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MCG Capital Corporation (NASDAQ:MCGC)

Q1 2013 Earnings Conference Call

April 30, 2013 10:00 ET

Executives

Hagen Saville - President and Chief Executive Officer

Tod Reichert - General Counsel and Chief Compliance Officer

Keith Kennedy - Chief financial Officer

Analysts

Mike Turner - Compass Point

Troy Ward - KBW

Scott Valentin - FBR Capital

Rick Fearon - Accretive Capital

Operator

Good day ladies and gentlemen and welcome to the MCG Capital Q1 2013 Earnings Investor Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder today’s conference call is being recorded.

I would now like to introduce your host for today’s conference Mr. Hagen Saville, President and CEO of MCG Capital. Mr. Saville, please begin.

Hagen Saville - President and Chief Executive Officer

Thank you. Good morning, welcome to the Q1 2013 earnings call for MCG Capital Corporation. I’m here with Keith Kennedy, our Chief financial Officer; and Tod Reichert, our General Counsel and Chief Compliance Officer. Before we begin I will ask Tod to take us through the Safe Harbor statement. Tod?

Tod Reichert - General Counsel and Chief Compliance Officer

Thanks Hagen. Good morning everyone. Before we begin, we’d like to remind you that various statements that we may make during this morning’s call will include forward-looking statements as to find under applicable securities laws. Management’s assumptions expectations and opinions reflected in those statements are subject to risks and uncertainties that may cause actual results and/or performance to differ materially from any future results performance or achievements discussed in or implied by such forward-looking statements and the company can give no assurance they will prove to be correct. Those risks and uncertainties are described in the company’s earnings release and in its filings with the Securities and Exchange Commission.

With that, I’ll turn the call over to our CEO Hagen Saville.

Hagen Saville - President and Chief Executive Officer

Thanks Tod. This morning we reported Q1 results of $0.11 per share and operating income and $0.11 per share in net income both slightly above our budget for the quarter. During the quarter, we originated one new investment, a $13 million subordinated loan to Huron Incorporated. We received loan repayments of $82 million higher than our forecast reflecting in part the current demand for quality investments. The current yield on the portfolio is slightly above 12% and credit quality is generally stable.

Portfolio evaluation for the quarter was also stable. You can see from the quarterly results that our expense base has been fully reset, except for modest quarterly fluctuations this is the expense structure you should expect on a go forward basis and leaves us as the top performer among the BDC comp set illustrating the efficiency benefits of internal management.

While we only closed one new origination in Q1, we expect to close four; five new transactions in Q2 and the use of proceeds in these deals are attractive, M&A and business expansion not opportunistic refinancings.

As you evaluate our progress in getting the balance sheet fully employed keep in mind that during the last 15 months we’ve monetized four investments over $33 million each and another seven names over $20 million while our origination activity has intentionally been more granular.

At this point we expect at year end to have investment balances of $500 million or more. A shortcut to quickly estimate on earnings power is to take investable cash net of all CLO debt about a $100 million deployed to add amount at a reasonable internal rate return and add to the run rate on a per share basis.

When I do that math the projected result is comfortably above the current dividend, this obviously excludes the benefit of a second SBIC license. While there maybe some near-term earnings volatility due to the portfolio rotation, the economic models intact, our objectives with respect to the cost base has been achieved and our prominent equity combined with long term SBA financings make it fairly straightforward to assess the efficacy of our business model is an extremely simple, we have powerful and shareholder friendly strategic plan.

We will hold a Annual Meeting of shareholders here in Arlington, Virginia on May 29th at 10 AM at the Meridien Hotel. We cordially invite shareholders to attend, so that you can visit with Management and the Board in person.

Finally on April 26th the Board declared dividend of $12.5 per share, the holders of record as of May 10th and (Huron) May 31, 2013. I’ll now ask Keith to outline the specific results for the quarter. Keith?

