UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-Q


(Mark One)


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


For the quarterly period ended September 30, 2013


OR


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


For the transition period from ______ to ______


___________________


Commission file number 0-33377


MCG CAPITAL CORPORATION


(Exact name of registrant as specified in its charter)


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


(703) 247-7500


(Registrant's telephone number, including area code)





None


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


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


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


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


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


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


As of October 25, 2013, there were 71,212,013 shares of the registrant’s $0.01 par value Common Stock outstanding.







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MCG CAPITAL CORPORATION


FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2013


TABLE OF CONTENTS








PART I. FINANCIAL INFORMATION1ITEM 1. FINANCIAL STATEMENTS1CONSOLIDATED BALANCE SHEETS1CONSOLIDATED STATEMENTS OF OPERATIONS2CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS3CONSOLIDATED STATEMENTS OF CASH FLOWS4CONSOLIDATED SCHEDULE OF INVESTMENTS5NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)12REVIEW REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM34ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS35ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK62ITEM 4. CONTROLS AND PROCEDURES63PART II. OTHER INFORMATION64ITEM 1. LEGAL PROCEEDINGS64ITEM 1A. RISK FACTORS64ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS66ITEM 3. DEFAULTS UPON SENIOR SECURITIES67ITEM 4. MINE SAFETY DISCLOSURES67ITEM 5. OTHER INFORMATION67ITEM 6. EXHIBITS68SIGNATURES69







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PART I. FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS


MCG Capital Corporation


Consolidated Balance Sheets


(in thousands, except per share amounts)September 30, 2013December 31, 2012(unaudited)AssetsCash and cash equivalents$96,384$73,588Cash, securitization accounts7,79316,980Cash, restricted38,40854,838Investments at fair valueNon-affiliate investments (cost of$480,467and $534,389, respectively)301,343365,639Affiliate investments (cost of$46,139and $69,500, respectively)47,22462,079Control investments (cost of$62,664and$64,898, respectively)46,96550,006Total investments (cost of$589,270and $668,787, respectively)395,532477,724Interest receivable4,3562,700Other assets3,5454,946Total assets$546,018$630,776LiabilitiesBorrowings (maturing within one year of$4,001and $15,038, respectively)$179,173$248,053Interest payable7252,496Other liabilities2,6198,499Total liabilities182,517259,048Stockholders’ equityPreferred stock, par value $0.01, authorized 1 share, none issued and outstanding——Common stock, par value $0.01, authorized 200,000 shares on September 30, 2013 and December 31, 2012,71,212issued and outstanding on September 30, 2013 and 71,721issued and outstanding on December 31, 2012712717Paid-in capital983,337984,468Distributions in excess of earnings(426,810)(422,395)Net unrealized depreciation on investments(193,738)(191,062)Total stockholders’ equity363,501371,728Total liabilities and stockholders’ equity$546,018$630,776Net asset value per common share at end of period$5.10$5.18





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


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MCG Capital Corporation


Consolidated Statements of Operations


(unaudited)


Three months endedNine months endedSeptember 30September 30(in thousands, except per share amounts)2013201220132012RevenueInterest and dividend incomeNon-affiliate investments (less than 5% owned)$10,060$9,174$28,915$35,401Affiliate investments (5% to 25% owned)1,2381,4184,5604,856Control investments (more than 25% owned)1,2891,2434,4624,696Total interest and dividend income12,58711,83537,93744,953Advisory fees and other incomeNon-affiliate investments (less than 5% owned)5702101,3441,357Control investments (more than 25% owned)1324251,262Total advisory fees and other income5832341,3692,619Total revenue13,17012,06939,30647,572Operating expenseInterest expense2,3162,9747,00312,728Employee compensationSalaries and benefits6442,0183,6108,684Amortization of employee restricted stock awards4205051,1741,694Total employee compensation1,0642,5234,78410,378General and administrative expense1,8242,5043,94210,714Restructuring expense2121459Total operating expense5,2068,01315,74333,879Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision7,9644,05623,56313,693Net realized gain (loss) on investmentsNon-affiliate investments (less than 5% owned)109—(658)12,550Affiliate investments (5% to 25% owned)(7)—(554)16,370Control investments (more than 25% owned)—(5,394)51(102,288)Total net realized gain (loss) on investments102(5,394)(1,161)(73,368)Net unrealized (depreciation) appreciation on investmentsNon-affiliate investments (less than 5% owned)(5,005)2,463(10,374)(13,892)Affiliate investments (5% to 25% owned)71(3,662)8,506(19,407)Control investments (more than 25% owned)2176,838(807)92,109Other fair value adjustments(1)(17)(1)(46)Total net unrealized (depreciation) appreciation on investments(4,718)5,622(2,676)58,764Net investment gain (loss) before income tax provision(4,616)228(3,837)(14,604)Loss on extinguishment of debt before income tax (benefit) provision———(174)Income tax provision5918111329Net income (loss)$3,289$4,266$19,615$(1,414)Income per basic and diluted common share$0.05$0.06$0.28$(0.02)Cash distributions declared per common share$0.125$0.14$0.38$0.45Weighted-average common shares outstanding—basic and diluted71,21873,43171,31374,588


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


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MCG Capital Corporation


Consolidated Statements of Changes in Net Assets


(unaudited)


Nine months endedSeptember 30(in thousands, except per share amounts)20132012Increase in net assets from operationsNet operating income before net investment loss, loss on extinguishment of debt and income tax provision$23,563$13,693Net realized loss on investments(1,161)(73,368)Net unrealized appreciation on investments(2,676)58,764Loss on extinguishment of debt before income tax provision—(174)Income tax provision(111)(329)Net income (loss)19,615(1,414)Distributions to stockholdersDistributions declared(26,706)(33,793)Net decrease in net assets resulting from stockholder distributions(26,706)(33,793)Capital share transactionsRepurchase of common stock(2,272)(22,416)Amortization of restricted stock awardsEmployee awards accounted for as employee compensation1,1741,694Non-employee director awards accounted for as general and administrative expense4353Common stock withheld to pay taxes applicable to the vesting of restricted stock(81)(336)Net decrease in net assets resulting from capital share transactions(1,136)(21,005)Total decrease in net assets(8,227)(56,212)Net assetsBeginning of period371,728434,952End of period$363,501$378,740Net asset value per common share at end of period$5.10$5.20Common shares outstanding at end of period71,21272,788





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


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MCG Capital Corporation


Consolidated Statements of Cash Flows


(unaudited)


Nine months endedSeptember 30(in thousands)20132012Cash flows from operating activitiesNet income (loss)$19,615$(1,414)Adjustments to reconcile net income to net cash provided by operating activitiesInvestments in portfolio companies(85,029)(42,619)Principal collections related to investment repayments or sales167,724314,598Decrease (increase) in interest receivable, accrued payment-in-kind interest and dividends(5,948)9,717Amortization of restricted stock awardsEmployee1,1741,694Non-employee director4353Decrease in cash—securitization accounts from interest collections2,4315,475Decrease in restricted cash—escrow accounts5,881327Depreciation and amortization1,0196,120Decrease in other assets5001,039Decrease in other liabilities(7,702)(1,676)Realized loss on investments1,16173,368Net unrealized appreciation on investments2,676(58,764)Loss on extinguishment of debt—174Net cash provided by operating activities103,545308,092Cash flows from financing activitiesRepurchase of common stock(2,272)(22,416)Payments on borrowings(68,879)(202,740)Proceeds from borrowings—21,400Decrease (increase) in cash in restricted and securitization accountsSecuritization accounts for repayment of principal on debt6,75631,156Restricted cash10,549(79,906)Payment of financing costs(116)(1,030)Distributions paid(26,706)(46,885)Common stock withheld to pay taxes applicable to the vesting of restricted stock(81)(336)Net cash used in financing activities(80,749)(300,757)Net increase in cash and cash equivalents22,7967,335Cash and cash equivalentsBeginning balance73,58858,563Ending balance$96,384$65,898Supplemental disclosure of cash flow informationInterest paid$7,802$9,261Income taxes paid15861Paid-in-kind interest collected2,1618,510Dividend income collected6808,149


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


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MCG Capital Corporation


Consolidated Schedule of Investments


September 30, 2013 (unaudited)


(dollars in thousands)


Interest Rate(8)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostControl Investments(4):GMC Television Broadcasting, LLC(2)BroadcastingSenior Debt (Due 12/16)(1)4.3%—4.3%$13,331$10,959$11,557Subordinated Debt (Due 12/16)(6)2.5%—2.5%11,5196,975—Class B Voting Units (8.0%, 86,700 units)(5)9,071—Jet Plastica Investors, LLC(2)(9)Plastic ProductsSenior Debt A (Due 3/15)(1)(6)2.4%7.5%9.9%5,2323,897—RadioPharmacy  Investors, LLC(2)HealthcareSenior Debt (Due 12/16)(1)7.5%—7.5%7,6407,6407,640Subordinated Debt (Due 12/16)(1)12.0%3.0%15.0%10,76210,75810,758Preferred LLC Interest (19.7%, 70,000 units)13,36417,010Total control investments (represents 11.9% of total investments at fair value)62,66446,965Affiliate Investments(3):C7 Data Centers, Inc.Business ServicesSenior Debt (Due 9/17)(1)9.5%—9.5%16,85016,56916,743Series B Preferred Units (10.0%, 7,142,857 units)2,2032,819Contract Datascan Holdings, Inc.Business ServicesSubordinated Debt (Due 3/16)(1)12.0%2.0%14.0%8,7068,2968,296Series A Preferred Stock (10.0%, 2,313 shares)(1)(5)2,3872,657Series B Preferred Stock (10.0%, 358 shares)(1)(5)307412Common Stock (8,519 shares)(1)(5)538—IDOC, LLCHealthcareSenior Debt (Due 8/17)(1)9.8%—9.8%15,00014,74614,746Limited Partner Interests (8.0%)(1)(2)1,0931,551Total affiliate investments (represents 11.9% of total investments at fair value)46,13947,224





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


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MCG Capital Corporation


Consolidated Schedule of Investments


September 30, 2013 (unaudited)


(dollars in thousands)


Interest Rate(8)Fair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalPrincipalCostNon-Affiliate Investments (less than 5% owned):Accurate Group Holdings, Inc.(2)Business ServicesSubordinated Unsecured Debt (Due 8/18)(1)12.5%—12.5%$10,000$9,822$9,822Series A Preferred Stock (974,805 shares)(5)2,0001,955Advanced Sleep  Concepts, Inc.(2)Home FurnishingsSenior Debt (Due 8/14 to 1/14)(1)10.3%—10.3%7,5597,5526,764Subordinated Debt (Due 1/14)(1)(6)—%10.0%10.0%3,6773,352—Broadview Networks Holdings, Inc.CommunicationsCommon Stock (132,779 shares)(5)159,579875Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)——Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)——Color Star Growers of Colorado, Inc.AgricultureSubordinated Debt (Due 11/16)(1)(6)12.0%3.0%15.0%13,86413,52213,195Community Investors, Inc.Business ServicesSenior Debt (Due 5/18)(1)9.8%—9.8%12,30012,06712,067Preferred Stock (10.0%, 297,436 shares)(1)309309Common Stock (2,564 shares)(1)(5)345Cruz Bay Publishing, Inc.PublishingSubordinated Debt (Due 3/15)(1)5.0%7.3%12.3%21,13021,08621,086Dorsey School of Business Holdings, Inc.EducationSenior Debt (Due 6/18)(1)9.5%—9.5%10,0009,8579,857Education Management, Inc.(11)EducationSenior Debt (Due 6/15)(1)10.5%—10.5%23,30023,17622,248G&L Investment Holdings, LLC(2)InsuranceSubordinated Debt (Due 5/14)(1)10.7%4.3%15.0%19,27519,17819,178Series A Preferred Shares (14.0%, 5,000,000 shares)(5)8,1914,934Class C Shares (621,907 shares)(5)529—Golden Knight II CLO, Ltd.(10)Diversified Financial ServicesIncome Notes (Due 4/19)2,5943,256Hammond's Candies Since 1920 II, LLCManufacturingSubordinated Debt (Due 9/18)(1)10.0%4.0%14.0%9,2849,1219,121Huron Inc.ManufacturingSubordinated Unsecured Debt (Due 8/18)(1)10.0%4.0%14.0%13,18712,94912,949Intrafusion Holding Corp.HealthcareSenior Debt (Due 6/18)(1)12.0%—12.0%11,50011,28111,281Legacy Cabinets Holdings II, Inc.Home FurnishingsClass B-1 Common Stock (2,000 shares)(5)2,18562Mailsouth, Inc.PublishingSenior Debt (Due 12/16)(1)6.8%—6.8%4,0804,0433,982Maverick HealthcareEquity, LLCHealthcarePreferred Units (10.0%, 1,250,000 units)(5)2,0212,013Class A Common Units (1,250,000 units)(5)——Midwest Technical Institute, Inc.EducationSenior Debt (Due 10/17)(1)9.5%—9.5%14,25013,97114,098Miles Media Group, LLC(2)Business ServicesSenior Debt (Due 6/16)(1)12.5%—12.5%19,36319,19719,197Oceans Acquisition, Inc.HealthcareSenior Debt (Due 12/17)(1)10.8%—10.8%12,71012,44312,443


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


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MCG Capital Corporation


Consolidated Schedule of Investments


September 30, 2013 (unaudited)


(dollars in thousands)


Interest Rate(8)PrincipalCostFair ValuePortfolio CompanyIndustryInvestmentCurrentPIKTotalRita’s Water Ice Franchise Company, LLCRestaurantsSenior Debt (Due 11/16)(1)14.0%—14.0%$9,375$9,315$9,315Sagamore Hill Broadcasting, LLC(2)BroadcastingSenior Debt (Due 8/14)(1)10.5%—10.5%8,9008,8688,868SC Academy Holdings, Inc.EducationSubordinated Debt (Due 7/16)(1)—%14.0%14.0%14,12914,06014,060South Bay Mental Health Center, Inc.HealthcareSubordinated Debt (Due 10/17)(1)12.0%2.5%14.5%18,68318,37918,478Summit Business Media Parent Holding Company LLCInformation ServicesClass E Series I Units (636 units)(1)(5)4,120547Class E Series II Units (276 units)(1)(5)1,78860Ted's Café Escondido Holdings, Inc.RestaurantsSenior Debt (Due 12/18)(1)9.5%—9.5%14,00013,67613,676The e-Media Club I, LLCInvestment FundLLC Interest (74 units)(5)8811Virtual Radiologic CorporationHealthcareSenior Debt (Due 12/16)(1)7.3%—7.3%13,63513,5168,675Visant CorporationConsumer ProductsSenior Debt (Due 12/16)(1)5.3%—5.3%4,7114,7114,581West World Media, LLCInformation ServicesSenior Debt (Due 9/15)(1)11.0%3.0%14.0%11,50711,09311,199Class A Membership Units (25,000 units)(1)(5)1390Warrant to purchase Class A Membership Units (expire 9/15)(1)(5)324378Xpressdocs Holdings, Inc.Business ServicesSeries A Preferred Stock (161,870 shares)(5)500368Total non-affiliate investments (represents 76.2% of total investments at fair value)480,467301,343Total Investments$589,270$395,532





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


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MCG Capital Corporation


Consolidated Schedule of Investments


December 31, 2012


(dollars in thousands)


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





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


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MCG Capital Corporation


Consolidated Schedule of Investments


December 31, 2012


(dollars in thousands)


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


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


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MCG Capital Corporation


Consolidated Schedule of Investments


December 31, 2012


(dollars in thousands)


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





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


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MCG Capital Corporation


Consolidated Schedule of Investments





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

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

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

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

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

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

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

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

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|(9) | During the three months ended June 30, 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets.  Including the proceeds from the liquidation, we have received $11.0 million of payments on our senior debt.

