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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





x

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the Quarter Ended September 30, 2002. ̈

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934Commission File Number: 0-33377





MCG CAPITAL CORPORATION


(Exact name of registrant as specified in its charter)





Delaware

54-1889518(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification No.)1100 Wilson Boulevard, Suite 800Arlington, VA

22209(Address of principal executive office)

(Zip Code)(703) 247-7500(Registrants telephone number, including area code)





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 and (2) has been subject to such filing requirements for the past 90 days. Yes x. No  ̈ .





Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date. The number of shares of the issuers Common Stock, $.01 par value, outstanding as of November 13,
2002 was 31,259,462.





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##### Table of Contents

MCG CAPITAL CORPORATION





FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2002





TABLE OF CONTENTS





PART I

FINANCIAL INFORMATIONSelected Consolidated Financial and Other DataSelected Operating DataItem 1.

Financial Statements UnauditedConsolidated Balance Sheets  September 30, 2002 and December 31, 2001Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001Consolidated Statement of Stockholders Equity for the nine months ended September 30, 2002Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001Consolidated Schedules of Investments as of September 30, 2002 and December 31, 2001Notes to Consolidated Financial StatementsIndependent Accountants Review ReportItem 2.

Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.

Quantitative and Qualitative Disclosures About Market RiskItem 4.

Controls and ProceduresPART II

OTHER INFORMATIONItem 1.

Legal ProceedingsItem 2.

Changes in Securities and Use of ProceedsItem 3.

Defaults upon Senior SecuritiesItem 4.

Submission of Matters to a Vote of Security HoldersItem 5.

Other InformationItem 6.

Exhibits and Reports on Form 8-KSignaturesCertifications







2




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##### Table of Contents




PART I.    FINANCIAL INFORMATION





In this Quarterly Report,
the Company, MCG, we, us and our refer to MCG Capital Corporation and its wholly owned subsidiaries and its affiliated securitization trusts unless the context otherwise requires.





Selected Consolidated Financial and Other Data





The selected consolidated financial and
other data below should be read in conjunction with our Managements Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements (unaudited) and notes thereto. Different
accounting principles are used in the preparation of financial statements of a business development company under the Investment Company Act of 1940 and, as a result, the financial results for the periods ending before December 1, 2001 are not
comparable to the period commencing on December 1, 2001 and are not expected to be representative of our financial results in the future.





(dollars in thousands except per share data)

Post-IPO as a Business Development Company Three Months Ended Sept. 30, 2002


Pre-IPO prior to becoming a Business Development Company Three Months Ended Sept. 30,
2001


Post-IPO as a Business Development Company Nine Months Ended Sept. 30, 2002

Pre-IPO prior to becoming a Business Development Company Nine Months Ended Sept. 30, 2001Income Statement Data:Operating income

$
20,138


$
18,725


$
56,625

$
54,326Net operating income (a)


11,653



8,179



33,058


22,324Income (loss) before cumulative effect of accounting changes


(3,461
)


(1,074
)


9,686


5,294Net increase (decrease) in stockholders equity resulting from earnings (loss)


(3,461
)


(1,074
)


9,686


7,071Per Common Share Data:Net operating income (a) per common share:basic

$
0.39


$
0.65


$
1.18

$
1.76diluted


0.39



0.64



1.18


1.76Income (loss) before cumulative effect of accounting changes per common share:basic


(0.12
)


(0.08
)


0.35


0.42diluted


(0.12
)


(0.08
)


0.34


0.42Earnings (loss) per common share:basic


(0.12
)


(0.08
)


0.35


0.56diluted


(0.12
)


(0.08
)


0.34


0.56Net asset value per common share


12.13



13.04



12.13


13.04Dividends declared per common share


0.46







1.34


Selected Period-End Balances:Total investment portfolio

$
707,258


$
574,879Total assets


747,658



645,509Borrowings


348,186



466,732Other data:Number of portfolio companies


81



74Number of employees


55



58





|(a) |  | Represents net operating income before provision for loan losses for periods ending prior to December 1, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Selected Operating Data





The following table shows our consolidated results of
operations for the three and nine months ended September 30, 2002 and 2001. The three and nine months ended September 30, 2002 reflect our financial results as a business development company (BDC), whereas the three and nine months ended September
30, 2001 reflect our financial results prior to operating as a BDC. Different accounting principles are used in the preparation of our financial statements as a BDC under the Investment Company Act of 1940 and, as a result, our financial results as
a BDC are not directly comparable to prior periods. The items in the table below were not affected by the change in accounting principles resulting from our conversion to a BDC.





(dollars in thousands)

Post-IPO as a Business Development Company Three Months Ended Sept. 30, 2002

Pre-IPO prior to becoming a Business Development Company Three Months Ended Sept. 30, 2001

Post-IPO as a Business Development Company Nine Months Ended Sept. 30, 2002

Pre-IPO prior to becoming a Business Development Company Nine Months Ended Sept. 30, 2001Operating incomeInterest and fees on commercial loans

$
19,396

$
17,588

$
53,240

$
52,652Advisory fees and other income


742


1,137


3,385


1,674Total operating income


20,138


18,725


56,625


54,326Operating expensesInterest expense


2,841


6,469


8,181


20,991Employee compensation:Salaries and benefits


1,958


2,550


5,821


7,156Long-term incentive compensation


1,816





5,073


Total employee compensation


3,774


2,550


10,894


7,156General and administrative expense


1,870


1,527


4,492


3,855Total operating expenses


8,485


10,546


23,567


32,002Net operating income (a)


11,653


8,179


33,058


22,324Long-term incentive compensation (b)


1,816





5,073


Distributable net operating income (c)

$
13,469

$
8,179

$
38,131

$
22,324





|(a) |  | Represents net operating income before provision for loan losses for periods ending prior to December 1, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------




|(b) |  | Includes expenses related to termination of the stock option plan and issuance of related restricted stock awards at the time of the IPO.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------




|(c) |  | Distributable net operating income is presented for the three and nine months ended September 30, 2001 to facilitate the understanding of the amount of net
earnings we may have potentially distributed if we had operated as a business development company and regulated investment company (without the effect of de-leveraging prior to December 1, 2001) for that period. The amounts of the distributable net
operating income identified in this table are not intended to represent amounts we will distribute in future periods. Distributable net operating income may not be comparable to similarly titled measures reported by other companies. Distributable
net operating income does not represent net increase (decrease) in stockholders equity resulting from earnings or cash generated from operating activities in accordance with GAAP and should not be considered an alternative to such items as an
indication of our performance or to cash flows as a measure of liquidity or ability to make distributions. For additional information on distributions, see the section entitled Financial Condition, Liquidity and Capital
ResourcesDividends.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Item 1.     Financial Statements (unaudited)





MCG Capital Corporation


Consolidated Balance Sheets


(in thousands, except per share data)





September 30, 2002


December 31, 2001(unaudited)AssetsCash and cash equivalents

$
22,283


$
48,148Investments:Commercial loans, at fair value (cost of $712,931 and $604,232)


700,933



596,002Investments in equity securitiesat fair value (cost of $32,753 and $24,173)


19,794



21,201Unearned income on commercial loans


(13,469
)


(12,134
)Total investments


707,258



605,069Interest receivable


7,632



5,623Other assets


10,485



14,226Total assets

$
747,658


$
673,066LiabilitiesBorrowings

$
348,186


$
287,808Interest payable


1,523



408Dividends payable


14,394



24,327Other liabilities


4,515



8,150Total liabilities


368,618



320,693Stockholders EquityPreferred stock, par value $.01, authorized 1 share, none issued and outstanding






Common stock par value $.01, authorized 100,000 shares, 31,253
issued and outstanding on September 30, 2002 and 28,287 issued and outstanding on December 31, 2001


313



283Paid-in capital


419,874



370,087Stockholder loans


(5,663
)


(6,510
)Unearned compensationrestricted stock


(9,524
)


(13,077
)Earnings (loss) in excess of distributions


(1,003
)


12,792Net unrealized depreciation on investments


(24,957
)


(11,202
)Total stockholders equity


379,040



352,373Total liabilities and stockholders equity

$
747,658


$
673,066





See notes to consolidated financial statements.




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MCG Capital Corporation


Consolidated Statements of Operations (unaudited)


(in thousands, except per share amounts)





Post-IPO as a Business Development Company Three Months Ended September 30, 2002


Pre-IPO prior to becoming a Business Development Company Three Months Ended
September 30, 2001


Post-IPO as a Business Development Company Nine Months Ended September 30, 2002


Pre-IPO prior to becoming a Business Development Company Nine Months Ended September 30, 2001Operating incomeInterest and fees on commercial loans

$
19,396


$
17,588


$
53,240


$
52,652Advisory fees and other income


742



1,137



3,385



1,674Total operating income


20,138



18,725



56,625



54,326Operating expensesInterest expense


2,841



6,469



8,181



20,991Employee compensation:Salaries and benefits


1,958



2,550



5,821



7,156Long-term incentive compensation


1,816







5,073



Total employee compensation


3,774



2,550



10,894



7,156General and administrative expense


1,870



1,527



4,492



3,855Total operating expenses


8,485



10,546



23,567



32,002Net operating income before provision for loan losses


11,653



8,179



33,058



22,324Provision for loan losses






(7,535
)






(10,155
)Realized losses on investments


(9,617
)


(165
)


(9,617
)


(1,715
)Net change in unrealized appreciation (depreciation) on investments


(5,497
)


(2,274
)


(13,755
)


(1,621
)Income (loss) from operations before income taxes and cumulative effect of accounting change


(3,461
)


(1,795
)


9,686



8,833Income tax expense (benefit)






(721
)






3,539Income (loss) before cumulative effect of accounting change


(3,461
)


(1,074
)


9,686



5,294Cumulative effect of accounting change, net of taxes of $1,223














1,777Net increase (decrease) in stockholders equity resulting from earnings / net income (loss)


($3,461
)


($1,074
)

$
9,686


$
7,071Income (loss) per common share before cumulative effect of accounting changebasic


($0.12
)


($0.08
)


$0.35



$0.42diluted


($0.12
)


($0.08
)


$0.34



$0.42Earnings (loss) per common sharebasic


($0.12
)


($0.08
)


$0.35



$0.56diluted


($0.12
)


($0.08
)


$0.34



$0.56Cash dividends declared


$0.46







$1.34



Weighted average common shares outstanding


29,932



12,672



28,041



12,672Weighted average common shares outstanding and dilutive common stock equivalents


29,932



12,672



28,102



12,691





See notes to consolidated financial statements.




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##### Table of Contents




MCG Capital Corporation


Consolidated Statement of Stockholders Equity (unaudited)


(in thousands, except per share amounts)








Common Stock

Paid-in Capital


Stock-holder Loans


Unearned Compen- sation  Restricted stock


Earnings (loss) in excess of Distri- butions


Net Unrealized Depreciation on Investments


Total Stockholders EquityShares


AmountBalance Dec. 31, 2001

28,287


$
283

$
370,087


$
(6,510
)

$
(13,077
)

$
12,792


$
(11,202
)

$
352,373Net increase (decrease) in stockholders equity resulting from earnings (loss)




















23,441



(13,755
)


9,686Issuance of common shares in stock offering, net of costs

3,000



30


50,220



















50,250Dividends declared, $1.34 per share




















(37,236
)






(37,236
)Dividend reinvestment

14






226



















226Amortization of restricted stock awards
















3,030











3,030Employee forfeiture of restricted shares

(48
)





(659
)


206



523











70Payments on employee loans












641















641Balance Sept. 30, 2002

31,253


$
313

$
419,874


$
(5,663
)

$
(9,524
)

$
(1,003
)

$
(24,957
)

$
379,040








See notes to consolidated financial
statements.




