ALLIED CAPITAL CORP - 10-Q Quarterly Report

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, 2002		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 12 of 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 [ ]

On November 13, 2002, there were 102,467,934 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		1




Consolidated Balance Sheet as of September 30, 2002 (unaudited) and December 31, 2001		1




Consolidated Statement of Operations — For the Three and Nine Months Ended September 30, 2002 and 2001 (unaudited)		2




Consolidated Statement of Changes in Net Assets — For the Nine Months Ended September 30, 2002 and 2001 (unaudited)		3




Consolidated Statement of Cash Flows — For the Nine Months Ended September 30, 2002 and 2001 (unaudited)		4




Consolidated Statement of Investments as of September 30, 2002 (unaudited) and December 31, 2001		5




Notes to Consolidated Financial Statements		25




Independent Accountants’ Review Report		43




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		44




Item 3. Quantitative and Qualitative Disclosures about Market Risk		84




Item 4. Controls and Procedures		86

PART II. OTHER INFORMATION




	Item 1. Legal Proceedings	87




	Item 2. Changes in Securities and Use of Proceeds	87




	Item 3. Defaults Upon Senior Securities	87




	Item 4. Submission of Matters to Vote of Security Holders	87




	Item 5. Other Information	87




	Item 6. Exhibits and Reports on Form 8-K	87




	Signatures	91




	Certification of Chief Executive Officer	92




	Certification of Chief Financial Officer	94

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET


				September 30,			December 31,
				2002			2001

(in thousands, except share and per share amounts)				(unaudited)




ASSETS




Portfolio at value:
	Private finance




		Companies more than 25% owned (cost: 2002-$550,629; 2001-$451,705)		$	589,613		$	505,620




		Companies 5% to 25% owned (cost: 2002-$235,006; 2001-$211,030)			266,131			232,399




		Companies less than 5% owned (cost: 2002-$871,077; 2001-$891,231)			806,824			857,053

			Total private finance		1,662,568			1,595,072




	Commercial real estate finance (cost: 2002-$645,219; 2001-$732,636)				681,056			734,518

			Total portfolio at value		2,343,624			2,329,590

Other assets					155,741			130,234




Cash and cash equivalents					23,630			889

			Total assets	$	2,522,995		$	2,460,713





LIABILITIES AND SHAREHOLDERS’ EQUITY




Liabilities:




	Notes payable and debentures			$	869,200		$	876,056




	Revolving line of credit				121,500			144,750




	Accounts payable and other liabilities				96,246			80,784

			Total liabilities		1,086,946			1,101,590

Commitments and contingencies




Preferred stock					7,000			7,000




Shareholders’ equity:




	Common stock, $0.0001 par value, 200,000,000 shares authorized; 102,467,934 and 99,607,396 shares issued and outstanding at September 30, 2002, and December 31, 2001, respectively				10			10




	Additional paid-in capital				1,420,995			1,352,688




	Notes receivable from sale of common stock				(25,356	)		(26,028	)




	Net unrealized appreciation				16,320			39,981




	Undistributed (distributions in excess of) earnings				17,080			(14,528	)

			Total shareholders’ equity		1,429,049			1,352,123

			Total liabilities and shareholders’ equity	$	2,522,995		$	2,460,713

Net asset value per common share				$	13.95		$	13.57

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS



					For the Three					For the Nine
					Months Ended					Months Ended
					September 30,					September 30,

					2002			2001		2002			2001
(in thousands, except per share amounts)

					(unaudited)					(unaudited)




Interest and related portfolio income:
	Interest and dividends




			Companies more than 25% owned		$	9,661		$	5,776	$	28,468		$	16,664




			Companies 5% to 25% owned			6,837			6,973		21,222			19,884




			Companies less than 5% owned			51,126			47,274		145,599			137,174

				Total interest and dividends		67,624			60,023		195,289			173,722
	Premiums from loan dispositions




			Companies more than 25% owned			—			339		—			850




			Companies less than 5% owned			392			—		2,051			1,220

				Total premiums from loan dispositions		392			339		2,051			2,070
	Fees and other income




			Companies more than 25% owned			5,250			9,059		19,115			15,136




			Companies 5% to 25% owned			636			49		1,112			199




			Companies less than 5% owned			2,427			3,164		14,346			15,317

				Total fees and other income		8,313			12,272		34,573			30,652

				Total interest and related portfolio income		76,329			72,634		231,913			206,444

Expenses:




	Interest					17,430			16,093		52,414			47,974




	Employee					8,153			8,213		24,462			22,269




	Administrative					5,052			4,139		12,913			10,166

				Total operating expenses		30,635			28,445		89,789			80,409

Net investment income before income tax expense and net realized and unrealized gains						45,694			44,189		142,124			126,035




Income tax expense						600			—		600			—

Net investment income before net realized and unrealized gains						45,094			44,189		141,524			126,035

Net realized and unrealized gains:
	Net realized gains (losses)




		Companies more than 25% owned				60,063			2,623		59,433			1,893




		Companies 5% to 25% owned				(700	)		—		18			4,571




		Companies less than 5% owned				(11,141	)		725		(2,379	)		1,875

				Total net realized gains		48,222			3,348		57,072			8,339




	Net unrealized gains (losses)					(47,796	)		12,166		(23,661	)		23,463

				Total net realized and unrealized gains		426			15,514		33,411			31,802

Net increase in net assets resulting from operations					$	45,520		$	59,703	$	174,935		$	157,837

Basic earnings per common share					$	0.44		$	0.64	$	1.73		$	1.77

Diluted earnings per common share					$	0.44		$	0.63	$	1.70		$	1.74

Weighted average common shares outstanding — basic						102,327			92,903		101,329			89,282

Weighted average common shares outstanding — diluted						103,302			94,585		103,040			90,864

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS



			For the Nine Months
			Ended September 30,

			2002			2001
(in thousands, except per share amounts)

			(unaudited)




Operations:




	Net investment income before income tax expense and net realized and unrealized gains		$	142,124		$	126,035




	Income tax expense			600			—




	Net realized gains			57,072			8,339




	Net unrealized gains (losses)			(23,661	)		23,463

		Net increase in net assets resulting from operations		174,935			157,837

Shareholder distributions:




	Common stock dividends			(166,823	)		(135,702	)




	Preferred stock dividends			(165	)		(165	)

		Net decrease in net assets resulting from shareholder distributions		(166,988	)		(135,867	)

Capital share transactions:




	Sale of common stock			49,920			237,037




	Issuance of common stock upon the exercise of stock options			13,290			7,826




	Issuance of common stock in lieu of cash distributions			4,696			4,879




	Net decrease (increase) in notes receivable from sale of common stock			672			(1,167	)




	Other			401			—

		Net increase in net assets resulting from capital share transactions		68,979			248,575

		Total increase in net assets	$	76,926		$	270,545

Net assets at beginning of period			$	1,352,123		$	1,029,692

Net assets at end of period			$	1,429,049		$	1,300,237

Net asset value per common share			$	13.95		$	13.42

Common shares outstanding at end of period				102,468			96,921

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS



				For the Nine Months
				Ended September 30,

				2002			2001
(in thousands)

				(unaudited)




Cash flows from operating activities:




	Net increase in net assets resulting from operations			$	174,935		$	157,837
	Adjustments




		Portfolio investments			(353,026	)		(513,489	)




		Repayments of investment principal			111,691			50,413




		Proceeds from investment sales			213,474			129,980




		Change in accrued or reinvested interest and dividends			(32,999	)		(40,359	)




		Changes in other assets and liabilities			(7,845	)		1,508




		Amortization of loan discounts and fees			(15,479	)		(11,793	)




		Depreciation and amortization			1,053			724




		Realized losses			36,282			1,603




		Net unrealized losses (gains)			23,661			(23,463	)

			Net cash provided by (used in) operating activities		151,747			(247,039	)

Cash flows from financing activities:




	Sale of common stock				49,920			237,037




	Sale of common stock upon the exercise of stock options				10,909			3,369




	Collections of notes receivable from sale of common stock				3,053			3,293




	Common stock dividends and distributions paid				(162,127	)		(130,823	)




	Preferred stock dividends paid				(165	)		(165	)




	Net borrowings under (repayments on) notes payable and debentures				(6,856	)		12,836




	Net borrowings under (repayments on) revolving line of credit				(23,250	)		125,000




	Other				(490	)		(2,817	)

			Net cash provided by (used in) financing activities		(129,006	)		247,730

Net increase in cash and cash equivalents				$	22,741		$	691

Cash and cash equivalents at beginning of period				$	889		$	2,449

Cash and cash equivalents at end of period				$	23,630		$	3,140

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value





Companies More Than 25% Owned
Acme Paging, L.P.		Loan	$	3,525	$	3,525
	(Telecommunications)	Common Stock (177 shares)		27		27
		Equity Interests		13,274		11,819

American Healthcare Services, Inc.		Debt Securities		40,643		40,643
	(Healthcare)	Common Stock (79,567,042 shares)		1,000		100
		Guaranty ($915)		—		—

Avborne, Inc.		Loan		9,625		9,625
	(Business Services)	Common Stock (27,500 shares)		—		—
		Preferred Stock (12,500 shares)		14,138		3,500

Business Loan Express, Inc.		Loan		6,000		6,000
	(Financial Services)	Debt Securities		83,206		83,206
		Preferred Stock (25,111 shares)		25,111		25,111
		Common Stock (25,503,043 shares)		104,641		140,000
		Guaranty ($48,476 — See Note 3)		—		—
		Standby Letters of Credit ($10,550 — See Note 3)		—		—

The Color Factory Inc.		Loan		8,590		8,590
	(Consumer Products)	Preferred Stock (1,000 shares)		1,002		1,002
		Common Stock (980 shares)		6,535		8,035

EDM Consulting, LLC		Debt Securities		1,875		443
	(Business Services)	Equity Interests		250		—

Elmhurst Consulting, LLC		Loan		14,484		14,484
	(Business Services)	Equity Interests		5,165		5,165

Foresite Towers, LLC		Equity Interests		15,522		15,022
	(Tower Leasing)

Gordian Group, Inc.		Loan		7,213		7,213
	(Business Services)	Common Stock (1,000 shares)		2,088		2,088

HealthASPex, Inc.		Preferred Stock (1,451,380 shares)		4,900		2,617
	(Business Services)	Preferred Stock (700,000 shares)		700		700
		Common Stock (1,451,380 shares)		4		—

The Hillman Companies Inc.(1)		Debt Securities		41,494		41,494
	(Consumer Products)	Common Stock (6,890,937 shares)		57,169		90,013

HMT, Inc.		Debt Securities		9,058		9,058
	(Business Services)	Preferred Stock (519,484 shares)		2,078		2,078
		Common Stock (300,000 shares)		3,000		1,694
		Warrants		1,155		651

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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

xMonitoring Solutions, Inc.		Debt Securities	$	1,823	$	153
	(Business Services)	Common Stock (33,333 shares)		—		—
		Warrants		—		—

MVL Group, Inc.		Loan		17,017		17,017
	(Business Services)	Debt Securities		16,236		16,236
		Common Stock (648,638 shares)		—		—

Powell Plant Farms, Inc.		Loan		22,223		12,709
	(Consumer Products)	Preferred Stock (1,483 shares)		—		—
		Warrants		—		—

Spa Lending Corporation		Preferred Stock (28,672 shares)		395		276
	(Recreation)	Common Stock (6,208 shares)		—		—

STS Operating, Inc.		Common Stock (3,000,000 shares)		3,177		3,177
	(Industrial Products)

Sure-Tel, Inc.		Preferred Stock (1,000,000 shares)		1,000		1,000
	(Consumer Services)	Common Stock (37,000 shares)		5,018		5,018

Total Foam, Inc.		Debt Securities		258		124
	(Industrial Products)	Common Stock (910 shares)		10		—





Total companies more than 25% owned			$	550,629	$	589,613





Companies 5% to 25% Owned

Aspen Pet Products, Inc.		Loans	$	16,368	$	16,368
	(Consumer Products)	Preferred Stock (2,024 shares)		1,981		1,981
		Common Stock (1,400 shares)		140		140

Autania AG(1,3)		Debt Securities		4,486		4,486
	(Industrial Products)	Common Stock (250,000 shares)		2,169		2,145

CBA-Mezzanine Capital Finance, LLC		Loan		2,418		2,418
	(Financial Services)

Colibri Holding Corporation		Loans		3,486		3,486
	(Consumer Products)	Preferred Stock (237 shares)		248		248
		Common Stock (3,362 shares)		1,250		1,088
		Warrants		290		252

CorrFlex Graphics, LLC		Debt Securities		11,940		11,940
	(Business Services)	Warrants		—		17,490
		Options		—		1,510

CyberRep		Loan		1,224		1,224
	(Business Services)	Debt Securities		14,716		14,716
		Warrants		660		4,510

The Debt Exchange Inc.		Preferred Stock (921,829 shares)		1,250		1,250
	(Business Services)

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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

International Fiber Corporation		Debt Securities	$	22,552	$	22,552
	(Industrial Products)	Common Stock (1,029,069 shares)		5,483		7,755
		Warrants		550		778

Liberty-Pittsburgh Systems, Inc.		Debt Securities		3,497		3,497
	(Business Services)	Common Stock (123,929 shares)		142		142

Litterer Beteiligungs-GmbH(3)		Debt Securities		1,070		1,070
	(Business Services)	Equity Interest		358		358

Logic Bay Corporation		Preferred Stock (1,131,222 shares)		5,000		—
	(Business Services)

Magna Card, Inc.		Debt Securities		153		153
	(Consumer Products)	Preferred Stock (1,875 shares)		94		94
		Common Stock (4,687 shares)		—		—

Master Plan, Inc.		Loan		959		959
	(Business Services)	Common Stock (156 shares)		42		42

MortgageRamp.com, Inc.		Common Stock (772,000 shares)		3,860		3,860
	(Business Services)

Morton Grove		Loan		16,356		16,356
	Pharmaceuticals, Inc.	Preferred Stock (106,947 shares)		5,000		14,000
	(Consumer Products)

Nobel Learning Communities,		Debt Securities		9,729		9,729
	Inc.(1)	Preferred Stock (1,063,830 shares)		2,000		2,000
	(Education)	Warrants		575		382

North American Archery, LLC		Loans		1,390		840
	(Consumer Products)	Convertible Debentures		2,248		59
		Guaranty ($1,020)		—		—

Packaging Advantage		Debt Securities		14,207		14,207
	Corporation	Common Stock (232,168 shares)		2,386		2,386
	(Business Services)	Warrants		963		963

Professional Paint, Inc.		Debt Securities		22,791		22,791
	(Consumer Products)	Preferred Stock (15,000 shares)		19,500		19,500
		Common Stock (110,000 shares)		69		5,000

Progressive International		Debt Securities		3,965		3,965
	Corporation	Preferred Stock (500 shares)		500		500
	(Consumer Products)	Common Stock (197 shares)		13		13
		Warrants		—		—

Redox Brands, Inc.		Debt Securities		9,744		9,744
	(Consumer Products)	Preferred Stock (2,404,086 shares)		6,974		6,974
		Warrants		584		584


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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

Staffing Partners Holding		Loan	$	2,500	$	2,500
	Company, Inc.	Debt Securities		4,993		4,993
	(Business Services)	Preferred Stock (414,600 shares)		2,073		2,073
		Common Stock (50,200 shares)		50		50
		Warrants		10		10





Total companies 5% to 25% owned			$	235,006	$	266,131





Companies Less Than 5% Owned
ACE Products, Inc.		Loans	$	17,164	$	13,061
	(Industrial Products)

Advantage Mayer, Inc.		Debt Securities		10,702		10,702
	(Business Services)	Warrants		382		1,455

Alderwoods Group, Inc.(1)		Common Stock (357,568 shares)		5,006		2,324
	(Consumer Services)

Allied Office Products, Inc.		Debt Securities		7,628		50
	(Business Services)	Warrants		629		—

American Barbecue & Grill, Inc.		Warrants		125		—
	(Retail)

American Home Care Supply,		Debt Securities		6,950		6,950
	LLC	Warrants		579		1,849
	(Consumer Products)

ASW Holding Corporation		Warrants		25		25
	(Industrial Products)

Bakery Chef, Inc.		Loans		17,908		17,908
	(Consumer Products)

Blue Rhino Corporation(1)		Debt Securities		13,965		13,965
	(Consumer Products)	Warrants		1,200		15,300

Border Foods, Inc.		Debt Securities		9,365		9,365
	(Consumer Products)	Preferred Stock (50,919 shares)		2,000		2,000
		Warrants		665		665

Camden Partners Strategic Fund II, L.P.(4)		Limited Partnership Interest		2,124		2,238
	(Private Equity Fund)

Candlewood Hotel Company(1)		Preferred Stock (3,250 shares)		3,250		975
	(Hospitality)

Celebrities, Inc.		Loan		220		220
	(Broadcasting & Cable)	Warrants		12		492

Clif Bar, Inc.		Loan		24,889		24,889
	(Consumer Products)


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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

Component Hardware Group, Inc.		Debt Securities	$	11,157	$	11,157
	(Industrial Products)	Preferred Stock (18,000 shares)		2,229		2,229
		Common Stock (2,000 shares)		200		200

Cooper Natural Resources, Inc.		Loan		299		299
	(Industrial Products)	Debt Securities		1,849		1,849
		Preferred Stock (6,316 shares)		1,427		1,427
		Warrants		832		832

Coverall North America, Inc.		Loan		12,403		12,403
	(Business Services)	Debt Securities		6,423		6,423

CPM Acquisition Corporation		Loan		10,055		10,055
	(Industrial Products)

CTT Holdings		Loan		1,500		1,500
	(Consumer Products)

Cumulus Media, Inc. (1)		Common Stock (11,037 shares)		198		195
	(Broadcasting & Cable)

Drilltec Patents &		Loan		10,918		—
	Technologies Company, Inc.	Debt Securities		1,500		—
	(Industrial Products)	Warrants		—		—

eCentury Capital Partners, L.P.(4)		Limited Partnership Interest		1,875		1,675
	(Private Equity Fund)

El Dorado Communications, Inc.		Loans		306		232
	(Broadcasting & Cable)

Elexis Beta GmbH(3)		Options		426		426
	(Industrial Products)

Eparfin S.A.(3)		Loan		29		29
	(Consumer Products)

E-Talk Corporation		Debt Securities		8,852		300
	(Business Services)	Warrants		1,157		—

Executive Greetings, Inc.		Debt Securities		18,061		18,061
	(Business Services)	Warrants		360		360

Fairchild Industrial Products		Debt Securities		5,924		5,924
	Company	Warrants		280		1,100
	(Industrial Products)

Galaxy American		Debt Securities		48,989		25,000
	Communications, LLC	Options		—		—
	(Broadcasting & Cable)	Standby Letter of Credit ($750)		—		—

Garden Ridge Corporation		Debt Securities		27,133		27,133
	(Retail)	Preferred Stock (1,130 shares)		1,130		1,130
		Common Stock (188,400 shares)		613		613


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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

GC-Sun Holdings II, LP (Kar Products, LP)		Loans	$	7,738	$	7,738
	(Business Services)

Gibson Guitar Corporation		Debt Securities		17,753		17,753
	(Consumer Products)	Warrants		525		2,325

