UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-Q


(Mark One)


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


For the quarterly period ended September 30, 2014


OR


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


For the transition period from ______ to ______


___________________


Commission file number 0-33377


MCG CAPITAL CORPORATION


(Exact name of registrant as specified in its charter)


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 October 27, 2014, there were 43,506,621 shares of the registrant’s $0.01 par value Common Stock outstanding.







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MCG CAPITAL CORPORATION


FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2014


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)9REVIEW 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 RISK58ITEM 4. CONTROLS AND PROCEDURES59PART II. OTHER INFORMATION59ITEM 1. LEGAL PROCEEDINGS59ITEM 1A. RISK FACTORS59ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS63ITEM 3. DEFAULTS UPON SENIOR SECURITIES64ITEM 4. MINE SAFETY DISCLOSURES64ITEM 5. OTHER INFORMATION64ITEM 6. EXHIBITS65SIGNATURES66







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PART I. FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS


MCG Capital Corporation


Consolidated Balance Sheets


(in thousands, except per share amounts)September 30, 2014December 31, 2013(unaudited)AssetsCash and cash equivalents$114,569$91,598Cash, restricted1,63333,895Cash, securitization accounts—13,906Investments at fair valueNon-affiliate investments (cost of$218,005and $444,217, respectively)56,232268,173Affiliate investments (cost of$999and $59,470, respectively)1,51256,792Control investments (cost of$54,471and$62,751, respectively)35,82643,908Total investments (cost of$273,475and $566,438, respectively)93,570368,873Interest receivable9522,087Other assets4883,634Total assets$211,212$513,993LiabilitiesBorrowings (maturing within one year of$0and $25,172, respectively)$—$175,172Interest payable—2,345Other liabilities5,2442,522Total liabilities5,244180,039Commitments and contingencies (Note 11)Stockholders’ equityPreferred stock, par value $0.01, authorized 1 share, none issued and outstanding——Common stock, par value $0.01, authorized 200,000 shares on September 30, 2014 and December 31, 2013,45,965issued and outstanding on September 30, 2014 and 70,510issued and outstanding on December 31, 2013460705Paid-in capital891,536980,930Distributions in excess of earnings(506,121)(449,915)Net unrealized depreciation on investments(179,907)(197,766)Total stockholders’ equity205,968333,954Total liabilities and stockholders’ equity$211,212$513,993Net asset value per common share at end of period$4.48$4.74





The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital Corporation


Consolidated Statements of Operations


(unaudited)


Three months endedNine months endedSeptember 30September 30(in thousands, except per share amounts)2014201320142013RevenueInterest and dividend incomeNon-affiliate investments (less than 5% owned)$3,664$10,060$18,387$28,915Affiliate investments (5% to 25% owned)9261,2382,8154,560Control investments (more than 25% owned)6831,2892,0894,462Total interest and dividend income5,27312,58723,29137,937Advisory fees and other incomeNon-affiliate investments (less than 5% owned)3785701,2061,344Control investments (more than 25% owned)13133825Total advisory fees and other income3915831,2441,369Total revenue5,66413,17024,53539,306Operating expenseInterest expense3,4832,3167,3397,003Employee compensationSalaries and benefits9966443,8573,610Amortization of employee restricted stock awards1274201,6811,174Total employee compensation1,1231,0645,5384,784General and administrative expense2,0341,8247,7603,942Restructuring expense—2—14Total operating expense6,6405,20620,63715,743Net operating (loss) income before net investment gain (loss) and income tax (benefit) provision(976)7,9643,89823,563Net realized (loss) gain on investmentsNon-affiliate investments (less than 5% owned)(13,905)109(22,739)(658)Affiliate investments (5% to 25% owned)(18,827)(7)(18,827)(554)Control investments (more than 25% owned)(3,372)—(3,258)51Total net realized (loss) gain on investments(36,104)102(44,824)(1,161)Net unrealized appreciation (depreciation) on investmentsNon-affiliate investments (less than 5% owned)12,151(5,005)14,271(10,374)Affiliate investments (5% to 25% owned)19,535713,1918,506Control investments (more than 25% owned)6,226217198(807)Other fair value adjustments301(1)199(1)Total net unrealized appreciation (depreciation) on investments38,213(4,718)17,859(2,676)Net investment gain (loss) before income tax provision2,109(4,616)(26,965)(3,837)Income tax (benefit) provision(152)59(148)111Net income (loss)$1,285$3,289$(22,919)$19,615Income (loss) per basic and diluted common share$0.03$0.05$(0.38)$0.28Cash distributions declared per common share$0.05$0.125$0.245$0.38Weighted-average common shares outstanding—basic and diluted49,80571,20859,94271,313


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital Corporation


Consolidated Statements of Changes in Net Assets


(unaudited)


Nine months endedSeptember 30(in thousands, except per share amounts)20142013Increase (decrease) in net assets from operationsNet operating income before net investment loss and income tax provision$3,898$23,563Net realized loss on investments(44,824)(1,161)Net unrealized appreciation (depreciation) on investments17,859(2,676)Income tax benefit (provision)148(111)Net income (loss)(22,919)19,615Distributions to stockholdersDistributions declared from net operating income(5,147)(20,158)Distributions declared in excess of net operating income(10,281)(6,548)Net decrease in net assets resulting from stockholder distributions(15,428)(26,706)Capital share transactionsRepurchase of common stock(90,720)(2,272)Amortization of restricted stock awardsEmployee awards accounted for as employee compensation1,6811,174Non-employee director awards accounted for as general and administrative expense4043Common stock withheld to pay taxes applicable to the vesting of restricted stock(640)(81)Net decrease in net assets resulting from capital share transactions(89,639)(1,136)Total decrease in net assets(127,986)(8,227)Net assetsBeginning of period333,954371,728End of period$205,968$363,501Net asset value per common share at end of period$4.48$5.10Common shares outstanding at end of period45,96571,212





The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital Corporation


Consolidated Statements of Cash Flows


(unaudited)


Nine months endedSeptember 30(in thousands)20142013Cash flows from operating activitiesNet (loss) income$(22,919)$19,615Adjustments to reconcile net (loss) income to net cash provided by operating activitiesInvestments in portfolio companies(8,944)(85,029)Principal collections related to investment repayments or sales247,825167,724Increase (decrease) in interest receivable, accrued payment-in-kind interest and dividends10,591(5,948)Amortization of restricted stock awardsEmployee1,6811,174Non-employee director4043Decrease in cash—securitization accounts from interest collections1,3992,431(Increase) decrease in restricted cash—escrow accounts(637)5,881Depreciation and amortization2,9081,019Decrease in other assets238500Increase (decrease) in other liabilities379(7,702)Realized loss on investments44,8241,161Net unrealized (appreciation) depreciation on investments(17,859)2,676Net cash provided by operating activities259,526103,545Cash flows from financing activitiesRepurchase of common stock(90,720)(2,272)Payments on borrowings(179,685)(68,879)Proceeds from borrowings4,513—Decrease in cash in restricted and securitization accountsSecuritization accounts for repayment of principal on debt12,4796,756Restricted cash32,92610,549Payment of financing costs—(116)Distributions paid(15,428)(26,706)Common stock withheld to pay taxes applicable to the vesting of restricted stock(640)(81)Net cash used in financing activities(236,555)(80,749)Net increase in cash and cash equivalents22,97122,796Cash and cash equivalentsBeginning balance91,59873,588Ending balance$114,569$96,384Supplemental disclosure of cash flow informationInterest paid$6,804$7,802Income taxes paid—158Paid-in-kind interest accrued2,7751,644Paid-in-kind interest collected12,1352,161Dividend income collected747680


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital CorporationConsolidated Schedule of InvestmentsSeptember 30, 2014 (unaudited)(dollars in thousands)Interest Rate(7)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostControl Investments(4):GMC Television Broadcasting, LLC(2)BroadcastingSenior Debt (Due 12/16)4.2%—4.2%$10,203$7,869$9,165Subordinated Debt (Due 12/16)(6)2.5%—2.5%11,8146,975—Class B Voting Units (8.0%, 86,700 units)(5)9,071—RadioPharmacy  Investors, LLC(2)HealthcareSenior Debt (Due 12/16)9.5%—9.5%17,19517,19217,192Preferred LLC Interest (19.7%, 70,000 units)(5)13,3649,469Total control investments (represents 38.3% of total investments at fair value)54,47135,826Affiliate Investments(3):IDOC, LLCHealthcareLimited Partner Interests(2)(5)9991,512Total affiliate investments (represents 1.6% of total investments at fair value)9991,512Non-Affiliate Investments (less than 5% owned):Accurate Group Holdings, Inc.(2)Business ServicesSubordinated Unsecured Debt (Due 8/18)12.5%—12.5%10,0009,8489,848Series A Preferred Stock (974,805 shares)(5)2,0001,247Broadview Networks Holdings, Inc.(9)CommunicationsCommon Stock (132,779 shares)(5)159,579266Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)——Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)——C7 Data Centers, Inc.Business ServicesSenior Debt (Due 9/19)9.5%—9.5%14,85014,67214,672Community Investors, Inc.Business ServicesPreferred Stock (10.0%, 271,169 shares)271206Series A-1 Preferred Stock (10.0%, 126,928 shares)298226Common Stock (2,564 shares)(5)3—Golden Knight II CLO, Ltd.(8)(10)Diversified Financial ServicesIncome Notes (Due 4/19)(5)2,0291,600Industrial Safety Technologies, LLCManufacturingSubordinated Debt (Due 6/19)9.5%2.0%11.5%10,18810,05610,056Intrafusion Holding Corp.HealthcareSubordinated Debt (Due 6/18)13.7%—13.7%8,5008,3678,367Maverick HealthcareEquity, LLCHealthcarePreferred Units (10.0%, 1,250,000 units)(5)2,021883Class A Common Units (1,250,000 units)(5)——South Bay Mental Health Center, Inc.HealthcareSubordinated Debt (Due 10/17)12.0%2.5%14.5%8,9748,8618,861Total non-affiliate investments (represents 60.1% of total investments at fair value)218,00556,232Total Investments$273,475$93,570





The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital CorporationConsolidated Schedule of InvestmentsDecember 31, 2013(dollars in thousands)Interest Rate(7)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostControl Investments(4):GMC Television Broadcasting, LLC(2)BroadcastingSenior Debt (Due 12/16)(1)4.3%—4.3%$13,329$10,963$12,252Subordinated Debt (Due 12/16)(6)2.5%—2.5%11,5936,975—Class B Voting Units (8.0%, 86,700 units)(5)9,071—Jet Plastica Investors, LLC(2)Plastic ProductsSenior Debt A (Due 3/15)(1)(6)2.4%7.5%9.9%5,3263,897—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%10,84510,84110,841Preferred LLC Interest (19.7%, 70,000 units)(5)13,36413,175Total control investments (represents 11.9% of total investments at fair value)62,75143,908Affiliate Investments(3):C7 Data Centers, Inc.Business ServicesSenior Debt (Due 9/17)(1)9.5%—9.5%17,35017,09217,092Series B Preferred Stock (7,142,857 shares)(5)2,0003,482Education Management, Inc.EducationSenior Debt (Due 12/15)(1)3.0%8.7%11.7%19,72319,61719,617Series C Preferred Stock (9.0%, 16,910 shares)(5)5,000174IDOC, LLCHealthcareSenior Debt (Due 8/17)(1)9.8%—9.8%15,00014,76214,762Limited Partner Interests(1)(2)(5)9991,665Total affiliate investments (represents 15.4% of total investments at fair value)59,47056,792Non-Affiliate Investments (less than 5% owned):Accurate Group Holdings, Inc.(2)Business ServicesSubordinated Unsecured Debt (Due 8/18)(1)12.5%—12.5%10,0009,8279,827Series A Preferred Stock (974,805 shares)(5)2,0001,731Advanced Sleep  Concepts, Inc.(2)Home FurnishingsSenior Debt (Due 1/14 to 8/14)(1)(6)10.3%—10.3%7,4097,2044,493Subordinated Debt (Due 1/14)(6)—%10.0%10.0%3,7713,352—Broadview Networks Holdings, Inc.(9)CommunicationsCommon Stock (132,779 shares)(5)159,579761Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)——Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)——Community Investors, Inc.Business ServicesSenior Debt (Due 5/18)(1)9.8%—9.8%12,30012,07912,079Preferred Stock (10.0%, 297,436 shares)(1)317317Common Stock (2,564 shares)(1)(5)3124Cruz Bay Publishing, Inc.PublishingSubordinated Debt (Due 3/15)(1)5.0%7.3%12.3%21,52121,48321,483Dorsey School of Business Holdings, Inc.EducationSenior Debt (Due 6/18)(1)9.5%—9.5%10,0009,8679,867G&L Investment Holdings, LLC(2)InsuranceSubordinated Debt (Due 5/14)(1)11.2%4.3%15.5%19,48419,42319,423Series A Preferred Shares (14.0%, 5,000,000 shares)(5)8,1914,196Class C Shares (621,907 shares)(5)529—Golden Knight II CLO, Ltd.(8)Diversified Financial ServicesIncome Notes (Due 4/19)2,4913,298Hammond's Candies Since 1920 II, LLCManufacturingSubordinated Debt (Due 9/18)(1)10.0%4.0%14.0%9,3799,2219,221Huron Inc.ManufacturingSubordinated Unsecured Debt (Due 8/18)(1)10.0%4.0%14.0%13,18712,95812,958Industrial Safety Technologies, LLCManufacturingSubordinated Debt (Due 6/19)9.7%2.0%11.7%10,0359,8889,888Intrafusion Holding Corp.HealthcareSubordinated Debt (Due 6/18)(1)11.9%—11.9%11,50011,29011,290Legacy Cabinets Holdings II, Inc.Home FurnishingsClass B-1 Common Stock (2,000 shares)(5)2,185237Mailsouth, Inc.PublishingSenior Debt (Due 12/16)(1)6.8%—6.8%3,9213,8883,830


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital CorporationConsolidated Schedule of InvestmentsDecember 31, 2013(dollars in thousands)Interest Rate(7)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostMaverick HealthcareEquity, LLCHealthcarePreferred Units (10.0%, 1,250,000 units)(5)2,0211,474Class A Common Units (1,250,000 units)(5)——Midwest Technical Institute, Inc.EducationSenior Debt (Due 10/17)(1)9.5%—9.5%13,81313,57513,670Miles Media Group, LLCBusiness ServicesSenior Debt (Due 6/16)(1)12.5%—12.5%19,06318,91318,913Oceans Acquisition, Inc.HealthcareSenior Debt (Due 12/17)(1)10.8%—10.8%12,71012,46012,460Rita’s Water Ice Franchise Company, LLCRestaurantsSenior Debt (Due 11/16)(1)14.0%—14.0%9,3759,3209,320SC Academy Holdings, Inc.EducationSubordinated Debt (Due 7/16)(1)—%14.0%14.0%14,64114,57714,577South Bay Mental Health Center, Inc.HealthcareSubordinated Debt (Due 10/17)(1)12.0%2.5%14.5%11,76111,58111,614Summit Business Media Parent Holding Company LLCInformation ServicesClass E Series I Units (636 units)(1)(5)4,120563Class E Series II Units (276 units)(1)(5)1,78867TCFI CP LLCManufacturingSubordinated Unsecured Debt (Due 4/19)(1)10.0%3.0%13.0%20,01019,66719,667Ted's Café Escondido Holdings, Inc.RestaurantsSenior Debt (Due 12/18)(1)9.5%—9.5%14,00013,69113,691The e-Media Club I, LLCInvestment FundLLC Interest (74 units)(5)8811Visant CorporationConsumer ProductsSenior Debt (Due 12/16)(1)5.3%—5.3%4,7114,7114,657West World Media, LLCInformation ServicesSenior Debt (Due 9/15)(1)11.0%3.0%14.0%11,46711,10511,182Class A Membership Units (25,000 units)(1)(5)1362Warrant to purchase Class A Membership Units (expire 9/15)(1)(5)324379Xpressdocs Holdings, Inc.Business ServicesSeries A Preferred Stock (161,870 shares)(5)500543Total non-affiliate investments (represents 72.7% of total investments at fair value)444,217268,173Total Investments$566,438$368,873








The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital Corporation


Consolidated Schedule of Investments





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

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

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

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

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

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

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|(7) | Interest rates represent the weighted-average annual stated interest rate on debt securities, presented by nature of indebtedness for a single issuer.  PIK interest represents contractually deferred interest that is generally added to the principal balance of the debt security and compounded if contractually required and not paid on a current basis.  PIK may be prepaid by either contract or the portfolio company's choice, but generally is paid at the end of the loan term.  Rates on preferred stock and preferred LLC interests, where applicable, represent the contractual rate.

