Allied Capital 10-Q 2006 Q2 Quarterly report

FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

x  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934

For The Quarterly Period

Ended June 30, 2006

o  Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

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) 721-6100

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

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.     Large Accelerated Filer     x  Accelerated Filer     oNon-Accelerated Filer     o

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o  NO x

      On August 8, 2006, there were 145,496,935 shares outstanding of the Registrant’s common stock, $0.0001 par value.

ALLIED CAPITAL CORPORATION

FORM 10-Q TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		Consolidated Balance Sheet as of June 30, 2006 (unaudited) and December 31, 2005	1
		Consolidated Statement of Operations (unaudited) — For the Three and Six Months Ended June 30, 2006 and 2005	2
		Consolidated Statement of Changes in Net Assets (unaudited) — For the Six Months Ended June 30, 2006 and 2005	3
		Consolidated Statement of Cash Flows (unaudited) — For the Six Months Ended June 30, 2006 and 2005	4
		Consolidated Statement of Investments as of June 30, 2006 (unaudited)	5
		Consolidated Statement of Investments as of December 31, 2005	15
		Notes to Consolidated Financial Statements	25
		Report of Independent Registered Public Accounting Firm	52
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		56
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		88
	Item 4. Controls and Procedures		88
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings		89
	Item 1A. Risk Factors		90
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		96
	Item 3. Defaults Upon Senior Securities		97
	Item 4. Submission of Matters to a Vote of Security Holders		98
	Item 5. Other Information		98
	Item 6. Exhibits		98
	Signatures		103

PART I: FINANCIAL INFORMATION

Item 1.  Financial Statements

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

				June 30,			December 31,
				2006			2005
(in thousands, except per share amounts)				(unaudited)
ASSETS
Portfolio at value:
	Private finance
		Companies more than 25% owned (cost: 2006-$1,282,768; 2005-$1,489,782)		$	1,188,131		$	1,887,651
		Companies 5% to 25% owned (cost: 2006-$371,550; 2005-$168,373)			371,156			158,806
		Companies less than 5% owned (cost: 2006-$1,933,932; 2005-$1,448,268)			1,901,139			1,432,833
			Total private finance (cost: 2006-$3,588,250; 2005-$3,106,423)		3,460,426			3,479,290
	Commercial real estate finance (cost: 2006-$127,748; 2005-$131,695)				133,051			127,065
			Total portfolio at value (cost: 2006-$3,715,998; 2005-$3,238,118)		3,593,477			3,606,355
U.S. Treasury bills					125,940			100,305
Investments in money market and other securities					97,810			121,967
Deposits of proceeds from sales of borrowed Treasury securities					17,156			17,666
Accrued interest and dividends receivable					49,270			60,366
Other assets					124,448			87,858
Cash					3,106			31,363
			Total assets	$	4,011,207		$	4,025,880
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
	Notes payable and debentures (maturing within one year: 2006-$150,000; 2005-$175,000)			$	1,207,137		$	1,193,040
	Revolving line of credit				1,750			91,750
	Obligations to replenish borrowed Treasury securities				17,156			17,666
	Accounts payable and other liabilities				95,145			102,878
			Total liabilities		1,321,188			1,405,334
Commitments and contingencies
Shareholders’ equity:
	Common stock, $0.0001 par value, 200,000 shares authorized; 140,312 and 136,697 shares issued and outstanding at June 30, 2006, and December 31, 2005, respectively				14			14
	Additional paid-in capital				2,284,117			2,177,283
	Common stock held in deferred compensation trust				(24,003	)		(19,460	)
	Notes receivable from sale of common stock				(3,370	)		(3,868	)
	Net unrealized appreciation (depreciation)				(136,929	)		354,325
	Undistributed earnings				570,190			112,252
			Total shareholders’ equity		2,690,019			2,620,546
			Total liabilities and shareholders’ equity	$	4,011,207		$	4,025,880
Net asset value per common share				$	19.17		$	19.17

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

1

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

				For the Three Months						For the Six Months
				Ended June 30,						Ended June 30,
				2006			2005			2006			2005
(in thousands, except per share amounts)
				(unaudited)						(unaudited)
Interest and Related Portfolio Income:
	Interest and dividends
		Companies more than 25% owned		$	23,419		$	30,199		$	53,565		$	58,450
		Companies 5% to 25% owned			11,419			5,597			17,069			11,518
		Companies less than 5% owned			60,595			35,534			113,680			86,307
			Total interest and dividends		95,433			71,330			184,314			156,275
	Loan prepayment premiums
		Companies more than 25% owned			134			—			5,094			—
		Companies 5% to 25% owned			—			—			—			—
		Companies less than 5% owned			1,611			853			1,937			2,530
			Total loan prepayment premiums		1,745			853			7,031			2,530
	Fees and other income
		Companies more than 25% owned			5,515			7,877			12,642			12,758
		Companies 5% to 25% owned			1,282			55			3,998			125
		Companies less than 5% owned			6,481			6,092			13,482			9,438
			Total fees and other income		13,278			14,024			30,122			22,321
			Total interest and related portfolio income		110,456			86,207			221,467			181,126
Expenses:
	Interest				21,607			19,154			45,907			39,379
	Employee				20,398			22,877			41,826			38,333
	Stock options				4,597			—			8,203			—
	Administrative				9,861			23,048			21,380			43,802
			Total operating expenses		56,463			65,079			117,316			121,514
Net investment income before income taxes					53,993			21,128			104,151			59,612
Income tax expense, including excise tax					3,798			5,861			12,656			5,593
Net investment income					50,195			15,267			91,495			54,019
Net Realized and Unrealized Gains (Losses):
	Net realized gains (losses)
		Companies more than 25% owned			95,212			(17,884	)		528,399			(17,485	)
		Companies 5% to 25% owned			(74	)		4,711			(417	)		4,708
		Companies less than 5% owned			5,102			220,669			5,093			230,558
			Total net realized gains		100,240			207,496			533,075			217,781
	Net change in unrealized appreciation or depreciation				(116,706	)		89,122			(491,254	)		159,706
			Total net gains (losses)		(16,466	)		296,618			41,821			377,487
Net increase in net assets resulting from operations				$	33,729		$	311,885		$	133,316		$	431,506
Basic earnings per common share				$	0.24		$	2.33		$	0.96		$	3.23
Diluted earnings per common share				$	0.24		$	2.29		$	0.94		$	3.17
Weighted average common shares outstanding — basic					140,024			133,701			139,395			133,493
Weighted average common shares outstanding — diluted					143,213			136,381			142,466			135,982

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

2

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

			For the Six Months
			Ended June 30,
			2006			2005
(in thousands, except per share amounts)
			(unaudited)
Operations:
	Net investment income		$	91,495		$	54,019
	Net realized gains			533,075			217,781
	Net change in unrealized appreciation or depreciation			(491,254	)		159,706
		Net increase in net assets resulting from operations		133,316			431,506
Shareholder distributions:
	Common stock dividends			(166,632	)		(152,329	)
		Net decrease in net assets resulting from shareholder distributions		(166,632	)		(152,329	)
Capital share transactions:
	Sale of common stock			82,970			—
	Issuance of common stock for portfolio investments			—			7,200
	Issuance of common stock in lieu of cash distributions			7,199			4,163
	Issuance of common stock upon the exercise of stock options			8,226			12,689
	Stock option expense			8,439			—
	Net decrease in notes receivable from sale of common stock			498			200
	Purchase of common stock held in deferred compensation trust			(4,649	)		(3,976	)
	Distribution of common stock held in deferred compensation trust			106			—
	Other			—			2,056
		Net increase in net assets resulting from capital share transactions		102,789			22,332
		Total increase in net assets		69,473			301,509
Net assets at beginning of period				2,620,546			1,979,778
Net assets at end of period			$	2,690,019		$	2,281,287
Net asset value per common share			$	19.17		$	17.01
Common shares outstanding at end of period				140,312			134,131