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##### Table of Contents

MCG Capital Corporation


Consolidated Statements of Cash Flows (unaudited)


(in thousands)





Post-IPO as a Business Development Company Nine Months Ended
September 30, 2002


Pre-IPO prior to becoming a Business Development Company Nine Months Ended
September 30, 2001Operating activitiesNet increase in stockholders equity resulting from earnings/net income

$
9,686


$
7,071Adjustments to reconcile net increase in stockholders equity resulting from earnings/net income to net cash
provided by operating activities:Provision for loan losses






10,155Depreciation and amortization


293



414Amortization of restricted stock awards


3,030



Amortization of deferred debt issuance costs


1,470



1,520Realized losses on investments


9,617



1,715Net change in unrealized depreciation (appreciation) on investments


13,755



(1,379
)Increase in interest receivable


(1,986
)


(28
)Increase in accrued payment-in-kind interest


(8,196
)


(7,911
)Increase (decrease) in unearned income


(1,034
)


242Decrease (increase) in other assets


2,617



(2,575
)Increase (decrease) in interest payable


1,114



(262
)Increase (decrease) in other liabilities


(1,586
)


798Net cash provided by operating activities


28,780



9,760Investing activitiesNet increase in loans


(112,755
)


(112,056
)Net increase in equity investments


(3,600
)


(555
)Proceeds from the sale of foreclosed property






3,000Purchase of premises, equipment and software


(540
)


(340
)Net cash used in investing activities


(116,895
)


(109,951
)Financing activitiesNet proceeds from borrowings


60,378



109,899Payment of financing costs


(28
)


(283
)Issuance of common stock, net of costs


50,476



Dividends paid


(49,217
)


Repayment of loans granted to officers/shareholders


641



Net cash provided by financing activities


62,250



109,616Increase (decrease) in cash and cash equivalents


(25,865
)


9,425Cash and cash equivalents at beginning of period


48,148



16,766Cash and cash equivalents at end of period

$
22,283


$
26,191Supplemental disclosuresInterest paid

$
5,597


$
19,733Income taxes paid (received)


(1,696
)


5,918





See notes to consolidated financial statements




8




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##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (8)

(unaudited)September 30, 2002

December 31, 2001Cost

Fair Value

Cost

Fair ValueNewspaper:American Consolidated Media, Inc. (1)

Senior Debt



20,000

20,000



Badoud Enterprises, Inc. (1)

Senior Debt



9,818

9,818

11,320

11,320Brookings Newspapers,L.L.C. (1)

Senior Debt



3,200

3,200

3,500

3,500Community Media Group,Inc. (1)

Senior Debt



12,730

12,730

13,505

13,505Country Media, Inc.

Senior Debt



7,773

7,773

8,448

8,448Common Stock

6.3%

100

232

100

205Creative Loafing, Inc. (1)

Senior Debt



16,000

16,000

16,795

16,795Crescent PublishingCompany LLC

Senior Debt



14,085

14,085

13,700

13,700The Joseph F. BiddlePublishing Company (1)

Senior Debt



12,266

12,266

14,207

14,207The Korea Times LosAngeles, Inc.

Senior Debt



11,598

11,598

11,927

11,927McGinnis-JohnsonConsulting, LLC (1)

Subordinated Debt



8,178

8,178

7,828

7,828Minnesota Publishers, Inc. (1)

Senior Debt



14,250

14,250

14,250

14,250Murphy McGinnis Media,Inc. (1)

Senior Debt



14,000

14,000

14,000

14,000Pacific-Sierra Publishing, Inc.

Senior Debt



24,338

24,338

24,160

24,160Stonebridge Press, Inc. (1)

Senior Debt



6,009

6,009

5,473

5,47321st Century Newspapers,

Subordinated Debt



20,645

20,645



Inc.

Common Stock

1.0%

452

618



Wyoming Newspapers,Inc. (1)

Senior Debt



12,300

12,300

12,563

12,563Total Newspaper





207,742

208,040

171,776

171,881Publishing:Boucher

Senior Debt



2,300

2,300

2,450

2,450Communications, Inc. (1)

Stock Appreciation Rights





305



297





See notes to consolidated financial statements.




9




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##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Title of Securities Held by theCompany

Percentage of Class Held on a Fully Diluted Basis (8)


(unaudited)September 30, 2002

December 31, 2001Cost

Fair Value

Cost

Fair ValueCanon Communications

Subordinated Debt




15,308

15,308



LLC and Chemical Week Publishing L.L.C. (1)Connective Corp. (6)

Common Stock

0.3
%

57

3

57

13Corporate Legal Times

Senior Debt




5,417

4,838

4,813

4,813L.L.C.

LLC Interest

46.7
%

233





Warrants to purchase membership interest in LLC

5.0
%





153

86Dowden Health Media, Inc.

Senior Debt




1,200

1,200

1,500

1,500Edgell Communications, Inc. (1)

Senior Debt




353

353

520

520Fawcette Technical

Senior Debt




18,168

18,168

14,787

14,787Publications Holdings (1)

Warrants to purchase Common Stock

38.9
%

519

64

519

519Halcyon BusinessPublications, Inc.

Senior Debt








275

275Jeffrey A. Stern (6)

Senior Debt




83

83

157

157Media Central LLC

Senior Debt




10,000

10,000

10,000

10,000Miles Media Group, Inc. (1)

Senior Debt




7,801

7,801

7,850

7,850Warrants to purchase Common Stock

12.4
%

20

169

20

490Newsletter Holdings, LLC (1)

Senior Debt




920

920

1,340

1,340Pfingsten Publishing, LLC (1)

Senior Debt




9,800

9,800

10,250

10,250Rising Tide Holdings LLC

Senior Debt




3,085

771

3,097

1,597(1)(6)

Warrants to purchase membership interest in LLC

6.5
%







Sabot Publishing, Inc. (1)

Senior Debt




10,067

10,067

9,800

9,800Warrants to purchase Common Stock

0.9
%



22









See notes to consolidated financial statements.




10




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##### Table of Contents




MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Title of Securities Held by theCompany

Percentage of Class Held on a Fully Diluted Basis (8)


(unaudited)September 30, 2002

December 31, 2001Cost

Fair Value

Cost

Fair ValueSunshine Media Delaware,

Senior Debt




12,662

12,662

13,094

13,094LLC (1)

Class A LLC interest

12.8
%

500

251

500

553Warrants to purchase Class B LLC interest

100.0
%







THE Journal, LLC (6)

Senior Debt




3,266

1,631

3,196

2,100UMAC, Inc. (3) (6)

Common Stock

100.0
%

10,281

1,065

8,360

8,360VS&A-PBI Holding LLC

Senior Debt




12,375

10,202

12,375

12,375(1)

LLC Interest

0.8
%

500



500

Wiesner Publishing

Senior Debt




6,000

6,000



Company, LLC (1)

Subordinated Debt




5,529

5,529



Warrants to Purchase membership interest in LLC

15.0
%

406

598



Witter Publishing

Senior Debt




2,730

2,730

2,747

2,747Co., Inc.

Warrants to purchase Common Stock

9.5
%

87

75

78

76Working Mother Media,

Senior Debt




7,060

7,060

6,718

6,718Inc. (2) (6)

Preferred Stock Class A

98.2
%

5,497

3,878

4,499

4,499Preferred Stock Class B

100.0
%

1





Preferred Stock Class C

100.0
%

1





Common Stock

51.0
%

1



1

1Total Publishing






152,227

133,853

119,656

117,267Broadcasting:Amalfi Coast, L.L.C. (1)

Senior Debt




13,000

13,000

13,000

13,000Costa De Oro Television, Inc.

Senior Debt




6,513

6,513

5,011

5,011dick clark productions,

Subordinated Debt




15,209

15,209



inc.

Warrants to purchase Common Stock

6.2
%

858

843



JMP Media, L.L.C.

Senior Debt




14,008

14,008

15,781

15,781





See notes to consolidated financial statements.




11




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##### Table of Contents




MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Title of SecuritiesHeld by theCompany

Percentage of Class Held ona Fully Diluted Basis(8)


(unaudited)September 30, 2002

December 31, 2001Cost

Fair Value

Cost

Fair ValueNBG Radio Network,Inc. (1)

Senior Debt




6,305

6,305

6,298

6,298Warrants to purchase Common Stock

25.0
%







New Vision Broadcasting, LLC (1)

Senior Debt




20,000

20,000



New Northwest Broadcasters LLC (1)

Senior Debt




11,104

11,104

10,853

10,853Total Broadcasting






86,997

86,982

50,943

50,943Telecommunications:AMI Telecommunications

Senior Debt




10,637

10,389

10,715

10,715Corporation (1)

Common Stock

5.1
%

200



200

Preferred Stock

37.5
%

1,100





Biznessonline.com, Inc. (1)

Senior Debt




14,274

14,106

13,529

13,529Common Stock

3.6
%

18

43

18

27Preferred Stock

100.0
%

2,864



2,864

100Warrants to purchase Common Stock

48.2
%

253

466

253

253Bridgecom Holdings, Inc. (1)

Senior Debt




21,471

21,471

17,969

17,969Warrants to purchase Common Stock

13.2
%







I-55 Internet Services, Inc.

Senior Debt




3,257

3,257

3,623

3,623Warrants to purchase Common Stock

7.5
%







IDS Telcom LLC

Senior Debt




18,061

18,061

17,039

17,039Warrants to purchase membership interestin LLC

11.0
%

375

748

376

637Joseph C. Millstone

Senior Debt




500

500

500

500Manhattan

Senior Debt




24,605

24,605

22,975

22,975Telecommunications Corporation (1)

Warrants to purchase Common Stock

17.5
%

754

1,319

754

644Midwest Towers Partners, LLC (1)

Senior Debt




16,788

16,788

16,307

16,307nii communications, inc. (1)

Senior Debt




6,926

6,926

5,565

5,565Common Stock

3.2
%

400

97

400

162Warrants to purchase Common Stock

35.2
%

1,095

915

747

991


See notes to consolidated financial statements.




12




---

##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Title of SecuritiesHeld by theCompany

Percentage of Class Held ona Fully Diluted Basis(8)


(unaudited)September 30, 2002

December 31, 2001Cost

Fair Value

Cost

Fair ValueNOW Communications, Inc. (1)

Senior Debt Warrants to purchase




4,460

4,460

4,367

4,367Common Stock

10.0
%







Powercom Corporation (1)

Senior Debt




3,410

3,410

3,917

3,917Warrants to purchase Class A Common Stock

9.6
%

139

32

139

105Talk America Holdings,

Senior Debt




15,000

15,000

17,500

17,500Inc. (1)

Common Stock

1.7
%

1,150

3,192

1,050

482Warrants to purchase Common Stock

0.7
%

25

246

25

Telecomm South, LLC

Senior Debt




3,695

3,695



(4)(6)

LLC Interest

100.0
%

10

10



Tower Resource

Senior Debt




2,642

2,642

1,573

1,573Management, Inc.

Warrants to purchase Common Stock

8.9
%







ValuePage Holdings, Inc. (1)(4)(6)

Senior Debt








13,105

8,472WirelessLines, Inc. (1)

Senior Debt




6,150

6,150

6,150

6,150Warrants to purchase Common Stock

5.0
%







Total Telecommunications






160,259

158,528

161,660

153,602Information Services:Cambridge Information Group, Inc. (1)

Senior Debt




20,002

20,002

19,334

19,334Creatas, L.L.C. (1)

Senior Debt




12,975

12,975

13,664

13,664LLC Interest

20.0
%

100

619

100

465Eli Research, Inc. (1)

Senior Debt




9,905

9,905



Warrants to purchase Common Stock

3.0
%







Images.com, Inc.

Senior Debt




3,000

3,000

2,775

2,775Information Today, Inc.

Senior Debt




9,850

9,850

7,500

7,500R.R. Bowker LLC

Senior Debt




12,813

12,813

15,000

15,000Warrants to purchase membership interest in LLC

14.0
%

882

990

882

882


See notes to consolidated financial statements.




13




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##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Title of SecuritiesHeld by theCompany

Percentage of Class Held ona Fully Diluted Basis(8)


(unaudited)September 30, 2002

December 31, 2001Cost

Fair Value

Cost

Fair ValueRobert N. Snyder

Senior Debt




1,300

1,300

1,300

1,300TGI Group, LLC

Senior Debt




7,343

7,343

7,920

7,920Warrants to purchase membership interest in LLC

5.0
%

126



126

23Unifocus, Inc.

Senior Debt




3,427

3,427

3,300

3,300and Unifocus, LLC (1)

Warrants to purchase Common Stock and LLC interests

20.0
%

247

378

139

369Total Information Services






81,970

82,602

72,040

72,532Technology:The Adrenaline Group,

Senior Debt








750

750Inc. (1)

Common Stock

2.7
%



18



Warrants to purchase Common Stock

0.0
%







Dakota Imaging, Inc.

