MCG Capital Corporation Q1 2010 Earnings Call Transcript

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 |  About: MCG Capital (MCGC)
by: SA Transcripts

MCG Capital Corporation (NASDAQ:MCGC)

Q1 2010 Earnings Call Transcript

May 4, 2010 10:00 am ET

Executives

Steven Tunney – President and CEO

Tod Reichert – SVP and Corporate Secretary

Steve Bacica – CFO

Analysts

Troy Ward – Stifel Nicolaus

Vernon Plack – BB&T Capital Markets

David Chiaverini – BMO Capital Markets

Gregg Hillman – First Wilshire

Rick Fearon – Accretive Capital

Operator

Good day, ladies and gentlemen and welcome to the MCG Capital 2010 first quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, MCG Capital's Co-Founder, President, and Chief Executive Officer, Steven Tunney; and Steve Bacica, Chief Financial Officer. You may begin.

Steven Tunney

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

Tod Reichert

Thanks, Steve. Good morning, everyone. Before we begin, we would like to remind that you various statements that we may make during this morning's call will include forward-looking statements as defined 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 that they will prove to be correct. Those risks and uncertainties are described in the company's earnings release and its filings with the Securities and Exchange Commission.

Also, during this call, management will be referring to a non-GAAP financial measure, DNOI. This measure is not prepared in accordance with U.S. Generally Accepted Accounting Principles. You can find a reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measures and other related information in MCG's first quarter 2010 earnings release and in the Investor Relations section of our website at www.mcgcapital.com under the heading Financial Information, Non-GAAP Financial Measures.

With that, I'll turn the call over to our President and CEO, Steve Tunney.

Steven Tunney

Thank you, Tod. And again, welcome, everyone. First, before we begin the call in earnest, as many of you know, an activist hedge fund has launched a proxy fight to unseat two of our directors. Their rhetoric has been inflammatory, includes a number of things that we do not believe to be true, and does not recognize the tremendous accomplishments that the company has achieved over the last 16 months or the 800% increase in our share price since the beginning of 2009.

However, the focus of this call is to update you on the results for the first quarter and on the significant progress we've made in executing on our strategic plan to increase our share price relative to our net asset value and delivering long-term value to all of our stockholders. We won't be discussing or taking questions on this call about the proxy contest.

Hopefully, by now you've had a chance to review the earnings release, which was issued today. We are extremely pleased to announce that we will be paying a dividend of $0.11 per share based on the first quarter's results. Further, we are encouraged that our portfolio has become increasingly stable over the past four quarters and that our net asset value has increased to $8.16 per share as of March 31, 2010.

During the quarter, we have remained disciplined and focused on our strategy of monetizing low-yielding investments, building liquidity, originating new investments, and reducing our leverage. In that regard, we successfully monetized four additional portfolio investments during the first quarter, totaling $26 million which were completed at 102.8% of their most recently reported fair values.

Subsequent to quarter-end, we also announced that Jet Broadband Holdings, LLC had signed a definitive agreement to sell all of its assets. This transaction is expected to close in August of 2010 with expected proceeds to MCG of $49.7 million. We also closed on three new deals totaling $29 million during the quarter and one new deal totaling $10 million after quarter-end.

We also paid down $23 million of outstanding debt obligations after year-end, which, when added to the $103.8 million of debt paid down under our SunTrust Warehouse unsecured revolver and our unsecured notes during 2009, brings our total debt paydowns to approximately $126.8 million in the last five quarters. We also repurchased $8 million of our outstanding CLO debt securities at 55% of par, resulting in a $3.6 million gain which will be recognized in the second quarter of 2010. And we also increased our asset coverage ratio to 222% as of quarter-end and 224% as of April 29, 2010.

Since we began our monetization initiatives in July of 2008, we have completed or announced $335.7 million of investment monetizations, $324.1 million of which have been completed at 100.3% of their most recently reported fair values and one of which was completed at 42.3% of its most recently reported fair value.

We are also excited about being back in the origination business after a long hiatus. As I mentioned on our last call, we began calling on private equity firms and reinserting ourselves into the deal flow last November. As previously mentioned, by quarter-end, we had funded three new deals totaling $29 million. We expect to gather momentum in the coming quarters and that our origination pacing will continue to increase.

In total, during the quarter, our originations and advances were $40.7 million with $32.8 million in senior loans, $6.5 million in second lien loans, and $1.3 million in equity investments. The portfolio grew slightly from $986 million to $991 million as compared to the last quarter as we experienced three loan payoffs, one equity sale during the quarter, and had additional amortization and valuation adjustments.

During the quarter, we also renewed our SunTrust Warehouse. This renewal extended the final legal maturity date on this facility to August of 2012. We accomplished this renewal at our current interest rate of 250 basis points over the commercial paper rate. We believe this renewal reflects the confidence that our lenders have in our ongoing strategic plan and provides balance sheet flexibility and strengthens our liquidity profile as we now have no scheduled debt maturities until October of 2011.

Our debt structure is set up to reduce our obligations over time as we monetize assets so that any bullet payment obligations are mitigated prior to the scheduled maturity dates. We continue to explore avenues to improve our capital efficiency.

Our primary focus is on the enhancement of long-term stockholder value, which we believe can be best accomplished by closing the gap between our stock price and our net asset value and through increasing our operating income to support the future growth of dividends. We firmly believe that we can accomplish this without excess incremental equity or debt capital. As of April 29, 2010, we had $240 million of origination capacity to fund new investment opportunities.

