MCG Capital's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: MCG Capital (MCGC)
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MCG Capital (NASDAQ:MCGC) Q4 2012 Results Earnings Call March 5, 2013 10:00 AM ET


Hagen Seville - President and CEO

Keith Kennedy - CFO

Tod Reichert - General Counsel and Chief Compliance Officer


Troy Ward - KBW

Rick Fearon - Accretive Capital

Steve Seperson - Compass Point


Good morning ladies and gentlemen and welcome to the MCG Capital fourth quarter fiscal year 2012 results conference call. [Operator instructions.] Mr. Hagen Saville, president and chief executive officer, will now begin the conference. Please go ahead.

Hagen Saville

Thank you, operator. Good morning everyone. Welcome to the Q4 2012 earnings call for MCGC Capital Corporation. I’m here with our chief financial officer, Keith Kennedy, and Tod Reichert, our general counsel and chief compliance officer. Tod, will you take us through the Safe Harbor statement?

Tod Reichert

Sure. Thanks, Hagen. Good morning everyone. Before we begin, we would like to remind you that 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 our 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 in its filings with the Securities and Exchange Commission.

With that, I will turn the call back over to our CEO, Hagen Saville.

Hagen Saville

Thank you, Tod. We canceled our Q3 earnings call as Hurricane Sandy came ashore, so it has been seven months since we last spoke in this format to discuss the repositioning of MCG. I’ll take this opportunity to speak in detail about our accomplishments during the last year, and our three-year operating plan. Keith will then take us through the specifics of the Q4 and full year 2012 financial results, and following his remarks, we will open the line for questions.

Before we begin, I’d like to thank Rick Neu for his service as CEO and B. Millner and Hugh Ewing for their service on the board. B. has worked with the company since it was established as an independent entity in 1998, and Hugh was a member of the board for five years. Hugh and B. provided wise counsel during and after the financial crisis. Their contributions helped guide us through that difficult period and the planning associated with our efforts during the last year.

Rick has now returned to his role as chairman of the company after gaining a deep understanding of the company’s professional complement, its operations, and assets from his time as CEO. This added insight confirms the tight integration of management and the board regarding the business plan and the scorecard for management going forward.

2012 effectively marks the end of a 15-month process we undertook to reengineer the company to reduce risk and create a platform with a more predictable earnings and dividend stream, and to position the company for the future with embedded operating leverage and the capacity for growth and earnings. There is no question that we have made significant progress in laying the groundwork for 2013 and beyond.

During 2012, we successfully achieved a series of objectives. First, we continued to monetize control and standalone equity investments as well as debt investments with significant minority equity ownership positions, thus eliminating associated last dollar valuation risk and time consuming oversight responsibilities.

Second, we’ve become more granular through the sale or repayment of a handful of our largest investments, including the repayment of NDSSI shortly after year-end, a $33 million debt and equity monetization. We’ve instituted a new policy eliminating underwriting and hold positions to $25 million and $15 million respectively, which will create added granularity over time.

Third, through sale or repayment of $412 million of assets during 2012, we have substantially proven the book value of the company. Fourth, we have repaid or significantly reduced credit facilities containing covenant packages and borrowing bases which have, over time, proven to be inappropriate for financing small business loans.

Fifth, our fully loaded cost base has been reduced to enable us to operate at 2.3% of total assets, including incentive compensation, which is earnings dependent, and we’ve meaningfully simplified our back office operations in accordance with the requirements necessary to manage the portfolio comprised primarily of loan assets.

Sixth, during Q4, we closed on an unsecured revolving credit facility which will enable full utilization of our balance sheet for maximum earnings power on the current capital base. Finally, we recently earned a green light letter from the SBA for a second SBIC license, an important milestone in returning the company to earnings growth.

With regard to capital management, during 2012 we repurchased 6.2 million shares of stock at an average price of $4.40 per share and 18% weighted average discount to NAV, and we paid $0.58 through five dividend payments, all of which will be classified for tax purposes as a return of capital.