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|(8) | Investment is not a qualifying asset under section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of total assets at the time of acquisition of any additional non-qualifying assets.

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|(9) | Broadview Networks Holdings, Inc.’s financial statements are currently publicly available and may be accessed on-line using either the Company’s website (www.broadviewnet.com) or using the EDGAR System available on the SEC’s website (www.sec.gov)

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|(10) | In October 2014, we sold our income notes in Golden Knight II CLO, Ltd. for $1.6 million.




The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
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MCG Capital Corporation


Notes to the Condensed Consolidated Financial Statements (Unaudited)


NOTE 1—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION


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


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


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


Small Business Investment Subsidiary —We own Solutions Capital I, L.P., or Solutions Capital, a wholly owned subsidiary that, until September 19, 2014, had been licensed by the United States Small Business Administration, or SBA, and operated as a small business investment company, or SBIC, under the Small Business Investment Act of 1958, as amended, or SBIC Act.  In connection with the formation of Solutions Capital, MCG also established another wholly owned subsidiary, Solutions Capital G.P., LLC, to act as the general partner of Solutions Capital, while MCG is the sole limited partner.


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


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


Basis of Presentation and Use of Estimates


These unaudited financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America and conform to Regulation S-X under the Securities  Exchange Act of 1934 , as amended.  We believe we have made all necessary adjustments so that the financial statements are presented fairly and that all such adjustments are of a normal recurring nature.  We eliminated all significant intercompany balances.  In accordance with Article 6 of Regulation S-X of the Securities Act of 1933 , as amended, and the Securities Exchange Act of 1934 , as amended, we do not consolidate portfolio company investments, including those in which we have a controlling interest.  Further, in connection with the preparation of these Condensed Consolidated Financial Statements , we have evaluated subsequent events that occurred after the balance sheet date as of September 30, 2014 through the date these financial statements were issued.


Preparing financial statements requires us to make estimates and assumptions that affect the amounts reported on our Condensed Consolidated Financial Statements and accompanying notes.  Although we believe the estimates and


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assumptions used in preparing these Condensed Consolidated Financial Statements and related notes are reasonable, actual results could differ materially.


Interim results are not necessarily indicative of results for a full year.  You should read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2013 .


Recent Accounting Pronouncement


In June 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2013-08, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, or ASU 2013-08.  This update changes the approach to the assessment of whether a company is an investment company, clarifies the characteristics of an investment company, provides comprehensive guidance for the investment company assessment and contains certain disclosure requirements.  We adopted this standard update beginning January 1, 2014.  The implementation of this standard update did not have a material impact on our consolidated financial statements.


In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) , or ASU 2014-09 . This update supersedes the revenue recognition requirements in Accounting Standards Update No. 2011-230: Revenue Recognition (Topic 605) , and most industry-specific guidance throughout the industry topics of the codification.  The core principal of the update is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to exchange for those goods or services.  In applying the revenue model to contracts within its scope, an entity should identify the contract(s) with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the entity satisfies a performance obligation.  ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.  We are currently evaluating the potential impact the adoption of this update will have on our consolidated financial statements.


NOTE 2—INVESTMENT PORTFOLIO


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


COST BASISFAIR VALUE BASISSeptember 30, 2014December 31, 2013September 30, 2014December 31, 2013(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$39,73214.6%$190,78333.7%$41,02943.8%$185,52450.3%Subordinated debtSecured34,25912.5118,63220.927,28329.2108,33829.4Unsecured9,8483.642,4527.59,84810.542,45211.5Total debt investments83,83930.7351,86762.178,16083.5336,31491.2Equity investmentsPreferred29,05510.644,9568.013,63214.628,3907.7Common/common equivalents160,58158.7169,61529.91,7781.94,1691.1Total equity investments189,63669.3214,57137.915,41016.532,5598.8Total investments$273,475100.0%$566,438100.0%$93,570100.0%$368,873100.0%


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


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floors between 2.8% and 4.5% .  At origination, our loans generally have four- to six-year stated maturities.  Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.


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


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


COST BASISFAIR VALUE BASISSeptember 30, 2014December 31, 2013September 30, 2014December 31, 2013(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$——%$3,8971.11%$——%$——%Total loans greater than 90 days past due$——%$3,8971.11%$——%$——%Loans on non-accrual status0 to 90 days past due$6,9758.32%$17,5314.98%$——%$4,4931.34%Greater than 90 days past due——3,8971.11————Total loans on non-accrual status$6,9758.32%$21,4286.09%$——%$4,4931.34%


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


September 30, 2014December 31, 2013(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioHealthcare$46,28449.5%$84,92223.0%Business services26,20028.064,10817.4Manufacturing10,05610.751,73514.0Broadcasting9,1659.812,2523.3Diversified financial services1,6001.73,2980.9Education——57,90515.7Publishing——25,3126.9Insurance——23,6206.4Restaurants——23,0106.2Information services——12,5523.4Home furnishings——4,7301.3Consumer products——4,6571.3Other(a)2650.37720.2Total$93,570100.0%$368,873100.0%______________________(a)No individual industry within this category exceeds 1%.


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We provide financial support to our portfolio companies for investment purposes in the form of originations or draws and advances.  Originations represent financial support for which we have not been previously contractually required to provide and draws and advances represent financial support for which we have been previously contractually required to provide.  The following table shows our significant originations and advances:


(in thousands)Nine months endedSeptember 30, 2014CompanyOriginationsDraws/ AdvancesPIK Advances/ DividendsTotalDebtOceans Acquisition, Inc.$—$3,250$—$3,250Community Investors, Inc.—1,667—1,667Other (< $1 million)—1,4002,7744,174Total debt—6,3172,7749,091EquityOther (< $1 million)—298547845Total Equity—298547845Total originations and advances$—$6,615$3,321$9,936


As of September 30, 2014 , we have commitments to invest an additional $2.0 million to our portfolio companies.  See Note 11—Commitments and Contingencies.


NOTE 3—FAIR VALUE MEASUREMENT


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


Fair Value Hierarchy


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


ASC 820 Fair Value 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.


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Assets Measured at Fair Value on a Recurring Basis


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


September 30, 2014(in thousands)Internal Models with SignificantTotal Fair Value  Reported in  Consolidated  Balance SheetObservable Market Parameters(Level 2)Unobservable  Market Parameters(Level 3)Non-affiliate investmentsSenior secured debt$—$14,672$14,672Subordinated secured debt—27,28327,283Unsecured subordinated debt—9,8489,848Preferred equity1,6002,5634,163Common/common equivalents266—266Total non-affiliate investments1,86654,36656,232Affiliate investmentsCommon/common equivalents—1,5121,512Total affiliate investments—1,5121,512Control investmentsSenior secured debt—26,35726,357Preferred equity—9,4699,469Total control investments—35,82635,826Total assets at fair value$1,866$91,704$93,570


As of September 30, 2014 , we had no investments that had quoted market prices in active markets which we would categorize as Level 1 investments under ASC 820.  Cash and cash equivalents are carried at cost which approximates fair value and are Level 1 assets.  Interest receivable is carried at cost which approximates fair value.


Valuation Methodologies and Procedures


As required by the 1940 Act, we classify our investments by level of control.  Control investments include both majority-owned control investments and non-majority owned control investments.  A majority-owned control investment represents a security in which we own more than 50% of the voting interest of the portfolio company and generally control its board of directors.  A non-majority owned control investment represents a security in which we own 25% to 50% of the portfolio company’s voting equity.  As of each of September 30, 2014 and December 31, 2013 , our portfolio contained zero non-majority control investments.  Non-control investments represent both affiliate and non-affiliate securities for which we do not have a controlling interest.  Affiliate investments represent securities in which we own 5% to 25% of the portfolio company’s equity.  Non-affiliate investments represent securities in which we own less than 5% of the portfolio company’s equity.


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|• | Majority-Owned Control Investments—Majority-owned control investments comprise38.3%of our investment portfolio as ofSeptember 30, 2014.  Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value.  Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value.  Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question.  Also, in a limited number of cases, we use income approaches to determine fair value, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs.  Our valuation approaches for majority-owned investments estimate the value upon a hypothetical sale or exit and then allocates such value to the investment's securities in order of their relative liquidation preference.  In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par.  These valuation approaches consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.

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|• | Non-Control Investments—Non-control investments comprise61.7%of our investment portfolio as ofSeptember 30, 2014.  Quoted prices are not available for96.8%of our non-control investments as ofSeptember 30, 2014.  For our non-control equity investments, we use the same market and income approaches used to value our control investments.  For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective

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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.


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|• | 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 ofSeptember 30, 2014, these securities represented2.0%of our investment portfolio.  We utilize independent pricing services to arrive at certain of our fair value estimates.  To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.

Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales.  Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks.  We also engage independent valuation firms to provide additional data points for our quarterly valuation analyses.  Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months.  In total, as of September 30, 2014 , we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve-month period to calculate 99.1% of our investment portfolio, calculated on a fair value basis.


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


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


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


Changes in Level 3 Fair Value Measurements


We classify securities in the Level 3 valuation hierarchy based on the significance of the unobservable factors to the overall fair value measurement.  Our fair value approach for Level 3 securities primarily uses unobservable inputs, but may also include observable, actively quoted components derived from external sources.  Accordingly, the gains and losses in the table below include fair value changes due, in part, to observable factors.  Additionally, we transfer investments in and out of Level 1, 2 and 3 securities as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.  During the three and nine months ended September 30, 2014 , our investment in Broadview Networks Holdings, Inc. was transferred from level 3 to level 2, because its common stock began trading in an inactive market.  During the three and nine months ended September 30, 2013 , there were no transfers in or out of Level 1, 2 or 3.


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The following table provides a reconciliation of fair value changes during the three months ended September 30, 2014 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value as of June 30, 2014Senior secured debt$49,681$33,650$16,737$100,068Subordinated secured debt42,384—11,00553,389Unsecured subordinated debt22,821——22,821Preferred equity2,5893,2757,18313,047Common/common equivalents equity1,5921,512—3,104Total fair value as of June 30, 2014119,06738,43734,925192,429Realized/unrealized gain (loss)Senior secured debt875825681,525Preferred equity137252,2863,024Common/common equivalents equity(840)——(840)Total realized/unrealized gain488072,8543,709IssuancesSenior secured debt15,033(14,439)10,19710,791Subordinated secured debt407—(10,108)(9,701)Unsecured subordinated debt95——95Preferred equity322——322Total issuances15,857(14,439)891,507SettlementsSenior secured debt(46,404)(15,831)(1,145)(63,380)Subordinated secured debt(9,508)—(897)(10,405)Unsecured subordinated debt(13,068)——(13,068)Preferred equity(361)——(361)Common/common equivalents equity(41)——(41)Total settlements(69,382)(15,831)(2,042)(87,255)SalesSenior secured debt(4,513)(3,462)—(7,975)Subordinated secured debt(6,000)——(6,000)Preferred equity—(4,000)—(4,000)Common/common equivalents equity(711)——(711)Total sales(11,224)(7,462)—(18,686)Fair value as of September 30, 2014Senior secured debt14,672—26,35741,029Subordinated secured debt27,283——27,283Unsecured subordinated debt9,848——9,848Preferred equity2,563—9,46912,032Common/common equivalents equity—1,512—1,512Total fair value as of September 30, 2014$54,366$1,512$35,826$91,704


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


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The following table provides a reconciliation of fair value changes during the three -month period ended September 30, 2013 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value as of June 30, 2013Senior secured debt$166,355$31,489$19,191$217,035Subordinated secured debt94,1278,21710,676113,020Unsecured subordinated debt39,244——39,244Preferred equity12,7067,26116,22036,187Common/common equivalents equity2,475——2,475Total fair value as of June 30, 2013314,90746,96746,087407,961Realized/unrealized gain (loss)Senior secured debt(1,267)(41)5(1,303)Subordinated secured debt(372)——(372)Preferred equity(3,134)105211(2,818)Common/common equivalents equity(108)——(108)Total realized/unrealized gain (loss)(4,881)64216(4,601)IssuancesSenior secured debt2,1523562,193Subordinated secured debt1,36380821,525Unsecured subordinated debt462——462Preferred equity872579659Total issuances3,9851876674,839SettlementsSenior secured debt(6,348)6(5)(6,347)Unsecured subordinated debt(16,935)——(16,935)Total settlements(23,283)6(5)(23,282)SalesSenior secured debt(9,880)——(9,880)Total sales(9,880)——(9,880)Fair value as of September 30, 2013Senior secured debt151,01231,48919,197201,698Subordinated secured debt95,1188,29710,758114,173Unsecured subordinated debt22,771——22,771Preferred equity9,5807,43817,01034,028Common/common equivalents equity2,367——2,367Total fair value as of September 30, 2013$280,848$47,224$46,965$375,037


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


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Unrealized (Depreciation) Appreciation of Level 3 Investments


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


Three months ended September 30, 2014Three months ended September 30, 2013(in thousands)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalNon-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalChange in unrealized appreciation (depreciation)Senior secured debt$3,885$15,809$3,940$23,634$(1,379)$(35)$5$(1,409)Subordinated secured debt3,352——3,352(372)——(372)Preferred equity133,7252,2866,024(3,134)106211(2,817)Common/common equivalents equity6,502——6,502(108)——(108)Total change in unrealized appreciation (depreciation) on Level 3 investments$13,752$19,534$6,226$39,512$(4,993)$71$216$(4,706)


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The following table provides a reconciliation of fair value changes during the nine months ended September 30, 2014 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value as of December 31, 2013Senior secured debt$105,674$51,471$19,892$177,037Subordinated secured debt97,497—10,841108,338Unsecured subordinated debt42,452——42,452Preferred equity8,2613,65613,17525,092Common/common equivalents equity2,5041,665—4,169Total fair value as of December 31, 2013256,38856,79243,908357,088Realized/unrealized gain (loss)Senior secured debt(297)(15,727)532(15,492)Subordinated secured debt(4,070)——(4,070)Preferred equity(1,177)344(3,706)(4,539)Common/common equivalents equity(871)(153)—(1,024)Total realized/unrealized (loss)(6,415)(15,536)(3,174)(25,125)IssuancesSenior secured debt21,732(13,869)10,22418,087Subordinated secured debt2,263—(9,944)(7,681)Unsecured subordinated debt1,011——1,011Preferred equity643——643Total issuances25,649(13,869)28012,060SettlementsSenior secured debt(62,432)(18,413)(4,291)(85,136)Subordinated secured debt(52,873)—(897)(53,770)Unsecured subordinated debt(33,615)——(33,615)Preferred equity(425)——(425)Common/common equivalents equity(41)——(41)Total settlements(149,386)(18,413)(5,188)(172,987)SalesSenior secured debt(50,005)(3,462)—(53,467)Subordinated secured debt(15,534)——(15,534)Preferred equity(4,739)(4,000)—(8,739)Common/common equivalents equity(1,117)——(1,117)Total sales(71,395)(7,462)—(78,857)TransfersCommon/common equivalents equity(475)——(475)Total transfers(475)——(475)Fair value as of September 30, 2014Senior secured debt14,672—26,35741,029Subordinated secured debt27,283——27,283Unsecured subordinated debt9,848——9,848Preferred equity2,563—9,46912,032Common/common equivalents equity—1,512—1,512Total fair value as of September 30, 2014$54,366$1,512$35,826$91,704