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

3

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

				For the Six Months Ended
				June 30,
				2006			2005
(in thousands)
				(unaudited)
Cash flows from operating activities:
	Net increase in net assets resulting from operations			$	133,316		$	431,506
	Adjustments:
		Portfolio investments			(1,071,243	)		(647,248	)
		Principal collections related to investment repayments or sales			769,598			1,090,813
		Change in accrued or reinvested interest and dividends			9,064			3,567
		Amortization of discounts and fees			(3,094	)		(3,334	)
		Redemption of (investments in) U.S. Treasury bills			(22,875	)		—
		Redemption of (investments in) money market securities			25,581			(74,200	)
		Stock option expense			8,439			—
		Changes in other assets and liabilities			(1,410	)		8,136
		Depreciation and amortization			870			963
		Realized gains from the receipt of notes and other securities as consideration from sale of investments, net of collections			(217,086	)		(916	)
		Realized losses			4,405			41,643
		Net change in unrealized (appreciation) or depreciation			491,254			(159,706	)
			Net cash provided by (used in) operating activities		126,819			691,224
Cash flows from financing activities:
	Sale of common stock				82,970			—
	Sale of common stock upon the exercise of stock options				8,226			12,689
	Collections of notes receivable from sale of common stock				498			200
	Borrowings under notes payable and debentures				50,000			—
	Repayments on notes payable and debentures				(37,000	)		(76,700	)
	Net borrowings under (repayments on) revolving line of credit				(90,000	)		(112,000	)
	Purchase of common stock held in deferred compensation trust				(4,649	)		(3,976	)
	Other financing activities				(1,590	)		(1,958	)
	Common stock dividends and distributions paid				(163,531	)		(150,826	)
			Net cash provided by (used in) financing activities		(155,076	)		(332,571	)
Net increase (decrease) in cash					(28,257	)		358,653
Cash at beginning of period					31,363			57,160
Cash at end of period				$	3,106		$	415,813

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

4

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Companies More Than 25% Owned
Acme Paging, L.P.(4)		Senior Loan (6.0%, Due 12/07)(6)	$	3,750	$	3,750	$	—
	(Telecommunications)	Subordinated Debt (10.0%, Due 1/08)(6)		881		881		—
		Common Stock (23,513 shares)				27		—
Alaris Consulting, LLC		Senior Loan (16.5%, Due 12/05 – 12/07)(6)		27,055		27,018		—
	(Business Services)	Equity Interests				5,305		—
		Guaranty ($1,100)
American Healthcare Services, Inc.		Senior Loan (0.7%, Due 12/04 – 12/05)(6)		4,997		4,599		4,329
	and Affiliates
	(Healthcare Services)
Avborne, Inc.(7)		Preferred Stock (12,500 shares)				658		773
	(Business Services)	Common Stock (27,500 shares)				—		—
Avborne Heavy Maintenance, Inc.(7)		Preferred Stock (1,568 shares)				2,401		—
	(Business Services)	Common Stock (2,750 shares)				—		—
		Guaranty ($2,401)
Business Loan Express, LLC		Class A Equity Interests		64,427		64,427		64,427
	(Financial Services)	Class B Equity Interests				119,436		130,890
		Class C Equity Interests				109,301		121,900
		Guaranty ($149,162 — See Note 3)
		Standby Letters of Credit ($32,000 —   See Note 3)
Callidus Capital Corporation		Senior Loan (12.0%, Due 12/06)		1,650		1,650		1,650
	(Financial Services)	Subordinated Debt (18.0%, Due 10/08)		5,276		5,276		5,276
		Common Stock (10 shares)				2,058		12,093
Cambridge Capital Partners(5)		Senior Loan (8.0%, Due 5/09)(6)		250		250		250
	(Financial Services)	Equity Interests				1,751		1,751
CR Brands, Inc.		Subordinated Debt (16.6%, Due 2/13)		38,898		38,712		38,712
	(Consumer Products)	Common Stock (37,200,551 shares)				33,321		37,431
Diversified Group Administrators, Inc.		Preferred Stock (1,000,000 shares)				700		728
	(Business Services)	Preferred Stock (1,451,380 shares)				841		841
		Common Stock (1,451,380 shares)				—		322
Financial Pacific Company		Subordinated Debt (17.4%, Due 2/12 – 8/12)		70,878		70,630		70,630
	(Financial Services)	Preferred Stock (10,964 shares)				10,276		14,460
		Common Stock (14,735 shares)				14,819		44,418
ForeSite Towers, LLC		Equity Interests				7,620		12,818
	(Tower Leasing)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(7)	Avborne, Inc. and Avborne Heavy Maintenance, Inc. are affiliated companies.

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

5

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Global Communications, LLC		Senior Loan (10.7%, Due 9/02 – 11/07)(6)	$	15,957	$	15,957	$	15,957
	(Business Services)	Subordinated Debt (17.0%, Due 12/03 – 9/05)(6)		11,339		11,336		9,648
		Preferred Equity Interest				14,067		—
		Options				1,639		—
Gordian Group, Inc.		Senior Loan (10.0%, Due 6/06 – 12/08)(6)		11,792		11,812		—
	(Business Services)	Common Stock (1,000 shares)				6,762		—
Healthy Pet Corp.		Senior Loan (9.5%, Due 8/10)		15,938		15,938		15,938
	(Consumer Services)	Subordinated Debt (15.0%, Due 8/10)		43,286		43,125		43,125
		Common Stock (30,142 shares)				30,142		28,152
HMT, Inc.		Preferred Stock (554,052 shares)				2,637		2,637
	(Energy Services)	Common Stock (300,000 shares)				3,000		7,942
		Warrants				1,155		3,058
Impact Innovations Group, LLC		Equity Interests in Affiliate				—		870
	(Business Services)
Insight Pharmaceuticals Corporation		Subordinated Debt (16.1%, Due 9/12)		59,284		59,067		59,067
	(Consumer Products)	Preferred Stock (25,000 shares)				25,000		26,249
		Common Stock (620,000 shares)				6,325		218
Jakel, Inc.		Subordinated Debt (15.5%, Due 3/08)(6)		14,442		14,442		2,533
	(Industrial Products)	Preferred Stock (6,460 shares)				6,460		—
		Common Stock (158,061 shares)				9,347		—
Legacy Partners Group, LLC		Senior Loan (14.0%, Due 5/09)(6)		7,646		7,646		5,048
	(Financial Services)	Subordinated Debt (18.0%, Due 5/09)(6)		2,952		2,952		—
		Equity Interests				4,248		—
Litterer Beteiligungs-GmbH(4)		Subordinated Debt (8.0%, Due 3/07)		658		658		658
	(Business Services)	Equity Interest				1,809		1,615
Mercury Air Centers, Inc.		Subordinated Debt (16.0%, Due 4/09 –
	(Business Services)	11/12)		48,369		48,198		48,198
		Common Stock (57,970 shares)				35,053		93,188
		Standby Letters of Credit ($1,968)
MVL Group, Inc.		Senior Loan (12.0%, Due 10/07 – 7/09)		26,498		26,324		26,324
	(Business Services)	Subordinated Debt (14.5%, Due 6/09)		34,354		33,921		33,921
		Common Stock (648,661 shares)				643		1,262
Powell Plant Farms, Inc.		Senior Loan (15.0%, Due 12/06)		30,490		21,642		21,642
	(Consumer Products)	Subordinated Debt (20.0%, Due 6/03)(6)		19,291		19,223		—
		Preferred Stock (1,483 shares)				—		—
		Warrants				—		—