Senior Debt




6,569

6,569



Warrants to purchase Common Stock

9.4
%

188

189



FTI Technologies

Senior Debt




20,825

20,825

20,500

20,500Holdings, Inc. (1)

Warrants to purchase Common Stock

4.2
%







Netplexus Corporation

Senior Debt




1,993

974

3,500

2,500Preferred Stock

51.0
%

766



766

Warrants to purchase Class A Common Stock

4.8
%







Total Technology






30,341

28,575

25,516

23,750Security Alarm:Alarm Management II LLC (1)

Senior Debt








1,800

1,800Barcom Electronic Inc.

Senior Debt




3,792

3,792

3,911

3,911Copperstate Technologies,

Senior Debt




1,050

1,050



Inc. (5)

Common Stock

100.0
%

2,000

2,000



Intellisec Holdings, Inc. (1)(5)(7)

Debtor in Possession




987

987



Senior Debt




11,381

7,519

14,265

14,265Warrants to purchase Common Stock

5.2
%










See notes to consolidated financial statements.




14




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##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Title of SecuritiesHeld by theCompany

Percentage of Class Held on a Fully Diluted Basis (8)


(unaudited)September 30, 2002


December 31, 2001Cost


Fair Value


Cost


Fair ValueKings III of America, Inc.,North America

Senior Debt





4,998



4,998



4,997



4,997Total Security Alarm







24,208



20,346



24,973



24,973Other:BuyMedia Inc. (6)

Warrants to purchase Common Stock

1.5
%














42CCG Consulting, LLC

Senior Debt





1,392



1,392



1,293



1,293Warrants to purchase membership interest in LLC

14.1
%






17







294Option to purchase additional LLC Interest

5.6
%














The e-Media Club, LLC

LLC Interest

0.8
%


90



66



90



90Executive Enterprise Institute, LLC

LLC Interest

10.0
%


301



100



301



167New Century Companies,

Common Stock

2.8
%


157



189



157



294Inc. (6)

Preferred Stock

30.8
%






27







42Warrants to purchase Common Stock

0.6
%






10







33Total Other







1,940



1,801



1,841



2,255Total Investments







745,684



720,727



628,405



617,203Unearned income







(13,469
)


(13,469
)


(12,134
)


(12,134
)Total Investments net of unearned income

$
732,215


$
707,258


$
616,271


$
605,069





|(1) |  | Some of the securities listed are issued by affiliate(s) of the listed portfolio company.
|--- |  | -----------------------------------------------------------------------------------------

|(2) |  | In August 2001, we foreclosed on the assets of MacDonald Communication Corporation and transferred them to Working Mother Media, Inc. (formerly WMAC, Inc.), a
majority owned subsidiary of MCG Finance I, LLC (formerly MCG Finance Corporation).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | In September 2001, we foreclosed on the assets of Upside Media, Inc. and transferred them to UMAC, Inc., a wholly owned subsidiary of MCG Finance I, LLC
(formerly MCG Finance Corporation).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | In July 2002, we acquired in satisfaction of debt the assets of ValuePage Holdings, Inc. and transferred them to Telecomm South, LLC, a wholly owned subsidiary
of MCG Finance I, LLC. MCG realized a $9.6 million loss on this transaction.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | In August 2002, we acquired in partial satisfaction of debt the Arizona division of Intellisec Holdings, Inc. and transferred it to Copperstate Technologies,
Inc., a wholly owned subsidiary of MCG Finance I, LLC. There was no gain or loss recognized on this transaction.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Non-income producing.
|--- |  | ---------------------

|(7) |  | The Debtor In Possession portion of our Intellisec Holdings, Inc. investment is senior to the Senior Debt in bankruptcy proceedings.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------




See notes to consolidated financial statements.




15




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##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





|(8) |  | The percentage of class held on a fully diluted basis represents the percentage of the class of security we may own assuming we exercise our
warrants or options (whether or not they are in-the-money) and assuming that warrants, options or convertible securities held by others are not converted. We have not included any security which is subject to significant vesting contingencies.
Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted. The percentage was calculated based on the most current outstanding share information available to us (i) in the case of private
companies, provided by that company, and (ii) in the case of public companies, provided by that companys most recent public filings with the SEC.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




See notes to consolidated financial statements.




16




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##### Table of Contents

MCG Capital Corporation


Notes To Consolidated Financial Statements (unaudited)





(in thousands except per share data)





Note 1.    Unaudited Interim Consolidated Financial Statements Basis of Presentation





Interim consolidated financial statements of MCG Capital Corporation (MCG or the Company or
we or us or our) are prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and
Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring
accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The current periods results of operations are not necessarily indicative of results that ultimately may be achieved
for the year. The interim unaudited consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Companys Form 10-K for the fiscal year ended December 31,
2001, as filed with the SEC.





The accompanying financial statements reflect the consolidated accounts of MCG,
including its special purpose financing subsidiaries MCG Finance I, LLC, MCG Finance II, LLC, and MCG Finance III, LLC, with all significant intercompany balances eliminated, and the related consolidated results of operations. In accordance with
Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, the Company does not consolidate portfolio company investments in which the Company has a controlling interest.





Conversion to Business Development Company





The operating results for the three and nine months ended September 30, 2002 reflect the Companys results as a business development company under the Investment Company Act of 1940, as amended,
whereas the operating results for the three and nine months ended September 30, 2001 reflect the Companys results prior to operating as a business development company under the Investment Company Act of 1940, as amended. Accounting principles
used in the preparation of the consolidated financial statements for these two periods are different and, therefore, the results of operations are not directly comparable. The primary differences in accounting principles relate to the carrying value
of investments and accounting for income taxessee corresponding sections in the notes to our consolidated financial statements included in the Companys Form 10-K for the fiscal year ended December 31, 2001.





Note 2.    Description of Business





MCG is a solutions-focused financial services company that provides financing and advisory services to companies throughout the United States in the communications, information services, media and
technology industry sectors. Prior to its name change effective June 14, 2001, the Companys legal name was MCG Credit Corporation. On December 4, 2001, MCG completed an initial public offering (IPO) of 13,375,000 shares of common
stock and a concurrent private offering of 625,000 shares of common stock. Upon completion of the offerings, the Company became a non-diversified internally managed, closed-end investment company that elected to be treated as a business development
company under the Investment Company Act of 1940, as amended. The Company will elect to be treated for federal income tax purposes as a regulated investment company under the Internal Revenue Code with the filing of our corporate income tax return
for 2002 which election will be effective January 1, 2002. On June 17, 2002, MCG raised $54 million of gross proceeds in an additional public offering by selling 3,000,000 shares of common stock at an offering price of $18 per share.







17




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##### Table of Contents

MCG Capital Corporation


Notes
To Consolidated Financial Statements (unaudited)(continued)


(in thousands except per share data)





Note 3.    Investments





As
of September 30, 2002 and December 31, 2001, investments consisted of the following:





September 30, 2002


December 31, 2001Cost


Value


Cost


ValueCommercial loans

$
712,931


$
700,933


$
604,232


$
596,002Investments in equity securities


32,753



19,794



24,173



21,201Unearned income


(13,469
)


(13,469
)


(12,134
)


(12,134
)Total

$
732,215


$
707,258


$
616,271


$
605,069





The composition of MCGs portfolio of publicly and
non-publicly traded investments as of September 30, 2002 and December 31, 2001 at cost and fair value was as follows excluding unearned income:





September 30, 2002


December 31, 2001Investments at Cost

Percentage of Total Portfolio


Investments at Cost

Percentage of Total PortfolioSenior Debt

$
648,062

86.9
%

$
596,403

94.9
%Subordinated Debt


64,869

8.7
%


7,829

1.2
%Equity


26,779

3.6
%


19,962

3.2
%Warrants to Acquire Equity


5,974

0.8
%


4,211

0.7
%Equity Appreciation Rights


0

0.0
%


0

0.0
%Total

$
745,684

100.0
%

$
628,405

100.0
%September 30, 2002


December 31, 2001Investments at Fair Value

Percentage of Total Portfolio


Investments at Fair Value

Percentage of Total PortfolioSenior Debt

$
636,064

88.3
%

$
588,174

95.3
%Subordinated Debt


64,869

9.0
%


7,828

1.2
%Equity


12,409

1.7
%


15,460

2.5
%Warrants to Acquire Equity


7,080

1.0
%


5,444

0.9
%Equity Appreciation Rights


305

0.0
%


297

0.1
%Total

$
720,727

100.0
%

$
617,203

100.0
%







18




---

##### Table of Contents

MCG Capital Corporation


Notes
To Consolidated Financial Statements (unaudited)(continued)


(in thousands except per share data)





Set forth below are tables showing the composition of MCGs portfolio by industry sector at cost and fair value at September 30, 2002 and December 31, 2001
excluding unearned income:





September 30, 2002


December 31, 2001Investments at Cost

Percentage of Total Portfolio


Investments at Cost

Percentage of Total PortfolioMediaNewspaper

$
207,742

27.9
%

$
171,776

27.3
%Publishing


152,227

20.4
%


119,656

19.0
%Broadcasting


86,997

11.7
%


50,943

8.1
%Telecommunications


160,259

21.5
%


161,660

25.7
%Information Services


81,970

11.0
%


72,040

11.5
%Technology


30,341

4.1
%


25,516

4.1
%Security Alarm


24,208

3.2
%


24,973

4.0
%Other


1,940

0.2
%


1,841

0.3
%Total

$
745,684

100.0
%

$
628,405

100.0
%September 30, 2002


December 31, 2001Investments at Fair Value

Percentage of Total Portfolio


Investments at Fair Value

Percentage of Total PortfolioMediaNewspaper

$
208,040

28.9
%

$
171,881

27.8
%Publishing


133,853

18.6
%


117,267

19.0
%Broadcasting


86,982

12.1
%


50,943

8.3
%Telecommunications


158,528

22.0
%


153,602

24.9
%Information Services


82,602

11.5
%


72,532

11.8
%Technology


28,575

4.0
%


23,750

3.8
%Security Alarm


20,346

2.8
%


24,973

4.0
%Other


1,801

0.1
%


2,255

0.4
%Total

$
720,727

100.0
%

$
617,203

100.0
%





Note 4.    Borrowings





As of September 30, 2002, MCG, through MCG Master Trust, an affiliated business trust, had $101,826 in borrowings outstanding under a
Revolving Credit Facility. The maximum amount outstanding under the Revolving Credit Facility during the three and nine months ended September 30, 2002 was $102,001. The average outstanding balance during the three and nine months ended September
30, 2002 was $80,122 and $60,378, respectively. The weighted average interest rate, including unused commitment and trustee fees but excluding the amortization of deferred financing costs, for the three and nine months ended September 30, 2002 was
3.3% and 3.4%, respectively, and the interest rate at September 30, 2002 was 3.1%.





As of September 30, 2002, we
had no notes outstanding under a swingline credit facility (the Swingline Notes), which is part of the Revolving Credit Facility, that allows us to borrow up to $25,000, as part of the $200,000 total facility limit, for a period of up to
four days. The Swingline Notes are repaid through the issuance of Series 2000-1 Notes. The Swingline Notes bear interest based on the federal funds rate plus 1.0% and interest is payable monthly. The maximum outstandings under the Swingline Notes
during the three and nine months ended September 30, 2002 was $20,000 and $22,900, respectively. The average outstanding balance during the three and nine months ended September 30, 2002 was $1,304 and $859, respectively. The weighted average
interest rate for the three and nine months ended September 30, 2002 was 2.8%.




19




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##### Table of Contents

MCG Capital Corporation


Notes
To Consolidated Financial Statements (unaudited)(continued)


(in thousands except per share data)





On December 27, 2001, MCG Finance III, LLC (MCG Finance III) sponsored the creation of MCG Commercial Loan Trust (the Trust), which entered
into a term funding securitization agreement by issuing Series 20011 Notes (the Trust Notes). The Trust issued $229,860 of Class A Notes rated AAA/Aaa/AAA, and $35,363 of Class B Notes rated A/A2/A (the Series 2001-1 Class A
Asset Backed Bonds and Series 20011 Class B Asset Backed Bonds) as rated by Standard & Poors, Moodys and Fitch, respectively. The Series 20011 Class A Asset Backed Bonds bear interest of LIBOR plus 0.60% and
Series 20011 Class B Asset Backed Bonds bear interest of LIBOR plus 1.75%, and interest on both is payable quarterly. The maximum outstandings under the Notes issued by the Trust during the three and nine months ended September 30, 2002 was
$254,617 and $265,223, respectively. The average outstanding balance during the three and nine months ended September 30, 2002 was $248,245 and $255,489, respectively. The weighted average interest rate, excluding fee amortization, for the three and
nine months ended September 30, 2002 was 2.6%, and the interest rate at September 30, 2002 was also 2.6%.





