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MCG Capital Corporation (NASDAQ:MCGC)

Q4 2008 Earnings Call Transcript

March 6, 2009 10:00 am ET

Executives

Steve Tunney – Co-founder, President and CEO

Tod Reichert – Chief Compliance Officer, SVP and Corporate Secretary

Steve Bacica – EVP and CFO

Analysts

Greg Mason – Stifel Nicolaus

Vernon Plack – BB&T Capital Markets

Steven Fox [ph] – KBW

Gregg Hillman – First Wilshire Securities Management

Alan Gelband – Alan Gelband Company

Ron Hollander [ph] – Morgan Stanley

Operator

Good day, and welcome to the MCG Capital Corporation fourth quarter earnings conference call. Today's call is being recorded.

With us today are Steve Bacica, Chief Financial Officer and MCG Capital's Co-founder, President and Chief Executive Officer, Steven Tunney. Please go ahead, sir.

Steven Tunney

Good morning, everyone. First, before we get started, I would like to have Tod Reichert, our Chief Compliance Officer to provide the necessary Safe Harbor disclosures, Tod?

Tod Reichert

Thanks, Steve. As a reminder to everybody on call this morning, the slides for today's presentation and our Q4 earnings release can be found in the Investor Relations tab of our website. Today's call being recorded and webcast live through our website at www.mcgcapital.com. A replay of the call will be available on our website and an audio replay will be available through March 20, 2009. The replay information is included in our press release announcing this call and is posted in the Investor Relations section of our website. This recording is the property of MCG Capital Corporation and cannot be used or reproduced without the prior written consent of MCG.

Now before we begin this morning, we would like to remind that you various remarks that we may make during this morning's call regarding MCG's future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor protection under applicable security laws. These forward-looking statements involve risks and uncertainties that may cause actual results and/or performance to differ materially from any future results, performance and achievements discussed in or implied by such forward-looking statements.

The risks and uncertainty include, but are not limited to expectations regarding results of operation including revenues, net operating income, distributable net operating income and general and administrative expenses and the factors that may affect such results. The steps we have taken to ensure that we have maintained stability through challenging economic conditions and our ability to emerge from the current economic cycle in a position of relative strength, our current strategic direction, including opportunistically monetizing assets, preserving liquidity, building our unrestricted cash position, deleveraging our balance sheet and increasing our BDC coverage ratio, the amount, timing and price relative to the fair value of asset monetization, the flexibility that covenant modifications have provided to support the management of our portfolio, the effects of the monetization of second lien and equity investments have on our liquidity and net asset values, our improved collateral position and financing flexibility, our ability to repurchase equity, additional debt securities and make stockholder distributions, the relief that our debt modifications will provide in the challenging market, our belief that our portfolio will weather a protracted recession, our ability to exclude debt from our BDC asset coverage ratio, our ability to execute on our strategy throughout 2009, the performance of our portfolio companies and general economic factors.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. We may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligations to do so, even if our estimates change and therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

Now during this call, we will be referring to a non-GAAP financial measure, distributable net operating income, also referred to as DNOI. This non-GAAP measure is not prepared in accordance with generally accepted accounting principles. A reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measures is available in MCG's fourth quarter 2008 earnings release and in the Investor Relations section of our website at www.mcgcapital.com under the heading Financial Information, non-GAAP Financial Measures.

I would now like to turn the call over to our President and CEO, Steve Tunney.

Steve Tunney

Thank you, Tod, and, again, welcome everyone. Hopefully by now you've had a chance to review our fourth quarter earnings release which was issued last evening. While we, like others throughout the financial services industry, have had to confront the issues associated with liquidity, leverage and the impact of fair value accounting on portfolio company valuations, we believe that we took the necessary steps early in the process to ensure that we maintain stability through these challenging economic conditions.

For example, we began our deleveraging initiatives during the middle of 2008 and since then, have made significant strides to improve our liquidity, preserve our capital and reduce our debt obligations. Given that we anticipate capital market conditions will remain difficult, we will continue to execute this strategy throughout 2009. We believe that by doing so, we will come out of this cycle in a position of relative strength.

Despite this challenging environment, we are extremely pleased that we have been able to monetize assets near their fair value. Since we began our deleveraging initiatives in July 2008, MCG has announced a total of $156.3 million in investment monetizations at approximately 100% of their previously reported fair value. This has enabled us to maintain our asset coverage ratio above 200%, build unrestricted cash and reduce our debt since the second quarter of 2008.

Further, we were successful in renegotiating the covenant requirements on our unsecured revolver with SunTrust and our private placement note holders and we obtained the renewal of the SunTrust liquidity facility on our warehouse, which extends this $190 million facility for another year. We believe that these covenant modifications will provide us with the flexibility and allow us to support the management of our portfolio in an unsettled market environment.

While the current market conditions have certainly been challenging, they have also created some opportunities for us. First, during the fourth quarter and in January 2009, we were able to redeem a portion of our debt at a significant discount from par. In total, we purchased $22.6 million of our 2006-1 CLO securities for $6.1 million, resulting in a gain of $16.5 million, $11.1 million of this gain, which was realized in the fourth quarter of 2008 and $5.4 million of which will be realized in the first quarter of 2009. Second, we have been able to amend certain of our borrower's credit facilities to recombine these facilities into a single senior security which was previously bifurcated into senior securities and second lien securities. As a result, we have improved our collateral position and increased our financing flexibility.