While much was accomplished during 2012, we were unsuccessful in efforts to exit the investment in Broadview Networks and through a restructuring, we were permanently diluted, limiting any prospects for meaningful recovery. Additionally, our earning assets were below budget for much of the year, as a result of slow origination pacing due in part to the restructuring of the company, higher than expected prepayment of several loans, and selective asset acquisition.

I should point out that much of the payoff activity during 2012 was by design, and as I mentioned a moment ago, this substantially validates the book value of the company. Looking forward, we are excited about the prospects for MCG. After a long period of portfolio depreciation balance sheet restructuring, the company is now poised for positive momentum.

Our three-year business plan is 1) to deliver predictable and high-quality earnings and dividends on our existing capital base through the origination and management of a granular loan portfolio, and 2) to meaningfully grow earnings through incremental leverage from long term flexible funding sources including the SBA. Let’s review the attributes of the company today.

At 12/31, we had $522 million of long term capital, $372 million of equity, plus $150 million of SBA debentures. Revenue associated with the remaining $85 million of CLO capital will help bridge earnings as we prudently invest available cash during 2013. Assuming full deployment of our long term capital, a 2.3% fully loaded management cost, and roughly 72 million shares, we should produce $0.50 of NOI per share in the ordinary course. The only question regarding this level of earnings in 2013 is the exact pace of deployment.

Our existing liability base is fully fixed, as will future incremental leverage. Our current loan book is two-thirds senior and one-third subdebt, and 76% of our loans are indexed at floating rates. This mix represents a good risk profile, and supplemental earnings in the event of a rising interest rate environment.

From a business development standpoint, we are well-positioned. We offer financial sponsors deep industry expertise in a handful of sectors, including healthcare, software and information services, data centers, for profit education, niche manufacturing, and business services. The common thread through most of these industry sectors is franchise value driven from intellectual property and intangible assets.

We have significant experience and skill underwriting and managing loans with these types of characteristics. Our focus is on borrowers experiencing above average growth, which helps to speed deleveraging, thus reducing risk.

In 2012, we established relationships with several new tier one sponsors in addition to expanding relationships with other long term customers. We focused on smaller business, generally companies with $3-10 million of EBITDA. Loans in the lower middle market typically enjoy better pricing and tighter contractual terms.

I would also remark that it seems the BDC sector is one of the few within financial services experiencing a generally favorable regulatory environment. Capital requirements on level three assets and the expanding definition of leveraged loans should result in less competition over time from the depository sector. Legislation is pending which would increase permissible leverage for BDCs, classify preferred stock as equity, not debt, and potentially expand the SBIC program.

Our three-year business plan calls for growing earnings by 25% to 50% over the base level of earnings power I’ve just described. The building blocks to achieve this include securing incremental leverage of $100 million to $200 million of long term flexible sources such as the SBA, retail, or institutional markets. We believe these sources create multiple pathways to obtain leverage.

As I mentioned earlier, MCG was recently issued a green light letter from the SBA for a second SBIC license. While there are obviously no guarantees, we hope to be issued a license in the next three to six months. Further, there is bipartisan support for an expansion of the SBIC program from $225 million to $350 million, and aggregate debentures to a single issuer. BDC analysts from both Wells Fargo and Stifel, now KBW, have stated that expansion of the program is likely in 2013.

This expansion, should it occur, creates a direct pathway for the incremental leverage we seek. However, should that be delayed, or not materialize, we can hopefully access an incremental $75 million through the second license, and supplement with other sources to reach our objective. Under our plan, the resulting MCG balance sheet would still be leveraged less than 1:1, even less for BDC’s statutory coverage given [exempted release] to exclude our SBIC debt.

For modeling purposes, you can assign your own assumptions about how exactly this capital is deployed from a mix and yield standpoint, but IRRs are often higher given the capital velocity of the loan portfolio. A fixed liability structure creates added flexibility in portfolio construction.

