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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 0-22832
ALLIED CAPITAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 52-1081052
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION) IDENTIFICATION NO.)
1919 PENNSYLVANIA AVENUE NW 20006
WASHINGTON, D.C. (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (202) 331-1112
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.0001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant as of March 28, 2000 was approximately
$1,137,232,000 based upon the last sale price for the registrant's common stock
on that date. As of March 28, 2000 there were 68,628,044 shares of the
registrant's common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Shareholders for the year ended
December 31, 1999 are incorporated by reference into Parts II and IV of this
Report. Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held on May 9, 2000 are incorporated by reference
into Part III of this Report.
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PART I
ITEM 1. BUSINESS OF THE COMPANY
BUSINESS
We are principally a lender to and investor in private companies in a variety of
different industries and in diverse geographic locations throughout the United
States. We have been investing in growing businesses for over 40 years and have
financed thousands of private companies nationwide. Our investment activity is
focused in three areas:
- - private finance
- - commercial real estate finance, including the purchase of CMBS, and
- - Allied Capital Express -- small business and commercial real estate loans of
up to $3 million originated for sale.
Our investment portfolio consists primarily of long-term unsecured loans with
equity features, commercial mortgage-backed securities, commercial mortgage
loans and small senior loans, including SBA 7(a) guaranteed loans. At December
31, 1999, our investment portfolio totaled $1.2 billion representing 641
borrower relationships in 38 states and the District of Columbia. The Company's
investment objective is to achieve current income and capital gains.
PRIVATE FINANCE
We provide long-term debt and equity financing to private companies nationwide.
Our private finance activities target a market niche between the senior debt
financing provided by traditional lenders, such as banks, commercial finance
companies and insurance companies, and the equity capital provided by private
equity investors.
Our private financing is generally used to fund growth, buyouts, note purchases,
acquisitions, recapitalizations, and bridge financings. We generally invest in
private companies though, from time to time, we may invest in undervalued public
companies that lack access to public capital and whose securities may not be
marginable. We target two types of companies when seeking new investments. The
first type of company we seek is a market leader in a stable industry that has
demonstrated over many years of operations that it can successfully achieve its
business plan and thereby achieve our investment objective. The second type of
company we seek is an emerging company in a growing industry that is positioned
for significant growth. We have spent over 40 years refining our highly
selective investment discipline, which is founded on seeking portfolio companies
having key characteristics and targeting specific industries.
We originate investments generally ranging in size from $5 million to $30
million, and in 1999 our average investment size was approximately $12.4
million. Our private finance investments are generally structured as an
unsecured, subordinated loan that carries a relatively high fixed interest rate
(generally 12% to 18%), with interest-only payments in the early years and
payments of both principal and interest in the later years, with maturities of
five to ten years. Approximately 98% of the investments in the private finance
portfolio have fixed rates of interest. Our private finance investments
typically include equity features, such as warrants or options to buy a minority
interest in the portfolio company. We also make preferred and common equity
investments, particularly when we see unique opportunities to profit from the
growth of an emerging company. At December 31, 1999, 87% of the private finance
portfolio consisted of debt securities, and 13% consisted of equity securities.
Our private finance portfolio is geographically diverse, and includes
investments in a wide variety of industries, including business services,
consumer products, telecommunications, industrial products and broadcasting.
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Capital providers for the finance of private companies can be generally
categorized as shown in the diagram below:
CAPITAL PROVIDER Banks Commercial Insurance Allied Capital Private Private
Finance Companies/ Mezzanine Equity
Companies High Yield Funds Funds
Market
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PRIMARY Senior, short- Asset-based Large > $30 Unsecured Unsecured Equity
BUSINESS term debt lending million long-term debt long-term debt
FOCUS credits with equity with equity
upside upside
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TYPICAL PRICING LIBOR+ [graphic of arrow stretching between 'LIBOR+' and '30%+'] 30%+
SPECTRUM*
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* Based on market experience of our marketing and investment professionals.
Banks are primarily focused on providing senior secured and unsecured short-term
debt. They typically do not provide meaningful long-term unsecured loans.
Commercial finance companies are primarily focused on providing senior secured
long-term debt. The private insurance company and high-yield debt markets are
focused primarily on very large financing transactions, typically in excess of
the financings we do. We generally do not compete with banks, commercial finance
companies, or the insurance company/high yield market. Instead, we compete
directly with the private mezzanine sector of the private equity market. Private
mezzanine funds are also focused on providing unsecured long-term debt to
private companies for the types of transactions discussed above. We believe that
we have key structural and operational advantages when compared to private
mezzanine funds.
Our scale of operations, equity capital base, and successful track record as a
private finance investor has enabled us to borrow long-term capital to leverage
our returns on our common equity. Therefore, our access to debt capital reduces
our total cost of capital. In many cases, a private mezzanine fund is unable to
access the debt capital markets, and therefore must achieve an unleveraged
equity return for their investors. Our lower cost of capital gives us a pricing
advantage when competing for new investments. In addition, the perpetual nature
of our corporate structure enables us to be a better long-term partner for our
portfolio companies than a traditional mezzanine fund, which typically has a
finite life.
We estimate that we fund only 2% of all the private finance investments that we
review. When assessing a prospective investment, we look for a company that has
achieved, or has the potential to achieve, market leadership in a niche,
critical mass, and a sustainable cash flow. We also look for companies that,
because of their industry and business plan, can demonstrate minimal
vulnerability to changes in economic cycles. Since our debt securities are
primarily unsecured in nature, we look for companies in industries that are
non-cyclical, cash flow intensive, and can demonstrate a high return on their
invested capital. We generally do not target companies in industries where
businesses tend to be vulnerable to changes in economic cycles, are capital
intensive, and have low returns on their invested capital. We generally target
and do not target the following industries, though we will consider investments
in any industry if the prospective company demonstrates unique characteristics
that make it an attractive investment opportunity:
INDUSTRIES TARGETED
NON-CYCLICAL/CASH FLOW INTENSIVE/
HIGH RETURN ON CAPITAL
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Business services
Telecommunications
Broadcasting
Education
Healthcare
Consumer products
Light industrial products
INDUSTRIES NOT TARGETED
CYCLICAL/CAPITAL INTENSIVE/
LOW RETURN ON CAPITAL
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Heavy manufacturing
Natural resources
Commodity retail
Low value-add distribution
Agriculture
Transportation
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Another critical element of our investment discipline is to invest in companies
with a significant equity capital base, and a strong private equity sponsor. For
example, in 1999, 77% of our private financings were completed in conjunction
with private equity firms, which provided capital that is junior to ours. We
believe strong equity sponsorship significantly strengthens our position as a
long-term lender. A strong equity sponsor provides not only strong equity
capital beneath our investment, but also provides a reliable source of
additional equity capital if the portfolio company requires additional
financing. Private equity sponsors also help us confirm our own due diligence
findings when assessing a new investment opportunity, and they provide
assistance and leadership to the portfolio company's management team throughout
our investment period.
The typical private finance structure focuses, first and foremost, on the
protection of our investment principal. Our debt instruments generally provide
for a contractual interest rate ranging from 12% to 18%, which provides current
interest income. The debt instruments also have restrictive covenants that
protect our interests in the transaction. The warrants we receive with our debt
securities generally require only a minimal cost to exercise, and thus as the
portfolio company appreciates in value, we achieve additional investment return
from this equity interest. We seek to achieve additional investment returns of
up to 1000 basis points from the appreciation and sale of our warrants.