Also, we have been able to effectively manage our liquidity and asset coverage ratio through portfolio monetizations and the renegotiation of our credit facilities. As we outlined on last quarter's call, our principal focus is on the opportunistic monetization of certain debt and equity investments in our portfolio so as to deleverage our balance sheet and build cash reserves. In the event that we are able to build adequate unrestricted cash resources and further reduce our leverage, we intend to evaluate on a quarterly basis potential discounted debt and share repurchases and the resumption of shareholder distributions. However, for the fourth quarter of 2008, there will nobody dividend distributions declared or paid.

Now let me review the results for the quarter. For the fourth quarter, we reported a loss of $0.77 per share with net valuation write-downs of $76.7 million and realized losses of $300,000. For the fourth quarter, revenue was $30 million, a 40% decrease from Q4 2007. Net operating income decreased 69% to $8.9 million or $0.12 per share, while DNOI was down 54% to $14 .2 million or $0.19 per share. The decrease from 2007 levels is primarily attributable to the absence of dividend income on our Broadview investment, a decrease in fee income due to lower originations and a goodwill impairment charge of $3.9 million.

During the fourth quarter of 2008, we monetized approximately $25.6 million in portfolio investments. Since the end of fourth quarter of 2008, we monetized an additional $64.2 million in portfolio investments. We will seek to continue to monetize assets over the next several quarters. The proceeds from all four of these portfolio company monetizations closely approximated our previously reported fair value. We are focusing on our monetization activities on second lien and equity investments as we believe that these assets provide the best enhancement to our liquidity and substantiate net asset values on junior capital investments. We will continue to focus on preserving our net asset value as we monetize assets and therefore, the actual timing of monetizations may vary depending on market conditions. But as I will detail below, we are under no contractual or other obligation to monetize assets at specified times, levels or prices.

As of quarter end, we had $46.1 million of unrestricted cash and an asset coverage ratio of 201%. As of March 3, 2009, we had $60.5 million of unrestricted cash before any debt pay-down and an asset coverage ratio of 207%. The asset coverage ratio for both periods was impacted by a $25 million drawdown on our unsecured revolver in December 2008 that was effected as a precautionary measure to provide unrestricted cash, given the turbulent capital market environment. Our focus with respect to renegotiating or borrowing facilities was to reduce and/or eliminate the need to monetize assets in an unfavorable market environment to repay debt. In this regard, we were able to successfully modify our debt covenants to give us relief that we believe will allow us to manage through these unpredictable and challenging market conditions.

Specifically, we reduced the most restricted minimum shareholders equity covenant from $654 million to $525 million with a pre-negotiated methodology to reduce it further to $500 million. This gives us $134 million of cushion under this covenant as of December 31, 2008. Further, we modified the BDC asset coverage ratio from the previous level of 200% to 180% requirement.

As a reminder, there are two considerations regarding the BDC asset coverage test. One is the credit facility compliance fees which I just addressed, and the second aspect is the regulatory compliance, which requires us as a business development company to meet a coverage ratio of total assets to total borrowings and other senior securities of at least 200%. If this ratio declines below 200%, we can not incur additional debt and cannot make cash distributions until we are back in compliance. As of December 31, 2008 and prior to the amendments of our facilities, we were in compliance with the minimum shareholders equity requirement and all other key financial covenants under each of our borrowing facilities.

Additionally, we were successful in extending the liquidity renewal date on our $190 million SunTrust warehouse. The new liquidity renewal date for this facility is February of 2010. Finally, each of our unsecured revolver and our private placement notes remain unsecured obligations of the company. In consideration for these concessions, our lenders received certain modifications such as a reduction in the limit of our SunTrust warehouse facility from $250 million to $190 million with a goal to get it to $150 million by next February's liquidity renewal rate. In addition, our own secured revolver was reduced from $70 million to $35 million. We also agreed to allocate a portion of our monetization proceeds towards debt repayment. Again, asset monetizations are at the sole discretion of MCG based upon the economic merits of any proposed deal. We believe that these concessions contribute to our business strategy and will reduce our overall borrowings.

In the short term, we have $35 million in debt due in 2009 which is the anticipated paydown of our unsecured revolver in May of 2009 and which we can pay from cash resources on hand. Absent any acceleration events, our SunTrust warehouse matures in 2011 and our private placement notes mature in October 2010 with respect to $50 million of the notes and October 2012 with respect to the $25 million in notes. With regard to our SunTrust warehouse, there is no event that would require us to write a check for the amount outstanding at any given point. If the liquidity facility is not renewed in February 2010, the facility would enter an 18-month amortization period during which the amount outstanding is paid down through an orderly monetization process. Since the SunTrust warehouse and our 2006 CLO for that matter, are financed through bankruptcy remote vehicles, the only at MCG capital at risk is MCG's equity portion of the finance collateral. We are pleased that we have the continued support of our lenders and we were able to reach a timely and mutually satisfactory amendment on each of our credit facilities.