In summary, given these attributes and the business plan, I believe that MCG is well-positioned to deliver compelling total returns to our stockholders. Our plan doesn’t require incremental equity. In fact, the whole point is to achieve returns to the existing base of equity capital.

As an internally managed flow through vehicle, there are no incentives for the management company to raise extra equity capital per se. To the contrary, given our smaller scale, the deployment requirements permit us to be selective in challenging markets where portfolio quality can migrate in just a few quarters.

At our current share price relative to NAV, earnings potential and the existing capital, the reasonable pathway to additional leverage, the fixed liability structure, flexible asset mix, platform operating leverage, a regulatory tailwind, and the attractive underlying industries we serve, I believe the opportunity for investors is favorable.

Finally, with respect to capital management in 2013, absent a significant change in market conditions, is our intention to create predictability for our investors through a stable dividend. To the extent that asset deployment pacing results in dividends in excess of earnings, that is simply a return of capital to owners. It should not be construed as a flaw in business model design or a lack of efficacy, and any excess payout would be a modest reduction to NAV.

It is our expectation that a meaningful portion of our unrestricted cash will need to be earmarked as equity capital for solutions capital too. Therefore, unless there is a significant decline in the share price, we do not expect a material expansion to our existing stock buyback program. The return on equity for this investment should be in the mid-20% range, illustrating the attractive nature of the SBIC program.

On March 1, the board declared a dividend of $0.125 per share to holders of record as of March 15, with payment on March 29, 2013.

I’ll now turn the call over to Keith, who will discuss financial results.

Keith Kennedy

Thank you, Hagen. Good morning everyone. I plan to speak about our fourth quarter and annual results for the period ended December 31, 2012. You may also find our Q4 2012 investor presentation on our website at, by clicking on investor relations, and then investor presentations. The slide deck includes key metrics and other highlights that I’m going to mention on the call today.

The significant developments and key highlights for the fourth quarter and for the year ended December 31, 2012 are as follows. In the fourth quarter, we generated net operating income or NOI of $5.1 million, or $0.07 per share, and net income of $6.4 million, or $0.09 per share. For the year, we generated NOI of $18.8 million, or $0.25 per share, and net income of $5 million, or $0.07 per share.

In the fourth quarter, we recognized a net investment gain of $1.3 million, our second consecutive quarter of net gains. For the year, we recognized a $13.3 million net investment loss, principally from the $9.8 million writedown of Broadview Networks, and $6 million writedown of Advanced Sleep.

Regarding our transition, as Hagen mentioned, 2012 effectively marked the end of our transition. In the fourth quarter, we incurred transition costs of $2.1 million, or $0.03 per share, including $1.6 million, or $0.02 per share, included in operating expenses, and $500,000, or $0.01 per share, of realized losses.

For the year, we incurred transition costs of $9.3 million, or $0.13 per share, including $8.8 million, or $0.12 per share, included in operating expenses and $500,000, or $0.01 per share, of realized losses. Consistent with our previous guidance, a portion of our staff realignment charges will fall within the first half of 2013, but we do not anticipate the charge exceeding $0.01 per share.

Our total yield on our average loan portfolio was 11.8% for the quarter, slightly higher than the annual yield of 11.3%. At December 31, 2012, our portfolio at fair value was $478 million, consisting principally of loans. In the fourth quarter, we funded $113.9 million of origination and advances, the details of which are on 10 of the presentation, including five new portfolio companies: Accurate Group, Color Star Growers, Hammond’s Candies, Midwest Technical Institute, and Oceans Acquisition.

For the year, we funded $162 million to existing customers and eight new portfolio companies including [Eye Doc], South Bay, and C7. In the fourth quarter, we monetized $81 million of our investment portfolio, the details of which you can see on page 11 of the investment deck, principally from portfolio companies that have been acquired, [unintelligible] acquisition, or refinanced our capital structure and refinance [unintelligible].