Ginsey Industries, Inc.		Loans		5,000		5,000
	(Consumer Products)	Convertible Debentures		500		500
		Warrants		—		1,500

Global Communications, LLC		Loan		1,998		1,998
	(Business Services)	Debt Securities		16,033		16,033
		Equity Interest		12,707		12,707
		Options		1,639		1,639

Grant Broadcasting Systems II		Warrants		87		3,000
	(Broadcasting & Cable)

Grotech Partners, VI, L.P.(4)		Limited Partnership Interest		2,803		2,369
	(Private Equity Fund)

The Hartz Mountain Corporation		Debt Securities		27,616		27,616
	(Consumer Products)	Common Stock (200,000 shares)		2,000		2,000
		Warrants		2,613		2,613

Haven Eldercare of New England, LLC		Loan		35,633		35,633
	(Healthcare)

Headwaters Incorporated(1)		Loan		9,951		9,951
	(Industrial Products)

Hotelevision, Inc.		Preferred Stock (315,100 shares)		315		—
	(Broadcasting & Cable)

Icon International, Inc.		Common Stock (35,228 shares)		1,219		2,712
	(Business Services)

Impact Innovations Group, LLC		Debt Securities		6,797		3,436
	(Business Services)	Warrants		1,674		—

Intellirisk Management Corporation		Loans		23,035		23,035
	(Business Services)

Interline Brands, Inc.		Debt Securities		33,733		33,733
	(Business Services)	Preferred Stock (199,313 shares)		1,849		1,849
		Common Stock (15,615 shares)		139		139
		Warrants		1,181		1,181

Jakel, Inc.		Loan		23,307		14,255
	(Industrial Products)

JRI Industries, Inc.		Debt Securities		2,018		2,018
	(Industrial Products)	Warrants		74		74


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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

Julius Koch USA, Inc.		Warrants	$	259	$	8,000
	(Industrial Products)

Kirker Enterprises, Inc.		Warrants		348		3,501
	(Industrial Products)	Equity Interest		4		4

Kirkland’s, Inc.(1)		Common Stock (240,442 shares)		66		3,700
	(Retail)

Kyrus Corporation		Debt Securities		7,145		7,145
	(Business Services)	Warrants		348		348

Love Funding Corporation		Preferred Stock (26,000 shares)		359		213
	(Financial Services)

Matrics, Inc.		Preferred Stock (511,876 shares)		500		500
	(Business Services)	Warrants		—		—

MedAssets.com, Inc.		Debt Securities		15,618		15,618
	(Business Services)	Preferred Stock (260,417 shares)		2,049		2,049
		Warrants		136		136

Mid-Atlantic Venture Fund IV, L.P.(4)		Limited Partnership Interest		3,975		2,555
	(Private Equity Fund)

Midview Associates, L.P.		Warrants		—		—
	(Housing)

Most Confiserie GmbH & Co KG(3)		Loan		943		50
	(Consumer Products)

NetCare, AG(3)		Loan		760		50
	(Business Services)	Common Stock (262,784 shares)		226		—

Norstan Apparel Shops, Inc.		Debt Securities		11,786		11,786
	(Retail)	Common Stock (29,477 shares)		4,750		4,750
		Warrants		655		655

Northeast Broadcasting Group, L.P.		Debt Securities		278		278
	(Broadcasting & Cable)

Novak Biddle Venture Partners III, L.P.(4)		Limited Partnership Interest		690		690
	(Private Equity Fund)

Nursefinders, Inc.		Debt Securities		11,178		11,178
	(Business Services)	Warrants		900		2,200

Onyx Television GmbH(3)		Preferred Units (120,000 shares)		201		8
	(Broadcasting & Cable)

Opinion Research Corporation(1)		Debt Securities		14,313		14,313
	(Business Services)	Warrants		996		687


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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

Oriental Trading Company, Inc.		Preferred Equity Interest	$	1,751	$	1,751
	(Consumer Products)	Common Equity Interest		—		2,600

Outsource Partners, Inc.		Debt Securities		24,077		24,077
	(Business Services)	Warrants		826		826

Pico Products, Inc.		Loan		1,406		1,406
	(Industrial Products)

Polaris Pool Systems, Inc.		Debt Securities		10,691		10,691
	(Consumer Products)	Warrants		1,145		1,145

Proeducation GmbH(3)		Loan		261		261
	(Education)

Prosperco Finanz Holding AG(3)		Convertible Debentures		5,305		5,305
	(Financial Services)	Common Stock (1,528 shares)		1,059		708
		Warrants		—		—

Raytheon Aerospace, LLC		Debt Securities		5,169		5,169
	(Business Services)	Equity Interest		—		250

Scitor Corporation		Loan		21,893		21,893
	(Business Services)

Simula, Inc.(1)		Loan		20,863		20,863
	(Industrial Products)

Soff-Cut Holdings, Inc.		Debt Securities		8,999		8,999
	(Industrial Products)	Preferred Stock (300 shares)		300		300
		Common Stock (2,000 shares)		200		200

Southwest PCS, LLC		Loan		6,220		6,220
	(Telecommunications)

Startec Global Communications		Loan		23,815		23,815
	Corporation(1)	Debt Securities		20,737		245
	(Telecommunications)	Common Stock (258,064 shares)		3,000		—
		Warrants		—		—

SunStates Refrigerated		Loans		4,722		2,847
	Services, Inc.	Debt Securities		2,445		—
	(Warehouse Facilities)

Sydran Food Services II, L.P.		Debt Securities		12,973		12,973
	(Retail)	Equity Interests		3,909		—
		Warrants		—		—

Tubbs Snowshoe		Debt Securities		3,924		3,924
	Company, LLC	Equity Interests		500		500
	(Consumer Products)	Warrants		54		54

United Pet Group, Inc.		Debt Securities		9,023		9,023
	(Consumer Products)	Warrants		85		85


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

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



			September 30, 2002
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(2)	Cost		Value

Updata Venture Partners II, L.P.(4)		Limited Partnership Interest	$	502	$	1,650
	(Private Equity Fund)

Venturehouse Group, LLC(4)		Equity Interest		667		378
	(Private Equity Fund)

Walker Investment Fund II, LLLP(4)		Limited Partnership Interest		1,200		887
	(Private Equity Fund)

Warn Industries, Inc.		Debt Securities		11,522		11,522
	(Consumer Products)	Warrants		1,429		3,379

Wilshire Restaurant Group, Inc.		Debt Securities		15,901		15,901
	(Retail)	Warrants		735		735

Wilton Industries, Inc.		Loan		12,000		12,000
	(Consumer Products)

Woodstream Corporation		Loan		2,621		2,621
	(Consumer Products)	Debt Securities		7,665		7,665
		Equity Interests		1,700		4,547
		Warrants		450		1,203





Total companies less than 5% owned			$	871,077	$	806,824





Total private finance (127 portfolio companies)			$	1,656,712	$	1,662,568


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

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



								September 30, 2002
								(unaudited)
			Stated
(in thousands, except number of loans)			Interest			Face		Cost		Value

Commercial Real Estate Finance

Commercial Mortgage-Backed Securities
CMBS Bonds
	Mortgage Capital Funding, Series 1998-MC3			5.5	%	$	50,404	$	24,871	$	25,901
	Morgan Stanley Capital I, Series 1999-RM1			6.4	%		47,566		19,470		20,175
	COMM 1999-1			5.6	%		70,159		33,472		34,584
	Morgan Stanley Capital I, Series 1999-FNV1			6.1	%		33,485		14,005		14,379
	DLJ Commercial Mortgage Trust 1999-CG2			6.1	%		74,140		31,194		32,470
	Commercial Mortgage Acceptance Corp., Series 1999-C1			6.8	%		31,884		14,338		15,205
	LB Commercial Mortgage Trust, Series 1999-C2			6.7	%		25,872		9,767		10,704
	Chase Commercial Mortgage Securities Corp., Series 1999-2			6.5	%		33,380		13,906		15,217
	FUNB CMT, Series 1999-C4			6.5	%		39,283		15,696		16,827
	Heller Financial, HFCMC Series 2000 PH-1			6.8	%		42,442		16,795		18,267
	SBMS VII, Inc., Series 2000-NL1			7.2	%		18,549		9,200		9,941
	DLJ Commercial Mortgage Trust, Series 2000-CF1			7.0	%		35,773		16,577		17,716
	Deutsche Bank Alex. Brown, Series Comm 2000-C1			6.9	%		34,935		14,773		16,458
	LB-UBS Commercial Mortgage Trust, Series 2000-C4			6.9	%		31,820		11,130		12,364
	Credit Suisse First Boston Mortgage Securities Corp., Series 2001-CK1			5.9	%		35,847		13,677		15,212
	JP Morgan-CIBC-Deutsche 2001			5.8	%		39,933		15,725		16,836
	Lehman Brothers-UBS Warburg 2001-C4			6.4	%		42,014		17,397		19,017
	SBMS VII, Inc., Series 2001-C1			6.1	%		35,536		12,559		13,789
	GE Capital Commercial Mortgage Securities Corp., Series 2001-2			6.1	%		39,012		16,089		17,280
	Credit Suisse First Boston Mortgage Securities Corp., Series 2001-CKN5			5.2	%		40,150		15,464		16,515
	JP Morgan Chase Commercial Mortgage Securities Corp., Series 2001-C1			5.6	%		37,178		12,879		13,944
	SBMS VII, Inc., Series 2001-C2			6.2	%		31,369		11,604		12,620
	FUNB CMT, Series 2002-C1			6.0	%		38,238		16,722		18,618
	GE Capital Commercial Mortgage Corp., Series 2002-1			6.2	%		80,490		44,510		52,892
	GMAC Commercial Mortgage Securities, Inc., Series 2002-C2			5.8	%		62,703		34,790		39,471

		Total CMBS bonds				$	1,052,162	$	456,610	$	496,402

Collateralized Debt Obligation Preferred Shares
	Crest 2001-1, Ltd.(3)						23,639		23,639		23,639
	Crest 2002-1, Ltd.(3)						23,513		23,513		23,513
	Crest 2002-IG, Ltd.(3)						4,915		4,915		4,915
	Crest Clarendon Street 2002-1, Ltd.(3)						964		964		964

		Total collateralized debt obligation preferred shares				$	53,031	$	53,031	$	53,031

		Total CMBS				$	1,105,193	$	509,641	$	549,433


		Interest		Number of
		Rate Ranges		Loans		Cost		Value

Commercial Mortgage Loans
			Up to 6.99%		9	$	9,723	$	10,753
			7.00%- 8.99%		18		19,514		17,150
			9.00%-10.99%		9		9,858		9,858
			11.00%-12.99%		10		14,436		13,970
			13.00%-14.99%		7		7,880		7,880
		15.00% and above			1		45		45

	Total commercial mortgage loans				54	$	61,456	$	59,656

Residual Interest						$	69,335	$	69,035




Real Estate Owned							4,787		2,932

	Total commercial real estate finance					$	645,219	$	681,056

Total portfolio						$	2,301,931	$	2,343,624

(1) Public company.

(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

(3) Non-U.S. company.

(4) Non-registered investment company.

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value





Companies More Than 25% Owned

Acme Paging, L.P.		Debt Securities	$	6,992	$	6,992
	(Telecommunications)	Equity Interests		3,640		2,184

American Healthcare Services,		Debt Securities		40,194		40,194
	Inc.	Common Stock (79,567,042 shares)		1,000		100
	(Healthcare)	Guaranty ($195)		—		—

Business Loan Express, Inc.		Loan		6,000		6,000
	(Financial Services)	Debt Securities		76,242		76,242
		Preferred Stock (25,111 shares)		25,111		25,111
		Common Stock (25,503,043 shares)		104,596		120,096
		Guaranty ($51,350 — See Note 3)		—		—

The Color Factory Inc.		Loan		5,346		5,346
	(Consumer Products)	Preferred Stock (600 shares)		788		788
		Common Stock (980 shares)		6,535		8,035

Directory Investment Corporation		Common Stock (470 shares)		112		32
	(Publishing)

Directory Lending Corporation		Series A Common Stock (34 shares)		—		—
	(Publishing)	Series B Common Stock (6 shares)		8		—
		Series C Common Stock (10 shares)		22		—

EDM Consulting, LLC		Debt Securities		1,875		443
	(Business Services)	Equity Interest		250		—

Elmhurst Consulting, LLC		Loan		7,762		7,762
	(Business Services)	Equity Interests		5,157		5,157

Foresite Towers, LLC		Equity Interests		15,500		15,500
	(Tower Leasing)

HealthASPex, Inc.		Preferred Stock (1,451,380 shares)		4,900		3,900
	(Business Services)	Preferred Stock (611,923 shares)		612		612
		Common Stock (1,451,380 shares)		4		—

The Hillman Companies, Inc.		Debt Securities		40,071		40,071
	(Consumer Products)	Common Stock (6,890,937 shares)		57,156		57,156

HMT, Inc.		Debt Securities		8,995		8,995
	(Business Services)	Common Stock (300,000 shares)		3,000		3,000
		Warrants		1,155		1,155

Monitoring Solutions, Inc.		Debt Securities		1,823		153
	(Business Services)	Common Stock (33,333 shares)		—		—
		Warrants		—		—

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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value

Spa Lending Corporation		Preferred Stock (28,625 shares)	$	485	$	375
	(Recreation)	Common Stock (6,208 shares)		25		18

STS Operating, Inc.		Common Stock (3,000,000 shares)		3,177		3,177
	(Industrial Products)

Sure-Tel, Inc.		Loan		1,207		1,207
	(Consumer Services)	Preferred Stock (1,116,902 shares)		4,642		4,642
		Warrants		662		662
		Options		—		—

Total Foam, Inc.		Debt Securities		263		127
	(Industrial Products)	Common Stock (910 shares)		10		—

WyoTech Acquisition		Debt Securities		12,588		12,588
	Corporation	Preferred Stock (100 shares)		3,700		3,700
	(Education)	Common Stock (99 shares)		100		44,100





Total companies more than 25% owned			$	451,705	$	505,620





Companies 5% to 25% Owned

Aspen Pet Products, Inc.		Loans	$	14,576	$	14,576
	(Consumer Products)	Preferred Stock (1,860 shares)		1,981		1,981
		Common Stock (1,400 shares)		140		140

Autania AG(1,3)		Debt Securities		4,762		4,762
	(Industrial Products)	Common Stock (250,000 shares)		2,261		2,261

Colibri Holding Corporation		Loans		3,464		3,464
	(Consumer Products)	Preferred Stock (237 shares)		237		237
		Common Stock (3,362 shares)		1,250		1,250
		Warrants		290		290

CorrFlex Graphics, LLC		Debt Securities		2,312		2,312
	(Business Services)	Warrants		—		6,674
		Options		—		576

Csabai Canning Factory Rt(3)		Hungarian Quotas (9.2%)		700		—
	(Consumer Products)

CyberRep		Loan		1,109		1,109
	(Business Services)	Debt Securities		14,209		14,209
		Warrants		660		3,310

The Debt Exchange Inc.		Preferred Stock (921,829 shares)		1,250		1,250
	(Business Services)

FTI Consulting, Inc.(1)		Warrants		—		510
	(Business Services)

Gibson Guitar Corporation		Debt Securities		17,175		17,175
	(Consumer Products)	Warrants		525		2,325

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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value

International Fiber Corporation		Debt Securities	$	22,257	$	22,257
	(Industrial Products)	Common Stock (1,029,068 shares)		5,483		6,982
		Warrants		550		700

Liberty-Pittsburgh Systems, Inc.		Debt Securities		3,487		3,487
	(Business Services)	Common Stock (123,929 shares)		142		142

Logic Bay Corporation		Preferred Stock (1,131,222 shares)		5,000		5,000
	(Business Services)

Magna Card, Inc.		Debt Securities		153		153
	(Consumer Products)	Preferred Stock (1,875 shares)		94		94
		Common Stock (4,687 shares)		—		—

Master Plan, Inc.		Loan		1,204		1,204
	(Business Services)	Common Stock (156 shares)		42		2,042

MortgageRamp.com, Inc.		Common Stock (772,000 shares)		3,860		3,860
	(Business Services)

Morton Grove		Loan		16,150		16,150
	Pharmaceuticals, Inc.	Preferred Stock (106,947 shares)		5,000		9,000
	(Consumer Products)

Nobel Learning Communities,		Debt Securities		9,656		9,656
	Inc.(1)	Preferred Stock (265,957 shares)		2,000		2,000
	(Education)	Warrants		575		575

North American Archery, LLC		Loans		1,390		840
	(Consumer Products)	Convertible Debentures		2,248		2,008
		Guaranty ($270)		—		—

Packaging Advantage		Debt Securities		11,586		11,586
	Corporation	Common Stock (200,000 shares)		2,000		2,000
	(Business Services)	Warrants		963		963

Professional Paint, Inc.		Debt Securities		21,409		21,409
	(Consumer Products)	Preferred Stock (15,000 shares)		17,215		17,215
		Common Stock (110,000 shares)		69		3,069

Progressive International		Debt Securities		3,958		3,958
	Corporation	Preferred Stock (500 shares)		500		500
	(Consumer Products)	Common Stock (197 shares)		13		13
		Warrants		—		—

Staffing Partners Holding		Debt Securities		4,992		4,992
	Company, Inc.	Preferred Stock (414,600 shares)		2,073		2,073
	(Business Services)	Common Stock (50,200 shares)		50		50
		Warrants		10		10





Total companies 5% to 25% owned			$	211,030	$	232,399


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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value





Companies Less Than 5% Owned

Ability One Corporation		Loans	$	10,657	$	10,657
	(Consumer Products)

ACE Products, Inc.		Loans		16,875		16,875
	(Industrial Products)

Advantage Mayer, Inc.		Debt Securities		10,945		10,945
	(Business Services)	Warrants		—		—

Allied Office Products, Inc.		Debt Securities		7,491		7,491
	(Business Services)	Warrants		629		629

American Barbecue & Grill, Inc.		Warrants		125		—
	(Retail)

American Home Care Supply, LLC		Debt Securities		6,906		6,906
	(Consumer Products)	Warrants		579		1,579

ASW Holding Corporation		Warrants		25		25
	(Industrial Products)

Aurora Communications, LLC		Loans		15,809		15,809
	(Broadcasting & Cable)	Equity Interest		2,461		6,050

Avborne, Inc.		Debt Securities		12,750		6,375
	(Business Services)	Warrants		1,180		—

Bakery Chef, Inc.		Loans		17,018		17,018
	(Consumer Products)

Blue Rhino Corporation(1)		Debt Securities		13,816		13,816
	(Consumer Products)	Warrants		1,200		2,000

Border Foods, Inc.		Debt Securities		9,313		9,313
	(Consumer Products)	Preferred Stock (50,919 shares)		2,000		2,000
		Warrants		665		665

Camden Partners Strategic Fund II, L.P.(4)		Limited Partnership Interest		1,295		1,295
	(Private Equity Fund)

CampGroup, LLC		Debt Securities		2,702		2,702
	(Recreation)	Warrants		220		220

Candlewood Hotel Company(1)		Preferred Stock (3,250 shares)		3,250		3,250
	(Hospitality)