Generally, our warrants expire five years after the related debt is repaid. The
warrants typically include registration rights, which allow us to sell the
securities if the portfolio company completes a public offering. In most cases,
the warrants also have a put option that requires that the borrower repurchase
our equity position after a specified period of time at a formula price or at
its fair market value. Most of the gains we realize from our warrant portfolio
arise as a result of the sale of the portfolio company to another business, or
through a recapitalization. Historically, we have not been dependent on the
public equity markets for the sale of our warrant positions.
We hold a portion of our private finance investments in a wholly owned
subsidiary, Allied Investment Corporation. Allied Investment is a BDC and is
licensed and regulated by the Small Business Administration to operate as a
small business investment company ("SBIC"). See "Certain Government Regulations"
below for further information about SBIC regulation.
COMMERCIAL REAL ESTATE FINANCE
COMMERCIAL MORTGAGE LOANS. We have been a commercial real estate lender for
many years, and maintain a commercial mortgage loan portfolio. During 1998, we
significantly reduced our middle-market commercial real estate lending
activities, because we believed that the market was under-pricing commercial
real estate loans, and that the returns on senior commercial real estate loans
were below a level that would result in a fair return on equity for our
shareholders. We, however, continue to see a strong demand for small commercial
mortgage loans that can be attractively priced for sale to banks and other
financial institutions. As a result of this market demand, we combined our small
real estate lending with our SBA lending activity to form Allied Capital
Express, which is discussed below.
We continue to seek unique opportunities for commercial mortgage loans for our
portfolio when our risk/return objectives can be achieved. These loans are
generally priced at higher fixed interest rates and include subordinated real
estate loans. Subordinated loans are priced similarly to our private finance
loans and may be accompanied by an equity interest in the real estate or in the
underlying business. We derive income from the interest charged on the
commercial mortgage loan portfolio through contractual interest and amortization
of discounts.
We compete with banks, real estate conduits, equity and mortgage real estate
investment trusts ("REITs") and other lenders for the commercial mortgage loans
we originate for investment. We believe we have earned a reputation in the
commercial real estate finance market as a specialist in credits that require
more difficult structuring or underwriting techniques, and that we compete
successfully in this niche.
During 1999, we sold a significant portion of our lower yielding commercial
mortgage loan portfolio, and redeployed the proceeds into higher yielding
investments. We may continue to sell loans from this portfolio during 2000.
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COMMERCIAL MORTGAGE-BACKED SECURITIES. The same pricing pressures that caused
us to reduce our origination of commercial mortgage loans in 1998 created
significant liquidity problems for many other real estate lenders who had
remained active lenders as pricing declined throughout 1998. In the fourth
quarter of 1998, many of these lenders experienced severe liquidity constraints
that caused them to exit the commercial mortgage-backed securities market. This
liquidity turmoil in the real estate capital markets created a unique
opportunity for us to acquire newly issued, non-investment grade commercial
mortgage-backed securities ("Purchased CMBS") at significant discounts from the
face amount of the bonds and at attractive yields.
As an investor, we believe that Purchased CMBS has attractive risk/return
characteristics. The Purchased CMBS in which we invest are non-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." Unlike most "junk bonds,"
which are typically unsecured debt instruments, the non-investment grade
Purchased CMBS in which we invest are secured by mortgage loans with real estate
collateral. Our Purchased CMBS are fully collateralized by senior mortgage loans
on commercial real estate properties where the loans are, on average, supported
by a 30% equity investment. We acquire our Purchased CMBS on the initial
issuance of the CMBS bond offering, and are able to underwrite and negotiate to
purchase the securities at a significant discount from their face amount,
generally resulting in an estimated yield to maturity ranging from 13% to 16%.
Our negotiated discount and estimated yield to maturity assumes a 1% loss rate
on the entire underlying commercial mortgage loan collateral pool, which takes
into consideration certain business and economic uncertainties and
contingencies. We find the yields for Purchased CMBS very attractive given their
collateral protection.
We believe this risk/return dynamic exists in this market today because there
are significant barriers to entry as a non-investment grade CMBS investor.
First, non-investment grade CMBS are long-term investments and require long-term
investment capital. Our capital structure, which is in excess of 50% equity
capital, is well suited for this asset class. Second, when we purchase CMBS on
an initial issuance, we re-underwrite every mortgage loan in the underlying
collateral pool, and we meet with the issuer to discuss the nature and type of
loans we will accept into the pool. We have significant commercial mortgage loan
underwriting expertise, both in terms of the number of professionals we employ
and the depth of their commercial real estate experience. Access to this type of
expertise is another barrier to entry into this market.
As a non-investment grade CMBS investor, we recognize that non-investment grade
securities have a higher degree of risk than do investment grade bonds.
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. They tend to be less liquid, may have a higher risk of default, and may
be more difficult to value. We invest in non-investment grade CMBS represented
by the "BB" to non-rated tranches of a CMBS issuance. Due to the underlying
structure of the CMBS issuances, our CMBS tranches receive principal payments
only after the securities that are senior to our securities are repaid. Thus, if
losses are incurred in the underlying mortgage loan collateral pool, we would
experience these losses.
To mitigate this risk, we perform extensive due diligence prior to an investment
in Purchased CMBS. When we evaluate a CMBS investment, we use the same
underwriting procedures and criteria for the mortgage loans in the collateral
pool as we do for all of the loans we originate. These underwriting procedures
and criteria are described in detail below. We will only invest in CMBS when we
believe, as a result of our underwriting procedures, that the underlying
mortgage pool adequately secures our position. Our portfolio of CMBS is secured
by more than 2,000 commercial real estate properties located in diverse
geographic locations across the United States in a wide variety of property
types, including retail, multi-family housing, office, and hospitality. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our 1999 Annual Report to Shareholders for a summary of the loan
to value ratios and debt service coverage ratios of the mortgage loans securing
our Purchased CMBS investments.
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Our Purchased CMBS activity complements our private finance activity because it
provides a steady stream of recurring interest income. In order to maintain a
balanced investment portfolio, we expect to limit our Purchased CMBS activity on
a proportional basis as our private finance portfolio grows.
ALLIED CAPITAL EXPRESS
We originate small business and commercial real estate loans, primarily for
sale, under the brand name "Allied Capital Express." The loans we originate in
this program are generally for financings of up to $3 million in size, and may
be composed of an SBA 7(a) guaranteed loan and a conventional commercial
mortgage loan. These loans are sold to banks and other financial institutions
for premiums ranging from 5% to 10% of the loan amount sold. We also may sell
these loans for a retained servicing spread that can range from 1% to 5% of the
outstanding loan balance for the period that the loan remains outstanding. We
began using a separate brand name for these smaller loans in the second quarter
of 1999, to distinguish this program from our core private finance activity and
avoid confusion in the market place. Allied Capital Express provides a steady
stream of premium income to the Company with minimal capital employed, and thus
complements our other portfolio activities.
Many of the loans originated under the Allied Capital Express brand name are
through our participation in the SBA's 7(a) Guaranteed Loan Program. The SBA
7(a) program is estimated to provide approximately $10 billion to small
businesses on an annual basis. One of our subsidiaries is licensed by the SBA as
a Small Business Lending Company ("SBLC") and is one of only fourteen non-bank
SBLCs operating in the United States. Under the SBA 7(a) program, we extend
senior secured loans that are partially guaranteed by the SBA. Our 7(a) loans
are provided to small businesses for the purposes of acquiring a business or
real estate, purchasing machinery or equipment, or providing working capital.