For the year, we monetized $412 million of our investment portfolio, consisting of $347 million, or 84% loans, and $65 million, or 16% equity. For the year, our average borrowing costs were 4.6%, consisting of 2.9% attributable to borrowing rates and 1.7% attributable to amortization and deferred financing costs, some of which we accelerated earlier in the year when we terminated or repaid the facilities and notes.

We paid $56 million in dividends in 2012, 100% of which was a return of capital. During the fourth quarter, we repurchased $4.8 million, or 1.1 million shares, of our common stock at an average price of $4.48 per share, reducing our outstanding shares at December 31, 2012 to 71.7 million.

For the year, we repurchased $27.2 million, or 6.2 million shares, of our common stock at an average price of $4.40 per share. At December 31, 2012, our loans on nonaccrual were $16.8 million, or 3.7% of our loan portfolio at cost and $0.6 million, or 14 basis points, of our loan portfolio at fair value.

For comparison, at December 31, 2011, loans on nonaccrual were meaningfully higher at $83.2 million, or 11.9% of our loan portfolio at cost, and $19.3 million, or 3.1% of our loan portfolio, at fair value. In 2012, substantially all of the assets of Jet Plastica investors were liquidated and we sold our controlling interest in MPS Holdings Group.

Our NAV, as you can see on page seven, at December 31, 2012 was $371.7 million, or $5.18 per share, down from $5.65 at December 31, 2011. The reconciliation on page seven shows that the $0.47 per share change in our NAV is composed of $0.07 of net income less $0.575 for our dividends declared, plus $0.07 attributable to the issuance of restricted shares, increased by $0.06 attributable to our share repurchase program, increased by $0.03 attributable to the amortization of restricted stock, and increased $0.02 attributable to other stock transactions such as share forfeitures, net share settlement, and other transactions that increased stockholders’ equity.

As Hagen mentioned, we have substantially exited our control equity position and we have redeployed our capital into income producing loans. At December 31, 2012, our investment portfolio at fair value is in line with our intended target mix of 90% loans and 10% equity. In addition, our control investments are practically 10% of our total investment portfolio, and consist mostly of loans.

During 2012, we simplified our leverage profile and improved our financial flexibility by taking the following steps. We monetized over 50% of our equity portfolio, generating $65 million in proceeds from the sale of these investments. We increased unrestricted cash and restricted cash from our [SBIC] to make new investments from $86.8 million to $121 million.

We reduced our outstanding debt by $182 million, reducing our debt to equity leverage profile from 1:1 to 0.7:1. Additionally, we had $13 million of securitized cash at December 31, 2012 that we used to pay down debt in January 2013.

In the fourth quarter, we closed a $20 million unsecured revolving credit facility with Bank of America that provides us with short term liquidity to finance working capital and for general corporate purposes, which we believe gives us additional flexibility to fully deploy our investable cash.

We improved our operating leverage by reducing our total operating expenses, excluding interest and debt service costs, by approximately 50% from $27 million in 2012 to a target of $13.5 million in 2013, which includes $1.5 million of amortization of restricted stock and $2 million of performance based incentive compensation that we anticipate that will be earnings driven.

And finally, as Hagen mentioned, we received a green light letter from the SBA inviting us to submit a formal license application for a second SBA license. We intend to file the application shortly. If approved, the second license will grant us the ability to borrow up to an additional $75 million when we invest $77.5 million of statutory capital.

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

Hagen Saville

Thanks, Keith. That constitutes the end of our prepared remarks. Operator, we’ll now open up the line for questions.

Question-and-Answer Session


[Operator instructions.] The first question comes from Troy Ward of KBW. Please go ahead.

Troy Ward - KBW

You ripped through a lot of stats pretty quick there. Just to go back, you mentioned $0.50 of ordinary course NOI. Can you just kind of repeat what you said around that, and what are the assumptions that are based on that with regard to expense?