Celebrities, Inc.		Loan		244		244
	(Broadcasting & Cable)	Warrants		12		550

Classic Vacation Group, Inc.(1)		Loan		6,399		6,399
	(Consumer Products)


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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value

Component Hardware Group, Inc.		Debt Securities	$	10,774	$	10,774
	(Industrial Products)	Preferred Stock (18,000 shares)		1,800		1,800
		Common Stock (2,000 shares)		200		200

Convenience Corporation of		Debt Securities		8,355		2,738
	America	Preferred Stock (22,301 shares)		334		—
	(Retail)	Warrants		—		—

Cooper Natural Resources, Inc.		Debt Securities		1,750		1,750
	(Industrial Products)	Preferred Stock (6,316 shares)		1,427		1,427
		Warrants		832		832

Coverall North America, Inc.		Loan		10,309		10,309
	(Business Services)	Debt Securities		5,324		5,324
		Warrants		—		—

CPM Acquisition Corporation		Loan		9,604		9,604
	(Industrial Products)

CTT Holdings		Loan		1,388		1,388
	(Consumer Products)

Drilltec Patents &		Loan		10,918		9,262
	Technologies Company, Inc.	Debt Securities		1,500		1,500
	(Industrial Products)	Warrants		—		—

eCentury Capital Partners, L.P.(4)		Limited Partnership Interest		1,875		1,800
	(Private Equity Fund)

El Dorado Communications, Inc.		Loans		306		306
	(Broadcasting & Cable)

Elexis Beta GmbH(3)		Options		426		526
	(Industrial Products)

Eparfin S.A.(3)		Loan		29		29
	(Consumer Products)

E-Talk Corporation		Debt Securities		8,852		6,509
	(Business Services)	Warrants		1,157		—

Ex Terra Credit Recovery, Inc.		Preferred Stock (500 shares)		568		318
	(Business Services)	Common Stock (2,500 shares)		—		—
		Warrants		—		—

Executive Greetings, Inc.		Debt Securities		15,938		15,938
	(Business Services)	Warrants		360		360

Fairchild Industrial Products		Debt Securities		5,872		5,872
	Company	Warrants		280		2,378
	(Industrial Products)

Galaxy American		Debt Securities		48,869		39,217
	Communications, LLC	Options		—		—
	(Broadcasting & Cable)	Standby Letter of Credit ($750)		—		—


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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value

Garden Ridge Corporation		Debt Securities	$	26,948	$	26,948
	(Retail)	Preferred Stock (1,130 shares)		1,130		1,130
		Common Stock (471 shares)		613		613

Ginsey Industries, Inc.		Loans		5,000		5,000
	(Consumer Products)	Convertible Debentures		500		500
		Warrants		—		504

Global Communications, LLC		Loan		1,990		1,990
	(Business Services)	Debt Securities		14,884		14,884
		Equity Interest		11,067		11,067
		Options		1,639		1,639

Grant Broadcasting Systems II		Warrants		87		5,976
	(Broadcasting & Cable)

Grant Television II LLC		Options		492		492
	(Broadcasting & Cable)

Grotech Partners, VI, L.P.(4)		Limited Partnership Interest		1,463		1,060
	(Private Equity Fund)

The Hartz Mountain Corporation		Debt Securities		27,408		27,408
	(Consumer Products)	Common Stock (200,000 shares)		2,000		2,000
		Warrants		2,613		2,613

Hotelevision, Inc.		Preferred Stock (315,100 shares)		315		315
	(Broadcasting & Cable)

Icon International, Inc.		Common Stock (37,821 shares)		1,219		1,519
	(Business Services)

Impact Innovations Group, LLC		Debt Securities		6,598		6,598
	(Business Services)	Warrants		1,674		1,674

Intellirisk Management Corporation		Loans		22,334		22,334
	(Business Services)

Interline Brands, Inc.		Debt Securities		32,839		32,839
	(Business Services)	Warrants		3,169		3,169

iSolve Incorporated		Preferred Stock (14,853 shares)		874		—
	(Business Services)	Common Stock (13,306 shares)		14		—

Jakel, Inc.		Loan		22,291		22,291
	(Industrial Products)

JRI Industries, Inc.		Debt Securities		1,972		1,972
	(Industrial Products)	Warrants		74		74

Julius Koch USA, Inc.		Debt Securities		1,066		1,066
	(Industrial Products)	Warrants		259		7,000

Kirker Enterprises, Inc.		Warrants		348		3,501
	(Industrial Products)	Equity Interest		4		4


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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value

Kirkland’s, Inc.		Debt Securities	$	7,676	$	7,676
	(Retail)	Preferred Stock (917 shares)		412		412
		Warrants		96		96

Kyrus Corporation		Debt Securities		7,810		7,810
	(Business Services)	Warrants		348		348

The Loewen Group, Inc.(1)		High-Yield Senior Secured Debt		15,150		12,440
	(Consumer Services)

Love Funding Corporation		Preferred Stock (26,000 shares)		359		213
	(Financial Services)

Matrics, Inc.		Preferred Stock (511,876 shares)		500		500
	(Business Services)	Warrants		—		—

MedAssets.com, Inc.		Debt Securities		14,949		14,949
	(Business Services)	Preferred Stock (260,417 shares)		2,049		2,049
		Warrants		136		136

Mid-Atlantic Venture Fund IV, L.P.(4)		Limited Partnership Interest		2,475		1,586
	(Private Equity Fund)

Midview Associates, L.P.		Warrants		—		—
	(Housing)

Most Confiserie GmbH & Co KG(3)		Loan		933		933
	(Consumer Products)

MVL Group, Inc.		Loan		1,856		1,856
	(Business Services)	Debt Securities		14,806		14,806
		Warrants		643		643
		Guaranty ($1,357)		—		—

NetCare, AG(3)		Loan		811		811
	(Business Services)

NETtel Communications, Inc.		Debt Securities and Receivables		11,334		4,334
	(Telecommunications)

Northeast Broadcasting Group, L.P.		Debt Securities		310		310
	(Broadcasting & Cable)

Novak Biddle Venture Partners III, L.P.(4)		Limited Partnership Interest		330		330
	(Private Equity Fund)

Nursefinders, Inc.		Debt Securities		11,341		11,341
	(Business Services)	Warrants		900		1,500

Onyx Television GmbH(3)		Preferred Units (120,000 shares)		201		201
	(Broadcasting & Cable)


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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value

Opinion Research Corporation(1)		Debt Securities	$	14,186	$	14,186
	(Business Services)	Warrants		996		996

Oriental Trading Company, Inc.		Debt Securities		12,847		12,847
	(Consumer Products)	Preferred Equity Interest		1,500		1,500
		Common Equity Interest		—		—
		Warrants		13		588

Outsource Partners, Inc.		Debt Securities		23,994		23,994
	(Business Services)	Warrants		826		826

Pico Products, Inc.		Loan		1,406		1,406
	(Industrial Products)

Polaris Pool Systems, Inc.		Debt Securities		6,581		6,581
	(Consumer Products)	Warrants		1,050		1,050

Powell Plant Farms, Inc.		Loan		16,993		16,993
	(Consumer Products)

Proeducation GmbH(3)		Loan		206		206
	(Education)

Prosperco Finanz Holding AG(3)		Convertible Debentures		4,899		4,899
	(Financial Services)	Common Stock (1,528 shares)		956		956
		Warrants		—		—

Raytheon Aerospace, LLC		Debt Securities		5,051		5,051
	(Business Services)	Equity Interest		—		—

Redox Brands, Inc.		Debt Securities		9,462		9,462
	(Consumer Products)	Warrants		584		584

Schwinn Holdings Corporation		Debt Securities		10,195		1,835
	(Consumer Products)

Seasonal Expressions, Inc.		Preferred Stock (504 shares)		500		—
	(Consumer Products)

Simula, Inc.(1)		Loan		19,914		19,914
	(Industrial Products)

Soff-Cut Holdings, Inc.		Debt Securities		8,569		8,569
	(Industrial Products)	Preferred Stock (300 shares)		300		300
		Common Stock (2,000 shares)		200		200
		Warrants		446		446

Southwest PCS, LLC		Loan		8,243		8,243
	(Telecommunications)

Startec Global Communications		Loan		22,815		22,815
	Corporation(1)	Debt Securities		21,286		10,301
	(Telecommunications)	Common Stock (258,064 shares)		3,000		—
		Warrants		—		—


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

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



Private Finance			December 31, 2001
Portfolio Company
(in thousands, except number of shares)		Investment(2)	Cost		Value

SunStates Refrigerated		Loans	$	6,062	$	4,573
	Services, Inc.	Debt Securities		2,445		877
	(Warehouse Facilities)

Sydran Food Services II, L.P.		Debt Securities		12,973		12,973
	(Retail)	Equity Interests		3,909		3,909
		Warrants

Tubbs Snowshoe		Debt Securities		3,913		3,913
	Company, LLC	Equity Interests		500		500
	(Consumer Products)	Warrants		54		54

United Pet Group, Inc.		Debt Securities		4,965		4,965
	(Consumer Products)	Warrants		15		15

Updata Venture Partners II, L.P.(4)		Limited Partnership Interest		2,300		3,865
	(Private Equity Fund)

Velocita, Inc.(1)		Debt Securities		11,677		11,677
	(Telecommunications)	Warrants		3,540		3,540

Venturehouse Group, LLC(4)		Equity Interest		667		398
	(Private Equity Fund)

Walker Investment Fund II, LLLP(4)		Limited Partnership Interest		1,000		743
	(Private Equity Fund)

Warn Industries, Inc.		Debt Securities		18,624		18,624
	(Consumer Products)	Warrants		1,429		3,129

Williams Brothers Lumber		Warrants		24		322
	Company
	(Retail)

Wilshire Restaurant Group, Inc.		Debt Securities		15,106		15,106
	(Retail)	Warrants		735		735

Wilton Industries, Inc.		Loan		12,000		12,000
	(Consumer Products)

Woodstream Corporation		Loan		572		572
	(Consumer Products)	Debt Securities		7,631		7,631
		Equity Interests		1,700		4,547
		Warrants		450		1,203





Total companies less than 5% owned			$	891,231	$	857,053





Total private finance (135 portfolio companies)			$	1,553,966	$	1,595,072


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

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



								December 31, 2001
			Stated
(in thousands, except number of loans)			Interest			Face		Cost		Value

Commercial Real Estate Finance

Commercial Mortgage-Backed Securities
CMBS Bonds
	Mortgage Capital Funding, Series 1998-MC3			5.5	%	$	54,491	$	26,888	$	26,888
	Morgan Stanley Capital I, Series 1999-RM1			6.4	%		51,046		21,462		21,462
	COMM 1999-1			5.6	%		74,879		35,636		35,636
	Morgan Stanley Capital I, Series 1999-FNV1			6.1	%		45,527		22,272		22,272
	DLJ Commercial Mortgage Trust 1999-CG2			6.1	%		96,432		44,732		44,732
	Commercial Mortgage Acceptance Corp., Series 1999-C1			6.8	%		34,856		16,304		16,304
	LB Commercial Mortgage Trust, Series 1999-C2			6.7	%		29,005		11,326		11,326
	Chase Commercial Mortgage Securities Corp., Series 1999-2			6.5	%		43,046		20,535		20,535
	FUNB CMT, Series 1999-C4			6.5	%		49,287		22,253		22,253
	Heller Financial, HFCMC Series 2000 PH-1			6.8	%		45,456		18,657		18,657
	SBMS VII, Inc., Series 2000-NL1			7.2	%		24,230		13,309		13,309
	DLJ Commercial Mortgage Trust, Series 2000-CF1			7.0	%		40,502		19,481		19,481
	Deutsche Bank Alex. Brown, Series Comm 2000-C1			6.9	%		41,084		19,418		19,418
	LB-UBS Commercial Mortgage Trust, Series 2000-C4			6.9	%		31,471		11,455		11,455
	Credit Suisse First Boston Mortgage Securities Corp., Series 2001-CK1			5.9	%		58,786		29,050		29,050
	JP Morgan-CIBC-Deutsche 2001			5.8	%		60,889		29,584		29,584
	Lehman Brothers-UBS Warburg 2001-C4			6.4	%		65,130		32,326		32,326
	SBMS VII, Inc., Series 2001-C1			6.1	%		54,780		25,267		25,267
	GE Capital Commercial Mortgage Securities Corp., Series 2001-2			6.1	%		57,039		28,103		28,103
	Credit Suisse First Boston Mortgage Securities Corp., Series 2001-CKN5			5.2	%		84,482		46,176		46,176
	JP Morgan Chase Commercial Mortgage Securities Corp., Series 2001-C1			5.6	%		55,432		24,075		24,075
	SBMS VII, Inc., Series 2001-C2			6.2	%		72,422		40,037		40,037

		Total CMBS bonds					1,170,272		558,346		558,346

Collateralized Debt Obligation Preferred Shares
	Crest 2001-1, Ltd.(3)						24,207		24,207		24,207

		Total CMBS				$	1,194,479	$	582,553	$	582,553


		Interest		Number of
		Rate Ranges		Loans		Cost		Value

Commercial Mortgage Loans
			Up to 6.99%		7	$	3,404	$	5,100
			7.00%- 8.99%		30		34,583		36,589
			9.00%-10.99%		16		13,617		13,618
			11.00%-12.99%		14		11,977		11,979
			13.00%-14.99%		7		12,455		12,251
		15.00% and above			2		84		60

	Total commercial mortgage loans				76	$	76,120	$	79,597

Residual Interest						$	70,179	$	69,879




Real Estate Owned							3,784		2,489

	Total commercial real estate finance					$	732,636	$	734,518

Total portfolio						$	2,286,602	$	2,329,590

(1) Public company.

(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

(3) Non-U.S. company.

(4) Non-registered investment company.

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information at September 30, 2002 and 2001 and for the

nine months ended September 30, 2002 and 2001 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. In April 2001, ACC established a subsidiary, A.C. Corporation (“AC Corp”), which provides diligence and structuring services on private finance and commercial real estate 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 hereinafter 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 primarily in private companies in a variety of industries and non-investment grade commercial mortgage-backed securities (“CMBS”).

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2001 balances to conform with the 2002 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, the interim financial information does 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 statements 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, 2002 and December 31, 2001 and the results of operations for the three and nine months ended September 30, 2002 and 2001, and changes in net assets and cash flows for the nine months ended September 30, 2002 and 2001. The results of operations for the nine months ended September 30, 2002 are not necessarily indicative of the operating results to be expected for the full year.

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

The private finance portfolio is presented in three categories — companies more 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 or 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 primarily private companies and non-investment grade CMBS. 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. Conversely, the Company will record unrealized appreciation if it believes that the underlying portfolio company has appreciated in value and the Company’s equity security has also appreciated in value, where appropriate. The value of investments in public securities are determined using quoted market prices discounted for restrictions on resale.

Loans and Debt Securities

For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value or 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.

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

that the payment-in-kind interest is not collectible. Loans classified as Grade 4 or Grade 5 assets do not accrue interest. Loan origination fees, original issue discount and market discount are capitalized and then amortized into interest income using the effective interest method. Prepayment premiums are recorded on loans 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’s securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority control positions.

The value of the Company’s equity interests in public companies for which market quotations are readily available is based upon 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”)

CMBS are carried at fair value, which is based upon a discounted cash flow model that utilizes prepayment and loss assumptions based upon historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable market yields for similar CMBS bonds. The Company’s assumption with regard to discount rate for determining fair value is based upon the yield of comparable securities. 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 estimates of future credit losses, actual losses incurred, or actual and estimated prepayment speeds. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the CMBS from the date the estimated yield is changed. The Company recognizes unrealized appreciation or depreciation on its CMBS as comparable yields in the market change and recognizes unrealized depreciation whenever it determines that the value of its CMBS is less than the cost basis due to changes in cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool.

Residual Interest

The Company values its residual interest from a previous securitization and recognizes income using the same accounting policies used for the CMBS. The residual interest is carried at fair value

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

based on discounted estimated future cash flows. The Company recognizes income from the residual interest using the effective interest method. At each reporting date, the effective yield is recalculated and used to recognize income until the next reporting date.

Net Realized and Unrealized Gains or Losses

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

Fee Income

Fee income includes fees for diligence, structuring, transaction services, management services and investment advisory services rendered by the Company to portfolio companies and other third parties. 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.

Deferred Financing Costs

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.

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.

Dividends to Shareholders

Dividends to shareholders are recorded on the record date.

Stock Compensation Plans

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations to account for its stock compensation plans. Under this method, the Company records compensation expense for awards of stock options to employees only if the market price of the stock on the grant date exceeds the amount the employee is required to pay to acquire the stock.

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

corporation subject to federal and state income taxes and records a provision for income taxes as appropriate.

Per Share Information

Basic earnings per share is calculated using the weighted average number of shares outstanding for the period presented. Diluted earnings per 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 GAAP 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 investments at value of $2,343,624,000 and $2,329,590,000 as of September 30, 2002, and December 31, 2001, respectively (93% and 95%, respectively, of total assets). Substantially all of these investments represent investments whose fair values have been determined by the board of directors in good faith in the absence of readily ascertainable 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.

Note 3. Portfolio

Private Finance

At September 30, 2002, and December 31, 2001, the private finance portfolio consisted of the following:



		2002							2001

		Cost		Value		Yield			Cost		Value		Yield
($ in thousands)
Loans and debt securities		$	1,233,583	$	1,122,552		14.4	%	$	1,169,673	$	1,107,890		14.8	%




Equity interests			423,129		540,016					384,293		487,182

	Total	$	1,656,712	$	1,662,568				$	1,553,966	$	1,595,072

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, 2002, and December 31,

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

2001, approximately 97% and 98%, respectively, of the Company’s private finance loan portfolio was composed of fixed interest rate loans.

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 gain on sale.

At September 30, 2002, and December 31, 2001, the Company had an investment at value totaling $254,317,000 and $227,449,000, respectively, in Business Loan Express, Inc. (“BLX”), a small business lender that participates in the U.S. Small Business Administration or SBA 7(a) Guaranteed Loan Program. At September 30, 2002, the Company owns 94.9% of BLX’s common stock. The Company’s common stock ownership is subject to dilution by management options. As the controlling shareholder 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 3-year unsecured $124,000,000 revolving credit facility that matures in March 2004. The amount guaranteed by the Company at September 30, 2002, and December 31, 2001, was $48,476,000 and $51,350,000, respectively. 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, 2002. In consideration for providing this guaranty, BLX will pay the Company an annual guaranty fee of approximately $3,100,000 in 2002. The Company has also provided two standby letters of credit in connection with two term securitization transactions completed by BLX in the second quarter of 2002 totaling $10,550,000. BLX is headquartered in New York, NY.

At September 30, 2002, and December 31, 2001, the Company had an investment in The Hillman Companies, Inc. (formerly SunSource, Inc.) totaling $131,507,000 and $97,227,000 at value, respectively. At September 30, 2002, the Company owns 93.2% 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’s primary operations are located in Cincinnati, Ohio.

At December 31, 2001, the Company had an investment in WyoTech Acquisition Corporation at value totaling $60,388,000. WyoTech is a proprietary trade school and its primary operations are in Laramie, Wyoming. On July 1, 2002, the Company completed the sale of WyoTech Acquisition Corporation to a third party. The Company’s total proceeds from the sale of WyoTech, including the repayment of debt and preferred stock and the sale of the Company’s 91% common equity ownership, were $77.2 million, resulting in a realized gain of $60.8 million in the third quarter of 2002. The sale of WyoTech is subject to post-closing working capital adjustments, if any, and customary indemnification provisions.