Keith Kennedy - Chief financial Officer

Thank you, Hagen. Good morning everyone. I plan to speak about our first quarter results for the period ended March 31st 2013. You may also find our Q1 2013 investor presentation on our website www.mcgcapital.com by clicking on investor relations and then investor presentations. The slide that includes key metrics and other highlights and I am going to mention on the call today.

Highlights for the first quarter are as follows. We generated net operating income or NOI of $8 million or $0.11 per share and net income of $7.8 million or $0.11 per share. Our net asset value per share remained consistent with our December 31st 2012 NAV at $5.18. We repaid $12.5 per share or $8.9 million in dividends. On April 26 2013 we declared a $12.5 dividend per share payable on May 31st 2013 to shareholders of record on May 10 2013. During the quarter we repurchased $2.3 million of stock of 505,000 shares at $4.50 per share. At March 31st 2013 our portfolio at fair value was $409 million. We funded $15.9 million of originations and advances including a $13 million loan to Huron as Hagen mentioned.

We received $85.2 million in monetizations and other payments including $67 million in debt and equity payoff. Approximately $60 million of these payoffs came from two names $33 million from NDSSI Holdings and $27 million from Capstone Logistics and $7.5 million from sowing down a larger position at par in our loan portfolio. Since January 1, 2010 we have monetized over $950 million of our investment portfolio. At March 31, 2013 approximately 64% of our investments at fair value had been originated since January 1, 2010.

For the quarter our total yield on our average loan portfolio was 12.08%. Excluding interest expense our total operating cost were $2.8 million or approximately 50 basis points of total assets of $607 million. We had not transition cost in the first quarter. For the quarter our average borrowing cost were 4% as pay down less expense CLO debt we expect our borrowing cost to approach our end place long term funding facilities are approximately 4.5% including deferred financing cost. Loans on non-accrual at fair value remained under 20 basis points of our total loan portfolio. We paid down $15.1 million in debt reducing our borrowings under our 2006-1 Trust from $98.1 million to $83 million as of March 31st, 2013. In April 2013 we further reduced our CLO borrowings by $28.1 million thus reducing our borrowings from $83 million to $54.9 million.

And with that I’ll turn it back to Hagen.

Hagen Saville - President and Chief Executive Officer

Thank you, Keith. This concludes our prepared remarks and we will now open the line for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) the first question is from Mike Turner of Compass Point. Please go ahead sir.

Mike Turner - Compass Point

Hi good morning. Could you talk about what the level of I guess prepayments were in the core relative to the schedule payments?

Hagen Saville

We, there were, there was one prepayment that was not expected it's in the investor presentation it's called Capstone Logistics otherwise everything else was more or less budgeted.

Mike Turner - Compass Point

Okay and is there looking forward I guess you never necessarily know when you are going to get a prepayment but anything that gives you comfort or makes you think prepayments will should flow through out the year?

Hagen Saville

Yes I think that booking place is substantially an advantage Capstone for example had been alone in place for several years long term customer relationship while it was not fully anticipated it's a good company and it's, it was a larger company in our portfolio so I am not terribly surprised.

Mike Turner - Compass Point

And then where do you say maybe overall you think the best risk-adjusted returns are in the capital structure in the environment I know we hear more and more about how structures are shifting and people are taking on more risk. So any color on that and where you think the best target spots are?

Hagen Saville

We are generally originating unitranche loans to smaller companies, companies with EBITDA of $3 million to $10 million. We’ll certainly consider subordinated debt in companies that we believe are appropriately leveraged but there is no question market conditions are aggressive and our close rates are lower because we’re throwing a lot of shuffle back.

Mike Turner - Compass Point

Okay. Thank you very much. Good quarter.

Operator

The next question is from Troy Ward of KBW. Please go ahead.

Troy Ward - KBW

Great. Thank you and good morning guys.

Hagen Saville

Good morning.

Troy Ward - KBW

Just another kind of follow-up on the prepayment, can you talk about what percentage I know these one of the large ones you said was from I think was 2011 vintage it looks like Hammond Candies as well was from a recent vintage. Can you just talk about the opportunities you have to stay involved in those transactions if you want to or they’ve done away from you kind of without your opportunity to participate?