Hagen Saville

In 2012, we had NOI of $0.25. We had transition costs above the line of $0.12, and we had another $0.01 below the line of transition expense for total NOI of about $0.38. In Q4, we had $0.07 of NOI plus $0.02 of transition and $0.01 below the line. And that $0.01 was classified below the line for accounting purposes, but really it’s an operating expense.

As a result, we’re running at $0.10. If you look at our balance sheet, you see $120 million of investable cash. If you invest that cash at the current portfolio yield, it should deliver another $0.18. So that would have us up at $0.58.

Now, throughout the year, the CLO will continue to amortize. We don’t have very many loans that have scheduled maturities during 2013, but nonetheless, there will be some payoffs. And the pacing to deploy the $120 million will occur throughout the year, and so the balance of those factors, we believe, should get us to $0.50.

With respect to our expense base, I indicated a total fully loaded cost of 2.3%. You should think about that in really four components: 1) base and benefits, 2) G&A, 3) cash bonuses, which are earnings dependent, and 4) stock amortization. And all of that together, all four of those components, add up to about 2.3%.

Does that answer your question?

Troy Ward - KBW

It does. And then as a follow up, on the buybacks, I think I saw in the press release where you gave two different numbers for buyback, one at year end and one through February, which indicated you had purchased another 275,000 shares in the first quarter. Do you think the buyback is going to stop from here, and you’re going to start using cash to fund the SBIC base? Or will it be at the end of the quarter? Can you just repeat your use of buybacks and restricted cash?

Hagen Saville

If you review our filings, you will find some of how we’ve bracketed some of the language around the buybacks, but we are currently operating under the 10B-18 program in accordance with board approved criteria, and we continue to do so.

Troy Ward - KBW

And one last one. You step back, and as an analyst looking at MCGC over the years, there’s been a lot of issues, but definitely at the forefront has been credit. That has led to, quite honestly, all of the troubles, I believe, you’ve had over the course of the last several years. How have you changed the underwriting process and the credit culture at MCGC so we can get more comfortable with your credit profile going forward?

Hagen Saville

I would amend what you said slightly. The troubles with MCG, I believe, relate to a couple of factors. One is significant losses in concentrated equity investments. Lack of granularity in a couple of names that happened to be equity securities really, at the end of the day, are the tail of the tape at MCG. We’ve been underwriting credit for a long time, and I think in point of fact we have a pretty darn good track record underwriting credit. And we certainly have significant industry expertise in the sectors I discussed.

But we haven’t changed our model per se, other than to try to embed more granularity into the portfolio, which I think is probably the single most important thing you can do to manage risk. You don’t have to trust me. Take a look at the numbers, and you can’t see through to the underlying obligors, but if it’s granular portfolio, generally, then you can take comfort that you’re not going to get blindsided by some big concentrated risk.

We’ve got longstanding relationships throughout the country with a lot of lower middle market sponsors. We’ve got a terrific team here at MCG that has got a lot of experience, and a lot of contacts. So I feel very comfortable about what we’ve been able to accomplish in 2012, and if you see the ramp up in origination activity during Q4, I think that illustrates that we can go out and originate both sponsor back credit and credit to owner operators at the yields we’ve articulated, and at a mix that doesn’t constitute undue risk.

Two-thirds of our book is senior, one-third subdebt. We’ve got the ability to rotate, and to shift mix, and so I feel pretty good, all things considered, about where we are. And frankly, if you look at the attributes of the company as I laid out, all things considered, I think it’s a pretty attractive trade in the space, in part because of where the share price is today.

Keith Kennedy

I’d also add to that the shift in our investment ratings, as you look through our K, are very stable. Our non-earnings are down. Our leverage on the book is non-passive. It is under 4x levered. The [unintelligible] platform, the companies that we originated, were 3.5x levered or under on average, and so I think relative to what’s going on in the market, I think we’re putting assets on there that we believe in, and that are moderate leverage with the right yield.