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|(10) | Investment is not a qualifying asset under section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of total assets at the time of acquisition of any additional non-qualifying assets.

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|(11) | In October 2013, we signed a letter of intent to exchange $5.0million of our senior debt to Education Management, Inc. for $5.0million of a new class of preferred stock of Education Management, Inc.  If the transaction is consummated as contemplated, Education Management, Inc. will become an affiliate.







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


Notes to the Condensed Consolidated Financial Statements (Unaudited)


NOTE 1—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION


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


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


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


Small Business Investment Subsidiaries —We own Solutions Capital I, L.P., or Solutions Capital, a wholly owned subsidiary licensed by the United States Small Business Administration, or SBA, which operates as a small business investment company, or SBIC, under the Small Business Investment Act of 1958 , as amended, or SBIC Act.  In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L.P. in order to apply for a second SBIC license.  In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013 and was accepted by the SBA in May 2013.  Neither receipt of such an invitation nor acceptance of the application from the SBA assures an applicant that the SBA will grant the additional license in any specified time period or at all.  MCG is also the sole member of Solutions Capital G.P., LLC, which acts as the general partner of Solutions Capital and Solutions Capital II, L.P.


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


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


BASIS OF PRESENTATION AND USE OF ESTIMATES


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


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Consolidated Financial Statements , we have evaluated subsequent events that occurred after the balance sheet date as of September 30, 2013 through the date these financial statements were issued.


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


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


NOTE 2—INVESTMENT PORTFOLIO


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


COST BASISFAIR VALUE BASISSeptember 30, 2013December 31, 2012September 30, 2013December 31, 2012(dollars in thousands)Investments at Cost% of Total PortfolioInvestments at Cost% of Total PortfolioInvestments at Fair Value% of Total PortfolioInvestments at Fair Value% of Total PortfolioDebt InvestmentsSenior secured debt$228,57738.8%$297,84244.6%$218,93755.4%$291,76061.1%Subordinated debtSecured124,72721.2127,28819.0114,17328.8114,98324.1Unsecured22,7713.826,2743.922,7715.826,2745.4Total debt investments376,07563.8451,40467.5355,88190.0433,01790.6Equity investmentsPreferred44,0417.546,4036.937,2849.441,5588.7Common/common equivalents169,15428.7170,98025.62,3670.63,1490.7Total equity investments213,19536.2217,38332.539,65110.044,7079.4Total investments$589,270100.0%$668,787100.0%$395,532100.0%$477,724100.0%


Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0% , a portion of which may be in the form of paid-in-kind interest, or PIK.  As of September 30, 2013 , approximately 72.8% of the fair value of our loan portfolio had variable interest rates, based on a London Interbank Offer Rate, or LIBOR, benchmark or the prime rate, and 27.2% of the fair value of our loan portfolio had fixed interest rates.  As of September 30, 2013 , approximately 63.6% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR-based index and prime floors between 2.5% and 6.0% .  At origination, our loans generally have four- to six-year stated maturities.  Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.


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


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


COST BASISFAIR VALUE BASISSeptember 30, 2013December 31, 2012September 30, 2013December 31, 2012(dollars in thousands)Investments at Cost% of Loan PortfolioInvestments at Cost% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioLoans greater than 90 days past dueOn non-accrual status$3,8971.04%$3,8970.86%$——%$——%Not on non-accrual status————————Total loans greater than 90 days past due$3,8971.04%$3,8970.86%$——%$——%Loans on non-accrual status0 to 90 days past due$23,8496.34%$12,8802.85%$13,1953.71%$6070.14%Greater than 90 days past due3,8971.043,8970.86————Total loans on non-accrual status$27,7467.38%$16,7773.71%$13,1953.71%$6070.14%


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


September 30, 2013December 31, 2012(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioHealthcare$104,59826.4%$106,11922.2%Business services74,68918.964,94713.6Education60,26215.259,78312.5Publishing25,0696.430,6466.4Insurance24,1126.126,5295.6Restaurants22,9915.89,3011.9Manufacturing22,0705.628,7286.0Broadcasting20,4245.225,3725.3Agriculture13,1953.321,7814.6Information services12,5733.212,6462.7Home furnishings6,8261.77,8061.6Consumer products4,5811.24,3380.9Auto parts——6,4341.3Cable——5,0611.1Electronics——33,3617.0Logistics——27,2375.7Other(a)4,1421.07,6351.6Total$395,532100.0%$477,724100.0%______________________(a)No individual industry within this category exceeds 1%.


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NOTE 3—FAIR VALUE MEASUREMENT


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


Fair Value Hierarchy


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


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


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


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Assets Measured at Fair Value on a Recurring Basis


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


September 30, 2013(in thousands)Internal Models with SignificantTotal Fair Value  Reported in  Consolidated  Balance SheetObservable Market Parameters(Level 2)Unobservable  Market Parameters(Level 3)Non-affiliate investmentsSenior secured debt$17,239$151,012$168,251Subordinated secured debt—95,11895,118Unsecured subordinated debt—22,77122,771Preferred equity3,2569,58012,836Common/common equivalents—2,3672,367Total non-affiliate investments20,495280,848301,343Affiliate investmentsSenior secured debt—31,48931,489Subordinated secured debt—8,2978,297Preferred equity—7,4387,438Total affiliate investments—47,22447,224Control investmentsSenior secured debt—19,19719,197Subordinated secured debt—10,75810,758Preferred equity—17,01017,010Total control investments—46,96546,965Total assets at fair value$20,495$375,037$395,532


As of September 30, 2013 , we had no investments that had quoted market prices in active markets which we would categorize as Level 1 investments under ASC 820.  Cash and cash equivalents are carried at cost which approximates fair value and are Level 1 assets.


Valuation Methodologies and Procedures


As required by the 1940 Act, we classify our investments by level of control.  Control investments include both majority-owned control investments and non-majority owned control investments.  A majority-owned control investment represents a security in which we own more than 50% of the voting interest of the portfolio company and generally control its board of directors.  A non-majority owned control investment represents a security in which we own 25% to 50% of the portfolio company’s voting equity.  As of each of September 30, 2013 and December 31, 2012, our portfolio contained zero non-majority control investments.  Non-control investments represent both affiliate and non-affiliate securities for which we do not have a controlling interest.  Affiliate investments represent securities in which we own 5% to 25% of the portfolio company’s equity.  Non-affiliate investments represent securities in which we own less than 5% of the portfolio company’s equity.


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|• | Majority-Owned Control Investments—Majority-owned control investments comprised11.9%of our investment portfolio as ofSeptember 30, 2013.  Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value.  Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value.  Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question.  Also, in a limited number of cases, we use income approaches to determine fair value, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs.  Our valuation approaches for majority-owned investments estimate the value upon a hypothetical sale or exit and then allocate such value to the investment's securities in order of their relative liquidation preference.  In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par.  These valuation approaches consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit.

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|• | Non-Control Investments—Non-control investments comprised88.1%of our investment portfolio as ofSeptember 30, 2013.  Quoted prices were not available for94.1%of our non-control investments as of

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September 30, 2013 .  For our non-control equity investments, we use the same market and income approaches used to value our control investments.  For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates.  We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower.  In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.


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|• | Thinly Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end.  However, we may apply a discount to the market value of restricted or thinly-traded public securities to reflect the impact that these restrictions have on the value of these securities.  We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2).  As ofSeptember 30, 2013, these securities represented5.2%of our investment portfolio.  We utilize independent pricing services to arrive at certain of our fair value estimates.  The majority of our level 2 investments are senior debt investments that are secured and collateralized.  To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.

Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales.  Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks.  We also use independent valuation firms to provide additional data points for our quarterly valuation analyses.  Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months.  In total, as of September 30, 2013 , we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve-month period for 99.0% of our investment portfolio, calculated on a fair value basis.


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


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


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


Changes in Level 3 Fair Value Measurements


We classify securities in the Level 3 valuation hierarchy based on the significance of the unobservable factors to the overall fair value measurement.  Our fair value approach for Level 3 securities primarily uses unobservable inputs, but may also include observable, actively quoted components derived from external sources.  Accordingly, the gains and losses in the table below include fair value changes due, in part, to observable factors.  Additionally, we transfer investments in and out of Level 1, 2 and 3 securities as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.  During the three and nine months ended September 30, 2013 and 2012 , there were no transfers in or out of Level 1, 2 or 3.


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


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


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


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The following table provides a reconciliation of fair value changes during the three -month period ended September 30, 2012 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value as of June 30, 2012Senior secured debt$197,716$21,718$34,817$254,251Subordinated secured debt64,65513,41210,43688,503Preferred equity14,1402,66215,75432,556Common/common equivalents equity1,883——1,883Total fair value as of June 30, 2012278,39437,79261,007377,193Realized/unrealized gain (loss)Senior secured debt(10)(848)857(1)Subordinated secured debt1,848(2,239)—(391)Preferred equity310(517)588381Common/common equivalents equity(33)(61)—(94)Total realized/unrealized gain (loss)2,115(3,665)1,445(105)IssuancesSenior secured debt94524,3381225,295Subordinated secured debt5677081718Preferred equity463,3194823,847Common/common equivalents equity—61—61Total issuances1,55827,78857529,921SettlementsSenior secured debt(23,777)——(23,777)Subordinated secured debt(9,290)(349)—(9,639)Preferred equity——2323Total settlements(33,067)(349)23(33,393)Fair value as of September 30, 2012Senior secured debt174,87445,20835,686255,768Subordinated secured debt57,78010,89410,51779,191Preferred equity14,4965,46416,84736,807Common/common equivalents equity1,850——1,850Total fair value as of September 30, 2012$249,000$61,566$63,050$373,616


There were no purchases or sales of level 3 investments during the three months ended September 30, 2012 .


Unrealized (Depreciation) Appreciation of Level 3 Investments


The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the three months ended September 30, 2013 and 2012 :


Three months ended September 30, 2013Three months ended September 30, 2012(in thousands)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalNon-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalChange in unrealized appreciation (depreciation)Senior secured debt$(1,379)$(35)$5$(1,409)$(10)$(848)$857$(1)Subordinated secured debt(372)——(372)1,983(2,239)—(256)Preferred equity(3,134)106211(2,817)310(517)611404Common/common equivalents equity(108)——(108)(33)(61)—(94)Total change in unrealized appreciation (depreciation) on Level 3 investments$(4,993)$71$216$(4,706)$2,250$(3,665)$1,468$53


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


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value December 31, 2012Senior secured debt$163,125$48,060$23,376$234,561Subordinated secured debt96,5857,88010,518114,983Unsecured subordinated debt26,274——26,274Preferred equity16,5616,03816,11238,711Common/common equivalents equity3,048101—3,149Total fair value December 31, 2012305,59362,07950,006417,678Realized/unrealized gain (loss)Senior secured debt(140)1671138Subordinated secured debt(473)190—(283)Preferred equity(3,289)1,189(820)(2,920)Common/common equivalents equity(681)2,899—2,218Total realized/unrealized gain (loss)(4,583)4,445(809)(947)IssuancesSenior secured debt87,157(9,020)4978,186Subordinated secured debt8,4162372408,893Unsecured subordinated debt13,432——13,432Preferred equity4062111,7182,335Common/common equivalents equity3——3Total issuances109,414(8,572)2,007102,849SettlementsSenior secured debt(81,900)(7,718)(4,239)(93,857)Subordinated secured debt(9,410)(10)—(9,420)Unsecured subordinated debt(16,935)——(16,935)Total settlements(108,245)(7,728)(4,239)(120,212)SalesSenior secured debt(17,230)——(17,230)Preferred equity(4,098)——(4,098)Common/common equivalents equity(3)(3,000)—(3,003)Total sales(21,331)(3,000)—(24,331)Fair value as of September 30, 2013Senior secured debt151,01231,48919,197201,698Subordinated secured debt95,1188,29710,758114,173Unsecured subordinated debt22,771——22,771Preferred equity9,5807,43817,01034,028Common/common equivalents equity2,367——2,367Total fair value as of September 30, 2013$280,848$47,224$46,965$375,037


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


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The following table provides a reconciliation of fair value changes during the nine -month period ended September 30, 2012 for all investments for which we determine fair value using unobservable (Level 3) factors:


(in thousands)Fair value measurements using unobservable inputs (Level 3)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalFair value December 31, 2011Senior secured debt$280,371$40,572$62,615$383,558Subordinated secured debt100,96712,96710,355124,289Unsecured subordinated debt12,203——12,203Preferred equity28,97812,45346,29387,724Common/common equivalents equity18,6453,610—22,255Total fair value December 31, 2011441,16469,602119,263630,029Realized/unrealized gain (loss)Senior secured debt980(3,499)4,6432,124Subordinated secured debt(1,790)(2,053)—(3,843)Unsecured subordinated debt(194)—8(186)Preferred equity(903)2,479(14,828)(13,252)Common/common equivalents equity9337—130Total realized/unrealized gain (loss)(1,814)(3,036)(10,177)(15,027)IssuancesSenior secured debt4,78727,93510332,825Subordinated secured debt9,52132924110,091Unsecured subordinated debt172——172Preferred equity4153,3651,4375,217Common/common equivalents equity—61—61Total issuances14,89531,6901,78148,366SettlementsSenior secured debt(111,264)(19,800)(31,675)(162,739)Subordinated secured debt(50,918)(349)(79)(51,346)Unsecured subordinated debt(12,181)—(8)(12,189)Preferred equity(12,103)—(192)(12,295)Common/common equivalents equity(16,844)——(16,844)Total settlements(203,310)(20,149)(31,954)(255,413)SalesPreferred equity(1,891)(12,833)(15,863)(30,587)Common/common equivalents equity(44)(3,708)—(3,752)Total sales(1,935)(16,541)(15,863)(34,339)Fair value as of September 30, 2012Senior secured debt174,87445,20835,686255,768Subordinated secured debt57,78010,89410,51779,191Preferred equity14,4965,46416,84736,807Common/common equivalents equity1,850——1,850Total fair value as of September 30, 2012$249,000$61,566$63,050$373,616


There were no purchases of level 3 investments during the nine months ended September 30, 2012 .