Before I turn the call over to Steve, I would like to say a few words about our portfolio companies and our investment strategy. Our investment criteria have always included a requirement to avoid highly cyclical sectors and businesses with significant volatility exposure. While the recent economic downturn has put great pressure on our company and the financial services industry in general, our strategy has served us well during previous economic cycles, and we believe that our portfolio will weather a protracted recession. A majority of our investments are in sectors which we believe will be less volatile than the market as a whole, sectors such as healthcare, cable, business services and telecom, to name a few. It is important to note that the last 14 months of this recession has been more of a financial services and housing recession, and the true effects of our economy's contraction are just recently extending into other sectors of the economy. This softness is evidenced in a portion of our portfolio that includes advertising based businesses such as publishing and broadcasting, housing and diversified goods manufacturers. On a portfolio wide basis, however, we still experience growth and revenue in EBITDA on a year-over-year basis of over 6% and 10%, respectively.

Our debt portfolio has a weighted average fair value debt-to-EBITDA ratio of 5.7 times and with the exclusion of one broadcast deal, our debt-to-EBITDA ratio is 5.4 times. Our non-accruals are at 4.9% of fair value and our equity portfolio fair value is 7.8 times on a trailing 12 month basis and 6.6 times on a forward 12 month basis. Our equity values reflect our views that the recession will continue throughout 2009 and are supported by a rigorous valuation process, which includes third party reviews. As of December 31, 2008, 99% of our portfolio has had a third party review, and 90% of our equity portfolio has had those valuations completed within 90 days of year end.

In conclusion, while we expect to continue to face challenging economic conditions during fiscal 2009, we believe that we have built a strong company that is capable of not only surviving the current turmoil, but also emerging from this cycle in a stronger relative position. We have assembled an experienced, dedicated and seasoned management team with a proven track record of working through and enduring challenging business cycles. It is clear that our business has been impacted by factors that are out of our control, but it is important to recognize that which are doing everything to manage what we can control.

Many of the investors and analysts listening to today's call follow the other publicly traded companies in the financial services space. A number these companies are facing similar financial challenges, and I am pleased that the MCG management team has met these challenges and has been able to complete this series of critical initiatives that we have announced in recent days. We remain principally focused on strategically monetizing assets, preserving capital, improving our BDC asset coverage ratio and deleveraging our balance sheet. Over time, if we meet our goals with respect to leverage levels and unrestricted cash balances, we will seek to potentially repurchase equity and additional debt securities and resume shareholder distributions.

With that, I will turn the call over to Steve Bacica, our Chief Financial Officer for a financial overview of the quarter. Following Steve's presentation, the two of us will be available to address any questions you may have about our performance. Steve?

Steve Bacica

Thanks, Steve. Good morning, everyone. For those who are listening along the webcast, we have posted slides that you can refer to as I give the financial update.

Starting with slide three, yearly and quarterly update, our revenue for the three months ended December 31, 2008 decreased about $20 million compared to the three months ended last year. That change was primarily driven by a decrease in dividend income stemming from our no longer recognizing Broadview dividends compared to the prior year and decreases in interest income from a reduction of LIBOR. Also, we had decreases in advisory fees driven by reductions in origination activity. DNOI decreased about $17 million due to these changes, which included an $8 million impact from Broadview dividends, a $2.7 million impact in fee income and a $3 million effect from decreases in other dividends as well as the impact of the small overall investment portfolio.

Net operating income decreased about $20 million compared to the prior three-month period driven by these changes in revenue but were partially offset by decreases in operating expenses compared to the prior year period, which primarily included lower interest expense and decreases in employee compensation. Additionally, we wrote off a $3.9 million goodwill balance due to the requirements of financial accounting standards number 142. This amount, which represented MCG's entire goodwill balance, came about from MCG's original formation transactions. DNOI per share was a positive $0.19 and NOI per share was a positive $0.12. Our net loss for the three months ended December 31, 2008 was approximately $57 million or $0.77 per share driven by unrealized losses in our portfolio but offset by an $11 million gain on the repurchase of debt.

Moving to slide four, events subsequent to 12/31/08, this slide shows a summary of key events after year end. In February, we successfully executed a comprehensive amendment package with our key lenders which provided flexibility that allowed MCG to pursue our current strategy of monetizing assets to reduce net debt and pursue other initiatives to improve shareholder value. With our unsecured revolver, the shareholder equity covenant was reduced from $650 million to $500 million. As of today, we owe a little over $30 million, and we have the cash on hand to pay this down. The revolver commitment was reduced from $70 million to $35 million and pricing increased from LIBOR plus 235 to LIBOR plus 400. MCG will pay down a pro rata portion of 6% of modernization proceeds through May 2009 on this facility.

With our unsecured private placement, we reduced the minimum shareholder equity covenant from $643 million to $500 million and the minimum asset coverage ratio was reduced from 200% to 180%. Pricing increased on the 2005 notes from 6.73% to 8.98% and with the 2007 notes, from 6.71% to 8.96%. A key change was that the amendments removed certain cross default provisions that add flexibility. Further, we will pay down a pro rata portion of 60% of modernization proceeds to noteholders through May 2009 and then 40% thereafter.

