We are a solutions-focused commercial finance company that provides capital and advisory services to middle-market companies throughout the United States. Our investment objective is to achieve current income and capital gains.
We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, or the 1940 Act. As a BDC, we are required to meet various regulatory tests, which include investing at least 70% of our total assets in private or thinly traded public U.S.-based companies and meeting a 200% asset coverage ratio of total net assets to total senior securities, which include most of our borrowings (including accrued interest payable) and any preferred stock we may issue in the future.
For federal income tax purposes, we have elected to be treated as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code. In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements.
We conduct some of our activities through wholly owned, special-purpose financing subsidiaries. These subsidiaries are bankruptcy remote, special-purpose entities to which we transfer certain loans. Each financing subsidiary, in turn, transfers the loans to a Delaware statutory trust. For accounting purposes, the transfers of the loans to the Delaware statutory trusts are structured as on-balance sheet securitizations.
In December 2004, we formed Solutions Capital I, L.P., a wholly owned subsidiary licensed by the United States Small Business Administration, or SBA, to operate as a small business investment company, or SBIC, under the Small Business Investment Act of 1958, as amended, or SBIC Act. Concurrently, we established another wholly owned subsidiary, Solutions Capital G.P., LLC, as a Delaware limited liability company. Solutions Capital G.P., LLC acts as the general partner of Solutions Capital I, L.P. and we are the sole limited partner. In October 2008, we received exemptive relief from the Securities and Exchange Commission, or SEC, which effectively allows us to, among other things, exclude debt borrowed from the SBA to Solutions Capital I, L.P. from the calculation of our consolidated BDC asset coverage ratio.
We also use wholly owned subsidiaries, all of which are structured as Delaware corporations and limited liability companies, to hold the assets of one or more of our portfolio companies. Some of these subsidiaries have wholly owned subsidiaries, all of which are Delaware corporations that hold the assets of certain of our portfolio companies.
We were incorporated in Delaware in 1998. On March 18, 1998, we changed our name from MCG, Inc. to MCG Credit Corporation and, on June 14, 2001, we changed our name from MCG Credit Corporation to MCG Capital Corporation. Our principal executive offices are located at 1100 Wilson Boulevard, Suite 3000, Arlington, VA 22209 and our telephone number is (703) 247-7500.
Our logo, trademarks and service marks are the property of MCG. Other trademarks or service marks appearing in this Annual Report on Form 10-K are the property of their respective holders.
Significant Developments in 2009 and 2008
Since late 2007, the United States economy has been in a recession, which has had a severe adverse impact on many companies, especially those in the financial services sector. These economic conditions have led to decreased spending by both consumers and businesses, which has resulted in a reduction of the multiples and market pricing used to estimate the fair value of our portfolio companies. As a result, as discussed more fully in our Management’s Discussion and Analysis of Financial Condition and Results of Operations, our results of operations were negatively impacted and, as a result, we incurred losses during both 2008 and 2009. In addition, the availability of debt and equity capital in 2009 and 2008 was significantly lower than in other recent years. Generally, the limited amount of available debt financing has shorter maturities, higher interest rates and fees and more restrictive terms than debt facilities available in the past. In addition, in 2009 our common stock traded well below our net asset value, or NAV, making it undesirable to issue additional shares of our common stock.
Because of these challenges, our strategies in 2009 and 2008 shifted from originating debt and equity investments to deleveraging our balance sheet and preserving the liquidity and capital necessary to meet our obligations. During those years, we: suspended origination activities to seek new debt and equity investments until the third quarter of 2009; focused on monetizations of our portfolio; renegotiated debt agreements; suspended dividends; repurchased, at a significant discount, debt issued by our securitization trust; and implemented a corporate restructuring.
Beginning in the third quarter of 2009 and early 2010, certain economic indicators have shown modest improvements. As we enter 2010, we remain cautious about a long-term economic recovery. However, because of the actions we undertook in 2009 and 2008, we have begun again to make new investments and will begin to make decisions regarding dividend distributions after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our asset coverage ratio at the time of such decision. We expect we will make the first such determination after the results for the first quarter of 2010 are finalized. For additional information about these strategic initiatives, see our Management’s Discussion and Analysis of Financial Condition and Results of Operations.
MCG’s Investment Portfolio
Our investment portfolio is composed primarily of middle-market companies in which we have made up to $75 million of debt and equity investments. Typically, these middle-market companies have $20 million to $200 million in annual revenue and $3 million to $25 million for earnings before interest, taxes, depreciation and amortization, or EBITDA. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, buyouts, organic growth and working capital. Buyouts generally include transactions that involve the acquisition of a controlling interest in an entity, either by management or other investors.
Overview of Investment Portfolio in 2009
As of December 31, 2009, we had debt and equity investments in 59 portfolio companies with a combined fair value of $986.3 million. As shown in the following chart, over two-thirds of the fair value of our portfolio as of December 31, 2009 was invested in senior and subordinated debt, while the remaining one-third of our portfolio was invested in preferred equity, common equity and warrant securities. Our diversified investment portfolio spans 30 industries. The following chart also shows that 19% of the fair value of our portfolio is invested in companies in the communications industry and approximately 13% is invested in the cable industry. Approximately 40% of our portfolio is composed of investments in industries that comprise less than 5% of our portfolio. See Portfolio Composition in our Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional detail about our investment portfolio, including a detailed listing of the industries represented in our investment portfolio.
Determination of Fair Value of Portfolio
The fair value of our investment portfolio is determined in good faith by our board of directors each quarter, as required by Section 2(a)(41) of the 1940 Act and Accounting Standard Codification, or ASC, Topic 820—Fair Value Measurements and Disclosures, or ASC 820. We use several valuation methodologies to estimate the fair value of our investment portfolio, which generally result in a range of fair values from which we derive a single estimate of each individual portfolio company’s fair value. To determine a portfolio company’s fair value, we assume we would exchange it in an orderly transaction on the measurement date. The majority of our portfolio is composed of investments that are not publicly traded. As a result, we use other approaches to estimate the exit price, including public and private merger and acquisitions transactions, comparisons to publicly traded comparable companies, third-party assessments of valuation, discounted cash flow analyses, the nature and realizable value of any collateral, the portfolio company’s earnings and ability to make payments, the markets in which the portfolio company does business, market-based pricing and other relevant factors.
We also use independent valuation firms to provide additional data points for our quarterly valuation analyses. Our general practice is to obtain a valuation or review of valuation from an independent firm once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company. Independent valuation firms performed valuations or reviewed valuations of 41 portfolio companies over the last four quarters, representing $921.2 million, or 93.4%, of the fair value of our total portfolio investments and $292.0 million, or 97.0%, of the fair value of our equity portfolio investments. In addition, the fair value of $51.8 million of our debt investments, representing 7.6% of the fair value of our debt portfolio and 5.2% of the fair value of our total portfolio, was derived from sales transactions involving the portfolio company. As set forth in more detail below, in total, either we obtained a valuation or review from an independent firm or we derived the fair value from recent sales transactions for 98.6% of the fair value of our investment portfolio as of December 31, 2009.
Valuations/reviews prepared by independent firms more than one time during the twelve months ended December 31, 2009 have that investment’s fair value reflected in the most recent quarter for which a valuation/review was prepared.
For additional detail about the methodologies that we use to determine the fair value of our portfolio, see Valuation of Investments in the Critical Accounting Policies section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Asset quality is generally a function of portfolio company performance, economic conditions, and our underwriting and ongoing management of our investment portfolio. In addition to various risk management and monitoring tools.