Amounts
outstanding under the Revolving Credit Facility and the Trust Notes as of September 30, 2002 and December 31, 2001 by interest rate benchmark were as follows:





September 30, 2002

December 31, 200190-day LIBOR

$246,360

$265,223CP Rate

101,826

22,585$348,186

$287,808





Subject to certain minimum equity restrictions and other covenants,
total unused available commitments from the borrowing facilities totaled $98,174 and $177,415 at September 30, 2002 and December 31, 2001, respectively.





Note 5.    Earnings (Loss) Per Share





The following table sets
forth the computation of basic and diluted earnings (loss) per common share for the three and nine months ended September 30, 2002 and 2001:





(in thousands, except per share amounts)

Three Months Ended September 30,


Nine Months Ended September 30,2002


2001


2002

2001BasicNet increase (decrease) in stockholders equity resulting from earnings/ net income (loss)

$
(3,461
)

$
(1,074
)

$
9,686

$
7,071Weighted average common shares outstanding


29,932



12,672



28,041


12,672Earnings (loss) per common share-basic

$
(0.12
)

$
(0.08
)

$
0.35

$
0.56DilutedNet increase (decrease) in stockholders equity resulting from earnings/ net income (loss)

$
(3,461
)

$
(1,074
)

$
9,686

$
7,071Weighted average common shares outstanding


29,932



12,672



28,041


12,672Dilutive effect of stock options and restricted stock on which forfeiture provisions have not lapsed










61


19Weighted average common shares and common stock equivalents


29,932



12,672



28,102


12,691Earnings (loss) per common share-diluted

$
(0.12
)

$
(0.08
)

$
0.34

$
0.56




20




---

##### Table of Contents

MCG Capital Corporation


Notes
To Consolidated Financial Statements (unaudited)(continued)


(in thousands except per share data)





Note 6.    Financial Highlights





The following is a schedule of financial highlights for the nine months ended September 30, 2002:





(dollars in thousands, except per share data)

Nine Months Ended September 30, 2002Per Share Data (1):Net asset value at beginning of period

$
12.46Net operating income


1.06Realized losses on investments


(0.31
)Increase in unrealized depreciation on investments


(0.44
)Net increase in stockholders equity resulting from earnings


0.31Dividends declared


(1.34
)Effect of stock offering on distributions


0.08Antidilutive effect of distributions recorded as compensation expense


0.07Net decrease in stockholders equity resulting from distributions


(1.19
)Net increase in shareholders equity from restricted stock amortization


0.10Net increase in shareholders equity resulting from reduction in employee loans


0.02Issuance of shares net of dilutive effect of $3.86


0.43Net asset value at end of period

$
12.13Per share market value at end of period

$
13.18Total return (2)


(16.18
)%Shares outstanding at end of period


31,253Ratio/Supplemental Data:Net assets at end of period


379,040Ratio of operating expenses to average net assets


8.34
%Ratio of net operating income to average net assets


11.71
%





|(1) |  | Basic and diluted per share data
|--- |  | --------------------------------

|(2) |  | Total return equals the decrease of the ending market value at September 30, 2002 from the December 31, 2001 price of $17.80 per share plus dividends paid
($1.74 per share), divided by the beginning price. Total return is not annualized.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Note
7.    New Accounting Pronouncement





In July 2001, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (FAS 142), which requires goodwill and intangible assets with indefinite useful lives to no longer be amortized but to be tested
for impairment at least annually. Intangible assets that have finite lives will continue to be amortized over their estimated useful lives. The amortization and non-amortization provisions of FAS 142 will be applied to all goodwill and intangible
assets acquired after June 30, 2001. Effective January 1, 2002, the Company adopted the provisions of FAS 142 and ceased amortization of goodwill and intangible assets with indefinite lives. The adoption of FAS 142 did not have a material impact on
the Companys financial position or results of operations. In accordance with FAS 142, the Company has tested its intangible assets with indefinite lives, $3,850 at January 1, 2002, for impairment as of the date of adoption and determined that
there was no impairment.




21




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##### Table of Contents

MCG Capital Corporation


Notes
To Consolidated Financial Statements (unaudited)(continued)


(in thousands except per share data)





Note 8.    Income From Controlled Companies and Other Affiliates





Controlled companies are generally defined under the Investment Company Act of 1940 as companies in which MCG owns more than 25% of the voting securities of the company. During the three and
nine months ended September 30, 2002, MCG recognized $799 and $2,192, respectively, of interest and fee income from controlled companies. During the three and nine months ended September 30, 2001, MCG recognized $265 and $1,585, respectively, of
interest and fee income from controlled companies. During the three and nine months ended September 30, 2002, MCG recognized $6,284 and $12,537, respectively, of net unrealized depreciation on investments in controlled companies. During the three
and nine months ended September 30, 2001, MCG recognized $116 and $25 of net unrealized depreciation on investments in controlled companies. MCG held $41.1 million and $35.8 million of loans at fair value to controlled companies at September 30,
2002 and December 31, 2001, respectively. Of the controlled company loans, $14.6 million and $0 were on non-accrual status at September 30, 2002 and December 31, 2001. MCG held $7.5 million and $13.3 million of equity investments at fair value in
controlled companies at September 30, 2002 and December 31, 2001, respectively.





Other affiliates are generally
defined under the Investment Company Act of 1940 as companies in which MCG owns 5% to 25% of the voting securities of the company. Interest and fee income from other affiliates amounted to $943 and $2,917 for the three and nine months ended
September 30, 2002, respectively. During the three and nine months ended September 30, 2001, MCG recognized $2,065 and $6,470, respectively, of interest and fee income from other affiliates. During the three and nine months ended September 30, 2002,
MCG recognized $7 and ($207), respectively, of net unrealized appreciation (depreciation) on investments in other affiliates. During the three and nine months ended September 30, 2001, MCG recognized no unrealized appreciation or depreciation on
investments in other affiliates. MCG held $34.4 million and $37.7 million of loans at fair value to other affiliates at September 30, 2002 and December 31, 2001, respectively. MCG held $1.2 million and $1.4 million of equity investments at fair
value in other affiliates at September 30, 2002 and December 31, 2001, respectively.





Note
9.    Subsequent Events





In October 2002, MCG discontinued the operations of Upside
magazine owned by UMAC, Inc., one of its portfolio companies.





In August 2002, we were awarded, through a
bankruptcy proceeding, the right to acquire in satisfaction of outstanding indebtedness the Arizona and North Carolina divisions of one of our portfolio companies, Intellisec Holdings, Inc. The Arizona division sale was completed in the third
quarter of 2002 and is now controlled by us and being operated as a separate portfolio company, Copperstate Technologies, Inc. In addition, in October 2002, the North Carolina division sale was completed and is now controlled by us and being
operated as a separate portfolio company, Interactive Business Solutions. We do not expect to realize a material gain or loss related to these transactions. However, there can be no assurance that a gain or loss will not occur upon the ultimate
disposition of these divisions or upon the disposition of the remainder of our investment in Intellisec Holdings, Inc.





In October 2002, three of our portfolio companies, Talk America Holdings, Inc., Kings III of America, Inc. and Media Central LLC paid their outstanding loan balances in full, which aggregated approximately $29,998 at September 30,
2002.




22




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##### Table of Contents

Independent Accountants Review Report





Board of Directors and Shareholders


MCG Capital Corporation





We have reviewed the accompanying consolidated balance sheet of
MCG Capital Corporation as of September 30, 2002, including the consolidated schedule of investments, and the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2002 and 2001, the
consolidated statement of stockholders equity for the nine-month period ended September 30, 2002 and the consolidated statement of cash flows for the nine-month periods ended September 30, 2002 and 2001. These financial statements are the
responsibility of the Companys management.





We conducted our reviews in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.





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





We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated balance sheet of MCG Capital
Corporation as of December 31, 2001, including the consolidated schedules of investments, and the related consolidated statements of income, stockholders equity, and cash flows for the one-month period ended December 31, 2001 and the
eleven-month period ended November 30, 2001 (not presented herein), and in our report dated January 25, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of December 31, 2001, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.





/s/ ERNST & YOUNG





Ernst & Young





Richmond, Virginia


October 29, 2002




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##### Table of Contents




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 Consolidated Financial and Other
Data, the Selected Operating Data and our Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report. This Quarterly Report, including the Management's Discussion and Analysis of Financial Condition and Results
of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about our
industry, our beliefs, and our assumptions. Words such as anticipates, expects, intends, plans, believes, seeks, and estimates and variations of these words and
similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to
predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements including without limitation (1) an economic downturn could impair our customers' ability to repay our loans and
increase our non-performing assets, (2) an economic downturn could disproportionately impact the communications, information services, media and technology industries in which we concentrate causing us to suffer losses in our portfolio and
experience diminished demand for capital in these industry sectors, (3) a contraction of available credit and/or an inability to access the equity markets could impair our lending and investment activities, (4) interest rate volatility could
adversely affect our results and (5) the risks, uncertainties and other factors we identify from time to time in our filings with the Securities and Exchange Commission, including our Form 10-K for the fiscal year ended December 31, 2001. 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 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.





Overview





The information contained in this section should be read in conjunction with the
Selected Consolidated Financial and Other Data and our Consolidated Financial Statements and notes thereto appearing herein.





MCG Capital Corporation is a solutions-focused financial services company providing financing and advisory services to companies throughout the United States in the communications, information services, media and technology industry
sectors. On December 4, 2001, we completed an initial public offering of 13,375,000 shares of our common stock and a concurrent private offering of 625,000 shares of our common stock with gross proceeds totaling $237.3 million. Upon completion of
these offerings, we became an internally managed, non-diversified, closed-end investment company that elected to be treated as a business development company under the Investment Company Act of 1940. MCG Capital Corporation will elect to be treated
for federal income tax purposes as a regulated investment company under the Internal Revenue Code with the filing of its federal corporate income tax return for 2002, which election will be effective as of January 1, 2002. Pursuant to this election,
we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level tax liability. On June 17, 2002, MCG raised $54.0 million of
gross proceeds in an additional public offering by selling 3,000,000 shares of common stock at an offering price of $18 per share.





The results of operations for the three and nine months ended September 30, 2002 reflect the Companys results as a business development company under the Investment Company Act of 1940, as amended, whereas the
operating results for the three and nine months ended September 30, 2001 reflect the Companys results prior to operating as a business development company under the Investment Company Act of 1940, as amended. Accounting principles used in the
preparation of the consolidated financial statements for these two periods are different and, therefore, the results of operations are not directly comparable. The primary differences in




24




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##### Table of Contents

accounting principles relate to the carrying value of investments and accounting for income taxessee corresponding sections in the notes to our consolidated financial statements included in
the Companys Form 10-K for the fiscal year ended December 31, 2001.





We were formed by our management and
affiliates of Goldman, Sachs & Co. to purchase a loan portfolio and certain other assets from First Union National Bank in a management buyout that was completed on June 24, 1998. Prior to this purchase, we conducted our business as a division
of Signet Bank. This separate division was known as the media communications group. Signet Banking Corporation, the parent of Signet Bank, was acquired by First Union Corporation (now Wachovia Corporation) on November 28, 1997.