The loans are secured by a mortgage or other liens on the assets of the
borrower, and in all cases the owners of the business must personally guarantee
the repayment of the loan. We focus our 7(a) loan origination activity on loans
secured by commercial real estate assets. We are a Preferred Lender and we
operate in 20 SBA-designated markets throughout the United States. We have
Allied Capital Express offices in seven locations.
In 1999, we began an initiative to increase the growth and profitability of
Allied Capital Express. We developed technology to streamline the closing
process and reduce cycle times for transactions. We strengthened our sales force
and increased our loan sale network. We also began a process to migrate the
application process to the Internet to increase our loan origination activity.
We intend to continue with all aspects of this initiative throughout 2000.
Our 7(a) loans typically range in size from $250,000 to $1 million. The SBA
guarantees 80% of any qualified loan up to $100,000 regardless of maturity, and
75% of any qualified loan over $100,000 regardless of maturity, to a maximum
guarantee of $750,000 for any one borrower. SBA regulations define qualified
small businesses generally as businesses with (1) no more than $5 million in
annual sales or (2) no more than 500 employees. The SBA stipulates that loans
used to acquire real estate may have a maximum maturity of 25 years; loans used
to purchase machinery and equipment may have a maximum maturity of 15 years;
loans used for working capital may have a maximum maturity of seven years.
We generally price our 7(a) loans with variable interest rates typically ranging
from 1.75% to 2.75% over the prime rate, adjusted monthly. Approximately 98% of
this portfolio has variable interest rates. Generally loans are payable in equal
monthly installments of principal and interest on the first day of the month
following the month in which the loan is funded, until maturity. We routinely
sell the guaranteed portion of our 7(a) loans in the well-established secondary
market of banks and other institutional buyers. We earn a premium, net of
origination costs, on the sale of the guaranteed portion of our 7(a) loans,
which typically range from 4% to 7.5% of the face amount of each loan sold. We
also may sell these loans for a retained servicing spread that generally ranges
from 1% to 5% of the loan balance for the period that the loan remains
outstanding. In 1999, we entered into an agreement with a commercial paper
conduit to sell up to 90% of the unguaranteed interests in our 7(a) loans. We
retain a servicing spread of approximately 3.75% on the unguaranteed interests
sold. We continue to service 100% of each 7(a) loan we originate.
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In addition to 7(a) loans, we originate small commercial real estate loans for
sale to banks and other institutional buyers. These loans are often originated
in conjunction with 7(a) loans. The small commercial real estate loans generally
are priced and structured such that we can receive premiums for the sale of
these loans to banks and other financial institutions. Our net premium on these
loan sales is generally up to 10% of the loan balance sold.
INVESTMENT ADVISORY SERVICES
We are a registered investment adviser, pursuant to the Investment Advisers Act
of 1940, and have certain investment advisory agreements to manage private
investment funds. The revenue generated from these agreements is not material to
the Company's operations.
LOAN SOURCING
Over the last two years, we have significantly increased the scope of our sales
and marketing activity by opening new regional offices and increasing our sales
and marketing staff. To source new investment opportunities, we work with
thousands of intermediaries including:
- - regional and boutique investment banks;
- - private mezzanine and equity investors;
- - business and mortgage brokers;
- - national retail financial services companies; and
- - banks, law firms and accountants.
We believe that our experience and reputation provide a competitive advantage in
originating new investments. We have established an extensive network of
investment referral relationships over our 41-year history. We are recognized as
a pioneer in the private finance industry, and have developed a reputation in
the commercial real estate finance market for our ability to finance complex
transactions.
For Allied Capital Express activities, we continue to build our network of
Internet relationships to direct traffic to our web site,
AlliedCapitalExpress.com, which we believe will increase our business
opportunities. We have entered into a strategic relationship with an online loan
broker and plan to enter into similar agreements with other small business
portals and online intermediaries throughout 2000.
INVESTMENT APPROVAL AND UNDERWRITING PROCEDURES
In assessing new investment opportunities, we maintain conservative credit
standards based on our underwriting guidelines, a thorough due diligence
process, and a centralized credit approval process requiring committee review,
all of which are described below. The combination of conservative underwriting
standards and our credit-oriented culture has resulted in a record of minimal
realized losses.
PRIVATE FINANCE. We generally require that the companies in which we invest
demonstrate strong market position, sales growth, positive cash flow, and
profitability, as discussed above. We emphasize the quality of management, and
seek experienced entrepreneurs with a management track record, relevant industry
experience and a significant equity stake in the business. In a typical private
financing, we thoroughly review, analyze and substantiate, through due
diligence, the business plan and operations of the potential portfolio company.
We perform financial due diligence, often with assistance of an accounting firm;
perform operational due diligence, often with the assistance of an industry
consultant; study the industry and competitive landscape; and conduct numerous
reference checks with current and former employees, customers, suppliers and
competitors. The typical private finance transaction requires two to three
months of diligence and structuring before funding occurs.
Private finance transactions are approved by an investment committee consisting
of our most senior private finance professionals and chaired by our Chairman and
Chief Executive Officer. The private finance approval process benefits from the
experience of the investment committee members and from the
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experience of our other investment professionals who together with the committee
members, on average, have over eleven years of professional experience. For
every transaction of $10 million or greater, we also require approval from the
executive committee of the board of directors in addition to the investment
committee approval. Even after all such approvals are received, due diligence
must be successfully completed with final investment committee approval before
funds are disbursed to a new portfolio company.
PURCHASED CMBS. We receive extensive packages of information regarding the
mortgage loans comprising a CMBS pool. We work with the issuer, the investment
bank, and the rating agencies in performing our diligence on a CMBS purchase.
The typical CMBS purchase takes between two to three months to complete because
of the breadth and depth of our diligence procedures. We re-underwrite all of
the underlying commercial mortgage loans securing the CMBS. We challenge the
estimate of underwriteable cash flow and challenge necessary carve-outs, such as
replacement reserves. We study the trends of the industry and geographic
location of each property, and independently assess our own estimate of the
anticipated cash flow over the period of the loan. Our loan officers physically
inspect most of the collateral properties, and assess appraised values based on
our own opinion of comparable market values.
Based on the findings of our diligence procedures, we may reject certain
mortgage loans from inclusion in the pool. We then formulate our negotiated
purchase price and discount to achieve an effective yield on our investment over
a ten-year period to approximate 13% to 16%. In computing this estimated yield,
we assume a 1% loss rate on the entire underlying mortgage pool.
CMBS transactions are approved by an investment committee and, because of their
size, every CMBS transaction is reviewed and approved by the executive committee
of the board of directors. The investment committee for CMBS transactions
consists of our most senior commercial real estate professionals and is chaired
by our Chairman and Chief Executive Officer.
COMMERCIAL REAL ESTATE FINANCE. When we evaluate commercial mortgage loans, we
generally receive an initial package of information that typically includes
underwriting information that was developed by the borrower. Typical
underwriting information that is required from potential borrowers in order to
conduct appropriate due diligence includes: financial statements of the
borrower, appraisals, rent rolls and lease information, environmental reports,
structural and engineering reports, and any other information deemed appropriate
under the circumstances. Our underwriting process includes assessing the
borrower's estimated earnings and current cash flow coverage, the
creditworthiness of the borrower, the net worth and financial strength of the
borrower, the estimated current liquidation value of the related mortgaged
property, the financial strength of the significant tenants and any other
collateral. We also study trends in the borrower's industry and in real estate
values in the borrower's geographic region. Our loan officers inspect the
property during the due diligence process, and value the property using
internally developed valuation analyses.