The next question is from Rick Fearon of Accretive Capital. Please go ahead.

Rick Fearon - Accretive Capital

It sounded like from the last caller that there was some color that you all just provided on the performance of the underlying portfolio companies, and I’m not sure I caught it. Can you just track the average debt to EBITDA ratio? And how are these companies performing both from a top line perspective and an average EBITDA perspective? Are they growing quarter over quarter and year over year?

Hagen Saville

Let me make a few comments, and then I’ll let Keith add some color. When you talk about averages, you need to be careful because we’ve got a wide span of investment levels, we’ve got a wide span of EBITDA levels, and we operate in industries that range in enterprise value from 5x EBITDA to 12x EBITDA, generally.

And so you need to be careful, when you talk about trends globally like that. Having said that, I think it is safe to say that, generally speaking, our portfolio, the underlying names, are experiencing decent revenue growth, reduced leverage. And generally speaking, I think our leverage levels are below the market that you see being financed today.

I feel pretty good about what we’ve got. We’ve completed some meaningful restructurings during 2012 that helped to mitigate risk to the portfolio. There have been a handful of names that we have spoken about over time that I feel pretty good about. If you look at the sequential improvement in earnings at Miles Media, it’s significant.

If you look at the performance and the risk profile of GMC TV, we have got about $15 million outstanding, which will be reduced by another $4-5 million shortly, through a [sweet] payment. And that level of outstandings is supported by two television stations that are probably earning around $7 million of EBITDA. And so the risk profile of that investment is very good.

If you look at the paperwork we’ve put up on the website today, you see that we have taken some marks, not insignificant, in Advanced Sleep during 2012. However, that company has recently signed a meaningful contract, multiyear contract, and our valuation at 12/31 is based off of what I believe to be a low point in terms of EBITDA and given the expectations for 2013, I’m hopeful that we can have a meaningful recovery of that unrealized mark during 2013.

So, all things considered, I feel pretty good about the status of the portfolio. Keith, do you have any other comments?

Keith Kennedy

No, I would add any more to that.

Rick Fearon - Accretive Capital

That’s great color. And regarding the reduction to loans on nonaccrual, did I read this correctly, that they’ve gone from about 12% nonaccruals two years ago to 3.7% a year ago to 0.1% today?

Hagen Saville

On a fair value basis, yes.

Keith Kennedy

Slide 13, there’s detail.

Hagen Saville

I would point out that on a cost basis, when you look at those names, you’ve got GMC TV and Jet Plastica, and as a practical matter, that GMC subdebt, while it hasn’t been recognized for accounting purposes, we will not see a recovery there. That Jet Plastica senior debt is simply there. We have not finally finished the paperwork on that. So from both a cost basis and a fair value standpoint, the nonaccrual statistics are obviously very low.

Rick Fearon - Accretive Capital

Yeah, the point there is that those impaired loans have been written down and are reflected in your NAV per share today, and in aggregate represent 0.1% of the total portfolio, which I just find extraordinary. And with that in mind, isn’t there a terrific opportunity here to drive up the NAV per share by aggressively repurchasing stock? Did I hear your comments correctly that you do not plan to increase the stock repurchase plan once this existing program is deployed?

Hagen Saville

That is what I said. The solutions capital two, the second SBIC license, would include $75 million of debentures from the SBA, and that’s supported by $37.5 million of equity capital into that vehicle. And so when you look at the composition of our cash balances today, that $37.5 million would need to come from unrestricted cash and that would be a meaningful portion of our unrestricted cash.

And so yes, absent a material decline in the share price, that would be our expectation. As it relates to buybacks generally speaking, I agree with you that they are obviously a very attractive investment on a standalone basis, because it’s a risk-free investment.