With our SunTrust warehouse, SunTrust provided its annual liquidity renewal through February 2010. With this amendment, the minimum shareholders equity covenant was reduced from $654 million to $525 million with the ability to reduce it to $500 million. The facility size was reduced from $250 million to $190 million. Pricing increased from commercial paper plus $150 on Class A to commercial paper plus 250. MCG also contributed approximately $37 million of additional collateral as part of the transaction and will pay down a total of $7.5 million contingent on asset monetizations. MCG will pay down the facility to $150 million from asset monetization proceeds as Steve talked about earlier.

Additionally, after year end, we sold our equity investment in LMF for $40.5 million, which was 11% above the previously reported fair value. Net cash proceeds after financing were about $21 million, with an additional $5 million expected upon completion of transfer of collateral to our 2006-1 term securitization. MCG also expects additional liquidity after syndicating a portion of the loan. Lastly, we received a $21.5 million repayment on a loan from Dayton Parts. This repayment was at par and approximately $1 million above its previously reported fair value.

On slide five, selected balance sheet data, you will see that despite the marks recorded in the fourth quarter, we still have a well capitalized balance sheet with $659 million in total shareholders equity supporting $1.3 billion in total assets. Our debt-to-equity ratio is 0.97:1 and our plan is to improve that ratio. Our net asset value per share has been impacted by valuation losses and dividends we declared during 2008 and it currently sits at $8.66 per share.

Moving on to slide six, selected operating data, we have touched on several of these points, but I will point out that the absence of Broadview dividends was a significant driver in the decrease in revenues year-over-year. Salaries and benefits have decreased compared to the prior year due to the reduction in force and through attrition. And our G&A in 2008 included about $1.3 million for a corporate restructuring charge. For those of you running your models, you can estimate that we expect that G&A will run about 2.5% to 3.0% of portfolio value over the near term. We will continue to focus on opportunities to decrease our costs. For those who need more data, we will be filing our form 10-K with the SEC in the very near term. As it relates to our 10-K, our auditors will be issuing a clean opinion on our financial statements.

Moving on to gains and losses on slide seven, the most significant changes for the fourth quarter were driven by writedowns with T&R Holdings, Superior Industries and Active Brands. Our unrealized depreciation for Q4 was $77 million.

Going to slide eight, Steve spent some time talking about our debt agreements; however, I wanted to re-emphasize certain aspects. Each of our credit facilities have certain collateral requirements or financial covenants, but a key element to focus on is that over $500 million of our outstanding debt balances are made up of the 2006-1 facility and the SunTrust warehouse. Those are non-recourse facilities. That means that over 80% of our debt is non-recourse to MCG, the parent. Also, our parent company's debt obligations continue to be unsecured. And although our forecasted annual interest expense for 2009 will increase by about $2.5 million, we are pleased with the outcome of our negotiation with our lenders, and we look forward to continuing to partner with them in the future.

Moving on to slide 10 which covers originations, advances and paydowns, you will see that we had minimal originations of $22 million during the quarter and $40 million in paydowns. The $22 million all related to existing portfolio assets. Originations consisted of about $3 million of new originations, revolver advances were approximately $12 million and pick and dividend accruals were about $7 million.

On slide 11, we have listed our monetization activities since July 2008. This slide shows the value at which we exited the investment compared to prior quarter fair values. We have monetized over $156 million in assets at approximately 100% of our fair value. As you can see, we are realizing our NAV when we monetize assets. With the enhanced flexibility under our new debt agreements, we will be able to continue to monetize assets at our fair values, which will continue to enhance shareholder value. Our focus is on junior capital modernization to enhance liquidity and substantiate NAV. 71% of our $156 million in monetizations were equity and second lien monetizations.

Moving on to slide 12, which shows our portfolio distribution by asset class, looking at our $1.2 billion portfolio, you can see our distribution is a little more than 36% in senior debt, one-third sub debt and third in equities. Our recombination of bifurcated securities has shifted about 5% to more senior loans.

On slide 13, you can see we are still well diversified by industry group. Our target is to have no industry above 15%, and we are currently meeting that goal.

Moving on to the next slide, as it relates to our portfolio investment ratings, one item to note that is that although investments rated IR-1 have decreased by about 6 points, about 70% of the shift has moved to IR-2 ratings and the remaining 30% have been rated IR-4s. With IR-4s, though, we still expect an overall positive internal rate of return on the investment. Also on this slide, one other item I wanted to mention relates to non-accrual loans. We had two new loans go on non-accrual status in Q4, but our overall portfolio continues to perform in the fourth quarter and total non-accruals have only changed from 4.2% in Q3 to 4.9% in Q4.

On slide 15, we show the coverage we have related to third-party valuations of our portfolio investments. As you can see, we continue to have very comprehensive coverage by outside third party valuation firms. 99% of our portfolio has been reviewed by outside valuation firms in the last four quarters. Further, as Steve mentioned earlier, as of December 31, 2008, for 90% of our equity portfolio, those valuations have been completed within 90 days of year end.

Moving to slide 16; in summary for the quarter, distributable net operating income or DNOI for the quarter ended December 31, 2008 was $14.2 million or $0.19 per share. DNOI for all of 2008 were $66.9 million or $0.93 per share. Net operating income or NOI for the quarter ended December 31, 2008, $8.9 million or $0.12. NOI for all of '08 was $56 million or $0.78 per share. The net loss for the quarter was $57 million or $0.77 per share, and net loss for the full year was $191 million or $2.65 per share.