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Unrealized (Depreciation) Appreciation of Level 3 Investments


The following table summarizes the unrealized appreciation (depreciation) that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the nine months ended September 30, 2013 and 2012 :


Nine months ended September 30, 2013Nine months ended September 30, 2012(in thousands)Non-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalNon-affiliate InvestmentsAffiliate InvestmentsControl InvestmentsTotalChange in unrealized appreciation (depreciation)Senior secured debt$(252)$174$11$(67)$1,175$(3,499)$4,156$1,832Subordinated secured debt1,560190—1,750(1,484)(2,053)—(3,537)Unsecured subordinated debt————81——81Preferred equity(3,086)1,189(820)(2,717)(62)(129)(13,759)(13,950)Common/common equivalents equity1,02223—1,04569(669)—(600)Total change in unrealized appreciation (depreciation) on Level 3 investments$(756)$1,576$(809)$11$(221)$(6,350)$(9,603)$(16,174)


Significant Unobservable Inputs


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


The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2013 :


($ in thousands)Fair ValueValuation TechniquesUnobservable InputsRangeWeighted AverageMinimumMaximumSenior debt$201,698Discounted cash flowMarket interest rate5.7%12.7%8.8%Discounted cash flowDiscount rate4.0%4.0%4.0%Market comparable companiesRevenue Multiple0.2x0.2x0.2xMarket comparable companiesEBITDA multiple(a)7.5x7.5x7.5xSubordinated debt136,944Discounted cash flowMarket interest rate12.2%16.7%13.7%Market comparable companiesRevenue multiple0.2x0.2x0.2xMarket comparable companiesEBITDA multiple(a)7.5x7.5x7.5xPreferred and common equity36,395Market comparable companiesEBITDA multiple(a)4.4x10.0x7.7xDiscount for minority interest—%25.0%2.5%Residual assetsDiscount rate25.0%25.0%25.0%$375,037


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

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NOTE 4—CONCENTRATIONS OF INVESTMENT RISK


During the nine months ended September 30, 2013 , we had concentrations in certain industries, including the healthcare, business services and education industries.  The following table summarizes our fair value and revenue concentrations in each of those industries:


Investments at fair valueRevenue for the nine months endedSeptember 30, 2013December 31, 2012September 30, 2013September 30, 2012(dollars in thousands)Amount% of Total PortfolioAmount% of Total PortfolioAmount% of Total RevenueAmount% of Total RevenueIndustryHealthcare$104,59826.4%$106,11922.2%$10,18925.9%$7,02314.8%Business services74,68918.964,94713.66,07315.45,65811.9Education60,26215.259,78312.54,92212.54,3489.1


NOTE 5—BORROWINGS


As of September 30, 2013 , we reported $179.2 million of borrowings on our Consolidated Balance Sheets at cost.  The following table summarizes our borrowing facilities, the facility amounts and amounts outstanding.


September 30, 2013December 31, 2012(dollars in thousands)Maturity DateTotal Facility/ ProgramAmount OutstandingTotal Facility/ ProgramAmount OutstandingSBIC2008-10BSeptember 2018$2,600$2,600$2,600$2,6002009-10AMarch 201912,00012,00012,00012,0002009-10BSeptember 201913,00013,00013,00013,0002010-10BSeptember 202027,50027,50027,50027,5002011-10AMarch 202153,50053,50053,50053,5002012-10AMarch 202241,40041,40041,40041,400MCG Commercial Loan Trust 2006-1Series 2006-1 Class B Notes(a)April 2018(b)——37,15137,151Series 2006-1 Class C Notes(a)(c)April 2018(b)38127145,00032,000Series 2006-1 Class D Notes(d)April 2018(b)45,94528,90245,94528,902Bank of America Unsecured RevolverUnsecured Revolving NoteNovember 201420,000—20,000—Total borrowings$216,326$179,173$298,096$248,053__________(a)In April 2013, the Class B Notes were repaid in full and, in October 2013, the Class C Notes were repaid in full.(b)Borrowings under the MCG Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt.(c)Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.(d)Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.


We estimate that the fair value of these borrowings as of September 30, 2013 was approximately $181.7 million, based on market data and current interest rates.  This fair value is estimated from market quotes in an inactive market provided by an independent pricing service for $28.4 million of our borrowings (level 2) and a market-yield approach for $153.3 million (level 3) of our borrowings.


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


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our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have an asset coverage ratio of at least 200% after deducting the amount of such dividend, distribution or purchase price.  If we are unable to meet this asset coverage requirement, we may not be able to incur additional debt.  As of September 30, 2013 , our ratio of total assets to total borrowings and other senior securities was 1,338% .  In October 2008, we received exemptive relief from the SEC which allows us to exclude debt issued by Solutions Capital from the calculation of our consolidated BDC asset coverage ratio.


Each of our borrowing facilities has certain financial covenants and non-financial covenants.  We were in compliance with the covenants as of September 30, 2013 and 2012 .


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


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


(in thousands)September 30, 20132013(a)$4,0012014—2015—2016—2017—Thereafter175,172Total$179,173


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

SBIC Debentures


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


In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L. P. in order to apply for a second SBIC license.  In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013 and was accepted by the SBA in May 2013.  Neither receipt of such an invitation nor acceptance of the application from the SBA assures an applicant that the SBA will grant the additional license in any specified time period or at all.  Currently, a second SBIC license would grant us the ability to borrow up to an additional $75.0 million from the SBA, or two times the amount of statutory equity capital we invest in Solutions Capital II, L.P.  If approved and depending on available capital, we intend to fund the entire $37.5 million using unrestricted cash.  In the second quarter of 2013, we invested $10.0 million of unrestricted cash in Solutions Capital II, L.P. and funded a small business loan to Dorsey School of Business Holdings, Inc, or Dorsey.  We also received pre-licensing investment approval from the SBA for the Dorsey investment which, if closed in accordance with our pre-investment documentation, will count toward the required statutory capital of $37.5 million in our second SBIC.


To realize the full $150.0 million in borrowings for which we have received approval to date under the SBIC program, we have funded a total of $75.0 million to Solutions Capital.  As of each of September 30, 2013 and December 31, 2012 , Solutions Capital had borrowed $150.0 million.  We are permitted to use these funds to provide debt and equity capital to qualifying small businesses.  However, we may not use these borrowings to provide additional financing to certain companies that are currently in our portfolio without SBA approval.  In addition, we may not use these funds to provide working capital to MCG, Solutions Capital's parent company.


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As of September 30, 2013 and December 31, 2012 , we had $209.8 million and $187.9 million, respectively, of investments in Solutions Capital and we had $36.7 million and $48.3 million, respectively, of restricted cash to be used for additional investments in Solutions Capital.


As of September 30, 2013 , Solutions Capital had borrowings outstanding as summarized in the following table:


Amount Outstanding(dollars in thousands)September 30, 2013December 31, 2012RateTranche2008-10B$2,600$2,6006.44%Fixed2009-10A12,00012,0005.34%Fixed2009-10B13,00013,0004.95%Fixed2010-10B27,50027,5003.93%Fixed2011-10A53,50053,5004.80%Fixed2012-10A41,40041,4003.38%FixedTotal$150,000$150,0004.33%


MCG Commercial Loan Trust 2006-1


In April 2006, we completed a $500.0 million debt securitization through the MCG Commercial Loan Trust 2006-1, or 2006-1 Trust, a wholly owned subsidiary.  The 2006-1 Trust issued $106.25 million of Class A-1 Notes, $50.0 million of Class A-2 Notes, $85.0 million of Class A-3 Notes, $58.75 million of Class B Notes, $45.0 million of Class C Notes and $47.5 million of Class D Notes.  The respective classes of notes were issued with interest at LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%.  As of September 30, 2013 , we have repaid all of the Class A and Class B Notes.


All of the notes are secured by the assets of the 2006-1 Trust. The following table summarizes the fair value of the assets securitized under this facility as of September 30, 2013 and December 31, 2012 :


(dollars in thousands)September 30, 2013December 31, 2012Amount%Amount%Securitized assetsSenior secured debt$59,69260.9%$136,51374.2%Subordinated secured debt30,00130.630,02516.3Common Equity6060.64520.3Total securitized assets90,29992.1166,99090.8Cash, securitization accounts7,7937.916,9809.2Total collateral$98,092100.0%$183,970100.0%


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


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


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Bank of America Unsecured Revolver


In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or Bank of America Unsecured Revolver.  The Bank of America Unsecured Revolver will expire in November 2014.  In August 2013, we executed an amendment to the Bank of America Unsecured Revolver that requires that we maintain a zero balance for a period of at least five consecutive days during the six-month period immediately preceding June 30th and December 31st of each year, which testing was previously required quarterly.  In the event we borrow under the Bank of America Unsecured Revolver, we agreed to increase the interest rate on such advances from LIBOR plus 3.5% to LIBOR plus 4.0%.  As of September 30, 2013 , there were no borrowings outstanding on the Bank of America Unsecured Revolver.


The Bank of America Unsecured Revolver is subject to certain collateral requirements and financial covenants.  Included among them are requirements that we maintain a ratio of all unencumbered assets to outstanding amounts under the Bank of America Unsecured Revolver of at least four-to-one, as well as a ratio of unencumbered cash and senior portfolio loans to outstanding amounts under the Bank of America Unsecured Revolver of at least three-to-one.  The Bank of America Unsecured Revolver may be prepaid at any time.


NOTE 6—CAPITAL STOCK


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


STOCK REPURCHASE PROGRAM


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million.  During the three months ended September 30, 2013 , we did not repurchase any shares of our common stock.  During the nine months ended September 30, 2013 , we repurchased 504,639 shares of our common stock at a weighted average purchase price of $4.50 per share, which was a 13.1% discount from our quarterly net asset value per share.  On October 25, 2013, our board of directors authorized an additional stock repurchase program of up to $25.0 million.  See Note 14—Subsequent Event. Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.


We requested and received the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engage in a stock repurchase program and agree not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans.  Although there were 1,239,074 shares of our common stock available for issuance under our Third Amended and Restated 2006 Employee Restricted Stock Plan, as of September 30, 2013 and December 31, 2012, an aggregate of 40,505 and 107,924 shares of restricted stock, respectively, could be issued under our Third Amended and Restated 2006 Employee Restricted Stock Plan and our Third Amended and Restated 2006 Non-Employee Director Restricted Stock Plan before reaching the 10% threshold set forth in the SEC's order.  The decrease in shares that could be issued under the restricted stock plans is attributable to the shares we repurchased under our stock repurchase program.


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DISTRIBUTIONS


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


Date DeclaredRecord DatePayment DateAmountOctober 25, 2013November 8, 2013November 22, 2013$0.125July 26, 2013August 9, 2013August 30, 2013$0.125April 26, 2013May 10, 2013May 31, 2013$0.125March 1, 2013March 15, 2013March 29, 2013$0.125October 26, 2012November 16, 2012November 30, 2012$0.125July 27, 2012August 17, 2012August 31, 2012$0.140April 27, 2012June 13, 2012July 13, 2012$0.140February 24, 2012April 13, 2012May 15, 2012$0.170


NOTE 7—SHARE-BASED COMPENSATION


EMPLOYEE SHARE-BASED COMPENSATION


Third Amended and Restated 2006 Employee Restricted Stock Plan


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


During the nine months ended September 30, 2013 , no shares of restricted stock were issued under the 2006 Plan.  During nine months ended September 30, 2012 , we issued 1,000,000 shares of restricted stock under the 2006 Plan with a weighted-average fair value per share of common stock at the award date of $4.43.


During the nine months ended September 30, 2013 and 2012 , we recognized $1.2 million and $1.7 million, respectively, of compensation expense related to share-based compensation awards.  As of September 30, 2013 , all the restricted share awards for which forfeiture provisions had not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares.  As of September 30, 2013 , we had $3.2 million of unrecognized compensation cost related to restricted common stock awarded to employees.  We expect to recognize these costs over the remaining weighted-average requisite service period of 2.3 years.


Non-Employee Director Share-Based Compensation


During June 2006, our stockholders initially approved the 2006 Non-Employee Director Restricted Stock Plan, which was subsequently amended and restated and which we refer to as the 2006 Non-Employee Plan.  In May 2010, our stockholders approved an amendment to the 2006 Non-Employee Plan that increased the number of shares we may award to non-employee members of our board of directors from 100,000 to 150,000 shares.  During the nine months ended September 30, 2013 and 2012 , we awarded 15,000 and 22,500 shares, respectively, of restricted common stock to non-employee directors.  During the nine months ended September 30, 2013 and 2012 , we recognized less than $0.1  million of compensation costs related to share-based awards to non-employee directors.  We include this compensation cost in general and administrative expense on our Consolidated Statements of Operations .  As of September 30, 2013 , we had $0.1 million of unrecognized compensation cost related to restricted common stock awarded to non-employee directors, which we expect to recognize over the remaining weighted-average requisite service period of 2.0 years.


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


The following table summarizes our restricted stock award activity during the nine months ended September 30, 2013 :


SharesWeighted-Average Grant Date Fair Value per ShareSubject to forfeiture provisions as of December 31, 20121,142,020$4.70Awarded15,000$5.01Forfeiture provision satisfied(60,660)$6.55Forfeited(3,620)$7.09Subject to forfeiture provisions as of September 30, 20131,092,740$4.58


NOTE 8—CORPORATE RESTRUCTURING


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


During the nine months ended September 30, 2013 , we incurred $14,000 of restructuring expenses related to severance obligations, which we reported as a separate line item on our Consolidated Statements of Operations .


