10-Q

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

QUARTERLY REPORT PURSUANT TO

SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period
Ended September 30, 2003 Commission File Number:
0-22832

ALLIED CAPITAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Maryland
(State or Jurisdiction of
Incorporation or Organization) 52-1081052
(IRS Employer
Identification No.)

1919 Pennsylvania Avenue, N.W.

Washington, DC 20006

(Address of Principal Executive Offices)

     Registrant’s telephone number, including area code: (202) 331-1112

      Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x  NO o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES x  NO o

      On November 11, 2003, there were 125,662,365 shares outstanding of the Registrant’s common stock, $0.0001 par value.

ALLIED CAPITAL CORPORATION

FORM 10-Q INDEX

PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		Consolidated Balance Sheet as of September 30, 2003 (unaudited) and December 31, 2002	1
		Consolidated Statement of Operations (unaudited) — For the Three and Nine Months Ended September 30, 2003 and 2002	2
		Consolidated Statement of Changes in Net Assets (unaudited) — For the Nine Months Ended September 30, 2003 and 2002	3
		Consolidated Statement of Cash Flows (unaudited) — For the Nine Months Ended September 30, 2003 and 2002	4
		Consolidated Statement of Investments as of September 30, 2003 (unaudited)	5
		Notes to Consolidated Financial Statements	16
		Independent Accountants’ Review Report	38
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		39
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		74
	Item 4. Controls and Procedures		75
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings		76
	Item 2. Changes in Securities and Use of Proceeds		76
	Item 3. Defaults Upon Senior Securities		76
	Item 4. Submission of Matters to a Vote of Security Holders		76
	Item 5. Other Information		76
	Item 6. Exhibits and Reports on Form 8-K		77
	Signatures		80

PART I: FINANCIAL INFORMATION

Item 1.  Financial Statements

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

				September 30,			December 31,
				2003			2002
(in thousands, except share and per share amounts)				(unaudited)
ASSETS
Portfolio at value:
	Private finance
		Companies more than 25% owned (cost: 2003-$732,578; 2002-$628,535)		$	842,570		$	710,587
		Companies 5% to 25% owned (cost: 2003-$199,935; 2002-$219,124)			224,886			255,677
		Companies less than 5% owned (cost: 2003-$895,888; 2002-$863,243)			741,252			776,951
			Total private finance		1,808,708			1,743,215
	Commercial real estate finance (cost: 2003-$789,370; 2002-$718,312)				792,350			744,952
			Total portfolio at value		2,601,058			2,488,167
Deposits of proceeds from sales of borrowed Treasury securities					221,732			194,745
Accrued interest and dividends receivable					52,370			40,354
Other assets					64,668			59,867
Cash and cash equivalents					69,071			11,186
			Total assets	$	3,008,899		$	2,794,319
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
	Notes payable and debentures			$	954,200		$	794,200
	Revolving line of credit				—			204,250
	Obligations to replenish borrowed Treasury securities				221,853			197,027
	Accounts payable and other liabilities				51,259			45,771
			Total liabilities		1,227,312			1,241,248
Commitments and contingencies
Preferred stock					6,000			7,000
Shareholders’ equity:
	Common stock, $0.0001 par value, 200,000,000 shares authorized; 122,765,830 and 108,698,409 shares issued and outstanding at September 30, 2003, and December 31, 2002, respectively				12			11
	Additional paid-in capital				1,854,253			1,547,183
	Notes receivable from sale of common stock				(19,502	)		(24,704	)
	Net unrealized appreciation (depreciation) on portfolio				(38,349	)		39,411
	Undistributed (distributions in excess of) earnings				(20,827	)		(15,830	)
			Total shareholders’ equity		1,775,587			1,546,071
			Total liabilities and shareholders’ equity	$	3,008,899		$	2,794,319
Net asset value per common share				$	14.46		$	14.22

The accompanying notes are an integral part of these consolidated financial statements.

1

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

				For the Three Months						For the Nine Months
				Ended September 30,						Ended September 30,
				2003			2002			2003			2002
(in thousands, except per share amounts)
				(unaudited)						(unaudited)
Interest and Related Portfolio Income:
	Interest and dividends
		Companies more than 25% owned		$	14,533		$	10,125		$	42,464		$	28,972
		Companies 5% to 25% owned			6,313			6,710			19,286			21,731
		Companies less than 5% owned			58,049			50,789			149,803			144,586
			Total interest and dividends		78,895			67,624			211,553			195,289
	Premiums from loan dispositions
		Companies more than 25% owned			33			—			141			—
		Companies 5% to 25% owned			60			—			685			—
		Companies less than 5% owned			2,430			392			4,455			2,051
			Total premiums from loan dispositions		2,523			392			5,281			2,051
	Fees and other income
		Companies more than 25% owned			4,382			5,319			14,395			19,248
		Companies 5% to 25% owned			229			734			459			1,149
		Companies less than 5% owned			2,841			2,260			7,526			14,176
			Total fees and other income		7,452			8,313			22,380			34,573
			Total interest and related portfolio income		88,870			76,329			239,214			231,913
Expenses:
	Interest				20,334			17,430			57,614			52,414
	Employee				9,480			8,153			26,859			24,462
	Administrative				5,897			5,052			15,395			12,913
			Total operating expenses		35,711			30,635			99,868			89,789
Net investment income before income taxes					53,159			45,694			139,346			142,124
Income tax expense (benefit)					(449	)		600			(1,530	)		600
Net investment income					53,608			45,094			140,876			141,524
Net Realized and Unrealized Gains (Losses):
	Net realized gains (losses)
		Companies more than 25% owned			(114	)		60,063			1,200			59,433
		Companies 5% to 25% owned			(5,895	)		(700	)		10,793			18
		Companies less than 5% owned			(429	)		(11,141	)		38,448			(2,379	)
			Total net realized gains (losses)		(6,438	)		48,222			50,441			57,072
	Net change in unrealized appreciation or depreciation				(13,426	)		(47,796	)		(77,760	)		(23,661	)
			Total net gains (losses)		(19,864	)		426			(27,319	)		33,411
Net increase in net assets resulting from operations				$	33,744		$	45,520		$	113,557		$	174,935
Basic earnings per common share				$	0.28		$	0.44		$	0.99		$	1.73
Diluted earnings per common share				$	0.28		$	0.44		$	0.98		$	1.70
Weighted average common shares outstanding — basic					118,855			102,327			113,985			101,329
Weighted average common shares outstanding — diluted					120,906			103,302			115,228			103,040

The accompanying notes are an integral part of these consolidated financial statements.

2

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

			For the Nine Months
			Ended September 30,
			2003			2002
(in thousands, except per share amounts)
			(unaudited)
Operations:
	Net investment income		$	140,876		$	141,524
	Net realized gains			50,441			57,072
	Net change in unrealized appreciation or depreciation			(77,760	)		(23,661	)
		Net increase in net assets resulting from operations		113,557			174,935
Shareholder distributions:
	Common stock dividends			(196,159	)		(166,823	)
	Preferred stock dividends			(155	)		(165	)
		Net decrease in net assets resulting from shareholder distributions		(196,314	)		(166,988	)
Capital share transactions:
	Sale of common stock			298,249			49,920
	Issuance of common stock upon the exercise of stock options			3,674			13,290
	Issuance of common stock in lieu of cash distributions			4,959			4,696
	Net decrease in notes receivable from sale of common stock			5,202			672
	Other			189			401
		Net increase in net assets resulting from capital share transactions		312,273			68,979
		Total increase in net assets		229,516			76,926
Net assets at beginning of period				1,546,071			1,352,123
Net assets at end of period			$	1,775,587		$	1,429,049
Net asset value per common share			$	14.46		$	13.95
Common shares outstanding at end of period				122,766			102,468

The accompanying notes are an integral part of these consolidated financial statements.

3

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

				For the Nine Months
				Ended September 30,
				2003			2002
(in thousands)
				(unaudited)
Cash flows from operating activities:
	Net increase in net assets resulting from operations			$	113,557		$	174,935
	Adjustments
		Portfolio investments			(664,814	)		(353,026	)
		Repayments of investment principal			219,702			111,691
		Proceeds from investment sales			281,826			213,474
		Change in accrued or reinvested interest and dividends			(39,983	)		(32,999	)
		Amortization of loan discounts and fees			(10,067	)		(10,060	)
		Changes in other assets and liabilities			4,650			(13,264	)
		Depreciation and amortization			1,233			1,053
		Gain on cashless exercise of warrants			(3,876	)		—
		Realized losses			14,228			36,282
		Net change in unrealized appreciation or depreciation			77,760			23,661
			Net cash provided by (used in) operating activities		(5,784	)		151,747
Cash flows from financing activities:
	Sale of common stock				298,249			49,920
	Sale of common stock upon the exercise of stock options				3,674			10,909
	Collections of notes receivable from sale of common stock				5,202			3,053
	Common stock dividends and distributions paid				(194,382	)		(162,127	)
	Preferred stock dividends paid				(155	)		(165	)
	Borrowings under notes payable and debentures				300,000			—
	Repayments on notes payable and debentures				(140,000	)		(6,856	)
	Net repayments on revolving line of credit				(204,250	)		(23,250	)
	Other financing activities				(4,669	)		(490	)
			Net cash provided by (used in) financing activities		63,669			(129,006	)
Net increase in cash and cash equivalents					57,885			22,741
Cash and cash equivalents at beginning of period					11,186			889
Cash and cash equivalents at end of period				$	69,071		$	23,630

The accompanying notes are an integral part of these consolidated financial statements.

4

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Companies More Than 25% Owned
Acme Paging, L.P.(3)		Loan	$	4,395	$	4,395
	(Telecommunications)	Equity Interests		13,274		6,087
		Common Stock (1,145 shares)		27		—
Alaris Consulting, LLC		Loan		19,344		12,500
	(Business Services)	Equity Interests		5,165		—
		Guaranty ($1,100)
American Healthcare Services, Inc.		Loan		25,751		25,751
	(Healthcare Services)	Debt Securities		17,311		11,042
		Common Stock (7,956,704 shares)		1,000		—
		Guaranty ($1,415)
Avborne, Inc.		Loan		2,863		2,863
	(Business Services)	Preferred Stock (12,500 shares)		14,138		2,300
		Common Stock (27,500 shares)		—		—
		Standby Letter of Credit ($6,978)
Business Loan Express, LLC		Loans		10,000		10,000
	(Financial Services)	Debt Securities		38,976		38,976
		Class A Equity Interests		46,394		46,394
		Class B Equity Interests		53,111		94,586
		Class C Equity Interests		109,340		154,960
		Guaranty ($64,871 — See Note 3)
		Standby Letters of Credit ($25,550 —   See Note 3)
The Color Factory, Inc.		Loan		14,239		7,007
	(Consumer Products)	Preferred Stock (1,000 shares)		1,002		—
		Common Stock (980,000 shares)		6,535		—
Foresite Towers, LLC		Equity Interests		18,522		17,561
	(Tower Leasing)
Global Communications, LLC		Loan		2,349		2,349
	(Business Services)	Debt Securities		16,969		16,969
		Preferred Equity Interest		14,067		18,020
		Options		1,639		1,639
Gordian Group, Inc.		Loan		9,155		9,155
	(Business Services)	Common Stock (1,000 shares)		2,385		3,500
HealthASPex, Inc.		Preferred Stock (1,000,000 shares)		700		700
	(Business Services)	Preferred Stock (1,451,380 shares)		4,900		2,601
		Common Stock (1,451,380 shares)		4		—
The Hillman Companies, Inc.(2)		Debt Securities		43,456		43,456
	(Consumer Products)	Common Stock (6,890,937 shares)		50,645		142,519

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

5

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
HMT, Inc.		Debt Securities	$	9,157	$	9,157
	(Business Services)	Preferred Stock (554,052 shares)		2,303		2,303
		Common Stock (300,000 shares)		3,000		4,264
		Warrants		1,155		1,641
Housecall Medical Resources, Inc.		Loan		15,151		15,151
	(Healthcare Services)	Preferred Stock (3,890,344 shares)		3,889		3,889
		Common Stock (864,000 shares)		86		10,600
Jakel, Inc.		Loan		1,624		1,624
	(Industrial Products)	Debt Securities		7,551		7,551
		Preferred Stock (6,460 shares)		6,460		3,864
		Common Stock (158,061 shares)		9,347		—
		Standby Letter of Credit ($3,379)
Litterer Beteiligungs-GmbH(3)		Debt Securities		1,423		825
	(Business Services)	Equity Interest		295		—
MVL Group, Inc.		Loan		19,002		18,708
	(Business Services)	Debt Securities		16,655		16,015
		Common Stock (648,661 shares)		643		—
Powell Plant Farms, Inc.		Loan		20,852		20,852
	(Consumer Products)	Debt Securities		19,224		9,692
		Preferred Stock (1,483 shares)		—		—
		Warrants		—		—
Redox Brands, Inc.		Loan		3,079		3,079
	(Consumer Products)	Debt Securities		10,140		10,140
		Preferred Stock (2,404,086 shares)		6,965		6,965
		Warrants		584		584
		Guaranty ($125)
Staffing Partners Holding		Debt Securities		5,589		5,589
	Company, Inc.	Preferred Stock (414,600 shares)		4,968		3,058
	(Business Services)	Common Stock (50,200 shares)		50		—
		Warrants		10		—
STS Operating, Inc.		Preferred Stock (5,769,424 shares)		6,525		6,525
	(Industrial Products)	Common Stock (3,000,000 shares)		3,177		3,177
Sure-Tel, Inc.		Preferred Stock (1,000,000 shares)		1,000		1,000
	(Consumer Services)	Common Stock (37,000 shares)		5,018		987
Total companies more than 25% owned			$	732,578	$	842,570
Companies 5% to 25% Owned
Aspen Pet Products, Inc.		Loans	$	17,407	$	17,407
	(Consumer Products)	Preferred Stock (2,158 shares)		2,024		1,141
		Common Stock (1,400 shares)		140		—
		Warrants		—		—

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

6

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Blue Rhino Corporation(2)		Common Stock (1,070,179 shares)	$	5,076	$	11,858
	(Consumer Products)
Border Foods, Inc.		Debt Securities		9,442		9,442
	(Consumer Products)	Preferred Stock (50,919 shares)		2,000		2,000
		Common Stock (1,810 shares)		45		71
		Warrants		665		1,059
CBA-Mezzanine Capital Finance, LLC		Loan		12,072		12,072
	(Financial Services)
CorrFlex Graphics, LLC		Debt Securities		12,506		12,506
	(Business Services)	Warrants		—		18,411
		Options		—		1,589
The Debt Exchange Inc.		Preferred Stock (921,875 shares)		1,250		1,250
	(Business Services)
EDM Consulting, LLC		Debt Securities		1,802		207
	(Business Services)	Equity Interests		250		—
International Fiber Corporation		Debt Securities		22,771		22,771
	(Industrial Products)	Common Stock (1,029,069 shares)		5,483		6,816
		Warrants		550		684
Liberty-Pittsburgh Systems, Inc.		Debt Securities		3,384		3,384
	(Business Services)	Common Stock (123,929 shares)		142		—
Logic Bay Corporation		Common Stock (1,437,420 shares)		5,000		—
	(Business Services)
Master Plan, Inc.		Loan		959		959
	(Business Services)	Common Stock (156 shares)		42		—
MortgageRamp, Inc.		Common Stock (772,000 shares)		3,860		2,084
	(Business Services)
Nobel Learning Communities,		Debt Securities		9,838		9,838
	Inc.(2)	Preferred Stock (1,214,356 shares)		2,764		2,764
	(Education)	Warrants		575		166
Packaging Advantage Corporation		Debt Securities		14,320		14,320
	(Business Services)	Common Stock (232,168 shares)		2,386		2,386
		Warrants		963		963
Professional Paint, Inc.		Loan		4,975		4,975
	(Consumer Products)	Debt Securities		24,258		24,258
		Preferred Stock (15,000 shares)		22,156		22,156
		Common Stock (110,000 shares)		69		5,995
Progressive International		Debt Securities		3,975		3,975
	Corporation	Preferred Stock (500 shares)		500		696
	(Consumer Products)	Common Stock (197 shares)		13		550
		Warrants		—		—

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

7

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Sidarus Holdings, Inc.		Debt Securities	$	4,977	$	4,977
	(Business Services)	Preferred Stock (98,000 shares)		1,014		1,014
		Common Stock (492,941 shares)		20		20
		Warrants		—		—
Total Foam, Inc.		Debt Securities		252		122
	(Industrial Products)	Common Stock (164 shares)		10		—
Total companies 5% to 25% owned			$	199,935	$	224,886
Companies Less Than 5% Owned
ACE Products, Inc.		Loan	$	17,164	$	50
	(Industrial Products)
Advantage Mayer, Inc.		Loan		6,668		6,668
	(Business Services)	Debt Securities		10,637		10,637
		Warrants		382		1,556
Alderwoods Group, Inc.(2)		Common Stock (357,568 shares)		5,006		2,789
	(Consumer Services)
American Barbecue & Grill, Inc.		Warrants		125		—
	(Retail)
Aviation Technologies, Inc.		Loan		20,009		20,009
	(Industrial Products)
Bakery Chef, Inc.		Loans		19,161		19,161
	(Consumer Products)
Benchmark Medical, Inc.		Debt Securities		13,464		13,464
	(Healthcare Services)	Warrants		18		117
Camden Partners Strategic Fund II, L.P.(4)		Limited Partnership Interest		3,166		3,052
	(Private Equity Fund)
Candlewood Hotel Company(2)		Preferred Stock (3,250 shares)		3,189		546
	(Hospitality)
Clif Bar, Inc.		Loan		24,912		24,912
	(Consumer Products)
Colibri Holding Corporation		Debt Securities		3,498		3,498
	(Consumer Products)	Preferred Stock (237 shares)		300		388
		Common Stock (3,362 shares)		1,250		679
		Warrants		290		158
Component Hardware Group, Inc.		Debt Securities		11,675		11,675
	(Industrial Products)	Preferred Stock (18,000 shares)		2,359		2,359
		Common Stock (2,000 shares)		200		750

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

8

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Cooper Natural Resources, Inc.		Loan	$	299	$	299
	(Industrial Products)	Debt Securities		1,993		1,993
		Preferred Stock (6,316 shares)		1,427		1,427
		Warrants		832		405
Coverall North America, Inc.		Loan		13,804		13,804
	(Business Services)	Debt Securities		7,148		7,148
CTT Holdings		Loan		1,250		1,250
	(Consumer Products)
Drilltec Patents & Technologies		Loan		10,918		—
	Company, Inc.	Debt Securities		1,500		—
	(Industrial Products)
eCentury Capital Partners, L.P.(4)		Limited Partnership Interest		3,125		—
	(Private Equity Fund)
Elexis Beta GmbH(3)		Options		426		289
	(Industrial Products)
Eparfin S.A.(3)		Loan		29		29
	(Consumer Products)
E-Talk Corporation		Debt Securities		8,852		—
	(Business Services)	Warrants		1,157		—
Executive Greetings, Inc.		Debt Securities		18,830		50
	(Business Services)	Warrants		360		—
Fairchild Industrial Products		Debt Securities		5,954		3,534
	Company	Warrants		280		—
	(Industrial Products)
Frozen Specialties, Inc.		Debt Securities		10,144		10,144
	(Consumer Products)	Warrants		435		435
Galaxy American		Loan		501		501
	Communications, LLC	Debt Securities		49,703		12,211
	(Broadcasting & Cable)	Options		—		—
		Standby Letter of Credit ($37)
Garden Ridge Corporation		Debt Securities		27,271		25,000
	(Retail)	Preferred Stock (1,130 shares)		1,130		—
		Common Stock (847,800 shares)		613		—
Gibson Guitar Corporation		Debt Securities		18,559		18,559
	(Consumer Products)	Warrants		525		2,000
Ginsey Industries, Inc.		Loans		5,000		5,000
	(Consumer Products)	Convertible Debentures		500		635
		Warrants		—		1,440
Grant Broadcasting Systems II		Warrants		87		3,000
	(Broadcasting & Cable)

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

9

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Grotech Partners, VI, L.P.(4)		Limited Partnership Interest	$	3,599	$	2,621
	(Private Equity Fund)
The Hartz Mountain Corporation		Debt Securities		27,927		27,927
	(Consumer Products)	Common Stock (200,000 shares)		2,000		899
		Warrants		2,613		1,174
Haven Eldercare of New England, LLC		Loans		41,646		42,689
	(Healthcare Services)
Headwaters Incorporated(2)		Loan		9,961		9,961
	(Industrial Products)
Healthmarket, Inc.		Debt Securities		9,704		9,704
	(Health Insurance)	Warrants		440		440
Hotelevision, Inc.		Common Stock (315 shares)		315		—
	(Broadcasting & Cable)
Icon International, Inc.		Common Stock (9,394 shares)		1,219		947
	(Business Services)
Impact Innovations Group, LLC		Debt Securities		7,278		50
	(Business Services)	Warrants		1,674		—
Insight Pharmaceuticals Corporation		Loan		10,007		10,007
	(Consumer Products)
Intellirisk Management Corporation		Loan		24,005		24,005
	(Business Services)
Interline Brands, Inc.		Preferred Stock (199,313 shares)		1,849		1,849
	(Business Services)	Common Stock (15,615 shares)		139		—
		Warrants		1,181		—
JRI Industries, Inc.		Debt Securities		1,545		1,545
	(Industrial Products)	Warrants		74		39
Julius Koch USA, Inc.		Warrants		259		3,000
	(Industrial Products)
Kirker Enterprises, Inc.		Equity Interest		4		4
	(Industrial Products)	Warrants		348		3,501
Love Funding Corporation		Preferred Stock (26,000 shares)		359		359
	(Financial Services)
Matrics, Inc.		Preferred Stock (511,876 shares)		500		930
	(Industrial Products)	Warrants		—		—
MedAssets, Inc.		Debt Securities		16,685		16,685
	(Business Services)	Preferred Stock (229,806 shares)		2,049		2,049
		Warrants		136		—

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

10

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Mid-Atlantic Venture Fund IV, L.P.(4)		Limited Partnership Interest	$	4,725	$	2,500
	(Private Equity Fund)
Midview Associates, L.P.		Warrants		—		—
	(Housing)
Mogas Energy, LLC		Debt Securities		16,711		16,711
	(Energy Services)	Warrants		1,774		1,774
Norstan Apparel Shops, Inc.		Debt Securities		11,872		11,872
	(Retail)	Common Stock (29,622 shares)		4,750		2,373
		Warrants		655		327
Northeast Broadcasting Group, L.P.		Debt Securities		222		222
	(Broadcasting & Cable)
Novak Biddle Venture Partners III, L.P.(4)		Limited Partnership Interest		1,020		771
	(Private Equity Fund)
Nursefinders, Inc.		Debt Securities		11,293		11,293
	(Healthcare Services)	Warrants		900		780
Oahu Waste Services, Inc.		Debt Securities		8,315		8,315
	(Business Services)	Stock Appreciation Rights		239		295
Onyx Television GmbH (3)		Preferred Units		201		—
	(Broadcasting & Cable)
Opinion Research Corporation(2)		Debt Securities		14,401		14,401
	(Business Services)	Warrants		996		800
Oriental Trading Company, Inc.		Equity Interests		1,500		4,000
	(Consumer Products)
Polaris Pool Systems, Inc.		Debt Securities		10,948		10,948
	(Consumer Products)	Warrants		1,145		1,145
Prosperco Finanz Holding AG(3)		Convertible Debentures		7,802		5,000
	(Financial Services)	Common Stock (1,528 shares)		1,059		—
		Warrants		—		—
Resun Leasing, Inc.		Loan		30,000		30,000
	(Business Services)
Simula, Inc.(2)		Loan		19,769		19,769
	(Industrial Products)
SmartMail, LLC		Loan		3,744		3,744
	(Business Services)	Debt Securities		4,471		4,471
		Equity Interests		1,070		1,070
		Warrants		3		3

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

11

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Soff-Cut Holdings, Inc.		Debt Securities	$	9,809	$	9,809
	(Industrial Products)	Preferred Stock (300 shares)		300		300
		Common Stock (2,000 shares)		200		—
Spa Lending Corporation		Preferred Stock (28,672 shares)		437		321
	(Recreation)
Startec Global Communications		Loan		25,715		25,715
	Corporation(2)	Debt Securities		20,670		—
	(Telecommunications)
SunStates Refrigerated Services, Inc.		Loans		4,517		1,500
	(Warehouse Facilities)	Debt Securities		2,445		—
Sydran Food Services II, L.P.		Debt Securities		12,973		50
	(Retail)	Equity Interests		3,747		—
		Warrants		162		—
Tubbs Snowshoe Company, LLC		Debt Securities		4,164		4,164
	(Consumer Products)	Equity Interests		500		500
		Warrants		54		54
United Pet Group, Inc.		Debt Securities		9,157		9,157
	(Consumer Products)	Warrants		85		439
United Site Services, Inc.		Loan		15,029		15,029
	(Business Services)
Updata Venture Partners II, L.P.(4)		Limited Partnership Interest		1,705		1,984
	(Private Equity Fund)
U.S. Security Holdings, Inc.		Debt Securities		24,195		24,195
	(Business Services)	Warrants		826		2,000
Venturehouse-Cibernet Investors, LLC		Equity Interest		34		34
	(Business Services)
Venturehouse Group, LLC(4)		Equity Interest		1,000		242
	(Private Equity Fund)
Vertex Aerospace, LLC		Debt Securities		5,330		5,330
	(Business Services)	Equity Interest		—		400
VICORP Restaurants, Inc.		Debt Securities		23,890		23,890
	(Retail)	Warrants		33		33
Walker Investment Fund II, LLLP(4)		Limited Partnership Interest		1,246		416
	(Private Equity Fund)
Warn Industries, Inc.		Debt Securities		4,472		4,472
	(Consumer Products)	Warrants		1,429		8,284

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

12

			September 30, 2003
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)	Cost		Value
Weston Solutions, Inc.		Loan	$	12,192	$	12,192
	(Business Services)
Wilshire Restaurant Group, Inc.		Debt Securities		16,953		16,953
	(Retail)	Warrants		735		541
Wilton Industries, Inc.		Loan		9,600		9,600
	(Consumer Products)
Woodstream Corporation		Loan		249		249
	(Consumer Products)	Debt Securities		16,422		16,422
		Common Stock (180 shares)		1,800		1,800
		Warrants		587		587
Total companies less than 5% owned			$	895,888	$	741,252
Total private finance (120 portfolio companies)			$	1,828,401	$	1,808,708

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

13

								September 30, 2003
			Stated					(unaudited)
(in Thousands)			Interest			Face		Cost		Value
Commercial Real Estate Finance
Commercial Mortgage-Backed Securities
	Mortgage Capital Funding, Series 1998-MC3			5.5	%	$	47,103	$	26,221	$	24,413
	Morgan Stanley Capital I, Series 1999-RM1			6.4	%		29,629		9,658		9,658
	COMM 1999-1			5.7	%		62,163		31,252		33,884
	Morgan Stanley Capital I, Series 1999-FNV1			6.1	%		28,595		14,140		11,114
	DLJ Commercial Mortgage Trust 1999-CG2			6.1	%		44,635		13,787		13,787
	Commercial Mortgage Acceptance Corp., Series 1999-C1			6.8	%		18,346		5,054		6,917
	LB Commercial Mortgage Trust, Series 1999-C2			6.7	%		11,603		1,757		1,770
	Chase Commercial Mortgage Securities Corp., Series 1999-2			6.5	%		20,545		5,396		6,325
	FUNB CMT, Series 1999-C4			6.5	%		22,887		7,800		6,399
	Heller Financial, HFCMC Series 2000 PH-1			6.6	%		25,767		8,753		8,753
	SBMS VII, Inc., Series 2000-NL1			7.2	%		9,214		4,535		3,878
	DLJ Commercial Mortgage Trust, Series 2000-CF1			7.0	%		24,328		9,484		10,366
	Deutsche Bank Alex. Brown, Series Comm 2000-C1			6.9	%		17,922		4,937		3,166
	LB-UBS Commercial Mortgage Trust, Series 2000-C4			6.9	%		17,484		3,878		5,024
	Credit Suisse First Boston Mortgage Securities Corp., Series 2001-CK1			5.9	%		21,805		8,491		8,569
	JP Morgan-CIBC-Deutsche 2001			5.8	%		25,370		6,822		6,822
	Lehman Brothers-UBS Warburg 2001-C2			6.4	%		22,756		6,567		6,567
	SBMS VII, Inc., Series 2001-C1			6.1	%		23,049		5,618		5,618
	GE Capital Commercial Mortgage Securities Corp., Series 2001-2			6.1	%		21,228		6,384		6,384
	Credit Suisse First Boston Mortgage Securities Corp., Series 2001-CKN5			5.2	%		21,456		5,207		5,207
	JP Morgan Chase Commercial Mortgage Securities Corp., Series 2001-C1			5.6	%		24,493		5,816		5,816
	SBMS VII, Inc., Series 2001-C2			6.2	%		21,619		5,850		5,850
	FUNB CMT, Series 2002-C1			6.0	%		28,303		11,711		12,162
	GE Capital Commercial Mortgage Corp., Series 2002-1			6.2	%		50,631		25,062		28,746
	GMAC Commercial Mortgage Securities, Inc., Series 2002-C2			5.8	%		40,573		20,204		22,271
	GE Capital Commercial Mortgage Corp., Series 2002-3			5.1	%		50,047		22,655		23,446
	Morgan Stanley Dean Witter Capital I Trust 2002-IQ3			6.0	%		27,858		13,171		13,837
	LB-UBS Commercial Mortgage Trust 2003-C1			4.6	%		50,896		22,200		22,435
	GS Mortgage Securities Corporation II Series 2003-C1			4.7	%		39,543		19,249		19,501
	J.P. Morgan Chase Commercial Mortgage Securities Corp., Series 2003-ML1			4.9	%		15,946		12,357		12,694
	Credit Suisse First Boston Mortgage Securities Corp., Series 2003-CK2			4.9	%		69,680		37,884		38,811
	GE Commercial Mortgage Corporation 2003-C1			5.1	%		20,389		16,067		16,836
	COMM 2003-LNB1			4.4	%		36,803		14,742		14,660
	Wachovia Bank Commercial Mortgage Trust, Series 2003-C5			4.3	%		61,202		27,613		27,414
	GE Commercial Mortgage Corporation, Series 2003-C2			5.1	%		8,873		7,098		7,466
	LB-UBS Commercial Mortgage Trust 2003-C5			4.9	%		10,327		8,051		8,300
	Credit Suisse First Boston Mortgage Securities Corp., Series 2003-CPN1			4.8	%		11,850		9,261		9,815
	GMAC Commercial Mortgage Securities, Inc., Series 2003-C2			5.5	%		77,441		41,268		43,120
	Credit Suisse First Boston Mortgage Securities Corp., Series 2003-C4			5.3	%		7,369		5,508		5,791
		Total commercial mortgage-backed securities (39 issuances)				$	1,169,728	$	511,508	$	523,592

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

14

			September 30, 2003
			(unaudited)
(in Thousands)			Cost		Value
Collateralized Debt Obligations
	Crest 2001-1, Ltd.(3)		$	22,852	$	22,852
	Crest 2002-1, Ltd.(3)			23,894		23,894
	Crest 2002-IG, Ltd.(3)			4,668		4,668
	Crest Clarendon Street 2002-1, Ltd.(3)			1,017		1,017
	Crest 2003-1, Ltd.(3)			112,538		112,349
		Total collateralized debt obligations	$	164,969	$	164,780

		Interest		Number of
		Rate Ranges		Loans
Commercial Mortgage Loans
			Up to 6.99%		15	$	12,644	$	13,551
			7.00%–8.99%		13		26,010		25,450
			9.00%–10.99%		7		32,199		31,592
			11.00%–12.99%		9		13,127		10,145
			13.00%–14.99%		3		3,567		2,155
		15.00% and above			2		2,605		2,605
	Total commercial mortgage loans				49	$	90,152	$	85,498
Real Estate Owned							17,419		13,497
Equity Interests (Guarantees — $2,748)							5,322		4,983
	Total commercial real estate finance					$	789,370	$	792,350
Total portfolio						$	2,617,771	$	2,601,058

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(2)	Public company.
(3)	Non-U.S. company or principal place of business outside the U.S.
(4)	Non-registered investment company.

The accompanying notes are an integral part of these consolidated financial statements.