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


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The following table provides a reconciliation of fair value changes during the nine months ended September 30, 2013 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate 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 debt(140)1671138Subordinated secured debt(473)190—(283)Preferred equity(3,289)1,189(820)(2,920)Common/common equivalents equity(681)2,899—2,218Total realized/unrealized gain (loss)(4,583)4,445(809)(947)IssuancesSenior secured debt87,157(9,020)4978,186Subordinated secured debt8,4162372408,893Unsecured subordinated debt13,432——13,432Preferred equity4062111,7182,335Common/common equivalents equity3——3Total issuances109,414(8,572)2,007102,849SettlementsSenior secured debt(81,900)(7,718)(4,239)(93,857)Subordinated secured debt(9,410)(10)—(9,420)Unsecured subordinated debt(16,935)——(16,935)Total settlements(108,245)(7,728)(4,239)(120,212)SalesSenior secured debt(17,230)——(17,230)Preferred equity(4,098)——(4,098)Common/common equivalents equity(3)(3,000)—(3,003)Total sales(21,331)(3,000)—(24,331)Fair value as of September 30, 2013Senior secured debt151,01231,48919,197201,698Subordinated secured debt95,1188,29710,758114,173Unsecured subordinated debt22,771——22,771Preferred equity9,5807,43817,01034,028Common/common equivalents equity2,367——2,367Total fair value as of September 30, 2013$280,848$47,224$46,965$375,037





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


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Unrealized (Depreciation) Appreciation of Level 3 Investments


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


Nine months ended September 30, 2014Nine months ended September 30, 2013(in thousands)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalNon-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalChange in unrealized appreciation (depreciation)Senior secured debt$2,539$—$3,903$6,442$(252)$174$11$(67)Subordinated secured debt3,319——3,3191,560190—1,750Preferred equity2,7413,344(3,706)2,379(3,086)1,189(820)(2,717)Common/common equivalents equity7,008(153)—6,8551,02223—1,045Total change in unrealized appreciation (depreciation) on Level 3 investments$15,607$3,191$197$18,995$(756)$1,576$(809)$11


Significant Unobservable Inputs


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


The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2014 :


($ in thousands)Fair ValueValuation TechniquesUnobservable InputsRangeWeighted AverageMinimumMaximumSenior debt$41,029Discounted cash flowMarket interest rate7.8%7.8%7.8%Pending transactions/Letters of intentDiscount—%—%—%Market comparable companiesEBITDA multiple(a)6.0x6.0x6.0xSubordinated debt37,131Discounted cash flowMarket interest rate7.8%14.5%11.7%Pending transactions/Letters of intentDiscount—%—%—%Preferred and common equity13,544Market comparable companiesEBITDA multiple(a)6.0x10.0x6.7xPending transactions/Letters of intentDiscount—%—%—%$91,704





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

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NOTE 4—CONCENTRATIONS OF INVESTMENT RISK


During the nine months ended September 30, 2014 , we had concentrations in certain industries, including the healthcare, business services, and manufacturing industries.  The following table summarizes our fair value and revenue concentrations in each of those industries:


Investments at fair valueRevenue for the nine months endedSeptember 30, 2014December 31, 2013September 30, 2014September 30, 2013(dollars in thousands)Amount% of Total PortfolioAmount% of Total PortfolioAmount% of Total RevenueAmount% of Total RevenueIndustryHealthcare$46,28449.5%$84,92223.0%$6,47626.4%$10,18925.9%Business services26,20028.064,10817.46,11624.96,07315.4Manufacturing10,05610.751,73514.05,24121.44,42411.3Total$82,54088.2$200,76554.4$17,83372.7$20,68652.6


NOTE 5—BORROWINGS


As of September 30, 2014 , we had no outstanding borrowings or borrowing facilities.  The following table summarizes our borrowing facilities, the facility amounts and amounts outstanding.


September 30, 2014December 31, 2013(dollars in thousands)Maturity DateTotal Facility/ ProgramAmount OutstandingTotal Facility/ ProgramAmount OutstandingSBIC(a)2008-10BSeptember 2018$—$—$2,600$2,6002009-10AMarch 2019——12,00012,0002009-10BSeptember 2019——13,00013,0002010-10BSeptember 2020——27,50027,5002011-10AMarch 2021——53,50053,5002012-10AMarch 2022——41,40041,400MCG Commercial Loan Trust 2006-1(b)Series 2006-1 Class D NotesApril 2018——40,01625,172Bank of America Unsecured Revolver(c)Unsecured Revolving NoteNovember 2014——20,000—Total borrowings$—$—$210,016$175,172


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|(a) | In September 2014, the SBIC Debentures were repaid in full.

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|(b) | In January 2014, the Class D Notes were repaid in full.

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|(c) | In April 2014, we terminated the undrawn Bank of America Unsecured Revolver.

On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital.  In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.  In addition, on April 21, 2014, based on our assessment of our excess liquidity, we terminated our undrawn unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or the Bank of America Unsecured Revolver.


As a BDC, we are not permitted to incur indebtedness or issue senior securities, including preferred stock, unless immediately after such borrowing we have an asset coverage for total borrowings (which excluded our SBIC debentures) of at least 200%.  In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have an asset coverage ratio of at least 200% after deducting the amount of such dividend, distribution or purchase price.  If we are unable to meet this asset coverage requirement, we may not be able to incur additional debt.  In October 2008, we received exemptive relief from the SEC which allowed us to exclude debt issued by Solutions Capital from the calculation of our consolidated BDC asset coverage ratio.  As of September 30, 2014 , there were no senior securities outstanding.


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


We had funded our secured borrowing debt facility through a bankruptcy remote, special-purpose, wholly owned subsidiary.  Therefore, this subsidiary’s assets were not available to our creditors.  While the secured borrowing was in place, we continued to service those portfolio investments that we used as collateral in our secured borrowing facility.


SBIC Debentures


In September 2014, we prepaid in full the $150 million of SBIC debentures owed to the SBA by Solutions Capital, using excess restricted cash. After repayment, Solutions Capital surrendered its SBIC license to the SBA’s Office of SBIC Operations.  As of December 31, 2013 , Solutions Capital had borrowed $150.0 million from the SBA.  We were permitted to use these funds to provide debt and equity capital to qualifying small businesses.  However, we were not permitted to use these funds to provide working capital to MCG, Solutions Capital's parent company.


As of December 31, 2013 , we had $207.0 million of investments in Solutions Capital and we had $32.5 million, of restricted cash which could be used for additional investments by Solutions Capital.


Bank of America Unsecured Revolver


In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million.  On April 21, 2014, we terminated our Bank of America Unsecured Revolver.


MCG Commercial Loan Trust 2006-1


In April 2006, we completed a $500.0 million debt securitization through the MCG Commercial Loan Trust 2006-1, or 2006-1 Trust, a wholly owned subsidiary.  The 2006-1 Trust issued six classes of notes with interest rates ranging from LIBOR plus 0.33% to LIBOR plus 2.25%.  The reinvestment period for the 2006-1 Trust ended on July 20, 2011 and all subsequent principal collections or monetization proceeds that we received from collateral used to securitize this 2006-1 Trust were applied to the outstanding balance of that facility.  As of December 31, 2013, we had $25.2 million of securitized Class D Notes outstanding under the 2006-1 Trust, which was secured by $76.3 million of loans and equity investments and $13.9 million of cash.  We retained all of the equity in the securitization.  In November 2013, we directed the trustee to redeem the remaining notes on the next quarterly payment date and, on January 21, 2014, we repaid the Class D Notes in full and the loan and equity investments held by the 2006-1 Trust were transferred back to MCG, the parent.


Note 6—SECURED FINANCING


In June 2014, we monetized substantially all of our investment in Advanced Sleep Concepts, Inc., or Advanced Sleep, through the sale of a 95% participation interest in our senior and subordinated loans.  Under the terms of the sale, the purchaser would receive 100% of the payments related to the loan, including interest and principal, until the total payments received exceeded the purchase price plus any additional advances funded by the purchaser to Advanced Sleep and certain expenses incurred by the purchaser.  Thereafter, the purchaser would receive 95% and we would receive 5% of any payments received from Advanced Sleep.  Under the terms of the sale, the purchaser had no recourse to us for any payments.  We continued to service the Advanced Sleep loans on behalf of the purchaser.


We follow the guidance in Accounting Standard Codification Topic 860—Transfers and Servicing, or ASC 860, when accounting for loan participations and other partial loan sales.  Such guidance requires a participation or other partial loan sale to meet the definition of a “participating interest,” as defined in the guidance, in order for sale treatment to be allowed.  Due to the non-pro-rata allocation of payments, the sale of the interest in Advanced Sleep's loans did not meet the definition of a participating interest under ASC 860 resulting in the loans remaining on our Consolidated Balance Sheets and the proceeds from the sale being recorded as a secured financing.  In September 2014, we sold the remaining participation interest in our senior and subordinated loans.  The sale of the remaining interest resulted in the derecognition of the loans to Advanced Sleep and the liability for the secured financing and the realization of a loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million on our Consolidated Income Statement .  In addition, we no longer service the loans on behalf of the purchaser.


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NOTE 7—CAPITAL STOCK


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


STOCK REPURCHASE PROGRAM


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million.  On October 25, 2013, our board of directors authorized a second stock repurchase program of up to $25.0 million.  On February 28, 2014, our board of directors increased the second stock repurchase program to $35.0 million.  On April 25, 2014, our board of directors terminated the second stock repurchase program effective as of May 2, 2014 and authorized a third stock repurchase program of up to $50.0 million effective as of May 5, 2014.  On August 5, 2014, our board of directors terminated the third stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014.  Under the new program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases are made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.  The following table summarizes our stock repurchases for the three and nine months ended September 30, 2014 .


Three months ended September 30, 2014Nine months ended September 30, 2014Dollar amount repurchased(in thousands)$32,902$90,720Shares repurchased8,285,83624,358,596Average price per share$3.97$3.72Discount to quarterly weighted average net asset value per share10.2%15.9%


We requested and received the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engage in a stock repurchase program and agree not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans.  Although as of September 30, 2014 , there were 1,426,811 shares of our common stock available for issuance under our Third Amended and Restated 2006 Employee Restricted Stock Plan , or 2006 Plan, no shares of restricted stock could be issued under our 2006 Plan or our Third Amended and Restated 2006 Non-Employee Director Restricted Stock Plan , or 2006 Non-Employee Plan, because the 10% threshold set forth in the SEC's order had been reached due to shares we repurchased under our stock repurchase program.


DISTRIBUTIONS


The following table summarizes our distributions per share declared since January 1, 2013:


Date DeclaredRecord DatePayment DateAmountAugust 5, 2014August 20, 2014August 29, 2014$0.050April 25, 2014May 9, 2014May 30, 2014$0.070February 28, 2014March 14, 2014March 28, 2014$0.125October 25, 2013November 8, 2013November 22, 2013$0.125July 26, 2013August 9, 2013August 30, 2013$0.125April 26, 2013May 10, 2013May 31, 2013$0.125March 1, 2013March 15, 2013March 29, 2013$0.125


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NOTE 8—SHARE-BASED COMPENSATION


EMPLOYEE SHARE-BASED COMPENSATION


Third Amended and Restated 2006 Employee Restricted Stock Plan


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


During each of the nine months ended September 30, 2014 and 2013 , no shares of restricted stock were issued under the 2006 Plan.


During the nine months ended September 30, 2014 , we recognized $1.7 million of compensation expense related to share-based compensation awards including $1.1 million of compensation costs associated with the retirement of our former chief executive officer and other employee terminations.  During the nine months ended September 30, 2013 , we recognized $1.2 million of compensation expense related to share-based compensation awards.  As of September 30, 2014 , all the restricted share awards for which forfeiture provisions had not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares.  As of September 30, 2014 , we had $0.6 million of unrecognized compensation cost related to restricted common stock awarded to employees.  We expect to recognize the remaining costs over the remaining weighted-average requisite service period of 1.43 years.


Non-Employee Director Share-Based Compensation


During June 2006, our stockholders initially approved the 2006 Non-Employee Plan which was subsequently amended and restated.  In May 2010, our stockholders approved an amendment to the 2006 Non-Employee Plan that increased the number of shares we may award to non-employee members of our board of directors from 100,000 to 150,000 shares.  During the nine months ended September 30, 2014 , no shares of restricted stock were issued to non-employee directors.  Our board of directors has waived the right to an automatic award of 7,500 shares of restricted stock, previously awarded to non-employee directors upon the commencement of each three-year term of board service.  During the nine months ended September 30, 2013 , we awarded 15,000 shares of restricted common stock to non-employee directors.  During each of the nine months ended September 30, 2014 and 2013 , we recognized less than $0.1  million of compensation costs related to share-based awards to non-employee directors.  We include this compensation cost in general and administrative expense on our Consolidated Statements of Operations .  As of September 30, 2014 , we had less than $0.1 million of unrecognized compensation cost related to restricted common stock awarded to non-employee directors, which we expect to recognize over the remaining weighted-average requisite service period of 1.3 years.


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


The following table summarizes our restricted stock award activity during the nine months ended September 30, 2014 :


SharesWeighted-Average Grant Date Fair Value per ShareSubject to forfeiture provisions as of December 31, 2013895,740$4.55Awarded—$—Forfeiture provision satisfied(521,855)$4.60Forfeited(1,805)$6.97Subject to forfeiture provisions as of September 30, 2014372,080$4.48


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NOTE 9—INCOME TAXES


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


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|1. | continue to qualify as a BDC under the 1940 Act at all times during each taxable year;

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|2. | derive in each taxable year at least 90% of our gross income from (1) dividends, interest, payments with respect to certain securities, loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities and (2) net income derived from an interest in a “qualified publicly traded partnership;” and

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|3. | diversify our holdings so that at the end of each quarter of the taxable year:

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|a. | at least 50% of the value of our assets consist of cash, cash items, U.S. government securities, securities of other RICs, and other securities, if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and

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|b. | no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of (i) one issuer, (ii) two or more issuers that are controlled, as determined under applicable Internal Revenue Code rules, by us and are engaged in the same or similar or related trades or businesses or (iii) one or more “qualified publicly traded partnerships.”

If we fail to satisfy the distribution requirement or fail to qualify as a RIC in any taxable year, we would be subject to tax in that year on all of our taxable income at regular corporate rates, regardless of whether we make any distributions to our stockholders.  Distributions would not be required, and any distributions made in taxable years beginning on or after January 1, 2014 would be taxable to our stockholders as ordinary dividend income that, subject to certain limitations, may be eligible for the 15% or 20% maximum tax rate (depending on income thresholds) to the extent of our current and accumulated earnings and profits.  Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends-received deduction.  Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain.


We use the asset and liability method to account for our Taxable Subsidiaries' income taxes.  Using this method, we recognize deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and the tax basis of assets and liabilities.  In addition, we recognize deferred tax benefits associated with net operating carryforwards that we may use to offset future tax obligations.  We measure deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences.  During the nine months ended September 30, 2014 , we recorded an income tax benefit of $0.1 million, which was primarily attributable to an NOL carryback and lower than expected flow-through taxable income on certain investments held by our subsidiaries.  During the nine months ended September 30, 2013 , we recorded an income tax provision of $0.1 million, which was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


From December 2001 through September 30, 2014 , we declared aggregate per share distributions of $14.13 .  Each year, we mail statements on Form 1099-DIV to our stockholders that identify whether we made distributions from ordinary income, net capital gains on the sale of securities, each of which are taxable distributions, and/or a return of paid-in-capital surplus, which is a nontaxable distribution.  A portion of our distributions may represent a return of capital to our stockholders, to the extent that the total distributions paid in a given year exceed current and accumulated taxable earnings and profits.  All or a portion of the distributions that we paid to stockholders during fiscal years 2013, 2012, 2011, 2008, 2006, 2005, 2004 and 2003 represented a return of capital.


We determine the tax attributes of our distributions as of the end of our fiscal year based upon our taxable income for the full year and distributions paid during the full year.  Therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.  If we determined the tax attributes of our distributions as of September 30, 2014 , 33% would be from ordinary income and 67% would be a return of capital.  Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.


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On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 , or the Modernization Act, was enacted, which changed various technical rules governing the tax treatment of RICs.  The changes are generally effective for taxable years beginning after the date of enactment.  One of the more prominent changes addresses capital loss carryforwards.  Under the Modernization Act, each RIC will be permitted to carry forward capital losses incurred in taxable years beginning after the date of enactment for an unlimited period.  However, any losses incurred during those subsequent taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date.  As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to expire unused.  Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short-term as permitted under previous regulation.  For the tax years ended December  31, 2013, 2012 and 2011, we have total net capital losses of $120.5  million which have no expiration and will be carried forward indefinitely to offset future net capital gains.  Capital loss carryforwards from tax years 2009 of $54.2  million and 2010 of $5.2  million will expire December  31, 2017 and December  31, 2018, respectively, unless utilized to offset future net capital gains prior to those expiration dates to the extent permitted by federal tax law.