Commercial mortgage loans are approved by an investment committee, which is
composed of the Company's most senior commercial real estate finance investment
professionals. For loans of $10 million or greater, the executive committee of
the board of directors must also approve the transaction, as described above.
ALLIED CAPITAL EXPRESS. Loans made to small businesses are generally secured by
real estate and other liens on the assets of the borrower and, frequently, by
the assets of principals. The entrepreneur must personally guarantee the payment
of interest and principal on the loans. We generally follow the same
underwriting procedures and criteria for 7(a) loans as we do for our commercial
real estate loans, however, in addition to those underwriting standards, the SBA
has established certain financial ratios and guidelines that generally govern
7(a) loans. Factors to be considered include the debt service coverage ratio,
value of the collateral, and the net worth of the borrower.
Allied Capital Express loans require the review and approval of three senior
small business lending professionals prior to funding. The small business
investment committee periodically ratifies each new investment.
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PORTFOLIO MANAGEMENT
PORTFOLIO DIVERSITY. We monitor the portfolio to maintain both industry and
geographic diversity. We currently do not have a policy with respect to
"concentrating" (i.e., investing 25% or more of our total assets) in any
industry or group of industries and currently our portfolio is not concentrated.
We may or may not concentrate in any industry or group of industries in the
future.
LOAN SERVICING. Our loan servicing staff is responsible for routine loan
servicing, which includes:
- delinquency monitoring;
- payment processing;
- borrower inquiries;
- escrow analysis and processing;
- third-party reporting; and
- insurance and tax administration.
In addition, our staff is responsible for special servicing activities including
delinquency monitoring and collection, workout administration and management of
foreclosed assets.
PORTFOLIO MONITORING AND VALUATION
We use a grading system in order to help us monitor the credit quality of our
portfolio and the potential for capital gains. The grading system assigns grades
to investments from 1 to 5, and the portfolio was graded at December 31, 1999 as
follows:
PERCENTAGE
PORTFOLIO AT OF TOTAL
GRADE DESCRIPTION VALUE PORTFOLIO
- ----- ----------- ------------- ----------
(IN MILLIONS)
1 Probable capital gain....................................... $ 156.0 12.7%
2 Performing security......................................... 1,002.9 81.7%
Close monitoring -- no loss of principal or interest
3 expected.................................................... 22.5 1.8%
4 Workout -- Some loss of interest expected................... 32.2 2.6%
5 Workout -- Some loss of principal expected.................. 14.9 1.2%
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$1,228.5 100.0%
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The 1940 Act requires that the board of directors value each asset in the
portfolio on a quarterly basis. We are not permitted to have a general loan loss
reserve, but instead must value each specific investment. We have a written
valuation policy that governs the valuation of our assets, and we follow a
consistent valuation process quarterly. In valuing each individual investment,
we consider the financial performance of each portfolio company, loan payment
histories, indications of potential equity realization events, current
collateral values and determine whether the value of the asset should be
increased through unrealized appreciation or decreased through unrealized
depreciation. After each investment professional has made his or her
determination of value, members of senior management review the valuations.
These valuations are then presented to the board of directors for review and
approval.
As a general rule, we do not value our loans above cost, but loans are subject
to depreciation events when the asset is considered impaired. Also as a general
rule, equity securities may be assigned appreciation if circumstances warrant.
With respect to private equity securities, each investment is valued using
industry valuation benchmarks, and then the value is assigned a discount
reflecting the illiquid nature of the
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investments as well as our minority, non-control position. When an external
event such as a purchase transaction, public offering, or subsequent equity sale
occurs, the pricing indicated by the external event is used to corroborate our
private equity valuation. Equity securities in public companies that carry
certain restrictions on sale are generally valued at a discount from the public
market value of the securities. Restricted and unrestricted publicly traded
stocks may also be valued at discounts due to the size of our investment,
restrictions on trading or market liquidity concerns.
We monitor loan delinquencies weekly. The following outlines the treatment of
each delinquency category:
30 DAYS PAST DUE Our loan servicing staff monitors loans and contacts
borrowers for collection.
60 DAYS PAST DUE We generally transfer loans to professionals responsible
for special servicing activity for monitoring,
collection and development of a workout plan, if
necessary.
90 DAYS PAST DUE Our accounting department reviews loans in conjunction
with the professional responsible for special servicing
to determine whether the loans should be placed on a
non-accrual status or whether a valuation adjustment is
required.
120 DAYS PAST DUE Generally, we place such loans on non-accrual status and
the loan is an active workout.
INVESTMENT GAINS AND LOSSES
As an investor focused primarily on debt investments, our investment decisions
are based on credit dynamics. Our underwriting focuses on the preservation of
principal, and we will pursue every available means to recover our capital
investment. As a result of this investment discipline and credit culture, we
have a history of low levels of loan losses, and have a demonstrated track
record of successfully resolving troubled credit situations with minimal losses.
In fact, we have historically experienced a loss rate that has averaged less
than 1% of total assets annually over the last five, ten and twenty years. Our
realized gains from the sale of our equity interests have historically exceeded
losses, as is reflected in the chart below.
1999 1998 1997 1996 1995
---------- -------- -------- -------- --------
Realized gains........................... $ 31,536 $ 25,757 $ 15,804 $ 30,417 $ 16,679
Realized losses.......................... $ (6,145) $ (3,216) $ (5,100) $(11,262) $ (4,679)
Net realized gains....................... $ 25,391 $ 22,541 $ 10,704 $ 19,155 $ 12,000
Total assets............................. $1,290,038 $856,079 $807,775 $713,360 $605,434
Realized losses/Total assets............. 0.5% 0.4% 0.6% 1.6% 0.8%
EMPLOYEES
At December 31, 1999, we employed 129 individuals including investment
professionals, operations professionals and administrative staff. The majority
of these individuals are located in the Washington, DC office. We believe that
our relations with employees are excellent.
CERTAIN GOVERNMENT REGULATIONS
We operate in a highly regulated environment. The following discussion generally
summarizes certain regulations.
BUSINESS DEVELOPMENT COMPANY ("BDC"). A business development company is defined
and regulated by the Investment Company Act of 1940. It is a unique kind of
investment company that primarily focuses on investing in or lending to small
private companies and making managerial assistance available to them. A BDC may
use capital provided by public shareholders and from other sources to invest in
long-term, private investments in growing small businesses. A BDC provides
shareholders the ability to retain the
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liquidity of a publicly traded stock, while sharing in the possible benefits, if
any, of investing in privately owned growth companies.
As a BDC, we may not acquire any asset other than "Qualifying Assets" unless, at
the time it makes the acquisition, our Qualifying Assets represent at least 70%
of the value of our total assets (the "70% test"). The principal categories of
Qualifying Assets relevant to our business are:
(1) Securities purchased in transactions not involving any public offering,
the issuer of which is an eligible portfolio company. An eligible
portfolio company is defined to include any issuer that (a) is
organized and has its principal place of business in the United States,
(b) is not an investment company other than an SBIC wholly owned by a
BDC (our investments in Allied Investment, Allied SBLC and certain
other subsidiaries generally are Qualifying Assets), and (c) does not
have any class of publicly traded securities with respect to which a
broker may extend margin credit;
(2) Securities received in exchange for or distributed with respect to
securities described in (1) above or pursuant to the exercise of
options, warrants, or rights relating to such securities; and
(3) Cash, cash items, government securities, or high quality debt
securities (within the meaning of the 1940 Act), maturing in one year
or less from the time of investment.