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

At September 30, 2002, and December 31, 2001, loans and debt securities, classified as Grades 4 and 5 under the Company’s internal grading system, that were not accruing interest at value were as follows:


	2002		2001
(in thousands)
Companies more than 25% owned	$	13,429	$	930




Companies 5% to 25% owned		899		2,848




Companies less than 5% owned		59,526		89,966

	$	73,854	$	93,744

Included in Grade 4 and 5 loans and debt securities not accruing interest were assets valued at $8,905,000 at December 31, 2001 that were related to portfolio companies in liquidation. As of September 30, 2002, $8,908,000 at value representing receivables related to portfolio companies in liquidation were included in other assets. In addition to Grade 4 and 5 assets that are in workout, the Company may not accrue interest on loans to companies that are more than 50% owned by the Company if such companies are in need of additional capital and, therefore, the Company may defer current debt service. Loans and debt securities to such companies totaled $63,810,000 at value at September 30, 2002.

The industry and geographic compositions of the private finance portfolio at value at September 30, 2002, and December 31, 2001, were as follows:


		2002			2001

Industry




Consumer products			31	%		28	%




Business services			27			22




Financial services			16			15




Industrial products			9			10




Retail			5			5




Healthcare services			4			3




Telecommunications			3			4




Broadcasting & cable			2			4




Education			1			5




Other			2			4

	Total		100	%		100	%

Geographic Region




Mid-Atlantic			44	%		43	%




West			17			19




Midwest			16			17




Southeast			14			14




Northeast			8			5




International			1			2

	Total		100	%		100	%

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

Commercial Real Estate Finance

At September 30, 2002, and December 31, 2001, the commercial real estate finance portfolio consisted of the following:



		2002							2001

		Cost		Value		Yield			Cost		Value		Yield
($ in thousands)
CMBS		$	509,641	$	549,433		14.7	%	$	582,553	$	582,553		14.8	%




Loans			61,456		59,656		8.0	%		76,120		79,597		7.7	%




Residual interest			69,335		69,035		9.4	%		70,179		69,879		9.4	%




Real estate owned			4,787		2,932					3,784		2,489

	Total	$	645,219	$	681,056				$	732,636	$	734,518

CMBS

At September 30, 2002, and December 31, 2001, the CMBS portfolio consisted of the following:



		2002							2001

		Cost		Value		Yield			Cost		Value		Yield
(in thousands)
CMBS bonds		$	456,610	$	496,402		14.5	%	$	558,346	$	558,346		14.7	%




Collateralized debt obligation preferred shares			53,031		53,031		17.2	%		24,207		24,207		16.9	%

	Total	$	509,641	$	549,433				$	582,553	$	582,553

CMBS Bonds. At September 30, 2002, and December 31, 2001, the CMBS bonds, which were purchased from the original issuer, consisted of the following:


	2002			2001
($ in thousands)
Face	$	1,052,162		$	1,170,272




Original issue discount		(595,552	)		(611,926	)

Cost	$	456,610		$	558,346

Value	$	496,402		$	558,346

Yield		14.5%			14.7%

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 Company’s most subordinate tranche will bear this loss first. At September 30, 2002, the Company’s CMBS bonds were subordinate to 91% to 97% of the tranches of bonds issued in various CMBS transactions. Given that the non-investment grade CMBS bonds in which the Company invests are junior in priority for payment of principal, the Company invests in these CMBS bonds at a discount from the face amount of the bonds.

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

The underlying rating classes of the CMBS bonds at value at September 30, 2002, and December 31, 2001, were as follows:



		2002					2001

				Percentage					Percentage
		Value		of Total			Value		of Total
($ in thousands)
BB+		$	26,434		5.3	%	$	24,785		4.4	%




BB			26,503		5.3			69,404		12.4




BB-			13,199		2.7			67,460		12.1




B+			112,741		22.7			103,560		18.6




B			140,764		28.4			131,362		23.5




B-			80,309		16.2			73,572		13.2




CCC			8,893		1.8			8,893		1.6




Unrated			87,559		17.6			79,310		14.2

	Total	$	496,402		100.0	%	$	558,346		100.0	%

At September 30, 2002, and December 31, 2001, the underlying pools of mortgage loans that are collateral for the Company’s CMBS bonds consisted of approximately 4,100 and 3,800 commercial mortgage loans with a total outstanding principal balance of $22.9 billion and $20.5 billion, respectively. At September 30, 2002, and December 31, 2001, 0.99% and 0.52%, respectively, of the mortgage loans in the underlying collateral pool for the Company’s CMBS bonds were over 30 days delinquent or were classified as real estate owned. The property types and the geographic composition of the underlying mortgage loans in the underlying collateral pool calculated using the outstanding principal balance at September 30, 2002, and December 31, 2001, were as follows:


		2002			2001

Property Type




Retail			32	%		31	%




Housing			27			27




Office			21			22




Hospitality			7			7




Industrial Real Estate			6			6




Other			7			7

	Total		100	%		100	%






Geographic Region




West		31	%	32	%




Mid-Atlantic		25		24




Midwest		22		21




Southeast		17		17




Northeast		5		6

	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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

timing and magnitude of credit losses on the mortgage loans underlying the CMBS that are a result of the general condition of the real estate market (including competition for tenants and their related 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 entire 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.

The Company acts as the directing certificate holder for the CMBS bonds, which allows the Company to approve disposition plans for individual collateral securities.

Collateralized Debt Obligation Preferred Shares. At September 30, 2002, the Company owned preferred shares in four collateralized debt obligations (“CDOs”) secured by investment grade unsecured debt issued by various real estate investment trusts (“REITs”) and investment and non-investment grade CMBS bonds. The investment grade REIT collateral consists of debt with a cut-off balance of $1,017,553,000 and was issued by 42 REITs. The investment grade CMBS collateral consisted of CMBS bonds with a face amount of $479,021,000 issued in 39 separate CMBS transactions. The non-investment grade CMBS collateral consists of BB+, BB and BB- CMBS bonds with a face amount of $463,426,000 issued in 39 separate CMBS transactions (“CMBS Collateral”). Included in the CMBS Collateral for the CDOs are $397,872,000 of CMBS bonds that are senior in priority of repayment to certain lower rated CMBS bonds held by the Company, which were issued in 23 separate CMBS transactions. The preferred shares are junior in priority for payment of principal and interest to the more senior tranches of debt issued by the CDOs. To the extent there are defaults and unrecoverable losses on the underlying collateral resulting in reduced cash flows, the preferred shares will bear this loss first. At September 30, 2002, the Company’s preferred shares in the CDOs were subordinate to approximately 96% of the more senior tranches of debt issued by the CDOs.

The Company acts as the disposition consultant with respect to three of the CDOs, which allows the Company to approve disposition plans for individual collateral securities. For these services with respect to the CDOs, the Company collects annual fees based on the outstanding collateral pool balance, and for the nine months ended September 30, 2002, this fee totaled $322,000.

Loans

The commercial mortgage loan portfolio contains loans that were originated by the Company or were purchased from third-party sellers.

At September 30, 2002 and December 31, 2001, approximately 78% and 22% and 76% and 24% of the Company’s commercial mortgage loan portfolio was composed of fixed and adjustable interest rate loans, respectively. As of September 30, 2002 and December 31, 2001, workout loans, or those loans in Grade 4 and 5, with a value of $14,255,000 and $15,241,000, respectively, were not accruing interest.

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 loan portfolio at value at September 30, 2002, and December 31, 2001, were as follows:


		2002			2001

Property Type




Office			29	%		34	%




Hospitality			25			25




Retail			24			21




Recreation			3			4




Other			19			16

	Total		100	%		100	%


Geographic Region




Southeast			43	%		36	%




West			22			20




Mid-Atlantic			15			23




Midwest			12			16




Northeast			8			5

	Total		100	%		100	%

Residual Interest

At September 30, 2002, and December 31, 2001, the residual interest consisted of the following:



		2002				2001

		Cost		Value		Cost		Value
(in thousands)
Residual interest		$	68,853	$	68,853	$	68,853	$	68,853




Residual interest spread			482		182		1,326		1,026

	Total	$	69,335	$	69,035	$	70,179	$	69,879

The residual interest primarily consists of a retained interest totaling $68,853,000 from a 1998 asset securitization whereby bonds were sold in three classes rated AAA, AA and A. The residual interest represents a right to cash flows from the underlying collateral pool of loans after these senior bond obligations are satisfied. At September 30, 2002, one class of bonds rated AAA is outstanding, totaling $21,707,000. The Company has the right to call the bonds upon a minimum of ten days notice to the bondholders. Once the bonds are fully repaid, either through the cash flows from the securitized loans or due to the Company calling the bonds, the remaining loans in the trust will be returned to the Company as payment on the residual interest.

The Company sold $295 million of loans, and received cash proceeds, net of costs, of approximately $223 million in January 1998. The Company retained a trust certificate for its residual interest in a loan pool sold, and will receive interest income from this residual interest as well as the residual interest spread (“Residual”) from the interest earned on the loans sold less the interest paid on the bonds over the life of the bonds. As of September 30, 2002, and December 31, 2001, the

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

mortgage loan pool had an approximate weighted average stated interest rate of 9.3%. The outstanding bond classes sold had an aggregate weighted average interest rate of 6.7% and 6.6% as of September 30, 2002, and December 31, 2001, respectively.

The Company uses a discounted cash flow methodology for determining the fair value of its retained Residual. In determining the cash flow of the Residual, the Company assumes a prepayment speed of 15% after the applicable prepayment lockout period and credit losses of 1% or approximately $1.0 million of the total principal balance of the underlying collateral throughout the life of the collateral. These assumptions result in an expected weighted average life of the bonds of 0.5 years. The value of the resulting Residual cash flows is then determined by applying a discount rate of 9% which, in the Company’s view, is commensurate with the market risk of comparable assets.

Note 4. Debt

The Company records debt at cost. At September 30, 2002, and December 31, 2001, the Company had the following debt:



			2002				2001

			Facility		Amount		Facility		Amount
			Amount		Drawn		Amount		Drawn
(in thousands)
Notes payable and debentures:




	Unsecured long-term notes payable		$	694,000	$	694,000	$	694,000	$	694,000




	SBA debentures			101,800		94,500		101,800		94,500




	Auction rate reset note			75,000		75,000		81,856		81,856




	OPIC loan			5,700		5,700		5,700		5,700

		Total notes payable and debentures		876,500		869,200		883,356		876,056

Revolving line of credit				527,500		121,500		497,500		144,750

	Total		$	1,404,000	$	990,700	$	1,380,856	$	1,020,806

Notes Payable and Debentures

Unsecured Long-Term Notes Payable. The Company 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, 2002, the notes had remaining maturities of eight months to four years. The weighted average fixed interest rate on the notes was 7.6% at September 30, 2002, and December 31, 2001. The notes may be prepaid in whole or in part, together with an interest premium, as stipulated in the note agreement.

SBA Debentures. At September 30, 2002, and December 31, 2001, the Company had debentures payable to the SBA with terms of ten years and at fixed interest rates ranging from 5.9% to 8.2% and 2.4% to 8.2%, respectively. At September 30, 2002, the debentures had remaining maturities of two to ten years. The weighted average interest rate was 7.0% and 6.7% at September 30, 2002 and December 31, 2001, respectively. 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 maturity. At September 30, 2002, the Company has a

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued

commitment from the SBA to borrow up to an additional $7,300,000 above the amount outstanding. The commitment expires on September 30, 2005.

Auction Rate Reset Note. The Company has an Auction Rate Reset Senior Note Series A that bears interest at the three-month London Interbank Offered Rate (“LIBOR”) plus 1.75%, which adjusts quarterly. Interest is due quarterly and the note matures on December 27, 2002, as amended.

As a means to repay the note, the Company has entered into an agreement with the placement agent of this note to serve as the placement agent on a future issuance of $75.0 million of debt, equity or other securities in one or more public or private transactions. Alternatively, the Company may repay the note in cash without conducting a capital raise. If the Company chooses to repay the note in cash without conducting a capital raise, the Company will incur additional expense of approximately $3,188,000.

Scheduled future maturities of notes payable and debentures at September 30, 2002, are as follows:


		Amount Maturing
Year		(in thousands)

2002		$	75,000




2003			140,000




2004			221,000




2005			179,000




2006			180,700




Thereafter			73,500

	Total	$	869,200

Revolving Line of Credit

The Company has an unsecured revolving line of credit for $527,500,000. The facility may be expanded up to $600,000,000 at the Company’s option. The facility bears interest at a rate equal to (i) the one-month LIBOR plus 1.25% or (ii) the higher of (a) the Bank of America, N.A. prime rate or (b) the Federal Funds rate plus 0.50%. The interest rate adjusts at the beginning of each new interest period, usually every thirty days. The interest rates were 3.3% and 3.2% at September 30, 2002, and December 31, 2001, respectively, and the facility requires an annual commitment fee equal to 0.25% of the committed amount. The line expires in August 2003, and may be extended under substantially similar terms for one additional year at the Company’s sole option. The line of credit requires monthly interest payments and all principal is due upon its expiration.

The average debt outstanding on the revolving line of credit was $55,785,000 and $106,338,000 for the nine months ended September 30, 2002, and for the year ended December 31, 2001, respectively. The maximum amount borrowed under this facility and the weighted average interest rate for the nine months ended September 30, 2002, and for the year ended December 31, 2001, were $145,250,000 and $213,500,000, and 3.2% and 5.4%, respectively.

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued

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, 2002, the Company was in compliance with these covenants.

Note 5. 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.

Note 6. Shareholders’ Equity

Sales of common stock for the nine months ended September 30, 2002, and the year ended December 31, 2001, were as follows:


		2002			2001
(in thousands)
Number of common shares			1,946			13,286




Gross proceeds		$	51,800		$	301,539




Less costs including underwriting fees			(1,880	)		(14,651	)

	Net proceeds	$	49,920		$	286,888

In addition, the Company issued 204,855 shares of common stock with a value of $5,157,000 to acquire one portfolio investment in a stock-for-stock exchange during 2001.

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 days immediately prior to the dividend payment date.

Dividend reinvestment plan activity for the nine months ended September 30, 2002, and for the year ended December 31, 2001, was as follows:


	2002		2001
(in thousands, except per share amounts)
Shares issued		203		271




Average price per share	$	23.12	$	23.32

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 7. Earnings Per Common Share

Earnings per common share for the three and nine months ended September 30, 2002, and 2001, were as follows:



	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,

	2002			2001			2002			2001
(in thousands, except per share amounts)
Net increase in net assets resulting from operations	$	45,520		$	59,703		$	174,935		$	157,837




Less preferred stock dividends		(55	)		(55	)		(165	)		(165	)

Income available to common shareholders	$	45,465		$	59,648		$	174,770		$	157,672

Basic shares outstanding		102,327			92,903			101,329			89,282




Dilutive options outstanding to officers		975			1,682			1,711			1,582

Diluted shares outstanding		103,302			94,585			103,040			90,864

Basic earnings per common share	$	0.44		$	0.64		$	1.73		$	1.77

Diluted earnings per common share	$	0.44		$	0.63		$	1.70		$	1.74

Note 8. Dividends and Distributions

The Company’s Board of Directors declared and the Company paid dividends of $0.53, $0.55 and $0.56 per common share for the first, second and third quarters of 2002, respectively. The dividends totaled $57,340,000 and $166,823,000 for the three and nine months ended September 30, 2002, respectively. The Company’s Board of Directors also declared a dividend of $0.56 per common share for the fourth quarter of 2002.

Note 9. Supplemental Disclosure of Cash Flow Information

For the nine months ended September 30, 2002, and 2001, the Company paid $40,565,000 and $36,867,000, respectively, for interest. For the nine months ended September 30, 2002, and 2001, the Company’s non-cash financing activities totaled $7,077,000 and $9,338,000, respectively, and includes stock option exercises and dividend reinvestment.

Note 10. Hedging Activities

The Company invests in CMBS bonds, which are purchased at prices that are based on the 10-year Treasury rate. The Company has entered into transactions with two financial institutions to hedge against movement in Treasury rates on certain of the BB+, BB and BB- rate CMBS bonds. These transactions involved the Company receiving the proceeds from the sale of borrowed Treasury securities, with the obligation to replenish the borrowed Treasury securities at a later date based on

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10. Hedging Activities, continued

the then current market price. Borrowed Treasury securities as of September 30, 2002, and December 31, 2001, consisted of the following:



	September 30, 2002				December 31, 2001
(in thousands)
Description of Issue	Cost		Value		Cost		Value

10-year Treasury, due August 2011	$	—	$	—	$	19,175	$	17,989




10-year Treasury, due August 2011		—		—		5,693		5,656




10-year Treasury, due August 2011		—		—		23,636		23,618




10-year Treasury, due February 2012		2,628		2,888		—		—




10-year Treasury, due February 2012		25,271		28,662		—		—




10-year Treasury, due February 2012		18,765		20,664		—		—

	$	46,664	$	52,214	$	48,504	$	47,263

Obligations to replenish borrowed Treasury securities as of September 30, 2002 and December 31, 2001 were $52,214,000 and $47,263,000 respectively, and are recorded as other liabilities. As of September 30, 2002, the total obligations on the hedge had increased since the original sale date due to changes in the yield on the borrowed Treasury securities, resulting in unrealized depreciation on the obligations of $5,550,000. The net proceeds related to the sales of the borrowed Treasury securities of $46,664,000 and $48,504,000 have been included in other assets at September 30, 2002 and December 31, 2001, respectively. Under the terms of the transactions, the Company has provided additional cash collateral of $5,026,000 at September 30, 2002 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. The cash collateral has been included in other assets in the accompanying consolidated financial statements.