We included liabilities associated with our restructuring in other liabilities on our Consolidated Balance Sheets .  The following table summarizes changes in the balance of our restructuring liabilities from January 1, 2013 through September 30, 2013 :


(in thousands)SeveranceBenefitsOtherTotalBalance as of December 31, 2012$648$21$669Additions—(11)(11)Accretion14—14Cash payments(662)(10)(672)Balance as of September 30, 2013$—$—$—


NOTE 9—INCOME TAXES


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


We use the asset and liability method to account for our Taxable Subsidiaries' income taxes.  Using this method, we recognize deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and the tax basis of assets and liabilities.  In addition, we recognize deferred tax benefits associated with net operating carryforwards that we may use to offset future tax obligations.  We measure deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences.  During the nine months ended September 30, 2013 and 2012 , we recorded income tax provisions of $0.1 million and $0.3 million, respectively, which were primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


From December 2001 through September 30, 2013 , we declared aggregate per share distributions of $13.76 .  Each year, we mail statements on Form 1099-DIV to our stockholders that identify whether we made distributions from ordinary income, net capital gains on the sale of securities, which are each taxable distributions, and/or a return of paid-in-capital surplus, which is a nontaxable distribution.  A portion of our distributions may represent a return of capital to our stockholders, to the extent that the total distributions paid in a given year exceed current and accumulated taxable earnings and profits.  All or a portion of the distributions that we paid to stockholders during fiscal years 2012, 2011, 2008, 2006, 2005, 2004 and 2003 represented a return of capital.


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We determine the tax attributes of our distributions as of the end of our fiscal year based upon our taxable income for the full year and distributions paid during the full year.  Therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.  If we determined the tax attributes of our distributions as of September 30, 2013 , 75% would be from ordinary income and 25% would be a return of capital.  Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.


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


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


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


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NOTE 10—EARNINGS PER SHARE


The following table sets forth the computation of basic and diluted income per common share for the three and nine months ended September 30, 2013 and 2012 :


(dollars in thousands, except per share amounts)Three months ended September 30,Nine months ended September 30,2013201220132012Numerator for basic and diluted earnings per shareNet income (loss)$3,289$4,266$19,615$(1,414)Less: Dividends declared—common and restricted shares(8,902)(10,274)(26,706)(33,793)Undistributed loss(5,613)(6,008)(7,091)(35,207)Percentage allocated to common shares(a)98.4%98.3%98.4%100.0%Undistributed earnings—common shares(5,523)(5,906)(6,978)(35,207)Add: Dividends declared—common shares8,76010,09926,28433,793Numerator for common shares outstanding excluding participating shares3,2374,19319,306(1,414)Numerator for participating unvested shares only5273309—Numerator for basic and diluted earnings per share—total$3,289$4,266$19,615$(1,414)Denominator for basic and diluted weighted-average shares outstandingCommon shares outstanding70,10972,20570,18974,588Participating unvested shares1,1091,2261,124—Basic and diluted weighted-average common shares outstanding—total71,21873,43171,31374,588Earnings (loss) per share—basic and dilutedExcluding participating unvested shares$0.05$0.06$0.28$(0.02)Including participating unvested shares$0.05$0.06$0.28$(0.02)(a)Basic and diluted weighted-average common shares:Weighted-average common shares outstanding70,10972,20570,18974,588Weighted-average restricted shares1,1091,2261,124—Total basic and diluted weighted-average common shares71,21873,43171,31374,588Percentage allocated to common shares98.4%98.3%98.4%100.0%(b)For the nine months ended September 30, 2012, we excluded 1,031 weighted-average shares of restricted common stock from the calculation of diluted loss per share because the inclusion of these shares would have had an anti-dilutive impact on the calculation of loss per share.


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


NOTE 11—CONTINGENCIES AND COMMITMENTS


LEGAL PROCEEDINGS


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


FINANCIAL INSTRUMENTS


During the normal course of business, we are party to certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments.  We conduct extensive due diligence and, when appropriate, obtain collateral to limit our credit risk.  Generally, these commitments have fixed expiration dates or other


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termination clauses, which may require payment of a fee by the counterparty.  We expect many of these commitments will not be fully used before they expire; therefore, the total commitment amounts do not necessarily represent future cash requirements.


We do not report the unused portions of these commitments on our Consolidated Balance Sheets .  As of September 30, 2013 and December 31, 2012 , we had $19.1 million and $23.0 million, respectively, of outstanding unused loan commitments.  We estimate that as of each of September 30, 2013 and December 31, 2012 , the fair value of these commitments was $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties.  As of September 30, 2013 and December 31, 2012 , we had no outstanding guarantees or standby letters of credit.


LEASE OBLIGATIONS


We lease our headquarters and certain other facilities and equipment under non-cancelable operating and capital leases which expire through 2014.  The lease on our former headquarters in Arlington, Virginia expired in February 2013.  In August 2012, we entered into a lease agreement for new office space in Arlington, Virginia.  The new lease term is from October 2012 to November 2014 with a base rent of $0.4 million per year.  The base rent will not increase during the term of the lease.  In November 2012, we ceased using our old headquarters and recognized the remaining amounts due under that lease in other liabilities on our Consolidated Balance Sheet as of December 31, 2012.  As of September 30, 2013 , our obligations for the remaining terms of these leases was $0.5 million , of which $0.4 million will be payable during the next twelve months.


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NOTE 12—FINANCIAL HIGHLIGHTS


The following schedule summarizes our financial highlights for the nine months ended September 30, 2013 and 2012 : Nine months ended(in thousands, except per share amounts)September 3020132012Per share dataNet asset value at beginning of period(a)$5.18$5.65Net income(b)Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision0.330.18Net realized gain (loss) on investments(0.02)0.79Net unrealized (depreciation) appreciation on investments(0.03)(0.98)Loss on extinguishment of debt before income tax (benefit) provision——Income tax provision—(0.01)Net income (loss)0.28(0.02)Net decrease in net assets resulting from distributions(0.38)(0.45)Net increase (decrease) in net assets relating to stock-based transactionsIssuance of shares of restricted common stock(c)—(0.07)Repurchase of common stock—0.06Net increase in stockholders’ equity from restricted stock amortization0.020.03Net increase (decrease) in net assets relating to share issuances0.020.02Net asset value at end of period(a)5.105.20Market price per shareBeginning of period$4.60$3.99End of period$5.04$4.61Total Return(d)17.72%31.08%Shares of Common Stock Outstanding(d)Weighted-average—basic and diluted71,31374,588End of period71,21272,788Net assetsAverage$367,445$406,263End of period$363,501$378,740Ratios (annualized)Operating expenses to average net assets5.74%11.14%Net operating income to average net assets8.60%4.50%General and administrative expense to average net assets1.44%3.52%Return on average equity7.16%-0.46%__________________(a)Based on total number of shares outstanding.(b)Based on weighted-average number of shares outstanding.(c)Represents the effects of shares issued during the period and the lapsing of forfeiture provisions on restricted stock on earnings per share.(d)Total return = [(ending market price per share–beginning market price per share+dividends paid per share)/beginning market price per share].


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NOTE 13—SIGNIFICANT SUBSIDIARY


We have determined that for the nine months ended September 30, 2013 , RadioPharmacy Investors, LLC, or RadioPharmacy, is an unconsolidated portfolio company that has met the conditions of a significant subsidiary and therefore, we are presenting summarized financial information of RadioPharmacy as of the most recent periods for which data is available.  RadioPharmacy is a private company, which has prepared financial statements in accordance with GAAP but not in accordance with Regulation S-X.  In addition, the financial information of RadioPharmacy has not been audited.  The following table sets forth summarized balance sheet information for RadioPharmacy as of August 31, 2013 and December 31, 2012 .


(in thousands)August 31, 2013December 31, 2012(unaudited)(unaudited)Assets:Total current assets$6,129$5,868Total non-current assets19,50918,783Total assets$25,638$24,651Liabilities and Stockholders' Equity:Current liabilities$3,972$2,907Long-term liabilities19,53719,679Preferred stock11Other stockholders' equity2,1282,064Total liabilities and stockholders' equity$25,638$24,651


The following table sets forth summarized income statement information for RadioPharmacy Investors, LLC for the eight months ended August 31, 2013 and 2012 .


Eight months ended August 31,(in thousands)20132012(unaudited)(unaudited)Sales$17,836$18,726Gross margin$10,525$10,285Net income (loss)$65$(241)


NOTE 14—SUBSEQUENT EVENT


STOCK REPURCHASE PROGRAM


On October 25, 2013, our board of directors authorized a stock repurchase program of up to $25.0 million.


Under the program, MCG management is authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.


The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate MCG to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.





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Review Report of Independent Registered Public Accounting Firm


The Board of Directors and Stockholders


MCG Capital Corporation


We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation, including the consolidated schedule of investments, as of September 30, 2013 , the related consolidated statements of operations for the three- and nine- month periods ended September 30, 2013 and 2012 , and the related consolidated statements of changes in net assets, cash flows and financial highlights for the nine -month periods ended September 30, 2013 and 2012 .  These financial statements are the responsibility of MCG Capital Corporation’s management.


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


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


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


/s/ ERNST & YOUNG LLP


McLean, Virginia


October 30, 2013





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


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


This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management including, without limitation: our expectations regarding our results of operations, including revenues, net operating income, net investment losses and general and administrative expenses and the factors that may affect such results; our expectations regarding the approval process for a second SBIC license, which is subject to approval by the SBA in its sole discretion and may not be granted in any specified time period, or at all; our intentions with respect to funding in full our equity portion of a second SBIC license using unrestricted cash; our expectations regarding the full use before expiration of certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments; our expectations regarding the level and timing of monetizations during 2013 and 2014; our expectations with regard to projected origination pacing and anticipated aggregate investment levels; our expectation that we will substantially deploy our cash on-hand by late 2014/early 2015; future dividend distributions, the timing and amount of which are subject to, among other things, approval of our board of directors and which may never be declared or distributed; the timing of our pay off of our 2006-1 Trust; projected per share net operating income levels, which may never be realized; our plans with respect to hiring of asset management professionals focused primarily on originations; our intentions to repurchase shares of our common stock under our stock repurchase program and purchase debt for cash in open markets purchases and/or privately-negotiated transactions; the sufficiency of liquidity to meet 2013 operating requirements, as well as new origination opportunities and potential dividend distributions; the use of our available liquidity to pay dividends to our stockholders and to repurchase our common stock in the open market under our stock repurchase program; estimated liquidity for repayment of our borrowing facilities from a number of sources, including cash on-hand, the maturity or monetization of our investment portfolio, other borrowing facilities and equity issuances, and from other borrowing arrangements; our decisions to make dividend distributions after taking into account our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio; our use of independent valuation firms to provide additional support for our internal analyses; our expectations regarding the outcome of legal proceedings incidental to our business; general market conditions; the state of the economy and other factors.  Forward-looking statements can be identified by terminology such as “anticipate,” “believe,” “could,” “could increase the likelihood,” “hope,” “target,” “project,” “goals,” “potential,” “predict,” “might,” “estimate,” “expect,” “intend,” “is planned,” “may,” “should,” “will,” “will enable,” “would be expected,” “look forward,” “may provide,” “would” or similar terms, variations of such terms or the negative of those terms. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those risk factors discussed in Item IA of Part II of this Quarterly Report on Form 10-Q.


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


DESCRIPTION OF BUSINESS


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


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


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We also make investments in qualifying small businesses through our wholly owned subsidiary licensed by the United States Small Business Administration, or the SBA, to operate as a SBIC under the Small Business Investment Act of 1958 , as amended, or the SBIC Act.  An SBIC is subject to a variety of regulations concerning, among other things, the size and nature of the companies in which it may invest and the structure of those investments.


In addition, we have elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code.  In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements.  If we satisfy these requirements, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders as distributions, allowing us to substantially reduce or eliminate our corporate-level tax liability.  From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities.  In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.


RECENT DEVELOPMENTS


|  |                                                                                                                                                                                                                    
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Originations and Advances— For the three and nine month periods ended September 30, 2013, we made $4.2 million and $91 million, respectively, in originations and advances to new and existing portfolio companies.

|  |                                                                                                                                                                                          
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Loan Monetizations— For the three and nine month periods ended September 30, 2013, we received $60.9 million and $162.4 million, respectively, in loan payoffs and amortization payments.

|  |                                                                                                                                                                                                                                                                                                                             
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Equity Monetizations and Realizations —For the three and nine month periods ended September 30, 2013, we received $0.3 million and $8.1 million, respectively, in proceeds from the sale of equity investments, principally the sale of securities in each of Miles Media Group, LLC, NDSSI Holdings, LLC and Jenzabar, Inc.

|  |                                                                                                                                                                                                                                                                                                                                                                                                
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Loans on Non-Accrual —As of September 30, 2013, loans on non-accrual were $27.7 million at cost (7.4% of the total loan portfolio), and $13.2 million at fair value (3.7% of the total loan portfolio).  During the quarter ended September 30, 2013, CWP/RMK Acquisition Corp. repaid the principal balance of its loan and we put Color Star Growers of Colorado, Inc. on non-accrual status.

|  |                                                                                                                                                                                                                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Operating Costs— For the three month period ended September 30, 2013, our total operating costs, excluding interest expense, were $2.9 million, or 0.5% of total assets of $546 million.  During this same period, we incurred severance costs of $0.8 million, or 0.1% of total assets, that we included in total operating costs.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Reduced Leverage— From June 30, 2013 to September 30, 2013, we reduced our outstanding borrowings under our MCG Commercial Loan Trust, or 2006-1 Trust, by $25.8 million, reducing our borrowings under our 2006-1 Trust from $54.9 million to $29.2 million as of September 30, 2013.  In October 2013, we further reduced our borrowings under our 2006-1 Trust by $4.0 million from $29.2 million to $25.2 million.

OUTLOOK


For the remainder of 2013, we anticipate monetizing an additional $20.0 million to $40.0 million of investments. For the twelve months ending December 31, 2013, we expect aggregate monetizations of approximately $190.0 million to $210.0 million of investments approximately two times the amount we projected at the beginning of 2013 and approximately 40% of our investment portfolio as of December 31, 2013.  Over the next four quarters, we generally expect portfolio monetizations to range between $90.0 million to $120.0 million.


Over the four quarters ended September 30, 2013, we originated or advanced over $200.0 million to portfolio companies. Assuming the wind-down of our 2006-1 Trust and based on our total assets available for investment of approximately $500.0 million, over time we would expect to monetize and redeploy approximately $150.0 million to $200.0 million of capital per year and remain fully deployed.  During the fourth quarter of 2013, we anticipate that we will originate or advance approximately $30.0 million to $45.0 million of investments.