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


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


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NOTE 10—EARNINGS PER SHARE


The following table sets forth the computation of basic and diluted income per common share for the three and nine months ended September 30, 2014 and 2013 :


(dollars in thousands, except per share amounts)Three months ended September 30,Nine months ended September 30,2014201320142013Numerator for basic and diluted earnings per shareNet income (loss)$1,285$3,289$(22,919)$19,615Less: Dividends declared—common and restricted shares(2,337)(8,902)(15,428)(26,706)Undistributed loss(1,052)(5,613)(38,347)(7,091)Percentage allocated to common shares(a)99.2%98.4%100.0%98.4%Undistributed earnings—common shares(1,044)(5,523)(38,347)(6,978)Add: Dividends declared—common shares2,3188,76015,42826,284Numerator for common shares outstanding excluding participating shares1,2743,237(22,919)19,306Numerator for participating unvested shares only1152—309Numerator for basic and diluted earnings per share—total$1,285$3,289$(22,919)$19,615Denominator for basic and diluted weighted-average shares outstandingCommon shares outstanding49,42870,10959,94270,189Participating unvested shares(b)3771,109—1,124Basic and diluted weighted-average common shares outstanding—total49,80571,21859,94271,313Earnings (loss) per share—basic and dilutedExcluding participating unvested shares$0.03$0.05$(0.38)$0.28Including participating unvested shares$0.03$0.05$(0.38)$0.28(a)Basic and diluted weighted-average common shares:Weighted-average common shares outstanding49,42870,10959,94270,189Weighted-average restricted shares(b)3771,109—1,124Total basic and diluted weighted-average common shares49,80571,21859,94271,313Percentage allocated to common shares99.2%98.4%100.0%98.4%(b)For the nine months ended September 30, 2014, we excluded 592 weighted-average shares of restricted common stock from the calculation of diluted loss per share because the inclusion of these shares would have had an anti-dilutive impact on the calculation of loss per share.


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


NOTE 11—COMMITMENTS AND CONTINGENCIES


LEGAL PROCEEDINGS


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


FINANCIAL INSTRUMENTS


During the normal course of business, we are party to certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments.  We conduct extensive due diligence and, when appropriate, obtain collateral to limit our credit risk.  Generally, these commitments have fixed expiration dates or other termination clauses, which may require payment of a fee by the counterparty.  We expect many of these commitments


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will not be fully used before they expire; therefore, the total commitment amounts do not necessarily represent future cash requirements.


We do not report the unused portions of these commitments on our Consolidated Balance Sheets .  As of September 30, 2014 and December 31, 2013 , we had $2.0 million and $18.1 million, respectively, of outstanding unused loan commitments.  We estimate that as of each of September 30, 2014 and December 31, 2013 , the fair value of these commitments was less than $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties.  As of September 30, 2014 and December 31, 2013 , we had no outstanding guarantees or standby letters of credit.


LEASE OBLIGATIONS


The lease on our headquarters in Arlington, Virginia has a term from October 2012 through November 2014 with a base rent of $0.4 million per year.  The base rent will not increase during the term of the lease.  In February 2014, we entered into a new lease for our headquarters in Arlington, Virginia which has a term from December 2014 through December 2015.  We have an option to extend the new lease for one additional one year period, which may be exercised prior to December 31, 2014.  The base rent for the new lease is $0.7 million per year with a $0.2 million rent credit.  The base rent will not increase during the term of the new lease.  As of September 30, 2014 , our obligations for the remaining term of the lease is $0.6 million , of which $0.5 million will be payable during the next twelve months.


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NOTE 12—FINANCIAL HIGHLIGHTS


The following schedule summarizes our financial highlights for the nine months ended September 30, 2014 and 2013 : Nine months ended(in thousands, except per share amounts)September 3020142013Per share dataNet asset value at beginning of period(a)$4.74$5.18Net (loss) income(b)Net operating income before net investment gain (loss) and income tax provision0.070.33Net realized loss on investments(0.75)(0.02)Net unrealized appreciation (depreciation) on investments0.30(0.03)Income tax provision——Net income (loss)(0.38)0.28Net decrease in net assets resulting from distributionsDistributions declared from net operating income(0.08)(0.29)Distributions declared in excess of net operating income(0.17)(0.09)Net decrease in net assets resulting from distributions(0.25)(0.38)Net increase in net assets relating to stock-based transactionsRepurchase of common stock(b)0.31—Net increase in stockholders’ equity from restricted stock amortization(b)0.030.02Net increase in stockholders’ equity from other stock transactions(b)0.03—Net increase in net assets relating to stock-based transactions0.370.02Net asset value at end of period(a)4.485.10Market price per shareBeginning of period$4.26$4.60End of period$3.52$5.04Total Return(c)-11.62%17.72%Shares of Common Stock OutstandingWeighted-average—basic and diluted59,94271,313End of period45,96571,212Net assetsAverage$270,486$367,445End of period$205,968$363,501Ratios (annualized)Operating expenses to average net assets10.20%5.74%Net operating income to average net assets1.93%8.60%General and administrative expense to average net assets3.84%1.44%Return on average equity-11.33%7.16%__________________(a)Based on total number of shares outstanding.(b)Based on weighted-average number of shares outstanding.(c)Total return = [(ending market price per share–beginning market price per share+dividends paid per share)/beginning market price per share].


NOTE 13—SIGNIFICANT SUBSIDIARY


We have determined that for the nine months ended September 30, 2014 , RadioPharmacy Investors, LLC, or RadioPharmacy, is an unconsolidated portfolio company that meets the conditions of a significant subsidiary and therefore, we are presenting unaudited summarized financial information of RadioPharmacy as of the most recent periods for which data is available.  RadioPharmacy is a private company, which has prepared financial statements in accordance with GAAP but not in accordance with Regulation S-X.


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


(in thousands)September 30, 2014December 31, 2013(unaudited)(unaudited)Assets:Total current assets$5,782$6,573Total non-current assets19,36419,409Total assets$25,146$25,982Liabilities and Stockholders' Equity:Current liabilities$3,932$3,351Long-term liabilities18,37420,411Preferred stock11Other stockholders' equity2,8392,219Total liabilities and stockholders' equity$25,146$25,982


The following table sets forth summarized income statement information for RadioPharmacy for the nine months ended September 30, 2014 and 2013.


Nine months ended September 30,(in thousands)20142013(unaudited)(unaudited)Sales$20,227$19,894Gross margin$12,195$11,753Net income (loss)$620$151


NOTE 14—SUBSEQUENT EVENTS


Tender Offer


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








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Review Report of Independent Registered Public Accounting Firm


The Board of Directors and Stockholders


MCG Capital Corporation


We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation, including the consolidated schedule of investments, as of September 30, 2014 , the related consolidated statements of operations for the three- and nine- month periods ended September 30, 2014 and 2013 , and the related consolidated statements of changes in net assets, cash flows and financial highlights for the nine -month periods ended September 30, 2014 and 2013 .  These financial statements are the responsibility of MCG Capital Corporation’s management.


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


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


We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of MCG Capital Corporation as of December 31, 2013 , including the consolidated schedule of investments, and the related consolidated statements of operations, changes in net assets, cash flows, and financial highlights for the year then ended (not presented herein), and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated March 5, 2014.  In our opinion, the accompanying consolidated balance sheet as of December 31, 2013 , including the consolidated schedule of investments, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.


/s/ ERNST & YOUNG LLP


McLean, Virginia


October 29, 2014





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


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


This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management including, without limitation: our expectations regarding our results of operations, including revenues, net operating income, net investment losses and general and administrative expenses and the factors that may affect such results; our intentions to commence, and the potential impact of, a self-tender offer for up to $75 million of our common stock when there can be no assurance that we will complete such an offer at such amounts or price levels or at all; our future intentions to repurchase shares of our common stock under our stock repurchase program subject to applicable law; our expectations regarding future monetizations of our investment portfolio; potential future transactions involving the Company, including a sale, a restructuring, a recapitalization, a special dividend to stockholders, a liquidation or other transaction or series of transactions, when there can be no assurance that we will engage in any such transaction, that any such transaction will be successfully consummated or of the value of such transaction if consummated; the sufficiency of liquidity to meet 2014 operating requirements, new origination opportunities, potential dividend distributions and any stock repurchases under our tender offer or under our stock repurchase program; our expectations regarding the full use before expiration of certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments; our decisions to make dividend distributions after taking into account our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio; the use of our available liquidity to pay dividends to our stockholders and to repurchase our common stock in our planned tender offer and in the open market under our stock repurchase program; our use of independent valuation firms to provide additional support for our internal analyses; our expectations regarding the outcome of legal proceedings incidental to our business; general market conditions; the state of the economy and other factors.  Forward-looking statements can be identified by terminology such as “anticipate,” “believe,” “could,” “could increase the likelihood,” “hope,” “target,” “project,” “goals,” “potential,” “predict,” “might,” “estimate,” “expect,” “intend,” “is planned,” “may,” “should,” “will,” “will enable,” “would be expected,” “look forward,” “may provide,” “would” or similar terms, variations of such terms or the negative of those terms. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those risk factors discussed in Item IA of Part II of this Quarterly Report on Form 10-Q.


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


DESCRIPTION OF BUSINESS


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


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


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


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corporate-level tax liability.  From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities.  In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.


RECENT DEVELOPMENTS — Q3 2014


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Strategic Exit of SBIC Fund -In September 2014, we prepaid in full the $150 million of SBIC debentures owed to the United States Small Business Administration, or SBA, by Solutions Capital I, L.P., or Solutions Capital, using excess restricted cash.  After repayment, Solutions Capital surrendered its small business investment company, or SBIC, license to the SBA’s Office of SBIC Operations.  In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.  From 2005-2014, Solutions Capital invested $468 million in 36 U.S. small businesses generating an approximate 12% IRR on its portfolio investments based on the total amounts invested and amounts received through the exit of the investments.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Open-Market Purchases of Our Stock-During the quarter ended September 30, 2014, we repurchased 8,285,836 shares of our common stock at a weighted average purchase price of $3.97 equal to an 11.4% discount to our September 30, 2014 Net Asset Value, or NAV, per share.  We acquired these shares in open market transactions.  We retire these shares upon settlement, thereby reducing the number of shares issued and outstanding.  From January 1, 2014 to October 16, 2014, we repurchased 26,816,896 shares of our common stock at a weighted average purchase price of $3.71 equal to a 17.2% discount to our September 30, 2014 NAV per share.

|  |                                                                                                                                                                                                                                               
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Originations and Advances- We made $0.6 million in advances to existing portfolio companies, principally paid-in-kind interest, or PIK, interest and dividends, a majority of which we collected in the same quarter ended September 30, 2014.

|  |                                                                                                                                                                                                                                                                        
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Loan Monetizations- We received $100.8 million in loan payoffs and amortization payments.  We exited nine loans and sold a portion of three investments to reduce our per investment concentration and to maintain our qualification as a regulated investment company.

|  |                                                                                                                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Equity Monetizations- We received $5.3 million in proceeds principally from the sale of our preferred stock in C7 Data Centers, Inc., Legacy Cabinets Holdings II, Inc. and Summit Business Media Parent Holding Company LLC.

|  |                                                                                                                                                                                                                                                                                                                                                      
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Loans on Non-Accrual- We exited all of our non-accrual loans with a fair value greater than zero and we put no new loans on non-accrual during the quarter.  We have one subordinated loan to GMC Broadcasting, LLC on non-accrual at $7.0 million cost (8.3% of the total loan portfolio) and zero at fair value (0.0% of the total loan portfolio).

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Operating Costs- Our total operating costs, excluding interest expense, were $3.2 million, or 1.5% of total assets of $211.2 million.  We incurred $0.4 million in salaries and benefits related to successful Solutions Capital investment exits that occurred during the quarter, $0.1 million in amortization of employee restricted stock awards, $0.5 million in general and administrative expense associated with contractual payments due our former CEO tied to successful Solutions Capital investment exits that occurred during the quarter and employee severance costs and $0.6 million in general and administrative expense related to our lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., all of which we include in total operating costs.

OUTLOOK


We continued to take steps in the third quarter ended September 30, 2014 to strengthen our balance sheet by selling assets that, in our judgment, did not produce adequate compensation for the assumed risk relative to purchasing our stock in open-market transactions, which we acquired at an 11.4% discount to our NAV per share at September 30, 2014.  In October 2014, we continued to buy back our stock in the open market and we purchased 2,458,300 shares at an average price of $3.52, which we anticipate will result in an additional $0.05 per share accretion to our NAV in the fourth quarter.


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As we stated previously, we believe that current market conditions in our primary lending markets are consistent with a peak of a credit cycle.  We believe that we have successfully monetized challenging investments into a very liquid market, improving the quality of our assets and our cash position and resulting in a stronger balance sheet.  We also elected to use excess cash to repay all of our outstanding debt and to repurchase our stock in the open market.  As a result of these capital allocation decisions, we have meaningfully reduced the size of our balance sheet and our net earning assets.  Though we continue to take steps to rationalize our cost infrastructure and to strengthen our balance sheet, we do not have sufficient net earning assets to generate positive net operating income at this time.


Our board of directors has decided not to declare a dividend for the quarter ended September 30, 2014.  Future distributions, if any, will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.


Based on the volume of shares that we have been able to acquire at prices significantly below our NAV, we believe that a significant number of our shareholders are seeking liquidity in our stock.  To that end, in November 2014 we intend to commence a tender offer for up to $75 million of our stock in the price range of $3.25 to $3.75 per share.  We intend to use unencumbered cash to fund the repurchase of our shares acquired through this tender offer.  Upon completion or termination of the self-tender offer and subject to applicable law, we may reinstitute the open market share purchase program that we initiated in August 2014, which is presently suspended until the termination of the tender offer.


We expect to continue to monetize our investment portfolio in the ordinary course of business, which may include a sale of any or all of our investments to a third party.  We may receive offers or engage in a transaction in the ordinary course which may ultimately result in a sale of any or all of our investments at, above or below the fair value of the investment on our balance sheet at that time.  We may also consider a variety of extraordinary transactions, such as a sale of the Company, a restructuring, a recapitalization, a special dividend to stockholders, a liquidation or other transaction or series of transactions.  Any such transaction could result in proceeds to stockholders at that time above the tender offer price and/or above the book value of our investments, although there is no assurance (i) that we will engage in any such transaction, (ii) that any such transaction will be successfully consummated or (iii) that the value of such transaction if consummated will be at or above the tender offer price or book value.


ACCESS TO CAPITAL AND LIQUIDITY


At September 30, 2014 , we had $114.6 million of cash and cash equivalents available for general corporate purposes and $1.6 million of restricted cash held in escrow.


On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital.  In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.


On January 21, 2014, we repaid and terminated our MCG Commercial Loan Trust 2006-1, or 2006-1 Trust.  As of December 31, 2013, we had $25.2 million of securitized Class D Notes outstanding under the 2006-1 Trust, which was secured by $76.3 million of loans and equity investments and $13.9 million of cash.  Upon termination, the assets of the 2006-1 Trust were transferred to MCG, the parent.


PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY


As of September 30, 2014 , the fair value of our investment portfolio was $93.6 million , which represents a $275.3 million , or 74.6% , decrease from the $368.9 million fair value as of December 31, 2013 .  The following sections describe the composition of our investment portfolio as of September 30, 2014 and key changes in our portfolio during the nine months ended September 30, 2014 .


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Portfolio Composition


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


September 30, 2014December 31, 2013(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioDebt investmentsSenior secured debt41,02943.8%$185,52450.3%Subordinated debtSecured27,28329.2108,33829.4Unsecured9,84810.542,45211.5Total debt investments78,16083.5336,31491.2Equity investmentsPreferred equity13,63214.628,3907.7Common/common equivalents equity1,7781.94,1691.1Total equity investments15,41016.532,5598.8Total investments$93,570100.0%$368,873100.0%


Our debt instruments bear contractual interest rates ranging from 2.5% to 14.5% , a portion of which may be in the form of PIK.  As of September 30, 2014 , approximately 63.4% of the fair value of our loan portfolio had variable interest rates, based on either the London Interbank Offer Rate, or LIBOR, or the prime rate, and 36.6% of the fair value of our loan portfolio had fixed interest rates.  As of September 30, 2014 , approximately 51.5% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 2.0% on a LIBOR-based index or prime floors between 2.8% and 4.5% .  At origination, our loans generally have four- to six-year stated maturities.  Borrowers typically pay an origination fee based on a percentage of the total commitment and a fee on undrawn commitments.