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

6

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Service Champ, Inc.		Subordinated Debt (15.5%, Due 4/12)	$	27,384	$	27,260	$	27,260
	(Business Services)	Common Stock (63,888 shares)				13,662		16,322
Staffing Partners Holding		Subordinated Debt (13.5%, Due 1/07)(6)		5,987		5,987		1,160
	Company, Inc.	Preferred Stock (439,600 shares)				4,968		—
	(Business Services)	Common Stock (69,773 shares)				50		—
		Warrants				10		—
		Guaranty ($1,300)
Startec Global Communications		Senior Loan (10.0%, Due 5/07 – 5/09)		21,926		21,926		21,926
	Corporation	Common Stock (19,180,000 shares)				37,255		6,480
	(Telecommunications)
Triview Investments, Inc.(8)		Senior Loan (9.4%, Due 6/07)		14,325		14,301		14,301
	(Broadcasting & Cable/	Subordinated Debt (15.0%, Due 7/12)		37,877		37,687		37,687
	Consumer Products)	Subordinated Debt (16.8%, Due 7/08 –
		7/12)(6)		19,600		19,520		19,520
		Common Stock (202 shares)				93,907		32,526
		Guaranty ($800)
		Standby Letter of Credit ($200)
Total companies more than 25% owned					$	1,282,768	$	1,188,131
Companies 5% to 25% Owned
Advantage Sales & Marketing, Inc.		Subordinated Debt (12.0%, Due 3/14)	$	150,775	$	150,056	$	150,056
	(Business Services)	Equity Interests				2,048		15,000
Air Medical Group Holdings LLC		Senior Loan (8.7%, Due 3/11 – 3/12)		1,584		1,512		1,512
	(Healthcare Services)	Subordinated Debt (14.0%, Due 11/12)		34,646		34,590		34,590
		Equity Interests				3,470		4,200
Amerex Group, LLC		Subordinated Debt (12.0%, Due 1/13)		8,400		8,400		8,400
	(Consumer Products)	Equity Interests				3,583		3,583
BB&T Capital Partners/Windsor
	Mezzanine Fund, LLC(5)	Equity Interests				5,867		5,867
	(Private Equity Fund)
Becker Underwood, Inc.		Subordinated Debt (14.5%, Due 8/12)		23,939		23,850		23,850
	(Industrial Products)	Common Stock (5,073 shares)				5,813		2,400
BI Incorporated		Subordinated Debt (13.5%, Due 2/14)		30,000		29,856		29,856
	(Business Services)	Common Stock (40,000 shares)				4,000		4,000

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(8)	Triview Investments, Inc. holds investments in Longview Cable & Data, LLC (Broadcasting & Cable) with a cost of $66.5 million and value of $14.3 million and Triax Holdings, LLC (Consumer Products) with a cost of $98.9 million and a value of $89.7 million. The guaranty and standby letter of credit relate to Longview Cable & Data, LLC.

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

7

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
MedBridge Healthcare, LLC		Senior Loan (4.0%, Due 8/09)(6)	$	7,164	$	7,164	$	6,595
	(Healthcare Services)	Subordinated Debt (10.0%, Due 8/14)(6)		5,184		5,184		—
		Convertible Subordinated Debt (2.0%, Due 8/14)(6)		2,970		984		—
		Equity Interests				1,306		—
Nexcel Synthetics, LLC		Subordinated Debt (14.5%, Due 6/09)		10,805		10,781		10,781
	(Consumer Products)	Equity Interests				1,742		1,730
Pres Air Trol LLC		Unitranche Debt (12.0%, Due 4/10)(6)		5,911		5,593		3,312
	(Industrial Products)	Equity Interests				1,361		—
Progressive International		Subordinated Debt (16.0%, Due 12/09)		7,476		7,454		7,454
	Corporation	Preferred Stock (500 shares)				500		920
	(Consumer Products)	Common Stock (197 shares)				13		500
		Warrants				—		—
Regency Healthcare Group, LLC		Senior Loan (11.1%, Due 6/12)		1,000		980		980
	(Healthcare Services)	Unitranche Debt (11.1%, Due 6/12)		20,000		19,900		19,900
		Equity Interests				1,500		1,500
SGT India Private Limited(4)		Common Stock (109,524 shares)				3,608		3,608
	(Business Services)
Soteria Imaging Services, LLC		Subordinated Debt (11.7%, Due 11/10)		16,500		15,505		15,505
	(Healthcare Services)	Equity Interests				2,163		2,400
Universal Environmental Services, LLC		Unitranche Debt (13.5%, Due 2/09)		10,989		10,956		10,956
	(Business Services)	Equity Interests				1,811		1,701
Total companies 5% to 25% owned					$	371,550	$	371,156
Companies Less Than 5% Owned
3SI Security Systems, Inc.		Senior Loan (10.9%, Due 2/12 – 2/13)	$	1,650	$	1,640	$	1,640
	(Consumer Products)	Subordinated Debt (14.4%, Due 8/13)		26,377		26,252		26,252
Anthony, Inc.		Subordinated Debt (13.2%, Due 8/11 –
	(Industrial Products)	9/12)		14,743		14,688		14,688
Benchmark Medical, Inc.		Warrants				18		—
	(Healthcare Services)
Border Foods, Inc.		Subordinated Debt (13.0%, Due 12/10)(6)		13,428		12,721		—
	(Consumer Products)	Preferred Stock (140,214 shares)				2,893		—
		Common Stock (1,810 shares)				45		—
		Warrants				910		—
Broadcast Electronics, Inc.		Senior Loan (8.9%, Due 7/12)		4,988		4,953		4,953
	(Business Services)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

8

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
C&K Market, Inc.		Subordinated Debt (14.0%, Due 12/08)	$	25,744	$	25,651	$	25,651
	(Retail)
Callidus Debt Partners
	CDO Fund I, Ltd.(4)(9)	Class C Notes (12.9%, Due 12/13)		18,800		18,962		18,962
	(Senior Debt Fund)	Class D Notes (17.0%, Due 12/13)		9,400		9,481		9,481
Callidus Debt Partners
	CLO Fund III, Ltd.(4)(9)	Preferred Shares (23,600,000 shares)				23,804		23,804
	(Senior Debt Fund)
Callidus Debt Partners
	CLO Fund IV, Ltd.(4)(9)	Income Notes				12,883		12,883
	(Senior Debt Fund)
Callidus MAPS CLO Fund I LLC(9)		Class E Notes (10.9%, Due 12/17)		17,000		17,000		17,000
	(Senior Debt Fund)	Income Notes				50,584		50,584
Camden Partners Strategic Fund II,
	L.P.(5)	Limited Partnership Interest				2,142		3,273
	(Private Equity Fund)
Carlisle Wide Plank Floors, Inc.		Unitranche Debt (10.5%, Due 6/11)		14,000		13,889		13,889
	(Consumer Products)	Preferred Stock (400,000 Shares)				400		400
Catterton Partners V, L.P.(5)		Limited Partnership Interest				3,065		3,150
	(Private Equity Fund)
Centre Capital Investors IV, LP(5)		Limited Partnership Interest				1,753		1,655
	(Private Equity Fund)
Commercial Credit Group, Inc.		Subordinated Debt (14.8%, Due 2/11)		5,000		4,954		4,954
	(Financial Services)	Preferred Stock (32,500 shares)				3,900		3,900
		Warrants				—		—
Community Education Centers, Inc.		Subordinated Debt (16.0%, Due 12/10)		33,643		33,540		33,540
	(Education Services)
Component Hardware Group, Inc.		Preferred Stock (18,000 shares)				2,605		3,000
	(Industrial Products)	Common Stock (2,000 shares)				200		3,001
Cook Inlet Alternative Risk, LLC		Unitranche Debt (10.5%, Due 4/12)		74,800		74,412		74,412
	(Business Services)	Equity Interests				2,000		2,000
Cooper Natural Resources, Inc.		Subordinated Debt (0%, Due 11/07)		559		559		866
	(Industrial Products)	Preferred Stock (6,316 shares)				1,424		20
		Warrants				830		—
Coverall North America, Inc.		Subordinated Debt (14.6%, Due 2/11)		27,664		27,621		27,621
	(Business Services)	Preferred Stock (6,500 shares)				6,500		7,073
		Warrants				2,950		3,890
Deluxe Entertainment Services Group, Inc.		Subordinated Debt (13.7%, Due 7/11)		30,000		30,000		30,000
	(Business Services)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(9)	The fund is managed by Callidus Capital, a portfolio company of Allied Capital.