We took active steps during the quarter ended September 30, 2013 to shift resources to the asset management portion of our business.  Over the next six months, we intend to hire additional asset management professionals focused primarily on originations.  We are targeting the origination of new loans and equity co-investments sufficient to end the year with total investments of $385 million to $420 million (calculated at fair value).


Before considering any potential implications of a second SBIC license, we anticipate that we will originate or advance the majority of our available capital by late 2014 or the first half of 2015.  Depending on the level of monetizations, and assuming we can fully deploy our available capital by December 31, 2014, we expect to end calendar year 2014


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with approximately $450.0 million to $500.0 million of total investments and $475.0 million to $525.0 million of total assets.  We also anticipate paying off our 2006-1 Trust by December 31, 2014.


Driven primarily by the accelerated levels of monetization that we have experienced to date and taking into consideration the levels of monetizations that we expect over the next five fiscal quarters, we estimate that our net operating income, or NOI, per quarter, will range from $0.08 to $0.10 per share over the next two-to-three fiscal quarters before increasing to $0.11 to $0.13 per share as we fully deploy our capital.  As a result and subject to approval by our board of directors, we anticipate maintaining our quarterly distribution at 12.5 cents per share over this horizon.


ACCESS TO CAPITAL AND LIQUIDITY


At September 30, 2013 , we had $96.4 million of cash and cash equivalents available for general corporate purposes, as well as $36.8 million of cash in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC and $1.6 million of restricted cash held in escrow.  In addition, we had $7.8 million of cash in securitization accounts, that may only be used to make interest and principal payments on our securitized borrowings or distributions to MCG in accordance with the indenture agreement of the 2006-1 Trust.


At September 30, 2013 , cash in securitization accounts included $6.3 million in the principal collections account of our 2006-1 Trust.  In October 2013, we used the $6.3 million of securitized cash to repay borrowings of our 2006-1 Trust, a pro rata portion of which we received for the principal we own.  The reinvestment period for this facility ended on July 20, 2011 and all subsequent principal collections received have been, and will be, used to repay the securitized debt.  At September 30, 2013 , the net outstanding borrowings under the 2006-1 Trust were $29.2 million , which was reduced to $25.2 million in October 2013.


At September 30, 2013 , $150.0 million of SBA borrowings were outstanding, the maximum available under our current SBIC license.


At September 30, 2013 , we had full access to our $20.0 million unsecured revolving credit facility with Bank of America, N.A.


PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY


As of September 30, 2013 , the fair value of our investment portfolio was $395.5 million , which represents a $82.2 million , or 17.2% , decrease from the $477.7 million fair value as of December 31, 2012 .  The following sections describe the composition of our investment portfolio as of September 30, 2013 and key changes in our portfolio during the nine months ended September 30, 2013 .


Portfolio Composition


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


September 30, 2013December 31, 2012(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioDebt investmentsSenior secured debt$218,93755.4%$291,76061.1%Subordinated debtSecured114,17328.8114,98324.1Unsecured22,7715.826,2745.4Total debt investments355,88190.0433,01790.6Equity investmentsPreferred equity37,2849.441,5588.7Common/common equivalents equity2,3670.63,1490.7Total equity investments39,65110.044,7079.4Total investments$395,532100.0%$477,724100.0%


Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0% , a portion of which may be in the form of paid-in-kind interest, or PIK.  As of September 30, 2013 , approximately 72.8% of the fair value of our loan portfolio had variable interest rates, based on either the London Interbank Offer Rate, or LIBOR, or the prime rate,


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and 27.2% of the fair value of our loan portfolio had fixed interest rates.  As of September 30, 2013 , approximately 63.6% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR based index and prime floors between 2.5% and 6.0% .  At origination, our loans generally have four- to six-year stated maturities.  Borrowers typically pay an origination fee based on a percentage of the total commitment and a fee on undrawn commitments.


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


September 30, 2013December 31, 2012(dollars in thousands)Investments at Fair ValuePercent of Total PortfolioInvestments at Fair ValuePercent of Total PortfolioHealthcare$104,59826.4%$106,11922.2%Business services74,68918.964,94713.6Education60,26215.259,78312.5Publishing25,0696.430,6466.4Insurance24,1126.126,5295.6Restaurants22,9915.89,3011.9Manufacturing22,0705.628,7286.0Broadcasting20,4245.225,3725.3Agriculture13,1953.321,7814.6Information services12,5733.212,6462.7Home furnishings6,8261.77,8061.6Consumer products4,5811.24,3380.9Auto parts——6,4341.3Cable——5,0611.1Electronics——33,3617.0Logistics——27,2375.7Other(a)4,1421.07,6351.6Total$395,532100.0%$477,724100.0%______________________(a)No individual industry within this category exceeds 1%.


As of September 30, 2013 , our ten largest portfolio companies represented approximately 51.7% of the total fair value of our investments.  These ten companies accounted for 48.4% of our total revenue during the nine months ended September 30, 2013 .


During the nine months ended September 30, 2013 , we had concentrations in certain industries, including the healthcare, business services and education industries.  The following table summarizes our fair value and revenue concentrations in each of those industries:


Investments at fair valueRevenue for the nine months endedSeptember 30, 2013December 31, 2012September 30, 2013September 30, 2012(dollars in thousands)Amount% of Total PortfolioAmount% of Total PortfolioAmount% of Total RevenueAmount% of Total RevenueIndustryHealthcare$104,59826.4%$106,11922.2%$10,18925.9%$7,02314.8%Business services74,68918.964,94713.66,07315.45,65811.9Education60,26215.259,78312.54,92212.54,3489.1


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Changes in Investment Portfolio


During the nine months ended September 30, 2013 , we completed $91.0 million of originations and advances compared to $48.1 million of originations and advances during the nine months ended September 30, 2012 .  The following table summarizes our total portfolio investment activity during the nine months ended September 30, 2013 and 2012 :


Nine months ended(in thousands)September 3020132012Beginning investment portfolio$477,724$741,166Originations and advances91,03248,070Gross payments, reductions and sales of securities(170,566)(331,256)Net realized loss(961)(73,368)Unrealized depreciation(5,286)(15,903)Reversals of unrealized depreciation2,61074,713Origination fees and amortization of unearned income9791,371Ending investment portfolio$395,532$444,793


Originations and Advances


The following table shows our originations and advances during the nine months ended September 30, 2013 and 2012 by security type:


Nine months ended September 30,20132012(dollars in thousands)Amount% of TotalAmount% of TotalDebt investmentsSenior secured debt$71,17878.2%$32,17466.9%Subordinated debtSecured3,5703.99,61820.0Unsecured13,32214.6700.2Total debt investments88,07096.741,86287.1Equity investmentsPreferred equity2,9593.36,14712.8Common/common equivalents equity3—610.1Total equity investments2,9623.36,20812.9Total originations and advances$91,032100.0%$48,070100.0%


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The following table shows our significant originations and advances:


(in thousands)Nine months endedSeptember 30, 2013CompanyOriginationsDraws/ AdvancesPIK Advances/ DividendsTotalDebtIntrafusion Holdings, Inc.$21,500$—$—$21,500Ted's Café Escondido Holdings, Inc.14,000——14,000Huron Inc.13,000—32213,322Community Investors, Inc.12,300——12,300Dorsey School of Business Holdings, Inc.10,000——10,000C7 Data Centers, Inc.—7,000—7,000Miles Media Group, LLC—3,450—3,450Cruz Bay Publishing, Inc.——1,1301,130Education Management, Inc.—1,000—1,000Other (< $1 million)—1,5002,8684,368Total debt70,80012,9504,32088,070EquityRadioPharmacy Investors, Inc.——1,7191,719Other (< $1 million)300—9431,243Total Equity300—2,6622,962Total originations and advances$71,100$12,950$6,982$91,032


Repayments, Sales and Other Reductions of Investment Portfolio


The following table shows our gross payments, reductions and sales of securities during the nine months ended September 30, 2013 and 2012 by security type:


Nine months ended September 30,20132012(dollars in thousands)Amount% of TotalAmount% of TotalDebt investmentsSenior secured debt$141,01182.7%$203,33161.4%Subordinated debtSecured4,5002.651,34715.5Unsecured16,9359.912,1893.7Total debt investments162,44695.2266,86780.6Equity investmentsPreferred equity5,1173.043,79213.2Common/common equivalents equity3,0031.820,5976.2Total equity investments8,1204.864,38919.4Total gross payments, reductions and sales of securities$170,566100.0%$331,256100.0%


During the nine months ended September 30, 2013 and 2012 , our gross payments, reductions and sales of securities by transaction type included:


Nine months ended September 30,(in thousands)20132012Principal repayments, reductions and loan sales$136,932$232,809Sale of equity investments7,44056,241Scheduled principal amortization23,35225,548Collection of accrued paid-in-kind interest and dividends2,84216,658Total gross payments, reductions and sales of securities$170,566$331,256


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As shown in the following table, during the nine months ended September 30, 2013 , we monetized all, or part of, 20 portfolio investments with proceeds totaling $144.9 million:


Nine months endedSeptember 30, 2013(in thousands)Principal Repayments and Proceeds from Loan SalesSale or Settlement of Equity InvestmentsPIK Interest and Dividend PrepaymentsTotalMonetizationsNDSSI Holdings, LLC$29,356$3,237$831$33,424Capstone Logistics, LLC27,347——27,347Chase Industries, Inc.16,800——16,800SoftLayer Technologies, Inc.13,462——13,462Intrafusion Holdings, Inc.10,000——10,000The Gavilon Group, LLC8,000——8,000Oceans Acquisition, Inc.7,500——7,500Constructions Trailer Specialists, Inc.6,442—346,476Barbri, Inc.6,099——6,099Gans Communications, L.P.5,015——5,015Other < 5 Million6,9113,864—10,775Total monetizations136,9327,101865144,898Other scheduled payments23,3523391,97725,668Total gross payments, sales and other reductions of investment portfolio$160,284$7,440$2,842$170,566


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


ASSET QUALITY


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


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


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The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of September 30, 2013 and December 31, 2012 :


(dollars in thousands)September 30, 2013December 31, 2012Investment RatingInvestments at Fair Value% of Total PortfolioInvestments at Fair Value% of Total  Portfolio1(a)$109,44527.7%$146,58930.7%2122,59031.0209,01643.73127,29432.296,93220.3434,2828.622,7894.851,9210.52,3980.5Total$395,532100.0%$477,724100.0%


_________________________


|    |                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | As ofSeptember 30, 2013andDecember 31, 2012, Investment Rating “1” included $82.9 million and $81.9 million, respectively, of loans to companies in which we also hold equity securities.

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


For the three month period ended September 30, 2013, we put Color Star Growers of Colorado, Inc., or Color Star, on non-accrual status and we changed the Investment Rating from 3 to 4.


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


COST BASISFAIR VALUE BASISSeptember 30, 2013December 31, 2012September 30, 2013December 31, 2012(dollars in thousands)Investments at Cost% of Loan PortfolioInvestments at Cost% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioInvestments at Fair Value% of Loan PortfolioLoans greater than 90 days past dueOn non-accrual status$3,8971.04%$3,8970.86%$——%$——%Not on non-accrual status————————Total loans greater than 90 days past due$3,8971.04%$3,8970.86%$——%$——%Loans on non-accrual status0 to 90 days past due$23,8496.34%$12,8802.85%$13,1953.71%$6070.14%Greater than 90 days past due3,8971.043,8970.86————Total loans on non-accrual status$27,7467.38%$16,7773.71%$13,1953.71%$6070.14%


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The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2012 through September 30, 2013 :


Nine months endedSeptember 30, 2013(In thousands)CostFair ValueNon-accrual loan balance as of December 31, 2012$16,777$607Additional loan on non-accrual status - Color Star13,52213,195Change in unrealized gain (loss) on non-accrual loans——Payments received from loans on non-accrual status(621)(621)Reversal of previously recognized unrealized loss on non-accrual loans(a)—1,946Realized loss on non-accrual loans(a)(1,932)(1,932)Total change in non-accrual loans10,96912,588Non-accrual loan balance as of September 30, 2013$27,746$13,195


_________________________


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




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Results of Operations


The following section compares our results of operations for the three months ended September 30, 2013 to the three months ended September 30, 2012 .


COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012


The following table summarizes the components of our net income for the three months ended September 30, 2013 and 2012 :


Three months ended September 30,Variance(dollars in thousands)20132012$PercentageRevenueInterest and dividend incomeInterest income$10,717$10,326$3913.8%Dividend income847867(20)(2.3)Loan fees1,02364238159.3Total interest and dividend income12,58711,8357526.4Advisory fees and other income583234349149.1Total revenue13,17012,0691,1019.1Operating expensesInterest expense2,3162,974(658)(22.1)Employee compensationSalaries and benefits6442,018(1,374)(68.1)Amortization of employee restricted stock420505(85)(16.8)Total employee compensation1,0642,523(1,459)(57.8)General and administrative expense1,8242,504(680)(27.2)Restructuring expense212(10)(83.3)Total operating expense5,2068,013(2,807)(35.0)Net operating income before net investment gain (loss) and income tax (benefit) provision7,9644,0563,90896.4Net investment gain (loss) before income tax provision(4,616)228(4,844)NMIncome tax provision591841227.8Net income (loss)$3,289$4,266$(977)(22.9)NM=Not Meaningful


TOTAL REVENUE


Total revenue includes interest and dividend income, loan fees, advisory fees and other income.  The following sections describe the reasons for the variances in each major component of our revenue during the three months ended September 30, 2013 from the three months ended September 30, 2012 .


INTEREST INCOME


The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments.  During the three months ended September 30, 2013 , the total yield on our average debt portfolio at fair value was 12.4% compared to 11.1% during the three months ended September 30, 2012 .  The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.


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The following table shows the various components of the total yield on our average debt portfolio at fair value for the three months ended September 30, 2013 and 2012 :


Three months ended September 30,20132012Average 90-day LIBOR0.3%0.4%Spread to average LIBOR on average loan portfolio12.010.9Impact of fee accelerations of unearned fees on paid/restructured loans0.60.3Impact of non-accrual loans(0.5)(0.5)Total yield on average loan portfolio12.4%11.1%


During the three months ended September 30, 2013 , interest income was $10.7 million , compared to $10.3 million during the three months ended September 30, 2012 , which represented a $0.4 million , or 3.8% , increase .  This increase reflected a $1.2 million increase in interest income attributable to a 1.2% increase in our net spread to LIBOR, partially offset by a $0.5 million decrease in interest income resulting from a 4.2% decrease in our average loan balance, a decrease of $0.2 million due to interest rate floors and a $0.2 million decrease related to the decrease in LIBOR.