Between July 2008 and February 2009, we completed $156 million of investment monetizations at 100% of their most recently reported fair values. We completed a comprehensive restructuring of MCG's credit facilities in February 2009, which provides covenant relief, decoupled certain cross default provisions and provides continued liquidity. We repurchased 22.6 million of the company's CLO at a 73% discount resulting in an $11.1 million gain in Q4 and $5.4 million gain to be recognized in Q1, 2009. We implemented cost-cutting measures, including a corporate restructuring, 30% reduction work force in consolidation of facilities.

In addition, MCG eliminated 2008 bonus and stock compensation for senior executive management team and has frozen 2009 base salaries for substantially all of its employees. We have received exemptive relief from the SEC in October 2008 to among other things; effectively exclude debt from the company's BDC asset coverage ratio. During 2009, we will make decisions with respect to dividends on a quarter-by-quarter basis after taking into consideration various factors impacting our business. Our current strategic focus is on monetizing assets, preserving our capital and deleveraging our balance sheet.

And with that, I think we'll open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) We will take our first question from Greg Mason of Stifel Nicolaus.

Greg Mason – Stifel Nicolaus

You talk about if the company is able to meet its goals with respect to leverage levels and a couple of other things you might have the potential to buy back stock or debt or resume shareholder distributions. What are the leverage level goals that you are setting for yourself?

Steve Tunney

We would like to be above 230%, perhaps more in the zip code of 235% with respect to the BDC asset coverage ratio, and I would like to have unrestricted cash in the zip code of $40 million, is sort of the internal targets. Those are obviously subject to change as we continue to evaluate market conditions and prospects for future liquidity and whatnot, but that gives you a sense of how we view it today.

Greg Mason – Stifel Nicolaus

Prioritize once you meet those goals, your capital use; prioritize buying back stock versus debt versus making new investments or paying a dividend?

Steve Tunney

With respect to unrestricted cash, the best and highest use of our capital is investing in our own securities. And as you do know, we had to make some concessions with respect to our agreements that put a little bit of a shackle around us with respect to the level of equity buy-ins. Basically, under our amendment with our private placement, we can only begin buying in equity after we have offered to buy in $35 million of their debt. So the answer to the question is, we really can't look at equity buy-ins until we achieve that objective.

Further, our SunTrust warehouse prohibits equity buy-ins, but that one should be taken care of by – not SunTrust warehouse, the SunTrust revolver has restriction in buying in equity. Until we pay that off in May '09, you couldn't do anything. So the principal focus is going to be debt in the near term, because we the capability of doing it. Further, let's talk about the time after we are above those restrictions that are embedded in the agreement. It is a little more complicated than just a simple return on capital computation looking at debt for equity, because of the requirement to meet the statutory level of 200% BDC asset coverage ratio for our regulatory purposes and the 180% threshold as our covenant requirements. So what you need to do is allocate buy-ins between debt and equity to make sure that you are managing that ratio as you shrink your balance sheet from a capitalization perspective.

Greg Mason – Stifel Nicolaus

Great. And can we dig a little bit more into your new debt agreements on the commercial loan funding trust? Are there any borrowing-based covenants, or did the advance rates change?

Steve Tunney

Yes, definitely, the advance rates did change. Prior to us executing this amendment, we had an advance rate of about 72%, which was a complicated calculation tied to the portfolio WARF rating and recovery rate. It basically is a grid metrics that you can see if you look in that debt agreement that shows you how the advance rates used to work as a triangulation of work and recovery rate of the actual portfolio. We did amend that grid such that the maximum borrowing advance rate is now 64% under that facility. But I would re-emphasize that this is a non-recourse facility. So that in the event that if the portfolio were to modify such that we tripped that covenant, the implication would be that it would be a termination event, which would require the facility to capture all of the interest and principal that comes from that portfolio to defease that debt if the other side Three Pillars declares a termination event. There is no change in that facility that would require MCG to write a check for the amount of borrowings due.

Greg Mason – Stifel Nicolaus

And what would you view as the most restrictive covenant? Minimum net worth, advance rates or borrowing base in that facility?

Steve Tunney

In that facility, probably the advance rate at this stage would be the most constricted, because I think that based on looking at the collateral that we have in the facility, we have fully drawn the facility, so there is no real excess availability available to us based on the makeup of the collateral pool.

Greg Mason – Stifel Nicolaus

Could you – if you foresee declining asset values or recovery rates, how do you cure that? Do you have to pay down the facility or can you pledge more collateral?

Steve Tunney

You can choose to. If you want to defend the facility, you can choose to either infuse additional cash into the facility to get the ratio back in – where it needs to be, or you could put more collateral into the facility to get the advance rate where it needs to be or if it deteriorated to a level where you decided it is not in your financial interest, you could allow the facility to go into a termination event which would then basically – they could look to the collateral to start to deal with defeasing the debt balance due on the facility. That being said, we have had a great track record with our facility, investments in that facility, and – And CLO.

Steve Bacica

– and the CLO.