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

9

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Distant Lands Trading Co.		Senior Loan (9.2%, Due 1/11)	$	500	$	477	$	477
	(Consumer Products)	Unitranche Debt (10.3%, Due 1/11)		25,000		24,888		24,888
		Common Stock (1,500 shares)				1,500		1,500
Drilltec Patents & Technologies		Subordinated Debt (18.0%, Due 8/06)		4,119		4,119		4,119
	Company, Inc.	Subordinated Debt (10.0%, Due 8/06)(6)		10,994		10,918		16,018
	(Energy Services)
DVS VideoStream, LLC		Unitranche Debt (11.0%, Due 2/12)		19,529		19,413		19,413
	(Business Services)	Convertible Subordinated Debt (10.0%, Due 2/16)		3,551		3,534		3,534
Dynamic India Fund IV(4)(5)		Equity Interests				3,850		3,850
	(Private Equity Fund)
eCentury Capital Partners, L.P.(5)		Limited Partnership Interest				5,649		194
	(Private Equity Fund)
Elexis Beta GmbH(4)		Options				426		50
	(Industrial Products)
Event Rentals, Inc. (Consumer Services)		Senior Loan (10.8%, Due 11/11)		23,739		23,631		23,631
Farley’s & Sathers Candy Company, Inc.		Subordinated Debt (11.6%, Due 3/11)		20,000		19,905		19,905
	(Consumer Products)
Frozen Specialties, Inc.		Warrants				435		320
	(Consumer Products)
Garden Ridge Corporation (Retail)		Subordinated Debt (7.0%, Due 5/12)(6)		22,500		22,500		8,455
Geotrace Technologies, Inc.		Subordinated Debt (10.0%, Due 6/09)		24,844		23,235		23,235
	(Energy Services)	Warrants				2,350		2,100
Ginsey Industries, Inc.		Subordinated Debt (12.5%, Due 3/07)		3,225		3,225		3,225
	(Consumer Products)
Grant Broadcasting Systems II		Subordinated Debt (5.0%, Due 6/09)		2,896		2,896		2,896
	(Broadcasting & Cable)
Grotech Partners, VI, L.P.(5)		Limited Partnership Interest				8,279		5,695
	(Private Equity Fund)
Havco Wood Products LLC		Senior Loan (11.3%, Due 8/11)		2,000		1,978		1,978
	(Industrial Products)	Unitranche Debt (10.7%, Due 8/11)		24,054		22,950		22,950
		Equity Interests				1,049		1,800
Haven Eldercare of New England, LLC(10)		Subordinated Debt (12.0%, Due 8/09)(6)		3,573		3,573		3,573
	(Healthcare Services)
Haven Healthcare Management, LLC(10)		Subordinated Debt (18.0%, Due 4/07)(6)		76		160		125
	(Healthcare Services)
HealthASPex Services Inc.		Senior Loan (4.0%, Due 7/08)		500		500		468
	(Business Services)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(10)	Haven Eldercare of New England, LLC and Haven Healthcare Management, LLC are affiliated companies.

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

10

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
The Hillman Companies, Inc.(3)		Subordinated Debt (10.0%, Due 9/11)	$	44,496	$	44,327	$	44,327
	(Consumer Products)
Homax Holdings, Inc.		Subordinated Debt (12.0%, Due 8/11)		14,000		13,110		13,110
	(Consumer Products)	Preferred Stock (89 shares)				89		77
		Common Stock (28 shares)				6		6
		Warrants				1,106		1,261
Hot Stuff Foods, LLC		Senior Loan (8.7%, Due 2/11-2/12)		47,080		47,080		47,080
	(Consumer Products)	Subordinated Debt (13.9%, Due 8/12 – 2/13)		72,967		72,688		72,688
		Common Stock (375,000 shares)(11)				37,445		8,791
		Warrants				—		—
Integrity Interactive Corporation		Unitranche Debt (10.5%, Due 2/12)		30,000		29,795		29,795
	(Business Services)
International Fiber Corporation		Subordinated Debt (14.0%, Due 6/12)		21,764		21,685		21,685
	(Industrial Products)	Preferred Stock (25,000 shares)				2,500		2,100
Kodiak Fund LP(5)		Equity Interests				4,975		4,975
	(Private Equity Fund)
Line-X, Inc.		Senior Loan (9.0%, Due 8/11)		3,000		2,978		2,978
	(Consumer Products)	Unitranche Debt (10.0% Due 8/11)		50,225		50,001		50,001
		Standby Letter of Credit ($1,500)
MedAssets, Inc.		Preferred Stock (227,865 shares)				2,049		3,485
	(Business Services)	Warrants				—		200
Meineke Car Care Centers, Inc.		Senior Loan (8.8%, Due 6/11)		28,000		27,877		27,877
	(Consumer Services)	Subordinated Debt (11.9%, Due 6/12 – 6/13)		72,000		71,705		71,705
		Common Stock (10,696,308 shares)(11)				26,985		23,152
		Warrants				—		—
MHF Logistical Solutions, Inc.		Subordinated Debt (13.2%, Due 6/12 – 6/13)		45,075		44,853		44,853
	(Business Services)	Common Stock (21,425 shares)(11)				21,425		21,425
		Warrants				—		—
Mid-Atlantic Venture Fund IV, L.P.(5)		Limited Partnership Interest				6,600		2,908
	(Private Equity Fund)
Mogas Energy, LLC		Subordinated Debt (9.5%, Due 3/12 – 4/12)		16,570		15,259		15,259
	(Energy Services)	Warrants				1,774		2,900
Network Hardware Resale, Inc.		Unitranche Debt (10.5%, Due 12/11)		38,060		38,283		38,283
	(Business Services)	Convertible Subordinated Debt (9.8%, Due 12/15)		12,000		12,072		12,072
N.E.W. Customer Service Companies, Inc.		Subordinated Debt (11.6%, Due 7/12)		40,000		40,013		40,013
	(Business Services)
Norwesco, Inc.		Subordinated Debt (12.6%, Due 1/12 – 7/12)		82,271		81,925		81,925
	(Industrial Products)	Common Stock (559,603 shares)(11)				38,313		55,992
		Warrants				—		—
Novak Biddle Venture Partners III, L.P.(5)		Limited Partnership Interest				1,595		1,700
	(Private Equity Fund)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(11)	Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

11

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Oahu Waste Services, Inc.		Stock Appreciation Rights			$	239	$	1,200
	(Business Services)
Odyssey Investment Partners Fund III,
	LP(5)	Limited Partnership Interest				1,832		1,688
	(Private Equity Fund)
Opinion Research Corporation(3)		Warrants				996		166
	(Business Services)
Oriental Trading Company, Inc.		Common Stock (13,820 shares)				—		6,995
	(Consumer Products)
Palm Coast Data, LLC		Senior Loan (8.5%, Due 8/10)	$	15,569		15,501		15,501
	(Business Services)	Subordinated Debt (15.5%, Due 8/12 – 8/15)		30,126		29,997		29,997
		Common Stock (21,743 shares)(11)				21,743		19,003
		Warrants				—		—
Passport Health
	Communications, Inc.	Subordinated Debt (14.0%, Due 4/12)		10,000		9,952		9,952
	(Healthcare Services)	Preferred Stock (651,381 shares)				2,000		2,000
Performant Financial Corporation		Common Stock (478,816 shares)				734		150
	(Business Services)
Pro Mach, Inc.		Subordinated Debt (13.8%, Due 6/12)		14,471		14,396		14,396
	(Industrial Products)	Equity Interests				1,500		2,650
Promo Works, LLC		Senior Loan (9.1%, Due 12/11)		3,000		2,953		2,953
	(Business Services)	Unitranche Debt (10.3%, Due 12/11)		31,000		30,751		30,751
		Guaranty ($1,500)
Red Hawk Industries, LLC		Unitranche Debt (11.0%, Due 4/11)		56,342		56,088		56,088
	(Business Services)
S.B. Restaurant Company		Unitranche Debt (10.3%, Due 4/11)		33,501		33,088		33,088
	(Retail)	Preferred Stock (54,125 shares)				135		135
		Warrants				619		1,200
		Standby Letters of Credit ($2,611)
SBBUT, LLC		Equity Interests				—		—
	(Consumer Products)
Soff-Cut Holdings, Inc.		Preferred Stock (300 shares)				300		300
	(Industrial Products)	Common Stock (2,000 shares)				200		114
SPP Mezzanine Fund, L.P.(5)		Limited Partnership Interest				2,594		2,675
	(Private Equity Fund)
STS Operating, Inc.		Subordinated Debt (15.0%, Due 1/13)		30,000		29,854		29,854
	(Industrial Products)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(11)	Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