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


September 30, 2014December 31, 2013(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioHealthcare$46,28449.5%$84,92223.0%Business services26,20028.064,10817.4Manufacturing10,05610.751,73514.0Broadcasting9,1659.812,2523.3Diversified financial services1,6001.73,2980.9Education——57,90515.7Publishing——25,3126.9Insurance——23,6206.4Restaurants——23,0106.2Investment fund——12,5523.4Home furnishings——4,7301.3Consumer products——4,6571.3Other(a)2650.37720.2Total$93,570100.0%$368,873100.0%______________________(a)No individual industry within this category exceeds 1%.


As of September 30, 2014 , our ten largest portfolio companies represented approximately 99.3% of the total fair value of our investments.  These ten companies accounted for 38.21% of our total revenue during the nine months ended September 30, 2014 .


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During the nine months ended September 30, 2014 , we had concentrations in certain industries, including the healthcare, business services, and manufacturing industries.  The following table summarizes our fair value and revenue concentrations in each of those industries:


Investments at fair valueRevenue for the nine months endedSeptember 30, 2014December 31, 2013September 30, 2014September 30, 2013(dollars in thousands)Amount% of Total PortfolioAmount% of Total PortfolioAmount% of Total RevenueAmount% of Total RevenueIndustryHealthcare$46,28449.5%$84,92223.0%$6,47626.4%$10,18925.9%Business services26,20028.064,10817.46,11624.96,07315.4Manufacturing10,05610.751,73514.05,24121.44,42411.3Total$82,54088.2$200,76554.4$17,83372.7$20,68652.6


Changes in Investment Portfolio


The following table summarizes our total portfolio investment activity during the nine months ended September 30, 2014 and 2013 :


Nine months ended(in thousands)September 3020142013Beginning investment portfolio$368,873$477,724Originations and advances9,93691,032Gross payments, reductions and sales of securities(260,707)(170,566)Net realized loss(44,522)(961)Unrealized depreciation(24,327)(5,286)Reversals of unrealized depreciation41,9872,610Origination fees and amortization of unearned income2,330979Ending investment portfolio$93,570$395,532


Originations and Advances


The following table shows our originations and advances during the nine months ended September 30, 2014 and 2013 by security type:


Nine months ended September 30,20142013(dollars in thousands)Amount% of TotalAmount% of TotalDebt investmentsSenior secured debt$6,45164.9%$71,17878.2%Subordinated debtSecured2,08921.03,5703.9Unsecured5515.513,32214.6Total debt investments9,09191.488,07096.7Equity investmentsPreferred equity8458.62,9593.3Common/common equivalents equity——3—Total equity investments8458.62,9623.3Total originations and advances$9,936100.0%$91,032100.0%


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The following table shows our significant originations and advances:


(in thousands)Nine months endedSeptember 30, 2014CompanyOriginationsDraws/ AdvancesPIK Advances/ DividendsTotalDebtOceans Acquisition, Inc.$—$3,250$—$3,250Community Investors, Inc.—1,667—1,667Other (< $1 million)—1,4002,7744,174Total debt—6,3172,7749,091EquityOther (< $1 million)—298547845Total Equity—298547845Total originations and advances$—$6,615$3,321$9,936


Repayments, Sales and Other Reductions of Investment Portfolio


The following table shows our gross payments, reductions and sales of securities during the nine months ended September 30, 2014 and 2013 by security type:


Nine months ended September 30,20142013(dollars in thousands)Amount% of TotalAmount% of TotalDebt investmentsSenior secured debt$146,80256.3%$141,01182.7%Subordinated debtSecured69,30326.64,5002.6Unsecured33,61612.916,9359.9Total debt investments249,72195.8162,44695.2Equity investmentsPreferred equity9,8293.85,1173.0Common/common equivalents equity1,1570.43,0031.8Total equity investments10,9864.28,1204.8Total gross payments, reductions and sales of securities$260,707100.0%$170,566100.0%


During the nine months ended September 30, 2014 and 2013 , our gross payments, reductions and sales of securities by transaction type included:


Nine months ended September 30,(in thousands)20142013Principal repayments, reductions and loan sales$213,869$136,932Sale of equity investments10,2397,440Scheduled principal amortization23,71723,352Collection of accrued paid-in-kind interest and dividends12,8822,842Total gross payments, reductions and sales of securities$260,707$170,566


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As shown in the following table, during the nine months ended September 30, 2014 , we monetized 25 portfolio investments with proceeds totaling $234.7 million:


Nine months endedSeptember 30, 2014(in thousands)Principal Repayments and Proceeds from Loan SalesSale or Settlement of Equity InvestmentsPIK Interest and Dividend PrepaymentsTotalMonetizationsTCFI CP LLC$20,000$—$282$20,282Miles Media Group, LLC18,463——18,463G&L Investment Holdings, LLC17,5004,1962,06023,756Cruz Bay Publishing, Inc.16,857—5,34522,202Ted's Café Escondido Holdings, Inc.14,306——14,306Oceans Acquisition, Inc.14,251——14,251IDOC, LLC13,832——13,832Huron Inc.12,868—20013,068Midwest Technical Institute, Inc.12,251——12,251West World Media LLC10,57644691911,941Dorsey's School of Business Holdings, Inc.9,653——9,653SC Academy Holdings, Inc.9,534—1,53011,064Rita's Water Ice Franchise Company, LLC9,282——9,282Hammond's Candies Since 1920 II, LLC9,000—5089,508Community Investors, Inc.8,292——8,292Visant Corporation4,670——4,670Advanced Sleep Concepts, Inc.4,518——4,518C7 Data Centers, Inc.—4,000—4,000Education Management, Inc.3,962——3,962Mailsouth, Inc.3,529——3,529Other < 1 Million5251,254571,836Total monetizations213,8699,89610,901234,666Other scheduled payments23,7173431,98126,041Total gross payments, sales and other reductions of investment portfolio$237,586$10,239$12,882$260,707


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


Secured Financing


In June 2014, we monetized substantially all of our investment in Advanced Sleep Concepts, Inc., or Advanced Sleep, through the sale of a 95% participation interest in our senior and subordinated loans.  Under the terms of the sale, the purchaser would receive 100% of the payments related to the loan, including interest and principal, until the total payments received exceeded the purchase price plus any additional advances funded by the purchaser to Advanced Sleep and certain expenses incurred by the purchaser.  Thereafter, the purchaser would receive 95% and we would receive 5% of any payments received from Advanced Sleep.  Under the terms of the sale, the purchaser had no recourse to us for any payments.  We continued to service the Advanced Sleep loans on behalf of the purchaser.


We follow the guidance in Accounting Standard Codification Topic 860—Transfers and Servicing, or ASC 860, when accounting for loan participations and other partial loan sales.  Such guidance requires a participation or other partial loan sale to meet the definition of a “participating interest,” as defined in the guidance, in order for sale treatment to be allowed.  Due to the non-pro-rata allocation of payments, the sale of the interest in Advanced Sleep's loans did not meet the definition of a participating interest under ASC 860 resulting in the loans remaining on our Consolidated Balance Sheets and the proceeds from the sale being recorded as a secured financing.  In September 2014, we sold the remaining participation interest in our senior and subordinated loans.  The sale of the remaining interest resulted in the derecognition of the loans to Advanced Sleep and the liability for the secured financing and the realization of a loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million on our Consolidated Income Statement .  In addition, we no longer service the loans on behalf of the purchaser.


ASSET QUALITY


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


Investment 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 September 30, 2014 and December 31, 2013 :


(dollars in thousands)September 30, 2014December 31, 2013Investment RatingInvestments at Fair Value% of Total PortfolioInvestments at Fair Value% of Total  Portfolio1(a)$1,9452.1%$104,65728.4%243,55546.5137,58637.3336,20538.794,10225.5410,71611.525,9767.051,1491.26,5521.8Total$93,570100.0%$368,873100.0%


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|(a) | As ofDecember 31, 2013, Investment Rating “1” included $83.4 million of loans to companies in which we also hold equity securities.

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


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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 BASISSeptember 30, 2014December 31, 2013September 30, 2014December 31, 2013(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$——%$3,8971.11%$——%$——%Total loans greater than 90 days past due$——%$3,8971.11%$——%$——%Loans on non-accrual status0 to 90 days past due$6,9758.32%$17,5314.98%$——%$4,4931.34%Greater than 90 days past due——3,8971.11————Total loans on non-accrual status$6,9758.32%$21,4286.09%$——%$4,4931.34%


The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2013 through September 30, 2014 :


Nine months endedSeptember 30, 2014(In thousands)CostFair ValueNon-accrual loan balance as of December 31, 2013$21,428$4,493Additional loan on non-accrual status19,8564,879Change in unrealized gain (loss) on non-accrual loans—(515)Payments received from loans on non-accrual status(9,469)(9,469)Reversal of previously recognized unrealized loss on non-accrual loans—25,452Realized loss on non-accrual loans(24,840)(24,840)Total change in non-accrual loans(14,453)(4,493)Non-accrual loan balance as of September 30, 2014$6,975$—


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Results of Operations


The following section compares our results of operations for the three months ended September 30, 2014 to the three months ended September 30, 2013 .


COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013


The following table summarizes the components of our net income for the three months ended September 30, 2014 and 2013 :


Three months ended September 30,Variance(dollars in thousands)20142013$PercentageRevenueInterest and dividend incomeInterest income$4,010$10,717$(6,707)(62.6)%Dividend income322847(525)(62.0)Loan fees9411,023(82)(8.0)Total interest and dividend income5,27312,587(7,314)(58.1)Advisory fees and other income391583(192)(32.9)Total revenue5,66413,170(7,506)(57.0)Operating expensesInterest expense3,4832,3161,16750.4Employee compensationSalaries and benefits99664435254.7Amortization of employee restricted stock127420(293)(69.8)Total employee compensation1,1231,064595.5General and administrative expense2,0341,82421011.5Restructuring expense—2(2)(100.0)Total operating expense6,6405,2061,43427.5Net operating (loss) income before net investment gain (loss) and income tax (benefit) provision(976)7,964(8,940)NMNet investment gain (loss) before income tax provision2,109(4,616)6,725NMIncome tax (benefit) provision(152)59(211)NMNet income (loss)$1,285$3,289$(2,004)(60.9)NM=Not Meaningful


TOTAL REVENUE


Total revenue includes interest and dividend income, loan fees, advisory fees and other income.  The following sections describe the reasons for the variances in each major component of our revenue during the three months ended September 30, 2014 from the three months ended September 30, 2013 .


INTEREST INCOME


The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments.  During the three months ended September 30, 2014 , the total yield on our average debt portfolio at fair value was 13.3% compared to 12.4% during the three months ended September 30, 2013 .  The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.


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The following table shows the various components of the total yield on our average debt portfolio at fair value for the three months ended September 30, 2014 and 2013 :


Three months ended September 30,20142013Average 90-day LIBOR0.2%0.3%Spread to average LIBOR on average loan portfolio12.412.0Impact of fee accelerations of unearned fees on paid/restructured loans1.40.6Impact of non-accrual loans(0.7)(0.5)Total yield on average loan portfolio13.3%12.4%


During the three months ended September 30, 2014 , interest income was $4.0 million , compared to $10.7 million during the three months ended September 30, 2013 , which represented a $6.7 million , or 62.6% , decrease .  This decrease reflected a $6.2 million decrease in interest income resulting from a 60.7% decrease in our average loan balance, a decrease of $0.9 million resulting from loans that were on non-accrual status during the three months ended September 30, 2014 , but that had been accruing interest during the three months ended September 30, 2013 , and a $0.1 million decrease due to interest rate floors.  These decreases were partially offset by a $0.4 million increase in interest income attributable to an increase in our net spread to LIBOR.


PIK Income


Interest income includes certain amounts that we have not received in cash, such as PIK interest.  PIK interest represents contractually deferred interest that is added to the principal balance of the loan and compounded if not paid on a current basis.  Borrowers may, in some instances, be required to prepay PIK because of certain contractual provisions or they may choose to prepay; however, more typically, PIK is paid at the end of the loan term.  The following table shows the PIK-related activity for the three months ended September 30, 2014 and 2013 , at cost :


Three months ended September 30,(in thousands)20142013Beginning PIK loan balance$4,056$9,336PIK interest earned during the period2481,644Payments received from PIK loans(1,662)(135)Realized loss(1,023)—Ending PIK loan balance$1,619$10,845


As of each of September 30, 2014 and September 30, 2013 , all of our PIK loans were accruing interest.  During the three months ended September 30, 2014 , the payments received from PIK loans included $0.9 million in payments on our loan to RadioPharmacy Investors, LLC and $0.5 million collected in conjunction with the repayment of our loan to Hammond's Candies Since 1920 II, LLC.


DIVIDEND INCOME


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


41


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ADVISORY FEES AND OTHER INCOME


Advisory fees and other income primarily include fees related to prepayment, advisory and management services, equity structuring, syndication, bank interest and other income.  Generally, advisory fees and other income relate to specific transactions or services and, therefore, may vary from period to period depending on the level and types of services provided.  During the three months ended September 30, 2014 , we earned $0.4 million of advisory fees and other income, which represented a $0.2 million , or 32.9% , decrease from the three months ended September 30, 2013 .  This decrease resulted principally from decreased loan prepayment fees in the third quarter of 2014.


TOTAL OPERATING EXPENSES


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


INTEREST EXPENSE


During the three months ended September 30, 2014 , we incurred $3.5 million of interest expense, which represented a $1.2 million , or 50.4% , increase from the same period in 2013 .  On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital, which had a cost of funds, including the amortization of deferred financing costs, of 4.6%.  In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.  As of September 30, 2014 , we had no outstanding borrowings or borrowing facilities.


During the three months ended September 30, 2014 , our average borrowings declined to approximately $125.5 million from an average of approximately $183.5 million for the same period in 2013 , which accounted for a $0.5 million reduction in our interest expense.  In addition, interest expense decreased by $0.3 million attributable to the spread to LIBOR decreasing from approximately 3.95% to 3.22% .  These decreases were offset by $2.0 million related to the increased amortization of debt issuance costs.


EMPLOYEE COMPENSATION


Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards.  During the three months ended September 30, 2014 , our employee compensation expense was $1.1 million , which represented a $0.1 million , or 5.5% , increase from the same period in September 30, 2013 .  Our salaries and benefits expense increase d by $0.4 million , or 54.7% , due to a $0.7 million increase in incentive compensation, which consisted of $0.4 million tied to successful Solutions Capital investment exits that occurred during the third quarter of 2014 and the reversal, in the third quarter of 2013, of $0.3 million of previously accrued incentive compensation.  The increase in incentive compensation was partially offset by a $0.4 million decrease in base salaries and benefits.  As of September 30, 2014 , we had 11 employees compared to 17 employees as of September 30, 2013 .  Amortization of employee stock awards decreased $0.3 million , or 69.8% .


GENERAL AND ADMINISTRATIVE


During the three months ended September 30, 2014 , general and administrative expense was $2.0 million , which represented a $0.2 million , or 11.5% , increase compared to the same period in 2013 .


|  |                                                                                                                                                                                                                                                                     
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | General and administrative expense increased $0.6 million due to an increase in legal fees related to our lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., Vast, Inc. and Color Star LLC.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | General and administrative expense also increased $0.3 million due to an increase in professional services fees.  Professional services fees expense for thethree months ended September 30, 2014included $0.3 million paid under the consulting agreement with our former chief executive officer and incentive compensation tied to successful Solutions Capital investment exits that occurred during the quarter due to our former chief executive officer.

|  |                                                                                                                                               
|- | ----------------------------------------------------------------------------------------------------------------------------------------------
|• | These increases in general and administrative expense were offset by a decrease of $0.6 million in severance related to employee terminations.