Greg Mason – Stifel Nicolaus

Two quick questions and I will hop back in the queue. You gave the non-accruals at fair value. Could you give it to us at cost for this quarter and last quarter?

Steve Bacica

Sure, no problem. As it relates to cost, if you take a look in my presentation, I had a reference of 4.9% for fair value for Q4 and 4.2% for Q3. If you wanted to do that on a cost basis, the non-accruals on a cost basis for Q4 were about 12.8%, and for Q3 about 11%, just under 11%.

Greg Mason – Stifel Nicolaus

Great, and then one last quick question. The impairment to goodwill, what was that related to?

Steve Bacica

Under financial accounting standard number 142, any company is required to evaluate its intangible assets. And with our decline in stock price in the fourth quarter as well as earlier in the year, we had to basically assess the goodwill value. So we applied the provisions of 142, and based on that assessment, we needed to write off the goodwill at year end.

Greg Mason – Stifel Nicolaus

Thank you.

Operator

We will go next to Vernon Plack, BB&T Capital Markets.

Vernon Plack – BB&T Capital Markets

Thanks very much. Just a little more color on movement in non-accruals. Were there – could you tell me how many new additions to non-accruals took place in the fourth quarter?

Steve Bacica

There were two new loans that went on non-accrual. And actually to give you – because there is an interest in cost, one of those, the cost of one of them was about $13 million, and the other one was very small, just about $1 million.

Vernon Plack – BB&T Capital Markets

Okay. And how many non-accrual loans do you have right now, the number of – just the number of loans?

Steve Bacica

It's 13.

Vernon Plack – BB&T Capital Markets

13, okay. Thanks. And I notice that origination advances were $22 million in the quarter. I am trying to get a sense of how much funding is going to be needed going forward to assist your portfolio companies. Is that a pretty decent number? Should we expect originations and advances to continue to be in the $20 million range, at least as far as you can tell?

Steve Tunney

As good as number as any. I think that – could it move around by $10 million or $15 million? Sure. But up or down, I would emphasize that we are focused on just the existing portfolio. And the support that we provide in that particular instance was just additional support for a particular portfolio company, where we put in debt to pay down senior debt to modify senior debt covenants in a facility on a control company. And we were able to accomplish that particular transaction by actually – is that one that we did SBA proceeds? Right. So in this particular instance was a real good example of where we were able to access the SBIC – the – I am just wanting to make sure, did this close in December of this year or did it close in January? No, this is something that closed in January this year. I am thinking of – pardon me.

But let me just take it to explain that there are different pockets of capital that are available to us to access to provide capital to our portfolio companies, such as our 2006-1 CLO and our SBIC. As I have mentioned before on previous calls, we can utilize the SBIC to make follow-on investments in our portfolio companies as long we have the approval of the SBA and this one deal that we are thinking of, that I don't know if it – whether it closed in Q4 or Q1, we actually received that authority and have funded those funds from the SBIC into that portfolio company.

Vernon Plack – BB&T Capital Markets

Think about giving a second license to allow your SBA limit to be up to $250 million?

Steve Tunney

Absolutely. It is something that we are looking at potentially doing. The advantage is that under the recent change in law, instead of being limited at $150 million, if you have a fund of SBICs, the borrowing limit is increased to $225 million, and we think that that capital is very attractive, and we would do everything in our power to get access to that type of capital.

Vernon Plack – BB&T Capital Markets

Okay. Just one other quick question on your warehouse facility. The amortization period if – in fact the 18-month amortization period, as that becomes effective, when would that start? Would that start February of '10 if it is not renewed, or August '11?

Steve Tunney

No, February of '10 would start the amortization period that gives you a final legal maturity if you add 18 months to that of August 2011.

Vernon Plack – BB&T Capital Markets

Thanks very much.

Steve Bacica

Sure thing .

Operator

We will take our next question from Sanjay Sakhrani, KBW.

Steven Fox – KBW

Hi, this is actually Steven Fox [ph] filling in for Sanjay, thanks for taking my question. Understanding that there are some restrictions that one must be paid off first on your debt, would you look to pay off the private notes which currently have the highest cost? And then a follow up would be with regards to buying back more debt at a discount, how liquid is that market?

Steve Tunney

First, with respect to your first question, we have actually agreed that while the revolver, the $35 million is outstanding, and it has a maturity of this May. We've agreed that 60% of our net proceeds from unencumbered asset sales goes to curtail debt. Now it is real important to note that the definition of net proceeds is cash actually received by MCG. So in the event that there is an escrow or a requirement to roll over capital, that deducted from the definition note net proceeds. So we are actually allocating cash in the door. Now, 60% of that will then be allocated on a pro rata basis based on outstanding balances between the revolver and the private placement notes. After the revolver is paid in full, the repayment ratio drops to 40%, unless we have a default on our structured finance facilities. It could then go back up to 60%, but in the event of a non – in the event that we are not in default, the ratio is 40% of net proceeds and all of that would be allocated to pay down the private placement. In addition, we have to take 7.5% of the net proceeds from unencumbered asset sales to make a prepayment on our Three Pillars SunTrust warehouse facility until such time that we have paid $7.5 million down through that mechanism. And then the second question was – can you remind me, your second part of the question?