12

			June 30, 2006
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
The Step2 Company, LLC		Unitranche Debt (10.5%, Due 4/12)	$	68,000	$	67,517	$	67,517
	(Consumer Products)	Equity Interests				2,000		2,000
Tradesmen International, Inc.		Subordinated Debt (12.0%, Due 12/09)		15,000		14,393		14,393
	(Business Services)	Warrants				710		2,900
TransAmerican Auto Parts, LLC		Subordinated Debt (14.0%, Due 11/12)		12,818		12,760		12,760
	(Consumer Products)	Equity Interests				1,190		1,039
TransTechnology Corporation(3)		Senior Loan (9.9%, Due 4/11)		10,000		10,000		10,000
	(Industrial Products)
Universal Air Filter Company		Unitranche Debt (11.0%, Due 11/11)		19,617		19,518		19,518
	(Industrial Products)
Universal Tax Systems, Inc.		Subordinated Debt (14.5%, Due 10/13)		19,310		19,243		19,243
	(Business Services)
Updata Venture Partners II, L.P.(5)		Limited Partnership Interest				5,077		4,898
	(Private Equity Fund)
Venturehouse-Cibernet Investors, LLC		Equity Interest				42		42
	(Business Services)
Venturehouse Group, LLC(5)		Equity Interest				598		407
	(Private Equity Fund)
VICORP Restaurants, Inc.(3)		Warrants				33		33
	(Retail)
Walker Investment Fund II, LLLP(5)		Limited Partnership Interest				1,330		521
	(Private Equity Fund)
Wear Me Apparel Corporation		Subordinated Debt (15.0%, Due 12/10)		40,000		39,190		39,190
	(Consumer Products)	Warrants				1,219		2,900
Wilton Industries, Inc.		Subordinated Debt (16.0%, Due 6/08)		4,800		4,800		4,800
	(Consumer Products)
Woodstream Corporation		Subordinated Debt (13.4%, Due 11/12 – 5/13)		52,753		52,617		52,617
	(Consumer Products)	Common Stock (180 shares)				673		3,352
		Warrants				—		2,348
York Insurance Services Group, Inc.		Subordinated Debt (14.5%, Due 10/13)		19,000		18,907		18,907
	(Business Services)	Common Stock (10,000 shares)				1,000		1,000
Other companies		Other debt investments(6)		453		453		334
		Other equity investments				8		—
		Guaranty ($159)
Total companies less than 5% owned					$	1,933,932	$	1,901,139
Total private finance (131 portfolio companies)					$	3,588,250	$	3,460,426

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

13

Commercial Real Estate Finance

(in thousands, except number of loans)

						June 30, 2006
		Interest		Number of		(unaudited)
		Rate Ranges		Loans		Cost		Value
Commercial Mortgage Loans
			Up to 6.99%		3	$	20,314	$	19,481
			7.00%–8.99%		25		48,798		49,024
			9.00%–10.99%		3		21,781		21,781
			11.00%–14.99%		1		2,291		2,291
		15.00% and above			2		3,970		3,970
	Total commercial mortgage loans(12)				34	$	97,154	$	96,547
Real Estate Owned						$	13,090	$	14,553
Equity Interests(2) — Companies more than 25% owned (Guarantees — $6,871)						$	17,504	$	21,951
	Total commercial real estate finance					$	127,748	$	133,051
Total portfolio						$	3,715,998	$	3,593,477

			Yield		Cost		Value
Liquidity Portfolio
	U.S. Treasury bills (Due October 2006)			4.9%	$	24,996	$	25,067
	U.S. Treasury bills (Due December 2006)			4.9%		100,004		100,873
	SEI Daily Income Tr Prime Obligation Fund(13)			5.0%		55,292		55,292
	Certificate of Deposit (Due September 2006)(13)			5.6%		20,000		20,000
		Total liquidity portfolio			$	200,292	$	201,232
Other Investments in Money Market Securities(13)
	Columbia Treasury Reserves Money Market Fund			5.2%	$	19,280	$	19,280
	PNC Bank Corporate Money Market Deposit Account			4.8%	$	524	$	524
	Columbia Money Market Reserves			5.0%	$	2,714	$	2,714

 ⁽¹⁾       Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for
            a single issuer. The maturity dates represent the earliest and the latest maturity dates.

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

 ⁽³⁾       Public company.

 ⁽⁴⁾       Non-U.S. company or principal place of business outside the U.S.

 ⁽⁵⁾       Non-registered investment company.

⁽¹²⁾       Commercial mortgage loans totaling $15.7 million at value were on non-accrual status and therefore were considered non-income producing.

⁽¹³⁾       Included in investments in money market and other securities on the accompanying Consolidated Balance Sheet.

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

14

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Companies More Than 25% Owned
Acme Paging, L.P.(4)		Senior Loan (6.0%, Due 12/07)(6)	$	3,750	$	3,750	$	—
	(Telecommunications)	Subordinated Debt (10.0%, Due 1/08)(6)		881		881		—
		Common Stock (23,513 shares)				27		—
Advantage Sales & Marketing, Inc.		Subordinated Debt (10.5%, Due 9/09)		60,000		59,787		59,787
	(Business Services)	Subordinated Debt (18.5%, Due 12/09)		124,000		124,000		124,000
		Common Stock (18,924,976 shares)				73,932		476,578
Alaris Consulting, LLC		Senior Loan (15.8%, Due 12/05 – 12/07)(6)		27,055		27,050		—
	(Business Services)	Equity Interests				5,305		—
		Guaranty ($1,100)
American Healthcare Services, Inc.		Senior Loan (0.7%, Due 12/04 – 12/05)(6)		4,999		4,600		4,097
	and Affiliates
	(Healthcare Services)
Avborne, Inc.(7)		Preferred Stock (12,500 shares)				658		892
	(Business Services)	Common Stock (27,500 shares)				—		—
Avborne Heavy Maintenance, Inc.(7)		Preferred Stock (1,568 shares)				2,401		—
	(Business Services)	Common Stock (2,750 shares)				—		—
		Guaranty ($2,401)
Business Loan Express, LLC		Subordinated Debt (6.9%, Due 4/06)		10,000		10,000		10,000
	(Financial Services)	Class A Equity Interests		60,693		60,693		60,693
		Class B Equity Interests				119,436		146,910
		Class C Equity Interests				109,301		139,521
		Guaranty ($135,437 — See Note 3)
		Standby Letters of Credit ($34,050 —   See Note 3)
Callidus Capital Corporation		Senior Loan (12.0%, Due 12/06)		600		600		600
	(Financial Services)	Subordinated Debt (18.0%, Due 10/08)		4,832		4,832		4,832
		Common Stock (10 shares)				2,049		7,968
Diversified Group Administrators, Inc.		Preferred Stock (1,000,000 shares)				700		728
	(Business Services)	Preferred Stock (1,451,380 shares)				841		841
		Common Stock (1,451,380 shares)				—		502
Financial Pacific Company (Financial Services)		Subordinated Debt (17.4%, Due 2/12 – 8/12)		70,175		69,904		69,904
		Preferred Stock (10,964 shares)				10,276		13,116
		Common Stock (14,735 shares)				14,819		44,180
ForeSite Towers, LLC		Equity Interests				7,620		9,750
	(Tower Leasing)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(7)	Avborne, Inc. and Avborne Heavy Maintenance, Inc. are affiliated companies.