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 11. Financial Highlights



		At and for the
		Nine Months Ended
		September 30,						At and for the Years Ended December 31,

		2002(5)			2001(5)			2001			2000			1999			1998			1997


		(unaudited)




Per Common Share Data




Net asset value, beginning of period		$	13.57		$	12.11		$	12.11		$	10.20		$	8.79		$	8.07		$	8.34

	Net investment income before income tax benefit (expense) and net realized and unrealized gains(1)		1.38			1.39			1.92			1.53			1.18			1.06			0.94




	Income tax benefit (expense)(1)		(0.01	)		—			0.01			—			—			(0.01	)		(0.03	)




	Net realized and unrealized gains(1)		0.33			0.35			0.23			0.41			0.46			0.45			0.36




	Minority interests(1)		—			—			—			—			—			—			(0.03	)

Net increase in net assets resulting from operations			1.70			1.74			2.16			1.94			1.64			1.50			1.24

Net decrease in net assets from shareholder distributions(2)			(1.64	)		(1.50	)		(2.01	)		(1.82	)		(1.60	)		(1.43	)		(1.71	)




Net increase in net assets from capital share transactions			0.32			1.07			1.31			1.79			1.37			0.65			0.20

Net asset value, end of period		$	13.95		$	13.42		$	13.57		$	12.11		$	10.20		$	8.79		$	8.07

Market value, end of period		$	21.89		$	22.75		$	26.00		$	20.88		$	18.31		$	17.31		$	22.25




Total return			(10	)%		16	%		36	%		25	%		15	%		(16	)%		77	%




Ratios and Supplemental Data ($ and shares in thousands, except per share amounts)




Ending net assets		$	1,429,049		$	1,300,237		$	1,352,123		$	1,029,692		$	667,513		$	491,358		$	420,060




Common shares outstanding at end of period(3)			102,468			96,921			99,607			85,057			65,414			55,919			52,047




Diluted weighted average shares outstanding			103,040			90,864			93,003			73,472			60,044			51,974			49,251




Employee and administrative expenses/ average net assets			2.67	%		2.85	%		3.80	%		4.98	%		6.25	%		7.09	%		4.66	%




Total expenses/average net assets(4)			6.42	%		7.06	%		9.31	%		11.88	%		12.44	%		11.86	%		12.43	%




Net investment income/ average net assets(4)			10.11	%		11.07	%		15.15	%		13.55	%		12.61	%		12.72	%		11.15	%




Portfolio turnover rate			13.97	%		9.27	%		10.04	%		28.92	%		34.19	%		63.53	%		42.72	%




Average debt outstanding		$	927,270		$	821,900		$	847,121		$	707,400		$	461,500		$	261,300		$	336,800




Average debt per share		$	9.00		$	9.05		$	9.11		$	9.63		$	7.69		$	5.03		$	6.84


(1)	Based on diluted weighted average number of shares outstanding for the period.

(2)	For the year ended December 31, 1997, shareholder distributions included $0.51 of merger-related dividends.

(3)	Excludes 234,977, 516,779 and 810,456 common shares held in the deferred compensation trust at or for the years ended December 31, 2000, 1999, and 1998, respectively.

(4)	For the purpose of calculating the ratios, total expenses and net investment income for the year ended December 31, 1997 exclude merger expenses of $5,159,000.

(5)	The results for the nine months ended September 30, 2002 and 2001, respectively, are not necessarily indicative of the operating results to be expected for the full year.

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 12. Litigation

A series of class action lawsuits had been filed in the United States District Court for the Southern District of New York against the Company, certain of its directors and officers and its former independent auditors, Arthur Andersen LLP, with respect to alleged violations of the securities laws. These lawsuits alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, specifically they alleged, among other things, that the Company purportedly misstated the value of certain portfolio investments in its financial statements, which allegedly resulted in the purchase of its common stock by purported class members at artificially inflated prices. Several of the complaints also alleged state law claims for common law fraud. The complaints sought compensatory and other damages, and costs and expenses associated with the litigation. The lawsuits have been consolidated into a single proceeding captioned In re Allied Capital Corp. Securities Litigation, 02 CV 3812. The consolidated complaint does not include Arthur Andersen LLP as a named defendant or assert any state law claims against the named defendants. The Company believes that the lawsuit is without merit, and it intends to defend the lawsuit vigorously. While the Company does not expect these matters to materially affect its financial condition or results of operations, there can be no assurance as to whether any such pending litigation will have a material adverse effect on its financial condition or results of operations in any future reporting period.

The Company also is party to certain other lawsuits in the normal course of business. 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 the Company’s financial condition or results of operations.

Independent Accountants’ Review Report

The Board of Directors and Shareholders
Allied Capital Corporation and Subsidiaries:

We have reviewed the accompanying consolidated balance sheet of Allied Capital Corporation and subsidiaries, including the consolidated statement of investments, as of September 30, 2002, and the related consolidated statements of operations for the three- and nine-month periods ended September 30, 2002, changes in net assets and cash flows for the nine-month period ended September 30, 2002, and financial highlights (included in Note 11) for the nine-month period ended September 30, 2002. These consolidated financial statements and financial highlights are the responsibility of the Company’s management.

We conducted our review 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 to financial data 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 review, 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.

The consolidated financial statements of the Company as of and for the year ended December 31, 2001, were audited by other accountants whose report dated February 20, 2002, expressed an unqualified opinion on those consolidated financial statements. Such consolidated financial statements were not audited by us and, accordingly, we do not express an opinion or any form of assurance on the information set forth in the accompanying consolidated balance sheet, including the consolidated statement of investments, as of December 31, 2001. Additionally, the consolidated statements of operations for the three-month and nine-month periods ended September 30, 2001, and the related statement of changes in net assets and cash flows for the nine-month period ended September 30, 2001, and financial highlights (included in Note 11) for the nine-month period ended September 30, 2001, were not reviewed or audited by us and, accordingly, we do not express an opinion or any form of assurance on them.

/s/ KPMG LLP

Washington, D.C.

October 21, 2002


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

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, 2001.

Financial or other information presented for private finance portfolio companies has been obtained from the portfolio company, 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 support the expansion of companies in a variety of industries. Our lending and investment activity is generally focused in private finance and commercial real estate finance, primarily in non-investment grade commercial mortgage-backed securities, which we refer to as CMBS. 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.

Our portfolio composition at September 30, 2002, and December 31, 2001, was as follows:


	At		At
	September 30,		December 31,
	2002		2001

Private Finance		71%		68%




Commercial Real Estate Finance		29%		32%

Our earnings depend primarily on the level of interest and related portfolio income, fee income and net realized and unrealized 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 for which interest is not accruing and our ability to secure debt and equity capital for our investment activities.

PORTFOLIO AND INVESTMENT ACTIVITY

Total portfolio investment activity and yields at and for the three and nine months ended September 30, 2002 and 2001, and at and for the year ended December 31, 2001, were as follows:



	At and for the						At and for the						At and for the
	Three Months Ended						Nine Months Ended						Year Ended
	September 30,						September 30,						December 31,

	2002			2001			2002			2001			2001
($ in millions)

	(unaudited)						(unaudited)




Portfolio at value	$	2,343.6		$	2,174.4		$	2,343.6		$	2,174.4		$	2,329.6




Investments funded	$	157.6		$	213.7		$	353.0		$	513.5		$	680.3




Change in accrued or reinvested interest and dividends	$	13.5		$	14.9		$	33.0		$	40.4		$	51.6




Principal repayments	$	44.7		$	7.9		$	111.7		$	50.4		$	74.5




CMBS and commercial real estate loan sales	$	87.2		$	55.4		$	213.5		$	130.0		$	130.0




Yield*		14.1	%		14.1	%		14.1	%		14.1	%		14.3	%


*	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.

Private Finance

The private finance portfolio, investment activity and yields at and for the three and nine months ended September 30, 2002 and 2001, and at and for the year ended December 31, 2001, were as follows:



		At and for the						At and for the						At and for
		Three Months Ended						Nine Months Ended						the Year Ended
		September 30,						September 30,						December 31,

		2002			2001			2002			2001			2001
($ in millions)

		(unaudited)						(unaudited)




Portfolio at value:




	Loans and debt securities	$	1,122.6		$	1,095.6		$	1,122.6		$	1,095.6		$	1,107.9




	Equity interests		540.0			443.7			540.0			443.7			487.2

Total portfolio		$	1,662.6		$	1,539.3		$	1,662.6		$	1,539.3		$	1,595.1

Investments funded		$	148.7		$	116.9		$	218.4		$	230.7		$	287.7




Change in accrued or reinvested interest and dividends		$	13.5		$	14.8		$	32.6		$	39.2		$	48.9




Principal repayments		$	44.2		$	6.0		$	100.2		$	29.1		$	43.8




Yield*			14.4	%		14.5	%		14.4	%		14.5	%		14.8	%


*	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.

Investments funded during the three and nine month periods ended September 30, 2002, and the year ended December 31, 2001, consisted of the following:


			Loans and		Equity
			Debt Securities		Interests		Total
($ in thousands)
*For the three months ended September 30, 2002(1)*




	Companies more than 25% owned		$	15,775	$	300	$	16,075




	Companies 5% to 25% owned			17,314		386		17,700




	Companies less than 5% owned			106,995		7,886		114,881

		Total	$	140,084	$	8,572	$	148,656

*For the nine months ended September 30, 2002(1)*




	Companies more than 25% owned		$	31,737	$	4,059	$	35,796




	Companies 5% to 25% owned			24,808		7,432		32,240




	Companies less than 5% owned			141,018		9,392		150,410

		Total	$	197,563	$	20,883	$	218,446

*For the year ended December 31, 2001(1)*




	Companies more than 25% owned		$	47,860	$	78,260	$	126,120




	Companies 5% to 25% owned			8,203		3,721		11,924




	Companies less than 5% owned			142,144		7,548		149,692

		Total	$	198,207	$	89,529	$	287,736

(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 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, 2002, we had outstanding funding commitments of $92.8 million to portfolio companies, including $28.1 million committed to private venture capital funds. At September 30, 2002, we also had total commitments to private finance portfolio companies in the form of standby letters of credit and guarantees of $61.7 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 growth investment.

We may acquire more than 50% of the common stock of a company in a control buyout transaction. Control 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 common stock, and management or transaction services fees to compensate us for the managerial assistance that we provide to a controlled portfolio company. In some cases for companies that are more than 50% owned, we may not accrue interest on loans and debt securities if such company is in need of additional capital and, therefore, we may defer current debt service. Our most significant

investments acquired through control buyout transactions at September 30, 2002, were The Hillman Companies, Inc., (formerly SunSource, Inc.), acquired in 2001 and Business Loan Express, Inc., acquired in 2000.

The Hillman Companies, Inc. During 2001, we acquired 93.2% of the common equity of SunSource, Inc. for $71.5 million in cash. Subsequently, SunSource completed the sale of its STS business unit and distributed $16.5 million in cash to us, reducing our common stock cost basis to $57.2 million at December 31, 2001. As part of the STS sale, we invested $3.2 million in the new STS. During the third quarter of 2001, we received fees from SunSource of $2.8 million related to transaction assistance for the SunSource sale and STS sale, and $1.6 million for the syndication of SunSource’s senior credit facilities. In addition, we realized a gain of $2.5 million from the sale of warrants prior to the buyout transaction. During the first quarter of 2002, SunSource changed its name to The Hillman Companies, Inc., also referred to as Hillman.

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.

During the second quarter of 2002, we recorded unrealized appreciation on this investment of $32.8 million. At September 30, 2002, our investment in Hillman totaled $131.5 million at value, or 5.2% of total assets. We did not change the unrealized appreciation on our investment in Hillman during the third quarter of 2002, as the fair value of our investment was still within our range of estimations of enterprise value for the company. Hillman remains on plan with respect to achieving its estimated 2002 earnings before interest, taxes, depreciation, amortization and management fees, of approximately $50 million.

Business Loan Express, Inc. On December 31, 2000, we acquired 94.9% of BLC Financial Services, Inc. in a “going private” buyout transaction for $95.2 million. We issued approximately 4.1 million shares of our common stock, or $86.1 million of new equity, and paid $9.1 million in cash to acquire BLC, which thereafter changed its name to Business Loan Express, Inc.

As part of the transaction, we recapitalized Allied Capital Express, our small business lending operation, as an independently managed private portfolio company and merged it into Business Loan Express. We contributed certain assets, including our online rules-based underwriting technology and fixed assets, and transferred 37 employees to the private portfolio company. Upon completion of the transaction, our investment in Business Loan Express as of December 31, 2000 totaled $204.1 million and consisted of $74.5 million of subordinated debt, $25.1 million of preferred stock, and $104.5 million of common stock.

At September 30, 2002, our investment in Business Loan Express totaled $254.3 million at value, or 10.1% of our total assets, which includes unrealized appreciation of $35.4 million. We did not change the unrealized appreciation on our investment in BLX during the third quarter of 2002, as the fair value of our investment was still within our range of estimations of enterprise value. In determining the equity value included in the estimated enterprise value, we assumed that BLX’s equity securities would be valued at a multiple of approximately 8 times trailing 2002 pro-forma net income of $23 million,

which results from BLX’s actual fiscal 2002 earnings adjusted for management fees and a pro-forma capital structure that assumes the sale of the company.

To view another measure of the fair value of our investment in BLX, we compared our investment at fair value in BLX of $254.3 million to our share of the book value of BLX’s junior capital. Our share of BLX’s junior capital totals $145.7 million and includes subordinated debt due to us of $89.4 million, preferred equity of $25.1 million and our share of common equity, including paid-in capital and retained earnings of $31.2 million. This comparison shows that the fair value of our $254.3 million investment is 1.7 times the cost or book basis of our share of BLX’s junior capital in total.

Summary financial data for Business Loan Express at and for the quarter ended September 30, 2002, and the year ended June 30, 2002, was as follows:


		At and for the			At and for the
		Quarter Ended			Year Ended
		September 30, 2002(1)			June 30, 2002
($ in millions)
Operating Data




	Total revenue	$	25.7		$	84.6




	Profits before taxes	$	1.5		$	3.6




	Earnings before interest, taxes and management fees (EBITM)	$	12.9		$	43.0




Balance Sheet Data




	Total assets(2)	$	279.7		$	277.1




	Total debt	$	186.1		$	183.0




	Total shareholders’ equity	$	60.7		$	59.9




Cash Flow Data




	Cash provided by operating activities	$	10.7		$	18.7




	Cash used in investing activities	$	(8.6	)	$	(37.1	)




	Cash provided by financing activities	$	0.7		$	3.0




Other Data




	Total loan originations	$	153.7		$	565.1




	Serviced loan portfolio	$	1,501.6		$	1,372.6




	Number of loans		2,251			2,083




	Loan delinquencies(3)		8.5%			9.4%


(1)	Financial data at and for the quarter ended September 30, 2002, is unaudited. The results of operations, changes in cash flows and loan originations for the three months ended September 30, 2002 are not necessarily indicative of the operating results to be expected for the full year.
(2)	Included in total assets is $6 million of goodwill. 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.
(3)	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 7.9% at September 30, 2002. Delinquencies for the types of small business loans made by BLX typically range between 8% and 12%.

The loans originated by BLX are generally secured by commercial real estate. Loans originated under the 7(a) Guaranteed Loan Program also require the personal guarantee of the borrower and, in many cases, the loans are also secured by additional real estate collateral. Because the loans are secured by collateral, BLX’s annual loan losses for its

serviced SBA 7(a) loans, computed using the unguaranteed balance of the SBA 7(a) loan portfolio, were less than 1% on average for the last five fiscal years.

Business Loan Express sells or securitizes substantially all of the loans it originates. BLX currently sells the guaranteed piece of SBA 7(a) guaranteed loans for cash premiums of up to 10% of the guaranteed loan amount plus a retained annual servicing fee generally between 1% and 2.0% of the guaranteed loan amount. Alternatively, BLX may sell the guaranteed piece of SBA 7(a) guaranteed loans at par and retain an annual servicing spread, at current prices, of generally between 4.0% and 4.8%. BLX securitizes the unguaranteed piece of the SBA 7(a) loans and conventional loans it originates. Typically, BLX retains up to 2.7% of the loan securitization pools and receives a spread from the excess of loan interest received on the loans sold over the interest cost on the securities issued in the securitization generally between 4.7% and 4.8%.

As a result of BLX’s guaranteed loan sales and as a result of securitization transactions, BLX had assets at September 30, 2002, totaling approximately $116.1 million representing the residual interests in and servicing assets for loans sold or securitized, together referred to as Residual Interests. These Residual Interests represent the discounted present value of future cash flow streams to be received from loans sold or securitized after making allowances for estimated prepayments, losses and loan delinquencies.

If loan payments on all loans were to be received as stated in the loan agreements, estimated future cash flows to BLX from loans sold or securitized would total approximately $469 million in the aggregate over the remaining term of these loans. Of the approximate $469 million, estimated cash flows for the 12 months ended September 30, 2003, 2004, 2005, and 2006 would be approximately $36 million, $35 million, $34 million and $33 million, respectively.

BLX’s cash flow from operations for the quarter ended September 30, 2002 was $10.7 million. Sources of cash flow from operations include net income, cash proceeds from loan sales net of cash used for loans originated, and changes in working capital. BLX’s cash used in investing activities for the quarter ended September 30, 2002 was $8.6 million. Cash used in investing activities includes the origination of residual interests from loans sold, net of collections of residual interests and cash used to purchase fixed assets. BLX’s external cash funding requirements to finance its operations and loan portfolio for the quarter were $0.7 million which was funded by the senior revolving line of credit.

Business Loan Express has a three-year $124 million revolving credit facility that matures in March 2004. As the controlling shareholder of Business Loan Express, 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 Business Loan Express under the revolving credit facility. The amount guaranteed by us at September 30, 2002 was $48.5 million. This guaranty can be called by the lenders only in the event of a default by Business Loan Express. Business Loan Express was in compliance with the terms of the revolving credit facility at September 30, 2002. We have also provided two standby letters of credit in connection with two term securitization transactions completed by Business Loan Express in the second quarter of 2002 totaling $10.6 million.

Business Loan Express is currently contemplating a corporate restructure and recapitalization whereby the company would convert from a corporation to a limited liability company. This restructure would enable the company to have greater flexibility as it grows. Upon such restructure and recapitalization, our equity interests would be converted to membership units and the earnings of Business Loan Express would pass through to its members as dividends. There can be no assurance when or if the corporate restructure and recapitalization will occur. BLX expects to incur certain reorganization expenses related to the corporate restructure and recapitalization.

Business Loan Express is the nation’s second largest 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). Therefore, changes in the laws or regulations that govern SBLCs or the SBA’s 7(a) Guaranteed Loan Program or changes in government funding for this program could have a material impact on Business Loan Express or its operations. As of October 1, 2002, the SBA implemented a maximum loan size of $500,000 for loans originated through the SBA 7(a) Guaranteed Loan Program. Pending revision of the government’s funding of this program, this limitation may be revisited. BLX does not anticipate that the change will have a material effect on its business. The company plans to emphasize its conventional loan program should the $500,000 SBA 7(a) loan size cap remain in place. Business Loan Express is a preferred lender as designated by the SBA in 68 markets across the United States, and originates, sells and services small business loans. In addition to the 7(a) Guaranteed Loan Program, Business Loan Express originates conventional small business loans and originates loans under the USDA Business and Industry Guaranteed Loan Program. Business Loan Express has 37 offices across the United States and is headquartered in New York, New York.

WyoTech Acquisition Corporation. On July 1, 2002, WyoTech Acquisition Corporation was sold for $84.4 million. We acquired WyoTech in December of 1998 and owned 91% of the common equity of WyoTech. At June 30, 2002, our investment had a cost basis of $16.4 million, which represented all of the debt ($12.6 million), preferred stock ($3.7 million) and 91% of the common equity capital ($0.1 million) of WyoTech. Our total proceeds from the sale of WyoTech, including the repayment of debt and preferred stock and the sale of our 91% common equity ownership, were $77.2 million. We recognized a realized gain of $60.8 million on the transaction. The sale of WyoTech is subject to post-closing working capital adjustments, if any, and customary indemnification provisions.