To include certain securities described above as Qualifying Assets for the
purpose of the 70% test, a BDC must make available to the issuer of those
securities significant managerial assistance such as providing significant
guidance and counsel concerning the management, operations, or business
objectives and policies of a portfolio company, or making loans to a portfolio
company. We will provide managerial assistance on a continuing basis to any
portfolio company that requests it, whether or not difficulties are perceived.
As a BDC, the Company is entitled to issue senior securities in the form of
stock or senior securities representing indebtedness, as long as each class of
senior security has an asset coverage of at least 200% immediately after each
such issuance. This limitation is not applicable to borrowings by our SBIC or
SBLC subsidiaries, and therefore any borrowings by these subsidiaries are not
included in this asset coverage test. See "Risk Factors."
We may not change the nature of our business so as to cease to be, or withdraw
our election as, a BDC unless authorized by vote of a "majority of the
outstanding voting securities," as defined in the 1940 Act, of our shares. Since
we made our BDC election, we have not made any substantial change in the nature
of our business.
REGULATED INVESTMENT COMPANY ("RIC"). Our status as a RIC enables us to avoid
the cost of federal and state taxation, and as a result achieve pre-tax
investment returns. We believe that this tax advantage enables us to achieve
strong equity returns without having to aggressively leverage our balance sheet.
In order to qualify as a RIC, the Company must, among other things:
(1) Derive at least 90% of its gross income from dividends, interest,
payments with respect to securities loans, gains from the sale of stock
or other securities or other income derived with respect to its
business of investing in such stock or securities.
(2) Diversify its holdings so that
(a) at least 50% of the value of the Company's assets consists of cash,
cash items, U.S. government securities, securities of other RICS and
other securities if such other securities of any one issuer do not
represent more than 5% of the Company's assets and 10% of the
outstanding voting securities of the issuer, and
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(b) no more than 25% of the value of the Company's assets are invested
in securities (other than U.S. government securities) of one issuer,
or of two or more issuers that are controlled by the Company.
(3) Distribute at least 90% of its "investment company taxable income" each
tax year to its shareholders. In addition, if a RIC distributes in a
timely manner (or treats as "deemed distributed") 98% of its capital
gain net income for each one year period ending on December 31 and
distributes 98% of its ordinary income for each calendar year, it will
not be subject to the 4% nondeductible federal excise tax on certain
undistributed income of RICs.
SBA REGULATIONS. Allied Investment is an SBIC and Allied SBLC is an SBLC.
SBIC REGULATIONS. Allied Investment, a wholly owned subsidiary of the Company,
is licensed by the SBA as an SBIC under Section 301(c) of the Small Business
Investment Act of 1958, as amended (the "1958 Act"), and has elected to be
regulated as a BDC.
SBICs are authorized to stimulate the flow of private equity capital to eligible
small businesses. Under present SBA regulations, eligible small businesses
include businesses that have a net worth not exceeding $18 million and have
average annual fully taxed net income not exceeding $6 million for the most
recent two fiscal years. In addition, an SBIC must devote 20% of its investment
activity to "smaller" concerns as defined by the SBA. A smaller concern is one
that has a net worth not exceeding $6 million and has average annual fully taxed
net income not exceeding $2 million for the most recent two fiscal years. SBA
regulations also provide alternative size standard criteria to determine
eligibility, which depend on the industry in which the business is engaged and
are based on such factors as the number of employees and gross sales. According
to SBA regulations, SBICs may make long-term loans to small businesses, invest
in the equity securities of such businesses, and provide them with consulting
and advisory services. Allied Investment provides long-term loans to qualifying
small businesses; equity investments and consulting and advisory services are
typically provided only in connection with such loans.
Allied Investment is periodically examined and audited by the SBA staff to
determine its compliance with SBIC regulations.
Allied Investment has the opportunity to sell to the SBA subordinated debentures
with a maturity of up to ten years, up to an aggregate principal amount of $101
million. This limit generally applies to all financial assistance provided by
the SBA to any licensee and its "associates," as that term is defined in SBA
regulations. Historically, an SBIC was also eligible to sell preferred stock to
the SBA. Allied Investment had received $62.7 million of subordinated debentures
and $7.0 million of preferred stock investments from the SBA at December 31,
1999; as a result of the $101 million limit, the Company is limited on its
ability to apply for additional financing from the SBA. Interest rates on the
SBA debentures currently outstanding have a weighted average interest cost of
8.0%.
At December 31, 1999, we had an outstanding commitment from the SBA to purchase
up to $12.0 million in additional SBIC debentures, which was borrowed in January
2000.
SBLC REGULATIONS. Allied SBLC is licensed to operate as an SBLC and is
periodically examined and audited by the SBA staff for purposes of determining
compliance with SBA regulations, including its participation in the Preferred
Lenders Program. See SBA 7(a) Lending, above.
FORWARD-LOOKING STATEMENTS
You should read the information contained in this Form 10-K in conjunction with
the Company's 1999 Consolidated Financial Statements and Notes thereto contained
in the Company's 1999 Annual Report to Shareholders. The 1999 Annual Report to
Shareholders and this Form 10-K contain certain forward-looking statements.
These statements include management's plans and objectives for future operations
and financial objectives, loan portfolio growth and availability of funds. There
are inherent uncertainties in predicting future results and conditions, and
certain factors could cause actual results and conditions to
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differ materially from those projected in these forward-looking statements.
These factors are described in the "Risk Factors" section below. Other factors
that could cause actual results to differ materially include the uncertainties
of economic, competitive and market conditions, and future business decisions,
all of which are difficult or impossible to predict accurately and many of which
are beyond our control. Although we believe that the assumptions underlying the
forward-looking statements included or incorporated by reference in this
document are reasonable, any of the assumptions could be inaccurate and
therefore, we cannot assure you that the forward-looking statements included or
incorporated by reference in this document will prove to be accurate. Therefore,
you should not regard the inclusion of this information as an assurance that the
Company's plans and objectives will be achieved.
RISK FACTORS
INVESTING IN PRIVATE COMPANIES INVOLVES A HIGH DEGREE OF RISK
Our portfolio consists primarily of long-term loans to and investments in
private companies. There is generally no publicly available information about
these companies, and we rely significantly on the diligence of our employees and
agents to obtain information in connection with the Company's 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.
Investments in private businesses, therefore, involve a high degree of business
and financial risk, which can result in substantial losses and accordingly
should be considered speculative.
OUR BORROWERS MAY DEFAULT ON THEIR PAYMENTS
We primarily invest in and lend to 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 the collateral for the loan. We
make unsecured, subordinated loans or invest in equity securities, which may
involve a higher degree of repayment risk.
OUR PORTFOLIO OF INVESTMENTS IS ILLIQUID
We acquire most of our investments directly from private companies. The majority
of the investments in our portfolio will be subject to restrictions on resale or
otherwise have no established trading market. The illiquidity of most of our
portfolio may adversely affect our ability to dispose of loans and securities at
times when it may be advantageous for us to liquidate such investments.
WE INVEST IN NON-INVESTMENT GRADE CMBS
The commercial mortgage-backed securities ("CMBS") in which we invest are
non-investment grade, which means that nationally recognized statistical rating
organizations rate them below the top four investment-grade rating categories
(e.g., "AAA" through "BBB"). Non-investment grade securities usually provide a
higher yield than do investment-grade bonds, but with the higher return comes
greater risk. 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. Therefore, the non-investment grade CMBS tend to be
less liquid, may have a higher risk of default and may be more difficult to
value.