Steven Fox – KBW

It was with regards to buying back more debt.

Steve Tunney

Buying back debt, liquid of market. In looking at that, we have completed the $22 million repurchase on face value. Of that amount, $20 million was in the most junior-rated BBB securities. The size of that security pool was about $47 million, so we bought in $20 million of the $47 million. As we executed our buys in there, our prices did creep up a little bit as we were the only ones really making a market there. In the next class of securities, which is the single A security, there is also an additional $47 million of face value of which we bought into. So I think the opportunity is probably going to shift a little bit from being able to buy in the BBBs to the single As or perhaps the AAAs. The AAAs, of course, are the biggest category, and that probably is on the order of about $260 million of face value, and I am aware of one trade that went through in January or early February for $15 million at a mark of 50. So is that would obviously be the most liquid market at this time. So I do think that there is additional opportunity, but as we continue to buy in securities and people see what we are doing from an execution perspective, it is going to impact the absolute execution on those buy-ins, but I would say that there is a tremendous opportunity there.

Steven Fox – KBW

Great, thank you.

Operator

We will take our next question from Gregg Hillman, First Wilshire Securities Management.

Gregg Hillman – First Wilshire Securities Management

Good morning, gentlemen.

Steve Tunney

Good morning.

Gregg Hillman – First Wilshire Securities Management

Could you talk about – you talked about healthcare in certain segments of your portfolio not being too economically sensitive. But what percentage of your portfolio would you say is economically sensitive?

Steve Tunney

The components that I would refer to you are advertising or media based business, which is about 9% of the portfolio right now. And components of our diversified goods, when you look through there, those are manufacturing type businesses that has some component of cyclicality in there. And let's see, I am trying to think off the top of my head. And then housing, which is a very small part of the portfolio of around 2% or 3%, is that component. I would size it up in the aggregate as I sort of went through this analysis. About 73% is in sectors that we think should outperform the market as a whole, and about 27% of the portfolio is going to be at the market or subject to the market kind of concepts of volatility.

Gregg Hillman – First Wilshire Securities Management

When you say "at the market," what do you mean by "at the market"?

Steve Tunney

Well, I think there is no niche strategic advantage that is going to dampen the volatility of about 27% of our portfolio relative of what is going to be experienced broadly in middle market universe.

Gregg Hillman – First Wilshire Securities Management

The middle market and the economy in general.

Steve Tunney

Right.

Gregg Hillman – First Wilshire Securities Management

Okay. Let me just ask you about a couple of the positions. The – TRN Holdings, what number is it –

Steve Tunney

The NOI.

Gregg Hillman – First Wilshire Securities Management

What is the residual investment you have in that in terms of debt and equity at this point?

Steve Tunney

From a cost basis, I don't have it off the top of my head, but in will be in the schedule of investments today. From a fair value perspective, it is about $27 million, but – our schedule of investments will be coming out rather shortly that you will be able to go through and look at that in detail.

Gregg Hillman – First Wilshire Securities Management

Okay. And also, is Jet Plastica cash flow positive?

Steve Tunney

Yes.

Gregg Hillman – First Wilshire Securities Management

Okay, and total sweep holdings, why did you have to mark that down?

Steve Tunney

Just a bit of a – a little bit of a combination of a slight tweak in softness in their numbers, and I do believe we did compress their valuation multiple as well.

Gregg Hillman – First Wilshire Securities Management

Okay. And then the other – the big marks. Well, just in terms of – are there any big investments, do you think, that are totally at risk that would result in a large write-down with –

Steve Tunney

Well, I think the first one that you mentioned, TNR is one that is at the top of my mind from a risk perspective. It is in a very competitive marketplace. It is a very neat and interesting company. We, as you may recall, partnered with NCR in August of last year, they made an investment in the company. But there are many challenges with respect to that company in this market environment and the challenges that they have in front of them. A lot of the other names, I would say Active Brands has been under some definite pressure. They – the company's products are distributed through Target, so it is a consumer-oriented product that has had some pressure on that type of business in the recent slowdown in spending. And then NPS has a significant customer concentration in Lowe's and Toys 'R' Us and Target and has had some downward pressure because of consumer spending.

Gregg Hillman – First Wilshire Securities Management

Okay. So – and what was the total value of those three? I'd have to look it up in the Q or the K when you –

Steve Tunney

So do I. I don't have them all –

Steve Bacica

We'll be following the 10-K in very near term. It has all the details in the schedule.

Steve Tunney

After you get that, you'd be welcome to call back in with additional detailed questions to the extent that we can answer in a nifty manner.

Gregg Hillman – First Wilshire Securities Management

Okay. Fair enough, thanks.

Operator

We will go next to Alan Gelband of Alan Gelband Company.

Alan Gelband – Alan Gelband Company

First of all, congratulations Steve, Robert and Marshal on really doing a phenomenal job in a very, very trying market.

Steve Tunney

Thank you.

Alan Gelband – Alan Gelband Company

It is amazing, you've got – it's a lot of restructuring to do. My question is that when you talked about the valuation on the portfolio, the equity value, you said that the valuation is 7.8 times this year, maybe the last 12 months and 6.6 times next year. I am wondering if you see what is happening that will lower that multiple.