15

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information at and for the nine months ended September 30, 2003 and 2002 is unaudited)

Note 1. Organization

      Allied Capital Corporation, a Maryland corporation, is a closed-end management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (“1940 Act”). Allied Capital Corporation (“ACC”) has a subsidiary that has also elected to be regulated as a BDC, Allied Investment Corporation (“Allied Investment”), which is licensed under the Small Business Investment Act of 1958 as a Small Business Investment Company (“SBIC”). In addition, ACC has a real estate investment trust subsidiary, Allied Capital REIT, Inc. (“Allied REIT”), and several subsidiaries which are single member limited liability companies established primarily to hold real estate properties. ACC also has a subsidiary, A.C. Corporation (“AC Corp”), that provides diligence and structuring services on private finance and commercial real estate finance transactions, as well as structuring, transaction, management, and advisory services to the Company, its portfolio companies and other third parties.

      Allied Capital Corporation and its subsidiaries, collectively, are referred to as the “Company.”

      In accordance with specific rules prescribed for investment companies, subsidiaries hold investments on behalf of the Company or provide substantial services to the Company. Portfolio investments are held for purposes of deriving investment income and future capital gains. The Company consolidates the results of its subsidiaries for financial reporting purposes. The financial results of the Company’s portfolio investments are not consolidated in the Company’s financial statements.

      The investment objective of the Company is to achieve current income and capital gains. In order to achieve this objective, the Company invests in companies in a variety of industries, non-investment grade commercial mortgage-backed securities (“CMBS”) and collateralized debt obligation bonds and preferred shares (“CDOs”).

Note 2. Summary of Significant Accounting Policies

  Basis of Presentation

      The consolidated financial statements include the accounts of ACC and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2002 balances to conform with the 2003 financial statement presentation.

      The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, the unaudited consolidated financial results of the Company included herein contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position of the Company as of September 30, 2003, and the results of operations for the three and nine months ended September 30, 2003 and 2002, and changes in net assets and cash flows for the nine months ended September 30, 2003 and 2002. The results of operations for the three and nine months ended September 30, 2003, are not necessarily indicative of the operating results to be expected for the full year.

      The private finance portfolio and the interest and related portfolio income and net realized gains (losses) earned on the private finance portfolio are presented in three categories: companies more

16

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

than 25% owned, which represent portfolio companies where the Company directly or indirectly owns more than 25% of the outstanding voting securities of such portfolio company and, therefore, are deemed controlled by the Company under the 1940 Act; companies owned 5% to 25%, which represent portfolio companies where the Company directly or indirectly owns 5% to 25% of the outstanding voting securities of such portfolio company or where the Company holds one or more seats on the portfolio company’s board of directors and, therefore, are deemed to be an affiliated person under the 1940 Act; and companies less than 5% owned which represent portfolio companies where the Company directly or indirectly owns less than 5% of the outstanding voting securities of such portfolio company and where the Company has no other affiliations with such portfolio company. The interest and related portfolio income and net realized gains (losses) from the commercial real estate finance portfolio and other sources are included in the companies less than 5% owned category on the consolidated statement of operations.

Valuation Of Portfolio Investments

      The Company, as a BDC, invests in illiquid securities including debt and equity securities of companies, non-investment grade CMBS, and the bonds and preferred shares of CDOs. The Company’s investments are generally subject to restrictions on resale and generally have no established trading market. The Company values substantially all of its investments at fair value as determined in good faith by the board of directors in accordance with the Company’s valuation policy. The Company determines fair value to be the amount for which an investment could be exchanged in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. The Company’s valuation policy considers the fact that no ready market exists for substantially all of the securities in which it invests. The Company’s valuation policy is intended to provide a consistent basis for determining the fair value of the portfolio. The Company will record unrealized depreciation on investments when it believes that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of the Company’s debt or equity investments. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. The Company will record unrealized appreciation if it believes that the underlying portfolio company has appreciated in value and, therefore, the Company’s equity security has also appreciated in value. The value of investments in publicly traded securities are determined using quoted market prices discounted for restrictions on resale, if any.

Loans and Debt Securities

      For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value, overall financial condition or other factors lead to a determination of fair value at a different amount.

      When the Company receives nominal cost warrants or free equity securities (“nominal cost equity”), the Company allocates its cost basis in its investment between its debt securities and its nominal cost equity at the time of origination. At that time, the original issue discount basis of the nominal cost equity is recorded by increasing the cost basis in the equity and decreasing the cost basis in the related debt securities.

17

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

      Interest income is recorded on an accrual basis to the extent that such amounts are expected to be collected. For loans and debt securities with contractual payment-in-kind interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity, the Company will not accrue payment-in-kind interest if the portfolio company valuation indicates that the payment-in-kind interest is not collectible. Interest on loans and debt securities is not accrued if the Company has doubt about interest collection. Loans in workout status classified as Grade 4 or 5 assets do not accrue interest. In addition, interest may not accrue on loans or debt securities to portfolio companies that are more than 50% owned by the Company depending on such company’s working capital needs. Loan origination fees, original issue discount, and market discount are capitalized and then amortized into interest income using the effective interest method. Upon the prepayment of a loan or debt security, any unamortized loan origination fees are recorded as interest income and any unamortized original issue discount or market discount is recorded as a realized gain. Prepayment premiums are recorded on loans and debt securities when received.

      The weighted average yield on loans and debt securities is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount, and market discount earned on accruing loans and debt securities, divided by (b) total loans and debt securities at value. The weighted average yield is computed as of the balance sheet date.

Equity Securities

      The Company’s equity interests in portfolio companies for which there is no liquid public market are valued at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including cash flow from operations of the portfolio company and other pertinent factors such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, or other liquidation events. The determined values are generally discounted to account for restrictions on resale and minority ownership positions.

      The value of the Company’s equity interests in public companies for which market quotations are readily available is based on the closing public market price on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.

      Dividend income is recorded on preferred equity securities on an accrual basis to the extent that such amounts are expected to be collected, and on common equity securities on the record date for private companies or on the ex-dividend date for publicly traded companies.

Commercial Mortgage-Backed Securities (“CMBS”) and Collateralized Debt Obligations (“CDO”)

      CMBS bonds and CDO bonds and preferred shares are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar CMBS bonds and CDO bonds and preferred shares. The Company recognizes unrealized appreciation or depreciation on its CMBS bonds and CDO bonds and preferred shares as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool.

18

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

      The Company recognizes income from the amortization of original issue discount using the effective interest method, using the anticipated yield over the projected life of the investment. Yields are revised when there are changes in actual and estimated prepayment speeds or actual and estimated credit losses. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the CMBS bonds and CDO bonds and preferred shares from the date the estimated yield is changed.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

      Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the year, net of recoveries. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period.

Fee Income

      Fee income includes fees for guarantees and services rendered by the Company to portfolio companies and other third parties such as diligence, structuring, transaction services, management services, and investment advisory services. Guaranty fees are recognized as income over the related period of the guaranty. Diligence, structuring, and transaction services fees are generally recognized as income when services are rendered or when the related transactions are completed. Management and investment advisory services fees are generally recognized as income as the services are rendered.

Guarantees

      The Company accounts for guarantees under FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (the “Interpretation”). In accordance with the Interpretation, guarantees meeting the characteristics described in the Interpretation, and issued or modified after December 31, 2002, are recognized at fair value. However, certain guarantees are excluded from the initial recognition provisions of the Interpretation. See Note 5 for disclosures related to the Company’s guarantees.

Financing Costs

      Debt financing costs are based on actual costs incurred in obtaining debt financing and are deferred and amortized as part of interest expense over the term of the related debt instrument. Costs associated with the issuance of common stock, such as underwriting, accounting and legal fees, and printing costs are recorded as a reduction to the proceeds from the sale of common stock.

Cash and Cash Equivalents

      Cash and cash equivalents include cash in banks and all highly liquid investments with original maturities of three months or less.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

Dividends to Shareholders

      Dividends to shareholders are recorded on the record date.

Stock Compensation Plans

      At September 30, 2003 and 2002, the Company had a stock-based employee compensation plan. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net increase in net assets resulting from operations, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net increase in net assets resulting from operations and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

		For the Three						For the Nine
		Months Ended						Months Ended
		September 30,						September 30,
		2003			2002			2003			2002
(in thousands, except per share amounts)
Net increase in net assets resulting from operations as reported		$	33,744		$	45,520		$	113,557		$	174,935
Less total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(2,043	)		(1,779	)		(10,121	)		(5,410	)
Pro forma net increase in net assets resulting from operations			31,701			43,741			103,436			169,525
Less preferred stock dividends			(45	)		(55	)		(155	)		(165	)
Pro forma net income available to common shareholders		$	31,656		$	43,686		$	103,281		$	169,360
Basic earnings per common share:
	As reported	$	0.28		$	0.44		$	0.99		$	1.73
	Pro forma	$	0.27		$	0.43		$	0.91		$	1.67
Diluted earnings per common share:
	As reported	$	0.28		$	0.44		$	0.98		$	1.70
	Pro forma	$	0.26		$	0.42		$	0.90		$	1.64

      Pro forma expenses are based on the underlying value of the options granted by the Company. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option

20

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

pricing model, with the following weighted average assumptions for options granted during the three and nine months ended September 30, 2003 and 2002:

	For the Three					For the Nine
	Months Ended					Months Ended
	September 30,					September 30,
	2003			2002(1)		2003			2002
Risk-free interest rate		3.2	%		—		2.7	%		4.5	%
Expected life		5.0			—		5.0			5.0
Expected volatility		38.1	%		—		38.8	%		39.7	%
Dividend yield		8.9	%		—		8.9	%		8.5	%
Weighted average fair value per option	$	3.67			—	$	3.35		$	4.82

⁽¹⁾ There were no stock options granted during the three months ended September 30, 2002.

Federal and State Income Taxes

      The Company intends to comply with the requirements of the Internal Revenue Code (“Code”) that are applicable to regulated investment companies (“RIC”) and real estate investment trusts (“REIT”). The Company and its subsidiaries that qualify as a RIC or a REIT intend to annually distribute or retain through a deemed distribution all of their taxable income to shareholders; therefore, the Company has made no provision for income taxes for these entities. AC Corp is a corporation subject to federal and state income taxes and records a benefit or expense for income taxes as appropriate.

Per Share Information

      Basic earnings per common share is calculated using the weighted average number of common shares outstanding for the period presented. Diluted earnings per common share reflects the potential dilution that could occur if options to issue common stock were exercised into common stock. Earnings per share is computed after subtracting dividends on preferred shares.

Use of Estimates in the Preparation of Financial Statements

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

      The consolidated financial statements include portfolio investments at value of $2.6 billion and $2.5 billion at September 30, 2003, and December 31, 2002, respectively. At September 30, 2003, and December 31, 2002, 86% and 88%, respectively, of our total assets represented investments whose fair values have been determined by the board of directors in good faith in the absence of readily available market values. Because of the inherent uncertainty of valuation, the board of directors’ determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

New Accounting Pronouncements

      In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, which provides guidance on how an

21

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

entity classifies and measures such instruments. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The statement requires cumulative effect transition for financial instruments existing at adoption date. The Company has adopted this statement as discussed in Note 6 and this adoption did not have a significant effect on the Company’s financial position or its results of operations.

      In January 2003, the FASB issued Interpretation No. 46 (“FIN No. 46”), Consolidation of Variable Interest Entities, which provides new guidance on the consolidation of certain entities defined as variable interest entities. FIN No. 46 specifies that any enterprise subject to SEC Regulation S-X Rule 6-03(c)(1) shall not consolidate any entity that is not also subject to the same rule. The Company is subject to Rule 6-03(c)(1), therefore FIN No. 46 does not apply to its portfolio investments.

Note 3. Portfolio

  Private Finance

      At September 30, 2003, and December 31, 2002, the private finance portfolio consisted of the following:

		2003							2002
		Cost		Value		Yield			Cost		Value		Yield
($ in thousands)
Loans and debt securities		$	1,339,131	$	1,158,745		15.3	% (1)	$	1,272,401	$	1,151,256		14.4	% (1)
Equity interests			489,270		649,963					438,501		591,959
	Total	$	1,828,401	$	1,808,708				$	1,710,902	$	1,743,215

(1)  The weighted average yield on loans and debt securities is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount, and market discount earned on accruing loans and debt securities, divided by (b) total loans and debt securities at value. At September 30, 2003, the cost and value of loans and debt securities include the Class A equity interests in BLX and the yield includes dividends earned on these equity interests. The weighted average yield is computed as of the balance sheet date.

     Private finance investment activity principally involves providing financing through privately negotiated long-term debt and equity investments. Private finance investments are generally structured as loans and debt securities that carry a relatively high fixed rate of interest, which may be combined with equity features, such as conversion privileges, or warrants or options to purchase a portion of the portfolio company’s equity at a pre-determined strike price, which is generally a nominal price for warrants or options in a private company. Private finance investments are generally issued by privately owned companies and are generally illiquid and subject to restrictions on resale or transferability.

      Loans and debt securities generally have a maturity of five to ten years, with interest-only payments in the early years and payments of both principal and interest in the later years, although debt maturities and principal amortization schedules vary. At September 30, 2003, and December 31, 2002, approximately 97% and 95%, respectively, of the Company’s loans and debt securities had fixed interest rates.

      Equity interests consist primarily of securities issued by privately owned companies and may be subject to restrictions on their resale or may be otherwise illiquid. Equity securities generally do not produce a current return, but are held in anticipation of investment appreciation and ultimate realized gain on sale.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      The Company may acquire more than 50% of the common stock or equity interests of a portfolio company in a control buyout transaction. The Company’s most significant investments acquired through control buyout transactions both at September 30, 2003, and December 31, 2002, were Business Loan Express, LLC and The Hillman Companies, Inc.

      At September 30, 2003, and December 31, 2002, the Company had an investment at value totaling $344.9 million and $256.8 million, respectively, in Business Loan Express, LLC (“BLX”), a small business lender that participates in the U.S. Small Business Administration’s 7(a) Guaranteed Loan Program. During the first quarter of 2003, the Company invested $50 million in BLX in the form of a $25 million short-term line of credit and $25 million of preferred equity in connection with BLX’s acquisition of $128 million in assets from Amresco Independence Funding, Inc. BLX also completed its corporate reorganization to a limited liability company during the first quarter of 2003 by merging BLX, Inc. into BLX, LLC. Prior to this transaction, BLX converted $43 million of the Company’s subordinated debt to preferred stock in BLX, Inc., which was exchanged upon the merger for Class A equity interests of BLX, LLC. In addition, as part of the merger, the Company exchanged its existing preferred stock and common equity investments in BLX, Inc. for similar classes of members’ equity in BLX, LLC represented by Class B and Class C equity interests, respectively. At September 30, 2003, the Company owned 94.9% of the voting Class C equity interests. BLX has an equity appreciation rights plan for management which will dilute the value available to the Class C equity interest holders.

      At the time of the corporate reorganization of BLX, Inc. from a C corporation to a limited liability company, for tax purposes BLX had a “built-in gain” representing the aggregate fair market value of its assets in excess of the tax basis of its assets. As a regulated investment company, the Company will be subject to the built-in gain rules on the assets of BLX. Under these rules, taxes will be payable by the Company at the time and to the extent that the built-in gains on BLX’s assets at the date of reorganization are recognized in a taxable disposition of such assets in the 10-year period following the date of the reorganization. At such time, the built-in gains realized upon the disposition of these assets will be included in the Company’s taxable income, net of the corporate level taxes paid by the Company on the built-in gains. However, if these assets are disposed of after the 10-year period, there will be no corporate level taxes on these built-in gains.

      While the Company has no obligation to pay the built-in gains tax until these assets are disposed of in the future, it may be necessary to record a liability for these taxes in the future should the Company intend to sell the assets of BLX within the 10-year period. The Company estimates that its future tax liability resulting from the built-in gains at the date of BLX’s reorganization may total up to $42 million. At September 30, 2003, the Company has considered the increase in fair value of its investment in BLX due to BLX’s tax attributes as an LLC and has also considered the reduction in fair value of its investment due to these estimated built-in gain taxes in determining the fair value of its investment in BLX.

      As the controlling equity owner of BLX, the Company has provided an unconditional guaranty to the BLX credit facility lenders in an amount up to 50% of the total obligations (consisting of principal, accrued interest, and other fees) on BLX’s three-year unsecured $169.0 million revolving credit facility that matures in March 2004. The amount guaranteed by the Company at September 30, 2003, was $64.9 million. This guaranty can be called by the lenders only in the event of a default by BLX. BLX was in compliance with the terms of its credit facility at September 30,

23

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

2003. At September 30, 2003, the Company had also provided three standby letters of credit in connection with three term securitization transactions completed by BLX totaling $25.6 million. In consideration for providing the guaranty and the three standby letters of credit, BLX paid the Company fees of $2.9 million and $2.3 million for the nine months ended September 30, 2003 and 2002, respectively. BLX is headquartered in New York, NY.

      At September 30, 2003, and December 31, 2002, the Company had an investment in The Hillman Companies, Inc. (“Hillman”) totaling $186.0 million and $180.5 million at value, respectively. At September 30, 2003, the Company owned 96.8% of Hillman’s common stock. The Company’s common stock ownership is subject to dilution by management options. Hillman is a leading manufacturer of key making equipment and distributor of key blanks, fasteners, signage, and other small hardware components and operates in multiple channels of the retail marketplace such as hardware stores, national and regional home centers, and mass merchants. Hillman has certain patent-protected products including key duplication technology that is important to its business. Hillman’s primary operations are located in Cincinnati, Ohio.

      Total interest and related portfolio income earned from the Company’s investments in BLX and Hillman for the nine months ended September 30, 2003 and 2002, was $40.0 million and $36.9 million, respectively.

      At September 30, 2003, and December 31, 2002, loans and debt securities in workout status (classified as Grades 4 and 5 under the Company’s internal grading system) that were not accruing interest were as follows at value:

		2003		2002
(in thousands)
Companies more than 25% owned		$	21,093	$	9,709
Companies 5% to 25% owned			330		411
Companies less than 5% owned			22,946		65,931
	Total	$	44,369	$	76,051

      In addition to Grade 4 and 5 assets that are in workout, the Company may not accrue interest on loans and debt securities to companies that are more than 50% owned by the Company depending on such company’s working capital needs and, therefore, the Company may defer current debt service. Loans and debt securities to such companies totaled $49.3 million and $63.6 million at value at September 30, 2003, and December 31, 2002, respectively. In addition, loans to companies that are less than 50% owned by the Company and were not in workout but were not accruing interest totaled $3.4 million and $7.2 million at value at September 30, 2003, and December 31, 2002, respectively.

24

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      The industry and geographic compositions of the private finance portfolio at value at September 30, 2003, and December 31, 2002, were as follows:

		2003			2002
Industry
Consumer products			30	%		34	%
Business services			22			25
Financial services			20			16
Industrial products			8			9
Healthcare services			8			6
Retail			5			4
Telecommunications			2			2
Education			1			1
Broadcasting & cable			1			1
Other			3			2
	Total		100	%		100	%
Geographic Region
Mid-Atlantic			38	%		33	%
Midwest			25			30
West			17			15
Southeast			15			17
Northeast			4			4
International			1			1
	Total		100	%		100	%

25

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

  Commercial Real Estate Finance

      At September 30, 2003, and December 31, 2002, the commercial real estate finance portfolio consisted of the following:

		2003							2002
		Cost		Value		Yield(1)			Cost		Value		Yield(1)
($ in thousands)
CMBS bonds		$	511,508	$	523,592		12.9	%	$	523,671	$	555,519		14.2	%
Collateralized debt obligation bonds and preferred shares			164,969		164,780		16.9	%		52,818		52,818		17.2	%
Loans			90,152		85,498		8.7	%		66,546		63,707		7.5	%
Residual interest			—		—					69,335		69,035		9.4	%
Real estate owned			17,419		13,497					5,942		3,873
Equity interests			5,322		4,983					—		—
	Total	$	789,370	$	792,350				$	718,312	$	744,952

⁽¹⁾ The weighted average yield on the interest-bearing investments is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount, and market discount earned on accruing interest- bearing investments, divided by (b) total interest-bearing investments at value. The weighted average yield is computed as of the balance sheet date. Interest-bearing investments for the commercial real estate finance portfolio include all investments except for real estate owned and equity interests.

     CMBS Bonds. At September 30, 2003, and December 31, 2002, CMBS bonds consisted of the following:

	2003			2002
($ in thousands)
Face	$	1,169,728		$	1,173,194
Original issue discount		(658,220	)		(649,523	)
Cost	$	511,508		$	523,671
Value	$	523,592		$	555,519

26

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      The underlying rating classes of the CMBS bonds at cost and value at September 30, 2003, and December 31, 2002, were as follows:

		2003							2002
						Percentage of							Percentage of
		Cost		Value		Total Value			Cost		Value		Total Value
($ in thousands)
BB+		$	106,952	$	113,327		21.7	%	$	45,609	$	49,811		9.0	%
BB			72,943		77,217		14.7			34,603		39,011		7.0
BB-			36,693		39,420		7.5			19,629		22,030		4.0
B+			43,758		43,542		8.3			109,235		121,038		21.8
B			34,755		34,786		6.7			131,309		141,998		25.6
B-			82,498		82,736		15.8			83,493		83,493		15.0
CCC+			15,736		15,510		3.0			—		—		—
CCC			13,377		11,255		2.1			8,634		8,634		1.5
CCC-			3,129		2,866		0.5			—		—		—
Unrated			101,667		102,933		19.7			91,159		89,504		16.1
	Total	$	511,508	$	523,592		100.0	%	$	523,671	$	555,519		100.0	%

      The non-investment grade and unrated tranches of the CMBS bonds in which the Company invests are junior in priority for payment of interest and principal to the more senior tranches of the related CMBS bond issuance. Cash flow from the underlying mortgages generally is allocated first to the senior tranches, with the most senior tranches having a priority right to the cash flow. Then, any remaining cash flow is allocated, generally, among the other tranches in order of their relative seniority. To the extent there are defaults and unrecoverable losses on the underlying mortgages or the properties securing those mortgages resulting in reduced cash flows, the most subordinate tranche will bear this loss first. At September 30, 2003, the Company’s CMBS bonds were subordinate to 87% to 99% of the tranches of bonds issued in these various CMBS transactions. Given that the non-investment grade CMBS bonds in which the Company invests are junior in priority for payment of interest and principal, the Company invests in these CMBS bonds at a significant discount from the face amount of the bonds.

      At September 30, 2003, and December 31, 2002, the Company held CMBS bonds in 39 and 27 separate CMBS issuances, respectively. The underlying collateral pool, consisting of commercial mortgage loans and real estate owned (“REO”) properties, for these CMBS issuances consisted of the following at September 30, 2003, and December 31, 2002:

	2003		2002
($ in millions)
Approximate number of loans and REO properties(1)		5,900		4,500
Total outstanding principal balance	$	39,475	$	24,974
Loans over 30 days delinquent or classified as REO properties(2)	0.9% (3)		1.0% (3)

(1)	Includes approximately 17 and 12 REO properties obtained through the foreclosure of commercial mortgage loans at September 30, 2003, and December 31, 2002, respectively.
(2)	As a percentage of total outstanding principal balance.
(3)	At September 30, 2003, and December 31, 2002, the Company’s investments included bonds in the first loss, unrated bond class in 33 and 27 separate CMBS issuances, respectively. For these issuances, loans over 30 days delinquent or classified as REO properties were 1.1% and 1.0% of the total outstanding principal balance at September 30, 2003, and December 31, 2002, respectively.

27

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

     The property types and the geographic composition of the underlying mortgage loans and REO properties in the underlying collateral pools for all CMBS issuances calculated using the outstanding principal balance at September 30, 2003, and December 31, 2002, were as follows:

		2003			2002
Property Type
Retail			35	%		32	%
Housing			25			27
Office			24			21
Industrial Real Estate			5			7
Hospitality			4			6
Other			7			7
	Total		100	%		100	%
Geographic Region
West			30	%		31	%
Mid-Atlantic			26			25
Midwest			23			22
Southeast			16			17
Northeast			5			5
	Total		100	%		100	%

      The Company’s yield on its CMBS bonds is based upon a number of assumptions that are subject to certain business and economic uncertainties and contingencies. Examples include the timing and magnitude of credit losses on the mortgage loans underlying the CMBS bonds that are a result of the general condition of the real estate market (including vacancies, rental rates and tenant credit quality) and changes in market rental rates. The initial yield on each CMBS bond has been computed assuming an approximate 1% loss rate on its underlying collateral mortgage pool, with the estimated losses being assumed to occur in three equal installments in years three, six, and nine. As each CMBS bond ages, the amount of losses and the expected timing of recognition of such losses will be updated, and the respective yield will be adjusted as necessary. As these uncertainties and contingencies are difficult to predict and are subject to future events which may alter these assumptions, no assurance can be given that the anticipated yields to maturity will be achieved.

      At September 30, 2003, and December 31, 2002, the unamortized discount related to the CMBS bond portfolio was $658.2 million and $649.5 million, respectively. At September 30, 2003, the Company has set aside $282.9 million of this unamortized discount to absorb potential future losses, and therefore, the yield on the CMBS bonds of 12.9% assumes that this amount will not be amortized. At September 30, 2003, and December 31, 2002, CMBS bonds with a value of $14.0 million and $28 thousand, respectively, were not accruing interest.

      Collateralized Debt Obligation Bonds and Preferred Shares (“CDOs”). At September 30, 2003, the Company owned BBB rated bonds in one CDO totaling $21.5 million at value and preferred shares in five CDOs totaling $143.3 million at value. The BBB rated bonds and preferred shares of the five CDOs in which the Company has invested are junior in priority for payment of interest and principal to the more senior tranches of debt issued by the CDOs. The CDO investments are secured by investment grade unsecured debt issued by various real estate investment trusts (“REITs”) and investment and non-investment grade CMBS bonds. Cash flow from the underlying REIT debt and CMBS bonds generally is allocated first to the senior bond tranches in order of priority, with the most

28

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

senior tranches having a priority right to the cash flow. Then, any remaining cash flow is generally distributed to the preferred shareholders. To the extent there are defaults and unrecoverable losses on the underlying collateral that result in reduced cash flows, the preferred shares will bear this loss first and then the BBB rated bonds would bear any loss after the preferred shares. At September 30, 2003, the Company’s BBB bonds in the CDO were subordinate to 61% of the more senior tranches of debt issued in the CDO transaction and the preferred shares in the CDOs were subordinate to 90% to 98% of the more senior tranches of debt issued in the various CDO transactions.

      The investment grade REIT collateral in the CDOs consists of debt with a an original underwritten balance of $1.2 billion and was issued by 39 REITs. The investment grade CMBS collateral consists of CMBS bonds with a face amount of $496.0 million issued in 41 separate CMBS transactions and the non-investment grade CMBS collateral consists of BB+, BB, BB–, B+, and B rated CMBS bonds with a face amount of $873.7 million issued in 42 separate CMBS transactions (“CMBS Collateral”). Included in the CMBS Collateral for the CDOs are CMBS bonds with a face amount of $793.7 million that are senior in priority of repayment to certain lower rated CMBS bonds held by the Company, which were issued in 27 separate CMBS transactions.

      The initial yields on the CDO bonds and preferred shares are based on the estimated future cash flows from the assets in the underlying collateral pool to be paid to these CDO classes. As each CDO bond and preferred share ages, the estimated future cash flows will be updated based on the performance of the collateral, and the respective yield will be adjusted as necessary. As future cash flows are subject to uncertainties and contingencies that are difficult to predict and are subject to future events which may alter current assumptions, no assurance can be given that the anticipated yields to maturity will be achieved.

      As of September 30, 2003, the Company acted as the disposition consultant with respect to four of the CDOs, which allows the Company to approve disposition plans for individual collateral securities. As of September 30, 2002, the Company acted as the disposition consultant with respect to three of the CDOs. For these services, the Company collects annual fees based on the outstanding collateral pool balance, and for the nine months ended September 30, 2003 and 2002, these fees totaled $864 thousand and $322 thousand, respectively.

      Loans and Equity Interests. The commercial mortgage loan portfolio contains loans that were originated by the Company or were purchased from third-party sellers. At September 30, 2003, approximately 92% and 8% of the Company’s commercial mortgage loan portfolio was composed of fixed and adjustable interest rate loans, respectively. As of December 31, 2002, approximately 84% and 16% of the Company’s commercial mortgage loan portfolio was composed of fixed and adjustable interest rate loans, respectively. As of September 30, 2003, and December 31, 2002, loans with a value of $7.2 million and $13.0 million, respectively, were not accruing interest. Loans greater than 120 days delinquent generally do not accrue interest.

      Equity interests consist primarily of equity securities issued by privately owned companies that invest in single real estate properties. These equity interests may be subject to restrictions on their resale and may otherwise be illiquid. Equity interests generally do not produce a current return, but are generally held in anticipation of investment appreciation and ultimate realized gain on sale.

29

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      The property types and the geographic composition securing the commercial mortgage loans and equity interests at value at September 30, 2003, and December 31, 2002, were as follows:

		2003			2002
Property Type
Hospitality			40	%		23	%
Office			21			20
Retail			20			21
Healthcare			10			15
Housing			4			8
Other			5			13
	Total		100	%		100	%
Geographic Region
Southeast			37	%		40	%
Midwest			26			12
West			23			20
Mid-Atlantic			8			17
Northeast			6			11
	Total		100	%		100	%

  Residual Interest. At December 31, 2002, the Company had $68.8 million at cost and value of residual interest and $0.5 million at cost and $0.2 million at value of residual interest spread.

      The residual interest primarily consisted of a retained interest from a 1998 asset securitization. At March 31, 2003, one class of bonds rated AAA was outstanding, totaling $6.0 million. During April 2003, the call provision was exercised and, accordingly, the bondholders were repaid in full and the remaining available cash, loans, and real estate owned of the trust were subsequently returned to the Company as payment on the residual interest. Therefore, the cost and value were zero at September 30, 2003.

      At December 31, 2002, the Company used a discounted cash flow methodology for determining the fair value of its retained residual interest and residual interest spread (“Residual”). In determining the cash flow of the Residual, the Company assumed a prepayment speed of 15% after the applicable prepayment lockout period and credit losses of 1% or approximately $0.8 million of the total principal balance of the underlying collateral throughout the life of the collateral. These assumptions resulted in an expected weighted average life of the bonds of four months. The value of the resulting Residual cash flows at December 31, 2002, was then determined by applying a discount rate of 9% which, in the Company’s view, was commensurate with the market risk of comparable assets.

30

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt

      At September 30, 2003, and December 31, 2002, the Company had the following debt:

			2003							2002
							Annual							Annual
			Facility		Amount		Interest			Facility		Amount		Interest
			Amount		Drawn		Cost(1)			Amount		Drawn		Cost(1)
(in thousands)
Notes payable and debentures:
	Unsecured long-term notes payable		$	854,000	$	854,000		7.2%		$	694,000	$	694,000		7.7	%
	SBA debentures			101,800		94,500		8.1%			101,800		94,500		8.2	%
	OPIC loan			5,700		5,700		6.6%			5,700		5,700		6.6	%
		Total notes payable and debentures		961,500		954,200		7.3%			801,500		794,200		7.8	%
Revolving line of credit				462,500		—		—	(2)		527,500		204,250		3.7	%(2)
	Total debt		$	1,424,000	$	954,200		7.5%	(3)	$	1,329,000	$	998,450		6.9	%(3)

(1)	The weighted average annual interest cost is computed as the (a) annual stated interest rate on the debt plus the annual amortization of commitment fees and other facility fees that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.
(2)	The stated interest rate payable on the revolving line of credit was 2.7% at December 31, 2002, which excluded the annual cost of commitment fees and other facility fees of $2.0 million. There were no amounts drawn on the revolving line of credit at September 30, 2003. The annual cost of commitment fees and other facility fees on the revolving line of credit is currently $2.4 million.
(3)	The annual interest cost for total debt includes the annual cost of commitment fees and other facility fees on the revolving line of credit regardless of the amount drawn on the facility as of the balance sheet date.

  Notes Payable and Debentures

      Unsecured Long-Term Notes Payable. The Company has issued unsecured long-term notes to private institutional investors. The notes require semi-annual interest payments until maturity and have original terms of five or seven years. At September 30, 2003, the notes had remaining maturities of one year to seven years. The notes may be prepaid in whole or in part, together with an interest premium, as stipulated in the note agreement.

      On May 14, 2003, the Company issued $153 million of five-year and $147 million of seven-year unsecured long-term notes, primarily to insurance companies. The five- and seven-year notes have fixed interest rates of 5.45% and 6.05%, respectively, and have substantially the same terms as the Company’s existing unsecured long-term notes. On May 30, 2003, $140 million of the Company’s existing unsecured long-term notes matured and the Company used the proceeds from the new long-term note issuance to repay this amount.

      SBA Debentures. At September 30, 2003, and December 31, 2002, the Company had debentures payable to the SBA with original terms of ten years and at fixed interest rates ranging from 5.9% to 8.2%. At September 30, 2003, the debentures had remaining maturities of one to nine years. The debentures require semi-annual interest-only payments with all principal due upon maturity. The SBA debentures are subject to prepayment penalties if paid prior to the fifth anniversary date of the notes. At September 30, 2003, the Company had a commitment from the

31

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued

SBA to borrow up to an additional $7.3 million above the current amount outstanding. The commitment expires on September 30, 2005.