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, 2002 and 2001, and at and for the year ended December 31, 2001, were as follows:



			At and for the						At and for the
			Three Months						Nine Months						At and for the
			Ended						Ended						Year Ended
			September 30,						September 30,						December 31,

			2002			2001			2002			2001			2001
($ in millions)

			(unaudited)						(unaudited)




Portfolio at value:




	CMBS bonds		$	496.4		$	447.5		$	496.4		$	447.5		$	558.3




	Collateralized debt obligation preferred shares			53.0			24.6			53.0			24.6			24.2

		Total CMBS		549.4			472.1			549.4			472.1			582.5




	Commercial mortgage loans			59.7			86.2			59.7			86.2			79.6




	Residual interest			69.0			74.4			69.0			74.4			69.9




	Real estate owned			2.9			2.4			2.9			2.4			2.5

Total Portfolio			$	681.0		$	635.1		$	681.0		$	635.1		$	734.5

Investments funded			$	8.9		$	96.8		$	134.6		$	282.8		$	392.6




Change in accrued or reinvested interest			$	—		$	0.1		$	0.4		$	1.2		$	2.7




Principal repayments			$	0.5		$	1.9		$	11.5		$	21.3		$	30.7




CMBS and commercial real estate loan sales			$	87.2		$	55.4		$	213.5		$	130.0		$	130.0




Yield*				13.6	%		13.5	%		13.6	%		13.5	%		13.5	%

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.

Our primary commercial real estate investment activity is the investment in non-investment grade commercial mortgage-backed securities, or CMBS. In 1998, we began to take advantage of a unique market opportunity to acquire non-investment grade CMBS bonds at significant discounts from the face amount of the bonds. We believe that CMBS is an attractive asset class because of the yields that can be earned on securities that are secured by commercial mortgage loans, and ultimately commercial real estate properties. We did not make any new CMBS bond investments during the third quarter of 2002 as there was a limited supply of new CMBS bond issuances in the market. The supply of new CMBS bond issuances has increased in the fourth quarter and we are currently in the process of underwriting two transactions that may close during the fourth quarter of 2002. Our CMBS investment activity level will be dependent upon our ability to invest in CMBS at attractive yields. We plan to continue our CMBS investment activity, however, in order to maintain a balanced portfolio, we expect that CMBS will not exceed 25% of our total assets.

Our commercial real estate investment activity for the three and nine months ended September 30, 2002, and for the year ended December 31, 2001, was as follows:



		Amount Invested

		Face					Amount
		Amount		Discount			Funded		Yield(1)(3)
($ in millions)
*For the three months ended September 30, 2002*




CMBS bonds		$	—	$	—		$	—




CDOs			1.0		—			1.0		17.4%




Commercial mortgage loans			—		—			—




Real estate owned(2)			7.9		—			7.9

	Total	$	8.9	$	—		$	8.9		17.4%

*For the nine months ended September 30, 2002*




CMBS bonds		$	181.4	$	(83.8	)	$	97.6		14.7%




CDOs			29.0		—			29.0		17.5%




Commercial mortgage loans			0.1		—			0.1		10.0%




Real estate owned(2)			7.9		—			7.9

	Total	$	218.4	$	(83.8	)	$	134.6		15.3%

*For the year ended December 31, 2001*




CMBS bonds		$	661.4	$	(295.6	)	$	365.8		14.0%




CDOs			24.6		—			24.6		16.9%




Commercial mortgage loans			2.2		—			2.2		10.0%

	Total	$	688.2	$	(295.6	)	$	392.6		14.2%


(1)	The yield on new CMBS bond investments will vary from period to period depending on the concentration of lower yielding BB+, BB and BB- CMBS bonds purchased in that period to the total amount invested.
(2)	During the quarter ended September 30, 2002, we acquired real estate property in connection with a foreclosed asset in order to facilitate the disposition of the property. A current yield was therefore not calculated for this investment.
(3)	Total yield calculation for the three and nine months ended September 30, 2002 excludes new investments in real estate owned.

CMBS Bonds. 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, 2002, our CMBS bonds were subordinate to 91% to 97% of the tranches of bonds issued in various CMBS transactions. Given that the non-investment grade CMBS bonds in which we invest are junior in priority for payment of principal and interest, 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, 2002, and the year ended December 31, 2001, the average discount for the CMBS bonds in which we invested was 46% and 45%, respectively.

The underlying pools of mortgage loans that are collateral for our new CMBS bond investments for the nine months ended September 30, 2002, and for the year ended

December 31, 2001, had respective underwritten loan to value and underwritten debt service coverage ratios as follows:



	For the Nine Months						For the Year Ended
	Ended September 30,						December 31,

	2002						2001

Loan to Value Ranges	Amount			Percentage			Amount			Percentage
($ in millions)
Less than 60%	$	401.9			16	%	$	1,259.7			15	%




60-65%		178.7			7			941.6			11




65-70%		264.1			11			1,140.6			14




70-75%		799.5			32			2,400.4			29




75-80%		812.7			33			2,466.4			30




Greater than 80%		12.0			1			119.6			1

Total	$	2,468.9			100	%	$	8,328.3			100	%

Weighted average loan to value		70.4	%					69.7	%



	For the Nine Months					For the Year Ended
	Ended September 30,					December 31,

	2002					2001
Debt Service Coverage
Ratio(1) Ranges	Amount		Percentage			Amount		Percentage
($ in millions)
Greater than 2.00	$	103.3		4	%	$	484.8		6	%




1.76-2.00		84.2		3			158.2		2




1.51-1.75		240.3		10			855.0		10




1.26-1.50		1,631.8		66			5,008.3		60




1.00-1.25		409.3		17			1,822.0		22

Total	$	2,468.9		100	%	$	8,328.3		100	%

Weighted average debt service coverage ratio		1.41					1.48


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

As a part of our strategy to maximize our return on equity capital, we sold CMBS bonds rated BB+ through B during the nine months ended September 30, 2002 with a cost basis of $205.9 million, and bonds rated BB+ through BB-during the year ended December 31, 2001 with a cost basis of $124.5 million. These bonds had a weighted average effective yield of 11.5% and 10.3%, and were sold for $225.6 million and $126.8 million, respectively, resulting in realized gains on the sales. The sales of these primarily lower-yielding bonds increased our overall liquidity. Included in the CMBS bond sales during the third quarter of 2002 were $129.8 million of face amount of CMBS bonds with a cost basis of $82.7 million. We recognized a gain on this sale of $12.0 million, net of a realized loss of $2.1 million from a hedge related to the CMBS bonds sold. The CMBS bonds sold represented a strip of BB+ through B from our portfolio and had a weighted average yield to maturity of 12.0%. The CMBS bonds were sold to institutional investors.

The effective yield on our CMBS bond portfolio at September 30, 2002 and December 31, 2001 was 14.5% and 14.7%, respectively. The yield on the CMBS portfolio at any point in time will vary depending on the concentration of lower yielding BB+, BB and BB- CMBS bonds held in the portfolio. At September 30, 2002, and December 31, 2001, the unamortized discount related to the CMBS portfolio was $595.6 million and $611.9 million, respectively. At September 30, 2002, the CMBS bond portfolio had a fair value of $496.4 million, which included net unrealized appreciation on the CMBS bonds of $39.8 million.

At September 30, 2002, the underlying pools of mortgage loans that are collateral for our CMBS bonds consisted of approximately 4,100 commercial mortgage loans with a total outstanding principal balance of $22.9 billion. At September 30, 2002, and December 31, 2001, 0.99% and 0.52%, respectively, of the loans in the underlying collateral pool for our CMBS bonds were over 30 days delinquent or were classified as real estate owned.

Collateralized Debt Obligation Preferred Shares. During the nine months ended September 30, 2002, and the year ended December 31, 2001, we invested in the preferred shares of three and one, respectively, collateralized debt obligations, or CDOs, 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. The investment grade REIT collateral consists of debt with a cut-off balance of $1,017.6 million and was issued by 42 REITs. The investment grade CMBS collateral consists of CMBS bonds with a face amount of $479.0 million issued in 39 separate CMBS transactions. The non-investment grade CMBS collateral consists of BB+, BB and BB- CMBS bonds with a face amount of $463.4 million issued in 39 separate CMBS transactions. Included in the CMBS collateral for the CDOs are $397.9 million of CMBS bonds that are senior in priority of repayment to certain lower rated CMBS bonds held by us, which were issued in 23 separate CMBS transactions. The preferred shares are junior in priority for payment of 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 resulting in reduced cash flows, the preferred shares will bear this loss first. At September 30, 2002, our preferred shares in the CDOs were subordinate to approximately 96% of the more senior tranches of debt issued by the CDOs. The yield on the CDOs was 17.2% and 16.9% at September 30, 2002, and December 31, 2001, respectively.

Commercial Mortgage Loans and Real Estate Owned. Since 1998, we have been liquidating much of our whole commercial mortgage loan portfolio so that we can redeploy the proceeds into higher yielding assets. For the nine months ended September 30, 2002, and for the year ended December 31, 2001, we sold $7.6 million and $5.5 million, respectively, of commercial mortgage loans and real estate owned. At September 30, 2002, our whole commercial mortgage loan portfolio had been reduced to $59.7 million from $79.6 million at December 31, 2001.

Residual Interests. The residual interest primarily consists of a retained interest totaling $68.9 million from a 1998 asset securitization whereby bonds were sold in three classes rated AAA, AA and A. The residual interest represents a right to cash flows from the underlying collateral pool of loans after these senior bond obligations are satisfied. At September 30, 2002, one class of bonds rated AAA was outstanding totaling $21.7 million. We have the right to call the bonds upon a minimum of ten days notice to the bondholders. Once the bonds are fully repaid, either through the cash flows from the securitized loans or due to us calling the bonds, the remaining loans in the trust will be returned to us as payment on the residual interest. At September 30, 2002, the residual interest had a fair value of $69.0 million.

Portfolio Asset Quality

As a means to review portfolio quality, we are providing data using three separate measures — 1) portfolio by grade, 2) loans and debt securities on non-accrual status, and 3) loans and debt securities over 90 days delinquent. These three separate categories should not be added together, but instead are three different measures to assist in

evaluating the portfolio. Our primary measure for portfolio quality remains the grade of each investment in the portfolio.

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 interest or principal is expected. Grade 4 is used for investments that are in workout and for which some loss of current interest 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 and the investment is written down to net realizable value.

At September 30, 2002, and December 31, 2001, our portfolio was graded as follows:



	2002					2001

			Percentage					Percentage
	Portfolio		of Total			Portfolio		of Total
Grade	at Value		Portfolio			at Value		Portfolio

($ in millions)




1	$	720.3		30.7	%	$	603.3		25.9	%




2		1,441.6		61.5			1,553.8		66.7




3		58.2		2.5			79.5		3.4




4		12.8		0.6			44.5		1.9




5		110.7		4.7			48.5		2.1

	$	2,343.6		100.0	%	$	2,329.6		100.0	%

Portfolio by Grade. Total Grades 4 and 5 assets as a percentage of the total portfolio at value at September 30, 2002 and December 31, 2001 were 5.3% and 4.0%, respectively. Grade 4 and 5 assets include loans, debt securities and equity securities. We expect that a number of portfolio companies will be in the Grades 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 Grades 4 and 5 may fluctuate significantly 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, but record unrealized depreciation for the expected full amount of the potential loss when such exposure is identified.

Loans and Debt Securities on Non-Accrual Status. Loans and debt securities on non-accrual status for which we have doubt about interest collection are classified as Grade 4 or 5 assets, which are investments in workout status. In addition to Grade 4 and 5 assets that are in workout, we may not accrue interest on loans to companies which are more than 50% owned by us from time to time if such companies are in need of additional capital and, therefore, we may defer current debt service. Loans and debt securities on non-accrual status may or may not be over 90 days delinquent, as it is not unusual for us to place a loan on non-accrual status before it is over 90 days past due, and there may be loans over 90 days delinquent for which we believe that the interest is fully collectible.

For the total investment portfolio, workout loans not accruing interest, or those loans and debt securities in Grade 4 and 5, were $88.1 million at value at September 30, 2002, or 3.8% of the total portfolio. Included in this category at September 30, 2002, were loans

of $14.3 million that were secured by commercial real estate. Workout loans not accruing interest were $109.0 million at value at December 31, 2001, or 4.7% of the total portfolio, of which $8.9 million were related to portfolio companies in liquidation, and $15.2 million represented loans secured by commercial real estate. As of September 30, 2002, $8.9 million representing receivables related to portfolio companies in liquidation were included in other assets. In addition to Grade 4 and 5 assets that are in workout, loans and debt securities to companies which are more than 50% owned by us that were not accruing interest totaled $63.8 million at value at September 30, 2002.

Loans and Debt Securities Over 90 Days Delinquent. Loans and debt securities over 90 days delinquent are all loans and debt securities in the portfolio that are over 90 days past due, and these loans and debt securities may or may not be included in Grade 4 or 5 assets. If the loan pertains to an investment in workout, the loan or debt security will be included in the Grade 4 or 5 categories. A loan or debt security may be included in Grade 4 or 5 before it is over 90 days past due. If a loan is past due but does not pertain to an investment in workout, the loan or debt security would be included in Grades 1, 2 or 3.

Loans and debt securities greater than 90 days delinquent were $66.5 million at value at September 30, 2002, or 2.8% of the total portfolio. Included in this category are loans valued at $26.9 million that are secured by commercial real estate. Loans greater than 90 days delinquent were $39.1 million at value at December 31, 2001, or 1.7% of the total portfolio. Included in this category are loans valued at $14.1 million that were secured by commercial real estate.

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 investments for a total return including interest or dividends plus capital gains from the sale of equity securities. Therefore, the amount of loans 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 principal (Grade 5 assets).

At September 30, 2002 and December 31, 2001, 0.99% and 0.52%, respectively, of the loans in the underlying collateral pool for our CMBS bond portfolio were over 30 days delinquent or were classified as real estate owned. We closely monitor the performance of all of the loans in the underlying collateral pools securing our CMBS investments.

Other Assets and Other Liabilities

terms of their contracts and from movements in the value of the borrowed Treasury securities and interest rates; we do not anticipate nonperformance by any counterparty.

The total obligations to replenish borrowed Treasury securities were $52.2 million and $47.3 million at September 30, 2002, and December 31, 2001, respectively, which included unrealized depreciation on the obligations of $5.6 million and unrealized appreciation on the obligations of $1.2 million, respectively, due to changes in the yield on the borrowed Treasury securities. The obligations have been recorded as an other liability. The proceeds related to the sales of the borrowed Treasury securities were $46.7 million and $48.5 million at September 30, 2002, and December 31, 2001, respectively, and have been recorded as an other asset. Under the terms of the transactions, we have provided additional cash collateral of $5.0 million at September 30, 2002 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. The cash collateral has been recorded as an other asset in the accompanying consolidated financial statements.

RESULTS OF OPERATIONS

Comparison of Three Months Ended September 30, 2002 and 2001

The following table summarizes our condensed operating results for the three months ended September 30, 2002 and 2001.



			For the Three
			Months Ended
			September 30,
											Percent
			2002			2001		Change			Change
($ in thousands, except per share amounts)

			(unaudited)




Interest and Related Portfolio Income




	Interest and dividends		$	67,624		$	60,023	$	7,601			13	%




	Premiums from loan dispositions			392			339		53			16	%




	Fees and other income			8,313			12,272		(3,959	)		(32	%)

		Total interest and related portfolio income		76,329			72,634		3,695			5	%

Expenses




	Interest			17,430			16,093		1,337			8	%




	Employee			8,153			8,213		(60	)		(1	%)




	Administrative			5,052			4,139		913			22	%

		Total operating expenses		30,635			28,445		2,190			8	%

Net investment income before income tax expense and net realized and unrealized gains				45,694			44,189		1,505			3	%




Income tax expense				600			—		600			—

Net investment income before net realized and unrealized gains				45,094			44,189		905			2	%

Net Realized and Unrealized Gains




	Net realized gains			48,222			3,348		44,874			*




	Net unrealized gains (losses)			(47,796	)		12,166		(59,962	)		*

		Total net realized and unrealized gains		426			15,514		(15,088	)		*

Net increase in net assets resulting from operations			$	45,520		$	59,703	$	(14,183	)		(24	%)

Diluted earnings per share			$	0.44		$	0.63	$	(0.19	)		(30	%)

Weighted average shares outstanding — diluted				103,302			94,585		8,717			9	%


*	Net realized and net unrealized gains and losses can fluctuate significantly from quarter to quarter. As a result, quarterly comparisons of net realized and net unrealized gains and losses may not be meaningful.

Net increase in net assets resulting from operations, or net income, results from total interest and related portfolio income earned, less total expenses incurred in our operations, plus net realized and unrealized gains or losses.

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.



	For the Three
	Months Ended
	September 30,

	2002		2001
($ in millions, except per share amounts)
Total Interest and Related Portfolio Income	$	76.3	$	72.6




Per share	$	0.74	$	0.77

The increase in interest and dividend income earned resulted from the growth of our interest bearing investment portfolio and the dividends earned on certain preferred equity securities. Our investment portfolio, excluding non-interest bearing equity interests in portfolio companies, increased by 4% to $1,803.6 million at September 30, 2002, from $1,730.7 million at September 30, 2001. The weighted average yield on the interest-bearing investments in the portfolio at September 30, 2002 and 2001, was as follows:



	September 30,

	2002		2001

Private Finance		14.4%		14.5%




Commercial Real Estate Finance		13.6%		13.5%




Total Portfolio		14.1%		14.1%

Included in premiums from loan dispositions are prepayment premiums of $0.4 million and $0.3 million for the three months ended September 30, 2002 and 2001, 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. 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, guaranties 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, information technology, web site development, marketing, human resources, personnel recruiting, board recruiting, corporate governance and risk management.

Fees and other income for the quarter ended September 30, 2002, included fees of $2.2 million related to structuring and diligence, fees of $0.4 million related to transaction services provided to portfolio companies, and fees of $5.7 million related to management services provided to portfolio companies, guaranty and other advisory services. Fees and other income are generally related to specific transactions or services, and therefore may vary substantially from period to period. Points or loan origination fees that represent yield

enhancement on a loan are capitalized and amortized into interest income over the life of the loan.

Business Loan Express and Hillman are our most significant portfolio investments and together represent 15.3% of our total assets at September 30, 2002. Total interest and related portfolio income earned from these investments for the three months ended September 30, 2002 and 2001, was $12.4 million and $11.0 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, 2002 and 2001, are attributable to changes in the level of our borrowings under various notes payable and debentures and our revolving credit facility. 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,

	2002		2001
($ in millions)
Total Outstanding Debt	$	990.7	$	924.5




Average Outstanding Debt	$	901.5	$	862.4




Weighted Average Cost		7.1%		7.1%




BDC Asset Coverage*		259%		255%


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

Employee expenses include salaries and employee benefits. The change in employee expense reflects the effect of wage increases and the change in the mix of employees given their area of responsibility and relevant experience level. Total employees were 103 and 95 at September 30, 2002 and 2001, respectively.

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 as compared to the same period in 2001 includes approximately $0.2 million from legal, consulting and other fees, including costs incurred to defend against class action lawsuits alleging violations of securities laws and to respond to market activity in our stock. Administrative expenses also increased by approximately $0.3 million due to increased costs for corporate liability insurance and $0.2 million due to travel costs, including corporate aircraft depreciation.