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

15

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Global Communications, LLC		Senior Loan (10.7%, Due 9/02 – 11/07)(6)	$	15,957	$	15,957	$	15,957
	(Business Services)	Subordinated Debt (17.0%, Due 12/03 – 9/05)(6)		11,201		11,198		11,198
		Preferred Equity Interest				14,067		4,303
		Options				1,639		—
Gordian Group, Inc.		Senior Loan (10.0%, Due 6/06 – 12/08)(6)		11,392		11,421		4,161
	(Business Services)	Common Stock (1,000 shares)				6,542		—
Healthy Pet Corp.		Senior Loan (10.1%, Due 8/10)		4,086		4,086		4,086
	(Consumer Services)	Subordinated Debt (15.0%, Due 8/10)		38,716		38,535		38,535
		Common Stock (25,766 shares)				25,766		25,766
HMT, Inc.		Preferred Stock (554,052 shares)				2,637		2,637
	(Energy Services)	Common Stock (300,000 shares)				3,000		5,343
		Warrants				1,155		2,057
Impact Innovations Group, LLC (Business Services)		Equity Interests in Affiliate				—		742
Insight Pharmaceuticals Corporation		Subordinated Debt (16.1%, Due 9/12)		58,534		58,298		58,298
	(Consumer Products)	Preferred Stock (25,000 shares)				25,000		26,791
		Common Stock (6,200 shares)				6,325		236
Jakel, Inc.		Subordinated Debt (15.5%, Due 3/08)(6)		13,742		13,742		—
	(Industrial Products)	Preferred Stock (6,460 shares)				6,460		—
		Common Stock (158,061 shares)				9,347		—
Legacy Partners Group, LLC		Senior Loan (14.0%, Due 5/09)(6)		7,646		7,646		5,029
	(Financial Services)	Subordinated Debt (18.0%, Due 5/09)(6)		2,952		2,952		—
		Equity Interests				4,229		—
Litterer Beteiligungs-GmbH(4)		Subordinated Debt (8.0%, Due 3/07)		621		621		621
	(Business Services)	Equity Interest				1,810		2,226
Mercury Air Centers, Inc.		Senior Loan (10.0%, Due 4/09)		31,720		31,720		31,720
	(Business Services)	Subordinated Debt (16.0%, Due 4/09)		46,703		46,519		46,519
		Common Stock (57,970 shares)				35,053		88,898
		Standby Letters of Credit ($1,397)
MVL Group, Inc.		Senior Loan (12.1%, Due 7/09)		27,519		27,218		27,218
	(Business Services)	Subordinated Debt (14.4%, Due 7/09)		32,905		32,417		32,417
		Common Stock (648,661 shares)				643		3,211
Pennsylvania Avenue Investors, L.P.(5)		Equity Interests				2,576		1,864
	(Private Equity Fund)
Powell Plant Farms, Inc.		Senior Loan (15.0%, Due 12/05 - 12/06)		32,640		23,792		23,792
	(Consumer Products)	Subordinated Debt (20.0%, Due 6/03)(6)		19,291		19,224		7,364
		Preferred Stock (1,483 shares)				—		—
		Warrants				—		—

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

16

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Redox Brands, Inc.		Preferred Stock (2,726,444 shares)			$	7,903	$	12,097
	(Consumer Products)	Warrants				584		500
Service Champ, Inc.		Subordinated Debt (15.5%, Due 4/12)	$	27,041		26,906		26,906
	(Business Services)	Common Stock (63,888 shares)				13,662		13,319
Staffing Partners Holding		Subordinated Debt (13.5%, Due 1/07)(6)		6,343		6,343		6,343
	Company, Inc.	Preferred Stock (439,600 shares)				4,968		1,812
	(Business Services)	Common Stock (69,773 shares)				50		—
		Warrants				10		—
Startec Global Communications		Senior Loan (10.0%, Due 5/07 – 5/09)		25,226		25,226		21,685
	Corporation	Common Stock (19,180,000 shares)				37,255		—
	(Telecommunications)
STS Operating, Inc.		Subordinated Debt (15.3%, Due 3/12)		6,593		6,593		6,593
	(Industrial Products)	Common Stock (3,000,000 shares)				3,522		64,963
		Options				—		560
Triview Investments, Inc.(8)		Senior Loan (8.6%, Due 12/06)		7,449		7,449		7,449
	(Broadcasting & Cable/	Subordinated Debt (15.0%, Due 7/12)		31,000		30,845		30,845
	Consumer Products)	Subordinated Debt (16.8%, Due 7/08 –
		7/12)(6)		19,600		19,520		19,520
		Common Stock (202 shares)				93,889		29,171
		Guaranty ($800)
		Standby Letter of Credit ($200)
Total companies more than 25% owned					$	1,489,782	$	1,887,651
Companies 5% to 25% Owned
Air Evac Lifeteam		Subordinated Debt (13.8%, Due 7/10)	$	42,414	$	42,267	$	42,267
	(Healthcare Services)	Equity Interests				3,941		4,025
Aspen Pet Products, Inc.		Subordinated Debt (19.0%, Due 6/08)		20,051		19,959		19,959
	(Consumer Products)	Preferred Stock (2,935 shares)				2,154		1,638
		Common Stock (1,400 shares)				140		17
		Warrants				—		—
Becker Underwood, Inc.		Subordinated Debt (14.5%, Due 8/12)		23,639		23,543		23,543
	(Industrial Products)	Common Stock (5,073 shares)				5,813		2,200
The Debt Exchange Inc.		Preferred Stock (921,875 shares)				1,250		3,219
	(Business Services)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(8)	Triview Investments, Inc. (formerly GAC Investments, Inc.) holds investments in Longview Cable & Data, LLC (Broadcasting & Cable) with a cost of $66.5 million and value of $16.0 million and Triax Holdings, LLC (Consumer Products) with a cost of $85.2 million and a value of $71.0 million. The guaranty and standby letter of credit relate to Longview Cable & Data, LLC.

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

17

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
MedBridge Healthcare, LLC		Senior Loan (4.0%, Due 8/09)	$	7,093	$	7,093	$	7,093
	(Healthcare Services)	Subordinated Debt (10.0%, Due 8/14)(6)		4,809		4,809		534
		Convertible Subordinated Debt (2.0%, Due 8/14)(6)		2,970		984		—
		Equity Interests				800		—
Nexcel Synthetics, LLC		Subordinated Debt (14.5%, Due 6/09)		10,617		10,588		10,588
	(Consumer Products)	Equity Interests				1,708		1,367
Pres Air Trol LLC		Unitranche Debt (12.0%, Due 4/10)		6,138		5,820		5,820
	(Industrial Products)	Equity Interests				1,356		318
Progressive International		Subordinated Debt (16.0%, Due 12/09)		7,401		7,376		7,376
	Corporation	Preferred Stock (500 shares)				500		884
	(Consumer Products)	Common Stock (197 shares)				13		13
		Warrants				—		—
Soteria Imaging Services, LLC		Subordinated Debt (11.8%, Due 11/10)		14,500		13,447		13,447
	(Healthcare Services)	Equity Interests				2,153		2,308
Universal Environmental Services, LLC		Unitranche Debt (15.5%, Due 2/09)		10,900		10,862		10,862
	(Business Services)	Equity Interests				1,797		1,328
Total companies 5% to 25% owned					$	168,373	$	158,806
Companies Less Than 5% Owned
Advanced Circuits, Inc.		Senior Loans (10.1%, Due 9/11 – 3/12)	$	18,732	$	18,642	$	18,642
	(Industrial Products)	Common Stock (40,000 shares)				1,000		1,000
Anthony, Inc. (Industrial Products)		Subordinated Debt (12.9%, Due 9/11 – 9/12)		14,670		14,610		14,610
Benchmark Medical, Inc.		Warrants				18		190
	(Healthcare Services)
BI Incorporated		Subordinated Debt (14.0%, Due 2/12)		16,203		16,133		16,133
	(Business Services)
Border Foods, Inc. (Consumer Products)		Subordinated Debt (13.0%, Due 12/10)(6)		13,428		12,721		—
		Preferred Stock (140,214 shares)				2,893		—
		Common Stock (1,810 shares)				45		—
		Warrants				910		—