      Scheduled Maturities. Scheduled future maturities of notes payable and debentures at September 30, 2003, were as follows:

		Amount Maturing
Year		(in thousands)
2003		$	—
2004			221,000
2005			179,000
2006			180,700
2007			—
Thereafter			373,500
	Total	$	954,200

Revolving Line of Credit

      On April 18, 2003, the Company renewed its unsecured revolving line of credit. The committed amount under the renewed facility is $462.5 million and may be expanded through new or additional commitments up to $600 million at the Company’s option. The renewed line of credit expires in April 2005 and may be extended under substantially similar terms for one additional year at the Company’s option. The facility bears interest at a rate, at the Company’s option, equal to (i) the one-month LIBOR plus 1.25%, (ii) the Bank of America, N.A. cost of funds plus 1.50% or (iii) the higher of the Bank of America, N.A. prime rate or the Federal Funds rate plus 0.50%. The interest rate adjusts at the beginning of each new interest period, usually every 30 days. There were no amounts drawn on the revolving line of credit at September 30, 2003. The stated interest rate was 2.7% at December 31, 2002, and the facility requires an annual commitment fee equal to 0.25% of the committed amount. The annual cost of commitment fees and other facility fees is currently $2.4 million. The line of credit generally requires monthly payments of interest, and all principal is due upon maturity.

      The average debt outstanding on the revolving line of credit was $55.4 million and $68.3 million for the nine months ended September 30, 2003, and the year ended December 31, 2002, respectively. The maximum amount borrowed under this facility and the weighted average stated interest rate for the nine months ended September 30, 2003, and the year ended December 31, 2002, were $208.8 million and $216.5 million, and 2.6% and 3.2%, respectively. As of September 30, 2003, the amount available under the revolving line of credit was $426.6 million, net of amounts committed for standby letters of credit of $35.9 million issued under the credit facility.

      The Company has various financial and operating covenants required by the revolving line of credit and the notes payable and debentures. These covenants require the Company to maintain certain financial ratios, including debt to equity and interest coverage, and a minimum net worth. The Company’s credit facilities limit its ability to declare dividends if the Company defaults under certain provisions. As of September 30, 2003, the Company was in compliance with these covenants.

Note 5. Guarantees

      In the ordinary course of business, the Company has issued guarantees and has extended standby letters of credit through financial intermediaries on behalf of certain portfolio companies. As of September 30, 2003, and December 31, 2002, the Company had issued guarantees of debt, rental

32

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 5. Guarantees, continued

obligations, lease obligations and severance obligations aggregating $70.3 million and $54.6 million, respectively, and had extended standby letters of credit aggregating $35.9 million and $11.3 million, respectively. Under these arrangements, the Company would be required to make payments to third-party beneficiaries if the portfolio companies were to default on their related payment obligations. The maximum amount of future payments was $106.2 million and $65.9 million at September 30, 2003, and December 31, 2002, respectively. At September 30, 2003, and December 31, 2002, no amounts had been recorded as a liability for the Company’s guarantees or standby letters of credit.

      As of September 30, 2003, the guarantees and standby letters of credit expire as follows:

		Total		2003		2004		2005		2006		2007		After 2007
(in millions)
Guarantees		$	70.3	$	0.2	$	65.6	$	0.5	$	0.2	$	0.2	$	3.6
Standby letters of credit			35.9		—		—		3.4		32.5		—		—
	Total	$	106.2	$	0.2	$	65.6	$	3.9	$	32.7	$	0.2	$	3.6

Note 6. Preferred Stock

      Allied Investment has outstanding a total of 60,000 shares of $100 par value, 3% cumulative preferred stock and 10,000 shares of $100 par value, 4% redeemable cumulative preferred stock issued to the SBA pursuant to Section 303(c) of the Small Business Investment Act of 1958, as amended. The 3% cumulative preferred stock does not have a required redemption date. Allied Investment has the option to redeem in whole or in part the preferred stock by paying the SBA the par value of such securities and any dividends accumulated and unpaid to the date of redemption. The 4% redeemable cumulative preferred stock has a required redemption date in June 2005.

      In accordance with SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, (SFAS No. 150) the Company has reclassified the 10,000 shares of $100 par value, 4% redeemable cumulative preferred securities to other liabilities on the accompanying consolidated balance sheet. Accordingly, the Company has also recorded the associated dividends as interest expense on the accompanying consolidated statement of operations beginning with the quarter ended September 30, 2003. The effect of this change in accounting principle was not material to the financial results or the results of operations of the Company. Also, in accordance with SFAS No. 150, no previously reported amounts have been reclassified.

Note 7. Shareholders’ Equity

      Sales of common stock for the nine months ended September 30, 2003 and 2002, were as follows:

		For the Nine Months
		Ended September 30,
		2003			2002
(in thousands)
Number of common shares			13,670			1,946
Gross proceeds		$	312,845		$	51,800
Less costs, including underwriting fees			(14,596	)		(1,880	)
	Net proceeds	$	298,249		$	49,920

33

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 7. Shareholders’ Equity, continued

      The Company has a dividend reinvestment plan, whereby the Company may buy shares of its common stock in the open market or issue new shares in order to satisfy dividend reinvestment requests. If the Company issues new shares, the issue price is equal to the average of the closing sale prices reported for the Company’s common stock for the five consecutive trading days immediately prior to the dividend payment date.

      Dividend reinvestment plan activity for the nine months ended September 30, 2003 and 2002, was as follows:

	For the Nine Months
	Ended September 30,
	2003		2002
(in thousands, except per share amounts)
Shares issued		219		203
Average price per share	$	22.62	$	23.12

Note 8. Earnings Per Common Share

      Earnings per common share for the three and nine months ended September 30, 2003 and 2002, were as follows:

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2003			2002			2003			2002
(in thousands, except per share amounts)
Net increase in net assets resulting from operations	$	33,744		$	45,520		$	113,557		$	174,935
Less preferred stock dividends		(45	)		(55	)		(155	)		(165	)
Income available to common shareholders	$	33,699		$	45,465		$	113,402		$	174,770
Weighted average common shares outstanding — basic		118,855			102,327			113,985			101,329
Dilutive options outstanding to officers		2,051			975			1,243			1,711
Weighted average common shares outstanding — diluted		120,906			103,302			115,228			103,040
Basic earnings per common share	$	0.28		$	0.44		$	0.99		$	1.73
Diluted earnings per common share	$	0.28		$	0.44		$	0.98		$	1.70

Note 9. Dividends and Distributions

      The Company’s Board of Directors declared and the Company paid dividends of $0.57 per common share for each of the first, second, and third quarters of 2003. The dividends totaled $68.7 million and $196.2 million for the three and nine months ended September 30, 2003, respectively. The Company declared an extra cash dividend of $0.03 per share during 2002 and this was paid to shareholders on January 9, 2003. The Company paid dividends to common shareholders of $57.3 million and $166.8 million for the three and nine months ended September 30, 2002, respectively.

      The Company’s Board of Directors also declared a dividend of $0.57 per common share for the fourth quarter of 2003.

34

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10. Supplemental Disclosure of Cash Flow Information

      For the nine months ended September 30, 2003 and 2002, the Company paid $42.3 million and $40.6 million, respectively, for interest. For the nine months ended September 30, 2003, the Company’s non-cash financing activities totaled $5.0 million related to the issuance of common stock in lieu of cash distributions. For the nine months ended September 30, 2002, the Company’s non-cash financing activities totaled $7.1 million related to stock option exercises and dividend reinvestment.

      Non-cash operating activities for the nine months ended September 30, 2003, included transfers of commercial mortgage loans and real estate owned in the repayment of the Company’s residual interest totaling $69.3 million, real estate owned received in connection with foreclosure on commercial mortgage loans of $9.1 million, receipt of commercial mortgage loans in satisfaction of private finance loans and debt securities of $9.1 million and receipt of a note as consideration from the sale of real estate owned of $2.1 million. Non-cash operating activities for the nine months ended September 30, 2002, included real estate owned received in connection with foreclosure on commercial mortgage loans of $2.5 million.

Note 11. Hedging Activities

      The Company invests in CMBS bonds, which are purchased at prices that are based in part on comparable Treasury rates. The Company has entered into transactions with one or more financial institutions to hedge against movement in Treasury rates on certain of the higher rated CMBS bonds and BBB rated CDO bonds. These transactions, referred to as short sales, involve the Company receiving the proceeds from the short sales of borrowed Treasury securities, with the obligation to replenish the borrowed Treasury securities at a later date based on the then current market price. Borrowed Treasury securities and the related obligations to replenish the borrowed Treasury securities at value, including accrued interest payable on the obligations, as of September 30, 2003, and December 31, 2002, consisted of the following:

(in thousands)
Description of Issue		2003		2002
10-year Treasury securities, due February 2012		$	—	$	52,053
10-year Treasury securities, due November 2012			43,985		107,327
10-year Treasury securities, due February 2013			80,590		—
10-year Treasury securities, due May 2013			36,161		—
10-year Treasury securities, due August 2013			39,582		—
5-year Treasury securities, due November 2007			9,908		37,647
5-year Treasury securities, due February 2008			6,900		—
5-year Treasury securities, due May 2008			4,727		—
	Total	$	221,853	$	197,027

      As of September 30, 2003, the total obligations to replenish borrowed Treasury securities had decreased since the original sale dates due to changes in the yield on the borrowed Treasury securities, resulting in unrealized appreciation on the obligations of $78 thousand. As of December 31, 2002, the total obligations to replenish borrowed Treasury securities had increased since the related original sale dates due to changes in the yield on the borrowed Treasury securities, resulting in unrealized depreciation on the obligations of $7.1 million. The net proceeds related to the sales of the borrowed Treasury securities were $220.9 million and $189.3 million at September 30, 2003, and December 31, 2002, respectively. Under the terms of the transactions, the Company has provided additional cash collateral of $0.8 million and $5.4 million at September 30, 2003, and December 31,

35

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 11. Hedging Activities, continued

2002, respectively, for the difference between the net proceeds related to the sales of the borrowed Treasury securities and the obligations to replenish the securities. The Company has deposited the proceeds related to the sales of the borrowed Treasury securities and the additional cash collateral with the financial institutions under repurchase agreements. The repurchase agreements are collateralized by U.S. Treasury securities and are settled weekly. As of September 30, 2003, the repurchase agreements were due on October 8, 2003, and had a weighted average interest rate of 0.4%. The weighted average interest rate on the repurchase agreements as of December 31, 2002, was 0.8%.

Note 12. Financial Highlights

		At and for the
		Nine Months Ended						At and for the
		September 30,						Year Ended
								December 31,
		2003(1)			2002(1)			2002
Per Common Share Data(2)
Net asset value, beginning of period		$	14.22		$	13.57		$	13.57
	Net investment income		1.22			1.37			1.77
	Net gains (losses)(3)		(0.24	)		0.33			0.43
Net increase in net assets resulting from operations			0.98			1.70			2.20
Net decrease in net assets from shareholder distributions			(1.71	)		(1.64	)		(2.23	)
Net increase in net assets from capital share transactions			0.97			0.32			0.68
Net asset value, end of period		$	14.46		$	13.95		$	14.22
Market value, end of period		$	24.59		$	21.89		$	21.83
Total return(4)			21	%		(10	)%		(7	)%
Ratios and Supplemental Data
Ending net assets		$	1,775,587		$	1,429,049		$	1,546,071
Common shares outstanding at end of period			122,766			102,468			108,698
Diluted weighted average common shares outstanding			115,228			103,040			103,574
Employee and administrative expenses/ average net assets			2.58	%		2.67	%		3.82	%
Total expenses/average net assets			6.09	%		6.42	%		8.75	%
Net investment income/average net assets			8.59	%		10.11	%		12.94	%
Net increase in net assets resulting from operations(3)/ average net assets			6.92	%		12.50	%		15.98	%
Portfolio turnover rate			20.04	%		13.97	%		15.12	%
Average debt outstanding		$	939,903		$	927,270		$	938,148
Average debt per share(2)		$	8.16		$	9.00		$	9.06

(1)	The results for the nine months ended September 30, 2003 and 2002, are not necessarily indicative of the operating results to be expected for the full year.
(2)	Based on diluted weighted average number of common shares outstanding for the period.
(3)	Net changes in unrealized appreciation or depreciation and net realized gains and losses can fluctuate significantly from period to period. As a result, quarterly comparisons may not be meaningful.
(4)	Total return assumes the reinvestment of all dividends paid for the periods presented.

36

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 13. Litigation

      The Company is a party to certain legal proceedings incidental to the normal course of its business, including enforcement of its rights under contracts with its portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, the Company does not expect that these proceedings will have a material effect upon its financial condition or results of operations.

37

Independent Accountants’ Review Report

The Board of Directors and Shareholders

Allied Capital Corporation:

      We have reviewed the accompanying consolidated balance sheet of Allied Capital Corporation and subsidiaries, including the consolidated statement of investments, as of September 30, 2003, and the related consolidated statements of operations for the three- and nine-month periods ended September 30, 2003 and 2002, changes in net assets and cash flows and the financial highlights (included in Note 12) for the nine-month periods ended September 30, 2003 and 2002. These consolidated financial statements and financial highlights are the responsibility of the Company’s management.

      We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

      Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements and financial highlights referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

      We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Allied Capital Corporation and subsidiaries as of December 31, 2002, and the related consolidated statements of operations, changes in net assets and cash flows (not presented herein), and the financial highlights (included in Note 12), for the year then ended; and in our report dated February 11, 2003, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2002, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG LLP

Washington, D.C.

October 27, 2003

38

Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

      The following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto included herein and in the Company’s annual report on Form 10-K for the year ended December 31, 2002. This quarterly report on Form 10-Q contains certain forward-looking statements. These statements include the plans and objectives of management for future operations and financial objectives and can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth below in the Risk Factors section. Other factors that could cause actual results to differ materially include:

•  changes in the economy;

•  risks associated with possible disruption in our operations due to terrorism;

•  future changes in laws or regulations and conditions in our operating areas; and

•  other risks and uncertainties as may be detailed from time to time in our public announcements and SEC filings.

      Financial or other information presented for private finance portfolio companies has been obtained from the portfolio companies, and the financial information presented may represent unaudited, projected or pro forma financial information, and therefore may not be indicative of actual results. In addition, the private equity industry uses financial measures such as EBITDA or EBITDAM (Earnings Before Interest, Taxes, Depreciation, Amortization and, in some instances, Management fees) in order to assess a portfolio company’s financial performance and to value a portfolio company. EBITDA and EBITDAM are not intended to represent cash flow from operations as defined by accounting principles generally accepted in the United States of America and such information should not be considered as an alternative to net income, cash flow from operations or any other measure of performance prescribed by accounting principles generally accepted in the United States of America.

OVERVIEW

      We are a business development company that provides long-term debt and equity investment capital to companies in a variety of industries. Our lending and investment activity is generally focused on private finance and commercial real estate finance, primarily the investment in non-investment grade commercial mortgage-backed securities, which we refer to as CMBS, and collateralized debt obligation bonds and preferred shares, which we refer to as CDOs. Our private finance activity principally involves providing financing through privately negotiated long-term debt and equity investment capital. Our private financing is generally used to fund growth, buyouts, acquisitions, recapitalizations, note purchases, and bridge financings. We generally invest in private companies though, from time to time, we may invest in public companies that lack access to public capital or whose securities may not be marginable.

39

      Our portfolio composition at September 30, 2003, and December 31, 2002, was as follows:

	2003			2002
Private Finance		70	%		70	%
Commercial Real Estate Finance		30	%		30	%

      Our earnings depend primarily on the level of interest and dividend income, fee income, and net gains or losses earned on our investment portfolio after deducting interest paid on borrowed capital and operating expenses. Interest income results from the stated interest rate earned on a loan and the amortization of loan origination points and discounts. The level of interest income is directly related to the balance of the interest-bearing investment portfolio multiplied by the weighted average yield. Our ability to generate interest income is dependent on economic, regulatory, and competitive factors that influence new investment activity, the amount of loans and debt securities for which interest is not accruing and our ability to secure debt and equity capital for our investment activities.

40

PORTFOLIO AND INVESTMENT ACTIVITY

      Total portfolio investment activity and yields at and for the three and nine months ended September 30, 2003 and 2002, and at and for the year ended December 31, 2002, were as follows:

	At and for the						At and for the
	Three Months Ended						Nine Months Ended						At and for the
	September 30,						September 30,						Year Ended
													December 31,
	2003			2002			2003			2002			2002
($ in millions)
	(unaudited)						(unaudited)
Portfolio at value	$	2,601.1		$	2,343.6		$	2,601.1		$	2,343.6		$	2,488.2
Investments funded	$	138.4		$	157.6		$	664.8		$	353.0		$	506.4
Change in accrued or reinvested interest and dividends	$	19.6		$	13.5		$	40.0		$	33.0		$	44.7
Principal repayments	$	69.4		$	44.7		$	219.7		$	111.7		$	143.2
Sales	$	5.1		$	87.2		$	281.8		$	213.5		$	213.5
Yield(1)		14.5	%		14.1	%		14.5	%		14.1	%		14.0	%

⁽¹⁾ The weighted average yield on interest-bearing investments is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount, and market discount earned on accruing interest-bearing investments, divided by (b) total interest-bearing investments at value. The weighted average yield is computed as of the balance sheet date.

Private Finance

      The private finance portfolio, investment activity, and yields at and for the three and nine months ended September 30, 2003 and 2002, and at and for the year ended December 31, 2002, were as follows:

		At and for the						At and for the
		Three Months Ended						Nine Months Ended						At and for the
		September 30,						September 30,						Year Ended
														December 31,
		2003			2002			2003			2002			2002
($ in millions)
		(unaudited)						(unaudited)
Portfolio at value:
	Loans and debt securities	$	1,158.7		$	1,122.6		$	1,158.7		$	1,122.6		$	1,151.2
	Equity interests		650.0			540.0			650.0			540.0			592.0
Total portfolio		$	1,808.7		$	1,662.6		$	1,808.7		$	1,662.6		$	1,743.2
Investments funded		$	31.7		$	148.7		$	305.7		$	218.4		$	297.2
Change in accrued or reinvested interest and dividends		$	18.4		$	13.5		$	37.8		$	32.6		$	42.6
Principal repayments		$	53.7		$	44.2		$	199.7		$	100.2		$	129.3
Yield(1)			15.3	%		14.4	%		15.3	%		14.4	%		14.4	%

⁽¹⁾ The weighted average yield on loans and debt securities is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount, and market discount earned on accruing loans and debt securities, divided by (b) total loans and debt securities at value. The weighted average yield is computed as of the balance sheet date.

41

     Investments funded for the nine months ended September 30, 2003 and 2002, and for the year ended December 31, 2002, consisted of the following:

			Loans and
			Debt		Equity
			Securities		Interests		Total
($ in millions)
For the Nine Months Ended September 30, 2003(1)
	Companies more than 25% owned		$	48.0	$	28.2	$	76.2
	Companies 5% to 25% owned			18.2		1.8		20.0
	Companies less than 5% owned			203.8		5.7		209.5
		Total	$	270.0	$	35.7	$	305.7
For the Nine Months Ended September 30, 2002(1)
	Companies more than 25% owned		$	31.7	$	4.1	$	35.8
	Companies 5% to 25% owned			24.8		7.4		32.2
	Companies less than 5% owned			141.0		9.4		150.4
		Total	$	197.5	$	20.9	$	218.4
For the Year Ended December 31, 2002(1)
	Companies more than 25% owned		$	86.1	$	18.7	$	104.8
	Companies 5% to 25% owned			22.3		0.4		22.7
	Companies less than 5% owned			154.6		15.1		169.7
		Total	$	263.0	$	34.2	$	297.2

⁽¹⁾ The private finance portfolio is presented in three categories — companies more than 25% owned, which represent portfolio companies where we directly or indirectly own more than 25% of the outstanding voting securities of such portfolio company and, therefore, are deemed controlled by us under the Investment Company Act of 1940, or the 1940 Act; companies owned 5% to 25%, which represent portfolio companies where we directly or indirectly own 5% to 25% of the outstanding voting securities of such portfolio company or where we hold one or more seats on the portfolio company’s board of directors and, therefore, are deemed to be an affiliated person under the 1940 Act; and companies less than 5% owned, which represent portfolio companies where we directly or indirectly own less than 5% of the outstanding voting securities of such portfolio company and where we have no other affiliations with such portfolio company.

     At September 30, 2003, we had outstanding funding commitments of $93.4 million to private finance portfolio companies, including $27.2 million committed to private equity funds. At September 30, 2003, we also had total commitments to private finance portfolio companies in the form of standby letters of credit and guarantees of $103.5 million.

      We fund new investments using cash, through the issuance of our common equity, the reinvestment of previously accrued interest and dividends in debt or equity securities, or the current reinvestment of interest and dividend income through the receipt of a debt or equity security (payment-in-kind income). From time to time we may opt to reinvest accrued interest receivable in a new debt or equity security in lieu of receiving such interest in cash and providing a subsequent investment.

      We may acquire more than 50% of the common stock or equity interests of a company in a control buyout transaction. Buyout investments are generally structured such that we earn a current return through a combination of interest income on our senior loans and subordinated debt, dividends on our preferred and/or common stock, and management or transaction services fees to compensate us for the managerial assistance that we provide to a controlled portfolio company. We plan to continue to seek buyout investments. Buyout investments provide the opportunity to invest meaningful

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amounts of capital with the potential for attractive current income returns as well as the potential for future capital gains. Buyout transactions are typically larger than our mezzanine investments. In some cases for companies that are more than 50% owned, we may not accrue interest on loans and debt securities depending on the working capital needs of such company. In such cases, we may defer current debt service.

      Our most significant investments acquired through control buyout transactions at September 30, 2003, were Business Loan Express, LLC (BLX), acquired in 2000, and The Hillman Companies, Inc. (Hillman), acquired in 2001.

      Business Loan Express, LLC.     At September 30, 2003, our investment in BLX totaled $257.8 million at cost and $344.9 million at value, or 11.5% of our total assets, which includes unrealized appreciation of $87.1 million.

      BLX is a national, non-bank, government guaranteed lender utilizing the SBA’s 7(a) Guaranteed Loan Program and is licensed by the SBA as a Small Business Lending Company (SBLC). BLX is a preferred lender in all 79 SBA districts as designated by the SBA, and originates, sells, and services small business loans. In addition to the SBA 7(a) Guaranteed Loan Program, BLX originates conventional small business loans and originates loans under the USDA Business and Industry Guaranteed Loan Program. BLX has offices across the United States and is headquartered in New York, New York. Changes in the laws or regulations that govern SBLCs or the SBA 7(a) Guaranteed Loan Program or changes in government funding for this program could have a material adverse impact on BLX and, as a result, negatively affect our financial results.

      During the quarter ended March 31, 2003, BLX completed two significant transactions, the purchase of loans and other assets from Amresco Independence Funding, Inc., or “AIF,” and the reorganization of BLX from a corporation to a limited liability company, or “LLC”.

      In January 2003, BLX completed the acquisition of $128.0 million of performing loans and other assets from AIF. BLX purchased $121.5 million of performing SBA 7(a) unguaranteed loans at par and $6.5 million of other assets. The acquisition increased BLX’s serviced portfolio and enhanced its nationwide loan origination platform. We provided $50 million of the capital to fund this acquisition. Our $50 million financing was in the form of a short-term revolving credit facility of $25 million to fund the temporary capital needs of construction loans purchased and loans pending sale, as well as $25 million of preferred equity to support the growth needs of BLX post acquisition.

      In February 2003, BLX completed a reorganization from a corporation to a limited liability company in order to simplify its corporate structure and provide certain income tax efficiencies. In connection with the reorganization, BLX’s stated book equity increased by $43 million because we converted $43 million of our subordinated debt into preferred stock in BLX, Inc., which was exchanged for Class A equity interests in BLX, LLC. In addition, we exchanged our existing preferred stock and common equity investments in BLX, Inc. for similar classes of members’ equity in BLX, LLC represented by Class B and Class C equity interests, respectively.

      Subsequent to the reorganization, BLX’s taxable earnings will generally flow directly to its members and we represent approximately 95% of the economic interests in the LLC. In connection with the reorganization, BLX changed its fiscal year end to September 30.

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      Summary financial data for BLX at and for the year ended September 30, 2003 and 2002, is presented below. The September 30, 2003, financial data is preliminary and unaudited.

		At and for the			At and for the
		Year Ended			Year Ended
		September 30,			September 30,
		2003(1)			2002
($ in millions)
Operating Data
	Total revenue	$	108.3		$	94.0
	Net income(2)	$	4.7		$	3.4
	Earnings before interest, taxes and management fees (EBITM)	$	37.5		$	47.0
Balance Sheet Data
	Total assets(3)	$	353.0		$	281.1
	Total debt	$	178.5		$	186.1
	Total owners’ equity	$	136.1		$	62.1
Other Data
	Total loan originations	$	685.8		$	624.5
	Serviced loan portfolio	$	2,227.4		$	1,501.6
	Number of loans		3,136			2,251
	Loan delinquencies(4)		8.3	%		8.5	%
Serviced Loan Portfolio by Industry
	Hotels		24	%		27	%
	Gas stations/convenience stores		19			17
	Professional and retail services		12			10
	Restaurants		9			10
	Manufacturing and industrial		9			10
	Car wash/auto repair services		7			3
	Child care and health care services		6			4
	Shrimp/fishing vessels		5			7
	Recreation		5			6
	Other		4			6
	Total		100	%		100	%

(1)	Post reorganization BLX’s fiscal year end changed to September 30.
(2)	For the year ended September 30, 2003, net income was reduced by $2.3 million due to costs associated with the AIF acquisition and the LLC reorganization and $2.3 million due to the increased value of issued and outstanding equity appreciation rights. In addition, net income was increased by $3.4 million due to the reversal of certain net deferred tax liabilities upon the conversion of BLX from a corporation to a limited liability company. As an LLC, BLX is generally not subject to federal income tax; however, BLX is subject to certain state income and franchise taxes, and income taxes associated with a taxable subsidiary corporation.
(3)	Included in total assets is $6 million of goodwill at September 30, 2003 and 2002. There is no other goodwill on BLX’s balance sheet. We acquired 94.9% of BLC Financial Services, Inc. on December 31, 2000. “Push-down” accounting was not required with respect to this transaction; accordingly, goodwill was not recorded by BLX.
(4)	Represents the percentage of loans in the total serviced loan portfolio that are greater than 30 days delinquent, which includes loans in workout status. Loans greater than 30 days delinquent for the SBA 7(a) loan portfolio only, which are included in the total serviced loan portfolio, were 8.5% at September 30, 2003. SBA 7(a) loans greater than one year old at September 30, 2003, had a delinquency rate of 10.6%. BLX will from time to time grant a 90-day deferment to borrowers experiencing short-term cash flow shortfalls. Loans that have been granted a deferment that perform as required are not considered delinquent consistent with SBA practice. The ability of small businesses to repay their loans may be adversely affected by numerous factors, including a downturn in their industry or negative economic conditions. Small businesses are also more vulnerable to customer preferences, competition, rising fuel prices and market conditions and, as a result, delinquencies in BLX’s portfolio may increase. For instance, the shrimp and fishing industry has been affected by rising fuel costs and competition from imported shrimp. For these reasons, BLX focuses on collateral protection for each loan in addition to the cash flow of the small business and receives personal guarantees from the principal owners of the small business.

      For the year ended September 30, 2003, BLX earned revenue of $108.3 million and EBITM of $37.5 million. EBITM was reduced by $2.3 million due to costs associated with the AIF acquisition

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and the LLC reorganization, as well as by $2.3 million due to the increased value of issued and outstanding equity appreciation rights to employees.

      For the year ended September 30, 2003, EBITM before one-time costs and equity appreciation rights expense was $42.1 million, which compares to EBITM of $47.0 million for the year ended September 30, 2002. Because of the AIF acquisition, BLX increased its infrastructure and has been implementing a company-wide integration and process improvement plan. At the same time, BLX began to focus on diversifying its portfolio to better balance its securitization pools with respect to industry diversity. The combination of these changes in processes had a negative impact on BLX’s loan originations in the latter part of its 2003 fiscal year, and loan originations in the fourth quarter of fiscal year 2003 were reduced to $121.4 million from a level of $148.7 million in the third quarter of 2003. The downturn in BLX’s loan originations combined with a higher cost structure had the impact of decreasing BLX’s EBITM for 2003 as compared to 2002. Management of BLX believes that its loan originations will begin to return to levels more consistent with the past in the upcoming quarters. Management of BLX also believes that the increased cost of infrastructure improvements will provide greater strength and stability for BLX in the future. As is discussed in the Results of Operations section below, we considered the decline in EBITM in our valuation analysis for our investment in BLX at September 30, 2003.

      BLX’s revenues consist of cash premiums from guaranteed loan sales, gain on sale income arising from loans sold at par or securitized where BLX will receive future cash flows representing the spread between loan interest and the interest paid on bonds issued including service fee income, interest income on loans remaining in BLX’s portfolio, and other income. Gain on sale income is a non-cash source of income when recognized, and as future cash flows are received, the resulting cash reduces the receivable or residual interest that is recognized when the loan is sold. The total of cash loan sale premiums, cash interest income and cash received from residual interests and other cash income is equal to approximately 83% of BLX’s revenue of $108.3 million during the year ended September 30, 2003.

      BLX’s business is to originate small business loans and then sell substantially all of the loans originated for cash proceeds. Loans originated during the year ended September 30, 2003, totaled $685.8 million, including loans purchased from AIF. Proceeds from loan sales during the year ended September 30, 2003, totaled approximately $664.2 million. BLX funds the construction of commercial real estate projects, and as a result is unable to sell a construction loan until the loan is fully funded and the construction is complete. In addition, BLX typically does not immediately receive the proceeds from the sale of its SBA 7(a) guaranteed and unguaranteed loan strips sold, but receives the cash upon settlement. Therefore until BLX sells construction loans or fully funded loans held for sale, it will finance the origination of the loans through funding on its revolving line of credit, or through financing provided by us.

      BLX has a three-year $169.0 million revolving credit facility that matures in March 2004. As the controlling equity owner in BLX, we have provided an unconditional guaranty to the revolving credit facility lenders in an amount of up to 50% of the total obligations (consisting of principal, accrued interest, and other fees) of BLX under the revolving credit facility. The principal amount outstanding on the revolving credit facility at September 30, 2003, was $129.5 million and the amount guaranteed by us was $64.9 million. This guaranty can be called by the lenders only in the event of a default by BLX. BLX was in compliance with the terms of the revolving credit facility at September 30, 2003. At September 30, 2003, we had provided three standby letters of credit in connection with three term securitization transactions completed by BLX totaling $25.6 million.

      BLX sells the guaranteed piece of guaranteed loans for cash premiums of up to 10% of the guaranteed loan amount plus a retained annual servicing fee generally between 1.0% and 2.3% of the guaranteed loan amount. Cash premiums received from guaranteed loan sales during the year ended September 30, 2003, were approximately $31.3 million in total.

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      Alternatively, BLX may sell the guaranteed pieces of SBA 7(a) guaranteed loans at par and receive cash only for the face amount of the loan sold, and instead of receiving a cash premium, BLX will receive an annual servicing spread on the loans sold of between 4.0% and 4.8%. In addition, BLX will sell the unguaranteed pieces of the SBA 7(a) loans and conventional loans it originates into a conduit facility. The conduit loans are securitized and BLX retains an interest of up to 2.7% of the loan pool. BLX then receives the excess of loan interest payments on the loans sold over the interest cost on the securities issued in the securitization over the life of the loan pool. BLX generally receives between 4.3% and 4.9% annually on the loans sold into the securitization pools.

      When BLX sells a guaranteed piece of an SBA 7(a) loan at par, or when BLX securitizes a loan, it will record a residual interest and servicing asset together referred to as Residual Interest in order to account for the retained interest in the loans sold and the net present value of the future cash flows it will receive from the loans sold or securitized. In computing the Residual Interest, BLX discounts estimated future cash flows after making assumptions as to future loan losses and loan prepayments which may reduce future cash flows. For the year ended September 30, 2003, BLX received cash payments from Residual Interest of approximately $49.3 million.

      At September 30, 2003, BLX’s Residual Interest totaled $175.6 million, representing BLX’s estimate of the net present value of future cash flows of scheduled loan payments, after estimated future loan losses and loan prepayments. If scheduled loan payments were to be received as stated in the loan agreements with no future losses or prepayments, BLX would receive future cash flows of $733.9 million over time, with approximately $56.6 million, $52.9 million, $51.6 million, and $50.2 million (or $211.2 million in the aggregate) scheduled to be received in the next four years ending on September 30, 2004, 2005, 2006, and 2007, respectively.