Portfolio Composition and Asset Quality





Our primary business is lending to and investing in businesses, primarily in the communications, information services, media, and technology industry sectors, through investments in senior debt,
subordinated debt and equity-based investments, including warrants and equity appreciation rights. The increase in investments during the first nine months of 2002 was primarily attributable to originated debt securities, including $55.5 million of
subordinated debt to four companies. We intend to increase our level of subordinated debt and equity-based investments. However, we expect a substantial majority of our managed portfolio will continue to consist of investments in senior secured
commercial loans. The total portfolio value of publicly traded and non-publicly traded investments was $720.7 million and $617.2 million, at September 30, 2002 and December 31, 2001, respectively (exclusive of unearned income). Total portfolio
investment activity for the nine months ended September 30, 2002 and year ended December 31, 2001, was as follows (exclusive of unearned income):





September 30,


December 31,(dollars in millions)

2002


2001 (a)Beginning Portfolio

$
617.2


$
510.9Originations/Draws/Advances on Loans


155.5



196.2Originations/Warrants Capitalized on Equity


8.6



19.8Gross Payments / Reductions


(34.8
)


(48.4
)Early Pay-offs/Sales of Securities


(2.4
)


(33.0
)Charge-offs/Write-downs






(14.8
)(b)Realized Losses on Investments


(9.6
)


(1.7
)Unrealized Appreciation on Investments


4.4



2.6Unrealized Depreciation on Investments


(18.2
)


(14.4
)Ending Portfolio

$
720.7


$
617.2





|(a) |  | Balances prior to our election to be regulated as a business development company primarily include amounts at cost.
|--- |  | -------------------------------------------------------------------------------------------------------------------

|(b) |  | Represents $14.8 million of loan charge-offs against the allowance for loan losses previously provided for prior to our election to be regulated as a business
development company. We had provided for loan losses of $20.3 million from inception through November 30, 2001 including $2.0 million of allowance recorded in the asset acquisition on June 24, 1998.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




The following table shows the fair value of our portfolio of investments by asset class as of September 30, 2002 and December 31, 2001:





September 30, 2002


December 31, 2001(dollars in millions)

Investments at Fair Value

Percentage of Total Portfolio


Investments at Fair Value

Percentage of Total PortfolioSenior Debt

$
636.0

88.3
%

$
588.2

95.3
%Subordinated Debt


64.9

9.0
%


7.8

1.2
%Equity


12.4

1.7
%


15.5

2.5
%Warrants to Acquire Equity


7.1

1.0
%


5.4

0.9
%Equity Appreciation Rights


0.3

0.0
%


0.3

0.1
%Total

$
720.7

100.0
%

$
617.2

100.0
%




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##### Table of Contents




Asset quality is generally a function of our underwriting and ongoing management
of our investment portfolio. As a business development company, our loans and equity investments are carried at market value or, in the absence of market value, at fair value as determined by our Board of Directors in good faith on a quarterly
basis. As of September 30, 2002 and December 31, 2001, net unrealized depreciation on investments totaled $25.0 million and $11.2 million, respectively.





In addition to various risk management and monitoring tools, we also use an investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio. We
use the following 1 to 5 investment rating scale. Below is a description of the conditions associated with each investment rating:





Investment Rating

Summary
Description1

Capital gain expected2

Full return of principal and interest or dividend expected with customer performing in accordance with plan3

Full return of principal and interest or dividend expected but customer requires closer monitoring4

Some loss of interest or dividend expected but still expecting an overall positive internal rate of return on the investment5

Loss of interest or dividend and some loss of principal investment expected which would result in an overall negative internal rate of return on the
investment





The following table shows the distribution of our investments on
the 1 to 5 investment rating scale at fair value as of September 30, 2002 and December 31, 2001:





(dollars in millions)September 30, 2002

December 31, 2001Investment Rating

Investments atFair Value

Percentage ofTotal Portfolio

Investments atFair Value

Percentage ofTotal Portfolio1

$166.7

23.1%

$135.2

21.9%2

333.8

46.3%

275.1

44.5%3

152.4

21.2%

158.6

25.7%4

53.8

7.5%

46.7

7.6%5

14.0

1.9%

1.6

0.3%$720.7

100.0%

$617.2

100.0%





We manage loan concentrations in our portfolio, both on an
individual loan basis and on a sector or industry basis, to manage overall portfolio performance due to specific customer issues or specific industry issues. At September 30, 2002, of the investments with a 5 rating, $13.0 million are loans, of
which $12.0 million are on non-accrual. Of the investments with a 4 rating, $49.3 million are loans, of which $8.8 million are on non-accrual.







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##### Table of Contents

Set forth below is a table showing the composition of MCGs portfolio by industry sector at fair value at September
30, 2002, and December 31, 2001:





September 30, 2002

December 31, 2001(dollars in millions)

Investments atFair Value

Percentage ofTotal Portfolio

Investments atFair Value

Percentage ofTotal PortfolioMediaNewspaper

$
208.0

28.9%

$
171.9

27.8%Publishing


133.9

18.6%


117.3

19.0%Broadcasting


87.0

12.1%


50.9

8.3%Telecommunications


158.5

22.0%


153.6

24.9%Information Services


82.6

11.5%


72.5

11.8%Technology


28.6

4.0%


23.7

3.8%Security Alarm


20.3

2.8%


25.0

4.0%Other


1.8

0.1%


2.3

0.4%Total

$
720.7

100.0%

$
617.2

100.0%





Set forth below is a table showing MCGs originations by
industry for the nine months ended September 30, 2002 and the year ended December 31, 2001:





Nine Months Ended September 30, 2002

Year Ended December 31, 2001(dollars in millions)

Amount

Percentageof Total

Amount

Percentageof TotalMediaNewspaper

$  40.8

30.7%

$  39.3

26.6%Publishing

27.3

20.5%

27.3

18.5%Broadcasting

35.0

26.3%

21.2

14.3%Telecommunications

8.1

6.1%

20.2

13.7%Information Services

12.3

9.2%

32.7

22.2%Technology

6.5

4.9%

0.0

0.0%Security Alarm

3.0

2.3%

7.0

4.7%Total

$133.0

100.0%

$147.7

100.0%





We monitor individual customers financial trends in order to
assess the appropriate course of action with respect to each customer and to evaluate overall portfolio quality. We closely monitor the status and performance of each individual investment on a quarterly and, in some cases, a monthly or more
frequent basis. Because we are a provider of long-term privately negotiated investment capital to high-growth companies and we actively manage our investments through tightly structured contracts, we do not believe that contract exceptions such as
breaches of contractual covenants or late delivery of financial statements are necessarily an indication of deterioration in the credit quality or the need to pursue remedies or an active workout of a portfolio investment.





At September 30, 2002, there were $16.2 million of loans, or approximately 2.2% of the investment portfolio greater than 60 days past due.
At September 30, 2002, non-accrual loans ($20.8 million) and loans greater than 60 days past due not on non-accrual status ($6.1 million) totaled $26.9 million or 3.7% of the investment portfolio. The non-accrual and past due loans primarily
represented borrowers in the publishing, security alarm and paging businesses. Portions of the trade publishing industry which are dependent on financial, technology or telecommunications advertising continue to experience an economic downturn and
the paging industry is negatively impacted by alternative technology. At December 31, 2001, there were $8.6 million of loans greater than 60 days past due representing 1.4% of the investment portfolio, of which $0.2 million were on non-accrual
status. When a loan becomes 90 days or more past due, or if we otherwise do not expect the




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##### Table of Contents

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 stop recognizing interest income on that loan until all
principal has been paid. However, we may make exceptions to this policy if the investment is well secured and in the process of collection.





When principal and interest on a loan is not paid within the applicable grace period, we will contact the customer for collection. At that time, we will make a determination as to the extent of the
problem, if any. We will then pursue a commitment for immediate payment and will begin to more actively monitor the investment. We will formulate strategies to optimize the resolution process and will begin the process of restructuring the
investment to better reflect the current financial performance of the customer. Such a restructuring may involve deferring payments of principal and interest, adjusting interest rates or warrant positions, imposing additional fees, amending
financial or operating covenants or converting debt to equity. In general, in order to compensate us for any enhanced risk, we receive appropriate compensation from the customer in connection with a restructuring. During the process of monitoring a
loan which is out of compliance, we will in appropriate circumstances send a notice of non-compliance outlining the specific defaults that have occurred and preserving our remedies, and initiate a review of the collateral. When a restructuring is
not the most appropriate course of action, we may determine to pursue remedies available under our loan documents or at law to minimize any potential losses, including initiating foreclosure and/or liquidation proceedings.





During 2001, we foreclosed upon two of our portfolio companies, which had an aggregate fair value of $12.0 million as of September 30,
2002 and $19.6 million as of December 31, 2001. Of the $14.8 million of charge-offs during 2001, $4.5 million related to these foreclosures. There were no foreclosures during the nine months ended September 30, 2002. However in July 2002, we
acquired in satisfaction of debt the assets of one of our portfolio companies, ValuePage Holdings Inc. The assets are held and operated through Telecomm South, LLC, a separate portfolio company controlled by MCG. This investment had a fair value of
$3.7 million at September 30, 2002. In August 2002, we acquired in satisfaction of debt the Arizona division of Intellisec Holdings, Inc. and transferred it to Copperstate Technologies, Inc., a wholly owned subsidiary of MCG Finance I, LLC. This
investment had a fair value of $3.1 million at September 30, 2002.





Prior to our conversion to a business
development company, we provided an allowance for loan losses estimated to be sufficient to absorb probable future losses, net of recoveries. From inception through November 30, 2001, we had provided $20.3 million of allowance for loan losses,
including $2.0 million of allowance recorded in the asset acquisition and had charged-off $14.8 million.







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##### Table of Contents

Results of Operations





Comparison of the Three and Nine Months Ended September 30, 2002 and 2001





The following table shows our consolidated results of operations for the three and nine months ended September 30, 2002 and 2001. The three and nine months ended September 30, 2002 reflect our financial results as a business
development company (BDC) whereas the three and nine months ended September 30, 2001 reflect our financial results prior to operating as a BDC. Different accounting principles are used in the preparation of our financial statements as a BDC under
the Investment Company Act of 1940 and, as a result, our financial results as a BDC are not directly comparable to prior periods. The items in the table below were not affected by the change in accounting principles resulting from our conversion to
a BDC. See Note 1 to Consolidated Financial Statements under the heading Conversion to Business Development Company.





(dollars in thousands)

Post-IPO as a Business Development CompanyThree Months EndedSept. 30, 2002

Pre-IPO prior to becoming a Business Development CompanyThree Months EndedSept. 30, 2001

Post-IPO as a Business Development CompanyNine Months EndedSept. 30, 2002

Pre-IPO prior to becoming a Business Development CompanyNine Months EndedSept. 30, 2001Operating incomeInterest and fees on commercial loans

$
19,396

$
17,588

$
53,240

$
52,652Advisory fees and other income


742


1,137


3,385


1,674Total operating income


20,138


18,725


56,625


54,326Operating expensesInterest expense


2,841


6,469


8,181


20,991Employee compensation:Salaries and benefits


1,958


2,550


5,821


7,156Long-term incentive compensation


1,816





5,073


Total employee compensation


3,774


2,550


10,894


7,156General and administrative expense


1,870


1,527


4,492


3,855Total operating expenses


8,485


10,546


23,567


32,002Net operating income (a)


11,653


8,179


33,058


22,324Long-term incentive compensation (b)


1,816





5,073


Distributable net operating income (c)

$
13,469

$
8,179

$
38,131

$
22,324


(a) Represents net operating income before provision for loan losses for periods ending prior to December 1, 2001





(b) Includes expenses related to termination of the stock option plan and issuance of related restricted stock awards at the time of the IPO.





(c) Distributable net operating income is presented for the three and nine months ended Sept. 30, 2001 to facilitate the understanding
of the amount of net earnings we may have potentially distributed if we had operated as a business development company and regulated investment company (without the effect of de-leveraging prior to December 1, 2001) for that period. The amounts of
the distributable net operating income identified in this table are not intended to represent amounts we will distribute in future periods. Distributable net operating income may not be comparable to similarly titled measures reported by other
companies. Distributable net operating income does not represent net increase (decrease) in stockholders equity resulting from earnings or cash generated from operating activities in accordance with GAAP and should not be considered an
alternative to such items as an indication of our performance or to cash flows as a measure of liquidity or ability to make distributions. For additional information on distributions, see the section entitled Financial Condition, Liquidity and
Capital ResourcesDividends.







29




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##### Table of Contents

Operating Income





Operating income includes interest income on commercial loans, advisory fees and other income. Interest income is comprised of commercial loan interest at contractual rates and upfront fees that are amortized into income over the
life of the loan. Most of our loans contain lending features that adjust the rate margin based on the financial and operating performance of the borrower, which generally occurs quarterly.