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NET INVESTMENT GAIN (LOSS) BEFORE INCOME TAX PROVISION


During the three months ended September 30, 2014 , we recorded $2.1 million of net investment gain before income tax (benefit) provision, compared to $4.6 million of net investment loss during the same period in 2013 .  These amounts represent the total of net realized gains and (losses), net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation.  We reverse unrealized (appreciation) depreciation at the time that we realize the gain or (loss).  The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2014 :


Three months ended September 30, 2014(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyNoteRadioPharmacy Investors, LLC1HealthcareControl$—$2,286$—$2,286Golden Knight II CLO, Ltd.2Diversified Financial ServicesNon-Affiliate—(1,614)—(1,614)C7 Data Centers, Inc.3BroadcastingAffiliate2,000—(1,275)725Jet Plastica Investors, LLC4Plastic ProductsControl(3,371)—3,897526Summit Business Media Parent Holding Company LLC5Information ServicesNon-Affiliate(5,717)—5,305(412)Education Management, Inc.6EducationAffiliate(20,727)—20,81083Advanced Sleep Concepts, Inc.7Home FurnishingsNon-Affiliate(5,741)—5,7465Legacy Cabinets Holdings II, Inc.8Home FurnishingsNon-Affiliate(1,665)—1,665—Other (< $1.0 million net gain (loss))(883)(50)1,443510Total$(36,104)$622$37,591$2,109


_______________________


|   |                                                                                                                                                                                
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | We recorded $2.3 million of unrealized appreciation on our investment in RadioPharmacy Investors, LLC to reflect improvement in that portfolio company's operating performance.

|   |                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | In October 2014, we sold our investment in Golden Knight II CLO, Ltd. for proceeds of $1.6 million.  The September 30, 2014 value of that investment reflects the market price indicated by the sale.

|   |                                                                                                                                                                                                                      
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3. | We sold our equity investment in C7 Data Centers, Inc. for net proceeds of $4.0 million resulting in a realized gain of $2.0 million and the reversal of previously recorded unrealized appreciation of $1.3 million.

|   |                                                                                                                                                                                                                                       
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4. | We received the final proceeds for the sale of the assets of Jet Plastica Investors, LLC of $0.5 million resulting in a realized loss of $3.4 million and the reversal of previously recorded unrealized depreciation of $3.9 million.

|   |                                                                                                                                                                                                                                                 
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|5. | We sold our equity investment in Summit Business Media Parent Holding Company LLC for net proceeds of $0.2 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.3 million.

|   |                                                                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|6. | We sold our senior debt and preferred stock investment in Education Management, Inc. for net proceeds of $3.5 million resulting in a realized loss of $20.7 million and the reversal of previously recorded unrealized depreciation of $20.8 million.

|   |                                                                                                                                                                                                                                     
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|7. | We sold our senior and subordinated debt investment in Advanced Sleep for net proceeds of $4.5 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million.

|   |                                                                                                                                                                                                                                  
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|8. | We sold our equity investment in Legacy Cabinets Holdings II, Inc. for net proceeds of $0.5 million resulting in a realized loss of $1.7 million and the reversal of previously recorded unrealized depreciation of $1.7 million.

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


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The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2013 :


Three months ended September 30, 2013(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyG&L Investment Holdings, LLCInsuranceNon-Affiliate$—$(2,915)$—$(2,915)Other (< $1.0 million net gain (loss))102(1,715)(88)(1,701)Total$102$(4,630)$(88)$(4,616)


In the third quarter of 2013, we recorded $2.9 million of unrealized depreciation on our investment in G&L Investment Holdings, LLC to reflect a decrease in that portfolio company's operating performance.


INCOME TAX (BENEFIT) PROVISION


During the three months ended September 30, 2014 , we recorded an income tax benefit of $152,000 , which was primarily attributable to an NOL carryback and lower than expected flow-through taxable income on certain investments held by our subsidiaries.  During the three months ended September 30, 2013 , we recorded an income tax provision of $59,000 , which was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


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COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013


The following table summarizes the components of our net (loss) income for the nine months ended September 30, 2014 and 2013 :


Nine months ended September 30,Variance(dollars in thousands)20142013$PercentageRevenueInterest and dividend incomeInterest income$20,325$33,023$(12,698)(38.5)%Dividend income5472,662(2,115)(79.5)Loan fees2,4192,2521677.4Total interest and dividend income23,29137,937(14,646)(38.6)Advisory fees and other income1,2441,369(125)(9.1)Total revenue24,53539,306(14,771)(37.6)Operating expensesInterest expense7,3397,0033364.8Employee compensationSalaries and benefits3,8573,6102476.8Amortization of employee restricted stock1,6811,17450743.2Total employee compensation5,5384,78475415.8General and administrative expense7,7603,9423,81896.9Restructuring expense—14(14)(100.0)Total operating expense20,63715,7434,89431.1Net operating income before net investment (loss) and income tax (benefit) provision3,89823,563(19,665)(83.5)Net investment loss before income tax benefit provision(26,965)(3,837)(23,128)602.8Income tax (benefit) provision(148)111(259)NMNet (loss) income$(22,919)$19,615$(42,534)NMNM=Not Meaningful





TOTAL REVENUE


Total revenue includes interest and dividend income, loan fees, advisory fees and other income.  The following sections describe the reasons for the variances in each major component of our revenue during the nine months ended September 30, 2014 from the nine months ended September 30, 2013 .


INTEREST INCOME


The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments.  During the nine months ended September 30, 2014 , the total yield on our average debt portfolio at fair value was 12.2% compared to 12.3% during the nine months ended September 30, 2013 .  The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.


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The following table shows the various components of the total yield on our average debt portfolio at fair value for the nine months ended September 30, 2014 and 2013 :


Nine months ended September 30,20142013Average 90-day LIBOR0.2%0.3%Spread to average LIBOR on average loan portfolio11.411.9Impact of fee accelerations of unearned fees on paid/restructured loans0.70.3Impact of non-accrual loans(0.1)(0.2)Total yield on average loan portfolio12.2%12.3%


During the nine months ended September 30, 2014 , interest income was $20.3 million , compared to $33.0 million during the nine months ended September 30, 2013 , which represented a $12.7 million , or 38.5% , decrease .  This decrease reflected a $10.9 million decrease in interest income resulting from a 34.9% decrease in our average loan balance, a decrease of $2.6 million resulting from loans that were on non-accrual status during the nine months ended September 30, 2014 , but that had been accruing interest during the nine months ended September 30, 2013 , a $0.2 million decrease due to interest rate floors, and a $0.1 million decrease related to the decrease in LIBOR.  These decreases were partially offset by a $1.1 million increase in interest income attributable to an increase in our net spread to LIBOR.


PIK Income


The following table shows the PIK-related activity for the nine months ended September 30, 2014 and 2013 , at cost :


Nine months ended September 30,(in thousands)20142013Beginning PIK loan balance$12,132$9,043PIK interest earned during the period2,7754,320Payments received from PIK loans(12,135)(2,161)Realized loss(1,153)(357)Ending PIK loan balance$1,619$10,845


During nine months ended September 30, 2014 , the payments received from PIK loans included $5.3 million collected in connection with the repayment of our loan to Cruz Bay Publishing, Inc., $2.1 million related to the repayment in full of our loan to G&L Investment Holdings, LLC, $1.5 million collected in connection with the sale of our loan to SC Academy Holdings, Inc., $0.9 million collected in connection with the repayment of our loan to West World Media, LLC, $0.9 million in payments on our loan to RadioPharmacy Investors, LLC and $0.5 million collected in connection with the repayment of our loan to Hammond's Candies Since 1920 II, LLC.  During the nine months ended September 30, 2013 , the payments received from PIK loans included $1.0 million collected in connection with the partial repayment of our investment in Education Management, Inc., as well as $0.8 million collected in connection with the repayment in full of our investment in NDSSI Holdings, LLC.


DIVIDEND INCOME


During the nine months ended September 30, 2014 and 2013 , we recognized dividend income of $0.5 million and $2.7 million , respectively.  In addition, during each of the nine months ended September 30, 2014 and 2013 , we received payments on accrued dividends of $0.7 million.  As of September 30, 2014 , the balance of accrued dividends was $7.5 million.


ADVISORY FEES AND OTHER INCOME


During the nine months ended September 30, 2014 , we earned $1.2 million of advisory fees and other income, which represented a $0.1 million , or 9.1% , decrease from the nine months ended September 30, 2013 .  This decrease resulted principally from decreased prepayment fees in 2014.


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TOTAL OPERATING EXPENSES


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


INTEREST EXPENSE


During the nine months ended September 30, 2014 , we incurred $7.3 million of interest expense, which represented a $0.3 million , or 4.8% , increase from the same period in 2013 .  During these respective periods, our average cost to borrow increased to 6.8% from 4.4% , principally due to the repayment of securitized debt in our 2006-1 Trust which carried interest rates ranging from L+0.33% to L+2.25%.  On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital, which had a cost of funds, including the amortization of deferred financing costs, of 4.6%.  In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.  In addition, interest expense for the nine months ended September 30, 2014 includes $0.2 million of interest and deferred financing costs associated with our 2006-1 Trust, which we terminated in January 2014.  As of September 30, 2014 , we had no outstanding borrowings or borrowing facilities.


During the nine months ended September 30, 2014 , our average borrowings declined to approximately $143.2 million from an average of approximately $209.4 million for the same period in 2013 , which accounted for a $2.1 million reduction in our interest expense.  This decreases was offset by increases of $1.9 million related to decreased amortization of debt issuance costs and $0.6 million attributable to the spread to LIBOR increasing from approximately 3.53% to 3.88% .


EMPLOYEE COMPENSATION


Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards.  During the nine months ended September 30, 2014 , our employee compensation expense was $5.5 million , which represented a $0.8 million , or 15.8% , increase from the same period in 2013 .  Our salaries and benefits increase d by $0.2 million , or 6.8% , due to a $1.1 million increase in incentive compensation tied to successful Solutions Capital investment exits, offset by a $0.9 million decrease in base salaries and benefits.  As of September 30, 2014 , we had 11 employees compared to 17 employees as of September 30, 2013 .  Amortization of employee stock awards increased $0.5 million , or 43.2% .  Amortization of employee stock awards for the nine months ended September 30, 2014 includes $1.1 million of accelerated amortization related to the retirement of our former chief executive officer and other employee terminations.


GENERAL AND ADMINISTRATIVE


During the nine months ended September 30, 2014 , general and administrative expense was $7.8 million , which represented a $3.8 million , or 96.9% , increase compared to the same period in 2013 .


|  |                                                                                                                                                                                                                                                                                                                    
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | General and administrative expense increased $2.0 million due to an increase in severance costs.  General and administrative expense for thenine months ended September 30, 2014included $2.8 million in severance related to the retirement of our former chief executive officer and other employee terminations.

|  |                                                                                                                                                                                                                                                                     
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | General and administrative expense increased $1.5 million due to an increase in legal fees related to our lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., Vast, Inc. and Color Star LLC.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | In addition, general and administrative expense increased $0.3 million due to an increase in professional services fees.  Professional services fees expense for thenine months ended September 30, 2014included $0.4 million paid under the consulting agreement with our former chief executive officer and incentive compensation tied to successful Solutions Capital investment exits due to our former chief executive officer.

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NET INVESTMENT LOSS BEFORE INCOME TAX PROVISION


During the nine months ended September 30, 2014 , we recorded $27.0 million of net investment loss before income tax (benefit) provision, compared to $3.8 million of net investment loss during the same period in 2013 .  These amounts represent the total of net realized gains and (losses), net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation.  We reverse unrealized (appreciation) depreciation at the time that we realize the gain or (loss).  The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2014 :


Nine months ended September 30, 2014(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyNoteEducation Management, Inc.1EducationAffiliate$(20,727)$(15,984)$20,810$(15,901)SC Academy Holdings, Inc.2EducationNon-Affiliate(4,037)——(4,037)RadioPharmacy Investors, LLC3HealthcareControl—(3,706)—(3,706)Golden Knight II CLO, Ltd.4Diversified Financial ServicesNon-Affiliate—(1,236)—(1,236)Jet Plastica Investors, LLC5Plastic ProductsControl(3,371)—3,897526C7 Data Centers, Inc.6Business ServicesAffiliate2,000(207)(1,275)518Summit Business Media Parent Holding Company LLC7Information ServicesNon-Affiliate(5,717)(27)5,305(439)Advanced Sleep Concepts, Inc.8Home FurnishingsNon-Affiliate(5,741)3175,746322Legacy Cabinets Holdings II, Inc.9Home FurnishingsNon-Affiliate(1,665)2831,665283G&L Investment Holdings, LLC10InsuranceNon-Affiliate(4,416)—4,523107Other (< $1.0 million net gain (loss))(1,150)(3,869)1,617(3,402)Total$(44,824)$(24,429)$42,288$(26,965)


____________________________


|   |                                                                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | We sold our senior debt and preferred stock investment in Education Management, Inc. for net proceeds of $3.5 million resulting in a realized loss of $20.7 million and the reversal of previously recorded unrealized depreciation of $20.8 million.

|   |                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------
|2. | We sold our subordinated debt investment in SC Academy Holdings, Inc. for net proceeds of $11.1 million resulting in a realized loss of $4.0 million.

|   |                                                                                                                                                                                                                                                                                                                  
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3. | We recorded $3.7 million of net unrealized depreciation on our investment in RadioPharmacy Investors, LLC due to reducing our valuation multiple in the first quarter of 2014 based on volume, pricing and supply-cost challenges facing the company's core business, offset by improved performance during 2014.

|   |                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4. | In October 2014, we sold our investment in Golden Knight II CLO, Ltd. for proceeds of $1.6 million.  The September 30, 2014 value of that investment reflects the market price indicated by the sale.

|   |                                                                                                                                                                                                                                       
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|5. | We received the final proceeds for the sale of the assets of Jet Plastica Investors, LLC of $0.5 million resulting in a realized loss of $3.4 million and the reversal of previously recorded unrealized depreciation of $3.9 million.

|   |                                                                                                                                                                                                                      
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|6. | We sold our equity investment in C7 Data Centers, Inc. for net proceeds of $4.0 million resulting in a realized gain of $2.0 million and the reversal of previously recorded unrealized depreciation of $1.3 million.

|   |                                                                                                                                                                                                                                                 
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|7. | We sold our equity investment in Summit Business Media Parent Holding Company LLC for net proceeds of $0.2 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.3 million.

|   |                                                                                                                                                                                                                                     
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|8. | We sold our senior and subordinated debt investment in Advanced Sleep for net proceeds of $4.5 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million.

|   |                                                                                                                                                                                                                                  
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|9. | We sold our equity investment in Legacy Cabinets Holdings II, Inc. for net proceeds of $0.5 million resulting in a realized loss of $1.7 million and the reversal of previously recorded unrealized depreciation of $1.7 million.

|    |                                                                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10. | In addition,we sold our preferred and common equity investments in G&L Investment Holdings, LLC resulting in a realized loss of $4.4 million and a reversal of previously recorded unrealized depreciation of $4.5 million.

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


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The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2013 :


Nine months ended September 30, 2013(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyNoteVirtual Radiologic Corporation1HealthcareNon-Affiliate$—$(3,341)$—$(3,341)G&L Investment Holdings, LLC2InsuranceNon-Affiliate—(3,133)—(3,133)Miles Media Group, LLC3Business ServicesAffiliate2,8771,192(1,170)2,899Advanced Sleep Concepts, Inc.4Home FurnishingsNon-Affiliate(3,424)(458)3,249(633)Other (< $1 million net gain (loss))(614)455530371Total$(1,161)$(5,285)$2,609$(3,837)


________________________


|   |                                                                                                                                                                               
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | We recorded $3.3 million of unrealized depreciation on our investment in Virtual Radiologic Corporation to reflect a decrease in the indicated market price for that security.

|   |                                                                                                                                                                                
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | We recorded $3.1 million of unrealized depreciation on our investment in G&L Investment Holdings, LLC, to reflect a decrease in that portfolio company's operating performance.

|   |                                                                                                                                                                                                               
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3. | We received $3.0 million for the sale of our equity investment in Miles Media Group, LLC, which resulted in a $2.9 million realized gain and a reversal of previously unrealized appreciation of $1.2 million.

|   |                                                                                                                                                                                                                                 
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4. | In addition, during 2013, we wrote off our preferred and common equity investments in Advanced Sleep resulting in a realized loss of $3.4 million and a reversal of previously recorded unrealized depreciation of $3.2 million.