Hagen Saville

Hammond’s is a good example; we originated that loan in Q4 as a unitranche with a complete intention of participating in the syndication of the credit to senior bank which was done right on schedule in Q1. And so that Hammond’s Candies expected to be a long term origination a build up in the confectionary industry it’s with a long term associate form of customer of ours and so we expect to be in that deal for number of years but that sell down of the senior debt was fully intended likewise we completed an acquisition - we completed a financing for Ocean’s acquisition in Q4 and subsequently in Q1 completed the plan for syndication of that credit.

I think the key is and I try to allude to this in my comments Troy is that over the last 18 to 24 months we on a larger capital base had larger names in the portfolio which in my view are inappropriate for a smaller company and so we’ve been methodically selling equities or facilitating and encouraging repayment of larger loans and if you look at what’s been originated they’re certainly smaller in size and so that’s absolute part of plan it’s obviously we live in unusual times and we’re trying to be thoughtful and so we’ve just had some prepayment that’s all.

Troy Ward - KBW

Okay. And then as you think about obviously you just commented on the size of the company your focus on is definitely different, as you talked about deploying the substantial amounts of cash that you have today throughout 2013 to get to that kind of portfolio growth expectation where do you anticipate you’ll do the most within the capital structure, where do you find the best opportunities and what types of - what impact will that have on the overall portfolio yields as we move through 2013?

Hagen Saville

Hopefully the yields will be consistent and I think it would be an equal mix between unitranche and sub debt, unitranche loans will probably be perhaps larger in scale and the sub debt loans smaller in scale but hopefully the yields will be consistent and we’re very encouraged about what we see I think that MCG has a long history and being able to appropriately underwrite and finance intellectual property based businesses and that we continue to see those kinds of proprietary opportunities in software and other areas and we continue to be optimistic.

Troy Ward - KBW

Okay. And then just couple of more quick ones, you talked about the expense structure just to reiterate do you feel like the current run rate of approximately 2% of total assets that you do feel like that’s a good run rate going forward?

Hagen Saville

Yes. So I mean it might be slightly below slightly above but it’s right (inaudible).

Troy Ward - KBW

Okay. And then a final one on the repurchase of your stock with the stock now having a little bit of move up over here closer to book value, can you just speak kind of your appetite for repurchase of stock going forward.

Hagen Saville

Well at these levels I mean I - you question the economics of it so I’ll leave that to you.

Troy Ward - KBW

Okay, great. Alright, great. Thanks guys.

Hagen Saville

Thank you.

Operator

The next question is from Scott Valentin of FBR Capital. Please go ahead.

Scott Valentin - FBR Capital

Good morning, thanks for taking my questions. Just hitting a little bit what you’ve started talking about earlier, in terms of industry focus you mentioned proprietary opportunities in software and other areas, just any of the focus in terms of the industry?

Hagen Saville

We have significant experience and exposure in healthcare, we’ve done a lot in healthcare over the years we did several deals in 2012 and so, service-based businesses, healthcare, intellectual property-based businesses and communication, software those were all areas where we have strong history, strong track record and people come to us.

Scott Valentin - FBR Capital

Okay and then in terms of competition I think (inaudible) mentioned earlier that was intense competition maybe a little bit less for the small whole sizes and the larger whole sizes, but are you seeing any kind of outsized competition in your industry you focused on like for instance in healthcare or maybe some of the software industries given the high cash flow for those businesses?

Hagen Saville

We work in a very competitive industry, there is always competition what I’ve absorbed over the years is that you might see a new entrant come aggressively into the market for some period of time and then withdraw that’s not uncommon. What I would say about I think what’s relevant in this market is that for the types of companies we finance in the size class we finance, you typically see lower leverage and tighter contracts. You don’t typically, we don’t do covenant like loans and we don’t agree to significant compromise in our basic form contracts. And so I think that’s an important distinction in these current market conditions.