However, in terms of accretion to NAV, unless you’re buying stock at a very, very significant discount to NAV, it’s really not that accretive. We purchased 6.2 million shares of stock during 2012, on a weighted average basis, of an 18% discount, on a weighted average basis, to NAV. That only constituted a $0.06 increase in NAV, notwithstanding the fact that those shares were purchased at an 18% discount.

And so the way I think about buybacks is that they are in fact a terrific investment because they’re risk free. But unless the share price is at a deep, deep discount to NAV, it’s just not that accretive. And in point of fact, we’ve got uses for the cash to expand our company and grow our earnings, and we think that, given the return on that capital, vis-à-vis the return from a buyback, that’s a prudent allocation of the capital and prudent management of your capital at this time.

Rick Fearon - Accretive Capital

But Hagen, does that 6% factor into the savings on the dividend payment that otherwise would have gone outside the company that now has been [paid]?

Hagen Saville

No, you’re absolutely right. We bought 6.2 million shares, and $0.50 on that is absolutely savings on future dividend. You’re exactly right. But it’s not an accretion to NAV.

Rick Fearon - Accretive Capital

That capital, that otherwise would have gone out in the form of a dividend, stays in the company, so on a go-forward basis, in fact it is accretive to NAV, because you’re not paying it out.

Hagen Saville

Well, I guess if you didn’t pay it out, you’d make another loan, and that loan would generate earnings, and so the earnings vis-à-vis NAV would be higher. I think that’s a fair statement.

Rick Fearon - Accretive Capital

Well, even if the cash just sat on the balance sheet. If it did not go out in the form of a dividend, it’s going to increase your per share NAV.

Hagen Saville

I hope to earn the NAV, so I hope that dividends aren’t in excess.

Rick Fearon - Accretive Capital

I think you’ll find that it’s more accretive than you may realize if you run those numbers, factoring in the assumption that you’re paying $0.50 dividend annually, and I know your hope is, and certainly ours is, that remains at $0.50 annually and goes up in the future if some of these growth opportunities actually materialize.

So I would encourage you to look at that in that light, because you’re right, it’s risk free. It does not require the time and energy of your staff, which the company is running very lean. We recognize that. And the potential of losing a deal after working very hard on putting it together and spending money with attorneys and whatnot is gone as well. You want to buy it, you go out and buy it. So the stock repurchase program, I’d just encourage you to analyze it again before making the decision not to extend it beyond this initial $35 million allocation.

Hagen Saville

You have my commitment to do that.

Rick Fearon - Accretive Capital

Thank you. And then I just wondered if you could make some remarks about your philosophy regarding managing our capital. For example, what benchmarks can we use to measure your success in the coming quarters? And will you consider other strategic alternatives if these goals are not met?

Hagen Saville

Well, I think if you go back and review my comments in the prepared remarks, the objectives we have are to earn $0.50 in 2013 and I am hopeful that we will get there. There are obviously no guarantees, and we have a few levers to pull in the event that our pacing is behind our forecast.

Look, I think as with most things in business, should our actual experience materially deviate from our expectations, it would be customary to pause and consider the reasons contributing to that deviation, including those factors within our control and factors outside of our control, and to the extent necessary, adjust our plans accordingly. I can tell you, Rick, that we are laser focused on the interest of stockholders, but at this point, we are focused on the execution of our business plan, which I believe is really compelling, and I am excited about where we sit.

Rick Fearon - Accretive Capital

Well, the SBIC green light letter is very encouraging, and it does suggest that the additional license will be granted. So we’ll hold good thoughts on that. But can you also comment on any progress in accessing additional leverage perhaps with baby bonds?

Hagen Saville

I have been contacted by multiple underwriters regarding capital, but we’ve had our head down, focused on running the business, and we haven’t really focused on incremental capital at this point other than the second SBIC license. But in fact, folks have reached out to us and we observe the attractive characteristics of that kind of debt, and so I don’t know what the market will bear for MCG at this moment, but I do believe that if we execute that we’re a very attractive issuer.