The change in operating income from the three and nine months ended Sept. 30, 2002 compared to the same periods in 2001 is attributable to the following items:





Periods Ended Sept. 30, 2002 vs. Sept. 30, 2001(dollars in millions)

Three MonthsEnded


Nine MonthsEndedChange due to:Asset growth (a)

$
3.2


$
8.5Change in LIBOR (a)


(2.6
)


(11.1
)Change in spread (a)


1.1



2.3Increase in fee income


0.1



0.9Advisory and other income


(0.4
)


1.7Total change in operating income

$
1.4


$
2.3





(a) The change in interest income due to change in LIBOR, change in spread and loan growth
has been allocated in proportion to the relationship of the absolute dollar amount of the changes in each.





Total
operating income for the three months ended September 30, 2002 increased $1.4 million, or 7.5%, to $20.1 million from $18.7 million for the three months ended September 30, 2001. The benefit of an increase in loan volume and interest spread was
partially offset by a decline in LIBOR rates from the third quarter of 2001 to the same period in 2002. Loan interest rose $1.7 million from the third quarter of 2001 to the third quarter of 2002. Average three month LIBOR decreased 168 basis points
over these periods from 3.49% to 1.81%, decreasing income by $2.6 million. Average commercial loans increased 21% for the third quarter of 2002 when compared to the third quarter of 2001, contributing a $3.2 million increase in income. The majority
of the loans are priced as a variable spread to LIBOR and this coupon spread increased by 74 basis points resulting in a $1.1 million addition to income. Loan fees increased $0.1 million primarily from origination fees. Due to a large advisory fee
earned during the third quarter of 2001, advisory and other income declined $0.4 million for the three months ended September 30, 2002. Advisory fees are recognized as earned, which is generally when the investment transaction closes or the services
are completed.





Total operating income for the nine months ended September 30, 2002 increased $2.3 million, or
4.2%, to $56.6 million from $54.3 million for the nine months ended September 30, 2001. Loan interest declined $0.3 million from the first nine months of 2001 compared to the first nine months of 2002. Average three month LIBOR decreased 248 basis
points over these periods from 4.36% to 1.88%, decreasing income by $11.1 million. Average commercial loans increased 19% for the first nine months of 2002 when compared to the first nine months of 2001, contributing an $8.5 million increase in
income. The coupon spread increased 59 basis points in the first nine months of 2002, resulting in a $2.3 million increase in income. The loan growth, increase in weighted average spreads and rise in advisory and other income more than offset the
affects of the decreases in LIBOR rates from the first nine months of 2001 to the same period in 2002. Loan fees increased $0.9 million primarily from origination fees. Due to a number of projects completed during the first nine months of 2002 for
new and existing customers, advisory and other income experienced growth of $1.7 million compared to the first nine months of 2001.





Operating Expenses





Operating expenses include interest expense on borrowings, including
amortization of deferred debt issuance costs, employee compensation, and general and administrative expenses.







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##### Table of Contents

The change in operating expense from the three and nine months ended September 30, 2002 compared to the same periods in
2001 is attributable to the following items:





Periods EndedSept. 30, 2002 vs. Sept. 30, 2001(dollars in millions)

Three MonthsEnded


Nine MonthsEndedChange due to:Decrease in borrowings (a)

$
(1.2
)

$
(3.6
)Change in LIBOR (a)


(1.6
)


(6.7
)Change in spread (a)


(0.8
)


(2.5
)Salaries and benefits


(0.6
)


(1.3
)Long-term incentive compensation


1.8



5.1General and administrative expense


0.3



0.6Total change in operating expense

$
(2.1
)

$
(8.4
)





(a) The change in interest expense due to decrease in borrowings,
change in LIBOR, and change in spread has been allocated in proportion to the relationship of the absolute dollar amount of the changes in each.





Total operating expenses for the three months ended September 30, 2002 decreased $2.1 million, or 19.5%, to $8.5 million from $10.5 million for the three months ended September 30, 2001. The decrease
was primarily due to a decline in interest expense as average borrowings and rates both declined. Average three month LIBOR decreased 168 basis points over these periods from 3.49% to 1.81% which caused interest expense to decline by $1.6 million.
Average borrowings decreased 23%, decreasing interest expense by $1.2 million. On December 27, 2001, we issued investment grade asset backed bonds with a blended coupon spread of 75 basis points over LIBOR and, along with a portion of the IPO
proceeds, replaced a debt facility priced at LIBOR plus 175 basis points. The decrease in spreads decreased interest expense by $0.8 million. Salaries and benefits declined $0.6 million. Partially offsetting the decline in interest expense and
salaries and benefits was an increase of $1.8 million in long-term incentive compensation in 2002 from $0 in 2001. The increase in long-term incentive compensation is related to the amortization of restricted stock awards and the treatment of
dividends on certain shares of common stock securing employee loans as compensation. General and administrative expenses rose $0.3 million for the period.





Total operating expenses for the nine months ended September 30, 2002 decreased $8.4 million, or 26.4%, to $23.6 million from $32.0 million for the nine months ended September 30, 2001. The decrease
was primarily due to a decline in interest expense as average borrowings and rates both declined. Average three month LIBOR decreased 248 basis points over these periods from 4.36% to 1.88% which caused interest expense to decline by $6.7 million.
Average borrowings decreased 22%, decreasing interest expense by $3.6 million. The decrease in spreads decreased interest expense by $2.5 million. Salaries and benefits declined $1.3 million. Partially offsetting the decline in interest expense and
salaries and benefits was a $5.1 million increase in long-term incentive compensation in 2002 from $0 in 2001. General and administrative expenses rose $0.6 million for the period.





Net operating income before provision for loan losses for the quarter ended September 30, 2002 totaled $11.7 million compared with $8.2 million for the quarter ended
September 30, 2001. MCG experienced a $3.5 million net loss for the quarter ended September 30, 2002 compared with a $1.1 million net loss for the quarter ended September 30, 2001.





Net operating income before provision for loan losses for the nine months ended September 30, 2002 totaled $33.1 million compared with $22.3 million for the nine months
ended September 30, 2001. Net income totaled $9.7 million for the nine months ended September 30, 2002 and $7.1 million for the nine months ended September 30, 2001.







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##### Table of Contents

Reconciliation of Net Operating Income to Net (Decrease) Increase in Stockholders Equity from Earnings (Loss)





Provision for Loan Losses





Because we are a business development company and our investments are carried at fair value, we no longer provide a provision for loan losses. The provision for loan losses for the three and nine months ended September 30,
2001 totaled $7.5 million and $10.2 million, respectively.





Realized Gains (Losses) on Investments and Net Unrealized Appreciation
(Depreciation) on Investments





Realized losses for the three and nine months ended September 30, 2002 totaled
$9.6 million related to the acquisition in satisfaction of outstanding indebtedness of the assets of one of our portfolio companies, ValuePage Holdings Inc. Realized losses for the three and nine months ended September 30, 2001 totaled $0.2 million
and $1.7 million, respectively, and represented impairment write-offs on equity investments. Net unrealized depreciation on investments for the three and nine months ended September 30, 2002 of $5.5 million and $13.8 million, respectively, reflects
the change in fair value primarily for assets in the telecommunications, security alarm and publishing sectors. The net unrealized depreciation on investments of $5.5 million for the three months ended September 30, 2002 consisted of $1.6 million of
gross appreciation and $7.1 million of gross depreciation. The appreciation was spread among several of our investments. The unrealized depreciation was primarily related to a decrease of $3.5 million in the value of one of our publishing
investments, UMAC Inc. (which is controlled by MCG) and approximately $0.8 million of adjustments to our loans on non-accrual primarily attributable to Intellisec Holdings, Inc.





The net unrealized depreciation on investments of $13.8 million for the nine months ended September 30, 2002 consisted of $4.4 million of gross appreciation and $18.2
million of gross depreciation. The appreciation occurred primarily in two of our telecommunications investments. Talk America Holdings, Inc., a publicly traded company, appreciated $2.9 million and Manhattan Telecommunications Corporation
appreciated $0.7 million. The unrealized depreciation was primarily related to a decrease of $9.2 million in the value of one of our publishing investments, UMAC Inc., and approximately $5.2 million of adjustments to loans on non-accrual.





Prior to conversion to a business development company, only certain investments were carried at fair value. Net
unrealized depreciation for the three and nine months ended September 30, 2001 was $2.3 million and $1.6 million, respectively, and was related to the decrease in the fair value of certain warrants accounted for in accordance with SFAS No. 133 and
138.




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The following table summarizes our gains and losses on investments for the three
and nine months ended September 30, 2002 and 2001:


MCG Capital Corporation





Summary of Gains and Losses on Investments





(dollars in
thousands)





Portfolio Company

Sector

Three Months Ended Sept. 30, 2002


Three Months Ended Sept. 30, 2001


Nine Months Ended Sept. 30, 2002


Nine Months Ended Sept. 30, 2001Realized lossesValuePage Holdings, Inc.

Telecommunications

$
(9,617
)

$



$
(9,617
)

$
MacDonald Communications Corporation

Publishing














(1,000
)Other








(165
)






(715
)$
(9,617
)

$
(165
)

$
(9,617
)

$
(1,715
)Unrealized appreciation on investmentsTalk America Holdings, Inc.

Telecommunications

$







$
2,856R.R. Bowker LLC

Information Services


421







108Creatas, L.L.C.

Information Services


374







154Biznessonline.com, Inc.

Telecommunications


343







Manhattan Telecommunications Corporation

Telecommunications










675IDS Telcom LLC

Telecommunications






69



110



437Other




489



212



460



540$
1,627


$
281


$
4,363


$
977Unrealized depreciation on investmentsUMAC, Inc.

Publishing

$
3,526






$
9,216Intellisec Holdings, Inc.

Security Alarm


458







3,862ValuePage Holdings, Inc.

Telecommunications


3,035







4,984VS&A-PBI Holding LLC

Publishing


2,173







2,173Talk America Holdings, Inc.

Telecommunications


2,762







Working Mother Media, Inc.

Publishing


1,273







1,622AMI Telecommunications Corporation

Telecommunications


1,348







1,348Rising Tide Holdings LLC

Publishing


245







814Corporate Legal Times L.L.C.

Publishing


480







745THE Journal, LLC

Publishing


137







539FTI Technologies Holdings, Inc.

Technology





$
2,029






$
2,029Manhattan Telecommunications Corporation

Telecommunications


345



202







465Other




959



324



2,432



10416,741



2,555



27,735



2,598Reversal of unrealized depreciation*ValuePage Holdings, Inc.

Telecommunications


9,617







9,617Total unrealized depreciation




7,124



2,555



18,118



2,598Net change in unrealized depreciation on investments

$
(5,497
)

$
(2,274
)

$
(13,755
)

$
(1,621
)





*  When a gain or loss becomes realized, the prior unrealized appreciation or
depreciation is reversed.




33




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##### Table of Contents

Income Taxes





Through December 31, 2001 we were taxed under Subchapter C of the Internal Revenue Code. We will elect to be a regulated investment company under Subchapter M of the Internal Revenue Code with the filing of our federal corporate
income tax return for 2002, which election will be effective as of January 1, 2002, and will not be subject to taxation of income to the extent such income is distributed to stockholders and we meet certain minimum dividend distribution and other
requirements. Our effective tax rate for the three and nine months ended September 30, 2001 was 40.2% and 40.1%, respectively. The effective rate includes both federal and state income tax components.





Financial Condition, Liquidity and Capital Resources





Cash and Cash Equivalents





At September 30, 2002 and
December 31, 2001, we had $22.3 million and $48.1 million, respectively, in cash and cash equivalents. We invest cash on hand in interest bearing deposit accounts with daily sweep features. On December 4, 2001, we completed an initial public
offering of 13,375,000 shares of our common stock and a concurrent private offering of 625,000 shares of our common stock with gross proceeds totaling $237.3 million (net proceeds totaling $216.9 million). On June 17, 2002, we raised an additional
$54.0 million in gross proceeds (net proceeds of approximately $50.3 million) as the result of an additional public stock offering. The decrease in cash from December 31, 2001 to September 30, 2002 is due to portfolio growth. Our objective is to
maintain a low cash balance, while keeping sufficient cash on hand to cover current funding requirements and operations.