      The Hillman Companies, Inc. At September 30, 2003, our investment in Hillman totaled $94.1 million at cost and $186.0 million at value, or 6.2% of total assets, which includes unrealized appreciation of $91.9 million.

      Hillman is a leading manufacturer of key making equipment and distributor of key blanks, fasteners, signage, and other small hardware components and operates in multiple channels of the retail marketplace such as hardware stores, national and regional home centers, and mass merchants. Hillman has certain patent-protected products including key duplication technology that is important to its business. Hillman’s primary operations are located in Cincinnati, Ohio.

      For the year ended December 31, 2002, Hillman had total revenue of $286.8 million, earnings before interest, taxes, depreciation, amortization, and management fees, or EBITDAM, of $50.2 million, and profits before taxes of $10.0 million. For the nine months ended September 30, 2003, Hillman had total revenue of $240.3 million and EBITDAM of $41.9 million. This EBITDAM is before the write-down of $6.3 million of a note receivable related to an investment made by Hillman. For the nine months ended September 30, 2003, Hillman had income before taxes of $1.9 million, which includes the write-down of the note receivable. The total revenue, EBITDAM, and loss before taxes for the nine months ended September 30, 2003, are not necessarily indicative of the operating results to be expected for the full year. Hillman had total assets of $378.4 million, total debt of $158.0 million and trust preferred obligations at par of $105.4 million at September 30, 2003.

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Commercial Real Estate Finance

      The commercial real estate finance portfolio, investment activity, and yields at and for the three and nine months ended September 30, 2003 and 2002, and at and for the year ended December 31, 2002, were as follows:

	At and for the								At and for the
	Three Months Ended September 30,								Nine Months Ended September 30,								At and for
																	the Year Ended
																	December 31,
	2003				2002				2003				2002				2002
	(unaudited)								(unaudited)
($ in millions)	Value		Yield(1)		Value		Yield(1)		Value		Yield(1)		Value		Yield(1)		Value		Yield(1)
CMBS bonds	$	523.6		12.9%	$	496.4		14.5%	$	523.6		12.9%	$	496.4		14.5%	$	555.5		14.2%
CDO bonds and preferred shares		164.8		16.9%		53.0		17.2%		164.8		16.9%		53.0		17.2%		52.8		17.2%
Commercial mortgage loans		85.5		8.7%		59.7		8.0%		85.5		8.7%		59.7		8.0%		63.7		7.5%
Residual interest		—				69.0		9.4%		—				69.0		9.4%		69.0		9.4%
Real estate owned		13.5				2.9				13.5				2.9				4.0
Equity interests		5.0				—				5.0				—				—
Total portfolio	$	792.4			$	681.0			$	792.4			$	681.0			$	745.0
Investments funded	$	106.7			$	8.9			$	359.1			$	134.6			$	209.2
Change in accrued or reinvested interest	$	1.2			$	—			$	2.2			$	0.4			$	2.1
Principal repayments	$	15.7			$	0.5			$	20.0			$	11.5			$	13.9
CMBS, CDO, and commercial real estate loan sales	$	5.1			$	87.2			$	281.8			$	213.5			$	213.5

⁽¹⁾ The weighted average yield on the interest-bearing investments is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount, and market discount earned on accruing interest- bearing investments, divided by (b) total interest-bearing investments at value. The weighted average yield is computed as of the balance sheet date. Interest-bearing investments for the commercial real estate finance portfolio include all investments except for real estate owned and equity interests.

     Our commercial real estate investment activity for the nine months ended September 30, 2003 and 2002, and for the year ended December 31, 2002, was as follows:

		Face					Amount
		Amount		Discount			Funded
($ in millions)
For the Nine Months Ended September 30, 2003
CMBS bonds		$	432.1	$	(195.1	)	$	237.0
CDO bonds and preferred shares			118.4		(0.3	)		118.1
Commercial mortgage loans			1.8		—			1.8
Equity interests			2.2		—			2.2
	Total	$	554.5	$	(195.4	)	$	359.1
For the Nine Months Ended September 30, 2002
CMBS bonds		$	181.4	$	(83.8	)	$	97.6
CDO preferred shares			29.0		—			29.0
Commercial mortgage loans			0.1		—			0.1
Real estate owned			7.9		—			7.9
	Total	$	218.4	$	(83.8	)	$	134.6
For the Year Ended December 31, 2002
CMBS bonds		$	302.5	$	(140.2	)	$	162.3
CDO preferred shares			29.0		—			29.0
Commercial mortgage loans			11.7		(1.7	)		10.0
Real estate owned			7.9		—			7.9
	Total	$	351.1	$	(141.9	)	$	209.2

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      At September 30, 2003, we had outstanding funding commitments of $2.7 million and commitments in the form of standby letters of credit and guarantees of $2.7 million to commercial real estate portfolio companies.

      CMBS Bonds. During the nine months ended September 30, 2003, we invested $237.0 million in 14 CMBS bond issuances, including $62.4 million of investments in BB+, BB and BB- rated bonds in six CMBS issuances where the below BB- rated bonds were purchased by other parties, and $97.6 million in three CMBS bond issuances during the nine months ended September 30, 2002. During the year ended December 31, 2002, we invested $162.3 million in five CMBS bond issuances.

      The underlying pools of mortgage loans that are collateral for our investments in new CMBS bond issuances for the nine months ended September 30, 2003 and 2002, and for the year ended December 31, 2002, had respective underwritten loan to value and underwritten debt service coverage ratios as follows:

	For the Nine Months Ended
	September 30,
													For the Year Ended
	2003						2002						December 31, 2002
Loan to Value Ranges	Amount			Percentage			Amount			Percentage			Amount			Percentage
($ in millions)
Less than 60%	$	3,265.2			23	%	$	401.9			16	%	$	909.3			20	%
60-65%		1,091.1			8			178.7			7			287.3			6
65-70%		1,484.1			10			264.1			11			587.9			13
70-75%		3,065.8			21			799.5			32			1,214.5			27
75-80%		5,324.2			37			812.7			33			1,477.5			33
Greater than 80%		75.5			1			12.0			1			47.8			1
Total	$	14,305.9			100	%	$	2,468.9			100	%	$	4,524.3			100	%
Weighted average loan to value		68.5	%					70.4	%					68.5	%

	For the Nine Months Ended
	September 30,
											For the Year Ended
	2003					2002					December 31, 2002
Debt Service Coverage
Ratio(1) Ranges	Amount		Percentage			Amount		Percentage			Amount		Percentage
($ in millions)
Greater than 2.00	$	3,563.6		25	%	$	103.3		4	%	$	366.9		8	%
1.76-2.00		1,439.9		10			84.2		3			229.6		5
1.51-1.75		2,589.5		18			240.3		10			477.4		11
1.26-1.50		5,654.4		40			1,631.8		66			2,739.6		60
Less than 1.25		1,058.5		7			409.3		17			710.8		16
Total	$	14,305.9		100	%	$	2,468.9		100	%	$	4,524.3		100	%
Weighted average debt service coverage ratio		1.75					1.41					1.41

⁽¹⁾ Defined as annual net cash flow before debt service divided by annual debt service payments.

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     From time to time, we may sell lower yielding CMBS bonds rated BB+ through BB-, and to a lesser extent CMBS bonds rated B+ and B, in order to maximize the return on our CMBS bond portfolio. The cost basis of and proceeds from CMBS bonds sold, the related net realized gains from these sales, and the weighted average yield on the CMBS bonds sold for the nine months ended September 30, 2003 and 2002, and for the year ended December 31, 2002, were as follows:

	For the Nine
	Months Ended						For the Year
	September 30,						Ended
							December 31,
	2003			2002			2002
($ in millions)
Cost basis	$	253.5		$	205.9		$	205.9
Sales proceeds	$	284.8		$	225.6		$	225.6
Net realized gains (net of related hedge gains or losses)	$	24.6		$	19.1		$	19.1
Weighted average yield		11.8	%		11.5	%		11.5	%

      The non-investment grade and unrated tranches of the CMBS bonds in which we invest are junior in priority for payment of interest and principal to the more senior tranches of the related CMBS bond issuance. Cash flow from the underlying mortgages generally is allocated first to the senior tranches, with the most senior tranches having a priority right to the cash flow. Then, any remaining cash flow is allocated, generally, among the other tranches in order of their relative seniority. To the extent there are defaults and unrecoverable losses on the underlying mortgages resulting in reduced cash flows, our most subordinate tranche will bear this loss first. At September 30, 2003, the CMBS bonds were subordinate to 87% to 99% of the tranches of bonds issued in these various CMBS transactions. Given that the non-investment grade CMBS bonds in which we invest are junior in priority for payment of interest and principal, we invest in these CMBS bonds at a discount from the face amount of the bonds. The discount increases with the decrease in the seniority of the CMBS bonds. For the nine months ended September 30, 2003 and 2002, and for the year ended December 31, 2002, the average discount for the CMBS bonds in which we invested was 45%, 46% and 46%, respectively.

      At September 30, 2003, and December 31, 2002, the unamortized discount related to the CMBS bond portfolio was $658.2 million and $649.5 million, respectively. At September 30, 2003, we have set aside $282.9 million of this unamortized discount to absorb potential future losses, and therefore, the yield on the CMBS bonds of 12.9% assumes that this amount will not be amortized. At September 30, 2003, the CMBS bond portfolio had a fair value of $523.6 million, which included net unrealized appreciation on the CMBS bonds of $12.1 million.

      The yield on our CMBS bond portfolio at September 30, 2003, and December 31, 2002, was 12.9% and 14.2%, respectively. The yield on the CMBS bond portfolio at any point in time will vary depending on the concentration of lower yielding BB+, BB, and BB- rated CMBS bonds held in the portfolio. The BB+, BB, and BB- rated CMBS bonds totaled $230.0 million and $110.9 million at value and had a yield of 8.0% and 8.8% at September 30, 2003, and December 31, 2002, respectively.

      At September 30, 2003, and December 31, 2002, we held CMBS bonds in 39 and 27 separate CMBS issuances, respectively. The underlying collateral pool, consisting of commercial mortgage

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loans and real estate owned (“REO”) properties, for these CMBS bonds consisted of the following at September 30, 2003, and December 31, 2002:

	2003		2002
($ in million)
Approximate number of loans and REO properties(1)		5,900		4,500
Total outstanding principal balance		$39,475		$24,974
Loans over 30 days delinquent or classified as REO properties (2)		0.9% (3)		1.0% (3)

(1)	Includes approximately 17 and 12 REO properties obtained through the foreclosure of commercial mortgage loans at September 30, 2003, and December 31, 2002, respectively.
(2)	As a percentage of total outstanding principal balance.
(3)	At September 30, 2003, and December 31, 2002, our investments included bonds in the first loss, unrated bond class in 33 and 27 separate CMBS issuances, respectively. For these issuances, loans over 30 days delinquent or classified as REO properties were 1.1% and 1.0% of the total outstanding principal balance at September 30, 2003, and December 31, 2002, respectively.

     Collateralized Debt Obligation Bonds and Preferred Shares. During the nine months ended September 30, 2003 and 2002, and the year ended December 31, 2002, we invested in the BBB rated bonds and preferred shares of one, three, and three collateralized debt obligations, respectively, which are secured by investment grade unsecured debt issued by various real estate investment trusts, or REITs, and investment and non-investment grade CMBS bonds. For all five outstanding CDO issuances, the investment grade REIT collateral consists of debt with an original underwritten balance of $1.2 billion and was issued by 39 REITs. The investment grade CMBS collateral consists of CMBS bonds with a face amount of $496.0 million issued in 41 separate CMBS transactions and the non-investment grade CMBS collateral consists of BB+, BB, BB–, B+, and B rated CMBS bonds with a face amount of $873.7 million issued in 42 separate CMBS transactions. Included in the CMBS collateral for the CDOs are CMBS bonds with a face amount of $793.7 million that are senior in priority of repayment to certain lower rated CMBS bonds held by us, which were issued in 27 separate CMBS transactions.

      During the nine months ended September 30, 2003, we sold $8.6 million of CDO bonds and preferred shares for a net realized loss of $114 thousand, net of the related hedge loss.

      The BBB rated bonds and the preferred shares of the five CDOs in which we have invested are junior in priority for payment of interest and principal to the more senior tranches of debt issued by the CDOs. To the extent there are defaults and unrecoverable losses on the underlying collateral that result in reduced cash flows, the preferred shares will bear this loss first and then the BBB rated bonds would bear any loss after the preferred shares. At September 30, 2003, our BBB bonds in the CDO were subordinate to 61% of the more senior tranches of debt issued in the CDO transaction and the preferred shares in the CDOs were subordinate to 90% to 98% of the more senior tranches of debt issued in the various CDO transactions.

      The yield on our CDO bonds and preferred shares at September 30, 2003, and December 31, 2002, was 16.9% and 17.2%, respectively. The yield on the CDO portfolio at any point in time will vary depending on the amount of lower yielding BBB rated CDO bonds held in the portfolio.

Portfolio Asset Quality

      Portfolio by Grade. We employ a standard grading system for the entire portfolio. Grade 1 is used for those investments from which a capital gain is expected. Grade 2 is used for investments performing in accordance with plan. Grade 3 is used for investments that require closer monitoring; however, no loss of investment return or principal is expected. Grade 4 is used for investments that

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are in workout and for which some loss of current investment return is expected, but no loss of principal is expected. Grade 5 is used for investments that are in workout and for which some loss of principal is expected.

      At September 30, 2003, and December 31, 2002, our portfolio was graded as follows:

	At September 30, 2003					At December 31, 2002
			Percentage					Percentage
	Portfolio		of Total			Portfolio		of Total
Grade	at Value		Portfolio			at Value		Portfolio
($ in millions)
1	$	941.8		36.2	%	$	801.0		32.1	%
2		1,383.8		53.2			1,400.8		56.3
3		165.5		6.4			166.0		6.7
4		16.2		0.6			23.6		1.0
5		93.8		3.6			96.8		3.9
	$	2,601.1		100.0	%	$	2,488.2		100.0	%

      Total Grade 4 and 5 assets as a percentage of the total portfolio at value at September 30, 2003, and December 31, 2002, were 4.2% and 4.9%, respectively. Included in Grade 4 and 5 assets at September 30, 2003, and December 31, 2002, were assets totaling $33.3 million and $24.1 million, respectively, that are secured by commercial real estate. Grade 4 and 5 assets include loans, debt securities, and equity securities. We expect that a number of portfolio companies will be in the Grade 4 or 5 categories from time to time. Part of the business of private finance is working with troubled portfolio companies to improve their businesses and protect our investment. The number of portfolio companies and related investment amount included in Grade 4 and 5 may fluctuate from period to period. We continue to follow our historical practice of working with a troubled portfolio company in order to recover the maximum amount of our investment. We continue to include our CMBS portfolio in Grade 2 assets, as we are uncertain as to whether the unrealized appreciation or depreciation on our CMBS portfolio at September 30, 2003, will necessarily result in a realized gain or loss.

      Loans and Debt Securities on Non-Accrual Status. Loans and debt securities on non-accrual status for which we have doubt about interest collection and are in workout status are classified as Grade 4 or 5 assets. In addition, we may not accrue interest on loans and debt securities to companies that are more than 50% owned by us from time to time depending on such company’s working capital needs. In these situations we may choose to defer current debt service.

      For the total investment portfolio, workout loans and debt securities (which excludes equity securities that are included in the total Grade 4 and 5 assets above) not accruing interest that were classified in Grade 4 and 5 were $51.6 million and $89.1 million at value at September 30, 2003, and December 31, 2002, respectively. Included in this category were secured real estate loans of $7.2 million and $13.0 million, respectively. In addition to Grade 4 and 5 assets that are in workout, loans and debt securities to companies that are more than 50% owned by us that were not accruing interest totaled $49.3 million and $63.6 million at value at September 30, 2003, and December 31, 2002, respectively, and loans and debt securities to companies that are less than 50% owned by us and were not in workout but were not accruing interest totaled $3.4 million and $7.2 million at value at September 30, 2003, and December 31, 2002, respectively. In addition, CMBS bonds with a value of $14.0 million and $28 thousand were not accruing interest at September 30, 2003, and December 31, 2002, respectively.

      Loans and Debt Securities Over 90 Days Delinquent. Loans and debt securities and CMBS bonds greater than 90 days delinquent were $135.1 million and $103.1 million at value at September 30, 2003, and December 31, 2002, respectively, or 5.2% and 4.1% of the total portfolio.

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Included in this category were secured real estate loans and CMBS bonds valued at $43.2 million and $26.0 million, respectively.

      As a provider of long-term privately negotiated investment capital, we may defer payment of principal or interest from time to time. As a result, the amount of the portfolio that is greater than 90 days delinquent or on non-accrual status may vary from quarter to quarter. The nature of our private finance portfolio company relationships frequently provide an opportunity for portfolio companies to amend the terms of payment to us or to restructure their debt and equity capital. During such restructuring, we may not receive or accrue interest or dividend payments. The investment portfolio is priced to provide current returns for shareholders assuming that a portion of the portfolio at any time may not be accruing interest currently. We also price our private finance investments for a total return including interest or dividends plus capital gains from the sale of equity securities. Therefore, the amount of loans or CMBS bonds greater than 90 days delinquent or on non-accrual status is not necessarily an indication of future principal loss or loss of anticipated investment return. Our portfolio grading system is used as a means to assess loss of investment return or investment principal.

Hedging Activities

      We have invested in CMBS bonds, which are purchased at prices that are based in part on comparable Treasury rates. We have entered into transactions with financial institutions to hedge against movement in Treasury rates on certain of the higher rated CMBS bonds and the BBB rated CDO bonds. These transactions, referred to as short sales, involve receiving the proceeds from the short sales of borrowed Treasury securities, with the obligations to replenish the borrowed Treasury securities at a later date based on the then current market price, whatever that price may be. Risks in these contracts arise from movements in the value of the borrowed Treasury securities due to changes in interest rates and from the possible inability of counterparties to meet the terms of their contracts. If the value of the borrowed Treasury securities increases, we will incur losses on these transactions, which are limited only by the increase in value of the borrowed Treasury securities; conversely, the value of the CMBS and CDO bonds would likely increase. If the value of the borrowed Treasury securities decreases, we will incur gains on these transactions which are limited only by the decline in value of the borrowed Treasury securities; conversely, the value of the CMBS and CDO bonds would likely decrease. We do not anticipate nonperformance by any counterparty in connection with these transactions.

      The total obligations to replenish borrowed Treasury securities, including accrued interest payable on the obligations, were $221.9 million and $197.0 million at September 30, 2003, and December 31, 2002, respectively, which included unrealized appreciation on the obligations of $78 thousand and unrealized depreciation on the obligations of $7.1 million, respectively, due to changes in the yield on the borrowed Treasury securities. The net proceeds related to the sales of the borrowed Treasury securities were $220.9 million and $189.3 million at September 30, 2003, and December 31, 2002, respectively. Under the terms of the transactions, we have provided additional cash collateral of $0.8 million and $5.4 million at September 30, 2003, and December 31, 2002, respectively, for the difference between the net proceeds related to the sales of the borrowed Treasury securities and the obligations to replenish the securities on the weekly settlement date, which is included in deposits of proceeds from sales of borrowed Treasury securities in the accompanying financial statements. The amount of the hedge will vary from period to period depending upon the amount of BB+ through B rated CMBS bonds and BBB rated CDO bonds that we own and have hedged on the balance sheet date.

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RESULTS OF OPERATIONS

Comparison of Three Months Ended September 30, 2003 and 2002

      The following table summarizes the Company’s operating results for the three months ended September 30, 2003 and 2002.

			For the Three
			Months Ended
			September 30,
												Percentage
			2003			2002			Change			Change
($ in thousands, except per share amounts)
			(unaudited)
Interest and Related Portfolio Income
	Interest and dividends		$	78,895		$	67,624		$	11,271			17	%
	Premiums from loan dispositions			2,523			392			2,131			*
	Fees and other income			7,452			8,313			(861	)		(10	)%
		Total interest and related portfolio income		88,870			76,329			12,541			16	%
Expenses
	Interest			20,334			17,430			2,904			17	%
	Employee			9,480			8,153			1,327			16	%
	Administrative			5,897			5,052			845			17	%
		Total operating expenses		35,711			30,635			5,076			17	%
Net investment income before income taxes				53,159			45,694			7,465			16	%
Income tax expense (benefit)				(449	)		600			(1,049	)		**
Net investment income				53,608			45,094			8,514			19	%
Net Realized and Unrealized Gains (Losses)
	Net realized gains (losses)			(6,438	)		48,222			(54,660	)		*
	Net change in unrealized appreciation or depreciation			(13,426	)		(47,796	)		34,370			*
		Total net gains (losses)		(19,864	)		426			(20,290	)		*
Net income			$	33,744		$	45,520		$	(11,776	)		(26	)%
Diluted earnings per common share			$	0.28		$	0.44		$	(0.16	)		(36	)%
Weighted average common shares outstanding — diluted				120,906			103,302			17,604			17	%

*	Premiums from loan dispositions, net realized gains (losses) and net change in unrealized appreciation or depreciation can fluctuate significantly from period to period. As a result, quarterly comparisons may not be meaningful.
**	Percentage change is not meaningful.

     Total Interest and Related Portfolio Income. Total interest and related portfolio income includes interest and dividend income, premiums from loan dispositions, and fees and other income.

      The level of interest income is directly related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average yield varies from period to period based on the current stated interest rate earned on interest-bearing investments and the amount of loans and debt securities and CMBS bonds for which interest is not accruing. Our interest-bearing investments in the portfolio increased by 7.9% from September 30, 2002, to September 30, 2003. The interest bearing portfolio at value and the weighted average yield on the interest-bearing investments in the portfolio at September 30, 2003 and 2002, was as follows:

($ in millions)	2003			2002
Interest-bearing portfolio	$	1,946.1		$	1,803.6
Portfolio yield		14.5	%		14.1	%

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      Interest income increased primarily due to portfolio growth and an increase in yield. In addition, we resumed accruing interest or were able to accrue interest that was contingent upon achieving performance milestones for certain portfolio companies during the quarter. Such additional interest income for the three months ended September 30, 2003, was $3.7 million.

      Included in premiums from loan dispositions are prepayment premiums of $2.5 million and $0.4 million for the three months ended September 30, 2003 and 2002, respectively. While the scheduled maturities of private finance and commercial real estate loans range from five to ten years, it is not unusual for our borrowers to refinance or pay off their debts to us ahead of schedule. Because we seek to finance primarily seasoned, performing companies, such companies at times can secure lower cost financing as their balance sheets strengthen, or as more favorable interest rates become available, or a company may enter into a transaction that results in the early repayment of their debt to us. Therefore, we generally structure our loans to require a prepayment premium for the first three to five years of the loan.

      Fees and other income primarily include fees related to financial structuring, diligence, transaction services, management services to portfolio companies, guarantees, and other advisory services. As a business development company, we are required to make significant managerial assistance available to the companies in our investment portfolio. Managerial assistance includes management and consulting services including, but not limited to, corporate finance, information technology, web site development, marketing, human resources, personnel recruiting, board recruiting, corporate governance, and risk management.

      Fees and other income for the quarters ended September 30, 2003 and 2002, primarily included fees of $0.7 million and $2.2 million, respectively, related to structuring and diligence; fees of $2.2 million and $0.4 million, respectively, related to transaction and other services provided to portfolio companies; and fees of $4.3 million and $5.7 million, respectively, related to management services provided to portfolio companies, other advisory services, and guaranty fees. Fees and other income are generally related to specific transactions or services, and therefore may vary substantially from period to period depending on the level and types of services provided. Loan origination fees that represent yield enhancement on a loan are capitalized and amortized into interest income over the life of the loan.

      BLX and Hillman are our most significant portfolio investments and together represented 17.7% of our total assets at September 30, 2003. Total interest and related portfolio income earned from these investments for the three months ended September 30, 2003 and 2002, were $12.5 million and $12.4 million, respectively.

      Operating Expenses. Operating expenses include interest, employee, and administrative expenses. Our single largest expense is interest on our indebtedness. The fluctuations in interest expense during the three months ended September 30, 2003 and 2002, were primarily attributable to changes in the level of our borrowings under various notes payable and debentures and our revolving

54

line of credit. Our borrowing activity and weighted average interest cost, including fees and closing costs, were as follows:

	At and for the
	Three Months
	Ended
	September 30,
	2003		2002
($ in millions)
Total Outstanding Debt	$	954.2	$	990.7
Average Outstanding Debt	$	965.3	$	901.5
Weighted Average Cost		7.5%		7.1%
BDC Asset Coverage*		306%		259%

*  As a BDC, the Company is generally required to maintain a minimum ratio of 200% of total assets to total borrowings.

      In addition to interest on indebtedness, interest expense includes interest on our obligations to replenish borrowed Treasury securities of $1.8 million and $0.9 million for the three months ended September 30, 2003 and 2002, respectively.

      Employee expenses include salaries and employee benefits. The change in employee expenses reflects the effect of wage increases, increased staffing, and the change in mix of employees given their area of responsibility and relevant experience level. Total employees were 117 and 103 at September 30, 2003 and 2002, respectively. We no longer provide loans to our employees to exercise stock options as a result of the Sarbanes-Oxley Act of 2002. This was an important benefit to our employees and as a result, we are considering compensation alternatives and expect to have a new compensation program in place by the beginning of 2004.

      Administrative expenses include the leases for our headquarters in Washington, DC, and our regional offices, travel costs, stock record expenses, directors’ fees, legal and accounting fees, insurance premiums, and various other expenses.

      Income Tax Benefit. The Company’s wholly owned subsidiary, AC Corp, is a corporation subject to federal and state income taxes and records a benefit or expense for income taxes as appropriate. For the three months ended September 30, 2003, we recorded a tax benefit of $0.4 million as a result of AC Corp’s operating loss for the period.

      Realized Gains and Losses. Net realized gains result from the sale of equity securities associated with certain private finance investments, the sale of CMBS bonds, and the realization of unamortized discount resulting from the sale and early repayment of private finance loans and commercial mortgage loans, offset by losses on investments. Net realized gains and losses for the three months ended September 30, 2003 and 2002, were as follows:

	For the
	Three Months
	Ended
	September 30,
($ in millions)	2003			2002
Realized gains	$	3.5		$	77.9
Realized losses		(9.9	)		(29.7	)
Net realized gains (losses)	$	(6.4	)	$	48.2

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      Realized gains and losses for the three months ended September 30, 2003, resulted from various private finance and commercial real estate finance transactions. Realized gains for the three months ended September 30, 2003, primarily resulted from transactions involving five private finance portfolio companies, including Autania AG ($0.9 million), Blue Rhino Corporation ($0.9 million), Kyrus Corporation ($0.6 million), Oriental Trading Company, Inc. ($0.3 million), and Icon International, Inc. ($0.2 million), and one transaction involving a commercial mortgage loan totaling $0.4 million. For the three months ended September 30, 2003 and 2002, we reversed previously recorded unrealized appreciation totaling $2.0 million and $70.1 million, respectively, when gains were realized. When we exit an investment and realize a gain, we make an accounting entry to reverse any unrealized appreciation we had previously recorded to reflect the appreciated value of the investment.

      Realized gains for the three months ended September 30, 2002, included $60.8 million from the sale of Wyoming Technical Institute.

      Realized losses for the three months ended September 30, 2003, primarily resulted from a private finance transaction involving Allied Office Products, Inc. totaling $7.7 million and one transaction involving a commercial mortgage loan totaling $1.5 million. For the three months ended September 30, 2003 and 2002, we reversed previously recorded unrealized depreciation totaling $9.4 million and $29.3 million, respectively, when losses were realized. When we exit an investment and realize a loss, we make an accounting entry to reverse any unrealized depreciation we had previously recorded to reflect the depreciated value of the investment.

      Change in Unrealized Appreciation or Depreciation. We determine the value of each investment in our portfolio on a quarterly basis, and changes in value result in unrealized appreciation or depreciation being recognized. Value, as defined in Section 2(a)(41) of the Investment Company Act of 1940, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the board of directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by the board of directors pursuant to a valuation policy and a consistently applied valuation process. At September 30, 2003, approximately 86% of our total assets represented portfolio investments recorded at fair value. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the board of directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

      There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we are required to specifically value each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value. Changes in fair value are recorded in the statement of operations as net change in unrealized appreciation or depreciation.

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      As a business development company, we invest in illiquid securities including debt and equity securities of companies, non-investment grade CMBS bonds, and CDO bonds and preferred shares. The structure of each private finance debt and equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. Our investments are generally subject to restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition, and market changing events that impact valuation.

      Valuation Methodology — Private Finance. Our process for determining the fair value of a private finance investment begins with determining the enterprise value of the portfolio company. The fair value of our investment is based on the enterprise value at which the portfolio company could be sold in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. The liquidity event whereby we exit a private finance investment is generally the sale, the recapitalization or, in some cases, the initial public offering of the portfolio company.

      There is no one methodology to determine enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values, from which we derive a single estimate of enterprise value. To determine the enterprise value of a portfolio company, we analyze its historical and projected financial results. We generally require portfolio companies to provide annual audited and quarterly unaudited financial statements, as well as annual projections for the upcoming fiscal year. Typically in the private equity business, companies are bought and sold based on multiples of EBITDA, cash flow, net income, revenues or, in limited instances, book value. The private equity industry uses financial measures such as EBITDA or EBITDAM (Earnings Before Interest, Taxes, Depreciation, Amortization and, in some instances, Management fees) in order to assess a portfolio company’s financial performance and to value a portfolio company. EBITDA and EBITDAM are not intended to represent cash flow from operations as defined by accounting principles generally accepted in the United States of America and such information should not be considered as an alternative to net income, cash flow from operations, or any other measure of performance prescribed by accounting principles generally accepted in the United States of America. When using EBITDA to determine enterprise value, we may adjust EBITDA for non-recurring items. Such adjustments are intended to normalize EBITDA to reflect the portfolio company’s earnings power. Adjustments to EBITDA may include compensation to previous owners, acquisition, recapitalization, or restructuring related items or one-time non-recurring income or expense items.

      In determining a multiple to use for valuation purposes, we look to private merger and acquisition statistics, discounted public trading multiples or industry practices. In estimating a reasonable multiple, we consider not only the fact that our portfolio company may be a private company relative to a peer group of public comparables, but we also consider the size and scope of our portfolio company and its specific strengths and weaknesses. In some cases, the best valuation methodology may be a discounted cash flow analysis based on future projections. If a portfolio company is distressed, a liquidation analysis may provide the best indication of enterprise value.

      If there is adequate enterprise value to support the repayment of our debt, the fair value of our loan or debt security normally corresponds to cost unless the borrower’s condition or other factors lead to a determination of fair value at a different amount. The fair value of equity interests in portfolio companies is determined based on various factors, including the enterprise value remaining for equity holders after the repayment of the portfolio company’s debt and other pertinent factors

57

such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, or other liquidation events. The determined equity values are generally discounted when we have a minority position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.

      Valuation Methodology — CMBS Bonds and CDO Bonds and Preferred Shares. CMBS bonds and CDO bonds and preferred shares are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar CMBS bonds and CDO bonds and preferred shares. Our assumption with regard to discount rate is based on the yield of comparable securities. We recognize unrealized appreciation or depreciation on our CMBS bonds and CDO bonds and preferred shares as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool.

      For the portfolio, net change in unrealized appreciation or depreciation for the three months ended September 30, 2003 and 2002, consisted of the following:

	2003(1)			2002(1)
($ in millions)
Net unrealized appreciation or depreciation		$(20.8	)	$	(7.0	)
Reversal of previously recorded unrealized appreciation associated with realized gains		(2.0	)		(70.1	)
Reversal of previously recorded unrealized depreciation associated with realized losses		9.4			29.3
Net change in unrealized appreciation or depreciation		$(13.4	)	$	(47.8	)

⁽¹⁾ The net change in unrealized appreciation or depreciation can fluctuate significantly from period to period. As a result, quarterly comparisons may not be meaningful.

     Our two most significant portfolio investments are in BLX and Hillman. The following is a simplified summary of the methodology that we used to determine the fair value of these investments.

      Business Loan Express, LLC. To determine the value of our investment in BLX at September 30, 2003, we performed four separate valuation analyses to determine its enterprise value: (1) analysis of comparable public company trading multiples, (2) analysis of BLX’s value assuming an initial public offering, (3) analysis of merger and acquisition transactions for financial services companies, and (4) a discounted dividend analysis.