PIK Income


Interest income includes certain amounts that we have not received in cash, such as PIK interest.  PIK interest represents contractually deferred interest that is added to the principal balance of the loan and compounded if not paid on a current basis.  Borrowers may, in some instances, be required to prepay PIK because of certain contractual provisions or they may choose to prepay; however, more typically, PIK is paid at the end of the loan term.  The following table shows the PIK-related activity for the three months ended September 30, 2013 and 2012 , at cost :


Three months ended September 30,(in thousands)20132012Beginning PIK loan balance$9,336$5,625PIK interest earned during the period1,6441,112Payments received from PIK loans(135)(623)Ending PIK loan balance$10,845$6,114


As of September 30, 2013 , all of our PIK loans were accruing interest and, as of September 30, 2012 , we were not accruing interest on $1.4 million of the PIK loans, at cost, shown in the preceding table.  During the three months ended September 30, 2012 , we received payments on PIK loans from five investments.


DIVIDEND INCOME


We accrete dividends on equity investments with stated dividend rates as they are earned, to the extent that we believe the dividends will be paid ultimately and the associated portfolio company has sufficient value to support the accretion.  We recognize dividends on our other equity investments when we receive the dividend payment.  Our dividend income varies from period to period because of changes in the size and composition of our equity investments, the yield from the investments in our equity portfolio and the ability of the portfolio companies to declare and pay dividends.  During the three months ended September 30, 2013 and 2012 , we recognized dividend income of $0.8 million and $0.9 million , respectively.  In addition, during the three months ended September 30, 2013 and 2012 , we received payments on accrued dividends of $0.2 million and $0.3 million, respectively.  As of September 30, 2013 , the balance of accrued dividends was $11.3 million.


ADVISORY FEES AND OTHER INCOME


Advisory fees and other income primarily include fees related to prepayment, advisory and management services, equity structuring, syndication, bank interest and other income.  Generally, advisory fees and other income relate to specific transactions or services and, therefore, may vary from period to period depending on the level and types of services provided.  During the three months ended September 30, 2013 , we earned $0.6 million of advisory fees and other income, which represented a $0.3 million , or 149.1% , increase from the three months ended September 30, 2012 .  This increase resulted from an increase in prepayment fees related to a loan prepayment in the third quarter of 2013.


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TOTAL OPERATING EXPENSES


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


INTEREST EXPENSE


During the three months ended September 30, 2013 , we incurred $2.3 million of interest expense, which represented a $0.7 million , or 22.1% , decrease from the same period in 2012 .  During these respective periods, our average cost to borrow increased to 4.9% from 4.3% , principally due to the repayment of securitized debt in our 2006-1 Trust which carries interest rates ranging from L+0.33% to L+2.25%, offset by a decrease in the amortization of deferred financing costs to $0.3 million from $0.8 million .


During the three months ended September 30, 2013 , our average borrowings declined to approximately $183.5 million from an average of approximately $267.8 million for the same period in 2012 , which accounted for a $0.9 million reduction in our interest expense.  In addition, interest expense decreased by $0.5 million related to decreased amortization of debt issuance costs and $0.1 million due to a decrease in the average LIBOR rate from 0.43% to 0.26% .  These decreases were offset by $0.8 million attributable to the spread to LIBOR increasing from approximately 2.71% to 3.95% .


We recognized $0.3 million in deferred financing costs during the three months ended September 30, 2013 , down $0.5 million from the same period in 2012 .  The decrease is primarily attributable to $0.5 million in accelerated deferred financing fees related to repayment of securitized debt in our 2006-1 Trust in the third quarter of 2012.


EMPLOYEE COMPENSATION


Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards.  During the three months ended September 30, 2013 , our employee compensation expense was $1.1 million , which represented a $1.5 million , or 57.8% , decrease from the same period in September 30, 2012 .  Our salaries and benefits decrease d by $1.4 million , or 68.1% , due to a $1.0 million decrease in incentive compensation and a $0.4 million decrease in salaries and benefits primarily resulting from our operational realignment.  As of September 30, 2013 , we had 17 employees compared to 24 employees as of September 30, 2012 .


GENERAL AND ADMINISTRATIVE


During the three months ended September 30, 2013 , general and administrative expense was $1.8 million , which represented a $0.7 million , or 27.2% , decrease compared to the same period in 2012 .  General and administrative expense decreased $0.6 million due to reduced occupancy and other costs for our new corporate office space and $0.3 million due to a decrease in professional fees related to portfolio litigation.  These decreases were offset by a $0.7 million increase in severance costs related to employee terminations in the third quarter of 2013.


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NET INVESTMENT (LOSS) GAIN BEFORE INCOME TAX PROVISION


During the three months ended September 30, 2013 , we recorded $4.6 million of net investment loss before income tax provision, compared to $0.2 million of net investment gains during the same period in 2012 .  These amounts represent the total of net realized gains and losses, net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation.  We reverse unrealized (appreciation) depreciation at the time that we realize the gain or loss.  The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2013 :


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


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


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


The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended September 30, 2012 :


Three months ended September 30, 2012(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyAdvanced Sleep Concepts, Inc.Home FurnishingsAffiliate$—$(2,618)$—$(2,618)Cruz Bay Publishing, Inc.PublishingNon-Affiliate—1,987—1,987PremierGarage Holdings, LLCHome FurnishingsControl(5,371)—5,371—Other (< $1 million net gain (loss))(23)1,017(135)859Total$(5,394)$386$5,236$228


|  |                                                                                                                                                                                                               
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|• | In the third quarter of 2012, we recorded $2.6 million of unrealized depreciation on our investment in Advanced Sleep Concepts, Inc., to reflect a decrease in that portfolio company's operating performance.

|  |                                                                                                                                                                                      
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | We also recorded $2.0 million of unrealized appreciation on our investment in Cruz Bay Publishing, Inc., to reflect an improvement in that portfolio company's operating performance.

|  |                                                                                                                                                                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | In addition, during the three months ended September 30, 2012, we wrote off our preferred and common equity investments in PremierGarage Holdings, LLC resulting in a realized loss of $5.4 million and a reversal of previously recorded unrealized depreciation of $5.4 million .

INCOME TAX (BENEFIT) PROVISION


During the three months ended September 30, 2013 , we incurred a $59,000 income tax provision compared to an $18,000 income tax provision during the three months ended September 30, 2012 .  The income tax provision for both periods was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


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COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012


The following table summarizes the components of our net income for the nine months ended September 30, 2013 and 2012 :


Nine months ended September 30,Variance(dollars in thousands)20132012$PercentageRevenueInterest and dividend incomeInterest income$33,023$39,748$(6,725)(16.9)%Dividend income2,6622,840(178)(6.3)Loan fees2,2522,365(113)(4.8)Total interest and dividend income37,93744,953(7,016)(15.6)Advisory fees and other income1,3692,619(1,250)(47.7)Total revenue39,30647,572(8,266)(17.4)Operating expensesInterest expense7,00312,728(5,725)(45.0)Employee compensationSalaries and benefits3,6108,684(5,074)(58.4)Amortization of employee restricted stock1,1741,694(520)(30.7)Total employee compensation4,78410,378(5,594)(53.9)General and administrative expense3,94210,714(6,772)(63.2)Restructuring expense1459(45)(76.3)Total operating expense15,74333,879(18,136)(53.5)Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision23,56313,6939,87072.1Net investment gain (loss) before income tax provision(3,837)(14,604)10,767(73.7)Loss on extinguishment of debt before income tax (benefit) provision—(174)174(100.0)Income tax provision111329(218)(66.3)Net income (loss)$19,615$(1,414)$21,029NMNM=Not Meaningful





TOTAL REVENUE


Total revenue includes interest and dividend income, loan fees, advisory fees and other income.  The following sections describe the reasons for the variances in each major component of our revenue during the nine months ended September 30, 2013 from the nine months ended September 30, 2012 .


INTEREST INCOME


The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments.  During the nine months ended September 30, 2013 , the total yield on our average debt portfolio at fair value was 12.3% compared to 11.2% during the nine months ended September 30, 2012 .  The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.


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The following table shows the various components of the total yield on our average debt portfolio at fair value for the nine months ended September 30, 2013 and 2012 :


Nine months ended September 30,20132012Average 90-day LIBOR0.3%0.5%Spread to average LIBOR on average loan portfolio11.910.7Impact of fee accelerations of unearned fees on paid/restructured loans0.30.4Impact of non-accrual loans(0.2)(0.4)Total yield on average loan portfolio12.3%11.2%


During the nine months ended September 30, 2013 , interest income was $33.0 million , compared to $39.7 million during the nine months ended September 30, 2012 , which represented a $6.7 million , or 16.9% , decrease .  This decrease reflected a $10.4 million decrease in interest income resulting from a 23.9% decrease in our average loan balance.  The decrease in interest income also reflected a decrease of $0.7 million due to interest rate floors, a $0.7 million decrease related to the decrease in LIBOR and a $0.5 million decrease resulting from the net impact of loans that had been on non-accrual status during the nine months ended September 30, 2013 that were accruing interest during the nine months ended September 30, 2012 .  These decreases were partially offset by a $5.5 million increase in interest income attributable to a 1.3% increase in our net spread to LIBOR.


PIK Income


The following table shows the PIK-related activity for the nine months ended September 30, 2013 and 2012 , at cost :


Nine months ended September 30,(in thousands)20132012Beginning PIK loan balance$9,043$15,653PIK interest earned during the period4,3203,983Payments received from PIK loans(2,161)(8,510)Realized loss(357)(5,012)Ending PIK loan balance$10,845$6,114


During the nine months ended September 30, 2013 , the payments received from PIK loans included $1.0 million collected in conjunction with the partial repayment of our investment in Education Management, Inc., as well as $0.8 million collected in conjunction with the repayment in full of our investment in NDSSI Holdings, LLC.  During the nine months ended September 30, 2012 , we received payments on PIK loans from eight investments, including $2.9 million from Jet Plastica Investors, LLC, $1.8 million from GSDM Holdings Corp. and $1.3 million from Coastal Sunbelt Holding, Inc.


DIVIDEND INCOME


During the nine months ended September 30, 2013 and 2012 , we recognized dividend income of $2.7 million and $2.8 million , respectively.  In addition, during the nine months ended September 30, 2013 and 2012 , we received payments on accrued dividends of $0.7 million and $8.1 million, respectively.  As of September 30, 2013 , the balance of accrued dividends was $11.3 million.


ADVISORY FEES AND OTHER INCOME


During the nine months ended September 30, 2013 , we earned $1.4 million of advisory fees and other income, which represented a $1.3 million , or 47.7% , decrease from the nine months ended September 30, 2012 .  This decrease resulted from a decrease in prepayment fees related to loan prepayments.


TOTAL OPERATING EXPENSES


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


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INTEREST EXPENSE


During the nine months ended September 30, 2013 , we incurred $7.0 million of interest expense, which represented a $5.7 million , or 45.0% , decrease from the same period in 2012 .  During these respective periods, our average cost to borrow decreased to 4.4% from 4.8% , principally due to a decrease in the amortization of deferred financing costs to $1.0 million from $5.3 million , offset by the repayment of securitized debt in our 2006-1 Trust, which carries interest rates ranging from L+0.33% to L+2.25%, and additional borrowings under the SBIC debenture program, which carry a weighted average fixed rate of 4.33%.


During the nine months ended September 30, 2013 , our average borrowings declined to approximately $209.4 million from an average of approximately $349.6 million for the same period in 2012 , which accounted for a $4.0 million reduction in our interest expense.  In addition, interest expense decreased by $4.3 million related to decreased amortization of debt issuance costs and $0.5 million due to a decrease in the average LIBOR rate from 0.47% to 0.28% .  These decreases were offset by $3.2 million attributable to the spread to LIBOR increasing from approximately 2.33% to 3.53% .


We recognized $1.0 million in deferred financing costs during the nine months ended September 30, 2013 , down $4.3 million from the same period in 2012 .  The decrease is primarily attributable to $2.9 million in deferred financing fees related to our SunTrust Warehouse financing facility which terminated in 2012.


EMPLOYEE COMPENSATION


Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards.  During the nine months ended September 30, 2013 , our employee compensation expense was $4.8 million , which represented a $5.6 million , or 53.9% , decrease from the same period in 2012 .  Our salaries and benefits decreased by $5.1 million , or 58.4% , due to a $3.3 million decrease in incentive compensation and a $1.8 million decrease in salaries and benefits primarily resulting from our operational realignment.  As of September 30, 2013 , we had 17 employees compared to 24 employees as of September 30, 2012 .


GENERAL AND ADMINISTRATIVE


During the nine months ended September 30, 2013 , general and administrative expense was $3.9 million , which represented a $6.8 million , or 63.2% , decrease compared to the same period in 2012 .  In the nine months ended September 30, 2012 , general and administrative expense included $3.0 million in severance costs.  In addition, general and administrative expense decreased $1.9 million due to reduced occupancy and other costs for our new corporate office space and $0.8 million due to a decrease in professional fees related to portfolio litigation.


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NET INVESTMENT GAIN BEFORE INCOME TAX PROVISION


During the nine months ended September 30, 2013 , we recorded $3.8 million of net investment losses before income tax provision, compared to $14.6 million of net investment losses during the same period in 2012 .  These amounts represent the total of net realized gains and losses, net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation.  We reverse unrealized (appreciation) depreciation at the time that we realize the gain or loss.  The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2013 :


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


|  |                                                                                                                                                                           
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|• | We recorded$3.3 millionof unrealized depreciation on our investment inVirtual Radiologic Corporationto reflect a decrease in the indicated market price for that security.

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|• | During 2013, we recorded $3.1 million of unrealized depreciation on our investment in G&L Investment Holdings, LLC, to reflect a decrease in that portfolio company's operating performance.