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

18

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
C&K Market, Inc.		Subordinated Debt (13.0%, Due 12/08)	$	14,694	$	14,638	$	14,638
	(Retail)
Callidus Debt Partners		Class C Notes (12.9%, Due 12/13)		18,800		18,973		18,973
	CDO Fund I, Ltd.(4)(9)	Class D Notes (17.0%, Due 12/13)		9,400		9,487		9,487
	(Senior Debt Fund)
Callidus Debt Partners		Preferred Shares (23,600,000 shares)				24,233		24,233
	CLO Fund III, Ltd.(4)(9)
	(Senior Debt Fund)
Callidus MAPS CLO Fund I LLC(9)		Class E Notes (9.7%, Due 12/17)		17,000		17,000		17,000
	(Senior Debt Fund)	Income Notes				48,108		48,108
Camden Partners Strategic Fund II, L.P.(5)		Limited Partnership Interest				2,142		2,726
	(Private Equity Fund)
Catterton Partners V, L.P.(5)		Limited Partnership Interest				2,650		2,691
	(Private Equity Fund)
CBS Personnel Holdings, Inc. (Business Services)		Subordinated Debt (14.5%, Due 12/09)		20,617		20,541		20,541
Community Education Centers, Inc.		Subordinated Debt (16.0%, Due 12/10)		32,852		32,738		32,738
	(Education Services)
Component Hardware Group, Inc.		Preferred Stock (18,000 shares)				2,605		2,783
	(Industrial Products)	Common Stock (2,000 shares)				200		700
Cooper Natural Resources, Inc.		Subordinated Debt (0%, Due 11/07)		840		840		840
	(Industrial Products)	Preferred Stock (6,316 shares)				1,424		20
		Warrants				830		—
Coverall North America, Inc.		Subordinated Debt (14.6%, Due 2/11)		27,309		27,261		27,261
	(Business Services)	Preferred Stock (6,500 shares)				6,500		6,866
		Warrants				2,950		3,100

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(9)	The fund is managed by Callidus Capital, a portfolio company of Allied Capital.

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

19

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Drilltec Patents & Technologies Company, Inc.		Subordinated Debt (17.0%, Due 8/06)(6)	$	1,500	$	1,500	$	1,500
	(Energy Services)	Subordinated Debt (10.0%, Due 8/06)(6)		10,994		10,918		9,792
eCentury Capital Partners, L.P.(5)		Limited Partnership Interest				5,649		83
	(Private Equity Fund)
Elexis Beta GmbH(4)		Options				426		50
	(Industrial Products)
Event Rentals, Inc.		Senior Loans (9.9%, Due 11/11)		18,341		18,244		18,244
	(Consumer Services)
Frozen Specialties, Inc.		Warrants				435		470
	(Consumer Products)
Garden Ridge Corporation (Retail)		Subordinated Debt (7.0%, Due 5/12)(6)		22,500		22,500		22,500
Geotrace Technologies, Inc.		Subordinated Debt (10.0%, Due 6/09)		25,618		23,875		23,875
(Energy Services)		Warrants				2,350		2,500
Ginsey Industries, Inc.		Subordinated Debt (12.5%, Due 3/07)		3,680		3,680		3,680
	(Consumer Products)
Grant Broadcasting Systems II		Subordinated Debt (5.0%, Due 6/09)		2,756		2,756		2,756
	(Broadcasting & Cable)
Grotech Partners, VI, L.P.(5)		Limited Partnership Interest				6,914		4,161
	(Private Equity Fund)
Havco Wood Products LLC		Unitranche Debt (10.4%, Due 8/11)		33,000		31,794		31,794
	(Industrial Products)	Equity Interests				1,048		1,048
Haven Eldercare of New England, LLC(10)		Subordinated Debt (12.0%, Due 8/09)(6)		4,320		4,320		4,320
	(Healthcare Services)
Haven Healthcare Management, LLC(10)		Subordinated Debt (18.0% Due 4/07)(6)		1,319		1,319		485
	(Healthcare Services)
HealthASPex Services Inc.		Senior Loans (4.0%, Due 7/08)		500		500		500
	(Business Services)
The Hillman Companies, Inc.(3)		Subordinated Debt (13.5%, Due 9/11)		44,000		43,815		43,815
	(Consumer Products)
Homax Holdings, Inc.		Subordinated Debt (12.0%, Due 8/11)		14,000		13,039		13,039
	(Consumer Products)	Preferred Stock (89 shares)				89		92
		Common Stock (28 shares)				6		6
		Warrants				1,106		1,492
Icon International, Inc.		Common Stock (25,707 shares)				76		16
	(Business Services)
International Fiber Corporation		Subordinated Debt (14.0%, Due 6/12)		21,546		21,460		21,460
	(Industrial Products)	Preferred Stock (25,000 shares)				2,500		1,900
Line-X, Inc.		Senior Loan (8.1%, Due 8/11)		4,134		4,111		4,111
	(Consumer Products)	Unitranche Debt (10.0% Due 8/11)		51,475		51,229		51,229
		Standby Letter of Credit ($1,500)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(10)	Haven Eldercare of New England, LLC and Haven Healthcare Management, LLC are affiliated companies.

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

20

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
MedAssets, Inc.		Preferred Stock (227,865 shares)			$	2,049	$	2,893
	(Business Services)	Warrants				136		180
Meineke Car Care Centers, Inc.		Senior Loan (8.0%, Due 6/11)	$	28,000		27,865		27,865
	(Consumer Services)	Subordinated Debt (11.9%, Due 6/12 – 6/13)		72,000		71,675		71,675
		Common Stock (10,696,308 shares)(11)				26,985		26,629
		Warrants				—		—
MHF Logistical Solutions, Inc.		Unitranche Debt (10.0%, Due 5/11)		22,281		22,177		22,177
	(Business Services)	Preferred Stock (431 shares)				431		455
		Common Stock (1,438 shares)				144		211
Mid-Atlantic Venture Fund IV, L.P.(5)		Limited Partnership Interest				6,600		3,339
	(Private Equity Fund)
Mogas Energy, LLC		Subordinated Debt (9.5%, Due 3/12 – 4/12)		16,855		15,472		15,472
	(Energy Services)	Warrants				1,774		3,550
Network Hardware Resale, Inc.		Unitranche Debt (10.5%, Due 12/11)		38,500		38,743		38,743
	(Business Services)	Convertible Subordinated Debt (9.8%, Due 12/15)		12,000		12,076		12,076
N.E.W. Customer Service Companies, Inc.		Subordinated Debt (11.0%, Due 7/12)		40,000		40,016		40,016
	(Business Services)
Nobel Learning Communities,		Preferred Stock (1,214,356 shares)				2,764		2,343
	Inc.(3)	Warrants				575		1,296
	(Education)
Norwesco, Inc. (Industrial Products)		Subordinated Debt (12.6%, Due 1/12 – 7/12)		82,061		81,683		81,683
		Common Stock (559,603 shares)(11)				38,313		38,313
		Warrants				—		—
Novak Biddle Venture Partners III, L.P.(5)		Limited Partnership Interest				1,669		1,809
	(Private Equity Fund)
Oahu Waste Services, Inc.		Stock Appreciation Rights				239		1,000
	(Business Services)
Opinion Research Corporation(3)		Warrants				996		45
	(Business Services)
Oriental Trading Company, Inc.		Common Stock (13,820 shares)				—		5,200
	(Consumer Products)
Palm Coast Data, LLC		Senior Loan (7.6%, Due 8/10)		16,100		16,024		16,024
	(Business Services)	Subordinated Debt (15.5%, Due 8/12 – 8/15)		29,600		29,461		29,461
		Common Stock (21,743 shares)(11)				21,743		21,743
		Warrants				—		—
Performant Financial Corporation		Common Stock (478,816 shares)				734		2,500
	(Business Services)
Pro Mach, Inc.		Subordinated Debt (13.8%, Due 6/12)		19,275		19,193		19,193
	(Industrial Products)	Equity Interests				1,500		1,200

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(11)	Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