OUR PORTFOLIO IS RECORDED AT FAIR VALUE AS DETERMINED BY THE BOARD OF DIRECTORS
Pursuant to the requirements of the Investment Company Act of 1940 ("1940 Act"),
the Board of Directors is required to value each asset quarterly, and we are
required to carry our portfolio at fair value as determined by the Board of
Directors. Since there is typically no public market for the loans and equity
securities of the companies in which we make investments, our Board of Directors
estimates the fair value of these loans and equity securities pursuant to a
written valuation policy and a consistently applied valuation process. Unlike
banks, we are not permitted to provide a general reserve for anticipated loan
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losses; we are instead required by the 1940 Act to specifically value each
individual investment and record an unrealized loss for an asset that we believe
has become impaired. We adjust quarterly the valuation of our portfolio to
reflect the Board of Directors' estimate of the current realizable value of each
investment in our portfolio. Without a readily ascertainable market value, the
estimated value of our portfolio of loans and equity securities may differ
significantly from the values that would be placed on the portfolio if there
existed a ready market for the loans and equity securities. Any changes in
estimated value are recorded in the Company's statement of operations as "Net
unrealized gains (losses)."
WE BORROW MONEY WHICH MAY INCREASE THE RISK OF INVESTING IN OUR COMPANY
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. 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. If the value of our consolidated assets increases,
then leveraging would cause the net asset value attributable to the Company's
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, and, if asset coverage for a
class of senior security representing indebtedness declines to less than 200%,
we may be required to sell a portion of our investments when it is
disadvantageous to do so. Leverage is generally considered a speculative
investment technique.
As of December 31, 1999, the Company's asset coverage for indebtedness was 228%.
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.
At December 31, 1999, the Company had $592.9 million of outstanding
indebtedness, bearing a weighted annual interest cost of 7.9%. In order for us
to cover annual interest payments on indebtedness, we must achieve annual
returns on our portfolio of at least 3.7%.
CHANGES IN INTEREST RATES MAY AFFECT OUR COST OF CAPITAL
Because we borrow money to make investments, our income is dependent upon the
difference between the rate at which we borrow funds and the rate at which we
invest these funds. In periods of sharply rising interest rates, our cost of
funds would increase, which would reduce our portfolio income before net
realized and unrealized gains. However, there would be no effect on the return,
if any, that could be generated from our equity interests. We use a combination
of long-term and short-term borrowings and equity capital to finance our
investing activities. Investments originated for sale generally carry variable
rates and are financed with short-term variable rate debt. Our long-term
fixed-rate investments are financed 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. There
can be no assurance that a significant change in market interest rates will not
have a material adverse effect on our portfolio income.
BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL CAPITAL
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 funds from financial
institutions could limit our ability to grow. We must distribute at least 90% of
our taxable net operating income excluding net realized long-term capital gains
to our stockholders to maintain
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our regulated investment company ("RIC") 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 the Company's common stock. In addition, as a
business development company ("BDC"), 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.
OUR PORTFOLIO MAY NOT PRODUCE CAPITAL GAINS
Private finance investments are typically structured as debt securities with a
relatively high fixed rate of interest and with an equity feature such as
conversion rights, warrants or options. As a result, private finance investments
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.
LOSS OF PASS-THROUGH TAX TREATMENT WOULD SUBSTANTIALLY REDUCE NET ASSETS AND
INCOME AVAILABLE FOR DIVIDENDS
We have operated the Company so as to qualify to be taxed as a RIC under
Subchapter M of the Code. If we meet certain diversification and distribution
requirements, the Company qualifies for pass-through tax treatment. The Company
would cease to qualify for pass-through tax treatment if it were unable to
comply with these requirements, or if it ceased to qualify as a BDC under the
1940 Act. We also could be subject to a 4% excise tax (and, in certain cases,
corporate level income tax) if we fail to make certain distributions. If the
Company fails to qualify as a RIC, the Company would become subject to federal
income tax as if it were an ordinary corporation, which would substantially
reduce our net assets and the amount of income available for distribution to our
shareholders.
WE OPERATE IN A COMPETITIVE MARKET FOR INVESTMENT OPPORTUNITIES
We compete for investments with many other companies and individuals, some of
whom 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 OPERATE IN A HIGHLY REGULATED ENVIRONMENT
We are regulated by the Commission and the SBA. In addition, changes in the laws
or regulations that govern BDCs, RICs, real estate investment trusts ("REITs"),
SBICs and SBLCs may significantly affect our business. Laws and regulations may
be changed from time to time, and the interpretations of the relevant laws and
regulations also are subject to change. Any change in the law or regulations
that govern our business could have a material impact on the Company or its
operations.
QUARTERLY RESULTS MAY FLUCTUATE
The Company's quarterly operating results could fluctuate due to a number of
factors. These factors include, among others, variations in the investment
origination volume, 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. As a result of these factors, you should not rely on quarterly
results to be indicative of the Company's performance in future quarters.
ITEM 2. PROPERTIES
Our principal offices are located on the third floor of 1919 Pennsylvania
Avenue, N.W., Washington, DC, in the heart of Washington's business and
financial district. Our lease for approximately 32,000 square feet
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of office space at that location expires in July 2008. That office is equipped
with an integrated network of computers for word processing, financial analysis,
accounting and loan servicing. We believe our office space is suitable for our
needs for the foreseeable future. The Company also maintains eleven offices
throughout the United States and an office in Frankfurt, Germany.
ITEM 3. LEGAL PROCEEDINGS
We are a party to certain lawsuits in the normal course of our business. While
the outcome of these legal proceedings cannot at this time be predicted with
certainty, we do not expect that these actions will have a material effect upon
our financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and positions of the executive
officers of the Company as of March 24, 2000, as well as certain other
information with respect to those persons. Periods of employment by the Company
include periods of employment by predecessor companies prior to the 1997 merger.
William L. Walton, age 50, has been the Chairman, Chief Executive Officer and
President of the Company since 1997. Mr. Walton was President of Allied Capital
Corporation II from 1996 to 1997. Mr. Walton is a director of Nobel Learning
Communities, Inc. (a portfolio company) and Riggs National Corporation. Mr.
Walton was co-founder and CEO of Success Lab, Inc. (children's educational
services) from 1993 to 1996, and founder and CEO of Language Odyssey
(educational publishing and services) from 1992 to 1996. Mr. Walton was Managing
Director of Butler Capital Corporation from 1987 to 1991.
Philip A. McNeill, age 40, Managing Director, has been employed by the Company
since 1993 and is responsible for co-managing the Company's private finance
group. Before joining the Company, he served as a vice president of M&T Capital
Corporation. Prior to entering the private finance industry, he was founding
director of Western Oklahoma National Bank, and structured and managed numerous
privately negotiated investments.
John M. Scheurer, age 47, Managing Director, has been employed by the Company
since 1991 and manages the Company's real estate finance group. He has more than
22 years of experience in commercial finance and real estate lending and
management. Prior to joining the Company, Mr. Scheurer worked in various
capacities with Capital Recovery Advisors, Inc. and First American Bank. He also
started his own company, The Scheurer Company, and co-founded Hunter &
Associates, a major leasing and consulting real estate firm in the Washington,
DC area.