      With respect to the analysis of comparable public company trading multiples and the analysis of BLX’s value assuming an initial public offering, we develop a median trailing and forward price earnings multiple to apply to BLX’s pro-forma net income adjusted for certain capital structure changes that we believe would likely occur should the company be sold. Each quarter we evaluate which public commercial finance companies should be included in the comparable group. Since December 31, 2002, we have consistently used CIT Group, Inc., Financial Federal Corporation, GATX Corporation, PMC Capital, Inc., and HPSC, Inc. in the comparable group. At December 31, 2002, we also included DVI, Inc. and Vestin Group, Inc. in the group; however, these companies were not included in the group at September 30, 2003, because they were no longer deemed comparable due to specific matters related to those companies. At September 30, 2003, we added CapitalSource Inc. to the group as this company went public during the third quarter of 2003.

      At September 30, 2003, the unrealized appreciation on our investment in BLX declined $5.0 million. The overall reduction in value of our investment at September 30, 2003, was primarily

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due to a decrease in the operating results of BLX for the year ended September 30, 2003, partially offset by increasing market values of the comparable group used in the valuation of our investment in BLX. The value of our investment in BLX’s Class B and Class C equity interests is $249.5 million at September 30, 2003. The value of our Class B and Class C equity interests are at an implied trailing price to pro-forma earnings ratio of approximately 11.9 times and on an implied forward projected price to pro-forma earnings ratio of approximately 11.3 times. The fair value of BLX’s Class B and Class C equity interests is at an implied multiple of investor cost basis of approximately 1.6 times.

      The Hillman Companies, Inc. We believe the current enterprise value for Hillman is approximately $430.5 million, or 7.0 times 2003 normalized EBITDAM of $61.5 million. To normalize EBITDAM, we adjust EBITDAM for non-recurring revenues and costs assuming the company were sold. Such items include customary add-backs or deductions to EBITDAM to reflect non-recurring executive payroll, one-time charges, normalized annual results for mid-year operational improvements or acquired operations, and other items. The multiple was determined by obtaining a range of multiples representing the multiple of enterprise value to EBITDA for comparable public companies and the multiple of enterprise value to EBITDA for acquisition transactions involving companies in Hillman’s peer group. From this market comparable analysis, we selected a 7.0 times multiple for our valuation. Using an enterprise value of $430.5 million, the value of our equity investment in Hillman is approximately $142.5 million, or $91.9 million greater than our cost basis of $50.6 million at September 30, 2003. While enterprise value at September 30, 2003, was consistent with the value at June 30, 2003, the value of our equity investment appreciated by $3.7 million during the third quarter due primarily to a reduction in the company’s senior debt since June 30, 2003.

      Per Share Amounts. All per share amounts included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section have been computed using the weighted average common shares used to compute diluted earnings per common share, which were 120.9 million and 103.3 million for the three months ended September 30, 2003 and 2002, respectively.

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RESULTS OF OPERATIONS

Comparison of Nine Months Ended September 30, 2003 and 2002

      The following table summarizes our condensed operating results for the nine months ended September 30, 2003 and 2002.

			For the Nine
			Months Ended
			September 30,
												Percentage
			2003			2002			Change			Change
($ in thousands, except per share amounts)
			(unaudited)
Interest and Related Portfolio Income
	Interest and dividends		$	211,553		$	195,289		$	16,264			8	%
	Premiums from loan dispositions			5,281			2,051			3,230			*
	Fees and other income			22,380			34,573			(12,193	)		(35	)%
		Total interest and related portfolio income		239,214			231,913			7,301			3	%
Expenses
	Interest			57,614			52,414			5,200			10	%
	Employee			26,859			24,462			2,397			10	%
	Administrative			15,395			12,913			2,482			19	%
		Total operating expenses		99,868			89,789			10,079			11	%
Net investment income before income taxes				139,346			142,124			(2,778	)		(2	)%
Income tax expense (benefit)				(1,530	)		600			(2,130	)		**
Net investment income				140,876			141,524			(648	)		(1	)%
Net Realized and Unrealized Gains (Losses)
	Net realized gains (losses)			50,441			57,072			(6,631	)		*
	Net change in unrealized appreciation or depreciation			(77,760	)		(23,661	)		(54,099	)		*
		Total net gains (losses)		(27,319	)		33,411			(60,730	)		*
Net income			$	113,557		$	174,935		$	(61,378	)		(35	)%
Diluted earnings per common share			$	0.98		$	1.70		$	(0.72	)		(42	)%
Weighted average common shares outstanding — diluted				115,228			103,040			12,188			12	%

  *  Premiums from loan dispositions, net realized gains (losses) and net change in unrealized appreciation or depreciation can fluctuate significantly from period to period. As a result, year-to-date comparisons may not be meaningful.

**  Percentage change is not meaningful.

     Total Interest and Related Portfolio Income. Total interest and related portfolio income includes interest and dividend income, premiums from loan dispositions, and fees and other income.

      The level of interest income is directly related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average yield varies from period to period based on the current stated interest rate earned on interest-bearing investments and the amount of loans and debt securities and CMBS bonds for which interest is not accruing. Our interest-bearing investments in the portfolio increased by 7.9% from September 30, 2002, to September 30, 2003. The interest bearing portfolio at value and the weighted

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average yield on the interest-bearing investments in the portfolio at September 30, 2003 and 2002, was as follows:

($ in millions)	2003			2002
Interest-bearing portfolio	$	1,946.1		$	1,803.6
Portfolio yield		14.5	%		14.1	%

      Included in premiums from loan dispositions are prepayment premiums of $5.3 million and $2.0 million for the nine months ended September 30, 2003 and 2002, respectively. While the scheduled maturities of private finance and commercial real estate loans range from five to ten years, it is not unusual for our borrowers to refinance or pay off their debts to us ahead of schedule. Because we seek to finance primarily seasoned, performing companies, such companies at times can secure lower cost financing as their balance sheets strengthen, or as more favorable interest rates become available or a company may enter into a transaction that results in early repayment of their debt to us. Therefore, we generally structure our loans to require a prepayment premium for the first three to five years of the loan.

      Fees and other income primarily include fees related to financial structuring, diligence, transaction services, management services to portfolio companies, guarantees, and other advisory services. As a business development company, we are required to make significant managerial assistance available to the companies in our investment portfolio. Managerial assistance includes management and consulting services including, but not limited to, corporate finance, information technology, web site development, marketing, human resources, personnel recruiting, board recruiting, corporate governance, and risk management.

      Fees and other income for the nine months ended September 30, 2003 and 2002, included fees of $4.1 million and $12.8 million, respectively, related to structuring and diligence, fees of $3.4 million and $4.1 million, respectively, related to transaction and other services provided to portfolio companies, and fees of $14.2 million and $17.4 million, related to management services provided to portfolio companies, other advisory services and guaranty fees. Fees and other income are generally related to specific transactions or services, and therefore may vary substantially from period to period depending on the level and types of services provided. Loan origination fees that represent yield enhancement on a loan are capitalized and amortized into interest income over the life of the loan.

      Fees and other income for the nine months ended September 30, 2002, include investment advisory fees of $1.6 million related to our investment advisory contract to provide services to the Allied Capital Germany Fund, LLC. During the fourth quarter of 2002, we discontinued our German operations.

      BLX and Hillman are our most significant portfolio investments and together represented 17.7% of our total assets at September 30, 2003. Total interest and related portfolio income earned from these investments for the nine months ended September 30, 2003 and 2002, was $40.0 million and $36.9 million, respectively. Total interest and related portfolio income earned from WyoTech for the nine months ended September 30, 2002 was $3.6 million. We sold WyoTech on July 1, 2002, and, as a result, we no longer receive such interest and related portfolio income.

      Operating Expenses. Operating expenses include interest, employee, and administrative expenses. Our single largest expense is interest on our indebtedness. The fluctuations in interest expense during the nine months ended September 30, 2003 and 2002, were primarily attributable to changes in the level of our borrowings under various notes payable and debentures and our revolving

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line of credit. Our borrowing activity and weighted average interest cost, including fees and closing costs, were as follows:

	At and for the
	Nine Months Ended
	September 30,
	2003		2002
($ in millions)
Total Outstanding Debt	$	954.2	$	990.7
Average Outstanding Debt	$	939.9	$	927.3
Weighted Average Cost		7.5%		7.1%
BDC Asset Coverage*		306%		259%

*  As a business development company, we are generally required to maintain a minimum ratio of 200% of total assets to total borrowings.

      In addition to interest on indebtedness, interest expense includes interest on our obligations to replenish borrowed Treasury securities of $4.5 million and $0.9 million for the nine months ended September 30, 2003 and 2002, respectively.

      Employee expenses include salaries and employee benefits. The change in employee expenses reflects the effect of wage increases, increased staffing, and the change in mix of employees given their area of responsibility and relevant experience level. Total employees were 117 and 103 at September 30, 2003 and 2002, respectively. We no longer provide loans to our employees to exercise stock options as a result of the Sarbanes-Oxley Act of 2002. This was an important benefit to our employees and as a result, we are considering compensation alternatives and expect to have a new compensation program in place by the beginning of 2004.

      Administrative expenses include the leases for our headquarters in Washington, DC, and our regional offices, travel costs, stock record expenses, directors’ fees, legal and accounting fees, insurance premiums, and various other expenses. The increase in administrative expenses of $2.5 million as compared to the nine months ended September 30, 2002, includes approximately $0.3 million from directors’ fees, $1.1 million from accounting and consulting fees, and $1.1 million due to increased costs for corporate liability insurance.

      Income Tax Benefit. The Company’s wholly owned subsidiary, AC Corp, is a corporation subject to federal and state income taxes and records a benefit or expense for income taxes as appropriate. For the nine months ended September 30, 2003, we recorded a tax benefit of $1.5 million as a result of AC Corp’s operating loss for the period.

      Realized Gains and Losses. Net realized gains result from the sale of equity securities associated with certain private finance investments, the sale of CMBS bonds, and the realization of unamortized discount resulting from the sale and early repayment of private finance loans and commercial mortgage loans, offset by losses on investments. Net realized gains and losses for the nine months ended September 30, 2003 and 2002, were as follows:

	For the Nine
	Months Ended
	September 30,
	2003			2002
($ in millions)
Realized gains	$	64.7		$	93.4
Realized losses		(14.3	)		(36.3	)
Net realized gains	$	50.4		$	57.1

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      Realized gains and losses for the nine months ended September 30, 2003, resulted from various private finance and commercial real estate finance transactions. Realized gains for the nine months ended September 30, 2003, primarily resulted from transactions involving seven private finance portfolio companies, including Morton Grove Pharmaceuticals, Inc. ($8.5 million), CyberRep ($8.3 million), Woodstream Corporation ($6.6 million), Blue Rhino Corporation ($4.7 million), Kirkland’s Inc. ($3.0 million), GC-Sun Holdings II, LP ($2.5 million), and Interline Brands, Inc. ($1.7 million). In addition, gains were also realized on CMBS bonds ($24.6 million, net of a realized loss of $6.7 million from hedges related to the CMBS bonds sold). For the nine months ended September 30, 2003 and 2002, we reversed previously recorded unrealized appreciation totaling $52.8 million and $77.4 million, respectively, when gains were realized. When we exit an investment and realize a gain, we make an accounting entry to reverse any unrealized appreciation we had previously recorded to reflect the appreciated value of the investment.

      Realized gains for the nine months ended September 30, 2002, included $60.8 million from the sale of Wyoming Technical Institute.

      Realized losses for the nine months ended September 30, 2003, primarily resulted from transactions involving two private finance portfolio companies, including Allied Office Products, Inc. ($7.7 million) and North American Archery, LLC ($2.1 million), and five transactions involving commercial mortgage loans ($4.0 million). For the nine months ended September 30, 2003 and 2002, we reversed previously recorded unrealized depreciation totaling $14.3 million and $34.5 million, respectively, when losses were realized. When we exit an investment and realize a loss, we make an accounting entry to reverse any unrealized depreciation we had previously recorded to reflect the depreciated value of the investment.

      Change in Unrealized Appreciation or Depreciation. For a discussion of our fair value methodology and how it affects the net change in unrealized appreciation or depreciation, see “Change in Unrealized Appreciation or Depreciation” included in the “Comparison of Three Months Ended September 30, 2003 and 2002.”

      For the portfolio, net change in unrealized appreciation or depreciation for the nine months ended September 30, 2003 and 2002, consisted of the following:

	2003(1)			2002(1)
($ in millions)
Net unrealized appreciation or depreciation	$	(39.3	)	$	19.2
Reversal of previously recorded unrealized appreciation associated with realized gains		(52.8	)		(77.4	)
Reversal of previously recorded unrealized depreciation associated with realized losses		14.3			34.5
Net change in unrealized appreciation or depreciation	$	(77.8	)	$	(23.7	)

⁽¹⁾ The net change in unrealized appreciation or depreciation can fluctuate significantly from period to period. As a result, year-to-date comparisons may not be meaningful.

     Net change in unrealized appreciation or depreciation for the nine months ended September 30, 2003, included those changes discussed under the caption “Change in Unrealized Appreciation or Depreciation” included in the “Comparison of Three Months Ended September 30, 2003 and 2002.”

      Per Share Amounts. All per share amounts included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section have been computed using the weighted average common shares used to compute diluted earnings per common share, which were

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115.2 million and 103.0 million for the nine months ended September 30, 2003 and 2002, respectively.

OTHER MATTERS

      Regulated Investment Company Status. We have elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986. As long as we qualify as a regulated investment company, we are not taxed on our investment company taxable income or realized capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to shareholders on a timely basis. Annual tax distributions generally differ from net income for the fiscal year due to temporary and permanent differences in the recognition of income and expenses, returns of capital and net unrealized appreciation or depreciation, which are not included in taxable income.

      In order to maintain our status as a regulated investment company, we must, in general, (1) continue to qualify as a business development company; (2) derive at least 90% of our gross income from dividends, interest, gains from the sale of securities and other specified types of income; (3) meet investment diversification requirements as defined in the Internal Revenue Code; and (4) distribute annually to shareholders at least 90% of our investment company taxable income as defined in the Internal Revenue Code. We intend to take all steps necessary to continue to qualify as a regulated investment company. However, there can be no assurance that we will continue to qualify for such treatment in future years.

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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents

      At September 30, 2003, we had $69.1 million in cash and cash equivalents. We invest otherwise uninvested cash in U.S. government- or agency-issued or guaranteed securities that are backed by the full faith and credit of the United States, or in high quality, short-term repurchase agreements fully collateralized by such securities. Our objective is to manage to a low cash balance and fund new originations with our revolving line of credit, and through the issuance of debt and equity securities.

Debt

      At September 30, 2003, we had outstanding debt as follows:

							Annual
			Facility		Amount		Interest
			Amount		Outstanding		Cost(1)
($ in millions)
Notes payable and debentures:
	Unsecured long-term notes payable		$	854.0	$	854.0		7.2	%
	SBA debentures			101.8		94.5		8.1	%
	OPIC loan			5.7		5.7		6.6	%
		Total notes payable and debentures		961.5		954.2		7.3	%
Revolving line of credit				462.5		—		—	(2)
		Total debt	$	1,424.0	$	954.2		7.5	%(3)

(1)	The weighted average annual interest cost is computed as the (a) annual stated interest rate on the debt plus the annual amortization of commitment fees and other facility fees that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.
(2)	There were no amounts drawn on the revolving line of credit at September 30, 2003. The annual cost of commitment fees and other facility fees on the revolving line of credit is currently $2.4 million.
(3)	The annual interest cost for total debt includes the annual cost of commitment fees and other facility fees on the revolving line of credit regardless of the amount outstanding on the facility as of the balance sheet date.

      Unsecured Long-Term Notes. We have issued long-term debt to institutional lenders, primarily insurance companies. The notes have five-or seven-year maturities, with maturity dates beginning in 2004. The notes require payment of interest only semi-annually, and all principal is due upon maturity. On May 14, 2003, we issued $153 million of five-year and $147 million of seven-year unsecured long-term notes, primarily to insurance companies. The five- and seven-year notes have fixed interest rates of 5.45% and 6.05%, respectively, and have substantially the same terms as our existing unsecured long-term notes. On May 30, 2003, $140 million of our existing unsecured long-term notes matured and we used the proceeds from the new long-term note issuance to repay this amount.

      Small Business Administration Debentures. We, through our small business investment company subsidiary, have debentures payable to the Small Business Administration with contractual maturities of ten years. The notes require payment of interest only semi-annually, and all principal is due upon maturity. Under the small business investment company program, we may borrow up to $113.4 million from the Small Business Administration. At September 30, 2003, we had a commitment from the Small Business Administration to borrow up to an additional $7.3 million above the current amount outstanding. The commitment expires on September 30, 2005.

      Revolving Line of Credit. We have a $462.5 million unsecured revolving line of credit that expires in April 2005, with the right to extend maturity for one additional year at our option under substantially similar terms. The revolving line of credit may be expanded through new or additional

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commitments up to $600 million at our option. As of September 30, 2003, $426.6 million remained unused and available, net of amounts committed for standby letters of credit of $35.9 million issued under the line of credit facility. Net repayments on the revolving line of credit for the nine months ended September 30, 2003, were $204.3 million. The credit facility bears interest at a rate, at our option, equal to (i) the one-month LIBOR plus 1.25%, (ii) the Bank of America, N.A. cost of funds plus 1.50% or (iii) the higher of the Bank of America, N.A. prime rate or the Federal Funds rate plus 0.50%. The line of credit generally requires monthly payments of interest, and all principal is due upon maturity.

      We have various financial and operating covenants required by the revolving line of credit and notes payable and debentures. These covenants require us to maintain certain financial ratios, including debt to equity and interest coverage, and a minimum net worth. Our credit facilities limit our ability to declare dividends if we default under certain provisions. As of September 30, 2003, we were in compliance with these covenants.

      The following table shows our significant contractual obligations as of September 30, 2003.

				Payments Due By Year
														After
(in millions)		Total		2003		2004		2005		2006		2007		2007
Notes payable and debentures:
	Unsecured long-term notes payable	$	854.0	$	—	$	214.0	$	165.0	$	175.0	$	—	$	300.0
	Small Business Administration debentures		94.5		—		7.0		14.0		—		—		73.5
	Overseas Private Investment Corporation loan		5.7		—		—		—		5.7		—		—
Revolving line of credit(1)			—		—		—		—		—		—		—
Operating Leases			19.1		0.7		2.7		2.7		2.6		2.5		7.9
Total contractual obligations		$	973.3	$	0.7	$	223.7	$	181.7	$	183.3	$	2.5	$	381.4

⁽¹⁾ The revolving line of credit expires in April 2005 and may be extended under substantially similar terms for one additional year at our option. We assume that we would exercise our option to extend the revolving line of credit resulting in an assumed maturity of April 2006. At September 30, 2003, there were no amounts drawn under the facility and $426.6 million remained unused and available, net of amounts committed for standby letters of credit of $35.9 million issued under the credit facility.

     The following table shows our contractual commitments that may have the effect of creating, increasing, or accelerating our liabilities as of September 30, 2003.

			Amount of Commitment Expiration Per Year
													After
(in millions)	Total		2003		2004		2005		2006		2007		2007
Guarantees	$	70.3	$	0.2	$	65.6	$	0.5	$	0.2	$	0.2	$	3.6
Standby letters of credit		35.9		—		—		3.4		32.5		—		—
Total commitments	$	106.2	$	0.2	$	65.6	$	3.9	$	32.7	$	0.2	$	3.6

Equity Capital and Dividends

      Because we are a regulated investment company, we distribute our income and require external capital for growth. Because we are a business development company, we are limited in the amount of debt capital we may use to fund our growth, since we are generally required to maintain a minimum ratio of 200% of total assets to total borrowings, or approximately a 1 to 1 debt to equity ratio. At September 30, 2003, our asset coverage for senior indebtedness was 306% and our debt to equity ratio was 0.54 to 1.00.

      During the nine months ended September 30, 2003 and 2002, we raised $298.2 million and $49.9 million, respectively, in new equity capital. We issue equity from time to time when we have

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investment opportunities. In addition, we raised $5.0 million and $4.7 million in new equity capital through the issuance of shares through our dividend reinvestment plan during the nine months ended September 30, 2003 and 2002, respectively. During the nine months ended September 30, 2003, total shareholders’ equity had increased 15% to $1.8 billion.

      Our board of directors reviews the dividend rate quarterly, and may adjust the quarterly dividend throughout the year. For each of the first, second, third and fourth quarters of 2003, the board of directors declared a dividend of $0.57 per common share. The fourth quarter dividend is payable on December 26, 2003, with a record date of December 12, 2003. Dividends are paid based on our taxable income, which includes our taxable interest and fee income as well as taxable net realized capital gains. Our board of directors evaluates whether to retain or distribute capital gains on an annual basis. Our dividend policy allows us to continue to distribute capital gains, but will also allow us to retain gains to support future growth.

      Liquidity and Capital Resources. We plan to maintain a strategy of financing our business and related debt maturities with cash from operations, through borrowings under short- or long-term credit facilities or other debt securities, through asset sales, or through the sale or issuance of new equity capital. Although there can be no assurance that we will secure new investments, we plan to raise new debt and equity capital as appropriate to fund investment growth. We have funded new investments totaling $664.8 million for the nine months ended September 30, 2003, as compared to $506.4 million for the year ended December 31, 2002.

      Dividends to common shareholders for the nine months ended September 30, 2003 and 2002, were $196.2 million and $166.8 million, respectively. Cash flow from operations before new investments has historically been sufficient to finance our operating expenses and pay dividends to shareholders.

      We maintain a matched-funding philosophy that focuses on matching the estimated maturities of our loan and investment portfolio to the estimated maturities of our borrowings. We use our revolving line of credit facility as a means to bridge to long-term financing, which may or may not result in temporary differences in the matching of estimated maturities. We evaluate our interest rate exposure on an ongoing basis. To the extent deemed necessary, we may hedge variable and short-term interest rate exposure through interest rate swaps or other techniques.

      At September 30, 2003, our debt to equity ratio was 0.54 to 1.00 and our weighted average cost of funds was 7.5%. Availability on the revolving line of credit, net of amounts committed for standby letters of credit issued under the line of credit facility, was $426.6 million on September 30, 2003. We believe that we have access to capital sufficient to fund our ongoing investment and operating activities.

CRITICAL ACCOUNTING POLICIES

      The consolidated financial statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management’s most difficult, complex, or subjective judgments. Our critical accounting policies are those applicable to the valuation of investments and certain revenue recognition matters as discussed below.

        Valuation of Portfolio Investments. As a business development company, we invest in illiquid securities including debt and equity securities of companies, non-investment grade CMBS, and the bonds and preferred shares of CDOs. Our investments are generally subject to restrictions on resale and generally have no established trading market. We value substantially all of our investments at fair value as determined in good faith by the board of directors in accordance with our valuation policy.

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We determine fair value to be the amount for which an investment could be exchanged in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. Our valuation policy considers the fact that no ready market exists for substantially all of the securities in which we invest. Our valuation policy is intended to provide a consistent basis for determining the fair value of the portfolio. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investments. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value. The value of investments in publicly traded securities are determined using quoted market prices discounted for restrictions on resale, if any.

        Loans and Debt Securities. For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value, overall financial condition or other factors lead to a determination of fair value at a different amount.

      When we receive nominal cost warrants or free equity securities (“nominal cost equity”), we allocate our cost basis in our investment between debt securities and nominal cost equity at the time of origination. At that time, the original issue discount basis of the nominal cost equity is recorded by increasing the cost basis in the equity and decreasing the cost basis in the related debt securities.

      Interest income is recorded on an accrual basis to the extent that such amounts are expected to be collected. For loans and debt securities with contractual payment-in-kind interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity, we will not accrue payment-in-kind interest if the portfolio company valuation indicates that the payment-in-kind interest is not collectible. Interest on loans and debt securities is not accrued if we have doubt about interest collection. Loans in workout status classified as Grade 4 or 5 assets do not accrue interest. In addition, interest may not accrue on loans or debt securities to portfolio companies that are more than 50% owned by us depending on such company’s working capital needs. Loan origination fees, original issue discount, and market discount are capitalized and then amortized into interest income using the effective interest method. Upon the prepayment of a loan or debt security, any unamortized loan origination fees are recorded as interest income and any unamortized original issue discount or market discount is recorded as a realized gain. Prepayment premiums are recorded on loans and debt securities when received.

      The weighted average yield on loans and debt securities is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount, and market discount earned on accruing loans and debt securities, divided by (b) total loans and debt securities at value. The weighted average yield is computed as of the balance sheet date.

        Equity Securities. Our equity interests in portfolio companies for which there is no liquid public market are valued at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including cash flow from operations of the portfolio company and other pertinent factors, such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, or other liquidation events. The determined values are generally discounted to account for restrictions on resale and minority ownership positions.

      The value of our equity interests in public companies for which market quotations are readily available is based on the closing public market price on the balance sheet date. Securities that carry

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certain restrictions on sale are typically valued at a discount from the public market value of the security.

      Dividend income is recorded on preferred equity securities on an accrual basis to the extent that such amounts are expected to be collected, and on common equity securities on the record date for private companies or on the ex-dividend date for publicly traded companies.

      Commercial Mortgage-Backed Securities (“CMBS”) and Collateralized Debt Obligations (“CDO”). CMBS bonds and CDO bonds and preferred shares are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar CMBS bonds and CDO bonds and preferred shares. We recognize unrealized appreciation or depreciation on our CMBS bonds and CDO bonds and preferred shares as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool.

      We recognize income from the amortization of original issue discount using the effective interest method, using the anticipated yield over the projected life of the investment. Yields are revised when there are changes in actual and estimated prepayment speeds or actual and estimated credit losses. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the CMBS bonds and CDO bonds and preferred shares from the date the estimated yield is changed.

      Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation. Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the year, net of recoveries. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period.

      Fee Income. Fee income includes fees for guarantees and services rendered by us to portfolio companies and other third parties such as diligence, structuring, transaction services, management services, and investment advisory services. Guaranty fees are recognized as income over the related period of the guaranty. Diligence, structuring, and transaction services fees are generally recognized as income when services are rendered or when the related transactions are completed. Management and investment advisory services fees are generally recognized as income as the services are rendered.

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RISK FACTORS

      Investing in Allied Capital involves a number of significant risks relating to our business and investment objective. As a result, there can be no assurance that we will achieve our investment objective.

      Investing in private companies involves a high degree of risk. Our portfolio consists of primarily long-term loans to and investments in private companies. Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative. There is generally no publicly available information about the companies in which we invest, and we rely significantly on the diligence of our employees and agents to obtain information in connection with our investment decisions. In addition, some smaller businesses have narrower product lines and market shares than their competition and may be more vulnerable to customer preferences, market conditions, or economic downturns, which may adversely affect the return on, or the recovery of, our investment in such businesses.

      Our portfolio of investments is illiquid. We generally acquire our investments directly from the issuer in privately negotiated transactions. The majority of the investments in our portfolio are typically subject to restrictions on resale or otherwise have no established trading market. We typically exit our investments when the portfolio company has a liquidity event such as a sale, recapitalization, or initial public offering of the company. The illiquidity of our investments may adversely affect our ability to dispose of debt and equity securities at times when it may be otherwise advantageous for us to liquidate such investments. In addition, if we were forced to immediately liquidate some or all of the investments in the portfolio, the proceeds of such liquidation would be significantly less than the current value of such investments.

      Substantially all of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there is uncertainty regarding the value of our portfolio investments. At September 30, 2003, approximately 86% of our total assets represented portfolio investments recorded at fair value. Pursuant to the requirements of the 1940 Act, we value substantially all of our investments at fair value as determined in good faith by our board of directors on a quarterly basis. Since there is typically no readily available market value for the investments in our portfolio, our board of directors determines in good faith the fair value of these investments pursuant to a valuation policy and a consistently applied valuation process.

      There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses; we are instead required by the 1940 Act to specifically value each individual investment on a quarterly basis and record unrealized depreciation for an investment that we believe has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value. Without a readily available market value and because of the inherent uncertainty of valuation, the fair value of our investments determined in good faith by the board of directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

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      We adjust quarterly the valuation of our portfolio to reflect the board of directors’ determination of the fair value of each investment in our portfolio. Any changes in fair value are recorded in our statement of operations as net change in unrealized appreciation or depreciation.

      Economic recessions or downturns could impair our portfolio companies and harm our operating results. Many of the companies in which we have made or will make investments may be susceptible to economic slowdowns or recessions. An economic slowdown may affect the ability of a company to engage in a liquidity event such as a sale, recapitalization, or initial public offering. Our nonperforming assets are likely to increase and the value of our portfolio is likely to decrease during these periods. These conditions could lead to financial losses in our portfolio and a decrease in our revenues, net income, and assets.

      Our business of making private equity investments and positioning them for liquidity events also may be affected by current and future market conditions. The absence of an active senior lending environment may slow the amount of private equity investment activity generally. As a result, the pace of our investment activity may slow. In addition, significant changes in the capital markets could have an effect on the valuations of private companies and on the potential for liquidity events involving such companies. This could affect the amount and timing of gains realized on our investments.

      Our borrowers may default on their payments, which may have an effect on our financial performance. We make long-term unsecured, subordinated loans and invest in equity securities, which may involve a higher degree of repayment risk. We primarily invest in companies that may have limited financial resources and that may be unable to obtain financing from traditional sources. Numerous factors may affect a borrower’s ability to repay its loan, including the failure to meet its business plan, a downturn in its industry, or negative economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in any related collateral.

      Our private finance investments may not produce current returns or capital gains. Private finance investments are typically structured as debt securities with a relatively high fixed rate of interest and with equity features such as conversion rights, warrants, or options. As a result, private finance investments are generally structured to generate interest income from the time they are made and may also produce a realized gain from an accompanying equity feature. We cannot be sure that our portfolio will generate a current return or capital gains.

      Our financial results could be negatively affected if Business Loan Express fails to perform as expected. Business Loan Express, LLC (BLX) is our largest portfolio investment. Our financial results could be negatively affected if BLX, as a portfolio company, fails to perform as expected or if government funding for, or regulations related to the Small Business Administration 7(a) Guaranteed Loan Program change. At September 30, 2003, the investment totaled $344.9 million at value, or 11.5% of total assets.

      In addition, as controlling equity owner of BLX, we have provided an unconditional guaranty to BLX’s senior credit facility lenders in an amount equal to 50% of BLX’s total obligations on its $169.0 million revolving credit facility. The amount we have guaranteed at September 30, 2003, was $64.9 million. This guaranty can only be called in the event of a default by BLX. At September 30, 2003, we had also provided three standby letters of credit in connection with three term securitization transactions completed by BLX totaling $25.6 million.

      Investments in non-investment grade commercial mortgage-backed securities and collateralized debt obligations may be illiquid, may have a higher risk of default, and may not produce current returns. The commercial mortgage-backed securities and collateralized debt obligation preferred shares in which we invest are not investment grade, which means that nationally recognized statistical

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rating organizations rate them below the top four investment-grade rating categories (i.e., “AAA” through “BBB”), and are sometimes referred to as “junk bonds.” Non-investment grade commercial mortgage-backed securities and collateralized debt obligation preferred shares tend to be less liquid, may have a higher risk of default and may be more difficult to value. Non-investment grade securities usually provide a higher yield than do investment grade securities, but with the higher return comes greater risk of default. Economic recessions or downturns may cause defaults or losses on collateral securing these securities to increase. Non-investment grade securities are considered speculative, and their capacity to pay principal and interest in accordance with the terms of their issue is not ensured.

      We may not borrow money unless we maintain asset coverage for indebtedness of at least 200%, which may affect returns to shareholders. We must maintain asset coverage for total borrowings of at least 200%. Our ability to achieve our investment objective may depend in part on our continued ability to maintain a leveraged capital structure by borrowing from banks or other lenders on favorable terms. There can be no assurance that we will be able to maintain such leverage. If asset coverage declines to less than 200%, we may be required to sell a portion of our investments when it is disadvantageous to do so. As of September 30, 2003, our asset coverage for senior indebtedness was 306%.

      We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us. Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. We borrow from and issue senior debt securities to banks, insurance companies, and other lenders. Lenders of these senior securities have fixed dollar claims on our consolidated assets that are superior to the claims of our common shareholders. If the value of our consolidated assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not leveraged. Conversely, if the value of our consolidated assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our consolidated income in excess of consolidated interest payable on the borrowed funds would cause our net income to increase more than it would without the leverage, while any decrease in our consolidated income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common stock dividend payments. Leverage is generally considered a speculative investment technique.

      At September 30, 2003, we had $954.2 million of outstanding indebtedness, bearing a weighted average annual interest cost of 7.5%. In order for us to cover these annual interest payments on indebtedness, we must achieve annual returns on our assets of at least 2.4%.

      Changes in interest rates may affect our cost of capital and net investment income. Because we borrow money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds would increase, which would reduce our net investment income. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. We utilize our revolving line of credit as a means to bridge to long-term financing. Our long-term fixed-rate investments are financed primarily with long-term fixed-rate debt and equity. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. We have analyzed the potential impact of changes in interest rates on interest income net of interest expense. Assuming that the balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical immediate 1% change in interest rates

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would have affected the net income by less than 1% over a one year horizon. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect net increase in assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate.