Liquidity
and Capital Resources





We expect our cash on hand and cash generated from operations to be adequate to meet
our cash needs at our current level of operations, including the next twelve months. We generally fund new originations using cash on hand, advances under our credit facilities and equity financings.





As of September 30, 2002, we had unused commitments to extend credit to our customers of $20.6 million, which are not reflected on the
balance sheet. At the same time, subject to certain minimum equity restrictions and other covenants, total unused available commitments from our commercial paper facility totaled $98.2 million.





The following table shows our contractual obligations as of September 30, 2002:





Payments Due by Period(dollars in millions) Contractual Obligations (a)

Total

Less than 1 year

1-3 years

4-5 years

After 5 yearsBorrowings (b)

$
348.2

$
101.8


$ 

$


$
246.4Future minimum rental obligations


13.8


1.1


2.5


2.6


7.6Total contractual obligations

$
362.0

$
102.9

$
2.5

$
2.6

$
254.0





(a)  This excludes the unused commitments to extend credit to our customers of
$20.6 million as discussed above.





(b)  Borrowings are listed based on the contractual maturity of the facility. However,
actual payments on borrowings could be earlier since they are based primarily on when we receive payments from our customers on the commercial loans collateralizing the borrowings.





As of December 31, 2001, we had unused commitments to extend credit to our customers of $29.4 million, which are not reflected on the balance sheet. At the same time,
subject to certain minimum equity restrictions and other covenants, total unused available commitments from our commercial paper facility totaled $177.4 million. See Borrowings section below for discussion of our borrowing facilities.




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The following table shows our contractual obligations as of December 31, 2001:





Payments Due by Period(dollars in millions) Contractual Obligations (a)

Total

Less than   1 year

1-3 years

4-5 years

After 5 yearsBorrowings (b)

$
287.8

$


$
22.6

$


$
265.2Future minimum rental obligations


1.5


0.8


0.5


0.2


Total contractual obligations

$
289.3

$
0.8

$
23.1

$
0.2

$
265.2





(a)  This excludes the unused commitments to extend credit to our customers of
$29.4 million as discussed above.





(b)  Borrowings are listed based on the contractual maturity of the facility. However,
actual payments on borrowings could be earlier since they are based primarily on when we receive payments from our customers on the commercial loans collateralizing the borrowings.





In order to satisfy the requirements applicable to a regulated investment company, we intend to distribute to our stockholders all of our income except for certain net
capital gains and adjustments for long-term incentive compensation. In addition, as a business development company, we generally will be required to meet a coverage ratio of total assets to total senior securities, which include all of our
borrowings and any preferred stock we may issue in the future, of at least 200%. This requirement limits the amount that we may borrow. To fund growth in our investment portfolio, we anticipate needing to raise additional capital from various
sources, including the public equity market and the securitization or other debt-related markets.





Borrowings





On December 27, 2001, we established the MCG Commercial Loan Trust 20011 (the Trust), which issued two
classes of Series 20011 Notes to 15 institutional investors. The facility is secured by all of the Trusts existing assets, totaling $328.7 million as of September 30, 2002 and $349.5 million as of December 31, 2001. This facility is
scheduled to terminate on February 20, 2013 or sooner upon full repayment of the Class A and Class B Notes.





The
Trust issued $229.8 million of Class A Notes rated AAA/Aaa/AAA, and $35.4 million of Class B Notes rated A/A2/A (the Series 20011 Class A Asset Backed Bonds and Series 20011 Class B Asset Backed Bonds) as rated by
Standard & Poors, Moodys and Fitch, respectively. As of September 30, 2002, $246.4 million of the Series 20011 Notes were outstanding and $265.2 million were outstanding as of December 31, 2001. The Series 20011 Class A Asset
Backed Bonds bear interest of LIBOR plus 0.60% and Series 20011 Class B Asset Backed Bonds bear interest of LIBOR plus 1.75%, and interest on both is payable quarterly.





As of June 1, 2000, we established a revolving credit facility (the Revolving Credit Facility), which allows us to issue up to $200.0 million of Series
20001 Class A Notes (the Series 20001 Notes or Series 20001 Class A Asset Backed Securities). As of September 30, 2002, $101.8 million of the Series 20001 Notes were outstanding with one investor and
as of December 31, 2001 $22.6 million were outstanding with one investor. As of September 30, 2002, we had no notes outstanding under a swingline credit facility (the Swingline Notes), which is part of the Revolving Credit Facility, that
allows us to borrow up to $25.0 million as part of the $200.0 million total facility limit for a period of up to four days. The Swingline Notes are repaid through the issuance of Series 20001 Notes. The Revolving Credit Facility is secured by
$197.2 million of commercial loans as of September 30, 2002 and $71.7 million of commercial loans as of December 31, 2001. We are subject to certain limitations on the amount of Series 20001 Notes we may issue at any point in time including
the requirement for a minimum amount of unleveraged loans that serve as collateral for the indebtedness. Such amount was a minimum of $30.0 million (subject to increase upon the occurrence of an event of default) prior to July 8, 2002 and $75.0
million as of July 8, 2002 and thereafter. The Series 20001 Notes




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bear interest based on a commercial paper rate plus 1.0% and interest is payable monthly. This facility is scheduled to terminate on May 31, 2003.





The Trust and the Revolving Credit Facility are both funded through bankruptcy remote, special purpose, wholly-owned subsidiaries of ours
and, therefore, their assets may not be available to our creditors.





On June 24, 1998, one of our subsidiaries
entered into a $400.0 million senior secured credit facility (the Facility). The lead bank for this Facility, Heller Financial, Inc. (Heller), held 334,566 Class A shares and 677,934 Class D shares at December 31, 2000 which
it purchased, along with Goldman Sachs, at our inception. On October 25, 2001, Heller was acquired by GE Capital. During 2001, the proceeds from our IPO and the sale of loans to the Trust were used to pay off the Facilitys outstanding balance
of $342.7 million. This Facility has been repaid in full and is no longer in place.





At September 30, 2002, we had
aggregate outstanding borrowings of $348.2 million and $287.8 million at December 31, 2001. The following table shows the facility amounts and outstanding borrowings from third-party lenders at September 30, 2002:





(dollars in millions)

Facilityamount

Amount outstanding

InterestRate (a)Series 2001-1 Class A Asset Backed Bonds

$
211.0

$
211.0

2.46
%Series 2001-1 Class B Asset Backed Bonds


35.4


35.4

3.61Series 2000-1 Class A Asset Backed Securities


200.0


101.8

2.82Total borrowings

$
446.4

$
348.2

2.68
%





|(a) |  | Excludes the cost of commitment fees and other facility fees.
|--- |  | -------------------------------------------------------------




At December 31, 2001, we had aggregate outstanding borrowings of $287.8 million. The following table shows the facility amounts and outstanding borrowings from third-party
lenders at December 31, 2001:





(dollars in millions)

Facilityamount

Amountoutstanding

InterestRate (a)Series 2001-1 Class A Asset Backed Bonds

$
229.8

$
229.8

2.50
%Series 2001-1 Class B Asset Backed Bonds


35.4


35.4

3.65Series 2000-1 Class A Asset Backed Securities


200.0


22.6

3.06Total borrowings

$
465.2

$
287.8

2.69
%





|(a) |  | Excludes the cost of commitment fees and other facility fees.
|--- |  | -------------------------------------------------------------




See Note 4 to the Consolidated Financial Statements for further discussion of our borrowings.





Dividends





Prior to our conversion, we did not make
distributions to our stockholders, but instead retained all of our income. As a regulated investment company, we are required to distribute at least 90% of our investment company taxable income to avoid corporate level taxes on the amount
distributed and at least 98% of our investment company taxable income to avoid an excise tax. We intend to make distributions on a quarterly basis to our stockholders of all of our income, except for certain net capital gains and adjustments for
long-term incentive compensation expense.





We may not be able to achieve operating results that will allow us to
make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to




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make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the Investment Company Act of 1940 and due to provisions in our credit
facilities. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. We cannot assure shareholders that they will receive
any distributions or distributions at a particular level.





The following table summarizes our dividends declared
to date:





Declared

Date of Record

Payable

AmountSeptember 30, 2002

October 16, 2002

October 30, 2002

$
0.46June 3, 2002

June 11, 2002

July 31, 2002


0.47March 28, 2002

April 17, 2002

April 30, 2002


0.41December 31, 2001

January 22, 2002

January 31, 2002


0.86





The aggregate dividend of $0.86 per share in December 2001
consisted of a dividend of $0.25 per share for the fourth quarter of 2001 and an additional dividend of $0.61 per share representing the distribution of substantially all of our earnings and profits since inception through December 31, 2001,
including the period after we elected to be a business development company through the effective date of our election to be a regulated investment company for tax purposes. The aggregate dividend of $0.46 in September 2002 consisted of a dividend of
$0.43 per share for the third quarter of 2002 and an additional dividend of $0.03 per share which is expected to be the remaining distribution of our earnings and profits since inception through December 31, 2001. The aggregate dividend declared in
December 2001 along with the $0.03 dividend declared in September, 2002 were required for us to qualify as a regulated investment company.





Related Party Transactions





Prior to election to be regulated as a Business Development
Company, we terminated our stock option plan and adopted a restricted stock program under which we issued 1,539,851 shares of restricted common stock to employees and directors. The total number of shares issued for the termination of the option
plan was based upon the Black-Scholes option-pricing model and assumptions and approved by our Board of Directors. See Notes to Consolidated Financial Statements.





Immediately prior to the initial public offering, we issued 68,930 shares of common stock for the termination of all warrants held by Wachovia Corporation related to the
management buyout in 1998 without regard to exercise price. At that time, Wachovia Corporation was also a shareholder. The total number of shares issued for the termination of the warrants was based on the Black-Scholes option-pricing model and
assumptions negotiated with Wachovia Corporation and approved by our Board of Directors. In addition, we have a $200 million variable series securitization facility and a $265.2 million term funding securitization agreement that were arranged by
Wachovia Securities, an affiliate of Wachovia Corporation. Interest paid to an affiliate of Wachovia Corporation holding the Series 2000-1 Notes under the variable series securitization facility totaled $0.6 million and $1.6 million for the three
and nine months ended September 30, 2002 and $4.9 million for the year ended December 31, 2001.





We made cash
payments totaling $1.7 million to non-executive employees for the taxes imposed on them associated with the issuance of restricted common stock. The cash payments assumed a combined federal and state tax rate of 48% for each employee.





Additionally, in connection with the termination of our stock option plan, certain executive officers and employees purchased a
portion of the 1,539,851 shares of restricted common stock at a per share price of $17.00. Those executive officers and employees issued partially non-recourse notes to us, with an aggregate face value of $5.8 million secured by approximately 1.4
million shares with a value of $23.8 million at the initial public offering price. The notes are payable at the end of a four and a half-year term, subject to acceleration, bear interest at 4.13% payable annually and are secured by all of the
restricted common stock held by such employee and for some employees, for a specified time-period, additional shares of our common stock the employee owns. The notes are non-recourse as to the principal amount but recourse as to the interest.
Amounts due on these loans are reflected as a reduction of stockholders equity in the consolidated balance sheets.




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Heller Financial, Inc. provided our primary lending facility prior to December
28, 2001. At that time, Heller was a shareholder. Interest paid to Heller Financial, Inc., as agent, totaled $20.2 million for the year ended December 31, 2001. The Heller lending facility was paid off on December 28, 2001.





Critical Accounting Policies





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





Income Recognition





Interest on commercial loans is computed by methods that
generally result in level rates of return on principal amounts outstanding. When a loan becomes 90 days or more past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general
matter, place the loan on non-accrual status and stop recognizing interest income on that loan until all principal has been paid. However, we may make exceptions to this policy if the investment is well secured and in the process of collection.





In accordance with GAAP, we include in income certain amounts that we have not yet received in cash, such as
contractual payment-in-kind (PIK) interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term. However, in certain cases, a customer makes principal payments on its loan
prior to making payments to reduce the PIK loan balances and, therefore, in certain cases the PIK portion of a customers loan can increase while the total outstanding amount of the loan to that customer may stay the same or decrease. PIK loans
represented $22.4 million or 3.1% of our portfolio of investments as of September 30, 2002 and $14.2 million or 2.3% of our portfolio of investments as of December 31, 2001.