However, I would point out that we have asked our stockholders to approve a proposal which would give our Board the authority to enable us to issue up to 15% of our outstanding common stock a price below our net asset value. If we are granted this approval, any issuance below net asset value requires a determination by a majority of our non-interested directors that such an equity raise was in the best interest of MCG and all of its stockholders and the price at which such stock is sold must closely approximate the market value of those shares.

While we do not intend to use this authority in the near term or at our current discount to net asset value, we think that during the course of the next year, there may be attractive investment opportunities that would be accretive on a distributable net operating income basis and would be beneficial to all of our stockholders. Further, by demonstrating an ability to access the equity capital markets, we believe that it would provide us with better access to the debt capital markets, which may lead to an upgrade in our corporate credit rating and improve capital efficiency.

Additionally, over the course of the last year, seven different business development companies have issued equity below net asset value. The average price to net asset value in those offerings was 0.83 times at the time of issuance. Currently, the average price to net asset value for these same seven companies is 1.18 times, an increase of 42%.

Now, if you may recall, last year, our stockholders approved a proposal that gave us the authority under appropriate circumstances to issue warrants, options, or rights to subscribe to, convert to, or purchase about the same number of shares of our common stock at below net asset value. The Board and management of MCG did not believe that it was prudent to use this authority last year and we would expect to be equally careful in expecting any offering, if at all.

It is our belief that we can increase stockholder value by monetizing low-yielding equity investments and redeploying the proceeds of those monetizations along with cash in restricted and securitization accounts into new yield-oriented investment opportunities that are expected to increase our operating income and will support the future growth of distributions to our stockholders. As we execute on this strategy, we will remain focused on preserving our net asset value and enhancing the overall return profile on our investment capital.

Also, we anticipate being able to improve our return on equity by generating more earnings from low-yield equity and debt investments by improving their operating performance and through the expansion of valuation multiples as the economy continues to recover.

With respect to our portfolio, we were disappointed to have a small mark of $2.4 million or 0.2% of our fair value as of the prior quarter-end. The $7.6 million mark we incurred on Jet Plastica this quarter was related to renewed volatility in resin prices and revenue losses tied to the abnormal weather we had on the East Coast this past February.

Overall, we are pleased however that the portfolio has become increasingly stable over the last four quarters and we hope that this – that as the recovery continues, we will see improved operating performance and valuation multiples that will allow the portfolio values to increase. However, as I stated before, we will not be immune to additional marks as we expect the recovery to affect some of our portfolio companies at a different rate than the economy as a whole.

The gross domestic product is showing continuing economic recovery by increasing for the third consecutive quarter with a 3.2% increase during the first quarter of 2010. We expect that as the recovery continues operating performance of our portfolio companies will continue to improve and build value for our stockholders.

Further, with respect to our portfolio, we've seen continued declines in the revenue of portfolio companies of 5.6% on a TTM basis versus a 5.3% decline of TTM revenue last quarter. However, we believe that this trend will start to improve next quarter as TTM revenue was flat sequentially two quarters ago and up a modest 2.4% sequentially last quarter. Additionally, our portfolio companies have been able to aggressively reduce expenses and produce EBITDA growth of 8.8% on a TTM basis compared to a 4.9% TTM growth last quarter.

As we reflect back in 2008, as the financial markets were in turmoil, we undertook decisive measures to stabilize the company, preserve liquidity, strengthen our capital base, and protect the long-term value of our MCG for all of its stockholders. We had to make some difficult decisions. We cut our workforce by almost 40%, suspended our origination activity, and the payment of dividends. But we made these hard choices with a singular goal of repositioning the company for the long run so that we could grow MCG and restore value to our stockholders.

To achieve these goals, in addition to the measures I just mentioned, we also renegotiated our key borrowing agreement, providing us with continued debt financing, repayment terms tied to future monetizations, and relaxed covenants. We also monetize portfolio investments with an emphasis on generating liquidity by focusing on junior debt and equity securities. We also cut general and administrative costs and we've reduced our leverage.

On December 31, 2008, our common stock was trading at $0.71 per share or 8.2% of net asset value. By December 31st, 2009, our common stock was trading at $4.32 per share or 53.4% of net asset value, an increase of 508%; and by April 29th, 2010, our common stock was trading at $6.84 per share or 84.9% of our December 31, 2009 net asset value and a more than 800% increase from our stock price at December 31, 2008.

While we are pleased that the market has recognized our accomplishments over the past 16 months, we will not be satisfied until we close the gap between our stock price and our net asset value. We believe that we are well positioned to execute on our strategic plan, which includes a resumption of the payment of dividends to our stockholders.

As we continue forward, our decisions regarding stockholder distributions will be based on a quarterly assessment of the statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings, and our asset coverage ratio.

For the first quarter, our distributable net operating income was $0.13 per share, our net operating income was $0.11 per share, and our taxable income was $0.16 per share. Our unrestricted cash balances at quarter-end were $54.6 million and our asset coverage ratio was 222%.

After considering all of these factors, our Board decided to set our distribution for the first quarter at $0.11. We are very pleased to achieve this milestone and we look forward to focusing on those measures that we will believe will enable us to continue to build value for our stockholders by closing the valuation gap between our net asset value and our share price and generate earnings that will allow us to make distributions to our stockholders and eventually grow those distributions as we continue to execute on our strategic plan.