      We will continue to need additional capital to grow because we must distribute our income. We will continue to need capital to fund growth in our investments. Historically, we have borrowed from financial institutions and have issued equity securities. A reduction in the availability of new capital could limit our ability to grow. We must distribute at least 90% of our taxable ordinary income, which excludes net realized long-term capital gains, to our shareholders to maintain our regulated investment company status. As a result, such earnings will not be available to fund investment originations. We expect to continue to borrow from financial institutions and issue additional debt and equity securities. If we fail to obtain funds from such sources or from other sources to fund our investments, it could limit our ability to grow, which could have a material adverse effect on the value of our common stock. In addition, as a business development company, we are generally required to maintain a ratio of at least 200% of total assets to total borrowings, which may restrict our ability to borrow in certain circumstances.

      Loss of pass-through tax treatment would substantially reduce net assets and income available for dividends. We have operated so as to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986. If we meet source of income, diversification, and distribution requirements, we will qualify for effective pass-through tax treatment. We would cease to qualify for such pass-through tax treatment if we were unable to comply with these requirements. In addition, we may have difficulty meeting the requirement to make distributions to our shareholders because in certain cases we may recognize income before or without receiving cash representing such income. If we fail to qualify as a regulated investment company, we will have to pay corporate-level taxes on all of our income whether or not we distribute it, which would substantially reduce the amount of income available for distribution to our stockholders. Even if we qualify as a regulated investment company, we generally will be subject to a corporate-level income tax on the income we do not distribute. Moreover, if we do not distribute at least 98% of our taxable income, we generally will be subject to a 4% excise tax.

      There is a risk that you may not receive dividends or distributions. We intend to make distributions on a quarterly basis to our stockholders. We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, due to the asset coverage test applicable to us as a business development company, we may be limited in our ability to make distributions. Also, our credit facilities limit our ability to declare dividends if we default under certain provisions. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. In addition, in accordance with accounting principles generally accepted in the United States of America and tax regulations, we include in income certain amounts that we have not yet received in cash, such as contractual payment-in-kind interest which represents contractual interest added to the loan balance that becomes due at the end of the loan term. The increases in loan balances as a result of contractual payment-in-kind arrangements are included in income in advance of receiving cash payment and are separately included in the change in accrued or reinvested interest and dividends in our consolidated statement of cash flows. Since we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our investment company taxable income to maintain our status as a regulated investment company.

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      We operate in a competitive market for investment opportunities. We compete for investments with a large number of private equity funds and mezzanine funds, investment banks and other equity and non-equity based investment funds, and other sources of financing, including traditional financial services companies such as commercial banks. Some of our competitors have greater resources than we do. Increased competition would make it more difficult for us to purchase or originate investments at attractive prices. As a result of this competition, sometimes we may be precluded from making otherwise attractive investments.

      We depend on key personnel. We depend on the continued services of our executive officers and other key management personnel. If we were to lose any of these officers or other management personnel, such a loss could result in inefficiencies in our operations and lost business opportunities.

      Changes in the law or regulations that govern us could have a material impact on us or our operations. We are regulated by the SEC and the Small Business Administration. In addition, changes in the laws or regulations that govern business development companies, regulated investment companies, real estate investment trusts, and small business investment companies may significantly affect our business. Any change in the law or regulations that govern our business could have a material impact on us or our operations. Laws and regulations may be changed from time to time, and the interpretations of the relevant laws and regulations also are subject to change.

      Results may fluctuate and may not be indicative of future performance. Our operating results may fluctuate and, therefore, you should not rely on current or historical period results to be indicative of our performance in future reporting periods. Factors that could cause operating results to fluctuate include, among others, variations in the investment origination volume and fee income earned, variation in timing of prepayments, variations in and the timing of the recognition of net realized and unrealized gains or losses, the degree to which we encounter competition in our markets, and general economic conditions.

      Our common stock price may be volatile. The trading price of our common stock may fluctuate substantially. The price of the common stock may be higher or lower than the price you pay for your shares, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include the following:

•  price and volume fluctuations in the overall stock market from time to time;

•  significant volatility in the market price and trading volume of securities of business development companies or other financial services companies;

•  volatility resulting from trading in derivative securities related to our common stock including puts, calls, long-term equity anticipation securities, or LEAPs, or short trading positions;

•  changes in regulatory policies or tax guidelines with respect to business development companies or regulated investment companies;

•  actual or anticipated changes in our earnings or fluctuations in our operating results or changes in the expectations of securities analysts;

•  general economic conditions and trends;

•  loss of a major funding source; or

•  departures of key personnel.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

      There has been no material change in quantitative or qualitative disclosures about market risk since December 31, 2002.

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Item 4.  Controls and Procedures

      (a) As of the end of the period covered by this quarterly report on Form 10-Q, the Company’s chief executive officer and chief financial officer conducted an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934). Based upon this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them of any material information relating to the Company that is required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934.

      (b) There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2003, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1.     Legal Proceedings

      We are party to certain legal proceedings incidental to the normal course of our business, including enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.

Item 2.  Changes in Securities and Use of Proceeds

      During the three months ended September 30, 2003, we issued a total of 64,519 shares of common stock under our dividend reinvestment plan pursuant to an exemption from the registration requirements of the Securities Act of 1933. The aggregate offering price for the shares of common stock sold under the dividend reinvestment plan was approximately $1.6 million.

Item 3.  Defaults Upon Senior Securities

      Not applicable.

Item 4.  Submission of Matters to a Vote of Security Holders

      None.

Item 5.  Other Information

      Not applicable.

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Item 6.  Exhibits and Reports on Form 8-K

      (a) List of Exhibits

Exhibit
Number		Description
	3.1	Restated Articles of Incorporation. (Incorporated by reference to Exhibit a.1 filed with Allied Capital’s Post-Effective Amendment No. 2 to registration statement on Form N-2 (File No. 333-67336) filed on March 22, 2002).
	3.2	Amended and Restated Bylaws. (Incorporated by reference to Exhibit b. filed with Allied Capital’s Post-Effective Amendment No. 2 to registration statement on Form N-2 (File No. 333-67336) filed on March 22, 2002).
	4.1	Specimen Certificate of Allied Capital’s Common Stock, par value $0.0001 per share. (Incorporated by reference to Exhibit d. filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).
	4.2	Form of debenture between certain subsidiaries of Allied Capital and the U.S. Small Business Administration. (Incorporated by reference to Exhibit 4.2 filed by a predecessor entity to Allied Capital on Form 10-K for the year ended December 31, 1996).
	10.1	Dividend Reinvestment Plan, as amended. (Incorporated by reference to Exhibit e. filed with Allied Capital’s registration statement on Form N-2 (File No. 333-87862) filed on May 8, 2002).
	10.2	Third Amended and Restated Credit Agreement, dated April 18, 2003. (Incorporated by reference to Exhibit 10.2 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10.2(a)*	First Amendment to Credit Agreement, dated as of October 6, 2003.
	10.3	Note Agreement, dated as of April 30, 1998. (Incorporated by reference to Exhibit 10.2 filed with Allied Capital’s Form 10-Q for the period ended June 30, 1998).
	10.4	Loan Agreement between a predecessor entity to Allied Capital and Overseas Private Investment Corporation, dated April 10, 1995. (Incorporated by reference to Exhibit f.7 filed by a predecessor entity to Allied Capital to Pre-Effective Amendment No. 2 to registration statement on Form N-2 (File No. 333-64629) filed on January 24, 1996). Letter, dated December 11, 1997, evidencing assignment of Loan Agreement from the predecessor entity of Allied Capital to Allied Capital. (Incorporated by reference to Exhibit 10.3 to Allied Capital’s Form 10-K for the year ended December 31, 1997).
	10.5	Note Agreement, dated as of May 1, 1999. (Incorporated by reference to Exhibit 10.5 filed with Allied Capital Form 10-Q for the period ended June 30, 1999).
	10.11	Note Agreement, dated as of November 15, 1999. (Incorporated by reference to Exhibit 10.4a of Allied Capital’s Form 10-K for the year ended December 31, 1999).
	10.12	Note Agreement, dated as of October 15, 2000. (Incorporated by reference to Exhibit 10.4b filed with Allied Capital’s Form 10-Q for the period ended September 30, 2000).
	10.13	Note Agreement, dated as of October 15, 2001. (Incorporated by reference to Exhibit f.10 filed with Allied Capital’s Post-Effective Amendment No. 1 to registration statement on Form N-2 (File No. 333-67336) filed on November 14, 2001).
	10.15	Control Investor Guaranty Agreement, dated as of March 28, 2001, between Allied Capital and Fleet National Bank and Business Loan Express, Inc. (Incorporated by reference to Exhibit f.14 filed with Allied Capital’s Post-Effective Amendment No. 3 to registration statement on Form N-2 (File No. 333-43534) filed on May 15, 2001).

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Exhibit
Number		Description
	10.18	Amended and Restated Deferred Compensation Plan, dated May 15, 2001. (Incorporated by reference to Exhibit i.2.b filed with Allied Capital’s Post-Effective Amendment No. 1 to registration statement on Form N-2 (File No. 333-67336) filed on November 14, 2001).
	10.19	Amended Stock Option Plan. (Incorporated by reference to Exhibit A of Allied Capital’s definitive proxy statement for Allied Capital’s 2002 Annual Meeting of Stockholders filed on April 3, 2002).
	10.20(a)	Allied Capital Corporation 401(k) Plan, dated September 1, 1999. (Incorporated by reference to Exhibit 4.4 filed with Allied Capital’s registration statement on Form S-8 (File No. 333-88681) filed on October 8, 1999).
	10.20(b)*	Amendment to Allied Capital Corporation 401(k) Plan, dated August 6, 2003.
	10.21	Employment Agreement, dated June 15, 2000, between Allied Capital and William L. Walton. (Incorporated by reference to Exhibit f.9 filed with Allied Capital’s registration statement on Form N-2 (File No. 333-43534) filed on August 11, 2000).
	10.22	Employment Agreement, dated June 15, 2000, between Allied Capital and Joan M. Sweeney. (Incorporated by reference to Exhibit f.10 filed with Allied Capital’s registration statement on Form N-2 (File No. 333-43534) filed on August 11, 2000).
	10.23	Employment Agreement, dated June 15, 2000, between Allied Capital and John M. Scheurer. (Incorporated by reference to Exhibit i.8 filed with Allied Capital’s Post-Effective Amendment No. 2 to registration statement on Form N-2 (File No. 333-43534) filed on March 21, 2001).
	10.24	Employment Agreement, dated June 15, 2002, between Allied Capital and Thomas H. Westbrook and amended as of March 10, 2003. (Incorporated by reference to Exhibit 10.24 filed with Allied Capital’s Form 10-K for the year ended December 31, 2002).
	10.25	Form of Custody Agreement with Riggs Bank N.A. (Incorporated by reference to Exhibit j.1 filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).
	10.26	Form of Custody Agreement with LaSalle National Bank. (Incorporated by reference to Exhibit j.2 filed with Allied Capital’s registration statement on Form N-2 (File No. 333- 51899) filed on May 6, 1998).
	10.27	Custodian Agreement with LaSalle National Bank Association dated July 9, 2001. (Incorporated by reference to Exhibit j.3 filed with Allied Capital’s registration statement on Form N-2 (File No. 333-67336) filed on August 10, 2001).
	10.28	Code of Ethics. (Incorporated by reference to Exhibit r. filed with Allied Capital’s Pre-Effective Amendment No. 1 to the registration statement on Form N-2 (File No. 333-43534) on September 12, 2000).
	10.30	Agreement and Plan of Merger by and among Allied Capital, Allied Capital Lock Acquisition Corporation, and Sunsource, Inc dated June 18, 2001. (Incorporated by reference to Exhibit k.1 filed with Allied Capital’s registration statement on Form N-2 (File No. 333-67336) filed on August 10, 2001).
	10.31	Note Agreement, dated as of May 14, 2003. (Incorporated by reference to Exhibit 10.31 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10.32	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of April 30, 1998. (Incorporated by reference to Exhibit 10.32 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).

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Exhibit
Number		Description
	10.33	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of May 1, 1999. (Incorporated by reference to Exhibit 10.33 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10.34	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of November 15, 1999. (Incorporated by reference to Exhibit 10.34 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10.35	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of October 15, 2000. (Incorporated by reference to Exhibit 10.35 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10.36	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of October 15, 2001. (Incorporated by reference to Exhibit 10.36 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	15.*	Letter regarding Unaudited Interim Financial Information
	31.1*	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934.
	31.2*	Certification of Chief Financial Officer Pursuant Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934.
	32.1**	Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2**	Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*      Filed herewith.

**     Submitted herewith.

(b) Reports on Form 8-K

      On July 21, 2003, we filed a Form 8-K pursuant to Item 9 reporting the issuance of a press release announcing that we had declared a dividend for the third quarter of 2003.

      On July 29, 2003, we filed a Form 8-K pursuant to Item 12 reporting the issuance of a press release announcing our financial results for the quarter ended June 30, 2003.

      On October 17, 2003, we filed a Form 8-K pursuant to Item 9 reporting the issuance of a press release announcing that we had declared a dividend for the fourth quarter of 2003.

      On October 28, 2003, we filed a Form 8-K pursuant to Item 12 reporting the issuance of a press release announcing our financial results for the quarter ended September 30, 2003.

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SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized.

ALLIED CAPITAL CORPORATION

               (Registrant)

Dated: November 13, 2003	/s/ WILLIAM L. WALTON --------------------------------------------------- William L. Walton Chairman and Chief Executive Officer
	/s/ PENNI F. ROLL --------------------------------------------------- Penni F. Roll Chief Financial Officer

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EXHIBIT INDEX

Exhibit
Number		Description
	10.2(a)*	First Amendment to Credit Agreement, dated as of October 6, 2003.
	10.20(b)*	Amendment to Allied Capital Corporation 401(k) Plan, dated August 6, 2003.
	15.*	Letter regarding Unaudited Interim Financial Information
	31.1*	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934.
	31.2*	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934.
	32.1**	Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2**	Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*      Filed herewith.

**     Submitted herewith. EX-10.2(A) 3 w89787exv10w2xay.htm EX-10.2(A) FIRST AMENDMENT TO CREDIT AGREEMENT

Exhibit 10.2(a)

FIRST AMENDMENT TO CREDIT AGREEMENT

     THIS FIRST AMENDMENT TO CREDIT AGREEMENT (the “Amendment") is entered into as of October 6, 2003, by and among ALLIED CAPITAL CORPORATION, a corporation organized under the laws of the State of Maryland (“Borrower"), the Lenders party hereto, and BANK OF AMERICA, N.A., as Administrative Agent (in such capacity, the “Administrative Agent") for the Lenders under the Credit Agreement (hereinafter defined).

RECITALS

     A.     Borrower, Administrative Agent, and certain other Agents and Lenders are parties to that certain Third Amended and Restated Credit Agreement dated as of April 18, 2003 (the “Credit Agreement"). Unless otherwise indicated herein, all terms used with their initial letter capitalized are used herein withtheir meaning as defined in the Credit Agreement; all Section references are to Sections in the Credit Agreement; and all Paragraph references are to Paragraphs in this Amendment.

     B.     Borrower has requested that the Credit Agreement be amended to increase the LC Commitment from $40,000,000 to $100,000,000.

     C.     Accordingly, Borrower, Administrative Agent, the LC Issuer, and the Lenders have agreed to amend the Credit Agreement as set forth herein.

     NOW, THEREFORE, in consideration of the premises and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Borrower, Administrative Agent, the LC Issuer and the Lenders agree, as follows:

PARAGRAPH 1.   AMENDMENT TO CREDIT AGREEMENT.

     1.1     The definition of “LC Commitment” set forth in Section 1.1 is amended in its entirety to read as follows:

“LC Commitment” means an amount (subject to availability, reduction, or cancellation as herein provided) equal to $100,000,000.

     1.2     The first footnote set forth in Exhibit B-2 is amended in its entirety to read as follows:

1     Not greater than the lesser of (a) an amount which when added to the LC Exposure does not exceed $100,000,000, and (b) the unused and available portion of the LC Subfacility.

PARAGRAPH 2.   AMENDMENT EFFECTIVE DATE. This Amendment shall be binding upon Borrower, Administrative Agent, the LC Issuer, and the Lenders on the last day (the “Amendment Effective Date") upon which (a) counterparts of this Amendment shall have been executed and delivered to Administrative Agent by Borrower, Administrative Agent, the LC Issuer, and the Requisite Lenders, or when Administrative Agent shall have received, telecopied, talexed, or other evidence satisfactory to it that all such parties have executed and are delivering to Administrative Agent counterparts thereof; and (h) Borrower shall have delivered to Administrative Agent copies (certified by the Secretary or Assistant Secretary of Borrower) of all corporate action taken by Borrower to authorize the execution, delivery, and performance of this Amendment.

First Amendment

PARAGRAPH 3.   REPRESENTATIONS AND WARRANTIES. As a material inducement to Administrative Agent, the LC Issuer, and the Lenders to execute and deliver this Amendment, Borrower hereby represents and warrants to Administrative Agent, the LC Issuer, and the Lenders (with the knowledge and intent that such parties are relying upon the same in entering into this Amendment) the following: (a) the representations and warranties in the Credit Agreement and in all other Loan Documents are tree and correct on the date hereof in all material respects, as though made on the date hereof, except to the extent that such representations and warranties expressly relate solely to an earlier date (in which case such representations and warranties shall have been tree and accurate as of such earlier date); (b) no Default or Event of Default exists under the Loan Documents or will exist after giving effect to this Amendment; (c) Borrower has the right and power, and has taken all necessary action to authorize it to borrow under the Credit Agreement, as further amended by this Amendment (the “Amended Facility” or to request the issuance of an LC and to incur reimbursement obligations with respect to the Amended Facility; (d) Borrower has the right and power, and has taken all necessary action to authorize it to execute, deliver, and perform this Amendment in accordance with its terms and to consummate the transaction contemplated hereby; and (e) this Amendment has been duly executed and delivered by the duly authorized officers of Borrower, and is a legal, valid, and binding obligation of Borrower, enforceable against it in accordance with its terms.

PARAGRAPH 4.   MISCELLANEOUS.

     4.1     Effect on Loan Documents. The Credit Agreement and all related Loan Documents shall remain unchanged and in full force and effect, except as provided in this Amendment, and are hereby ratified and confirmed. On and after the Amendment Effective Date, all references to the “Credit Agreement” or the “Agreement” shall be to the Credit Agreement as herein amended. The execution, delivery, and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any rights of the Lenders under the Credit Agreement or any Loan Documents, nor constitute a waiver under the Credit Agreement or any other provision of the Loan Documents.

     4.2     Reference to Miscellaneous Provisions. This Amendment and the other documents delivered pursuant to this Amendment are part of the Loan Documents referred to in the Credit Agreement, and the provisions relating to Loan Documents set forth in Section 12 are incorporated herein by reference the same as if set forth herein verbatim.

     4.3     Costs and Expenses. Borrower agrees to pay promptly the reasonable fees and expenses of counsel to Administrative Agent for services rendered in connection with the preparation, negotiation, reproduction, execution, and delivery of this Amendment.

     4.4     Counterparts. This Amendment may be executed in a number of identical counterparts, each of which shall be deemed an original for all purposes, and all of which constitute, collectively, one agreement; but, in making proof of this Amendment, it shall not be necessary to produce or account for more than one such counterpart. It is not necessary that all parties execute the same counterpart so long as identical counterparts are executed by Borrower, Administrative Agent, the LC Issuer, and the Requisite Lenders.

     4.5     Entirety. THIS WRITTEN AGREEMENT REPRESENTS THE FINAL AGREEMENT AMONG THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENT OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES.

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     4.6     Parties. This Amendment binds and inures to Borrower, Administrative Agent, the LC Issuer, the Lenders, and their respective successors and assigns.

     IN WITNESS WHEREOF, the parties hereto have executed this Amendment in multiple counterparts as of the respective dates indicated on each signature page hereof, but effective as of the Amendment Effective Date.

REMAINDER OF THIS PAGE INTENTIONALLY BLANK.
SIGNATURE PAGES FOLLOW.

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EX-10.2(A)

exv10w2xay

EX-10.20(B)

Exhibit 10.20(b)

Allied Capital 401(k)Plan

ADOPTION AGREEMENT #005
NONSTANDARDIZED 401(k) PROFIT SHARING PLAN

     The undersigned, Allied Capital Corporation (“Employer”), by executing this Adoption Agreement, elects to establish a retirement plan and trust (“Plan”) under the Wachovia Bank, National Association (basic plan document # 01 ). The Employer, subject to the Employer’s Adoption Agreement elections, adopts fully the Prototype Plan and Trust provisions. This Adoption Agreement, the basic plan document and any attached appendices or addenda, constitute the Employer’s entire plan and trust document. All section references within this Adoption Agreement are Adoption Agreement section references unless the Adoption Agreement or the context indicate otherwise. All article references are basic plan document and Adoption Agreement references as applicable. Numbers in parenthesis which follow headings are references to basic plan document sections. The Employer makes the following elections granted under the corresponding provisions of the basic plan document.

ARTICLE I
DEFINITIONS

1. PLAN (1.21). The name of the Plan as adopted by the Employer is Allied Capital 401(k) Plan.

2. TRUSTEE (1.33). The Trustee executing this Adoption Agreement is: (Choose one of (a), (b) or (c))

o  (a) A discretionary Trustee. See Plan Section 10.03[A].

x  (b) A nondiscretionary Trustee. See Plan Section 10.03[B].

o  (c) A Trustee under a separate trust agreement. See Plan Section 10.03[G].

3. EMPLOYEE (1.11). The following Employees are not eligible to participate in the Plan: (Choose (a) or one or more of (b) through (g) as applicable)

o  (a) No exclusions.

o  (b) Collective bargaining Employees.

o  (c) Nonresident aliens.

x  (d) Leased Employees.

x  (e) Reclassified Employees.

x  (f) Classifications: Any part time employee who works less than 35 hours per work week and any Temporary Employee as defined in Allied Capital’s Resource Guide who works less than 1 year.

o  (g) Exclusions by types of contributions. The following classification(s) of Employees are not eligible for the specified contributions:

               Employee classification:     
               Contribution type:     

4. COMPENSATION (1.07). The Employer makes the following election(s) regarding the definition of Compensation for purposes of the contribution allocation formula under Article III: (Choose one of (a), (b) or (c))

o  (a) W-2 wages increased by Elective Contributions.

o  (b) Code §3401(a) federal income tax withholding wages increased by Elective Contributions.

o  (c) 415 compensation.

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[Note: Each of the Compensation definitions in (a), (b) and (c) includes Elective Contributions. See Plan Section 1.07(D). To exclude Elective Contributions, the Employer must elect (g).]

Compensation taken into account. For the Plan Year in which an Employee first becomes a Participant, the Plan Administrator will determine the allocation of Employer contributions (excluding deferral contributions) by taking into account: (Choose one of (d) or (e))

o  (d) Plan Year. The Employee’s Compensation for the entire Plan Year.

x  (e) Compensation while a Participant. The Employee’s Compensation only for the portion of the Plan Year in which the Employee actually is a Participant.

Modifications to Compensation definition. The Employer elects to modify the Compensation definition elected in (a), (b) or (c) as follows. (Choose one or more of (f) through (n) as applicable. If the Employer elects to allocate its nonelective contribution under Plan Section 3.04 using permitted disparity, (i), (j), (k) and (l) do not apply):

o  (f) Fringe benefits. The Plan excludes all reimbursements or other expense allowances, fringe benefits (cash and noncash), moving expenses, deferred compensation and welfare benefits.

o  (g) Elective Contributions. The Plan excludes a Participant’s Elective Contributions. See Plan Section 1.07(D).

o  (h) Exclusion. The Plan excludes Compensation in excess of:      .

o  (i) Bonuses. The Plan excludes bonuses.

o  (j) Overtime. The Plan excludes overtime.

o  (k) Commissions. The Plan excludes commissions.

x  (l) Nonelective contributions. The following modifications apply to the definition of Compensation for nonelective contributions: Excludes cut-off awards, formula awards, retention awards, referral fees, relocation bonuses, deferred compensation distributions and non-cash benefits.

x  (m) Deferral contributions. The following modifications apply to the definition of Compensation for deferral contributions: Excludes cut-off awards, formula awards, retention awards, referral fees, all bonuses, deferred compensation distributions and non-cash benefits.

o  (n) Matching contributions. The following modifications apply to the definition of Compensation for matching contributions:      .

5.     PLAN YEAR/LIMITATION YEAR (1.24). Plan Year and Limitation Year mean the 12-consecutive month period (except for a short Plan Year) ending every: (Choose (a) or (b). Choose (c) if applicable)

x  (a) December 31.

o  (b) Other:       .

o  (c) Short Plan Year: commencing on:     and ending on:     .

6.     EFFECTIVE DATE (1.10). The Employer’s adoption of the Plan is a: (Choose one of (a) or (b))

o  (a) New Plan. The Effective Date of the Plan is:     .

x  (b) Restated Plan. The restated Effective Date is:     September 1, 1999     .

This Plan is an amendment and restatement of an existing retirement plan(s) originally established effective as of:     September 1, 1999     .

7.     HOUR OF SERVICE/ELAPSED TIME METHOD (1.15). The crediting method for Hours of Service is: (Choose one or more of (a) through (d) as applicable)

x  (a) Actual Method. See Plan Section 1.15(B).

© Copyright 2001 Wachovia Bank, National Association

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o  (b) Equivalency Method. The Equivalency Method is:       . [Note: Insert “daily,” “weekly,” “semi-monthly payroll periods” or “monthly.”] See Plan Section 1.15(C).

o  (c) Combination Method. In lieu of the Equivalency Method specified in (b), the Actual Method applies for purposes of:     .

o  (d) Elapsed Time Method. In lieu of crediting Hours of Service, the Elapsed Time Method applies for purposes of crediting Service for: (Choose one or more of (1), (2) or (3) as applicable)

o  (1) Eligibility under Article II.

o  (2) Vesting under Article V.

o  (3) Contribution allocations under Article III.

8.     PREDECESSOR EMPLOYER SERVICE (1.30). In addition to the predecessor service the Plan must credit by reason of Section 1.30 of the Plan, the Plan credits as Service under this Plan service with the following predecessor employer(s): NA.

[Note: If the Plan does not credit any additional predecessor service under this Section 1.30, insert “N/A” in the blank line. The Employer also may elect to credit predecessor service with specified Participating Employers only. See the Participation Agreement.] Service with the designated predecessor employer(s) applies: (Choose one or more of (a) through (d) as applicable)

o  (a) Eligibility. For eligibility under Article II. See Plan Section 1.30 for time of Plan entry.

o (b) Vesting. For vesting under Article V.

o (c) Contribution allocation. For contribution allocations under Article III.

o  (d) Exceptions. Except for the following Service:     .

ARTICLE II
ELIGIBILITY REQUIREMENTS

9.     ELIGIBILITY (2.01).

Eligibility conditions. To become a Participant in the Plan, an Employee must satisfy the following eligibility conditions:

(Choose one or more of (a) through (e) as applicable) [Note: If the Employer does not elect (c), the Employer’s elections under (a) and (b) apply to all types of contributions. The Employer as to deferral contributions may not elect (b)(2) and may not elect more than 12 months in (b)(4) and (b)(5).]

x  (a) Age. Attainment of age     21     (not to exceed age 21).

x  (b) Service. Service requirement. (Choose one of (1) through (5))

o  (1) One Year of Service.

o  (2) Two Years of Service, without an intervening Break in Service. See Plan Section 2.03(A).

x  (3) One Hour of Service (immediate completion of Service requirement). The Employee satisfies the Service requirement on his/her Employment Commencement Date.

o (4)          months (not exceeding 24).

o  (5) An Employee must complete     Hours of Service within the     time period following the Employee’s Employment Commencement Date. If an Employee does not complete the stated Hours of Service during the specified time period (if any), the Employee is subject to the One Year of Service requirement. [Note: The number of hours may not exceed 1,000 and the time period may not exceed 24 months. If the Plan does not require the Employee to satisfy the Hours of Service requirement within a specified time period, insert “N/A” in the second blank line.]

© Copyright 2001 Wachovia Bank, National Association

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o (c)  Alternative 401(k)/401(m) eligibility conditions. In lieu of the elections in (a) and (b), the Employer elects the following eligibility conditions for the following types of contributions (Choose (1) or (2) or both if the Employer wishes to impose less restrictive eligibility conditions for deferral/Employee contributions or for matching contributions)

(1)	o	Deferral/Employee contributions: (Choose one of a. through d. Choose e. if applicable)
a.	o	One Year of Service
b.	o	One Hour of Service (immediate completion of Service requirement)
c.	o	months (not exceeding 12)
d.	o	An Employee must complete              Hours of Service within the              time period following an Employee’s Employment Commencement Date. If an Employee does not complete the stated Hours of Service during the specified time period (if any), the Employee is subject to the One Year of Service requirement. [Note: The number of hours may not exceed 1,000 and the time period may not exceed 12 months. If the Plan does not require the Employee to satisfy the Hours of Service requirement within a specified time period, insert “N/A” in the second blank line.]
e.	o	Age        (not exceeding age 21)
(2)	o	Matching contributions: (Choose one of f. through i. Choose j. if applicable)
f.	o	One Year of Service
g.	o	One Hour of Service (immediate completion of Service requirement)
h.	o	months (not exceeding 24)
i.	o	An Employee must complete              Hours of Service within the              time period following an Employee’s Employment Commencement Date. If an Employee does not complete the state Hours of Service during the specified time period (if any), the Employee is subject to the One Year of Service requirement. [Note: The number of hours may not exceed 1,000 and the time period may not exceed 24 months. If the Plan does not require the Employee to satisfy the Hours of Service requirement within a specified time period, insert “N/A” in the second blank line.]
j.	o	Age        (not exceeding age 21)

o (d)  Service requirements:       .
[Note: any Service requirement the Employer elects in (d) must be available under other Adoption Agreement elections or a combination thereof.]

o (e)  Dual eligibility. The eligibility conditions of this Section 2.01 apply solely to an Employee employed by the Employer after             . If the Employee was employed by the Employer by the specified date, the Employee will become a Participant on the latest of: (i) the Effective Date; (ii) the restated Effective Date; (iii) the Employee’s Employment Commencement Date; or (iv) on the date the Employee attains age        (not exceeding age 21).

Plan Entry Date. “Plan Entry Date” means the Effective Date and: (Choose one of (f) through (j). Choose (k) if applicable) [Note: If the Employer does not elect (k), the elections under (f) through (j) apply to all types of contributions. The Employer must elect at least one Entry Date per Plan Year.]

o (f)  Semi-annual Entry Dates. The first day of the Plan Year and the first day of the seventh month of the Plan Year.

o (g)  The first day of the Plan Year.

x (h)  Employment Commencement Date (immediate eligibility).

o (i)  The first day of each:              (e.g. “Plan Year quarter”).

o (j)  The following Plan Entry Dates:             .

x (k)  Alternative 401(k)/401(m) Plan Entry Date(s). For the alternative 401(k)/401(m) eligibility conditions under (c), Plan Entry Date means: (Choose (1) or (2) or both as applicable)

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Allied Capital 401(k) Plan

(1)	x	Deferral/Employee contributions	(2)	o	Matching contributions
		(Choose one of a. through d.)			(Choose one of e. through h.)
	a.	o  Semi-annual Entry Dates		e.	o Semi-annual Entry Dates
	b.	o  The first day of the Plan Year		f.	o The first day of the Play Year
	c.	o  Employment Commencement Date       (immediate eligibility)		g.	o Employment Commencement Date      (immediate eligibility)
	d.	x  The first day of each:		h.	o The first day of each:
		Quarter

Time of participation. An Employee will become a Participant, unless excluded under Section 1.11, on the Plan Entry Date (if employed on that date): (Choose one of (l), (m) or (n). Choose (o) if applicable): [Note: If the Employer does not elect (o), the election under (l), (m) or (n) applies to all types of contributions.]

x (l)  Immediately following or coincident with

o (m)  Immediately preceding or coincident with

o (n)  Nearest

o (o)  Alternative 401(k)/401(m) election(s): (Choose (1) or (2) or both as applicable)

(1)	o	Deferral contributions	(2)	o	Matching contributions (Choose one of b., c. or d.)
	a.	o  Immediately following or coincident with		b.	o  Immediately following or coincident with
				c.	o  Immediately preceding or coincident with
				d.	o  Nearest

the date the Employee completes the eligibility conditions described in this Section 2.01 [Note: Unless otherwise excluded under Section 1.11, and Employee must become a Participant by the earlier of: (1) the first day of the Plan Year beginning after the date the Employee completes the age and service requirements of Code §410(a); or (2) 6 months after the date the Employee completes those requirements.]