[Operator instructions.] The next question is from Mike Turner of Compass Point. Please go ahead.

Steve Seperson - Compass Point

Good morning everyone, this is Steve Seperson from Mike’s team. Based on earlier commentary, should we assume new origination yields are relatively flat compared to year-end portfolio yields? Can you just provide some color on what you would say new origination yields are today?

Hagen Saville

I think that’s a fair estimate at this point. We’ve originated some subdebt in the last 90 days that is at 13-14% kinds of coupons. But there’s no question it is a competitive market. We’re seeing pressure and we are being very selective. And we’re originating both senior and subdebt. So I think on a blended basis, the current run rate at 11.3% or thereabouts is a reasonable assumption for deployment of the available cash at this time.

Keith Kennedy

And for a modeling perspective, as you’re going through that, we’re thinking about the CLO of runoffs of the year at around $40 million. So we’d take that up, cash invested. So take the bridge to fully deployed for your models. And I know you guys are looking at this as your investment’s at $4.78 at the end of the year, the increase of our available cash to invest, now look at that at around $110 million to $120 million, and then change in the CLO of around $40 million. We don’t know the timing of the CLO runoff, but if we estimated where things would come out, that probably gets you to around 550 book at the end of the year. And the timing of that is just something we’re going to have to play as we go. But we feel confident we’ll get that fully deployed by the end of the year.

Hagen Saville

And that excludes any investment from a second SBIC.

Steve Seperson - Compass Point

And then on that same note, assuming the no material prepayments, what would you say is an appropriate operating cash balance? And you touched upon the portfolio size, but deploying that $120 million of cash on hand in the next year?

Hagen Saville

We’ve got this revolving credit that is not intended to finance loans. It’s intended to bridge timing differences in working capital and so forth. But the availability of that revolving credit would allow us to take our cash way down. And so our assumption is we deploy the vast majority of that $120 million. And I think you should assume that it’s deployed ratably more or less over the year.

Steve Seperson - Compass Point

And then on past calls you provided expense guidance of roughly $10.5 million. Is this still an appropriate assumption going forward?

Hagen Saville

Yes, as I mentioned to Troy earlier, we’ve used a couple of different metrics to describe cost on previous earnings calls over the last year, and once again there are four components: base and benefits, G&A, and definitely both of those are combined to well under $10 million. And then you’ve got cash bonuses, which are incentive based and earnings dependent, and then you’ve got noncash amortization on restricted stock. So yes, the cash operating costs to operate day to day are under $10 million.

Keith Kennedy

As I said in my script, we’re targeting $13.5 million in 2013, and what Hagen is referencing is a $10 million base in benefits and SG&A, plus $1.5 million in amortization restricted stock and $2 million of performance based incentive comp. So that gets you to $13 million. So $10 million plus $1.5 million, plus $2 million gets you to $13.5 million.

Steve Seperson - Compass Point

And then finally, can you just provide some color on the post-quarter origination constraint? Were these deals supposed to close last quarter? Or it’s just overall quality of the deals getting better? Any color is helpful.

Hagen Saville

Q4 was very busy for I think the entire industry, as I’m sure you’re aware. January was definitely slower. But we’ve closed one deal in Q1 and we’re working a handful of other things. I will say that January was very slow, but now we’re seeing a steady build of new opportunity going forward. And I would say market conditions are tough, as they always are. We work in a very competitive industry. But we do work in the lower middle market, where pricing terms are generally better, sponsor equity contribution is higher as a percentage of total enterprise value, and I kind of like where we sit, because the demands on MCG to deploy are not as onerous as some of our larger brethren and that allows us to be a little more selective. And we’ve got strong relationships in the marketplace.


[Operator instructions.] I am showing no further questions in the queue, and I would like to turn the conference back for any further remarks.

Hagen Saville

Thank you, and we will see you shortly. Thanks so much.

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