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 any questions you may have about our performance. Steve?

Steve Bacica

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

Moving to slide three, quarterly update. During the three months ended March 31st, 2010, we reported net income of $6 million or $0.08 per diluted share compared to a net loss of $50.9 million or $0.68 per diluted share during the three months ended March 31st, 2009. The improvement we've seen in net income quarter-over-quarter was driven by the moderation of marks as our portfolio continues to stabilize and improve.

Our net operating income during the three months ended March 31st, 2010 was $8.4 million or $0.11 per diluted share compared to $11.9 million or $0.16 per diluted share during the three months ended March 31st, 2009. The $6 million of net income reported for the three months ended March 31st, 2010 resulted from net operating income of $8.4 million, partially offset by net investment losses of $2.4 million during the quarter.

The $3.5 million or 29.4% decrease in net operating income during the three months ended March 31st, 2010 from the three months ended March 31st, 2009 was attributable primarily to a decrease in interest income resulting from lower average LIBOR, changes in the composition and the average balance of loans that are on non-accrual status, and a decline in average loan balances, partially offset by lower interest expense, as we reduced our borrowing levels by $96 million comparing Q1 this year versus Q1 last year and a $1.2 million reduction in G&A expenses.

On slide four, selected balance sheet data, you will see that we still have a well-capitalized balance sheet with $623 million of total stockholders' equity and just under $1.2 billion of total assets. Our debt-to-equity ratio was 0.8621 at March 31st and we had $56 million in unrestricted cash as of April 29. Also, I wanted to point out that our debt-to-equity ratio, after adjusting for cash, restricted cash, and securitization cash, was 0.69 to 1 as of March 31st, 2010.

Our NAV per share has improved this quarter to $8.16 per share from $8.06 after stabilizing through 2009. Our BDC asset coverage ratio improved from 216% at the end of '09 to 222% as of March 31st. As of April 29, 2010 our BDC asset coverage ratio further increased by 200% – to 224%, which includes an impact of the dividend distribution declared on that day.

Moving on to slide five, selected operating data, you will see that across the board, our results continue to improve on an EPS basis. When comparing the fourth quarter of '09 to the first quarter of 2010, our valuation marks have shown improvement and have been less than 1% of the portfolio value for the last three quarters.

SG&A is at 3.6% of average invested assets on a current run rate basis and we expect that level to continue in the near term and decrease over the longer term as we begin to redeploy our cash with new originations.

Moving on to originations and paydowns on slide six, you will see that we had originations of $41 million during the first quarter and $33 million of paydowns. The $41 million included about $29 million of investments in three new portfolio companies, about $6.5 million of advances to existing customers, and the remainder of the originations were from PIK and dividend accruals.

Of the $33 million in paydowns, about $13 million was related to the monetization of Velocity, $10 million was due to the monetization of BLI, and $3 million was due the monetization of Amerifit. Other reductions in paydowns were spread across the portfolio.

Moving on to slide seven, we are positioned to grow income and dividends. We have worked hard to place MCG into a strategic position to grow operating income, which we expect to use this for current and future dividends. As we remain focused on investing in current yielding debt securities, we plan to make use of the $240 million of dry powder in potential borrowing capacity in our credit facilities as of April 29. MCG successfully completed $29 million of senior debt originations into three new portfolio companies in Q1 2010 and we expect to increase this trend into the future.

Moving on to gains and losses on slide eight, our net investment loss for Q1 was $2.4 million. The most significant valuation changes for the first quarter included a negative $7.6 million mark for Jet Plastica and a negative $1.8 million mark for Active Brands. Conversely, we had positive changes to valuation with a write-off of $4.5 million for Avenue Broadband and a $2.1 million markup on Jenzabar.

Overall, on a portfolio level, negative marks continued to moderate this quarter. In the case of Jet Plastica, the results were impacted by renewed volatility in resin prices and the unusually harsh winter we had on the East Coast this past February. Overall, valuation has become increasingly stable for the last four quarters with the first quarter activity resulting in less than a one-quarter-percent markdown against the portfolio value.

From an operational perspective, we will continue to be very proactive with our portfolio companies regarding all operational and business objectives and performance in the current economic environment.

Going to slide nine, which is debt obligation summary, we have outlined our current debt structure as of April 29. We recently renewed our SunTrust Warehouse facility, which extends the legal maturity date to August 2012 and our private placement agreements were amended in the fourth quarter of 2009. With these changes, we have no scheduled debt due until October 2011 beyond payment we will make to SunTrust and our private placement noteholders when we monetize assets.

Additionally, during the second quarter, we repurchased for $4.4 million in a privately negotiated transaction a total of $8 million of outstanding debt securities under our 2006-1 securitization. In connection with this repurchase, we expect to record a $3.6 million gain on the extinguishment of debt during the quarter ended June 30th, 2010. To date, we have repurchased an aggregate of $30.6 million of our outstanding debt securities under the 2006-1 Commercial Loan Trust for a total of $10.5 million.

Our access to leverage opportunities and the cash included in our 2006-1 facility and its undrawn revolver create attractively priced debt capital as we move forward with our origination activities. We intend in the coming quarters to put the potential capacity we have available to us to work, which totals $240 million as of April 29.