Joan M. Sweeney, age 40, Managing Director, has been employed by the Company
since 1993. Ms. Sweeney oversees all company operations and is responsible for
strategic planning, financial management, information technology, marketing,
investor relations, and all regulatory compliance. Ms. Sweeney also has direct
responsibility for the Company's small business lending operations through
Allied Capital Express. Prior to joining the Company, Ms. Sweeney spent ten
years of her career consulting with private and small public companies at both
Ernst & Young and Coopers & Lybrand. Ms. Sweeney was a member of the SEC
Division of Enforcement in the late 1980s.
G. Cabell Williams, III, age 45, Managing Director, has been employed by the
Company since 1981, and is responsible for co-managing the operations of the
Company's private finance group. He has over 19 years of private finance
experience, and has structured numerous types of private debt and equity finance
transactions. Mr. Williams has served in many capacities during his tenure with
the Company.
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Penni F. Roll, age 34, Principal and Chief Financial Officer, has been employed
by the Company since 1995. Ms. Roll is responsible for the Company's financial
management and reporting, accounting, loan servicing, special servicing,
portfolio monitoring and regulatory compliance activities. Prior to joining the
Company, she spent seven years in the financial services practice at KPMG Peat
Marwick, including serving as a Manager from 1993 to 1995.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information in response to this Item is incorporated herein by reference to the
"Stockholder Information" and to the "Selected Consolidated Financial Data"
section of the Company's Annual Report to Shareholders for the year ended
December 31, 1999 (the "1999 Annual Report") as well as Note 12, "Dividends and
Distributions" from the Company's 1999 Notes to the Consolidated Financial
Statements. The quarterly stock prices quoted therein represent interdealer
quotations and do not include markups, markdowns, or commissions and may not
necessarily represent actual transactions. During 1999, the Company issued a
total of 232,845 shares of common stock pursuant to a dividend reinvestment
plan. This plan is not registered and relies on an exemption from registration
in the Securities Act of 1933. The Company also issued 83,333 unregistered
shares during 1998. In addition, during 1999, the Company issued a total of
8,658,690 registered shares pursuant to a shelf registration statement on file
with the Commission. See Note 7, "Shareholders' Equity" for additional
information.
ITEM 6. SELECTED FINANCIAL DATA
Information in response to this Item is incorporated herein by reference to the
table in the "Selected Consolidated Financial Data" Section of the 1999 Annual
Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Information in response to this Item is incorporated herein by reference to the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section of the 1999 Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's business activities contain elements of risk. The Company
considers the principal types of market risk to be interest rate risk and
valuation risk. The Company considers the management of risk essential to
conducting its businesses and to maintaining profitability. Accordingly, the
Company's risk management systems and procedures are designed to identify and
analyze the Company's 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.
The Company manages its market risk by maintaining a portfolio of equity
interests that is diverse by industry, geographic area, property type, size of
individual investment and borrower. The Company does not have a significant
exposure to public market price fluctuations as the Company primarily invests in
private business enterprises. Since there is typically no public market for the
equity interests of the companies in which the Company invests, the valuation of
the equity interests in the Company's portfolio is subject to the estimate of
the Company's Board of Directors. In the absence of a readily ascertainable
market value, the estimated value of the Company's portfolio of equity interests
may differ significantly from the values that would be placed on the portfolio
if a ready market for the equity interests existed. Any changes in estimated
value are recorded in the Company's statement of operations as "Net unrealized
gains (losses)." Each hypothetical 1% increase or decrease in value of the
Company's portfolio of equity interests of $87.3 million at December 31, 1999
would have resulted in unrealized gains or losses and would have increased or
decreased net income in 1999 by less than 1%.
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The Company's sensitivity to changes in interest rates is regularly monitored
and analyzed by measuring the characteristics of assets and liabilities. The
Company utilizes various methods to assess interest rate risk in terms of the
potential effect on interest income net of interest expense, the value of net
assets and the value at risk in an effort to ensure that the Company is
insulated from any significant adverse effects from changes in interest rates.
Based on the model used for the sensitivity of interest income net of interest
expense, if the balance sheet were to remain constant and no actions were taken
to alter the existing interest rate sensitivity, a hypothetical immediate 100
basis point change in interest rates would have affected net income by less than
1% over a six month horizon. Although management believes that this measure is
indicative of the Company's sensitivity to interest rate changes, it does not
adjust for potential changes in credit quality, size and composition of the
balance sheet and other business developments that could affect net income.
Accordingly, no assurances can be given that actual results would not differ
materially from the potential outcome simulated by this estimate.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information in response to this Item is incorporated by reference to the
Consolidated Financial Statements, Notes thereto, and Report of Independent
Public Accountants thereon contained in the 1999 Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to this Item is incorporated by reference to the
identification of directors and nominees contained in the "Election of
Directors" section and the subsection captioned "Section 16(a) Beneficial
Ownership Reporting Compliance" of the Company's definitive proxy statement in
connection with its 1999 Annual Meeting of Shareholders, scheduled to be held on
May 9, 2000 (the "2000 Proxy Statement"), and from "Additional Item" in Part I.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to this Item is incorporated by reference to the
subsections captioned "Compensation of Executive Officers and Directors" of the
2000 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information in response to this Item is incorporated by reference to the
subsection captioned "Security Ownership of Management and Certain Beneficial
Owners" in the 2000 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information in response to this Item is incorporated by reference to the section
captioned "Certain Transactions" of the 2000 Proxy Statement.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. A. The following financial statements are incorporated by reference
from the Consolidated Financial Statements, Notes thereto and Report of
Independent Public Accountants thereon contained in the Company's 1999
Annual Report, filed herewith.
Consolidated Balance Sheet as of December 31, 1999 and 1998.
Consolidated Statement of Operations for the years ended December 31,
1999, 1998 and 1997.
Consolidated Statement of Changes in Net Assets for the years ended
December 31, 1999, 1998 and 1997.
Consolidated Statement of Cash Flows for the years ended December 31,
1999, 1998 and 1997.
Consolidated Statement of Investments as of December 31, 1999.
Notes to Consolidated Financial Statements.
B. The Report of Independent Public Accountants from Arthur Andersen
LLP is incorporated by reference to the Report of Independent Public
Accountants contained in the Company's 1999 Annual Report filed herewith.
2. No financial statement schedules are filed herewith because (i)
such schedules are not required or (ii) the information required has been
presented in the aforementioned financial statements.
3. The following exhibits are filed herewith or incorporated by
reference as set forth below:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3(i)(1) Articles of Amendment and Restatement of the Articles of
Incorporation.
3(ii)(2) Articles of Merger.
3(iii)* Bylaws.
4.1(6) Specimen certificate of the Company's Common stock, par
value $0.0001 per share. See exhibits 3(i), 3(ii) and 3(iii)
for other instruments defining the rights of security
holders.
4.2(4) Form of debenture between certain subsidiaries of the
Company and the U.S. Small Business Administration.
5 Not applicable.
9 Not applicable.
10.1(11) Credit Agreement dated as of March 9, 1999 between the
Company, as borrower, each of the financial institutions
initially a signatory thereto, as Lenders, and Nationsbank,
N.A., as administrative agent, Nationsbanc Montgomery
Securities LLC, as sole lead arranger and sole book manager,
First Union National Bank, as syndication agent, BankBoston,
N.A., as documentation agent, Riggs Bank, N.A., as managing
agent, and Chevy Chase Bank, F.S.B. and Credit Lyonnais New
York Branch, as co-agents.
10.1a(12) First Amendment to Credit Agreement dated May 7, 1999.
10.1b* Second Amendment to Credit Agreement dated January 18, 2000.