Scott Valentin - FBR Capital

Okay. And then one final question, because you implied target for total assets implies very strong growth and I just wonder in terms of staffing size if you still need to add more staff and how that factors into the expense guidance?

Hagen Saville

I shouldn’t change the expense guidance; we’re working around the edges on staffing, but nothing major.

Scott Valentin - FBR Capital

Okay, thanks very much.

Operator

(Operator Instructions) The next question is from Rick Fearon of Accretive Capital. Please go ahead.

Rick Fearon - Accretive Capital

Hi good morning guys.

Hagen Saville

Hi Rick.

Keith Kennedy

Hi Rick

Rick Fearon - Accretive Capital

Yeah nice quarter and, good work on rightsizing the cost structure, Hagen you mentioned that this quarter would be; you’re expecting more activity in the last quarter. These four to five new loans that you hope to close this quarter is what would you say with the rough average size those deals would be?

Hagen Saville

Rick, I know that’s probably not a question I want to answer but I think we spoken very clearly in the past that we’re typically, we’re compared to underwrite up to $25 million and our target hold is ultimately $15 million. I think its safe to say on senior debt, we probably are comfortable originated a little larger size and on sub-debt we try to be more granular. But I think what you’d see, what you’ve seen us do over the last couple of quarters is consistent with what we’re looking at now.

Rick Fearon - Accretive Capital

Okay, so this could be $60 million to $70 million on gross deployment and then, obviously you got to factor in some repayments. The - you are starting around, I think it’s a $409 million of portfolio value invested assets at March 31, and $500 million be in the year end goal, is that, is it fair to say that this quarter’s productivity could be kind of a pace for the rest of the year and you’ll exceed that or do you expect to hit that number sooner or is it kind of a year end objective at this point?

Hagen Saville

No, I think it’s – I think it’s year end Rick, but what I would say is at the end of 2012 it was very, very quite in January, and I guess that’s because of all the activities that occurred in our industry in Q4 of last year, but January was very quite. And then as Q1 progressed the activity levels progressed and as I think you are aware and our industry it’s not uncommon to have strong Q2s, and then as you go into the summer months perhaps August is quite, just kind of depends and then, the second half is often times fairly steady and strong. So I think we see that pattern continuing nothing out of the ordinary.

Rick Fearon - Accretive Capital

Okay. And really great job picking up shares at an average price of 4.50 new stock repurchases last quarter and you alluded your thinking about additional share repurchases and obviously if the stock trades down at those levels would be wonderful to be able to pick up some more, what are your thoughts about eventual equity issuances and I know that you’ve got a decent runway before you’ve got to seriously consider that given that you’ve got sufficient availability for the foreseeable future but just if you could share your philosophy that would be helpful?

Hagen Saville

As I’ve mentioned periodically on previously calls Rick we obviously today have got $370 million or thereabouts of book equity capital. And the, we've talked about accessing debt capital that is flexible and long term in nature to avoid the unintended consequences of excess structure or complicated structure rather in credit facilities. And as I look at our capital base today and a reasonable prudent level of growth in our total footings over one to three years my view is that we don’t need any equity capital for foreseeable future.

I think that if the hoping, I assume I hope we will be awarded the second SBIC license and I hope the SBIC program will be expanded and to the extent that it is we will have the capital we need for several years. If we need to supplement that with some other form of debt offering we’ll certainly consider it. But I think we have an adequate capital base given the nature of what we do to leverage that equity drive earnings and then hopefully the share price from there and so I think there is a good runway to do that. So, we are not contemplating equity issuance.

Rick Fearon - Accretive Capital

Great, we’ll hold a good thought on the second SBIC license and a great job.

Hagen Saville

Thank you, Rick.

Operator

I am showing no further questions in the queue and would like to turn the conference back to Mr. Saville for any further remarks.

Hagen Saville - President and Chief Executive Officer

No further remarks. Thank you very much and hope to see you all at the annual meeting.

Operator

Ladies and gentlemen thank you for participating in today’s program. This does conclude the conference and you may all disconnect. Everyone have a great day.

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