Slide 10 shows our portfolio distribution by asset class. Looking at our investment portfolio, as we move forward with origination activities, you will see us make new debt investments rather than significant new equity positions.

On slide 11, overall, our portfolio remains well diversified from industry concentration, although our highest concentration is still our CLEC component of telecom at 17.1%, driven by our investment in Broadview. We expect to focus on improving diversification with new originations and we do not intend to materially increase our weighting in telecom, cable, or health care.

Moving on to the next slide, slide 12, which outlines our portfolio investment ratings, portfolio investment ratings were stable in Q1. There was a minor increase in IR 1 due to payoffs, which was partially offset by valuation changes and an increase in IR 2 due to new origination, and a decrease in IR 3 due to payoffs and valuation changes.

One other point to note on this slide related to our non-accrual loan percentages. On a fair value basis, we have seen an increase in non-accrual loans from 3.7% to 4.1% this quarter compared to Q4. Also, on a cost basis, our non-accrual percentage has increased to 12.9% in Q1 from 10.8% in Q4 2009. The key driver of the change was driven by the sub debt B portion of Jet Plastica going on non-accrual.

Moving to slide 13, in summary for the quarter, we are pleased by the increasing stabilization and improvement of valuation marks in Q1, NAV has improved this quarter and was stable in the last three quarters, we were pleased to announced the repurchase of $8 million of outstanding debt securities which will result in a $3.6 million gain, we successfully originated investments in three new portfolio companies, and we are very pleased to be reinstating our dividend at a level of $0.11 per share this quarter.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question comes from Troy Ward from Stifel Nicolaus.

Troy Ward – Stifel Nicolaus

– (Technical Difficulty) release that you had $10 million you've originated so far in the second quarter. Can you talk to us what about the pipeline looks like in your expectation for pace of deployment going forward?

Steven Tunney

The pipeline has continued to build. We would expect significant quarter-over-quarter growth from Q2 to Q3 from an origination perspective and opportunities are building. So I would – if you look through April, we've been running at about $10 million-per-month quarter from a closing perspective and we would expect to see that to increase significantly.

Troy Ward – Stifel Nicolaus

Great. Can you give us – could you give us some insight on to your three new investments that you made during the first quarter? What do they look like in terms of yield, leverage covenants?

Steven Tunney

Sure. From an overall basis, they are senior loans that closed during the quarter and what I would say is relative to our historical originations, there is a much larger equity bid, i.e., anywhere from 50% to 67% equity bids in these companies. So they are sub three leveraged [ph] loans and at pricing that's a little over the board, anywhere from 6% to 11%. The low-end loan was done principally to manage our assets and distribution of assets in our CLO, whereas the other two had nice 600 and 850-basis point spreads. From an industry perspective, they are all services, they are leisure type businesses that are at very, very low advance rates.

Troy Ward – Stifel Nicolaus

And can you talk about the cost for the increase in compensation expense during the quarter and what should that look like going forward?

Steven Tunney

The principal cost was tied to the recognition of bonus expense on the $5 tranche of the long-term incentive program – incentive plan expense. As you may recall, last July, we instituted a new restricted grant program that had both shares and dollars that were provided to key leadership at the company that had vesting provisions that started at $3 and it went all the way up to $8. And we began working on this plan early last year when the stock was trading at $1.

So what happened during the quarter as the stock price had run up, we vested into the $5 block of shares perhaps a little quicker than we otherwise expected to and that caused that expense to increase from the first – fourth quarter.

Troy Ward – Stifel Nicolaus

And how does that – assuming the stock price is just flat from here, is that a one-time expense and comp goes back down or is this a new run rate given where the stock is?

Steven Tunney

I wouldn't say it's a run rate.

Steve Bacica

Yes.

Steven Tunney

There are levels that will be recognized if the stock stays above $6, $7, and $8. But the – from a run rate perspective, it wouldn't change.

Steve Bacica

Yes.

Steven Tunney

If we recognize the $6 block, the expense in the fourth quarter – I mean, the second quarter will be similar to the expense in the first quarter.

Steve Bacica

Yes, it's difficult for us to give guidance because of the variable – it has variable compensation elements. So under GAAP, we basically have to run Monte Carlo simulation models, et cetera and so it's something that is driven by stock price activity, which we can't predict.

Steven Tunney

But it's not a run rate in the sense that once you have it, that's all you've got with respect to that level of earning and then you wouldn't get anything additional for that $5 tranche. But there is a $6 tranche, a $7 tranche, and an $8 tranche.

Troy Ward – Stifel Nicolaus

And are – at each of those dollar marks, is the expense the same or does it grow exponentially as it hits each of those levels?

Steve Bacica

It goes up – it doesn't grow exponential.

Steven Tunney

No.

Steve Bacica

So it's basically as your stock price goes up, you will have a little bit of movement upward, but it's not an exponential –

Steven Tunney

Yes, it doesn't move much and it's fully disclosed in the filing that we did last July. So you can see the amounts for each level.

Troy Ward – Stifel Nicolaus

And when is the determination of the price? When does that hit in the quarter based on the average?

Steven Tunney

Based on the average for 20 days and then basically, two-thirds of the program vests when that occurs and then one-third of the amount vests the year later as long as the employee is still employed by MCG a year later.