Realized Gains and Losses. Net realized gains resulted 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 were as follows:



	For the Three
	Months Ended
	September 30,

	2002			2001
($ in millions)
Realized Gains	$	77.9		$	3.3




Realized Losses		(29.7	)		—

Net Realized Gains	$	48.2		$	3.3

Realized gains and losses for the three months ended September 30, 2002, resulted from various private finance and commercial real estate finance transactions. Realized gains for the three months ended September 30, 2002, primarily resulted from transactions involving three private finance portfolio companies, Wyoming Technical Institute ($60.8 million), Oriental Trading Company, Inc. ($2.5 million) and Kirkland’s, Inc. ($2.2 million), and the sale of CMBS bonds ($12.0 million, net of a realized loss of $2.1 million from a hedge related to the CMBS bonds sold). We reversed previously recorded unrealized appreciation totaling $70.1 million and $2.5 million when gains were realized for the three months ended September 30, 2002 and 2001, respectively.

Realized losses for the three months ended September 30, 2002, primarily resulted from transactions involving two private finance portfolio companies, Velocita, Inc. ($16.0 million) and Schwinn Holdings Corporation ($7.9 million), and two commercial real estate investments ($2.1 million). We reversed previously recorded unrealized depreciation totaling $29.3 million and zero when losses were realized for the three months ended September 30, 2002 and 2001, respectively.

Unrealized Gains and Losses. We determine the fair value of each investment in our portfolio on a quarterly basis, and changes in fair value result in unrealized gains or losses being recognized. At September 30, 2002, approximately 93% of our total assets represented portfolio investments recorded at fair value. 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 ascertainable market value for the investments in our portfolio, we value substantially all of our 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. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily ascertainable 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.

including where collection of a loan or realization of an equity security is doubtful. Conversely, we will record unrealized appreciation if we have an indication that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value, where appropriate. Changes in fair value are recorded in the statement of operations as unrealized gains and losses.

As a business development company, we invest primarily in illiquid securities including debt and equity securities of private companies and non-investment grade CMBS. The structure of each 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 upon 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 monthly 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 upon multiples of EBITDA, cash flow, net income, revenues or, in limited instances, book value. 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, or acquisition, recapitalization or restructuring related 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 private relative to a peer group, but 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 upon 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 are determined based upon various factors, including the enterprise value remaining for equity holders after the repayment of the portfolio company’s debt and other pertinent factors such as recent offers to purchase a portfolio company’s equity interest or other potential liquidity 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. CMBS bonds are carried at fair value, which is based upon a discounted cash flow model which utilizes prepayment and loss assumptions based upon historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable market yields for similar CMBS bonds. Our assumption with regard to discount rate is based upon the yield of comparable securities. 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 estimates of future credit losses, actual losses incurred, or actual and estimated prepayment speeds. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the CMBS bonds from the date the estimated yield is changed. We recognize unrealized appreciation or depreciation on our CMBS bonds, as comparable yields in the market change and/or whenever we determine that the value of our CMBS bonds is less than the cost basis due to changes in cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool.

Net Unrealized Gains and Losses — Net unrealized gains (losses) for the three months ended September 30, 2002 and 2001 were as follows:



			For the Three
			Months Ended
			September 30,

			2002			2001
($ in millions)
Unrealized appreciation:




	Unrealized gains		$	29.8		$	28.3




	Reversal of previously recorded depreciation			29.3			—

		Total unrealized appreciation		59.1			28.3

Unrealized depreciation:




	Unrealized losses			(36.8	)		(13.6	)




	Reversal of previously recorded appreciation			(70.1	)		(2.5	)

		Total unrealized depreciation		(106.9	)		(16.1	)

Net unrealized gains (losses)			$	(47.8	)	$	12.2

During the third quarter of 2002, we increased the fair value of our investment in Blue Rhino by $1.8 million based on the public market valuations of the company stock. In addition, we recorded unrealized appreciation totaling $6.2 million on ten other investments in our portfolio based upon the performance of the respective companies and/or indicative valuation estimates received from third parties.

We recorded unrealized losses of $32.5 million on 30 portfolio investments during the three months ended September 30, 2002, largely due to conditions in the manufacturing, media and technology sectors, and due to company specific matters in certain companies. Portfolio companies for which unrealized depreciation was recorded this quarter include

four companies in the portfolio that continue to be affected by weakness in the manufacturing sector for which we decreased fair value by $6.4 million; four companies in the media sector that have declined in fair value due to declining values in this sector for which we have decreased fair value by $10.5 million; and the three companies that have been affected by lower levels of technology spending for which we have decreased fair value by $1.8 million. In general, our portfolio companies in the consumer-driven sectors, such as retail and consumer products, continue to perform well. However, we decreased the fair value of three investments in this sector by $8.6 million. We also recorded depreciation of $2.0 million on five commercial mortgage loans and $0.7 million on one real estate owned property. As the economy improves, the financial performance of these portfolio companies may also improve. However, there can be no assurance when or if these companies’ performance may improve.

CMBS Bonds. We recorded a net unrealized gain on our CMBS bond portfolio of $17.5 million in the third quarter of 2002. We determined the fair value of our CMBS bond portfolio using a discounted cash flow model based upon (i) the current performance of the underlying collateral loans, which utilizes prepayment and loss assumptions based upon historical and projected experience, economic factors and the characteristics of the underlying cash flow, and (ii) current market yields for comparable CMBS bonds, based upon Treasury rates and market spreads.

Cash flow assumptions. With respect to the cash flows of the underlying collateral loans securing the CMBS bonds, the performance of the collateral loans to date is generally consistent with our original assumptions. We generally assume no prepayments on the collateral loans prior to maturity, as prepayments on the loans prior to maturity are generally prohibited or there are significant penalties, such as prepayment premiums, yield maintenance and/or defeasance requirements. Our credit loss assumptions for the underlying collateral loans at the time of investment in the CMBS bonds were generally estimated to assume that approximately 1% of the underlying collateral loan principal would be lost, and that one-third of the losses would be realized in year three, one-third in year six, and one-third in year nine. We believe that this is an appropriate approach to setting loss assumptions, as losses are expected to occur throughout the life of the CMBS bonds.

As of September 30, 2002, total estimated losses in the underlying collateral pools over the life of the CMBS bonds were assumed to total approximately $217 million. Through September 30, 2002, $2.3 million in actual losses have been realized. While the actual realized losses as of September 30, 2002 are less than our originally estimated losses, we have not reduced the original estimates of the total expected losses over the life of the CMBS bonds. Loss assumptions affecting future cash flows are updated quarterly to reflect the estimated current and expected performance of the collateral loans on a loan-by-loan basis.

Yield assumptions. During the third quarter of 2002, the overall yields on newly-issued CMBS bonds rated BB+ through B continued to decline due to the decline in Treasury yields combined with the narrowing of spreads, resulting in market yields for these bond classes being lower than the yields-to-maturity on our CMBS bonds for the same classes. More buyers of CMBS bonds have recently entered the market, particularly buyers for BB+ through BB rated CMBS bonds, which has contributed to the decline in spreads for these bond classes beginning in the second quarter of 2002. Historically, we

have found yields on new issuances to be in the same range as the CMBS bonds we own. We confirmed our CMBS bond portfolio pricing estimates at September 30, 2002 with respect to spreads for our BB+ through B rated bonds with other CMBS bond market participants. Lower yields imply an increase in the value of our BB+ through B rated CMBS bond portfolio. The yields on B- through the non-rated classes have generally remained relatively consistent with the yields on our CMBS bonds in these classes. Pricing for these deeply subordinated classes of bonds are generally much more a function of the credit quality of a single issuance rather than market conditions.

Fair Value. We have determined the fair value of our CMBS bonds based upon a discounted cash flow model using expected future cash flows and current market yields, as discussed above, to be approximately $496.4 million, and as a result have recorded a net unrealized gain on the CMBS bonds of $21.8 million for the quarter ended September 30, 2002. The net unrealized gain includes an unrealized loss of $0.7 million related to changes in estimated prepayment or loss assumptions.

Because we invest in BB+, BB and BB- rated CMBS bonds, which are purchased at prices that are based on the 10-year Treasury rate, we have entered into transactions with financial institutions to hedge against movement in Treasury rates on certain of these CMBS bonds. These transactions involved receiving the proceeds from the 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. The net proceeds related to the sales of the borrowed Treasury securities and the related obligations to replenish the borrowed Treasury securities totaled $46.7 million and $52.2 million, respectively, and have been included in other assets and other liabilities, respectively, at September 30, 2002. As of September 30, 2002, the total obligations on the hedge had increased to $52.2 million due to changes in the yield on the borrowed Treasury securities, resulting in unrealized depreciation on the obligation of $5.6 million. The decrease in the value of the hedge during the three months ended September 30, 2002, was $4.3 million and was recorded as an unrealized loss.

The net unrealized gain on the CMBS bonds of $21.8 million, net of the unrealized loss on the hedge of $4.3 million, resulted in a net unrealized gain from the CMBS bond portfolio of $17.5 million for the three months ended September 30, 2002.

Given that Treasury yields fluctuate, it is possible that there may be future adjustments to the fair value of the CMBS bonds. As a result, we have not classified the appreciated CMBS bonds as Grade 1 assets at September 30, 2002, since they may not result in any future capital gain. Therefore, CMBS bonds remain in Grade 2.

Other Matters. 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 shares used to compute diluted earnings per share, which were 103.3 million and 94.6 million for the three months ended September 30, 2002 and 2001, respectively.

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 increase in net assets resulting from operations for the fiscal year due to timing 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.

RESULTS OF OPERATIONS

Comparison of Nine Months Ended September 30, 2002 and 2001

The following table summarizes our condensed operating results for the nine months ended September 30, 2002, and 2001.



			For the Nine
			Months Ended
			September 30,
											Percent
			2002			2001		Change			Change
($ in thousands, except per share amounts)

			(unaudited)




Interest and Related Portfolio Income




	Interest and dividends		$	195,289		$	173,722	$	21,567			12	%




	Premiums from loan dispositions			2,051			2,070		(19	)		(1	%)




	Fees and other income			34,573			30,652		3,921			13	%

		Total interest and related portfolio income		231,913			206,444		25,469			12	%

Expenses




	Interest			52,414			47,974		4,440			9	%




	Employee			24,462			22,269		2,193			10	%




	Administrative			12,913			10,166		2,747			27	%

		Total operating expenses		89,789			80,409		9,380			12	%

Net investment income before income tax expense and net realized and unrealized gains				142,124			126,035		16,089			13	%




Income tax expense				600			—		600			—

Net investment income before net realized and unrealized gains				141,524			126,035		15,489			12	%

Net Realized and Unrealized Gains




	Net realized gains			57,072			8,339		48,733			*




	Net unrealized gains (losses)			(23,661	)		23,463		(47,124	)		*

		Total net realized and unrealized gains		33,411			31,802		1,609			*

Net increase in net assets resulting from operations			$	174,935		$	157,837	$	17,098			11	%

Diluted earnings per share			$	1.70		$	1.74	$	(0.04	)		(2	%)

Weighted average shares outstanding — diluted				103,040			90,864		12,176			13	%


*	Net realized and net unrealized gains and losses can fluctuate significantly from period to period. As a result, year-to-date comparisons of net realized and net unrealized gains and losses may not be 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.



	For the Nine
	Months Ended
	September 30,

	2002		2001
($ in millions, except per share amounts)
Total Interest and Related Portfolio Income	$	231.9	$	206.4




Per share	$	2.25	$	2.27

The increase in interest and dividend income earned resulted primarily from the growth of our investment portfolio and the dividends earned on certain preferred equity securities. Our investment portfolio, excluding non-interest bearing equity interests in portfolio companies, increased by 4% to $1,803.6 million at September 30, 2002, from $1,730.7 million at September 30, 2001. The weighted average yield on the interest-bearing investments in the portfolio at September 30, 2002 and 2001 was as follows:



	September 30,

	2002		2001

Private Finance		14.4%		14.5%




Commercial Real Estate Finance		13.6%		13.5%




Total Portfolio		14.1%		14.1%

Included in premiums from loan dispositions are prepayment premiums of $2.0 million and $1.6 million for the nine months ended September 30, 2002 and 2001, 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. 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, guaranty 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, 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, 2002, included fees of $12.8 million related to structuring and diligence, fees of $4.1 million related to transaction services provided to portfolio companies, and fees of $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. Points or 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 have decided to discontinue our German operations due to difficulty in finding attractive investment opportunities for the Germany Fund. In conjunction with this, we will incur some costs of discontinued operations, which we estimate will reduce our net income during the fourth quarter of 2002 and for the full year of 2002 by approximately 2.5 cents to 3.5 cents per share.

Business Loan Express and Hillman are our most significant portfolio investments and together represent 15.3% of our total assets at September 30, 2002. Total interest and related portfolio income earned from these investments for the nine months ended September 30, 2002 and 2001 was $36.9 million and $27.4 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 nine months ended September 30, 2002 and 2001 are attributable to changes in the level of our borrowings under various notes payable and debentures and our revolving credit facility. 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,

	2002		2001
($ in millions)
Total Outstanding Debt	$	990.7	$	924.5




Average Outstanding Debt	$	927.3	$	821.9




Weighted Average Cost		7.1%		7.1%




BDC Asset Coverage*		259%		255%


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

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 as compared to the same period in 2001 includes approximately $1.5 million from legal, consulting and other fees, including costs incurred to defend against class action lawsuits alleging violations of securities laws and to respond to market activity in our stock. Administrative expenses also increased by approximately $0.5 million due to increased costs for corporate liability insurance, $0.5 million due to outsourced technology assistance, and $0.2 million due to travel costs, including corporate aircraft depreciation.

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 were as follows:



	For the Nine
	Months Ended
	September 30,

	2002			2001
($ in millions)
Realized Gains	$	93.4		$	9.9




Realized Losses		(36.3	)		(1.6	)

Net Realized Gains	$	57.1		$	8.3

Realized gains and losses for the nine months ended September 30, 2002, resulted from various private finance and commercial real estate finance transactions. Realized gains for the nine months ended September 30, 2002, primarily resulted from transactions involving six private finance portfolio companies, Wyoming Technical Institute ($60.8 million), Aurora Communications, LLC ($4.9 million), Oriental Trading ($2.5 million), Kirkland’s, Inc. ($2.2 million), Cumulus Media, Inc. ($0.5 million), and Alderwoods Group, Inc. ($0.1 million), the sale of CMBS bonds ($19.1 million, net of a realized loss of $0.5 million from a hedge related to the CMBS bonds sold) and one commercial real estate investment ($1.3 million). For the nine months ended September 30, 2002 and 2001, we reversed previously recorded unrealized appreciation totaling $77.4 million and $6.5 million, respectively, when gains were realized.

Realized losses for the nine months ended September 30, 2002, primarily resulted from transactions involving six private finance portfolio companies, Velocita, Inc. ($16.0 million), Schwinn Holdings Corporation ($7.9 million), The Loewen Group, Inc. ($2.7 million), iSolve Incorporated ($0.9 million), Sure-Tel, Inc. ($0.5 million), Soff-Cut Holdings, Inc. ($0.5 million), and six commercial real estate investments ($3.8 million). In January 2002, The Loewen Group, Inc. emerged from bankruptcy and as a result, we exchanged our debt securities for cash, new debt securities and publicly traded common stock in the reorganized company, which resulted in a realized loss. The Loewen Group, Inc. changed its name to Alderwoods Group, Inc. For the nine months ended September 30, 2002, and 2001, we reversed previously recorded unrealized depreciation totaling $34.5 million and $2.2 million, respectively, when losses were realized.

Unrealized Gains and Losses. For a discussion of our fair value methodology and how it affects unrealized gains and losses, see “Unrealized Gains and Losses” included in the “Comparison of Three Months Ended September 30, 2002 and 2001.”

Net unrealized gains (losses) for the nine months ended September 31, 2002 and 2001 were as follows:



			For the Nine
			Months Ended
			September 30,

			2002			2001
($ in millions)
Unrealized appreciation:




	Unrealized gains		$	166.3		$	64.6




	Reversal of previously recorded depreciation			34.5			2.2

		Total unrealized appreciation		200.8			66.8

Unrealized depreciation:




	Unrealized losses			(147.1	)		(36.8	)




	Reversal of previously recorded appreciation			(77.4	)		(6.5	)

		Total unrealized depreciation		(224.5	)		(43.3	)

Net unrealized gains (losses)			$	(23.7	)	$	23.5

Unrealized gains and losses recognized for the nine months ended September 30, 2002 are summarized below.

During the nine months ended September 30, 2002, we increased the fair value of The Hillman Companies by $32.8 million and Business Loan Express, Inc. by $19.9 million based upon the performance of the companies; WyoTech Acquisition Corporation by $16.6 million based on the estimated proceeds expected to be received from the sale of this investment in July 2002; Blue Rhino and Kirkland’s by $13.3 million and $5.7 million, respectively, based on the public market valuations of each company’s stock; CorrFlex Graphics LLC and Morton Grove Pharmaceuticals, Inc. by $11.8 million, and $5.0 million, respectively, based on strong earnings growth and upon indicative valuation estimates received from third parties. In addition, we recorded unrealized gains totaling $15.5 million on 18 other investments in our portfolio.

During the nine months ended September 30, 2002, we decreased the fair value of our investment in Startec Global Communications Corporation by $10.2 million to reflect the current plan of reorganization filed with the bankruptcy court in the second quarter of 2002. We decreased the value of Alderwoods Group, Inc. by $2.7 million to reflect the change in the Company’s public stock value.

We also recorded $111.6 million in unrealized losses during the nine months ended September 30, 2002, largely due to conditions in the manufacturing, technology and media sectors, and the continuing effects of the events of September 11th, 2001. Portfolio companies for which unrealized depreciation was recorded included five companies that have been affected by weakness in the manufacturing sector for which we decreased fair value by $25.2 million; five companies that have been affected by lower levels of technology spending for which we decreased fair value by $18.5 million; seven companies in the media sector that have declined in fair value due to declining values in this sector for which we decreased fair value by $18.4 million; and two companies that continued to endure difficulties during 2002 as a result of the attacks of September 11th that have declined in fair value by $11.3 million. In general, our portfolio companies in the consumer-driven sectors, such as retail and consumer products, continue to perform well. However, we did decrease the fair value of six investments in this sector by $16.7 million during the nine months ended September 30, 2002. As the economy improves, the financial performance of these portfolio companies may also improve. However, there can be no assurance when or if these companies’ performance may improve. We also recorded

depreciation of $3.3 million on six commercial mortgage loans and $4.2 million on two real estate owned properties.

We also recorded $16.0 million of depreciation on our investment in Velocita, Inc. during the six months ended June 30, 2002, including accrued interest reserves, and we reversed the previously recorded depreciation during the third quarter of 2002 and recorded a realized loss of $16.0 million.

CMBS Bonds. Unrealized appreciation on the CMBS bond portfolio was $39.1 million for the nine months ended September 30, 2002, which consisted of a net unrealized gain on the CMBS bonds of $45.7 million less the net unrealized loss on the hedge of $6.6 million. See “Unrealized Gains and Losses — CMBS Bonds” included in the “Comparison of Three Months Ended September 30, 2002 and 2001.”

Other Matters. 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 shares used to compute diluted earnings per share, which were 103.0 million and 90.9 million for the nine months ended September 30, 2002 and 2001, respectively.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents

At September 30, 2002, and December 31, 2001, we had $23.6 million and $0.9 million, respectively, 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.