10.  YEAR OF SERVICE - ELIGIBILITY (2.02) (Choose (a) and (b) as applicable): [Note: If the Employer does not elect a Year of Service condition or elects the Elapsed Time Method, the Employer should not complete (a) or (b).]

o (a)  Year of Service. An Employee must complete        Hour(s) of Service during an eligibility computation period to receive credit for a Year of Service under Article II: [Note: The number may not exceed 1,000. If left blank, the requirement is 1,000.]

o (b)  Eligibility computation period. After the initial eligibility computation period described in Plan Section 2.02, the Plan measures the eligibility computation period as: (Choose one of (1) or (2))

o   (1) The Plan Year beginning with the Plan year which includes the first anniversary of the Employee’s Employment
             Commencement Date.

o   (2) The 12-consecutive month period beginning with each anniversary of the Employee’s Employment Commencement Date.

11.  PARTICIPATION - BREAK IN SERVICE (2.03). The one year hold-out rule described in Plan Section 2.03 (B):
(Choose one of (a), (b) or (c))

x (a)  Not applicable. Does not apply to the Plan.

o (b)  Applicable. Applies to the Plan and to all Participants.

o (c)  Limited application. Applies to the Plan, but only to a Participant who has incurred a Separation from Service.

© Copyright 2001 Wachovia Bank, National Association

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12. ELECTION NOT TO PARTICIPATE (2.06). The Plan: (Choose one of (a) or (b))

x (a) Election not permitted. Does not permit an eligible Employee to elect not to participate.

o (b) Irrevocable election. Permits an Employee to elect not to participate if the Employee makes a one-time irrevocable election prior to the Employee’s Plan Entry Date.

ARTICLE III
EMPLOYER CONTRIBUTIONS, DEFERRAL CONTRIBUTIONS AND FORFEITURES

13. AMOUNT AND TYPE (3.01). The amount and type(s) of the Employer’s contribution to the Trust for a Plan Year or other specified period will equal: (Choose one or more of (a) through (f) as applicable)

x (a) Deferral contributions (401(k) arrangement). The dollar or percentage amount by which each Participant has elected to reduce his/her Compensation, as provided in the Participant’s salary reduction agreement and in accordance with Section 3.02.

o (b) Matching contributions (other than safe harbor matching contributions under Section 3.01(d)). The matching contributions made in accordance with Section 3.03.

x (c) Nonelective contributions (profit sharing). The following nonelective contribution (Choose (1) or (2) or both as applicable): [Note: The Employer may designate as a qualified nonelective contribution, all or any portion of its nonelective contribution. See Plan Section 3.04(F).]

o (1) Discretionary. An amount the Employer in its sole discretion may determine.

x (2) Fixed. The following amount: 2% of eligible compensation under the Plan

x (d) 401(k) safe harbor contributions. The following 401(k) safe harbor contributions described in Plan Section 14.02(D): (Choose one of (1), (2) or (3). Choose (4), if applicable)

x (1) Safe harbor nonelective contribution. The safe harbor nonelective contribution equals 3% of a Participant’s Compensation [Note: the amount in the blank must be at least 3%.].

o (2) Basic safe harbor matching contribution. A matching contribution equal to 100% of each Participant’s deferral contributions not exceeding 3% of the Participant’s Compensation, plus 50% of each Participant’s deferral contributions in excess of 3% but not in excess of 5% of the Participant’s Compensation. For this purpose, “Compensation” means Compensation for:         . [Note: The Employer must complete the blank line with the applicable time period for computing the Employer’s basic safe harbor match, such as “each payroll period,” “each month,” “each Plan Year quarter” or “the Plan Year”.]

o (3) Enhanced safe harbor matching contribution. (Choose one of a. or b.).

o a. Uniform percentage. An amount equal to         % of each Participant’s deferral contributions not exceeding         % of the Participant’s Compensation. For this purpose, “Compensation” means Compensation for:         . [See the Note in (d)(2).]

o b. Tiered formula. An amount equal to the specified matching percentage for the corresponding level of each Participant’s deferral contribution percentage. For this purpose, “Compensation” means Compensation for:         . [See the Note in (d)(2).]

Deferral Contribution Percentage Matching Percentage

[Note: The matching percentage may not increase as the deferral contribution percentage increases and the enhanced matching formula otherwise must satisfy the requirements of Code §§401(k)(12)(B)(ii) and (iii). If the Employer wishes to avoid ACP testing on its enhanced safe harbor matching contribution, the Employer also must limit deferral contributions taken into account (the “Deferral Contribution Percentage”) for the matching contribution to 6% of Plan Year Compensation.]

o (4) Another plan. The Employer will satisfy the 401(k) safe harbor contribution in the following plan:        .

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o (e) Davis-Bacon contributions. The amount(s) specified for the applicable Plan Year or other applicable period in the Employer’s Davis-Bacon contract(s). The Employer will make a contribution only to Participants covered by the contract and only with respect to Compensation paid under the contract. If the Participant accrues an allocation of nonelective contributions (including forfeitures) under the Plan in addition to the Davis-Bacon contribution, the Plan Administrator will: (Choose one of (1) or (2))

o (1) Not reduce the Participant’s nonelective contribution allocation by the Davis-Bacon contribution.

o (2) Reduce the Participant’s nonelective contribution allocation by the Davis-Bacon contribution.

o (f) Frozen Plan. This Plan is a frozen Plan effective:         . For any period following the specified date, the Employer will not contribute to the Plan, a Participant may not contribute and an otherwise eligible Employee will not become a Participant in the Plan.

14. DEFERRAL CONTRIBUTIONS (3.02). The following limitations and terms apply to an Employee’s deferral contributions: (If the Employer elects Section 3.01(a), the Employer must elect (a). Choose (b) or (c) as applicable)

x (a) Limitation on amount. An Employee’s deferral contributions are subject to the following limitation(s) in addition to those imposed by the Code: (Choose (1), (2) or (3) as applicable)

x (1) Maximum deferral amount: any whole percentage of eligible compensation under the Plan.

x (2) Minimum deferral amount: 1%.

o (3) No limitations.

For the Plan Year in which an Employee first becomes a Participant, the Plan Administrator will apply any percentage limitation the Employer elects in (1) or (2) to the Employee’s Compensation: (Choose one of (4) or (5) unless the Employer elects (3))

x (4) Only for the portion of the Plan Year in which the Employee actually is a Participant.

o (5) For the entire Plan Year.

o (b) Negative deferral election. The Employer will withhold         % from the Participant’s Compensation unless the Participant elects a lesser percentage (including zero) under his/her salary reduction agreement. See Plan Section 14.02(C). The negative election will apply to: (Choose one of (1) or (2))

o (1) All Participants who have not deferred at least the automatic deferral amount as of:         .

o (2) Each Employee whose Plan Entry Date is on or following the negative election effective date.

o (c) Cash or deferred contributions. For each Plan Year for which the Employer makes a designated cash or deferred contribution under Plan Section 14.02(B), a Participant may elect to receive directly in cash not more than the following portion (or, if less, the 402(g) limitation) of his/her proportionate share of that cash or deferred contribution: (Choose one of (1) or (2))

o (1) All or any portion.                                         o     (2)         %.

Modification/revocation of salary reduction agreement. A Participant prospectively may modify or revoke a salary reduction agreement, or may file a new salary reduction agreement following a prior revocation, at least once per Plan Year or during any election period specified by the basic plan document or required by the Internal Revenue Service. The Plan Administrator also may provide for more frequent elections in the Plan’s salary reduction agreement form.

15. MATCHING CONTRIBUTIONS (INCLUDING ADDITIONAL SAFE HARBOR MATCH UNDER PLAN SECTION 14.02(D)(3)) (3.03). The Employer matching contribution is: (If the Employer elects Section 3.01(b), the Employer must elect one or more of (a), (b) or (c) as applicable. Choose (d) if applicable)

o (a) Fixed formula. An amount equal to         % of each Participant’s deferral contributions.

o (b) Discretionary formula. An amount (or additional amount) equal to a matching percentage the Employer from time to time may deem advisable of the Participant’s deferral contributions. The Employer, in its sole discretion, may designate as a qualified matching contribution, all or any portion of its discretionary matching contribution. The portion

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of the Employer’s discretionary matching contribution for a Plan Year not designated as a qualified matching contribution is a regular matching contribution.

o (c) Multiple level formula. An amount equal to the following percentages for each level of the Participant’s deferral contributions. [Note: The matching percentage only will apply to deferral contributions in excess of the previous level and not in excess of the stated deferral contribution percentage.]

Deferral Contributions Matching Percentage

o (d) Related Employers. If two or more Related Employers contribute to this Plan, the Plan Administrator will allocate matching contributions and matching contribution forfeitures only to the Participants directly employed by the contributing Employer. The matching contribution formula for the other Related Employer(s) is:       . [Note: If the Employer does not elect (d), the Plan Administrator will allocate all matching contributions and matching forfeitures without regard to which contributing Related Employer directly employs the Participant.]

Time period for matching contributions. The Employer will determine its matching contribution based on deferral contributions made during each: (Choose one of (e) through (h))

o (e) Plan Year.

o (f) Plan Year quarter.

o (g) Payroll period.

o (h) Alternative time period:       . [Note: Any alternative time period the Employer elects in (h) must be the same for all Participants and may not exceed the Plan Year.]

Deferral contributions taken into account. In determining a Participant’s deferral contributions taken into account for the above-specified time period under the matching contribution formula, the following limitations apply: (Choose one of (i), (j) or (k))

o (i) All deferral contributions. The Plan Administrator will take into account all deferral contributions.

o (j) Specific limitation. The Plan Administrator will disregard deferral contributions exceeding       % of the Participant’s Compensation. [Note: To avoid the ACP test in a safe harbor 401(k) plan, the Employer must limit deferrals and Employee contributions which are subject to match to 6% of Plan Year Compensation.]

o (k) Discretionary. The Plan Administrator will take into account the deferral contributions as a percentage of the Participant’s Compensation as the Employer determines.

Other matching contribution requirements. The matching contribution formula is subject to the following additional requirements: (Choose (l) or (m) or both if applicable)

o (l) Matching contribution limits. A Participant’s matching contributions may not exceed: (Choose one of (1) or (2))

o (1)       . [Note: The Employer may elect (1) to place an overall dollar or percentage limit on matching contributions.]

o (2) 4% of a Participant’s Compensation for the Plan Year under the discretionary matching contribution formula. [Note: The Employer must elect (2) if it elects a discretionary matching formula with the safe harbor 401(k) contribution formula and wishes to avoid the ACP test.]

o (m) Qualified matching contributions. The Plan Administrator will allocate as qualified matching contributions, the matching contributions specified in Adoption Agreement Section:       . The Plan Administrator will allocate all other matching contributions as regular matching contributions. [Note: If the Employer elects two matching formulas, the Employer may use (m) to designate one of the formulas as a qualified matching contribution.]

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16. CONTRIBUTION ALLOCATION (3.04).

Employer nonelective contributions (3.04(A)). The Plan Administrator will allocate the Employer’s nonelective contribution under the following contribution allocation formula: (Choose one of (a), (b) or (c). Choose (d) if applicable)

x (a) Nonintegrated (pro rata) allocation formula.

o (b) Permitted disparity. The following permitted disparity formula and definitions apply to the Plan: (Choose one of (1) or (2). Also choose (3))

o (1) Two-tiered allocation formula.

o (2) Four-tiered allocation formula.

o (3) For purposes of Section 3.04(b), “Excess Compensation” means Compensation in excess of: (Choose one of a. or b.)

o a.       % of the taxable wage base in effect on the first day of the Plan Year, rounded to the next highest $      (not exceeding the taxable wage base).

o b. The following integration level:       .
[Note: The integration level cannot exceed the taxable wage base in effect for the Plan Year for which this Adoption Agreement first is effective.]

o (c) Uniform points allocation formula. Under the uniform points allocation formula, a Participant receives: (Choose (1) or both (1) and (2) as applicable)

o (1)       point(s) for each Year of Service. Year of Service means:       .

o (2) One point for each $      [not to exceed $200] increment of Plan Year Compensation.

o (d) Incorporation of contribution formula. The Plan Administrator will allocate the Employer’s nonelective contribution under
Section(s) 3.01(c)(2), (d)(1) or (e) in accordance with the contribution formula adopted by the Employer under that Section.

Qualified nonelective contributions. (3.04(F)). The Plan Administrator will allocate the Employer’s qualified nonelective contributions to: (Choose one of (e) or (f))

o (e) Nonhighly compensated Employees only.

x (f) All Participants.

Related Employers. (Choose (g) if applicable)

o (g) Allocate only to directly employed Participants. If two or more Related Employers adopt this Plan, the Plan Administrator will allocate all nonelective contributions and forfeitures attributable to nonelective contributions only to the Participants directly employed by the contributing Employer. If a Participant receives Compensation from more than one contributing Employer, the Plan Administrator will determine the allocations under this Section 3.04 by prorating the Participant’s Compensation between or among the participating Related Employers. [Note: If the Employer does not elect 3.04(g), the Plan Administrator will allocate all nonelective contributions and forfeitures without regard to which contributing Related Employer directly employs the Participant. The Employer may not elect 3.04(g) under a safe harbor 401(k) Plan.]

17. FORFEITURE ALLOCATION (3.05). The Plan Administrator will allocate a Participant forfeiture: (Choose one or more of (a), (b) or (c) as applicable) [Note: Even if the Employer elects immediate vesting, the Employer should complete Section 3.05. See Plan Section 9.11.]

o (a) Matching contribution forfeitures. To the extent attributable to matching contributions: (Choose one of (1) through (4))

o (1) As a discretionary matching contribution.

o (2) To reduce matching contributions.

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o (3) As a discretionary nonelective contribution.

o (4) To reduce nonelective contributions.

x (b) Nonelective contribution forfeitures. To the extent attributable to Employer nonelective contributions: (Choose one of (1) through (4))

o (1) As a discretionary nonelective contribution.

x (2) To reduce nonelective contributions.

o (3) As a discretionary matching contribution.

o (4) To reduce matching contributions.

o (c) Reduce administrative expenses. First to reduce the Plan’s ordinary and necessary administrative expenses for the Plan Year and then allocate any remaining forfeitures in the manner described in Sections 3.05(a) or (b) as applicable.

Timing of forfeiture allocation. The Plan Administrator will allocate forfeitures under Section 3.05 in the Plan Year: (Choose one of (d) or (e))

o (d) In which the forfeiture occurs.

x (e) Immediately following the Plan Year in which the forfeiture occurs.

18. ALLOCATION CONDITIONS (3.06).

Allocation conditions. The Plan does not apply any allocation conditions to deferral contributions, 401(k) safe harbor contributions (under Section 3.01(d)) or to Davis-Bacon contributions (except as the Davis-Bacon contract provides). To receive an allocation of matching contributions, nonelective contributions, qualified nonelective contributions or Participant forfeitures, a Participant must satisfy the following allocation condition(s): (Choose one or more of (a) through (i) as applicable)

x (a) Hours of Service condition. The Participant must complete at least the specified number of Hours of Service (not exceeding 1,000) during the Plan Year:      1000      .

x (b) Employment condition. The Participant must be employed by the Employer on the last day of the      Plan Year      (designate time period).

o (c) No allocation conditions.

o (d) Elapsed Time Method. The Participant must complete at least the specified number (not exceeding 182) of consecutive calendar days of employment with the Employer during the Plan Year:       .

o (e) Termination of Service/501 Hours of Service coverage rule. The Participant either must be employed by the Employer on the last day of the Plan Year or must complete at least 501 Hours of Service during the Plan Year. If the Plan uses the Elapsed Time Method of crediting Service, the Participant must complete at least 91 consecutive calendar days of employment with the Employer during the Plan Year.

o (f) Special allocation conditions for matching contributions. The Participant must complete at least       Hours of Service during the       (designate time period) for the matching contributions made for that time period.

o (g) Death, Disability or Normal Retirement Age. Any condition specified in Section 3.06       applies if the Participant incurs a Separation from Service during the Plan Year on account of:       (e.g., death, Disability or Normal Retirement Age).

o (h) Suspension of allocation conditions for coverage. The suspension of allocation conditions of Plan Section 3.06(E) applies to the Plan.

o (i) Limited allocation conditions. The Plan does not impose an allocation condition for the following types of contributions:       . [Note: Any election to limit the Plan’s allocation conditions to certain contributions must be the same for all Participants, be definitely determinable and not discriminate in favor of Highly Compensated Employees.]

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ARTICLE IV
PARTICIPANT CONTRIBUTIONS

19. EMPLOYEE (AFTER TAX) CONTRIBUTIONS (4.02). The following elections apply to Employee contributions:
(Choose one of (a) or (b). Choose (c) if applicable)

x (a) Not permitted. The Plan does not permit Employee contributions.

o (b) Permitted. The Plan permits Employee contributions subject to the following limitations:       . [Note: Any designated limitation(s) must be the same for all Participants, be definitely determinable and not discriminate in favor of Highly Compensated Employees.]

o (c) Matching contribution. For each Plan Year, the Employer’s matching contribution made with respect to Employee contributions is:       .

ARTICLE V
VESTING REQUIREMENTS

20. NORMAL/EARLY RETIREMENT AGE (5.01). A Participant attains Normal Retirement Age (or Early Retirement Age, if applicable) under the Plan on the following date: (Choose one of (a) or (b). Choose (c) if applicable)

x (a) Specific age. The date the Participant attains age      59 1/2      . [Note: The age may not exceed age 65.]

o (b) Age/participation. The later of the date the Participant attains       years of age or the       anniversary of the first day of the Plan Year in which the Participant commenced participation in the Plan. [Note: The age may not exceed age 65 and the anniversary may not exceed the 5th.]

o (c) Early Retirement Age. Early Retirement Age is the later of: (i) the date a Participant attains age       or (ii) the date a Participant reaches his/her       anniversary of the first day of the Plan Year in which the Participant commenced participation in the Plan.

21. PARTICIPANT’S DEATH OR DISABILITY (5.02). The 100% vesting rule under Plan Section 5.02 does not apply to:
(Choose (a) or (b) or both as applicable)

o (a) Death.

o (b) Disability.

22. VESTING SCHEDULE (5.03). A Participant has a 100% Vested interest at all times in his/her deferral contributions, qualified nonelective contributions, qualified matching contributions, 401(k) safe harbor contributions and Davis-Bacon contributions (unless otherwise indicated in (f)). The following vesting schedule applies to Employer regular matching contributions and to Employer nonelective contributions: (Choose (a) or choose one or more of (b) through (f) as applicable)

x (a) Immediate vesting. 100% Vested at all times. [Note: The Employer must elect (a) if the Service condition under Section 2.01 exceeds One Year of Service or more than twelve months.]

o (b) Top-heavy vesting schedules. [Note: The Employer must choose one of (b)(1), (2) or (3) if it does not elect (a).]

o (1) 6-year graded as specified in the Plan.

o (2) 3-year cliff as specified in the Plan.

o (3) Modified top-heavy schedule

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Years of	Vested
Service	Percentage
Less than 1			%
1			%
2			%
3			%
4			%
5			%
6 or more		100	%

o (c) Non-top-heavy vesting schedules. [Note: The Employer may elect one of (c)(1), (2) or (3) in addition to (b).]

o (1) 7-year graded as specified in the Plan.

o (2) 5-year cliff as specified in the Plan.

o (3) Modified non-top-heavy schedule

Years of	Vested
Service	Percentage
Less than 1			%
1			%
2			%
3			%
4			%
5			%
6			%
7 or more		100	%

If the Employer does not elect (c), the vesting schedule elected in (b) applies to all Plan Years. [Note: The modified top-heavy schedule of (b)(3) must satisfy Code §416. If the Employer elects (c)(3), the modified non-top-heavy schedule must satisfy Code §411(a)(2).]

o (d) Separate vesting election for regular matching contributions. In lieu of the election under (a), (b) or (c), the following vesting schedule applies to a Participant’s regular matching contributions: (Choose one of (1) or (2))

o (1) 100% Vested at all times.

o (2) Regular matching vesting schedule:       .
[Note: The vesting schedule completed under (d)(2) must comply with Code §411(a)(4).]

o (e) Application of top-heavy schedule. The non-top-heavy schedule elected under (c) applies in all Plan Years in which the Plan is not a top-heavy plan. [Note: If the Employer does not elect (e), the top-heavy vesting schedule will apply for the first Plan Year in which the Plan is top-heavy and then in all subsequent Plan Years.]

o (f) Special vesting provisions:       . [Note: Any special vesting provision must satisfy Code §411(a). Any special vesting provision must be definitely determinable, not discriminate in favor of Highly Compensated Employees and not violate Code §401(a)(4).]

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23. YEAR OF SERVICE — VESTING (5.06). (Choose (a) and (b)): [Note: If the Employer elects the Elapsed Time Method or elects immediate vesting, the Employer should not complete (a) or (b).]

o (a) Year of Service. An Employee must complete at least       Hours of Service during a vesting computation period to receive credit for a Year of Service under Article V. [Note: The number may not exceed 1,000. If left blank, the requirement is 1,000.]

o (b) Vesting computation period. The Plan measures a Year of Service on the basis of the following 12-consecutive month period: (Choose one of (1) or (2))

o (1) Plan Year.

o (2) Employment year (anniversary of Employment Commencement Date).

24. EXCLUDED YEARS OF SERVICE — VESTING (5.08). The Plan excludes the following Years of Service for purposes of vesting: (Choose (a) or choose one or more of (b) through (f) as applicable)

o (a) None. None other than as specified in Plan Section 5.08(a).

o (b) Age 18. Any Year of Service before the Year of Service during which the Participant attained the age of 18.

o (c) Prior to Plan establishment. Any Year of Service during the period the Employer did not maintain this Plan or a predecessor plan.

o (d) Parity Break in Service. Any Year of Service excluded under the rule of parity. See Plan Section 5.10.

o (e) Prior Plan terms. Any Year of Service disregarded under the terms of the Plan as in effect prior to this restated Plan.

o (f) Additional exclusions. Any Year of Service before:       .
[Note: Any exclusion specified under (f) must comply with Code §411(a)(4). Any exclusion must be definitely determinable, not discriminate in favor of Highly Compensated Employees and not violate Code §401(a)(4). If the Employer elects immediate vesting, the Employer should not complete Section 5.08.]

ARTICLE VI
DISTRIBUTION OF ACCOUNT BALANCE

25. TIME OF PAYMENT OF ACCOUNT BALANCE (6.01). The following time of distribution elections apply to the Plan:

Separation from Service/Vested Account Balance not exceeding $5,000. Subject to the limitations of Plan Section 6.01(A)(1), the Trustee will distribute in a lump sum (regardless of the Employer’s election under Section 6.04) a separated Participant’s Vested Account Balance not exceeding $5,000: (Choose one of (a) through (d))

x (a) Immediate. As soon as administratively practicable following the Participant’s Separation from Service.

o (b) Designated Plan Year. As soon as administratively practicable in the       Plan Year beginning after the Participant’s Separation from Service.

o (c) Designated Plan Year quarter. As soon as administratively practicable in the       Plan Year quarter beginning after the Participant’s Separation from Service.

o (d) Designated distribution. As soon as administratively practicable in the:       following the Participant’s Separation from Service. [Note: The designated distribution time must be the same for all Participants, be definitely determinable, not discriminate in favor of Highly Compensated Employees and not violate Code §401(a)(4).]

Separation from Service/Vested Account Balance exceeding $5,000. A separated Participant whose Vested Account Balance exceeds $5,000 may elect to commence distribution of his/her Vested Account Balance no earlier than: (Choose one of (e) through (i). Choose (j) if applicable)

x (e) Immediate. As soon as administratively practicable following the Participant’s Separation from Service.

o (f) Designated Plan Year. As soon as administratively practicable in the       Plan Year beginning after the Participant’s Separation from Service.

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o (g) Designated Plan Year quarter. As soon as administratively practicable in the              Plan Year quarter following the Plan Year quarter in which the Participant elects to receive a distribution.

o (h) Normal Retirement Age. As soon as administratively practicable after the close of the Plan Year in which the Participant attains Normal Retirement Age and within the time required under Plan Section 6.01(A)(2).

o (i) Designated distribution. As soon as administratively practicable in the:              following the Participant’s Separation from Service. [Note: The designated distribution time must be the same for all Participants, be definitely determinable, not discriminate in favor of Highly Compensated Employees and not violate Code §401(a)(4).]

o (j) Limitation on Participant’s right to delay distribution. A Participant may not elect to delay commencement of distribution of his/her Vested Account Balance beyond the later of attainment of age 62 or Normal Retirement Age. [Note: If the Employer does not elect (j), the Plan permits a Participant who has Separated from Service to delay distribution until his/her required beginning date. See Plan Section 6.01(A)(2).]

Participant elections prior to Separation from Service. A Participant, prior to Separation from Service may elect any of the following distribution options in accordance with Plan Section 6.01(C). (Choose (k) or choose one or more of (l) through (o) as applicable). [Note: If the Employer elects any in-service distributions option, a Participant may elect to receive one in-service distribution per Plan Year unless the Plan’s in-service distribution form provides for more frequent in-service distributions.]

o (k) None. A Participant does not have any distribution option prior to Separation from Service, except as may be provided under Plan Section 6.01(C).

x (l) Deferral contributions. Distribution of all or any portion (as permitted by the Plan) of a Participant’s Account Balance attributable to deferral contributions if: (Choose one or more of (1), (2) or (3) as applicable)

x (1) Hardship (safe harbor hardship rule). The Participant has incurred a hardship in accordance with Plan Sections 6.09 and 14.11(A).

x (2) Age. The Participant has attained age 59 1/2 (Must be at least age 59 1/2).

o (3) Disability. The Participant has incurred a Disability.

o (m) Qualified nonelective contributions/qualified matching contributions/safe harbor contributions. Distribution of all or any portion of a Participant’s Account Balance attributable to qualified nonelective contributions, to qualified matching contributions, or to 401(k) safe harbor contributions if: (Choose (1) or (2) or both as applicable)

o (1) Age. The Participant has attained age                  (Must be at least age 59 1/2).

o (2) Disability. The Participant has incurred a Disability.

x (n) Nonelective contributions/regular matching contributions. Distribution of all or any portion of a Participant’s Vested Account Balance attributable to nonelective contributions or to regular matching contributions if: (Choose one or more of (1) through (5) as applicable)

x (1) Age/Service conditions. (Choose one or more of a. through d. as applicable):

x a. Age. The Participant has attained age 59 1/2.

o b. Two-year allocations. The Plan Administrator has allocated the contributions to be distributed for a period of not less than                  Plan Years before the distribution date. [Note: The minimum number of years is 2.]

o c. Five years of participation. The Participant has participated in the Plan for at least              Plan Years. [Note: The minimum number of years is 5.]

o d. Vested. The Participant is                 % Vested in his/her Account Balance. See Plan Section 5.03(A). [Note: If an Employer makes more than one election under Section 6.01(n)(1), a Participant must satisfy all conditions before the Participant is eligible for the distribution.]

o (2) Hardship. The Participant has incurred a hardship in accordance with Plan Section 6.09.

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o (3) Hardship (safe harbor hardship rule). The Participant has incurred a hardship in accordance with Plan Sections 6.09 and 14.11(A).

o (4) Disability. The Participant has incurred a Disability.

o (5) Designated condition. The Participant has satisfied the following condition(s):          .
[Note: Any designated condition(s) must be the same for all Participants, be definitely determinable and not discriminate in favor of Highly Compensated Employees.]

x (o) Participant contributions. Distribution of all or any portion of a Participant’s Account Balance attributable to the following Participant contributions described in Plan Section 4.01: (Choose one of (1), (2) or (3))

o (1) All Participant contributions.

o (2) Employee contributions only.

x (3) Rollover contributions only.

Participant loan default/offset. See Section 6.08 of the Plan.

26. DISTRIBUTION METHOD (6.03). A separated Participant whose Vested Account Balance exceeds $5,000 may elect distribution under one of the following method(s) of distribution described in Plan Section 6.03: (Choose one or more of (a) through (d) as applicable)

x (a) Lump sum.

x (b) Installments.

o (c) Installments for required minimum distributions only.

o (d) Annuity distribution option(s):           .
[Note: Any optional method of distribution may not be subject to Employer, Plan Administrator or Trustee discretion.].

27. JOINT AND SURVIVOR ANNUITY REQUIREMENTS (6.04). The joint and survivor annuity distribution requirements of Plan Section 6.04: (Choose one of (a) or (b))

x (a) Profit sharing plan exception. Do not apply to a Participant, unless the Participant is a Participant described in Section 6.04(H) of the Plan.

o (b) Applicable. Apply to all Participants.

     ARTICLE IX
PLAN ADMINISTRATOR — DUTIES WITH RESPECT TO PARTICIPANTS’ ACCOUNTS

28. ALLOCATION OF NET INCOME, GAIN OR LOSS (9.08). For each type of contribution provided under the Plan, the Plan allocates net income, gain or loss using the following method: (Choose one or more of (a) through (e) as applicable)

x (a) Deferral contributions/Employee contributions. (Choose one or more of (1) through (5) as applicable)

x (1) Daily valuation method. Allocate on each business day of the Plan Year during which Plan assets for which there is an established market are valued and the Trustee is conducting business.

o (2) Balance forward method. Allocate using the balance forward method.

o (3) Weighted average method. Allocate using the weighted average method, based on the following weighting period:          . See Plan Section 14.12.

o (4) Balance forward method with adjustment. Allocate pursuant to the balance forward method, except treat as part of the relevant Account at the beginning of the valuation period          % of the contributions made during the following valuation period: .

o (5) Individual account method. Allocate using the individual account method. See Plan Section 9.08.

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o (b) Matching contributions. (Choose one or more of (1) through (5) as applicable)

o (1) Daily valuation method. Allocate on each business day of the Plan Year during which Plan assets for which there is an established market are valued and the Trustee is conducting business.

o (2) Balance forward method. Allocate using the balance forward method.

o (3) Weighted average method. Allocate using the weighted average method, based on the following weighting period:       . See Plan Section 14.12.

o (4) Balance forward method with adjustment. Allocate pursuant to the balance forward method, except treat as part of the relevant Account at the beginning of the valuation period       % of the contributions made during the following valuation period:       .

o (5) Individual account method. Allocate using the individual account method. See Plan Section 9.08.

x (c) Employer nonelective contributions. (Choose one or more of (1) through (5) as applicable)

x (1) Daily valuation method. Allocate on each business day of the Plan Year during which Plan assets for which there is an established market are valued and the Trustee is conducting business.

o (2) Balance forward method. Allocate using the balance forward method.

o (3) Weighted average method. Allocate using the weighted average method, based on the following weighting period:       . See Plan Section 14.12.

o (4) Balance forward method with adjustment. Allocate pursuant to the balance forward method, except treat as part of the relevant Account at the beginning of the valuation period       % of the contributions made during the following valuation period:       .

o (5) Individual account method. Allocate using the individual account method. See Plan Section 9.08.

o (d) Specified method. Allocate pursuant to the following method:       .
[Note: The specified method must be a definite predetermined formula which is not based on Compensation, which satisfies the nondiscrimination requirements of Treas. Reg. §1.401(a)(4) and which is applied uniformly to all Participants.]

o (e) Interest rate factor. In accordance with Plan Section 9.08(E), the Plan includes interest at the following rate on distributions made more than 90 days after the most recent valuation date:       .

ARTICLE X
TRUSTEE AND CUSTODIAN, POWERS AND DUTIES

29. INVESTMENT POWERS (10.03). The following additional investment options or limitations apply under Plan Section 10.03:      NA      . [Note: Enter “N/A” if not applicable.]

30. VALUATION OF TRUST (10.15). In addition to the last day of the Plan Year, the Trustee must value the Trust Fund on the following valuation date(s): (Choose one of (a) through (d))

x (a) Daily valuation dates. Each business day of the Plan Year on which Plan assets for which there is an established market are valued and the Trustee is conducting business.

o (b) Last day of a specified period. The last day of each       of the Plan Year.

o (c) Specified dates:       .

o (d) No additional valuation dates.

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Execution Page

     The Trustee (and Custodian, if applicable), by executing this Adoption Agreement, accepts its position and agrees to all of the obligations, responsibilities and duties imposed upon the Trustee (or Custodian) under the Prototype Plan and Trust. The Employer hereby agrees to the provisions of this Plan and Trust, and in witness of its agreement, the Employer by its duly authorized officers, has executed this Adoption Agreement, and the Trustee (and Custodian, if applicable) has signified its acceptance, on:                                                 .