Troy Ward – Stifel Nicolaus

Great. Thank you, guys.

Operator

Our next question comes from the line of Vernon Plack from BB&T Capital Markets.

Vernon Plack – BB&T Capital Markets

Thanks very much. I was looking for a little more color on your monetization strategy at this point. I know that – if you look at the equity components in your portfolio, a big chunk is actually Avenue or Broadview. And I know that you've talked about reducing that number from around 30% perhaps lower, maybe even 20%. But I know that number has actually been hanging around 30% here for the – at least the last five quarters. So what do you thinking there other than – ?

Steven Tunney

Well, we have been monetizing and keeping in mind the portfolio shrunk over the last five quarters. So the remainder that stays behind increases as a percentage. So we've – we have shrunk the equity portfolio proportionate to the shrinkage in the portfolio. I think as you point out, Avenue Broadband and Broadview are two big remaining pieces. But there is also other names in there like Superior Industries and the like.

I think accomplishing the Jet Broadband transaction is a huge transaction for us and it won't be removed from the scheduled investments until that transaction closes in August. So that one will knock the number down, I daresay, probably 2.5%, 3% when that transaction closes.

As far as Broadview, we think that the current market conditions are improving, so we are always looking to try to be able to optimize there and we think everything is going on in the market with respect to capital markets opening up and a few M&A gets – deals getting done are broadening the opportunities for us to either get that asset earning at an equity level or monetizing that asset as we previously stated.

Avenue is a – an investment that we actually made in December of '07. So we have been in the asset a little over two years. As you can see, during the quarter, we did have a bit of a write-up [ph] on it. That one is performing pretty well. So that one is meeting the criteria that it's sort of carrying its weight from an earnings perspective. But as we get a little longer into the investment-hold period, that's obviously one that you will want to transition out of as we get a little further down the road with it.

Vernon Plack – BB&T Capital Markets

Okay. And in terms of perhaps tapping your SBA facility a little bit more, I would assume that will require pushing equity down to the SBIC.

Steven Tunney

We have about $28 million of borrowing cap – capacity inside of the SBIC before we have to do that. So we've – we have pre-funded the equity necessary to draw an additional $28 million. And then beyond that, the way to think about it is that we got to infuse $1 of equity for every $3 of investment balance. So if we originate a $9 million loan, you would – after you do that $28 million, you would put $3 million of equity in and then you would be able to borrow $6 million from the SBIC.

While – on – talking about the SBIC, I'd just like to point out there has been a significant reduction in the spread on the SBIC facility. The latest pooling that was done this past March was done at a spread of like 42 basis points over the 10-year treasury. So you will perhaps recall that our average spread on borrowings to date was over 200 basis points, but incremental borrowings right now are getting pooled at around 4%, 4.2%.

Vernon Plack – BB&T Capital Markets

Okay. So can I – I'm just looking at this and the additional capacity you may to grow the portfolio, it would seem to be a good idea to push some of the cash that you have down into your SBIC so that you could leverage that. Is that correct?

Steven Tunney

Absolutely, absolutely.

Vernon Plack – BB&T Capital Markets

Thank you very much.

Steve Bacica

Sure thing, Vernon.

Operator

Our next question comes from the line of David Chiaverini from BMO Capital Markets.

David Chiaverini – BMO Capital Markets

Average yield on the new investments was LIBOR plus 600 to 850. What's the LIBOR floor, 2%, 2.5% on those new investments?

Steven Tunney

Yes, between 2% and 2.5% on all of them.

David Chiaverini – BMO Capital Markets

Okay. And can you comment on what the average yield of the monetized assets was?

Steven Tunney

I'll have to dig that out. But it would have been on our last scheduled investments, but I don't have that handy. But we can dig that out and get back to you. It was disclosed during our December 31st scheduled investment.

David Chiaverini – BMO Capital Markets

Okay. I can follow up after on that. And generally, can you just give an update on the performance at Broadview?

Steven Tunney

It continues to perform as expected. We are actually seeing – through the recession, the company held up well in the sense that we were able to continue to grow EBITDA and we have begun to see a turn with respect to improvement in churn rates, improvement in collection rates. So you can see that the after-effects of the recession are starting to unwind and we – hopefully, we are going to be able to get back to growing value at Broadview as the economy continues to take hold.

David Chiaverini – BMO Capital Markets

Great. Thank you very much.

Operator

Our next question comes from the line of Gregg Hillman from First Wilshire.

Gregg Hillman – First Wilshire

Hey, gentlemen.

Steven Tunney

Hey, Gregg Hillman.

Gregg Hillman – First Wilshire

Hi. Hey, could you talk about in the sales – portfolio sales that you did have? Can you talk about the number of bidders you had on each property and whether there was a private equity buying it or a strategic buyer? And when it – and in the case of private equities, were they – is it like a "use it or lose it" type situation?

Steven Tunney

Well, in – only one I think was a result of a sale when they did do an auction process and had multiple bidders in the company transacted. But really in the other two instances, it was more of a refinancing from other banks. They had multiple banks willing to provide capital to them cheaper than we were charging and we were just paid off in the normal course.

Gregg Hillman – First Wilshire

Okay. So a lot of this – so the sales you made were primarily debt pieces?

