last column.


Incorporated by ReferenceExhibit No.DescriptionForm and SEC File No.Filing Date with SECExhibit No.Filed with this 10-Q10.1MCG Capital Corporation 2013 Annual Incentive Cash Bonus Plan8-K(0-33377)March 19, 201310.115.1Letter regarding unaudited interim financial information from Ernst & Young LLP, independent registered public accounting firm*31.1Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*31.2Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*32.1Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†32.2Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†*Filed herewith.†Furnished herewith.





57


---



SIGNATURES


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





MCG Capital CorporationDate:April 30, 2013By:/s/B. HAGEN SAVILLEB. Hagen SavilleChief Executive Officer(Principal Executive Officer)Date:April 30, 2013By:/s/KEITH KENNEDYKeith KennedyChief Financial Officer(Principal Financial and Accounting Officer)





58