PIK related activity for the nine months ended September 30, 2002 follows:





(in millions)PIK loan balance December 31, 2001

$
14.2PIK interest earned during the period


11.3Change in interest receivable on PIK loans


(0.1
)Principal payments of cash on PIK loans


(3.0
)PIK loan balance September 30, 2002

$
22.4Additional principal collections during the nine months ending September 30, 2002 from customers with PIK related loans up to the amount of such PIK
loan balance

$
3.1





As of September 30, 2002, 86.3% of the $22.4 million of PIK loans
outstanding have an investment rating of 3 or better and as of December 31, 2001, 98.8% of the $14.2 million of PIK loans outstanding had an investment rating of 3 or better. The increase in loan balances as a result of contracted PIK arrangements
are separately identified on our consolidated statements of cash flows.





Loan origination fees paid up front are
deferred and amortized as adjustments to the related loans yield over the contractual life. In certain loan arrangements, warrants or other equity interests are received from the borrower as additional origination fees. The borrowers granting
these interests are typically non-publicly traded companies. We record the financial instruments received at estimated fair value as determined by our Board of Directors. Fair values are determined using various valuation models which attempt to
estimate the underlying value of the associated entity. These models are then applied to our ownership share considering any discounts for transfer restrictions or other terms which impact the value. Changes in these values are recorded through our




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statement of operations. Any resulting discount on the loan from recordation of warrant and other equity instruments are accreted into income over the term of the loan. We had $13.5 million and
$12.1 million of unearned fees as of September 30, 2002 and December 31, 2001, respectively. We recognized $4.4 million of these fees in income during the first nine months of 2002 and $4.7 million of these fees in income during 2001.





Valuation of Investments





Portfolio assets for which market prices are available are valued at those prices. However, substantially all of our assets were acquired in privately negotiated transactions and have no readily determinable market values.
These securities are carried at fair value as determined by our Board of Directors under our valuation policy. The valuation committee of our Board of Directors reviews our loans and investments and will make recommendations to our Board of
Directors.





As a general rule, we do not value our loans above cost, but loans will be subject to fair value
write-downs when the asset is considered impaired. Substantially all of our commercial loans bear interest at LIBOR-based variable rates, which include a base index rate and a spread that changes with the overall financial and operational
performance of the customer. In many cases, our loan agreements allow for increases in the spread to the base index rate if the financial or operational performance of the customer deteriorates or shows negative variances from the customers
business plan and, in some cases, allow for decreases in the spread if financial or operational performance improves or exceeds the customers plan.





With respect to private equity securities, each investment is valued using industry valuation benchmarks, and then the value is assigned a discount reflecting the illiquid nature of the investment, as
well as our minority, non-control position. When an external event such as a purchase transaction, public offering, or subsequent equity sale occurs, the pricing indicated by the external event will be used to corroborate our private equity
valuation. Securities that are traded in the over-the-counter market or on a stock exchange generally will be valued at the prevailing bid price on the valuation date. However, restricted and unrestricted publicly traded securities may be valued at
discounts from the public market value due to restrictions on sale, the size of our investment or market liquidity concerns.





Substantially all of our assets consist of securities carried at fair value as determined by our Board of Directors. Determination of fair value involves subjective judgments and the resultant values may not represent amounts at
which investments could be bought or sold if we were forced to immediately liquidate some or all of these investments and the differences could be material.





Securitization Transactions





Periodically, the Company transfers pools of loans to
special purpose entities (SPEs) for use in securitization transactions. These on-balance sheet securitization transactions comprise a significant source of our overall funding, with the total face amount of the outstanding loans assumed by third
parties equaling $526.0 million at September 30, 2002 and $421.1 million at December 31, 2001. On April 1, 2001, the Company adopted the requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, which applies prospectively to all securitization transactions occurring after March 31, 2001. Adoption of SFAS No. 140 did not have a material impact on the operations or financial position of the Company.
Transfers of loans have not met the requirements of SFAS No. 140 for sales treatment and are, therefore, treated as secured borrowings, with the transferred loans remaining in investments and the related liability recorded in borrowings.





Recent Developments





In October 2002, MCG discontinued the operations of Upside magazine owned by UMAC, Inc., one of its portfolio companies.







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In August 2002, we were awarded, through a bankruptcy proceeding, the right to acquire in satisfaction of outstanding
indebtedness the Arizona and North Carolina divisions of one of our portfolio companies, Intellisec Holdings, Inc. The Arizona division sale was completed in the third quarter of 2002 and is now controlled by us and being operated as a separate
portfolio company, Copperstate Technologies, Inc. In addition, in October 2002, the North Carolina division sale was completed and is now controlled by us and being operated as a separate portfolio company, Interactive Business Solutions. We do not
expect to realize a material gain or loss related to these transactions. However, there can be no assurance that a gain or loss will not occur upon the ultimate disposition of these divisions or upon the disposition of the remainder of our
investment in Intellisec Holdings, Inc.





In October 2002, three of our portfolio companies, Talk America Holdings,
Inc., Kings III of America, Inc. and Media Central LLC paid their outstanding loan balances in full, which aggregated approximately $30.0 million at September 30, 2002.





Item 3.    Quantitative and Qualitative Disclosures About Market Risk





Interest rate sensitivity refers to the change in earnings that may result from the 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. Over 88% of our loan portfolio bears interest at a spread to LIBOR, with the remainder bearing interest at a fixed rate or at a spread to a prime rate. Our interest rates on our borrowings are based on LIBOR and commercial
paper rates, with the majority based on LIBOR.





We regularly measure exposure to interest rate risk. We have
interest rate risk exposure mainly from the portion of the commercial loan portfolio funded using stockholders equity. Our Board of Directors assesses interest rate risk and we manage our interest rate exposure on an ongoing basis. The
following table shows a comparison of the interest rate base for our outstanding commercial loans and our outstanding borrowings:





September 30, 2002

December 31, 2001(dollars in millions)

CommercialLoans

Borrowings

CommercialLoans

BorrowingsPrime Rate

$
28.7

$


$
31.1

$
30-Day LIBOR


43.7





19.2


60-Day LIBOR








2.3


90-Day LIBOR


571.3


246.4


539.6


265.2Commercial Paper Rate





101.8





22.6Fed Funds Rate











Fixed Rate


57.2





3.8


$
700.9

$
348.2

$
596.0

$
287.8





Based on our September 30, 2002 balance sheet, for every 100 basis
point increase in interest rates, our annual interest income would increase by $5.4 million and our annual interest expense would increase by $3.5 million resulting in an increase in annual net income of $1.9 million, assuming no changes in our
investments or borrowing structure. For every 100 basis point decrease in interest rates, our annual interest income would decrease by $5.2 million and our annual interest expense would decrease by $3.5 million, resulting in a decrease in annual net
income of $1.7 million, assuming no changes in our investment and borrowing structure.





Based on our December 31,
2001 balance sheet, for every 100 basis point increase in interest rates, our annual interest income would increase by $5.9 million and our annual interest expense would increase by $2.7 million resulting in an increase in annual net income of $3.2
million, assuming no changes in our investments or borrowing structure. For every 100 basis point decrease in interest rates, our annual interest income would decrease by $5.9 million and our annual interest expense would decrease by $2.7 million,
resulting in a decrease in annual net income of $3.2 million, assuming no changes in our investment and borrowing structure.







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As a business development company, we will use a greater portion of equity to fund our business than we have in the past.
Accordingly, other things being equal, increases in interest rates will result in greater increases in our net interest income and reductions in interest rates will result in greater decreases in our net interest income compared with the effects of
interest rate changes on our results under the more highly leveraged capital structure we have maintained in the past.





Currently, we do not engage in hedging activities because we have determined that the cost of hedging the risks associated with interest rate changes outweighs the risk reduction benefit. We monitor this position on an ongoing basis.





Item 4.    Controls and Procedures





| | (a) |  | Within the 90 days prior to the date of this report, MCG carried out an evaluation, under the supervision and with the participation of MCGs management,
including MCGs Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer, of the effectiveness of the design and operation of MCGs disclosure controls and procedures (as defined in Rule 13a-14 of the
Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer, the President and Chief Operating Officer and the Chief Financial Officer have concluded that MCGs current disclosure controls and procedures are
effective in timely alerting them of material information relating to MCG that is required to be disclosed in MCGs SEC filings.
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (b) |  | There have not been any significant changes in the internal controls of MCG or other factors that could significantly affect these internal controls subsequent
to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




PART II.    OTHER INFORMATION





Item 1.    Legal Proceedings





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





Item 2.    Changes in Securities and Use of Proceeds





During the nine months ended September 30, 2002, MCG issued a total of 13,891 shares of common stock under its dividend reinvestment plan pursuant to an exemption from the registration requirements of the Securities Act of 1933. The
aggregate offering proceeds for the shares of common stock sold under the dividend reinvestment plan was approximately $0.2 million.





Item 3.    Defaults Upon Senior Securities





Not
Applicable.





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





Not Applicable.





Item 5.    Other Information





On November 1, 2002,
Bryan J. Mitchell, the Chief Executive Officer of the Company, informed the Companys Board of Directors that he had misrepresented his educational credentials. After an investigation by the Companys Audit Committee, the Board of
Directors voted to accept Mr. Mitchells resignation as Chairman of the Board; retain Mr. Mitchell as Chief Executive Officer; and amend Mr. Mitchells employment agreement.







41




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Pursuant to Mr. Mitchells amended employment agreement, Mr. Mitchell, among other things, is (i) ineligible for any
bonus in 2002; (ii) required to repay his 2001 bonus, net of taxes; and (iii) required to use dividends on his 363,693 shares of restricted stock, net of taxes, to repay his existing indebtedness to the Company.





Wallace B. Millner, chair of the Audit Committee, was elected by the Board as the Companys non-executive Chairman.





Item 6.    Exhibits and Reports on Form 8-K





(a)  Exhibits





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





ExhibitNumber

Description of Document3.2

Amended and Restated Bylaws.10.50

Deed of Lease by and between Twin Towers II Associates Limited Partnership, and landlord, and MCG Capital Corporation, as tenant, dated as of September 24,
2002.10.51

Amended and Restated Employment Agreement between MCG Capital Corporation and Bryan J. Mitchell dated November 3, 200299.1

Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).99.2

Certification of President and Chief Operating Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).99.3

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U. S. C. 1350).





(b) Form 8-K - On August 6, 2002, the registrant filed a Form 8-K disclosing that its
Chairman and CEO, Bryan J. Mitchell, certified certain of the Companys Exchange Act Filings to the Securities and Exchange Commission (SEC).







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##### Table of Contents

SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on November 14, 2002.





MCG CAPITAL CORPORATION





By: /s/ BRYAN J. MITCHELL


Bryan J.
Mitchell


Chief Executive Officer





By: /s/ STEVEN F. TUNNEY


Steven F. Tunney


President and Chief Operating Officer








By:/s/ JANET C. PERLOWSKI


Janet C. Perlowski


Chief Financial Officer




43




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##### Table of Contents




CERTIFICATION OF CHIEF EXECUTIVE OFFICER





I, Bryan J. Mitchell, Chief Executive Officer of MCG Capital
Corporation, hereby certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of MCG Capital Corporation;
|-- |  | ------------------------------------------------------------------------------




|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing the equivalent function):
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Dated this 14th day of November, 2002





/s/ Bryan J. Mitchell


Bryan J. Mitchell


Chief Executive Officer




44




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##### Table of Contents




CERTIFICATION OF PRESIDENT AND CHIEF OPERATING OFFICER





I, Steven F. Tunney, President and Chief Operating Officer of MCG Capital Corporation, hereby certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of MCG Capital Corporation;
|-- |  | ------------------------------------------------------------------------------




|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | d) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | e) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | f) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing the equivalent function):
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | c) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | d) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Dated this 14th day of November, 2002





/s/ Steven F. Tunney


Steven F. Tunney


President and Chief Operating Officer




45




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##### Table of Contents




CERTIFICATION OF CHIEF FINANCIAL OFFICER





I, Janet C. Perlowski, Chief Financial Officer of MCG Capital Corporation, hereby certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of MCG Capital Corporation;
|-- |  | ------------------------------------------------------------------------------




|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing the equivalent function):
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Dated this 14th day of November, 2002





/s/ Janet C. Perlowski


Janet C. Perlowski


Chief Financial Officer




46