Steven Tunney

Yes, this was all debt. And just to reemphasize, back to perhaps Vernon's question, our strategy right now isn’t on monetizing debt investments other than underperforming non-accrual-oriented debt investments. So what you are seeing in the monetizations of these debt investments is more akin to just normal portfolio amortization and payoff activity. The only thing that we are actively trying to monetize is low and non-yielding equity and low and non-yielding debt investments at this time, because we are in a growth mode.

Gregg Hillman – First Wilshire

Okay. And the one that you – that was closed after the quarter, the Jet – the Cable one, that was just a debt piece too?

Steven Tunney

No. Actually, it's both a mezzanine debt and equity position of the company. We announced it after quarter-end, but it's expected to close in August. And when it close, we expect proceeds of $49.7 million for both our debt and equity position in that company.

Gregg Hillman – First Wilshire

Okay. And just in terms of the marks, I understand – that one table on page eight, to what extent are you using private industry transactions to evaluate your companies versus like public market multiples?

Steven Tunney

It would be predominantly private and which are much lower multiples than public market comps generally. So in the instance of – most of our portfolio, we look at a variety of methods, we look at public market comps, we look at private market comps, we look at M&A data, and we look at discounted cash flow analysis, and then we augment all that with reviews by third-party valuation firms to arrive at our values.

And just to reemphasize, since we've been monetizing investments, over $330 million of monetizations have been done at our most recently reported fair value and if you look back even two quarters, it's still at a comparable level at that as well.

Gregg Hillman – First Wilshire

And when you say most recently reported fair value, that's not necessarily what you paid for it. That was just the last time you valued it?

Steven Tunney

Correct, but we do disclose in our Q relative to cost and for all except that one TNR investment that we sort of hang out there as a distressed sale. I believe we are over 100% of our cost as well on a cumulative basis.

Gregg Hillman – First Wilshire

Okay. Since you started this monetization program two years ago?

Steven Tunney

Exactly.

Gregg Hillman – First Wilshire

Okay. And just in terms of closing the value between net asset value and your stock market, so I guess one way to close the value would be I guess increased earnings in the company, the other way would be I guess increased multiples. And you think both are going to occur to –

Steven Tunney

Yes.

Gregg Hillman – First Wilshire

– over the next couple of months to close the gap.

Steven Tunney

In our – I think in our portfolio, we should get valuation lift both from operating performance and multiple expansion as the recovery takes hold. Now, if you are talking about MCG as a whole, our primary way to drive value is to improve our net operating income which will allow us to grow the distributions over time and holding BDC valuation multiples constant would result in a – that valuation gap closing. Further, it would close quicker still if the all-in required cost of equity capital for BDCs went down.

So if you look at the peer group as a whole, they are trading well inside of us from both a discounted dividend and a price-to-book multiple. So as we close that valuation multiple gap, that is another way for us to complete the job of closing the gap.

Gregg Hillman – First Wilshire

Okay. And just continuing on that point, your rationale to sell stock below net asset value was – basically you are saying it's in the interest of the shareholders because you would be having such a great deal that would be accretive at the time.

Steven Tunney

We would be looking that; it would be accretive with respect to the use of proceeds. That – we wouldn't do it that would not create value on a distributable net operating income basis.

And further, we think that number one, if you sell equity at the below discounted – below net asset value, if you look at the track record, seven companies out there did it within the last year and I do believe that there is a difference of (inaudible) and momentum of the company, those that are issuing equity versus those that can't issue equity and you are viewed in the different light both in the lending community and the equity community and you – if you can do it and you can do it accretively, you will build value for shareholders, which will result in a increased multiple over time.

And as I mentioned in opening remarks, the seven companies that did it issued in an average of 83% of their net asset value and as of now, they are trading at 118% of net asset value, even though they did a small issuance below NAV. That's an increase of 42%.

We further still, unlike others – most BDCs have the authority from their stockholders to issue below net asset value. We are seeking the authority much like others, but we've chosen to cap the amount that we could sell at the low end of the range. You see generally a range of approvals running from a low of 15% to a high of unlimited and we've chosen to up to the lower end of the spectrum, because we are not interested in dilution of NAV in a material way to our shareholders.

Gregg Hillman – First Wilshire

Okay. But would it change the debt level of your company if you issued equity? Would it make it more risky because – would you use to pay down debt or would you just use it to – ?

Steven Tunney

No, I would say that the most likely use of proceeds in a hypothetical equity issuance would be take that equity and drop it into our SBIC and lever it 2 times inside of the SBIC and if you raise $40 million worth of capital or whatever the method – take $30 million of capital, you would be able to deploy $90 million worth of assets in the BDC at 2 to 1 leverage and you are borrowing money at 4% that has a 10-year maturity.

Gregg Hillman – First Wilshire

Okay. So – anyways, that's the plan. Okay. Okay, thank you.

Steven Tunney

That's the hypothetical – if we get to a level where number one, we get the approval from our shareholders to do it and we get to a stock price where we think it's justified. We wouldn't be doing it at our current net asset value discount.

Gregg Hillman – First Wilshire

And then at what level would you do it? So basically you try to issue equity at – like you can issue at 15% below, but you said you'd like to issue equity maybe like 5% below or something like that.

Steven Tunney

What we would do is take into account the situation at the time. Keep in mind, this is to seek authority sometime during the next year. We don't – we think that we have plenty of proceeds to deploy in the near term, we have $240 million worth of capital that we have to get about deploying before we are really given strong consideration to raising equity. We could do it, but it's not on my radar to do it or do it at these levels. It's just having the authority to do it sometime over the course of the next year as long as our independent directors on our Board make a determination that it makes sense for the company and for all of MCG shareholders.