INCOME TAX (BENEFIT) PROVISION


During the nine months ended September 30, 2014 , we recorded an income tax benefit of $148,000 , which was primarily attributable to an NOL carryback and lower than expected flow-through taxable income on certain investments held by our subsidiaries.  During the nine months ended September 30, 2013 , we recorded an income tax provision of $111,000 , which was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES


Our financial liquidity principally comes from our cash on hand, portfolio monetizations and net operating income.  In addition to making investments in portfolio companies, we may use our available liquidity to pay dividends to our stockholders and to repurchase our common stock in our planned tender offer and in the open market under our stock repurchase program (which is presently suspended until the termination of the tender offer).  For the nine months ended September 30, 2014 , we declared 24.5 cents per share in dividends and paid $15.4 million in total dividends.  We also repurchased 24,358,596 shares of our common stock for $90.7 million at a weighted average price of $3.72 per share representing a 15.9% discount from our quarterly weighted average net asset value per share.


For the nine months ended September 30, 2014 , we earned 12.2% on our average loan portfolio at fair value of $249.9 million and our weighted average cost to borrow was 6.8% on average borrowings of $143.2 million .  Including dividend income and fee income, we earned $3.9 million of net operating income.


At September 30, 2014 , we had $114.6 million in cash and cash equivalents available for general corporate purposes and $1.6 million of restricted cash held in escrow.  On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital.  On April 21, 2014, based on our assessment of our excess liquidity, we terminated our undrawn unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or the Bank of America Unsecured Revolver, that was set to expire in November 2014.


Although there can be no assurance, we believe we have sufficient liquidity to meet our operating requirements for the remainder of 2014, as well as liquidity for new origination opportunities, potential dividend distributions and any stock repurchases under our tender offer for up to $75.0 million of our common stock that we expect to commence on


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November 3, 2014 or under our stock repurchase program (which is presently suspended until the termination of the tender offer).


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


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


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Cash and cash 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 ofSeptember 30, 2014andDecember 31, 2013, we had$114.6 millionand $91.6 million, respectively, in cash and cash equivalents.  As ofSeptember 30, 2014, our cash and cash equivalents included$25.9 millionheld in interest-bearing accounts.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
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|• | Cash, restrictedincludes cash held in escrow and previously included cash held for regulatory purposes.  The largest component of restricted cash was represented by cash held by Solutions Capital, a wholly owned subsidiary which was licensed as an SBIC under the SBIC Act.  Cash held by an SBIC generally is restricted to the origination of new loans by the SBIC.  In September, 2014, we prepaid in full the $150 million of SBIC debentures owed to the SBA by Solutions Capital using excess restricted cash, surrendered our SBIC license and closed the investment vehicle, resulting in the reclassification of cash held by Solutions Capital toCash and cash equivalentson ourConsolidated Balance Sheets.  As ofDecember 31, 2013, we had $33.9 million of restricted cash.

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|• | Cash, securitization accountspreviously included principal and interest payments received on securitized loans, which, were held in designated bank accounts until monthly or quarterly disbursements were made from the securitization trusts.  We were generally required to use a portion of these amounts to pay interest expense, reduce borrowings or pay other amounts in accordance with the related securitization agreements.  Cash in securitization accounts had a negative impact on our earnings since the interest we paid on borrowings typically exceeded the rate of return that we were able to earn on temporary cash investments.  As of December 31, 2013, we had $13.9 million in cash, securitization accounts.  On January 21, 2014, we terminated our 2006-1 Trust and the securitized cash was used to repay principal and interest due on the notes including the notes owned by MCG Capital, the parent.

During the nine months ended September 30, 2014 , our operating activities provided $259.5 million of cash and cash equivalents, and our financing activities used $236.6 million of cash and cash equivalents.


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LIQUIDITY AND CAPITAL RESOURCES—BORROWINGS


As of September 30, 2014 , we had no outstanding borrowings or borrowing facilities.  The following table summarizes our borrowing facilities, the facility amounts and the amounts outstanding.


September 30, 2014December 31, 2013(dollars in thousands)Maturity DateTotal Facility/ ProgramAmount OutstandingTotal Facility/ ProgramAmount OutstandingSBIC(a)2008-10BSeptember 2018$—$—$2,600$2,6002009-10AMarch 2019——12,00012,0002009-10BSeptember 2019——13,00013,0002010-10BSeptember 2020——27,50027,5002011-10AMarch 2021——53,50053,5002012-10AMarch 2022——41,40041,400MCG Commercial Loan Trust 2006-1(b)Series 2006-1 Class D NotesApril 2018——40,01625,172Bank of America Unsecured Revolver(c)Unsecured Revolving NoteNovember 2014——20,000—Total borrowings$—$—$210,016$175,172


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|--- | -----------------------------------------------------------
|(a) | In September 2014, the SBIC Debentures were repaid in full.

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|--- | -------------------------------------------------------
|(b) | In January 2014, the Class D Notes were repaid in full.

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|(c) | In April 2014, we terminated the undrawn Bank of America Unsecured Revolver.

SBIC DEBENTURES


In September, 2014, we prepaid in full the $150 million of SBIC debentures owed to the SBA by Solutions Capital using excess restricted cash.  After repayment, Solutions Capital surrendered its SBIC license to the SBA’s Office of SBIC Operations.  In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.  From 2005-2014, Solutions Capital invested $468 million in 36 U.S. small businesses generating an approximate 12% IRR on its portfolio investments based on the total amounts invested and amounts received through the exit of the investments.


BANK OF AMERICA UNSECURED REVOLVER


In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million.  On April 21, 2014, based on our assessment of our excess liquidity, we terminated our undrawn Bank of America Unsecured Revolver.


MCG COMMERCIAL LOAN TRUST 2006-1


As of December 31, 2013, we had $25.2 million of securitized Class D Notes outstanding under the 2006-1 Trust, which was secured by $76.3 million of loans and equity investments and $13.9 million of cash.  We retained all of the equity in the securitization.  In November 2013, we directed the trustee to redeem the remaining notes on the next quarterly payment date and, on January 21, 2014, we repaid the Class D Notes in full and the loan and equity investments held by the 2006-1 Trust were transferred back to MCG, the parent.


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WEIGHTED-AVERAGE BORROWINGS AND COST OF FUNDS


The following table shows our weighted-average borrowings, the weighted-average interest rate on all of our borrowings, including amortization of deferred debt issuance costs and commitment fees, the average LIBOR, and the average spread to LIBOR for 2014 and 2013 :


Nine months ended September 30,(dollars in thousands)20142013Weighted-average borrowings$143,187$209,367Average LIBOR0.23%0.28%Average spread to LIBOR, excluding amortization of deferred debt issuance costs3.883.53Impact of amortization of deferred debt issuance costs2.650.60Total cost of funds6.76%4.41%


SECURED FINANCING


In June 2014, we monetized substantially all of our investment in Advanced Sleep through the sale of a 95% participation interest in our senior and subordinated loans.  Under the terms of the sale, the purchaser would receive 100% of the payments related to the loan, including interest and principal, until the total payments received exceeded the purchase price plus any additional advances funded by the purchaser to Advanced Sleep and certain expenses incurred by the purchaser.  Thereafter, the purchaser would receive 95% and we would receive 5% of any payments received from Advanced Sleep.  Under the terms of the sale, the purchaser had no recourse to us for any payments.  We continued to service the Advanced Sleep loans on behalf of the purchaser.


We follow the guidance in ASC 860 when accounting for loan participations and other partial loan sales.  Such guidance requires a participation or other partial loan sale to meet the definition of a “participating interest,” as defined in the guidance, in order for sale treatment to be allowed.  Due to the non-pro-rata allocation of payments, the sale of the interest in Advanced Sleep's loans did not meet the definition of a participating interest under ASC 860 resulting in the loans remaining on our Consolidated Balance Sheets and the proceeds from the sale being recorded as a secured financing.  In September 2014, we sold the remaining participation interest in our senior and subordinated loans.  The sale of the remaining interest resulted in the derecognition of the loans to Advanced Sleep and the liability for the secured financing and the realization of a loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million on our Consolidated Income Statement .  In addition, we no longer service the loans on behalf of the purchaser.


LIQUIDITY AND CAPITAL RESOURCES—COMMON STOCK


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


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million.  On October 25, 2013, our board of directors authorized a second stock repurchase program of up to $25.0 million.  On February 28, 2014, our board of directors increased the second stock repurchase program to $35.0 million.  On April 25, 2014, our board of directors terminated the second stock repurchase program effective as of May 2, 2014 and authorized a third stock repurchase program of up to $50.0 million effective as of May 5, 2014.  On August 5, 2014, our board of directors terminated the third stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014.  Under the new program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.  During the nine months ended September 30, 2014 , we repurchased 24,358,596 shares of our common stock at a weighted average purchase price of $3.72 per share, which was a 15.9% discount from our quarterly weighted average net asset value per share.


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We requested and received the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engage in a stock repurchase program and agree not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans.  Although as of September 30, 2014 , there were 1,426,811 shares of our common stock available for issuance under our Third Amended and Restated 2006 Employee Restricted Stock Plan , or 2006 Plan, no shares of restricted stock could be issued under our 2006 Plan or our Third Amended and Restated 2006 Non-Employee Director Restricted Stock Plan , because the 10% threshold set forth in the SEC's order had been reached due to shares we repurchased under our stock repurchase program.


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


OFF-BALANCE SHEET ARRANGEMENTS


FINANCIAL INSTRUMENTS


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


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


We do not report the unused portions of these commitments on our Consolidated Balance Sheets.  As of September 30, 2014 , we had $2.0 million of outstanding unused loan commitments.  We believe that our operations, monetizations and unrestricted cash will provide sufficient liquidity to fund, as necessary, requests to draw on these unfunded commitments.  We estimate that the fair value of these commitments was less than $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties.  From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies.  As of September 30, 2014 , we had no outstanding guarantees or standby letters of credit.


CONTRACTUAL OBLIGATIONS


The following table shows our contractual obligations as of September 30, 2014 :


(in thousands)Payments Due by PeriodContractual Obligations(a)TotalLess than 1 year1-3 years4-5 yearsAfter 5 yearsOperating leases641470171——Severance obligations(b)2,4581,829629——Total contractual obligations$3,099$2,299$800$—$—


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|(a) | Excludes the unused commitments to extend credit to our customers of$2.0 millionas discussed above.

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|(b) | Represents remaining severance payments, employer taxes and incentive payments that we are obligated to pay stemming from the resignation of our former chief executive officer.

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DISTRIBUTIONS


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


We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions.  In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act.  If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of favorable RIC tax treatment.  We cannot assure stockholders that they will receive any distributions, or distributions at a particular level.  We may make distributions to our stockholders of certain net capital gains.  Since December 2001, we have declared aggregate per share distributions of $14.13 .


The following table summarizes the distributions that we declared since January 1, 2012:


Date DeclaredRecord DatePayable DateDividends per ShareAugust 5, 2014August 20, 2014August 29, 2014$0.050April 25, 2014May 9, 2014May 30, 2014$0.070February 28, 2014March 14, 2014March 28, 2014$0.125October 25, 2013November 8, 2013November 22, 2013$0.125July 26, 2013August 9, 2013August 30, 2013$0.125April 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


If we determined the tax attributes of our distributions as of September 30, 2014 , 33% would be from ordinary income and 67% would be a return of capital.  A return of capital is a return of stockholder investment, rather than a return of earnings or gains derived from our investment activities.  While not immediately taxable to the extent of a stockholder's basis in its shares, a stockholder's basis in the investment will be reduced by the nontaxable amount, which will result in additional gain or a lower loss when the shares are sold.  However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year.  Therefore, a determination as to the tax attributes of the distributions made on a quarterly basis may not be representative of the actual tax attributes for a full year.  We intend to update stockholders quarterly with an estimated percentage of our distributions that resulted from taxable ordinary income.  The actual tax characteristics of distributions to stockholders will be reported to stockholders annually on a Form 1099-DIV.  Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.


CRITICAL ACCOUNTING POLICIES


These Condensed Consolidated Financial Statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions.  The following section describes our accounting policies associated with the valuation of our portfolio of investments.  For a full discussion of our other critical accounting policies and estimates, see Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2013 .


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VALUATION OF INVESTMENTS


FAIR VALUE MEASUREMENTS AND DISCLOSURES


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


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


ASC 820 Fair Value 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 rights, dilution parameters, liquidation preferences, voting rights, and put or call rights.  In some cases, our loan agreements also allow for increases in the spread to the base index rate, if the portfolio company’s financial or operational performance deteriorates or shows negative variances from its business plan and, in some cases, allow for decreases in the spread if financial or operational performance improves or exceeds the portfolio company’s plan.  Generally, our investments are subject to some restrictions on resale and have no established trading market.  Because of the type of investments that we make and the nature of our business, our valuation processes require analyses of numerous market, industry and company-specific factors, including: the performance of the underlying investment; the financial condition of the portfolio company; changing market events; market prices, when available; estimates of market interest rates that would otherwise be made available to our portfolio companies; and other factors relevant to the individual security.


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


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


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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:


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|• | Majority-Owned Control Investments—Majority-owned control investments comprise38.3%of our investment portfolio at fair value.  Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value.  Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value.  Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question.  Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs.  Our valuation approaches for majority-owned investments estimate the value upon a hypothetical sale or exit and then allocates such value to the investment's securities in order of their relative liquidation preference.  In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par.  These valuation approaches also consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.

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|• | Non-Control Investments—Non-control investments comprise61.7%of our investment portfolio at fair value.  Quoted prices are not available for96.8%of our non-control investments at fair value.  For our non-control equity investments, we use the same market and income approaches used to value our control investments.  For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates.  We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower.  In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.

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|• | 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 ofSeptember 30, 2014, these securities represented2.0%of our investment portfolio at fair value.  We utilize independent pricing services to arrive at certain of our fair value estimates.  To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.

Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales.  Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks.  We also engage independent valuation firms to provide additional data points for our quarterly valuation analyses.  Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months.  In total, as of September 30, 2014 , we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve month period to calculate 99.1% of the fair value of our investment portfolio.


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


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


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


Significant Unobservable Inputs


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


The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2014 .


($ in thousands)Fair ValueValuation TechniquesUnobservable InputsRangeWeighted AverageMinimumMaximumSenior debt$41,029Discounted cash flowMarket interest rate7.8%7.8%7.8%Pending transactions/Letters of intentDiscount—%—%—%Market comparable companiesEBITDA multiple(a)6.0x6.0x6.0xSubordinated debt37,131Discounted cash flowMarket interest rate7.8%14.5%11.7%Pending transactions/Letters of intentDiscount———Preferred and common equity13,544Market comparable companiesEBITDA multiple(a)6.0x10.0x6.7xPending transactions/Letters of intentDiscount—%—%—%$91,704


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

RECENT ACCOUNTING PRONOUNCEMENT


In June 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2013-08, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, or ASU 2013-08.  This update changes the approach to the assessment of whether a company is an investment company, clarifies the characteristics of an investment company, provides comprehensive guidance for the investment company assessment and contains certain disclosure requirements.  We adopted this standard update beginning January 1, 2014.  The implementation of this standard update did not have a material impact on our consolidated financial statements.


In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) , or ASU 2014-09 . This update supersedes the revenue recognition requirements in Accounting Standards Update No. 2011-230: Revenue Recognition (Topic 605) , and most industry-specific guidance throughout the industry topics of the codification.  The core principal of the update is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to exchange for those goods or services.  In applying the revenue model to contracts within its scope, an entity should identify the contract(s) with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the entity satisfies a performance obligation.  ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.  We are currently evaluating the potential impact the adoption of this update will have on our consolidated financial statements.


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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


We are subject to financial market risks, including changes in interest rates.  In the event of financial downturns affecting the banking system and financial markets, the financial position and results of operations of certain of the middle-market companies in our portfolio could be affected adversely, which ultimately could lead to difficulty in their meeting debt service requirements and an increase in defaults.


Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates.  Our net interest income is affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates.  As of September 30, 2014 , approximately 63.4% of our loan portfolio, at fair value, bore interest at a spread to either the LIBOR or the prime rate, and 36.6% at a fixed interest rate.  As of September 30, 2014 , approximately 51.5% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 2.0% on a LIBOR-base index or prime floors between 2.8% and 4.5% .  The three-month weighted-average LIBOR interest rate was 0.23% as of September 30, 2014 .  Thus, the LIBOR floors in these loan investments lessen the impact of such historically low LIBOR rates.


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


The following table shows a comparison of the interest rate base for our interest-bearing cash, outstanding commercial loans, at cost, and our outstanding borrowings as of September 30, 2014 and December 31, 2013 :


September 30, 2014December 31, 2013(in thousands)Interest Bearing Cash and Commercial LoansBorrowingsInterest Bearing Cash and Commercial LoansBorrowingsMoney market rate$27,578$—$56,685$—Prime rate————LIBOR30-day19—57,725—60-day————90-day48,267—194,13325,172180-day————Fixed rate35,554—100,009150,000Total$111,418$—$408,552$175,172


In addition, as of September 30, 2014 , we had $88.6 million of non-interest-bearing cash and cash equivalents.


Based on our September 30, 2014 balance sheet, the following table shows the impact to net income of hypothetical base rate increases in interest rates, assuming no changes in our investment and borrowing structure.  The impact to net income of hypothetical base rate decreases in interest rates is not shown in the following table because as of September 30, 2014 , the quarterly average LIBOR was 0.23% and a 100-basis point decrease could not occur:


(dollars in thousands)Basis Point ChangeInterest IncomeInterest ExpenseNet Income100$356$—$356200849—8493001,607—1,607


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ITEM 4.  CONTROLS AND PROCEDURES


DISCLOSURE CONTROLS AND PROCEDURES


Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2014 .  The term “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.


Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on the foregoing evaluation of our disclosure controls and procedures as of September 30, 2014 , our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.


INTERNAL CONTROL OVER FINANCIAL REPORTING


No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), occurred during the fiscal quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


PART II.  OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS.


From time to time, we are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations.  During the quarter ended September 30, 2014 , there were no new or material developments in legal proceedings.


ITEM 1A.  RISK FACTORS.


Investing in our common stock may be speculative and involves a high degree of risk.  In addition to the other information contained in this Quarterly Report on Form 10-Q, including our financial statements, the related notes, schedules and exhibits, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 , which could materially affect our business, financial condition and/or operating results.  The risks described in our Annual Report on Form 10-K are not the only risks facing our Company.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and/or operating results.


Other than described below, there have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013 , which should be read together with the other risk factors and information disclosed elsewhere in this Quarterly Report on Form 10-Q and our other reports filed with the SEC.


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The following disclosure removes the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2013 titled:


|  |                                                                                                                                                                                                                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "Our wholly owned subsidiary is licensed by the SBA and is subject to SBA regulations.  If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or revoke or suspend our license"; and

|  |                                                                                                                                                                                      
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "Our wholly-owned SBIC subsidiary may be unable to make distributions to us that will enable us to maintain RIC status, which could result in the imposition of an entity-level tax."

The following disclosure replaces and supplements the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2013 titled:


|  |                                                                                                                                                                                           
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns";

|  |                                                                                                                                                                                  
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "If we fail to qualify as a RIC, we will have to pay corporate-level taxes on our income and our income available for distribution would be reduced significantly or eliminated";

|  |                                                                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "If we fail to service our existing debt arrangements adequately, or to establish new credit facilities on favorable terms, our business could be harmed materially";

|  |                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------
|• | "Our stock price has been, and continues to be, volatile and purchasers of our common stock could incur substantial losses"; and

|  |                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "Any change in the regulation of our business could have a significant adverse effect on the profitability of our operations and our cost of doing business."

In addition, the following disclosure adds the new risk factor titled:


|  |                                                                                                                                                                                                                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "We cannot assure you that our tender offer or any stock repurchase program will actually result in repurchases of our common stock or enhance long-term stockholder value, and repurchases, if any, could affect our stock price, increase its volatility, will diminish our cash reserves and could impact our RIC status."

Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns .


From time to time, we target specific industries in which to invest on a recurring basis, which may result in significant concentrations in our portfolio.  As a consequence, the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of such investments or a substantial write-down of any one investment.  Beyond regulatory and income tax diversification requirements, we do not have fixed guidelines for industry concentration.  In addition, while we generally decline to make investments in a particular industry or group of industries that would exceed 15.0% of our total assets at the time of closing, it is possible that as the values of our portfolio companies change, one industry or a group of industries may come to exceed such level.  As a result, a downturn in an industry in which we have invested a significant portion of our total investments could have a materially adverse effect on us.  As of September 30, 2014 , due to the number of recent monetizations and loan repayments, 49.5% , 28.0% and 10.7% of our total investments at fair value were invested in healthcare, business services, and manufacturing industries, respectively.  Therefore, we are susceptible to the economic circumstances in these industries, and a downturn in any one of these industries could have a material adverse effect on our results of operations and financial condition.


If we fail to qualify as a RIC, we will have to pay corporate-level taxes on our income and our income available for distribution would be reduced significantly or eliminated.


We have elected to be taxed for federal income tax purposes as a RIC, under Subchapter M of the Internal Revenue Code. To qualify as a RIC under the Internal Revenue Code, we must meet certain source-of-income, asset diversification and annual distribution requirements and maintain our status as a BDC, including:


|  |                                                                                                                                                               
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Sources of Income.We must obtain at least 90% of our income each year from dividends, interest, gains from the sale of stock or securities or similar sources.

|  |                                                                                                                                                                                                                  
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Asset Diversification.At the end of each taxable year, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other acceptable

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securities.  No more than 25% of the value of our assets may be invested in the securities, other than U.S. government securities or securities of other RICs, (i) of one issuer, or (ii) of two or more issuers that are controlled, as determined under applicable Internal Revenue Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.”


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Income Distribution.We must distribute to our stockholders at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, on an annual basis. Because we are subject to an asset coverage ratio requirement under the 1940 Act, and may also be subject to certain financial covenants under any debt financings we may incur, we could, under certain circumstances, be restricted from making the distributions necessary to satisfy the IRS requirement.

As our total assets continue to decline associated with our stock repurchase program and tender offer, dividend distributions to stockholders and other transactions that reduce our total assets, there is an increased risk of non-qualification as a RIC due to the 50% or 25% asset diversification test as outlined in Internal Revenue Code Section 851(b)(3).  The 50% diversification test requires at least 50% of the value of a RIC’s total assets be invested in cash, cash items (including receivables), government securities (as defined under the 1940 Act), securities of other RIC’s, or investments in other securities that, with respect to any one issuer, do not represent more than 5 percent of the RIC’s assets or more than 10 percent of the issuer’s voting securities.


The 25% diversification test requires that not more than 25% of the value of the company’s total assets are invested in the securities (other than government securities or the securities of other RIC’s) of any one issuer, or of two or more issuers which the taxpayer controls and which are determined to be engaged in the same or similar trades or businesses.  The term “controls” means the ownership of 20% or more of the total combined voting power of all classes of voting stock in a corporation.


The 50% and 25% diversification test must be satisfied at the end of each quarter of a RIC’s taxable year.


Failure to meet the foregoing requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and, therefore, will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in losses.  If we fail to qualify as a RIC for any reason we would become subject to corporate-level income tax, substantially reducing our net assets, the amount of income available for distribution and the amount of our distributions.  Such a failure would have a material adverse effect on our stockholders and us.


If we fail to establish new credit facilities on favorable terms, our business could be harmed materially.


We cannot be certain that we will be able to establish new borrowing facilities to provide working and investment capital, including for new originations.  If we are unable to establish new facilities of a reasonable size, our liquidity will be reduced significantly.  Even if we are able to consummate new borrowing facilities, we may not be able to do so on favorable terms.


Our stock price has been, and continues to be, volatile and purchasers of our common stock could incur substantial losses.


The stock market in general, and the market prices for securities of financial services companies in particular, have experienced extreme volatility that often has been unrelated or disproportionate to the operating performance of these companies. If current levels of market volatility continue or worsen, we may continue to experience an adverse effect, possibly material, on our ability to access capital and on our business, financial condition and results of operations.


The market price and the liquidity of the market for our shares may from time to time be affected by a number of factors, which include, but are not limited to, the following:


|  |                                     
|- | ------------------------------------
|• | our quarterly results of operations;

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|- | ---------------------------------------------------------------------------------------------------
|• | our origination activity, including the pace of, and competition for, new investment opportunities;

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|- | ----------------------------------------------------------------------------
|• | price and volume fluctuations in the overall stock market from time to time;

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|- | ---------------------------------------------------------------------------------------
|• | investors'general perception of our company, the economy and general market conditions;

|  |                                                                                                                                              
|- | ---------------------------------------------------------------------------------------------------------------------------------------------
|• | actual or anticipated changes in our earnings or fluctuations in our operating results or changes in the expectations of securities analysts;

|  |                                                                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | the financial performance of the specific industries in which we invest on a recurring basis, including without limitation, our investments in the healthcare, business services and education industries;

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|  |                                                                          
|- | -------------------------------------------------------------------------
|• | significant transactions or capital commitments by us or our competitors;

|  |                                                                                                                           
|- | --------------------------------------------------------------------------------------------------------------------------
|• | significant volatility in the market price and trading volume of securities of BDCs or other financial services companies;

|  |                                                                                                                                         
|- | ----------------------------------------------------------------------------------------------------------------------------------------
|• | volatility resulting from trading in derivative securities related to our common stock including puts, calls or short trading positions;

|  |                                                                                                                                                     
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------
|• | potential future sales of debt securities convertible into or exchangeable or exercisable for our common stock or the conversion of such securities;

|  |                                                                                       
|- | --------------------------------------------------------------------------------------
|• | changes in laws or regulatory policies or tax guidelines with respect to BDCs or RICs;

|  |                    
|- | -------------------
|• | loss of RIC status;

|  |                                                           
|- | ----------------------------------------------------------
|• | the inability to secure additional debt or equity capital;

|  |                                                                                                                                                                    
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | our recent announcement and commencement of a tender offer to repurchase up to $75.0 million of shares of our common stock and the expiration of that tender offer;

|  |                                                                                                          
|- | ---------------------------------------------------------------------------------------------------------
|• | announcements of strategic developments, acquisitions and other material events by us or our competitors;

|  |                                                                              
|- | -----------------------------------------------------------------------------
|• | litigation or regulatory actions affecting us or our portfolio companies; and

|  |                             
|- | ----------------------------
|• | departures of key personnel.

If any of these factors causes an adverse effect on our business, our results of operations or our financial condition, the price of our common stock could fall and investors may not be able to sell their common stock at or above their respective purchase prices.


Any change in the regulation of our business could have a significant adverse effect on the profitability of our operations and our cost of doing business.


Changes in the laws, regulations or interpretations of the laws and regulations that govern BDCs, RICs or non-depository commercial lenders could have a significant adverse effect on our operations and our cost of doing business. We are subject to federal, state and local laws and regulations and also to judicial and administrative decisions that affect our operations. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted requirements that are more stringent than those in which we currently conduct business, we may have to incur significant expenses in order to comply or we may have to restrict our operations.


We cannot assure you that our tender offer or any stock repurchase program will actually result in repurchases of our common stock or enhance long-term stockholder value, and repurchases, if any, could affect our stock price, increase its volatility, will diminish our cash reserves and could impact our RIC status.


On October 28, 2014, our board of directors approved a modified “Dutch Auction” tender offer to repurchase up to $75.0 million of shares of our common stock.  The tender offer is scheduled to commence on November 3, 2014 and will expire on December 3, 2014, unless extended.  Until the tender offer expires, we will not know the amount of shares that have been tendered for repurchase, or the exact per share price (within the $3.25 to $3.75 range offered) that we will be required to pay to stockholders who tender shares.  We cannot provide any assurance that we will repurchase a sufficient number of shares of our common stock through the tender offer to accomplish our stated objectives.  Accordingly, we may pursue other strategies to return capital to stockholders, including open market repurchases.


Following the termination of our tender offer, we may resume our previously announced stock repurchase program, the size of which will be determined based upon the results of the tender offer and subject to applicable law.  Under the program, we are authorized to repurchase shares of our common stock in open market transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Exchange Act.  The timing and actual number of shares repurchased, if any, will depend on a variety of factors, including the price and availability of our shares, trading volume and general market conditions.  The program was suspended prior to the announcement of the tender offer, and, if resumed, may be suspended or discontinued at any time in the future without prior notice.


Repurchases pursuant to our tender offer and our stock repurchase program could affect our stock price and increase its volatility.  The successful completion of our tender offer, and continued repurchases under our stock repurchase program to the extent available, will reduce the market liquidity for our stock.  Additionally, repurchases under our tender offer and any renewed stock repurchase program will diminish our cash reserves, which could impact our ability to pursue possible future strategic opportunities, would result in lower cash available to invest resulting in potentially lower returns on investments and could impact our ability to qualify as a RIC because a reduced asset


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base would increase the chances that we could fail the asset diversification requirements under the Internal Revenue Code.  In addition, any such repurchases will increase the proportional ownership of the stockholders who do not participate, or participate only in part, in the tender offer.  There can be no assurance that any stock repurchases will, in fact, occur, or, if they occur, that they will enhance stockholder value because the market price of our common stock may decline below the levels at which we repurchased shares of stock.  Although our tender offer and our stock repurchase program are intended to enhance long-term stockholder value, short-term stock price fluctuations could reduce the effectiveness of these programs.


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


STOCK REPURCHASE PROGRAM


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million.  On October 25, 2013, our board of directors authorized a second stock repurchase program of up to $25.0 million.  On February 28, 2014, our board of directors increased the second stock repurchase program to $35.0 million.  On April 25, 2014, our board of directors terminated the second stock repurchase program effective as of May 2, 2014 and authorized a third stock repurchase program of up to $50.0 million effective as of May 5, 2014.  On August 5, 2014, our board of directors terminated the third stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014.  Under the new program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. The following table summarizes our stock repurchases for the three and nine months ended September 30, 2014 .


Three months ended September 30, 2014Nine months ended September 30, 2014Dollar amount repurchased(in thousands)$32,902$90,720Shares repurchased8,285,83624,358,596Average price per share$3.97$3.72Discount to quarterly weighted average net asset value per share10.2%15.9%


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


NET ISSUANCE OF RESTRICTED STOCK


For certain employees, we may be deemed to have purchased through the net issuance of shares, a portion of the shares of restricted stock previously issued under the 2006 Plan for which the forfeiture provisions have lapsed to satisfy the applicable employee’s income tax withholding obligations.  We retire immediately all such shares of common stock that we purchase in connection with such net issuance to employees.


DIVIDEND REINVESTMENT PLAN


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


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The following table summarizes the shares of common stock that we have purchased during the three months ended September 30, 2014 :


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 ProgramsJuly 1 – 31, 2014Stock repurchase program(a)4,751,236$3.944,751,236$4,441,554August 1 – 31, 2014Stock repurchase program(a)1,483,800$3.981,483,800$45,755,743Restricted stock vesting(b)289$3.96(c)n/an/aDividend reinvestment requirements(d)737$4.02(e)n/an/aTotal August 1 – 31, 20141,484,826$3.981,483,800$45,755,743September 1 – 30, 2014Stock repurchase program(a)2,050,800$4.022,050,800$37,503,353Restricted stock vesting(b)1,286$3.52(c)n/an/aTotal September 1 – 30, 20142,052,086$4.022,050,800$37,503,353Total8,288,148$3.978,285,836$37,503,353





|    |                                                                                                                                                                                                                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | On April 25, 2014, our board of directors authorized a stock repurchase program of up to $50.0 million effective as of May 5, 2014.  On August 5, 2014, our board of directors terminated the existing stock repurchase program and authorized a new stock repurchase program of up to $50.0 million effective as of August 12, 2014.

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

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

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

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

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.


Not Applicable.


ITEM 4.  MINE SAFETY DISCLOSURES.


Not Applicable.


ITEM 5.  OTHER INFORMATION.


Not Applicable.


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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-Q15.1Letter 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.





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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:October 29, 2014By:/s/KEITH KENNEDYKeith KennedyChief Executive Officer(Principal Executive Officer)Date:October 29, 2014By:/s/BEVERLY JANE ALLEYBeverly Jane AlleyChief Financial Officer(Principal Financial and Accounting Officer)





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