Steve Tunney

I am just quoting numbers. I think as we look at it, there is all types of factors that go into each individual company's portfolio valuation; and on previous calls, we've got some questions from – wanted some clarity around these types of metrics, and what we are doing is just providing the information. That being said, we obviously go through and manage every portfolio company, and we looked on evaluation on a company by company, security by security basis, and it is built up from the company's actual trailing results and our prospective results. As I mentioned before, our portfolio as a whole has EBITDA growth rates of about 10% on a trailing 12-month basis, and you have a number of companies that have various initiatives, be they cost cutting or a significant ramp in their structure that could provide changes to their EBITDA. So this was just a way of just trying to provide some clarity on broad portfolio metrics, but the key takeaway is it is done asset by asset, security by security, one deal at a time.

Alan Gelband – Alan Gelband Company

Because the other way to do it, obviously, is buying back debt, and I am wondering what kind of – where the company itself buys back debt, then the ratio obviously goes down if they buy it at a discount, which probably they will be able to do.

Steve Tunney

These ratios were equity ratios.

Alan Gelband – Alan Gelband Company

I know, but it is a multiple. But the EBITDA would change if the value of the debt went down, because the enterprise value would change.

Steve Tunney

Yes, I don't – we have not factored in the compliance of debt in portfolio companies in coming up with these valuations. We have selectively done that in the past, but not a big driver for us.

Alan Gelband – Alan Gelband Company

Okay. Is there an opportunity for the portfolio companies now to buy back debt?

Steve Tunney

Absolutely. It is something that we are looking at. We have executed on it in one particular company, and we are looking at that time in some others.

Alan Gelband – Alan Gelband Company

Okay. Anyway, congratulations on really doing a fine job.

Steve Bacica

Thank you very much.

Alan Gelband – Alan Gelband Company

Bye.

Operator

We will take our next question from Greg Mason, Stifel Nicolaus.

Greg Mason – Stifel Nicolaus

All right. Can you talk about the $77 million in unrealized depreciation in the quarter? Can you quantify how much was due to declining credit trends versus mark-to-market on weaker comps?

Steve Tunney

Well, I wouldn't say necessarily credit trends. The credit trend part of your comment isn't – is – you could have a small blip that really expands, obviously, in a mark, right? Because – especially if you are dealing with equity securities and you have a multiple on those securities, a small miss in EBITDA can give a rather large mark because of various multiples that you use to value that enterprise. That being said, I would characterize our losses in the quarter at about a 50/50 mix between decreases in EBITDA or performance or something like that versus decreases in multiples.

Greg Mason – Stifel Nicolaus

To follow up on a couple of the questions regarding portfolio companies, the only one I had was Superior Industrial, where you had last quarter the LOC units marked at a nice $15 million gain and wrote them down by $11 million this quarter. Can you give us a little color on that holding?

Steve Tunney

Yes, a little bit of EBITDA compression at the company because of – in fourth quarter, they came up a little short of our expectations from an EBITDA performance, and we did also hit them with a multiple contraction on that investment.

Greg Mason – Stifel Nicolaus

And then my last question, I want to be a little sensitive in asking it, but when we have talked with some shareholders, they have complained that you haven't cut enough costs given that you are kind of in a portfolio monitoring, deleveraging phase. How would you address those concerns?

Steve Tunney

Well, I would say that we have cut 30% of our headcount last year, which is a pretty Draconian cut. I would also say this is not a portfolio where you are writing loans and putting them on the shelf and clipping coupons like a bond. This is obviously a very actively-managed portfolio. We sit on the Boards of these companies. We are in communication with these companies every week, going through what is going on at the company, and it is a very intensively managed portfolio.

Steve Bacica

Yes and I would –

Steve Tunney

And I think that if you look at the benchmarks of NCG versus others in the BDC space, I think we compare favorably from a headcount perspective that relative to the number of companies in our portfolio and our overall cost of managing the portfolio relative to the investments that we are managing.

Steve Bacica

I would definitely suggest, please take a look and compare us on the SG&A front compared to BDC peers, and I think you will see that we compare favorably. Just one other point to add is with respect to our monetization process, our deal team did a fantastic job with the LNS transaction, and our portfolio managers, we expect them to perform in similar ways in future. So I think we have time for one more call.

Operator

We will go next to Ron Hollander [ph], Morgan Stanley.

Steve Bacica

Hi, Ron.

Ron Hollander – Morgan Stanley

Hi, guys. I just wanted to ask a simple question. How much of the decline in the net asset value or book value of the shares was attributable to the equity declines in the loan portfolio?

Steve Tunney

I think that on the face of the financial statement for the year, it's like $240 million of value, so that would be over $3 a share for the year.

Ron Hollander – Morgan Stanley

Okay. Thanks. You are doing a great job.

Steve Tunney

All right. Thank you.

And with that, we have reached our time and appreciate all the good questions. We look toward to continue servicing you for the next quarter, and we look forward to speaking with you on the next call. Thank you.

Steve Bacica

Thanks, everyone.

Operator

This concludes today's MCG conference call. Thank you for joining us. Have a wonderful day.

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Source: MCG Capital Corporation Q4 2008 Earnings Call Transcript
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