10.1c* Third Amendment to Credit Agreement dated March 17, 2000.
10.2(8) Note Agreement dated as of April 30, 1998.
19
20
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.3(5) Loan Agreement between Allied I and Overseas Private
Investment Corporation, dated April 10, 1995. Letter dated
December 11, 1997 evidencing assignment of Loan Agreement
from Allied I to the Company.
10.4(12) Note Agreement dated as of May 1, 1999.
10.4a* Note Agreement dated as of November 15, 1999.
10.5(14) Second Amended and Restated Master Loan & Security Agreement
dated October 28, 1999 between the Company and Morgan
Stanley Mortgage Capital, Inc.
10.6(6) Sale and Servicing Agreement dated as of January 1, 1998
among Allied Capital CMT, Inc., Allied Capital Commercial
Mortgage Trust 1998-1 and the Company and LaSalle National
Bank Inc. and ABN AMRO Bank N.V.
10.7(6) Indenture dated as of January 1, 1998 between Allied Capital
Commercial Mortgage Trust 1998-1 and LaSalle National Bank.
10.8(6) Amended and Restated Trust Agreement dated January 1, 1998
between Allied Capital CMT, Inc., LaSalle National Bank Inc.
and Wilmington Trust Company.
10.9(6) Guaranty dated as of January 1, 1998 by the Company.
10.10(3) Employee Stock Ownership Plan, as amended on December 31,
1997.
10.10a(7) First Amendment to the Company's Employee Stock Ownership
Plan dated April 30, 1998.
10.10b(14) Termination Amendment to the Allied Capital Employee Stock
Ownership Plan effective December 31, 1999.
10.11(10) Amended and Restated Deferred Compensation Plan dated
December 30, 1998.
10.12(9) Stock Option Plan.
10.12a(13) Allied Capital 401(k) Plan dated September 1, 1999.
10.13a(6) Form of Custody Agreement with Riggs Bank N.A. with respect
to safekeeping.
10.13b(6) Form of Custody Agreement with La Salle National Bank.
10.18(3) Dividend Reinvestment Plan.
11 Statement regarding computation of per share earnings is
incorporated by reference to Note 8 to the Company's Notes
to the Consolidated Financial Statements contained in the
Company's 1999 Annual Report filed as Exhibit 13 herewith.
13* Excerpts from the 1999 Annual Report to Shareholders.
21 Subsidiaries of the Company and jurisdiction of
incorporation/organization:
Allied Investment Corporation Maryland
Allied Capital SBLC Corporation Maryland
Allied Capital REIT, Inc. Maryland
Allied Capital Holdings LLC Delaware
Allied Capital Beteiligungsberatung GmbH Germany
23* Consent of Arthur Andersen LLP, independent public
accountants.
27* Financial Data Schedule
--------------------
* Filed herewith.
(1) Incorporated by reference to exhibit 3(i) with Allied Lending's Annual
Report on Form 10-K for the year ended December 31, 1996.
(2) Incorporated by reference from Appendix B to the Company's
registration statement on Form N-14 filed on the Company's behalf with
the Commission on September 26, 1997 (File No. 333-36459).
20
21
(3) Incorporated by reference to the exhibit of the same name filed with
the Company's Annual Report on Form 10-K for the year ended December
31, 1997.
(4) Incorporated by reference to the exhibit of the same name filed with
Allied I's Annual Report on Form 10-K for the year ended December 31,
1996.
(5) Incorporated by reference to Exhibit f.7 of Allied I's Pre-Effective
Amendment No. 2 filed with the registration statement on Form N-2 on
January 24, 1996 (File No. 33-64629). Assignment to Company is
incorporated by reference to Exhibit 10.3 of the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
(6) Incorporated by reference to the exhibit of the same name to the
Company's registration statement on Form N-2 filed on the Company's
behalf with the Commission on May 5, 1998 (File No. 333-51899).
(7) Incorporated by reference to the exhibit of the same name filed with
the Company's Quarterly Report on Form 10-Q for the period ended June
30, 1998.
(8) Incorporated by reference to the exhibit of the same name filed with
the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998.
(9) Incorporated by reference to Exhibit 4 of the Allied Capital
Corporation Stock Option Plan registration statement on Form S-8,
filed on behalf of such Plan on February 3, 1998 (File No. 333-45525).
(10) Incorporated by reference to the exhibit of the same name filed with
the Company's Annual Report on Form 10-K for the year ended December
31, 1998.
(11) Incorporated by reference to Exhibit f.2.a with the Company's
registration statement on Form N-2 (File No. 333-75161) filed on March
26, 1999.
(12) Incorporated by reference to the exhibit of the same name filed with
the Company's Quarterly Report on Form 10-Q for the period ended June
30, 1999.
(13) Incorporated by reference to Exhibit 4.4 of the Allied Capital 401(k)
Plan registration statement on Form S-8, filed on behalf of such Plan
on October 8, 1999 (File No. 333-88681).
(14) Incorporated by reference to the exhibit of the same name filed with
the Company's Post-Effective Amendment No. 1 to Form N-2 (File No.
333-84973) on November 19, 1999.
(b) Reports on Form 8-K.
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1999.
21
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized on March 28, 2000.
/s/ WILLIAM L. WALTON
--------------------------------------
William L. Walton
Chairman of the Board, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.
TITLE
SIGNATURE (CAPACITY) DATE
--------- ---------- ----
/s/ WILLIAM L. WALTON Chairman, President, and March 28, 2000
- -------------------------------------------------------- Chief Executive Officer
William L. Walton
/s/ BROOKS H. BROWNE Director March 28, 2000
- --------------------------------------------------------
Brooks H. Browne
/s/ JOHN D. FIRESTONE Director March 28, 2000
- --------------------------------------------------------
John D. Firestone
/s/ ANTHONY T. GARCIA Director March 28, 2000
- --------------------------------------------------------
Anthony T. Garcia
/s/ LAWRENCE I. HEBERT Director March 28, 2000
- --------------------------------------------------------
Lawrence I. Hebert
/s/ JOHN I. LEAHY Director March 28, 2000
- --------------------------------------------------------
John I. Leahy
/s/ ROBERT E. LONG Director March 28, 2000
- --------------------------------------------------------
Robert E. Long
/s/ WARREN K. MONTOURI Director March 28, 2000
- --------------------------------------------------------
Warren K. Montouri
/s/ GUY T. STEUART II Director March 28, 2000
- --------------------------------------------------------
Guy T. Steuart II
/s/ T. MURRAY TOOMEY Director March 28, 2000
- --------------------------------------------------------
T. Murray Toomey
22
23
TITLE
SIGNATURE (CAPACITY) DATE
--------- ---------- ----
/s/ LAURA W. VAN ROIJEN Director March 28, 2000
- --------------------------------------------------------
Laura W. van Roijen
/s/ GEORGE C. WILLIAMS, JR. Director March 28, 2000
- --------------------------------------------------------
George C. Williams, Jr.
/s/ PENNI F. ROLL Principal and Chief March 28, 2000
- -------------------------------------------------------- Financial Officer
Penni F. Roll (Principal Financial and
Accounting Officer)
23
24
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3(iii) Bylaws.
10.1b Second Amendment to Credit Agreement dated January 18, 2000.
10.1c Third Amendment to Credit Agreement dated March 17, 2000.
10.4a Note Agreement dated as of November 15, 1999.
13 Excerpts from the 1999 Annual Report to Shareholders.
23 Consent of Arthur Andersen LLP, independent public
accountants
27 Financial Data Schedule
24