Gregg Hillman – First Wilshire

And then also just in terms of buying back your share, I mean how does that figure into the picture of closing the gap?

Steven Tunney

At these levels, not as much as when it did when we were trading at $0.50 on $1.

Gregg Hillman – First Wilshire

Okay, okay. And you have limited ability to buy back your stock anyways?

Steven Tunney

Correct. But we did buy back debt at 55% of par and that, I think, was a real smart trade that built value for MCG and as I said on the opening remarks, that will result in a $3.6 million gain that we'll recognize in the second quarter.

Gregg Hillman – First Wilshire

Okay, thank you.

Steve Bacica

Thanks, Gregg.

Operator

Our next question comes from the line of Rick Fearon from Accretive Capital.

Rick Fearon – Accretive Capital

Hi, good morning, guys.

Steve Bacica

Hey, Rick.

Rick Fearon – Accretive Capital

Can you – Steve, can you – okay, I guess I have a couple of questions about the portfolio. First, what would you expect Jet Plastica to look like a year from now? And do you think they will be able pass through some of these resin price increases to customers, so perhaps their valuation improves and now that the harsher winter is behind the company?

Steven Tunney

Yes. Our expectation is that it's – almost think of it as like a wave and if you may recall, back in 2008, something similar happened where we took a valuation mark tied to the resin and we had a decrease in EBITDA and then eventually, under our contracts, we have the capability of passing it through to our shareholders – not our shareholders, but our customers of Jet Plastica. But it trailed by a quarter or two and so we will get a downstream lift to our results as we re-price up.

So our expectation is as we get deeper in the year, there will be some level of recovery of that as they are able to push through. But you can never get back the sales that didn’t happen. So that – the stuff that happened in February is just going to be in our results, our trailing results until a year goes by. And then that will flush out of the results as well.

Rick Fearon – Accretive Capital

Understood. And this is a valuation primarily based on TTM EBITDA rather than some sort of normalized – hey, we had a unusual winter, you are actually – ?

Steven Tunney

There is some normalization in the amounts, but it's been impacted by these events, because you discount things based on that.

Rick Fearon – Accretive Capital

Okay. And you mentioned that Broadview EBITDA grew through the recession and that churn is now improving. Roughly, what are you seeing the market as the trading multiple of EBITDA for CLECs currently?

Steven Tunney

It's moving up and we look at a whole basket of CLECs out there that drive our valuation multiples. But as you look over the course of last year, they've improved quite a bit and a good proxy for improving valuation trends would be Broadview's debt. If you look over the course of the last year, Broadview's debt has traded up from $0.44 on $1 to – I think the last trade was at $0.98 or $0.99.

Rick Fearon – Accretive Capital

Okay. Are – have you seen any recent trades of CLECs, entire companies and what have those multiple EBITDA been?

Steven Tunney

I don't think many of them have been publicly disclosed. But the NuVox transaction was done and that was by Windstream and then the CIMCO transaction that was sold to Comcast, my understanding was a very high multiple and I would say that Broadview would trade in between those two book ends.

Rick Fearon – Accretive Capital

Okay. North of 7 kind of thing?

Steven Tunney

No. I wouldn't say that, but I'd say that as you look at multiples in the space, they have been improving quite dramatically over the course of last year. And I – and we are encouraged by all the new entrants into the market. I think it gives us additional choices with respect to exits there and further, the improvement in the capital markets opens up the opportunity for additional M&A in the space.

Rick Fearon – Accretive Capital

Okay. So I guess with that, do you foresee any opportunities to monetize this one in the next, let's call it 12 months?

Steven Tunney

It’s – I think we have historically talked about it in terms of 12 to 24 months, but it's top of mind obviously because there is a lot of capital locked up in that deal that is presently not carrying its weight with respect to our return on equity.

Rick Fearon – Accretive Capital

Okay. And MCG, Steve, contractually still has the right to the PIK accruals, you are just not accounting for them on your books?

Steven Tunney

Correct.

Rick Fearon – Accretive Capital

Okay. And so you are basically next in line after the debt?

Steven Tunney

Correct.

Rick Fearon – Accretive Capital

Okay. On another topic, you mentioned one of the reasons you are considering raising equity below NAV in the future is because you think there might be some investment opportunities that will be accretive. Are you referring to additional opportunities to buy back your own debt or is that sort of a one-off deal that you just struck? I mean, that was extraordinary. Or are there other sort of similarly opportunistic investments within your existing portfolio or is this – or is it really all about potential new investments and using the SBIC leverage that you mentioned?

Steven Tunney

I think it's all three of the above.

Rick Fearon – Accretive Capital

Okay. Because the concept of just raising this money to go out and lever it 2 to 1 effectively puts a portion of your company at greater risk. And what the company has been doing successfully is reducing its debt and that's been commendable, you've got a much cleaner balance sheet, a much safer business.

Steven Tunney

Correct. But the opportunity with the SBIC is pretty safe debt. Just to frame it for you, the only risk to MCG for the SBIC debt is the equity capital that we've committed to the SBIC. So the total exposure on a fully drawn SBIC would be $65 million of equity capital. And we are not there yet.