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

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

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


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The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the nine months ended September 30, 2012 :


Nine months ended September 30, 2012(in thousands)IndustryTypeRealized Gain/(Loss)Unrealized (Depreciation)/ AppreciationReversal of Unrealized Depreciation/ (Appreciation)Net (Loss)/ GainPortfolio CompanyBroadview Networks Holdings, Inc.CommunicationsControl$—$(9,680)$—$(9,680)Miles Media Group, LLCBusiness ServicesNon-Affiliate—(4,023)—(4,023)Orbitel Holdings, LLCCableControl(2,066)(1,966)805(3,227)Advanced Sleep Concepts, Inc.Home FurnishingsAffiliate—(2,604)—(2,604)RadioPharmacy Investors, LLCHealthcareControl—(2,113)—(2,113)Cruz Bay Publishing, Inc.PublishingNon-Affiliate—(1,368)—(1,368)GSDM Holdings, LLCHealthcareNon-Affiliate1,576(849)(1,976)(1,249)Stratford School Holdings, Inc.EducationAffiliate16,370(99)(13,056)3,215NPS Holding Group, LLCBusiness ServicesControl—2,702—2,702Jet Plastica Investors, LLCPlastic ProductsControl(90,802)1,38591,2881,871NDSSI Holdings, LLCElectronicsNon-Affiliate—1,025—1,025PremierGarage Holdings, LLCHome FurnishingsControl(5,371)—5,371—Philadelphia Media Network, Inc.NewspaperNon-Affiliate(5,027)(1)5,06436Intran Media, LLCOther MediaControl(4,250)—4,250—Jenzabar, Inc.TechnologyNon-Affiliate16,370(1)(16,435)(66)Other (< $1 million net gain (loss))(168)1,643(598)877Total$(73,368)$(15,949)$74,713$(14,604)


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|• | In August 2012, Broadview filed a voluntary pre-packaged chapter 11 plan of reorganization.  As of September 30, 2012, our fair value estimate of our investment in Broadview reflects this restructuring if consummated on the then contemplated terms.

|  |                                                                                                                                                                                                                                                                                                                                 
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|• | In April 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets.  Including the proceeds from the liquidation, we received $11.0 million in payments on our senior debt, resulting in a $90.8 million realized loss and a $91.3 million reversal of unrealized depreciation in the second quarter of 2012.

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|• | In the second quarter of 2012, we received $34.0 million for the repayment of our debt and the sale of our equity investment in Stratford School Holdings, Inc., which resulted in a $16.4 million realized gain and a reversal of previously unrealized appreciation of $13.1 million.

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|• | We received $35.3 million for the repayment of our debt and the sale of our equity investment in Orbitel Holdings, LLC, which resulted in a $2.1 million realized loss and a reversal of previously unrealized depreciation of $0.8 million.

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|• | We received $34.7 million for the repayment of our debt and the sale of our equity investment in GSDM Holdings, LLC, which resulted in a $1.6 million realized gain and a reversal of previously unrealized appreciation of $2.0 million.

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|• | We recorded $4.0 million of unrealized depreciation on our investment in Miles Media Group, LLC, to reflect a decrease in the performance of that company.

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|• | We recorded $2.7 million of unrealized appreciation on our investment in NPS Holding Group, LLC, to reflect a contemplated transaction involving that company.

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|• | We also received $44,000 for our equity investment in Philadelphia Media Network, Inc. and wrote off part of our equity investment in Intran Media, LLC which resulted in realized losses and reversals of previously unrealized depreciation on those investments.

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

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INCOME TAX PROVISION


During the nine months ended September 30, 2013 , we incurred a $111,000 income tax provision compared to an $329,000 income tax provision during the nine months ended September 30, 2012 .  The income tax provision for both periods was primarily attributable to flow-through taxable income on certain investments held by our subsidiaries.


FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES


Our financial liquidity principally comes from our cash on hand and the spread we earn on our investments (principally loans, over our cost to borrow) and gains and losses on our investments.  In addition to making investments in portfolio companies, we may use our available liquidity to pay dividends to our stockholders and to repurchase our common stock in the open market under our stock repurchase program.  For the nine months ended September 30, 2013 , we declared 38 cents per share in dividends and paid $26.7 million in total dividends.  We also repurchased 504,639 shares of our common stock for $2.3 million at a weighted average price of $4.50 per share.


For the nine months ended September 30, 2013 , we earned 12.3% on our average loan portfolio at fair value of $383.8 million and our weighted average cost to borrow was 4.4% on average borrowings of $209.4 million .  Including dividend income and fee income, we earned $23.6 million of net operating income and $19.6 million of net income.


At September 30, 2013 , we had $96.4 million in cash and cash equivalents available for general corporate purposes, $36.8 million of cash in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC and $1.6 million of restricted cash held in escrow.  In addition, we had $7.8 million in securitization accounts that may only be used to make interest and principal payments on our securitized borrowings or distributions to MCG in accordance with the indenture agreement for the 2006-1 Trust.  We also have access to the full principal amount under our $20 million unsecured revolving credit facility that we may use for general corporate purposes.


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


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


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


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


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|• | Cash and cash equivalentsrepresent unrestricted cash, including checking accounts, interest bearing deposits collateralized by marketable debt securities and highly liquid investments with original maturities of 90 days or less.  As ofSeptember 30, 2013andDecember 31, 2012, we had$96.4 millionand $73.6 million, respectively, in cash and cash equivalents.  As ofSeptember 30, 2013, our cash and cash equivalents included$66.6 millionheld in interest-bearing accounts.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|• | Cash, securitization accountsinclude principal and interest payments received on securitized loans, which, are held in designated bank accounts until monthly or quarterly disbursements are made from the securitization trusts.  We are generally required to use a portion of these amounts to pay interest expense, reduce borrowings or pay other amounts in accordance with the related securitization agreements.  Cash in securitization accounts has a negative impact on our earnings since the interest we pay on borrowings typically exceeds the rate of return that we are able to earn on temporary cash investments.  Our objective is to maintain sufficient cash-on-hand and availability under our debt facilities to cover current funding requirements.  As ofSeptember 30, 2013andDecember 31, 2012, we had$7.8 millionand $17.0 million, respectively, in cash, securitization accounts.

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|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|• | Cash, restrictedincludes cash held for regulatory purposes and cash held in escrow.  The largest component of restricted cash was represented by cash held by Solutions Capital I, L.P., or Solutions Capital, a wholly owned subsidiary licensed as an SBIC under the SBIC Act, which generally is restricted to the origination of new loans by Solutions Capital.  As ofSeptember 30, 2013andDecember 31, 2012, we had$38.4 millionand $54.8 million respectively, of restricted cash.

During the nine months ended September 30, 2013 , our operating activities provided $103.5 million of cash and cash equivalents, and our financing activities used $80.7 million of cash and cash equivalents.


LIQUIDITY AND CAPITAL RESOURCES—BORROWINGS


As of September 30, 2013 , we reported $179.2 million of borrowings on our Consolidated Balance Sheets at cost.  The following table summarizes our borrowing facilities, the facility amounts and the amounts outstanding.


September 30, 2013December 31, 2012(dollars in thousands)Maturity DateTotal Facility/ ProgramAmount OutstandingTotal Facility/ ProgramAmount OutstandingSBIC2008-10BSeptember 2018$2,600$2,600$2,600$2,6002009-10AMarch 201912,00012,00012,00012,0002009-10BSeptember 201913,00013,00013,00013,0002010-10BSeptember 202027,50027,50027,50027,5002011-10AMarch 202153,50053,50053,50053,5002012-10AMarch 202241,40041,40041,40041,400MCG Commercial Loan Trust 2006-1Series 2006-1 Class B Notes(a)April 2018(b)——37,15137,151Series 2006-1 Class C Notes(a)(c)April 2018(b)38127145,00032,000Series 2006-1 Class D Notes(d)April 2018(b)45,94528,90245,94528,902Bank of America Unsecured RevolverUnsecured Revolving NoteNovember 201420,000—20,000—Total borrowings$216,326$179,173$298,096$248,053__________(a)In April 2013, the Class B Notes were repaid in full and, in October 2013, the Class C Notes were repaid in full.(b)Borrowings under the MCG Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date.  The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt.(c)Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.(d)Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million.  As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased.


As of September 30, 2013 , our asset coverage ratio was 1,338% .  This ratio does not include our SBIC debt which the SEC has permitted us to exclude from the asset coverage ratio requirements pursuant to an exemptive order.


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


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


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


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SBIC DEBENTURES


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


In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L.P. in order to apply for a second SBIC license.  In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013 and was accepted by the SBA in May 2013.  Neither receipt of such an invitation nor acceptance of the application from the SBA assures an applicant that the SBA will grant the additional license in any specified time period or at all.  Currently, a second SBIC license would grant us the ability to borrow up to an additional $75.0 million from the SBA, or two times the amount of statutory equity capital we invest in Solutions Capital II, L.P.  If approved and depending on available capital, we intend to fund the entire $37.5 million using unrestricted cash.  In the second quarter of 2013, we invested $10.0 million of unrestricted cash in Solutions Capital II, L.P. and  funded a small business loan to Dorsey School of Business Holdings, Inc, or Dorsey.  We also received pre-licensing investment approval from the SBA for the Dorsey investment which, if closed in accordance with our pre-investment documentation, will count toward the required statutory capital of $37.5 million in our second SBIC.


To realize the full $150.0 million borrowing for which we have received approval under the SBIC program, we have funded a total of $75.0 million to Solutions Capital.  As of each of September 30, 2013 and December 31, 2012 , Solutions Capital had borrowed $150.0 million.  We are permitted to use these funds to provide debt and equity capital to qualifying small businesses.  However, we may not use these borrowings to provide additional financing to certain companies that are currently in our portfolio without SBA approval.  In addition, we may not use these funds for MCG’s, the parent company’s, working capital.


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


The following table sets forth the maturity of Solutions Capital debentures, as well as the maturity of the investments and the current balance of restricted cash in Solutions Capital as of September 30, 2013 .


Maturities(in thousands)TotalLess than 1 year1-3 years4-5 yearsAfter 5 yearsBorrowings$150,000$—$—$2,600$147,400CollateralFair value of debt investments204,0752,63634,863154,35212,224Fair value of equity investments(a)5,742———5,742Cash, restricted account36,73736,737———Total collateral$246,554$39,373$34,863$154,352$17,966


____________


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


MCG COMMERCIAL LOAN TRUST 2006-1


As of September 30, 2013 , we had $29.2 million of securitized debt outstanding under the 2006-1 Trust, which matures in April 2018.  We retain all of the equity in the securitization.  The pool of commercial loans in the trust must meet certain requirements, such as asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.  The securitization included a five-year reinvestment period, during which the trust was permitted to use principal collections received on the underlying collateral to purchase new collateral from us.


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


Maturities(in thousands)TotalLess than 1 year1-3 years4-5 yearsAfter 5 yearsBorrowings(a)$29,173$4,001$—$25,172$—CollateralFair value of debt investments89,69316,44232,85040,401—Fair value of equity investments(b)606———606Cash, securitization account7,7937,793———Total collateral$98,092$24,235$32,850$40,401$606


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

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

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


BANK OF AMERICA UNSECURED REVOLVER


In November 2012, we obtained an unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or Bank of America Unsecured Revolver.  The Bank of America Unsecured Revolver will expire in November 2014.  In August 2013, we executed an amendment to the Bank of America Unsecured Revolver that requires that we maintain a zero balance for a period of at least five consecutive days during the six-month period immediately preceding June 30th and December 31st of each year, which testing was previously required quarterly.  In the event we borrow under the Bank of America Unsecured Revolver, we agreed to increase the interest rate on such advances from LIBOR plus 3.5% to LIBOR plus 4.0%.  As of September 30, 2013 , there were no borrowings outstanding on the Bank of America Unsecured Revolver.


The Bank of America Unsecured Revolver is subject to certain collateral requirements and financial covenants.  Included among them are requirements that we maintain a ratio of all unencumbered assets to outstanding amounts under the Bank of America Unsecured Revolver of at least four-to-one, as well as a ratio of unencumbered cash and senior portfolio loans to outstanding amounts under the Bank of America Unsecured Revolver of at least three-to-one.  The Bank of America Unsecured Revolver may be prepaid at any time.


WEIGHTED-AVERAGE BORROWINGS AND COST OF FUNDS


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


Nine months ended September 30,(dollars in thousands)20132012Weighted-average borrowings$209,367$349,615Average LIBOR0.28%0.47%Average spread to LIBOR, excluding amortization of deferred debt issuance costs3.532.33Impact of amortization of deferred debt issuance costs0.602.00Total cost of funds4.41%4.80%


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LIQUIDITY AND CAPITAL RESOURCES—COMMON STOCK


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


On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million.  During the nine months ended September 30, 2013 , we repurchased 504,639 shares of our common stock at a weighted average purchase price of $4.50 per share, which was a 13.1% discount from our quarterly net asset value per share.  On October 25, 2013, our board of directors authorized an additional stock repurchase program of up to $25.0 million.  Under the program, we are authorized to repurchase shares of our common stock in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.  The repurchase program may be extended, modified or discontinued at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.


OFF-BALANCE SHEET ARRANGEMENTS


FINANCIAL INSTRUMENTS


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


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


We do not report the unused portions of these commitments on our Consolidated Balance Sheets.  As of September 30, 2013 , we had $19.1 million of outstanding unused loan commitments.  We believe that our operations, monetizations, revolving credit facility and unrestricted cash will provide sufficient liquidity to fund, as necessary, requests to draw on these unfunded commitments.  We estimate that the fair value of these commitments was $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties.  From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies.  As of September 30, 2013 , we had no outstanding guarantees or standby letters of credit.


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CONTRACTUAL OBLIGATIONS


The following table shows our contractual obligations as of September 30, 2013 :


(in thousands)Payments Due by PeriodContractual Obligations(a)TotalLess than 1 year1-3 years4-5 yearsAfter 5 yearsBorrowingsTerm securitizations(b)$29,173$4,001$—$25,172$—SBIC150,000———150,000Total borrowings179,1734,001—25,172150,000Interest payments on borrowings(c)50,0027,16314,27214,11414,453Operating leases46439866——Severance obligations(d)931931———Total contractual obligations$230,570$12,493$14,338$39,286$164,453


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|(a) | Excludes the unused commitments to extend credit to our customers of$19.1 millionas discussed above.

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

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

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|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(d) | Represents remaining severance payments and employer taxes that we are obligated to pay stemming from the resignations of our former chief executive officer and former chief financial officer.

DISTRIBUTIONS


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


We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions.  In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act and due to provisions in our credit facilities and SBA regulations.  If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of favorable RIC tax treatment.  We cannot assure stockholders that they will receive any distributions, or distributions at a particular level.  We may make distributions to our stockholders of certain net capital gains.  Since December 2001, we have declared aggregate per share distributions of $13.76 .