Debt and Other Commitments

We had outstanding debt at September 30, 2002, and December 31, 2001, as follows:


							Annual
			Facility		Amount		Interest
			Amount		Outstanding		Cost(1)
($ in millions)
At September 30, 2002




Notes payable and debentures:




	Unsecured long-term notes		$	694.0	$	694.0		7.8	%




	Small Business Administration debentures			101.8		94.5		8.2	%




	Auction rate reset note			75.0		75.0		3.6	%




	Overseas Private Investment Corporation loan			5.7		5.7		6.6	%

		Total notes payable and debentures	$	876.5	$	869.2		7.4	%

Revolving line of credit				527.5		121.5		3.3	%(2)

		Total debt	$	1,404.0	$	990.7		7.1	%

At December 31, 2001




Notes payable and debentures:




	Unsecured long-term notes		$	694.0	$	694.0		7.8	%




	Small Business Administration debentures			101.8		94.5		7.7	%




	Auction rate reset note			81.9		81.9		3.9	%




	Overseas Private Investment Corporation loan			5.7		5.7		6.6	%

		Total notes payable and debentures	$	883.4	$	876.1		7.4	%

Revolving line of credit				497.5		144.7		3.2	%(2)

		Total debt	$	1,380.9	$	1,020.8		7.0	%


(1)	The annual interest cost on notes payable and debentures includes the cost of commitment fees and other facility fees that are recognized into interest expense over the contractual life of the respective borrowings.
(2)	The current interest rate payable on the revolving line of credit was 3.3% and 3.2% at September 30, 2002 and December 31, 2001, respectively, which excludes the annual cost of commitment fees and other facility fees of $2.0 million.

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 2003. The notes require payment of interest only semi-annually, and all principal is due upon maturity.

Small Business Administration Debentures. We, through our small business investment company subsidiary, have debentures payable to the Small Business Administration with terms 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 $111.7 million from the Small Business Administration. At September 30, 2002, the Small Business Administration has a commitment to lend up to an additional $7.3 million above the amount outstanding. The commitment expires on September 30, 2005.

Auction Rate Reset Note. We have an Auction Rate Reset Senior Note Series A that bears interest at the three-month London Inter-Bank Offered Rate (“LIBOR”) plus 1.75%, which adjusts quarterly. Interest is due quarterly and the note matures on December 27, 2002, as amended. As a means to repay the note, we have entered into an agreement with the placement agent of this note to serve as the placement agent on a

future issuance of $75.0 million of debt, equity or other securities in one or more public or private transactions. Alternatively, we may repay the note in cash without conducting a capital raise. If we choose to repay the note in cash without conducting a capital raise, we will incur additional expense of approximately $3.2 million.

Revolving Line of Credit. As of September 30, 2002, we have a $527.5 million unsecured revolving line of credit that expires in August 2003, with the right to extend the maturity for one additional year at our sole option under substantially similar terms. This facility was increased by $30.0 million during the first quarter of 2002 from $497.5 million at December 31, 2001, and may be further expanded up to $600 million. As of September 30, 2002, $400.7 million remains unused and available, net of amounts committed for standby letters of credit of $5.3 million issued under the credit facility. The credit facility bears interest at a rate equal to (i) the one-month LIBOR plus 1.25% or (ii) the higher of (a) the Bank of America, N.A. prime rate or (b) the Federal Funds rate plus 0.50%. The credit facility 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 the 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, 2002, we were in compliance with these covenants.

The following table shows our significant contractual obligations as of September 30, 2002.



				Payments Due By Year

($ in millions)														After
Contractual Obligations		Total		2002		2003		2004		2005		2006		2006

Notes payable and debentures:




	Unsecured long-term notes	$	694.0	$	—	$	140.0	$	214.0	$	165.0	$	175.0	$	—




	Small Business Administration debentures		94.5		—		—		7.0		14.0		—		73.5




	Auction rate reset note		75.0		75.0		—		—		—		—		—




	Overseas Private Investment Corporation loan		5.7		—		—		—		—		5.7		—




Revolving line of credit(1)			121.5		—		—		121.5		—		—		—




Operating leases			21.6		0.6		2.6		2.7		2.7		2.6		10.4

Total contractual cash obligations		$	1,012.3	$	75.6	$	142.6	$	345.2	$	181.7	$	183.3	$	83.9


(1)	The revolving line of credit expires in August 2003, and may be extended under substantially similar terms for one additional year at our sole option. We assume that we would exercise our option to extend the revolving line of credit, resulting in an assumed maturity of August 2004.

The following table shows, as of September 30, 2002, our contractual commitments that may have the effect of creating, increasing or accelerating our liabilities.



			Amount of Commitment Expiration Per Year

($ in millions)													After
Commitments	Total		2002		2003		2004		2005		2006		2006

Standby letters of credit	$	11.3	$	—	$	—	$	5.3	$	—	$	—	$	6.0




Guarantees		50.4		—		1.0		48.5		0.2		—		0.7

Total commitments	$	61.7	$	—	$	1.0	$	53.8	$	0.2	$	—	$	6.7

Equity Capital and Dividends

Because we are a regulated investment company, we distribute 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 capital ratio.

To support our growth during the nine months ended September 30, 2002, and for the year ended December 31, 2001, we raised $49.9 million and $286.9 million, respectively, in new equity capital through the sale of shares from our shelf registration statement. We issue equity from time to time when we have attractive investment opportunities. In addition, during the nine months ended September 30, 2002 and for the year ended December 31, 2001, we raised $4.7 million and $6.3 million, respectively, in new equity capital through the issuance of shares through our dividend reinvestment plan. At September 30, 2002, total shareholders’ equity had increased to $1,429.0 million.

In order to raise new investment capital for portfolio growth, we are conducting a non-transferable rights offering. Each shareholder of record at the close of business on October 21, 2002, received one non-transferable right for each share held. For every 20 rights held, the shareholder will be able to purchase one share of Allied Capital’s common stock. In addition, an over-subscription feature has been included, allowing shareholders to subscribe for additional shares not subscribed for by other shareholders on a pro rata basis.

The rights offering will expire on November 21, 2002, unless the offering is extended. The per share subscription price will be 93% of the average of the last reported sales price of a share of Allied Capital’s common stock on the NYSE on November 21, 2002, and the four preceding business days. All shares of common stock acquired through the rights offering are expected to receive the fourth quarter dividend of $0.56 per share. Subscription certificates evidencing the non-transferable rights and a copy of the prospectus for this offering have been mailed to record date shareholders. The rights offering will be made only by means of the rights offering prospectus.

Our board of directors reviews the dividend rate quarterly, and may adjust the quarterly dividend throughout the year. For the first, second and third quarters of 2002, the board of directors declared a dividend of $0.53, $0.55 and $0.56 per common share, respectively. The board of directors has recently declared a dividend of $0.56 per common share for the fourth quarter of 2002, which will be paid on December 27, 2002 to shareholders of record on December 13, 2002. 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 that exceed a normal capital gains distribution level, and therefore avoid any unusual spike in dividends in any one year. The dividend policy also enables the board of directors to selectively retain gains to support future growth.

We plan to maintain a strategy of financing our business 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. Cash flow from operations before new investments was $504.8 million for the nine months ended September 30, 2002, and $330.8 million for the year ended December 31, 2001. Cash flow from operations before new investments has historically been sufficient to finance our operations.

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 short-term credit facilities 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, 2002, our debt to equity ratio was 0.69 to 1 and our weighted average cost of funds was 7.1%. Availability on the revolving line of credit, net of amounts committed for standby letters of credit issued under the line of credit facility, was $400.7 million on September 30, 2002. We believe that we have access to capital sufficient to fund our ongoing investment and operating activities.

CRITICAL ACCOUNTING POLICIES

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 primarily in illiquid securities including debt and equity securities of private companies and non-investment grade CMBS. 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. 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 establishing 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. Conversely, we will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and our equity security has also appreciated in value, where appropriate. The value of investments in public securities are determined using quoted market prices discounted for restrictions on resale.

Loans and Debt Securities. For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value or 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. Loans classified as Grade 4 or Grade 5 assets do not accrue interest. Loan origination fees, original issue discount and market discount are capitalized and then amortized into interest income using the effective interest method. 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. Prepayment premiums are recorded on loans when received.

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’s securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority control positions.

The value of our equity interests in public companies for which market quotations are readily available is based upon 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 cumulative 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”). CMBS are carried at fair value, which is based upon a discounted cash flow model that utilizes prepayment and loss assumptions based upon historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable market yields for similar CMBS bonds. Our assumption with regard to discount rate is based upon the yield of comparable securities. 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 estimates of future credit losses, actual losses incurred, or actual and estimated prepayment speeds. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the CMBS from the date the estimated yield is changed. We recognize

unrealized appreciation or depreciation on our CMBS as comparable yields in the market change and/or whenever we determine that the value of our CMBS is less than the cost basis due to changes in cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool.

Residual Interest. We value our residual interest from a previous securitization and recognize income using the same accounting policies used for the CMBS. The residual interest is carried at fair value based on discounted estimated future cash flows. We recognize income from the residual interest using the effective interest method. At each reporting date, the effective yield is recalculated and used to recognize income until the next reporting date.

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

Fee Income. Fee income includes fees for diligence, structuring, transaction services, management services and investment advisory services rendered by us to portfolio companies and other third parties. 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.

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, 2002, approximately 93% 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 ascertainable 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 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. Conversely, we will record unrealized appreciation if we have an indication that the underlying portfolio company has appreciated in value and, therefore, our security has also appreciated in value, where appropriate. Without a readily ascertainable market value and because of the inherent uncertainty of valuation, 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.

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 estimated fair value are recorded in our statement of operations as “Net unrealized gains (losses).”

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. Our non-performing 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, Inc. is our largest portfolio investment. Our financial results could be negatively affected if Business Loan Express, 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, 2002, the investment totaled $254.3 million at value, or 10.1% of total assets.

In addition, as controlling shareholder of Business Loan Express, we have provided an unconditional guaranty to Business Loan Express’ senior credit facility lenders in an amount equal to 50% of Business Loan Express’ total obligations on its $124.0 million revolving credit facility. The amount we have guaranteed at September 30, 2002, was $48.5 million. This guaranty can only be called in the event of a default by Business Loan Express. We have also provided two standby letters of credit in connection with two term loan securitization transactions completed by Business Loan Express in the second quarter of 2002 totaling $10.6 million.

Investments in non-investment grade commercial mortgage-backed securities may be illiquid, may have a higher risk of default and may not produce current returns. The commercial mortgage-backed securities in which we invest are not investment grade, which means that nationally recognized statistical 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 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, 2002, our asset coverage for senior indebtedness was 259%.

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, 2002, we had $990.7 million of outstanding indebtedness, bearing a weighted average annual interest cost of 7.1%. In order for us to cover these annual interest payments on indebtedness, we must achieve annual returns on our assets of at least 2.8%.

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 before net realized and unrealized gains or losses, or 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 sharply 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 short-term credit facilities 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 would have affected the net increase in net assets resulting from operations, or 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 incremental 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 sell additional 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 income to maintain our status as a regulated investment company.

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 will 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 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.

Recently, the trading price of our common stock has been volatile. Due to the continued potential volatility of our stock price, we may be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from our business. For information about the current securities class action lawsuit filed against us, see “Part II. Other Information — Legal Proceedings.”

Disclosure Regarding Forward-Looking Statements

Information contained in this Form 10-Q may contain “forward-looking statements” which 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 or similar words or phrases. The matters described in “Risk Factors” and certain other factors noted throughout this Form 10-Q constitute cautionary statements identifying important factors with respect to any such forward-looking statements, including certain risks and uncertainties, that could cause actual results to differ materially from those in such forward-looking statements.

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. Important assumptions include our ability to originate new investments, maintain certain margins and levels of profitability, access the capital markets for debt and equity capital, the ability to meet regulatory requirements and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include those described in “Risk Factors” and elsewhere in this Form 10-Q. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Form 10-Q.


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*

Our business activities contain elements of risk. We consider the principal types of risk to be fluctuations in interest rates and portfolio valuations. We consider the management of risk essential to conducting our businesses. Accordingly, our risk management systems and procedures are designed to identify and analyze our risks, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs.

As a business development company, we invest primarily in illiquid securities including debt and equity securities of private companies and non-investment grade CMBS. Our investments are generally subject to restrictions on resale and generally have

no established trading market. Since there is typically no ready market 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. 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. 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.

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 establishing 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. Conversely, we will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and our equity security has also appreciated in value, where appropriate. The value of investments in public securities are determined using quoted market prices discounted for restrictions on resale. Without a readily ascertainable 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. See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations — Critical Accounting Policies” and “— Results of Operations — Comparison of Three and Nine Months Ended September 30, 2002 and 2001 — Unrealized Gains and Losses” for further discussion of our valuation policies and methodology.

In addition, the illiquidity of our investments may adversely affect our ability to dispose of loans and securities at times when it may be otherwise advantageous for us to liquidate such investments. In addition, if we were required to 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.

Because we borrow money to make investments, our net investment income before net realized and unrealized gains or losses, or 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 sharply 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 short-term credit facilities 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 would have affected the

net increase in net assets resulting from operations, or 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.

Item 4. Controls and Procedures

(a) Within the 90-day period prior to the filing date of this quarterly report, 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-14 and 15d-14 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 not been any significant changes in the Company’s internal controls or in other factors that could significantly affect those controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

A series of class action lawsuits had been filed in the United States District Court for the Southern District of New York against us, certain of our directors and officers and our former independent auditors, Arthur Andersen LLP, with respect to alleged violations of the securities laws. These lawsuits alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, specifically they alleged, among other things, that we purportedly misstated the value of certain portfolio investments in our financial statements, which allegedly resulted in the purchase of our common stock by purported class members at artificially inflated prices. Several of the complaints also alleged state law claims for common law fraud. The complaints sought compensatory and other damages, and costs and expenses associated with the litigation. The lawsuits have been consolidated into a single proceeding captioned In re Allied Capital Corp. Securities Litigation, 02 CV 3812. The consolidated complaint does not include Arthur Andersen LLP as a named defendant or assert any state law claims against the named defendants. We believe that the lawsuit is without merit, and we intend to defend the lawsuit vigorously. While we do not expect these matters to materially affect our financial condition or results of operations, there can be no assurance as to whether any such pending litigation will have a material adverse effect on our financial condition or results of operations in any future reporting period.

We also are party to certain other lawsuits in the normal course of business. 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, 2002, we issued a total of 74,570 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.

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).


Exhibit
Number		Description

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		Second Amended and Restated Credit Agreement, dated August 3, 2001. (Incorporated by reference to Exhibit f.2.g filed with Allied Capital’s registration statement on Form N-2 (File No. 333-67336) filed on August 10, 2001).
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 the registration statement on Form N-2 (File No. 33-64629) 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 of 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’s Form 10-Q for the period ended June 30, 1999).
10.6		Amendment and Consent Agreement, dated December 11, 2000, to the Amended and Restated Credit Agreement, dated May 17, 2000. (Incorporated by reference to Exhibit f.6 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).
10.7		Sale and Servicing Agreement, dated as of January 1, 1998, among Allied Capital CMT, Inc., Allied Capital Commercial Mortgage Trust 1998-1, Allied Capital Corporation, LaSalle National Bank and ABN AMRO Bank N.V. (Incorporated by reference to Exhibit f.7.a filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).
10.8		Indenture, dated as of January 1, 1998, between Allied Capital Commercial Mortgage Trust 1998-1 and LaSalle National Bank. (Incorporated by reference to Exhibit f.7.b filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).
10.9		Amended and Restated Trust Agreement, dated January 1, 1998, between Allied Capital CMT, Inc., LaSalle National Bank Inc. and Wilmington Trust Company. (Incorporated by reference to Exhibit f.7.c filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).


Exhibit
Number		Description

10.10		Guaranty, dated as of January 1, 1998, by Allied Capital. (Incorporated by reference to Exhibit f.7.d filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).
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).
10.14		Auction Rate Reset Note Agreement, dated as of August 31, 2000, between Allied Capital and Intrepid Funding Master Trust; Forward Issuance Agreement, dated as of August 31, 2000, between Allied Capital and Banc of America Securities LLC; Remarketing and Contingency Purchase Agreement, dated as of August 31, 2000, between Allied Capital and Banc of America Securities LLC. (Incorporated by reference to Exhibit f.12 filed with Allied Capital’s Pre-Effective Amendment No. 1 to registration statement on Form N-2 (File No. 333-43534) filed on September 12, 2000).
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).
10.16		Amended and Restated Deferred Compensation Plan, dated December 30, 1998. (Incorporated by reference to Exhibit 10.11 of Allied Capital’s Form 10-K for the year ended December 31, 1998).
10.17		Amendment to Deferred Compensation Plan, dated October 18, 2000. (Incorporated by reference to Exhibit i.2.a filed with Allied Capital’s Post-Effective Amendment No. 1 to registration statement on Form N-2 (File No. 333-43534) filed on January 19, 2001).
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		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).
10.21		Amendment to Allied Capital Corporation 401(k) Plan, dated December 31, 2000. (Incorporated by reference to Exhibit i.5.a filed with Allied Capital’s Post-Effective Amendment No. 1 to registration statement on Form N-2 (File No. 333-43534) filed on January 19, 2001).
10.22		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).


Exhibit
Number		Description

10.23		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).
10.24		Employment Agreement, dated June 15, 2000, between Allied Capital and John M. Scheurer. (Incorporated by reference to Exhibit f.10 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).
10.25		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).
10.29*		Letter Agreement amending the Auction Rate Reset Note Agreement, dated as of September 30, 2002, between Allied Capital and Intrepid Funding Master Trust; Letter Agreement amending the Forward Issuance Agreement, dated as of September 30, 2002, between Allied Capital and Banc of America Securities LLC; Amendment to the Remarketing and Contingent Purchase Agreement, dated as of September 30, 2002, between Allied Capital and Banc of America Securities LLC.
15*		Letter regarding Unaudited Interim Financial Information
99.1*		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.
99.2*		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.

(b) Reports on Form 8-K.

None.

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)
		/s/ WILLIAM L. WALTON --------------------------------------------------- Chairman and Chief Executive Officer

Dated: November 14, 2002		/s/ PENNI F. ROLL --------------------------------------------------- Chief Financial Officer

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 quarterly 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 quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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-14 and 15d-14) for the registrant and we have:

a. designed such disclosure controls and procedures 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 quarterly report is being prepared;

b. evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


Date: November 14, 2002		By: /s/ WILLIAM L. WALTON William L. Walton Chief Executive Officer

Certification of Chief Financial Officer

I, Penni F. Roll, Chief Financial Officer of Allied Capital Corporation, certify that:

b. evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and


Date: November 14, 2002		By: /s/ PENNI F. ROLL Penni F. Roll Chief Financial Officer


	•	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.


	1.	I have reviewed this quarterly report on Form 10-Q of Allied Capital Corporation;

	2.	Based on my knowledge, this quarterly 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 quarterly report;

	3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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-14 and 15d-14) for the registrant and we have:


	a.	designed such disclosure controls and procedures 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 quarterly report is being prepared;


	b.	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and


	c.	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;


	a.	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and


	b.	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and