Presently, we only have 18% million of equity capital on our SBIC. But it – your maximum exposure would be your equity commitment to the SBIC. And then that debt comes with no covenants. You just need to make your payments on the debt and it has a 10-year maturity and the most recent pooling was about 4.1%. So in the realm of risk, those are pretty low-risk debt options for us.

Steve Bacica

Yes. And Rick, I would just add to that. The SBIC doesn't count against the asset coverage test from a BDC standpoint.

Rick Fearon – Accretive Capital

Understood. I didn’t realize it comes without covenants. That is unique. Presumably, you can talk some real safe senior type investments in there, not think about –

Steven Tunney

Well, I think in this market opportunity, we are focusing on – we are very cognizant of making sure that we are deploying assets that we feel are good and provide value for our shareholders.

Rick Fearon – Accretive Capital

Okay. Well, you know, you are trading back down around 75% of NAV and it would seem to me that it certainly as a shareholder feels sort of premature to be asked to approve a blank check for issuing below NAV with a stock that to me still represents an extraordinary opportunity and the $8.16 NAV at current mark, it seems well as well. It seems that there could be some additional appreciation to the NAV. So the dialogue about issuing equity at this point just feels sort of premature and it's –

Steven Tunney

Well, what I would ask you to consider is number one, whether we are effective stewards or not. And as I like to remind you in my remarks, we had this approval, a similar type of approval with respect to the ability to issue similar level shares for our convertible debt offering that the company could do last year. And things at the beginning of the last year were pretty tough and we did not pursue that option because we did not think that that was in the best share – best interest of our shareholders.

And I hope you would conclude with the way that we've comported ourselves throughout this cycle that we are good stewards and we'll make good choices with respect to that issue, whether or not we take advantage of it. Because it's – it impacts you for the next year, okay? And it is not an unlimited bite of the apple, it is limited to 15% of our shares. And I've stated unequivocally that I'm not issuing it at our current discount to NAV or for that matter, in the ZIP code [ph] of this level.

So once again, we will be the stewards. It takes the approval of our independent directors to conclude that such an issuance is in the best interest of our shareholders and with so much cash left to deploy, this thing isn't really top of mind for us. But I can imagine come early next year, if we've deployed everything and we've really improved the share price, there could be an instance where it could make sense.

Rick Fearon – Accretive Capital

Well, it would certainly feel a lot better as a shareholder if that were part of the criteria. You stated it would not be below a certain discount to NAV, because since – then it's real – then it is real clear. And I guess there is a situation where if you had the opportunity to buy back some more debt at $0.53 on $1, I'd say sell the equity now if you needed it, because that is unusual.

Steven Tunney

But then the opportunity goes away because you've got through a shareholder vote to get the approval. So you either have to empower management and the Board to make those decisions or you don't. And just to put – to frame it big picture, if – let's say, you are 90% of NAV and you sell 15% at 90%, that's equity dilution of 1.5%, if it's [ph] 10% or 15%. It's a very small, modest impact on the net asset value at those kind of levels.

Rick Fearon – Accretive Capital

Yes, understood. I mean, it is hard to know what the future will hold. I think the paradox is if you went out and you raise the equity successfully because you needed it to buy back the debt at $0.50 on a $1, that opportunity will be gone the day you raise the equity anyway.

Steven Tunney

Precisely.

Rick Fearon – Accretive Capital

So I'm not sure I envision a scenario where I would like, as a shareholder and this – obviously, I'm speaking on behalf of our organization, but seeing you issue equity at these levels. So that would be, I guess, my comment is certainly as a shareholder to know that it wouldn't be below a certain discount to NAV would sit a lot better than a blank check request.

Steven Tunney

Understood. We will be communicating more fully the rationale and the reasoning and we will be on a shareholder outreach program over the next three weeks. So hopefully, we can schedule a visit and spend more time on this with you in person.

Rick Fearon – Accretive Capital

Okay. Well, I want to thank you for having been a good steward for our capital and great improvement with the company. We are – we remain excited to be shareholders and appreciate your management.

Steven Tunney

Great. Thank you very much. Time for one more call, I believe.

Operator

Our final question comes from Vernon Plack from BB&T Capital Markets.

Vernon Plack – BB&T Capital Markets

Yes, hi. I just wanted to confirm. You mentioned this earlier, but you had one new investment going non-accrual and that was the Series B?

Steve Bacica

Yes, sub debt B on Jet Plastica. That's right, Vernon.

Vernon Plack – BB&T Capital Markets

And did that account for the – was the write-down of $7.6 million in Jet Plastica, was that all taken out of that BPs [ph]?

Steven Tunney

Yes. I mean, it's all directly related. Basically, the loan has been cash paying, but we – we have a higher standard for control investments and with that level of mark on that particular security, we put that security on non-accrual as a result of that mark that we took.

Vernon Plack – BB&T Capital Markets

Okay. And has there been anything taken off the non-accrual during the quarter?

Steve Bacica

No.

Steven Tunney

No.

Vernon Plack – BB&T Capital Markets

Okay. All right, great. Thank you very much.

Steve Bacica

Thanks.

Steven Tunney

Thank you very much. And we look forward to speaking with you again soon. That's all.

Operator

Ladies and gentlemen, thank you for participation in today's conference. This concludes the program, you may all disconnect. Everyone have a great day.

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