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


Date DeclaredRecord DatePayable DateDividends per ShareOctober 25, 2013November 8, 2013November 22, 2013$0.125July 26, 2013August 9, 2013August 30, 2013$0.125April 26, 2013May 10, 2013May 31, 2013$0.125March 1, 2013March 15, 2013March 29, 2013$0.125October 26, 2012November 16, 2012November 30, 2012$0.125July 27, 2012August 17, 2012August 31, 2012$0.140April 27, 2012June 13, 2012July 13, 2012$0.140February 24, 2012April 13, 2012May 15, 2012$0.170October 31, 2011December 15, 2011January 13, 2012$0.170August 1, 2011September 14, 2011October 14, 2011$0.170May 5, 2011June 15, 2011July 15, 2011$0.170March 1, 2011March 15, 2011April 15, 2011$0.150


If we determined the tax attributes of our distributions as of September 30, 2013 , 75% would be from ordinary income and 25% would be a return of capital.  A return of capital is a return of stockholder investment, rather than a return of earnings or gains derived from our investment activities.  While not immediately taxable to the extent of a stockholder's basis in its shares, a stockholder's basis in the investment will be reduced by the nontaxable amount, which will result in additional gain or a lower loss when the shares are sold.  However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year.  Therefore, a determination as to the tax attributes of the distributions made on a quarterly basis may not be representative of the actual tax attributes for a full year.  We intend to update stockholders quarterly with an estimated percentage of our distributions that resulted from taxable ordinary income.  The actual tax characteristics of distributions to stockholders will be reported to stockholders annually on a Form 1099-DIV.  Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.


CRITICAL ACCOUNTING POLICIES


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


VALUATION OF INVESTMENTS


FAIR VALUE MEASUREMENTS AND DISCLOSURES


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


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


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


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


DETERMINATION OF FAIR VALUE IN GOOD FAITH


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


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


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


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|• | Majority-Owned Control Investments—Majority-owned control investments comprised11.9%of our investment portfolio at fair value.  Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value.  Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value.  Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company in question.  Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs.  Our valuation approaches for majority-owned investments estimate the value

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


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|• | Non-Control Investments—Non-control investments comprised88.1%of our investment portfolio at fair value.  Quoted prices were not available for94.1%of our non-control investments at fair value.  For our non-control equity investments, we use the same market and income approaches used to value our control investments.  For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates.  We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower.  In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.

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|• | Thinly-Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end.  However, we may apply a discount to the market value of restricted or thinly-traded public securities to reflect the impact that these restrictions have on the value of these securities.  We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2).  As ofSeptember 30, 2013, these securities represented5.2%of our investment portfolio at fair value.  We utilize independent pricing services to arrive at certain of our fair value estimates.  The majority of our level 2 investments are senior debt investments that are secured and collateralized.  To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence.

Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales.  Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks.  We also engage independent valuation firms to provide additional data points for our quarterly valuation analyses.  Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months.  In total, as of September 30, 2013 , we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve month period to calculate 99.0% of the fair value of our investment portfolio.


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


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


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


Significant Unobservable Inputs


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


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


The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of September 30, 2013 .


($ in thousands)Fair ValueValuation TechniquesUnobservable InputsRangeWeighted AverageMinimumMaximumSenior debt$201,698Discounted cash flowMarket interest rate5.7%12.7%8.8%Discounted cash flowDiscount rate4.0%4.0%4.0%Market comparable companiesRevenue Multiple0.2x0.2x0.2xMarket comparable companiesEBITDA multiple(a)7.5x7.5x7.5xSubordinated debt136,944Discounted cash flowMarket interest rate12.2%16.7%13.7%Market comparable companiesRevenue multiple0.2x0.2x0.2xMarket comparable companiesEBITDA multiple(a)7.5x7.5x7.5xPreferred and common equity36,395Market comparable companiesEBITDA multiple(a)4.4x10.0x7.7xDiscount for minority interest—%25.0%2.5%Residual assetsDiscount rate25.0%25.0%25.0%$375,037


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




ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


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


Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates.  Our net interest income is affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates.  As of September 30, 2013 , approximately 72.8% of our loan portfolio, at fair value, bore interest at a spread to either the LIBOR or the  prime rate, and 27.2% at a fixed interest rate.  As of September 30, 2013 , approximately 63.6% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR base index and prime floors between 2.5% and 6.0% .  The three-month weighted-average LIBOR interest rate was 0.26% as of September 30, 2013 .  Thus, the LIBOR floors in these loan investments lessen the impact of such historically low LIBOR rates.


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


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The following table shows a comparison of the interest rate base for our interest-bearing cash, outstanding commercial loans, at cost, and our outstanding borrowings as of September 30, 2013 and December 31, 2012 :


September 30, 2013December 31, 2012(in thousands)Interest Bearing Cash and Commercial LoansBorrowingsInterest Bearing Cash and Commercial LoansBorrowingsMoney market rate$66,592$—$43,291$—Prime rate39—13,603—LIBOR30-day29,589—18,635—60-day————90-day239,21429,173294,77498,053180-day——9,301—Fixed rate107,233150,000115,091150,000Total$442,667$179,173$494,695$248,053


Based on our September 30, 2013 balance sheet, the following table shows the impact to net income of hypothetical base rate increases in interest rates, assuming no changes in our investment and borrowing structure.  The impact to net income of hypothetical base rate decreases in interest rates is not shown in the following table because as of September 30, 2013 , the quarterly average LIBOR was 0.26% and a 100-basis point decrease could not occur:


(dollars in thousands)Basis Point ChangeInterest IncomeInterest ExpenseNet Income100$1,056$292$7642003,2565832,6733006,3748755,499


ITEM 4.  CONTROLS AND PROCEDURES


DISCLOSURE CONTROLS AND PROCEDURES


Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2013 .  The term “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.


Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on the foregoing evaluation of our disclosure controls and procedures as of September 30, 2013 , our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.


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INTERNAL CONTROL OVER FINANCIAL REPORTING


No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), occurred during the fiscal quarter ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


PART II.  OTHER INFORMATION





ITEM 1.  LEGAL PROCEEDINGS.


From time to time, we are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies.  While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations.  During the quarter ended September 30, 2013 , there were no new or material developments in legal proceedings.


ITEM 1A.  RISK FACTORS.


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


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


The following disclosure replaces and supplements the risk factors titled "Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns", "You may not receive future distributions" and "Our wholly owned subsidiary is licensed by the SBA and is subject to SBA regulations.  If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or revoke or suspend our license" included in our Annual Report on Form 10-K for the year ended December 31, 2012 and adds the risk factor titled "A failure or the perceived risk of a failure to raise the statutory debt limit of the United States could have a material adverse effect on our business, financial condition and results of operations":


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


From time to time, we target specific industries in which to invest on a recurring basis, which may result in significant concentrations in our portfolio.  As a consequence, the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of such investments or a substantial write-down of any one investment.  Beyond regulatory and income tax diversification requirements, we do not have fixed guidelines for industry concentration.  In addition, while we generally decline to make investments in a particular industry or group of industries that would exceed 15.0% of our total assets at the time of closing, it is possible that as the values of our portfolio companies change, one industry or a group of industries may come to exceed such level.  As a result, a downturn in an industry in which we have invested a significant portion of our total investments could have a materially adverse effect on us.  As of September 30, 2013 , 26.4% , 18.9% and 15.2% of our total investments at fair value were invested in healthcare, business services and education companies, respectively.  Therefore, we are


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susceptible to the economic circumstances in these industries, and a downturn in any one of these industries could have a material adverse effect on our results of operations and financial condition.


You may not receive future distributions.


In the event that the asset coverage ratio applicable to us as a BDC falls below 200%, we will be unable to make distributions until the ratio again meets or exceeds the threshold.  If we do not distribute at least 90% of our investment company taxable income annually, we will suffer adverse tax consequences, including the possible loss of our status as a RIC for the applicable period.  From December 2001 through September 30, 2013 , we declared distributions totaling $13.76 per common share.  Due to the market dislocation, we suspended our distributions from the third quarter of 2008 through the first quarter of 2010.  We reinstated our distribution on April  29, 2010, and have continued to declare a quarterly dividend since that time; however, there can be no assurance that distributions will continue in the future.


We will make future decisions with respect to the actual level of distributions after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our BDC asset coverage ratio at the time of such decision.  Regulatory constraints, our inability to achieve operating results or a decline in the performance of our business could prohibit our ability to make any future distributions.  In addition, we may not be able to make distributions at a specific level or to increase the amount of these distributions from time to time.


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


Our wholly owned subsidiary, Solutions Capital, is licensed to operate as an SBIC and is regulated by the SBA. The SBIC license allows Solutions Capital to obtain leverage, or borrowings, by issuing SBA-guaranteed debentures, subject to receipt of a capital commitment from the SBA and other customary procedures. The SBA regulations require, among other things, an annual periodic examination of a licensed SBIC by an SBA examiner to determine the SBIC ' s compliance with the relevant SBA regulations, and the performance of a financial audit by an independent auditor.


The SBA regulations permit licensed SBICs to make long term loans to small businesses and invest in the equity securities of such businesses. Under current SBA regulations, a licensed SBIC may provide capital to small businesses having a tangible net worth not exceeding $18.0 million and an average net income after federal income taxes not exceeding $6.0  million for the two most recent fiscal years. In addition, a licensed SBIC must devote 25% of its investment activity to entities having a tangible net worth not exceeding $6.0 million and an average annual net income after federal income taxes not exceeding $2.0 million for the two most recent fiscal years. If a proposed portfolio company does not meet the foregoing requirements, the SBA regulations also provide alternative criteria for eligibility which depend on the industry in which the prospective portfolio company is engaged as well as other factors such as the number of employees and gross sales. The SBA also restricts the financing terms of investments by SBICs in portfolio companies, and prohibits funds from being deployed in support of certain purposes or industries. Compliance with SBA requirements may cause our SBIC subsidiary to forego attractive investment opportunities that are not permitted under SBA regulations.


A single-license SBIC subsidiary may currently borrow up to a maximum of $150.0  million when it has at least $75.0  million in private capital, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of January 2013, we have funded $75.0  million to Solutions Capital, and Solutions Capital has borrowed the maximum $150.0  million of SBA-guaranteed debentures.  In the quarter ended September  30, 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P.  In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013.  However, receipt of a green light letter from the SBA does not assure that the SBA will ultimately issue an SBIC license and we have received no assurance or indication from the SBA either that we will receive a second SBIC license, or the timeframe in which we could expect to receive a second license should one ultimately be granted.


The SBA prohibits, without prior SBA approval, a “ change of control ” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of a licensed SBIC. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, depending on the severity of


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the violation, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or limit it from making new investments. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the SBIC Act or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our SBIC subsidiary is our wholly owned subsidiary and we rely on the ability to make investments through it.


A failure or the perceived risk of a failure to raise the statutory debt limit of the United States could have a material adverse effect on our business, financial condition and results of operations.


As has been widely reported, the United States Treasury Secretary has stated that the federal government may not be able to meet its debt payments in the relatively near future (currently February 2014) unless the federal debt ceiling is raised.  If legislation increasing the debt ceiling is not enacted and the debt ceiling is reached, the federal government may stop or delay making payments on its obligations.  A failure by Congress to raise the debt limit would increase the risk of default by the United States on its obligations, as well as the risk of other economic dislocations.  If the U.S. Government fails to complete its budget process or to provide for a continuing resolution before the expiration of the current continuing resolution (currently January 2014), another federal government shutdown may result.  Such a failure or the perceived risk of such a failure consequently could have a material adverse effect on the financial markets and economic conditions in the United States and throughout the world.  It could also limit our ability and the ability of our portfolio companies to obtain financing, and it could have a material adverse effect on the valuation of our portfolio companies.  Consequently, the continued uncertainty in the general economic environment, including the recent government shutdown and potential debt ceiling implications, as well in specific economies of several individual geographic markets in which our portfolio companies operate, could adversely affect our business, financial condition and results of operations.


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


NET ISSUANCE OF RESTRICTED STOCK


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


DIVIDEND REINVESTMENT PLAN


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


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The following table summarizes the shares of common stock that we have purchased during the three months ended September 30, 2013 :


Period/PurposeTotal number  of sharesAverage Price Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsMaximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or ProgramsJuly 1 – 31, 2013Restricted stock vesting(a)1,940$5.36(b)n/an/aAugust 1 – 31, 2013Dividend reinvestment requirements(c)1,361$4.99(d)n/an/aSeptember 1 – 30, 2013Restricted stock vesting(a)4,262$5.04(b)n/an/aTotal7,563$5.11n/an/a


____________________


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

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

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

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




ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.


Not Applicable.


ITEM 4.  MINE SAFETY DISCLOSURES.


Not Applicable.


ITEM 5.  OTHER INFORMATION.


TERMINATION OF OFFER LETTER


On October 28, 2013, Ehssan Peter Malekian, an Executive Vice President and Managing Director, executed a letter agreement with us, or the Letter Agreement, which terminated that certain offer letter dated July 23, 2001, or the Offer Letter.  Under the terms of the Offer Letter, if the employment of Mr. Malekian was terminated by us other than for cause, then he would have received all of his accrued compensation and severance pay equal to three months of his then-current base salary.


Upon execution of the Letter Agreement, Mr. Malekian is eligible for participation in the MCG Capital Corporation 2011 Severance Pay Plan, as amended, or the 2011 Severance Pay Plan, which is applicable to all MCG employees who are not entitled to receive severance benefits under another agreement or letter in excess of any wages accrued as of any termination of employment.


The 2011 Severance Pay Plan provides MCG employees with certain benefits under defined events of termination of employment.  Specifically, the plan provides that in the event that we terminate an eligible employee’s employment without cause or the employee resigns for good reason, the employee will be eligible for three, six or nine months of continuing separation pay, healthcare continuation benefits and lapsing of forfeiture provisions with respect to shares of restricted stock (based on years of service with MCG).


Under the 2011 Severance Pay Plan, if the employment of Mr. Malekian is terminated by us other than for cause, or if Mr. Malekian terminates his employment with us for good reason, Mr. Malekian would be eligible for nine months of


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continuing separation pay, healthcare continuation benefits and lapsing of forfeiture provisions with respect to shares of restricted stock.


STOCK REPURCHASE PROGRAM


On October 25, 2013, our board of directors authorized a stock repurchase program of up to $25.0 million.


Under the program, MCG management is authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors.


The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate MCG to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.


ITEM 6.  EXHIBITS.


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


Incorporated by ReferenceExhibit No.DescriptionForm and SEC File No.Filing Date with SECExhibit No.Filed with this 10-Q10.1First Amendment to Financing Agreement dated as of August 8, 2013 between MCG Capital Corporation and Bank of America, N.A.8-K(0-33377)August 8, 201310.115.1Letter regarding unaudited interim financial information from Ernst & Young LLP, independent registered public accounting firm*31.1Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*31.2Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*32.1Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†32.2Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002†*Filed herewith.†Furnished herewith.





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SIGNATURES


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





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





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