Name of Employer: Allied Capital Corporation
Employer’s EIN: 52-1081052
Signed:	/s/ Kelly A. Anderson
	Kelly A. Anderson
	[Name/Title]
Name(s) of Trustee:
	Wachovia Bank, National Association
	/s/ Lathan C. Mahaffey 8/6/03
Trust EIN (Optional):
Signed:
	[Name/Title]
Signed:
	[Name/Title]
Signed:
	[Name/Title]
Signed:
	[Name/Title]
Signed:
	[Name/Title]
Signed:
	[Name/Title]
Signed:
	[Name/Title]
Signed:
	[Name/Title]

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Name of Custodian (Optional):
Signed:
	[Name/Title]

31. Plan Number. The 3-digit plan number the Employer assigns to this Plan for ERISA reporting purposes (Form 5500 Series) is: 002.

Use of Adoption Agreement. Failure to complete properly the elections in this Adoption Agreement may result in disqualification of the Employer’s Plan. The Employer only may use this Adoption Agreement in conjunction with the basic plan document referenced by its document number on Adoption Agreement page one.

Execution for Page Substitution Amendment Only. If this paragraph is completed, this Execution Page documents an amendment to Adoption Agreement Section(s) 9 effective September 1, 1999, by substitute Adoption Agreement page number(s) 4 and 5.

Prototype Plan Sponsor. The Prototype Plan Sponsor identified on the first page of the basic plan document will notify all adopting employers of any amendment of this Prototype Plan or of any abandonment or discontinuance by the Prototype Plan Sponsor of its maintenance of this Prototype Plan. For inquiries regarding the adoption of the Prototype Plan, the Prototype Plan Sponsor’s intended meaning of any Plan provisions or the effect of the opinion letter issued to the Prototype Plan Sponsor, please contact the Prototype Plan Sponsor at the following address and telephone number: 1525 West W.T. Harris Blvd., Charlotte, NC 28288, (800) 669-5812.

Reliance on Sponsor Opinion Letter. The Prototype Plan Sponsor has obtained from the IRS an opinion letter specifying the form of this Adoption Agreement and the basic plan document satisfy, as of the date of the opinion letter, Code §401. An adopting Employer may rely on the Prototype Sponsor’s IRS opinion letter only to the extent provided in Announcement 2001-77, 2001-30 I.R.B. The Employer may not rely on the opinion letter in certain other circumstances or with respect to certain qualification requirements, which are specified in the opinion letter and in Announcement 2001-77. In order to have reliance in such circumstances or with respect to such qualification requirements, the Employer must apply for a determination letter to Employee Plans Determination of the Internal Revenue Service.

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PARTICIPATION AGREEMENT

o Check here if not applicable and do not complete this page.

     The undersigned Employer, by executing this Participation Agreement, elects to become a Participating Employer in the Plan identified in Section 1.21 of the accompanying Adoption Agreement, as if the Participating Employer were a signatory to that Adoption Agreement. The Participating Employer accepts, and agrees to be bound by, all of the elections granted under the provisions of the Prototype Plan as made by the Signatory Employer to the Execution Page of the Adoption Agreement, except as otherwise provided in this Participation Agreement.

32. EFFECTIVE DATE (1.10). The Effective Date of the Plan for the Participating Employer is:      May 1, 2001     .

33. NEW PLAN/RESTATEMENT. The Participating Employer’s adoption of this Plan constitutes: (Choose one of (a) or (b))

o (a) The adoption of a new plan by the Participating Employer.

x (b) The adoption of an amendment and restatement of a plan currently maintained by the Participating Employer,
identified as:      A.C. Corporation      ,
and having an original effective date of:      September 1, 1999      .

34. PREDECESSOR EMPLOYER SERVICE (1.30). In addition to the predecessor service credited by reason of Section 1.30 of the Plan, the Plan credits as Service under this Plan, service with this Participating Employer. (Choose one or more of (a) through (d) as applicable): [Note: If the Plan does not credit any additional predecessor service under Section 1.30 for this Participating Employer, do not complete this election.]

x (a) Eligibility. For eligibility under Article II. See Plan Section 1.30 for time of Plan entry.

x (b) Vesting. For vesting under Article V.

x (c) Contribution allocation. For contribution allocations under Article III.

o (d) Exceptions. Except for the following Service:       .

Name of Plan:	Name of Participating Employer:
Allied Capital 401(k) Plan	A.C. Corporation
	Signed:
		[Name/Title]
		[Date]

Participating Employer’s EIN: 52-2316212

Acceptance by the Signatory Employer to the Execution Page of the Adoption Agreement and by the Trustee.

Name of Signatory Employer:		Name(s) of Trustee:
Allied Capital Corporation		Wachovia Bank, National Association
	[Name/Title]		[Name/Title]
Signed:		Signed:
	[Date]		[Date]

[Note: Each Participating Employer must execute a separate Participation Agreement. If the Plan does not have a Participating Employer, the Signatory Employer may delete this page from the Adoption Agreement.]

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APPENDIX A
TESTING ELECTIONS/EFFECTIVE DATE ADDENDUM

35. The following testing elections and special effective dates apply: (Choose one or more of (a) through (n) as applicable)

o (a) Highly Compensated Employee (1.14). For Plan Years beginning after       , the Employer makes the following election(s) regarding the definition of Highly Compensated Employee:

(1) o Top paid group election.

(2) o Calendar year data election (fiscal year plan).

o (b) 401(k) current year testing. The Employer will apply the current year testing method in applying the ADP and ACP tests effective for Plan Years beginning after:       . [Note: For Plan Years beginning on or after the Employer’s execution of its “GUST” restatement, the Employer must use the same testing method within the same Plan Year for both the ADP and ACP tests.]

o (c) Compensation. The Compensation definition under Section 1.07 will apply for Plan Years beginning after:       .

o (d) Election not to participate. The election not to participate under Section 2.06 is effective:       .

x (e) 401(k) safe harbor. The 401(k) safe harbor provisions under Section 3.01(d) are effective:      January 1, 2000      .

o (f) Negative election. The negative election provision under Section 3.02(b) is effective:       .

o (g) Contribution/allocation formula. The specified contribution(s) and allocation method(s) under Sections 3.01 and 3.04 are effective:       .

x (h) Allocation conditions. The allocation conditions of Section 3.06 are effective:      January 1, 2001      .

o (i) Benefit payment elections. The distribution elections of Section(s)       are effective:       .

o (j) Election to continue pre-SBJPA required beginning date. A Participant may not elect to defer commencement of the distribution of his/her Vested Account Balance beyond the April 1 following the calendar year in which the Participant attains age 70 1/2. See Plan Section 6.02(A).

o (k) Elimination of age 70 1/2 in-service distributions. The Plan eliminates a Participant’s (other than a more than 5% owner) right to receive in-service distributions on April 1 of the calendar year following the year in which the Participant attains age 70 1/2 for Plan Years beginning after:       .

o (l) Allocation of earnings. The earnings allocation provisions under Section 9.08 are effective:       .

o (m) Elimination of optional forms of benefit. The Employer elects prospectively to eliminate the following optional forms of benefit: (Choose one or more of (1), (2) and (3) as applicable)

o (1) QJSA and QPSA benefits as described in Plan Sections 6.04, 6.05 and 6.06 effective:       .

o (2) Installment distributions as described in Section 6.03 effective:       .

o (3) Other optional forms of benefit (Any election to eliminate must be consistent with Treas. Reg. §1.411(d)-4):       .

x (n) Special effective date(s):      Employee Deferral Contributions modified to increase the deferral percentage (Section 14 (a) (1)) and Employee Classifications modified to include participation exclusions (Section 3 (f)) effective July 1, 2002      .

     For periods prior to the above-specified special effective date(s), the Plan terms in effect prior to its restatement under this Adoption Agreement will control for purposes of the designated provisions. A special effective date may not result in the delay of a Plan provision beyond the permissible effective date under any applicable law.

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APPENDIX B
GUST Remedial Amendment Period Elections

36. The following GUST restatement elections apply: (Choose one or more of (a) through (j) as applicable)

x (a)  Highly Compensated Employee elections. The Employer makes the following remedial amendment period elections with respect to the Highly Compensated Employee definition:

(1) 1997:	o	Top paid group election	o	Calendar year election.
	o	Calendar year data election.
(2) 1998:	o	Top paid group election	o	Calendar year data election.
(3) 1999:	o	Top paid group election	o	Calendar year data election.
(4) 2000:	o	Top paid group election	o	Calendar year data election.
(5) 2001:	o	Top paid group election	o	Calendar year data election.
(6) 2002:	x	Top paid group election	o	Calendar year data election.

x (b)  401(k) testing methods. The Employer makes the following remedial amendment period elections with respect to the ADP test and the ACP test: [Note: The Employer may use a different testing method for the ADP and ACP tests through the end of the Plan Year in which the Employer executes its GUST restated Plan.]

ADP test					ACP test
(1) 1997:	o	prior year	o	current year	1997:	o	prior year	o	current year
(2) 1998:	o	prior year	o	current year	1998:	o	prior year	o	current year
(3) 1999:	o	prior year	o	current year	1999:	o	prior year	o	current year
(4) 2000:	o	prior year	o	current year	2000:	o	prior year	o	current year
(5) 2001:	o	prior year	o	current year	2001:	o	prior year	o	current year
(6) 2002:	x	prior year	o	current year	2002:	x	prior year	o	current year

o (c)  Delayed application of SBJPA required beginning date. The Employer elects to delay the effective date for the required beginning date provision of Plan Section 6.02 until Plan Years beginning after: ___________________ .

o (d)  Model Amendment for required minimum distributions. The Employer adopts the IRS Model Amendment in Plan Section 6.02(E) effective                         . [Note: The date must not be earlier than January 1, 2001.]

Defined Benefit Limitation

o (e)  Code §415(e) repeal. The repeal of the Code §415(e) limitation is effective for Limitation Years beginning after ___________________ . [Note: If the Employer does not make an election under (e), the repeal is effective for Limitation Years beginning after December 31, 1999.]

Code §415(e) limitation. To the extent necessary to satisfy the limitation under Plan Section 3.17 for Limitation Years beginning prior to the repeal of Code §415(e), the Employer will reduce: (Choose one of (f) or (g))

o (f)  The Participant’s projected annual benefit under the defined benefit plan.

o (g)  The Employer’s contribution or allocation on behalf of the Participant to the defined contribution plan and then, if necessary, the Participant’s projected annual benefit under the defined benefit plan.

Coordination with top-heavy minimum allocation. The Plan Administrator will apply the top-heavy minimum allocation provisions of Article XII with the following modifications: (Choose (h) or choose (i) or (j) or both as applicable)

o (h) No modifications.

o (i)  For Non-Key Employees participating only in this Plan, the top-heavy minimum allocation is the minimum allocation determined by substituting            % (not less than 4%) for “3%,” except: (Choose one of (1) or (2))

o (1)  No exceptions.

o (2)  Plan Years in which the top-heavy ratio exceeds 90%.

o (j) For Non-Key Employees also participating in the defined benefit plan, the top-heavy minimum is: (Choose one of (1) or (2))

o (1)  5% of Compensation irrespective of the contribution rate of any Key Employee: (Choose one of a. or b.)

o a.  No exceptions.

o b.  Substituting “7 1/2%” for “5%” if the top-heavy ratio does not exceed 90%.

o (2)  0%. [Note: The defined benefit plan must satisfy the top-heavy minimum benefit requirement for these Non-Key Employees.]

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Actuarial assumptions for top-heavy calculation. To determine the top-heavy ratio, the Plan Administrator will use the following interest rate and mortality assumptions to value accrued benefits under a defined benefit plan: ___________________ .

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CHECKLIST OF EMPLOYER INFORMATION AND EMPLOYER ADMINISTRATIVE ELECTIONS

Commencing with the      2002     Plan Year

     The Prototype Plan permits the Employer to make certain administrative elections not reflected in the Adoption Agreement. This form lists those administrative elections and provides a means of recording the Employer’s elections. This checklist is not part of the Plan document.

37. Employer Information.

Allied Capital Corporation
[Employer Name]

1919 Pennsylvania Ave, NW
[Address]

Washington, District of Columbia 20006-3434	(202) 331-1112
[City, State and Zip Code]	[Telephone Number]

38. Form of Business.

(a) x Corporation	(b) o S Corporation
(c) o Limited Liability Company	(d) o Sole Proprietorship
(e) o Partnership	(f)  o

39. Section 1.07(F) — Nondiscriminatory definition of Compensation. When testing nondiscrimination under the Plan, the Plan permits the Employer to make elections regarding the definition of Compensation. [Note: This election solely is for purposes of nondiscrimination testing. The election does not affect the Employer’s elections under Section 1.07 which apply for purposes of allocating Employer contributions and Participant forfeitures.]

(a) x The Plan will “gross up” Compensation for Elective Contributions.

(b) o The Plan will exclude Elective Contributions.

40. Section 4.04 — Rollover contributions.

(a) x The Plan accepts rollover contributions.

(b) o The Plan does not accept rollover contributions.

41. Section 8.06 — Participant direction of investment/404(c). The Plan authorizes Participant direction of investment with Trustee consent. If the Trustee permits Participant direction of investment, the Employer and the Trustee should adopt a policy which establishes the applicable conditions and limitations, including whether they intend the Plan to comply with ERISA §404(c).

(a) x The Plan permits Participant direction of investment and is a 404(c) plan.

(b) o The Plan does not permit Participant direction of investment or is a non-404(c) plan.

42. Section 9.04[A] — Participant loans. The Plan authorizes the Plan Administrator to adopt a written loan policy to permit Participant loans.

(a) x TThe Plan permits Participant loans subject to the following conditions:
	(1) x Minimum loan amount: $1000.
	(2) x Maximum number of outstanding loans: 2.
	(3) x Reasons for which a Participant may request a loan:
		a. x Any purpose.
		b. o Hardship events.
		c. o Other:
	(4) x Suspension of loan repayments:
		a. o Not permitted.
		b. x Permitted for non-military leave of absence.
		c. x Permitted for military service leave of absence.
	(5) o The Participant must be a party in interest.
(b) o The Plan does not permit Participant loans.

43. Section 11.01 — Life insurance. The Plan with Employer approval authorizes the Trustee to acquire life insurance.

(a) o The Plan will invest in life insurance contracts

(b) x The Plan will not invest in life insurance contracts

44. Surety bond company: Gulf Insurance Group. Surety bond amount: $25,000,000.00

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EGTRRA — Employer Allied Capital 401(k) Plan

ARTICLE I
PREAMBLE

1.1 Adoption and effective date of amendment. This amendment of the plan is adopted to reflect certain provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”). This amendment is intended as good faith compliance with the requirements of EGTRRA and is to be construed in accordance with EGTRRA and guidance issued thereunder. Except as otherwise provided, this amendment shall be effective as of the first day of the first plan year beginning after December 31, 2001.

1.2 Supersession of inconsistent provisions. This amendment shall supersede the provisions of the plan to the extent those provisions are inconsistent with the provisions of this amendment.

ARTICLE II
ADOPTION AGREEMENT ELECTIONS

The questions in this Article II only need to be completed in order to override the default provisions set forth below. If all of the default provisions will apply, then these questions should be skipped.

Unless the employer elects otherwise in this Article II, the following defaults apply:

1) The vesting schedule for matching contributions will be a 6 year graded schedule (if the plan currently has a graded schedule that does not satisfy EGTRRA) or a 3 year cliff schedule (if the plan currently has a cliff schedule that does not satisfy EGTRRA), and such schedule will apply to all matching contributions (even those made prior to 2002).

2) Rollovers are automatically excluded in determining whether the $5,000 threshold has been exceeded for automatic cash-outs (if the plan is not subject to the qualified joint and survivor annuity rules and provides for automatic cash-outs). This is applied to all participants regardless of when the distributable event occurred.

3) The suspension period after a hardship distribution is made will be 6 months and this will only apply to hardship distributions made after 2001.

4) Catch-up contributions will be allowed.

5) For target benefit plans, the increased compensation limit of $200,000 will be applied retroactively (i.e., to years prior to 2002).

2.1 Vesting Schedule for Matching Contributions

If there are matching contributions subject to a vesting schedule that does not satisfy EGTRRA, then unless otherwise elected below, for participants who complete an hour of service in a plan year beginning after December 31, 2001, the following vesting schedule will apply to all matching contributions subject to a vesting schedule:

If the plan has a graded vesting schedule (i.e., the vesting schedule includes a vested percentage that is more than 0% and less than 100%) the following will apply:

Years of vesting service	Nonforfeitable percentage
2		20	%
3		40	%
4		60	%
5		80	%
6		100	%

If the plan does not have a graded vesting schedule, then matching contributions will be nonforfeitable upon the completion of 3 years of vesting service.

In lieu of the above vesting schedule, the employer elects the following schedule:

a. o 3 year cliff (a participant’s accrued benefit derived from employer matching contributions shall be nonforfeitable upon the participant’s completion of three years of vesting service).

b. o 6 year graded schedule (20% after 2 years of vesting service and an additional 20% for each year thereafter).

c. o Other (must be at least as liberal as a. or the b. above):

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EGTRRA — Employer Allied Capital 401(k) Plan

Years of vesting service	Nonforfeitable percentage
________		_______	%
________		_______	%
________		_______	%
________		_______	%
________		_______	%

The vesting schedule set forth herein shall only apply to participants who complete an hour of service in a plan year beginning after December 31, 2001, and, unless the option below is elected, shall apply to all matching contributions subject to a vesting schedule.

d. o The vesting schedule will only apply to matching contributions made in plan years beginning after December 31, 2001 (the prior schedule will apply to matching contributions made in prior plan years).

2.2 Exclusion of Rollovers in Application of Involuntary Cash-out Provisions (for profit sharing and 401(k) plans only). If the plan is not subject to the qualified joint and survivor annuity rules and includes involuntary cash-out provisions, then unless one of the options below is elected, effective for distributions made after December 31, 2001, rollover contributions will be excluded in determining the value of the participant’s nonforfeitable account balance for purposes of the plan’s involuntary cash-out rules.

a. o Rollover contributions will not be excluded.

b. o Rollover contributions will be excluded only with respect to distributions made after       . (Enter a date no earlier than December 31, 2001.)

c. x Rollover contributions will only be excluded with respect to participants who separated from service after December 31, 2001.        (Enter a date. The date may be earlier than December 31, 2001.)

2.3 Suspension period of hardship distributions. If the plan provides for hardship distributions upon satisfaction of the safe harbor (deemed) standards as set forth in Treas. Reg. Section 1.401(k)-1(d)(2)(iv), then, unless the option below is elected, the suspension period following a hardship distribution shall only apply to hardship distributions made after December 31, 2001.

o With regard to hardship distributions made during 2001, a participant shall be prohibited from making elective deferrals and employee contributions under this and all other plans until the later of January 1, 2002, or 6 months after receipt of the distribution.

2.4 Catch-up contributions (for 401(k) profit sharing plans only): The plan permits catch-up contributions (Article VI) unless the option below is elected.

o The plan does not permit catch-up contributions to be made.

2.5 For target benefit plans only: The increased compensation limit ($200,000 limit) shall apply to years prior to 2002 unless the option below is elected.

o The increased compensation limit will not apply to years prior to 2002.

ARTICLE III
VESTING OF MATCHING CONTRIBUTIONS

3.1 Applicability. This Article shall apply to participants who complete an Hour of Service after December 31, 2001, with respect to accrued benefits derived from employer matching contributions made in plan years beginning after December 31, 2001. Unless otherwise elected by the employer in Section 2.1 above, this Article shall also apply to all such participants with respect to accrued benefits derived from employer matching contributions made in plan years beginning prior to January 1, 2002.

3.2 Vesting schedule. A participant’s accrued benefit derived from employer matching contributions shall vest as provided in Section 2.1 of this amendment.

ARTICLE IV
INVOLUNTARY CASH-OUTS

4.1 Applicability and effective date. If the plan provides for involuntary cash-outs of amounts less than $5,000, then unless otherwise elected in Section 2.2 of this amendment, this Article shall apply for distributions made after December 31, 2001, and shall apply to all participants. However, regardless of the preceding, this Article shall not apply if the plan is subject to the qualified joint and survivor annuity requirements of Sections 401(a)(11) and 417 of the Code.

4.2 Rollovers disregarded in determining value of account balance for involuntary distributions. For purposes of the Sections of the plan that provide for the involuntary distribution of vested accrued benefits of $5,000 or less, the value

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EGTRRA — Employer Allied Capital 401(k) Plan

of a participant’s nonforfeitable account balance shall be determined without regard to that portion of the account balance that is attributable to rollover contributions (and earnings allocable thereto) within the meaning of Sections 402(c), 403(a)(4), 403(b)(8), 408(d)(3)(A)(ii), and 457(e)(16) of the Code. If the value of the participant’s nonforfeitable account balance as so determined is $5,000 or less, then the plan shall immediately distribute the participant’s entire nonforfeitable account balance.

ARTICLE V
HARDSHIP DISTRIBUTIONS

5.1 Applicability and effective date. If the plan provides for hardship distributions upon satisfaction of the safe harbor (deemed) standards as set forth in Treas. Reg. Section 1.401(k)-1(d)(2)(iv), then this Article shall apply for calendar years beginning after 2001.

5.2 Suspension period following hardship distribution. A participant who receives a distribution of elective deferrals after December 31, 2001, on account of hardship shall be prohibited from making elective deferrals and employee contributions under this and all other plans of the employer for 6 months after receipt of the distribution. Furthermore, if elected by the employer in Section 2.3 of this amendment, a participant who receives a distribution of elective deferrals in calendar year 2001 on account of hardship shall be prohibited from making elective deferrals and employee contributions under this and all other plans until the later of January 1, 2002, or 6 months after receipt of the distribution.

ARTICLE VI
CATCH-UP CONTRIBUTIONS

Catch-up Contributions. Unless otherwise elected in Section 2.4 of this amendment, all employees who are eligible to make elective deferrals under this plan and who have attained age 50 before the close of the plan year shall be eligible to make catch-up contributions in accordance with, and subject to the limitations of, Section 414(v) of the Code. Such catch-up contributions shall not be taken into account for purposes of the provisions of the plan implementing the required limitations of Sections 402(g) and 415 of the Code. The plan shall not be treated as failing to satisfy the provisions of the plan implementing the requirements of Section 401(k)(3), 401(k)(11), 401(k)(12), 410(b), or 416 of the Code, as applicable, by reason of the making of such catch-up contributions.

ARTICLE VII
INCREASE IN COMPENSATION LIMIT

Increase in Compensation Limit. The annual compensation of each participant taken into account in determining allocations for any plan year beginning after December 31, 2001, shall not exceed $200,000, as adjusted for cost-of-living increases in accordance with Section 401(a)(17)(B) of the Code. Annual compensation means compensation during the plan year or such other consecutive 12-month period over which compensation is otherwise determined under the plan (the determination period). If this is a target benefit plan, then except as otherwise elected in Section 2.5 of this amendment, for purposes of determining benefit accruals in a plan year beginning after December 31, 2001, compensation for any prior determination period shall be limited to $200,000. The cost-of-living adjustment in effect for a calendar year applies to annual compensation for the determination period that begins with or within such calendar year.

ARTICLE VIII
PLAN LOANS

Plan loans for owner-employees or shareholder-employees. If the plan permits loans to be made to participants, then effective for plan loans made after December 31, 2001, plan provisions prohibiting loans to any owner-employee or shareholder-employee shall cease to apply.

ARTICLE IX
LIMITATIONS ON CONTRIBUTIONS (IRC SECTION 415 LIMITS)

9.1 Effective date. This Section shall be effective for limitation years beginning after December 31, 2001.

9.2 Maximum annual addition. Except to the extent permitted under Article VI of this amendment and Section 414(v) of the Code, if applicable, the annual addition that may be contributed or allocated to a participant’s account under the plan for any limitation year shall not exceed the lesser of:

a. $40,000, as adjusted for increases in the cost-of-living under Section 415(d) of the Code, or

b. 100 percent of the participant’s compensation, within the meaning of Section 415(c)(3) of the Code, for the limitation year.

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EGTRRA — Employer Allied Capital 401(k) Plan

The compensation limit referred to in b. shall not apply to any contribution for medical benefits after separation from service (within the meaning of Section 401(h) or Section 419A(f)(2) of the Code) which is otherwise treated as an annual addition.

ARTICLE X
MODIFICATION OF TOP-HEAVY RULES

10.1    Effective date. This Article shall apply for purposes of determining whether the plan is a top-heavy plan under Section 416(g) of the Code for plan years beginning after December 31, 2001, and whether the plan satisfies the minimum benefits requirements of Section 416(c) of the Code for such years. This Article amends the top-heavy provisions of the plan.

10.2    Determination of top-heavy status.

10.2.1 Key employee. Key employee means any employee or former employee (including any deceased employee) who at any time during the plan year that includes the determination date was an officer of the employer having annual compensation greater than $130,000 (as adjusted under Section 416(i)(1) of the Code for plan years beginning after December 31, 2002), a 5-percent owner of the employer, or a 1-percent owner of the employer having annual compensation of more than $150,000. For this purpose, annual compensation means compensation within the meaning of Section 415(c)(3) of the Code. The determination of who is a key employee will be made in accordance with Section 416(i)(1) of the Code and the applicable regulations and other guidance of general applicability issued thereunder.

10.2.2 Determination of present values and amounts. This Section 10.2.2 shall apply for purposes of determining the present values of accrued benefits and the amounts of account balances of employees as of the determination date.

a. Distributions during year ending on the determination date. The present values of accrued benefits and the amounts of account balances of an employee as of the determination date shall be increased by the distributions made with respect to the employee under the plan and any plan aggregated with the plan under Section 416(g)(2) of the Code during the 1-year period ending on the determination date. The preceding sentence shall also apply to distributions under a terminated plan which, had it not been terminated, would have been aggregated with the plan under Section 416(g)(2)(A)(i) of the Code. In the case of a distribution made for a reason other than separation from service, death, or disability, this provision shall be applied by substituting “5-year period” for “1-year period.”

b. Employees not performing services during year ending on the determination date. The accrued benefits and accounts of any individual who has not performed services for the employer during the 1-year period ending on the determination date shall not be taken into account.

10.3    Minimum benefits.

10.3.1 Matching contributions. Employer matching contributions shall be taken into account for purposes of satisfying the minimum contribution requirements of Section 416(c)(2) of the Code and the plan. The preceding sentence shall apply with respect to matching contributions under the plan or, if the plan provides that the minimum contribution requirement shall be met in another plan, such other plan. Employer matching contributions that are used to satisfy the minimum contribution requirements shall be treated as matching contributions for purposes of the actual contribution percentage test and other requirements of Section 401(m) of the Code.

10.3.2 Contributions under other plans. The employer may provide, in an addendum to this amendment, that the minimum benefit requirement shall be met in another plan (including another plan that consists solely of a cash or deferred arrangement which meets the requirements of Section 401(k)(12) of the Code and matching contributions with respect to which the requirements of Section 401(m)(11) of the Code are met). The addendum should include the name of the other plan, the minimum benefit that will be provided under such other plan, and the employees who will receive the minimum benefit under such other plan.

ARTICLE XI
DIRECT ROLLOVERS

11.1    Effective date. This Article shall apply to distributions made after December 31, 2001.

11.2    Modification of definition of eligible retirement plan. For purposes of the direct rollover provisions of the plan, an eligible retirement plan shall also mean an annuity contract described in Section 403(b) of the Code and an eligible plan under Section 457(b) of the Code which is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state and which agrees to separately account for amounts

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EGTRRA – Employer Allied Capital 401(k) Plan

transferred into such plan from this plan. The definition of eligible retirement plan shall also apply in the case of a distribution to a surviving spouse, or to a spouse or former spouse who is the alternate payee under a qualified domestic relation order, as defined in Section 414(p) of the Code.

11.3 Modification of definition of eligible rollover distribution to exclude hardship distributions. For purposes of the direct rollover provisions of the plan, any amount that is distributed on account of hardship shall not be an eligible rollover distribution and the distributee may not elect to have any portion of such a distribution paid directly to an eligible retirement plan.

11.4 Modification of definition of eligible rollover distribution to include after-tax employee contributions. For purposes of the direct rollover provisions in the plan, a portion of a distribution shall not fail to be an eligible rollover distribution merely because the portion consists of after-tax employee contributions which are not includible in gross income. However, such portion may be transferred only to an individual retirement account or annuity described in Section 408(a) or (b) of the Code, or to a qualified defined contribution plan described in Section 401(a) or 403(a) of the Code that agrees to separately account for amounts so transferred, including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible.

ARTICLE XII
ROLLOVERS FROM OTHER PLANS

Rollovers from other plans. The employer, operationally and on a nondiscriminatory basis, may limit the source of rollover contributions that may be accepted by this plan.

ARTICLE XIII
REPEAL OF MULTIPLE USE TEST

Repeal of Multiple Use Test. The multiple use test described in Treasury Regulation Section 1.401(m)-2 and the plan shall not apply for plan years beginning after December 31, 2001.

ARTICLE XIV ELECTIVE
DEFERRALS

14.1 Elective Deferrals — Contribution Limitation. No participant shall be permitted to have elective deferrals made under this plan, or any other qualified plan maintained by the employer during any taxable year, in excess of the dollar limitation contained in Section 402(g) of the Code in effect for such taxable year, except to the extent permitted under Article VI of this amendment and Section 414(v) of the Code, if applicable.

14.2 Maximum Salary Reduction Contributions for SIMPLE plans. If this is a SIMPLE 401(k) plan, then except to the extent permitted under Article VI of this amendment and Section 414(v) of the Code, if applicable, the maximum salary reduction contribution that can be made to this plan is the amount determined under Section 408(p)(2)(A)(ii) of the Code for the calendar year.

ARTICLE XV
SAFE HARBOR PLAN PROVISIONS

Modification of Top-Heavy Rules. The top-heavy requirements of Section 416 of the Code and the plan shall not apply in any year beginning after December 31, 2001, in which the plan consists solely of a cash or deferred arrangement which meets the requirements of Section 401(k)(12) of the Code and matching contributions with respect to which the requirements of Section 401(m)(11) of the Code are met.

ARTICLE XVI
DISTRIBUTION UPON SEVERANCE OF EMPLOYMENT

16.1 Effective date. This Article shall apply for distributions and transactions made after December 31, 2001, regardless of when the severance of employment occurred.

16.2 New distributable event. A participant’s elective deferrals, qualified nonelective contributions, qualified matching contributions, and earnings attributable to these contributions shall be distributed on account of the participant’s severance from employment. However, such a distribution shall be subject to the other provisions of the plan regarding distributions, other than provisions that require a separation from service before such amounts may be distributed.

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EGTRRA – Employer Allied Capital 401(k) Plan

This amendment has been executed this ______ day of ____________, ______ .
Name of Employer: Allied Capital Corporation

By: EMPLOYER

Name of Plan:      Allied Capital 401(k) Plan     

© Copyright 2001 Wachovia Bank, National Association

6 EX-15 5 w89787exv15.htm EX-15 LETTER RE UNAUDITED INTERIM FINANCIAL INFO

Exhibit 15

The Board of Directors and Shareholders
Allied Capital Corporation:

Re: Registration Statement Nos. 333-45525, 333-13584, and 333-101849

Ladies and Gentlemen:

With respect to the subject registration statements, we acknowledge our awareness of the use therein of our report dated October 27, 2003 related to our review of interim financial information.

Pursuant to Rule 436 under the Securities Act of 1933 (the Act), such report is not considered part of a registration statement prepared or certified by an accountant, or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of the Act.

/s/ KPMG LLP

Washington, D.C.
November 13, 2003

EX-31.1 6 w89787exv31w1.htm EX-31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER

Exhibit 31.1

Certification of Chief Executive Officer

      I, William L. Walton, Chief Executive Officer of Allied Capital Corporation, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Allied Capital Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a.	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c.	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the period covered by the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.  The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a.	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 13, 2003

By: /s/ WILLIAM L. WALTON
          William L. Walton
Chief Executive Officer

EX-15

exv15

EX-31.1

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EX-31.2

Exhibit 31.2

Certification of Chief Financial Officer

      I, Penni F. Roll, Chief Financial Officer of Allied Capital Corporation, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Allied Capital Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a.	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c.	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the period covered by the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.  The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a.	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 13, 2003

By: /s/ PENNI F. ROLL
          Penni F. Roll
Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, (the “Report”) of Allied Capital Corporation (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof; I, William L. Walton, the Chief Executive Officer of the Registrant, certify, to the best of my knowledge, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

/s/ William L. Walton
Name: William L. Walton
Date:   November 13, 2003

EX-32.2 9 w89787exv32w2.htm EX-32.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER

Exhibit 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, (the “Report”) of Allied Capital Corporation (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof; I, Penni F. Roll, the Chief Financial Officer of the Registrant, certify, to the best of my knowledge, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

/s/ Penni F. Roll
Name: Penni F. Roll
Date:   November 13, 2003

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EX-32.2

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