21

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Promo Works, LLC		Senior Loan (8.5%, Due 12/11)	$	900	$	851	$	851
	(Business Services)	Unitranche Debt (10.3%, Due 12/11)		31,000		30,728		30,728
		Guaranty ($1,650)
RadioVisa Corporation		Unitranche Debt (15.5%, Due 12/08)		27,093		26,993		26,993
	(Broadcasting & Cable)
Red Hawk Industries, LLC		Unitranche Debt (11.0%, Due 4/11)		56,343		56,063		56,063
	(Business Services)
S.B. Restaurant Company (Retail)		Subordinated Debt (14.6%, Due 11/08 – 12/09)		29,085		28,615		28,615
		Preferred Stock (54,125 shares)				135		135
		Warrants				619		700
SBBUT, LLC		Equity Interests				—		—
	(Consumer Products)
Soff-Cut Holdings, Inc.		Preferred Stock (300 shares)				300		300
	(Industrial Products)	Common Stock (2,000 shares)				200		37
SPP Mezzanine Fund, L.P.(5)		Limited Partnership Interest				3,007		2,969
	(Private Equity Fund)
Tradesmen International, Inc.		Subordinated Debt (12.0%, Due 12/09)		15,000		14,323		14,323
	(Business Services)	Warrants				710		1,700
TransAmerican Auto Parts, LLC		Subordinated Debt (14.0%, Due 11/12)		10,000		9,951		9,951
	(Consumer Products)	Equity Interests				889		889
United Site Services, Inc.		Subordinated Debt (12.4%, Due 8/11)		49,712		49,503		49,503
	(Business Services)	Common Stock (160,588 shares)				1,000		1,200
Universal Air Filter Company		Senior Loans (7.9%, Due 11/11)		400		390		390
	(Industrial Products)	Unitranche Debt (11.0%, Due 11/11)		19,867		19,768		19,768
Universal Tax Systems, Inc.		Subordinated Debt (14.5%, Due 7/11)		19,068		18,995		18,995
	(Business Services)
Updata Venture Partners II, L.P.(5)		Limited Partnership Interest				4,977		4,686
	(Private Equity Fund)
Venturehouse-Cibernet Investors, LLC		Equity Interest				42		42
	(Business Services)
Venturehouse Group, LLC(5)		Equity Interest				598		397
	(Private Equity Fund)
VICORP Restaurants, Inc.(3)		Warrants				33		691
	(Retail)
Walker Investment Fund II, LLLP(5)		Limited Partnership Interest				1,330		676
	(Private Equity Fund)

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.
(11)	Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

22

			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Wear Me Apparel Corporation		Subordinated Debt (15.0%, Due 12/10)	$	40,000	$	38,992	$	38,992
	(Consumer Products)	Warrants				1,219		2,000
Wilshire Restaurant Group, Inc. (Retail)		Subordinated Debt (20.0%, Due 6/07)(6)		22,471		21,930		21,930
		Warrants				735		538
Wilton Industries, Inc.		Subordinated Debt (19.3%, Due 6/08)		4,800		4,800		4,800
	(Consumer Products)
Woodstream Corporation (Consumer Products)		Subordinated Debt (13.2%, Due 11/12 – 5/13)		52,397		52,251		52,251
		Common Stock (180 shares)				673		3,336
		Warrants				—		2,365
Other companies		Other debt investments		382		382		382
		Other debt investments(6)		470		470		348
		Other equity investments				8		—
		Guaranty ($135)
Total companies less than 5% owned					$	1,448,268	$	1,432,833
Total private finance (118 portfolio companies)					$	3,106,423	$	3,479,290

(1)	Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(2)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
(3)	Public company.
(4)	Non-U.S. company or principal place of business outside the U.S.
(5)	Non-registered investment company.
(6)	Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

23

Commercial Real Estate Finance

(in thousands, except number of loans)

						December 31, 2005
		Interest		Number of
		Rate Ranges		Loans		Cost		Value
Commercial Mortgage Loans
			Up to 6.99%		5	$	23,121	$	21,844
			7.00%–8.99%		24		48,156		48,156
			9.00%–10.99%		5		25,999		25,967
			11.00%–12.99%		1		338		338
			13.00%–14.99%		1		2,294		2,294
		15.00% and above			2		3,970		3,970
	Total commercial mortgage loans(12)				38	$	103,878	$	102,569
Real Estate Owned						$	14,240	$	13,932
Equity Interests(2) — Companies more than 25% owned (Guarantees — $7,054)						$	13,577	$	10,564
	Total commercial real estate finance					$	131,695	$	127,065
Total portfolio						$	3,238,118	$	3,606,355

			Yield		Cost		Value
Liquidity Portfolio
	U.S. Treasury bills (Due June 2006)			4.25%	$	100,000	$	100,305
	SEI Daily Income Tr Prime Obligation Fund(13)			4.11%		100,000		100,000
		Total liquidity portfolio			$	200,000	$	200,305
Other Investments in Money Market Securities(13)
	PNC Bank Corporate Money Market Deposit Account			4.15%	$	21,967	$	21,967

 ⁽¹⁾       Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for
            a single issuer. The maturity dates represent the earliest and the latest maturity dates.

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

 ⁽³⁾       Public company.

 ⁽⁴⁾       Non-U.S. company or principal place of business outside the U.S.

 ⁽⁵⁾       Non-registered investment company.

⁽¹²⁾       Commercial mortgage loans totaling $20.8 million at value were on non-accrual status and therefore were considered non-income producing.

⁽¹³⁾       Included in investments in money market securities on the accompanying Consolidated Balance Sheet.

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

24

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information at and for the three and six months ended June 30, 2006 and 2005 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, Allied Investments L.P. (“Allied Investments”), 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 that are single member limited liability companies established primarily to hold real estate properties. ACC also has a subsidiary, A.C. Corporation (“AC Corp”), that generally provides diligence and structuring services as well as structuring, transaction, management, consulting and other services to the Company and its portfolio companies. AC Corp has a wholly-owned subsidiary, AC Finance LLC (“AC Finance”), that generally originates, underwrites and arranges senior loans.

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

      The investment objective of the Company is to achieve current income and capital gains. In order to achieve this objective, the Company has primarily invested in companies in a variety of industries.

Note 2. Summary of Significant Accounting Policies

  Basis of Presentation

      The consolidated financial statements include the accounts of the Company. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2005 balances to conform with the 2006 financial statement presentation.

      The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, the unaudited consolidated financial results of the Company included herein contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position of the Company as of June 30, 2006, the results of operations for the three and six months ended June 30, 2006 and 2005, and changes in net assets and cash flows for the six months ended June 30, 2006 and 2005. The results of operations for the three and six months ended June 30, 2006, are not necessarily indicative of the operating results to be expected for the full year.

      The private finance portfolio and the interest and related portfolio income and net realized gains (losses) on the private finance portfolio are presented in three categories: companies more than 25% owned, which represent portfolio companies where the Company directly or indirectly owns more than

25

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

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

      In the ordinary course of business, the Company enters into transactions with portfolio companies that may be considered related party transactions.

Valuation Of Portfolio Investments

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

Loans and Debt Securities

      For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value, overall financial condition or other factors lead to a determination of fair value at a different amount. The value of loan and debt securities may be greater than the Company’s cost basis if the amount that would be repaid on the loan or debt security upon the sale of the portfolio company is greater than the Company’s cost basis.

26

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

      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.

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

      The weighted average yield on loans and debt securities is computed as the (a) annual stated interest plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans and debt securities less the annual amortization of loan origination costs, 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 securities in portfolio companies for which there is no liquid public market are valued at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including cash flow from operations of the portfolio company and other pertinent factors, such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, liquidation events, or other events. The determined equity values are generally discounted to account for restrictions on resale or minority ownership positions.

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

      Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are expected to be collected and to the extent that the Company has the option to receive the dividend in cash. Dividend income on common equity

27

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

securities is recorded on the record date for private companies or on the ex-dividend date for publicly traded companies.

Collateralized Debt Obligations (“CDO”) and Collateralized Loan Obligations (“CLO”)

      CDO and CLO bonds and preferred shares/ income notes (“CDO/ CLO Assets”) are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar bonds and preferred shares/income notes, when available. The Company recognizes unrealized appreciation or depreciation on its CDO/ CLO Assets as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. The Company determines the fair value of its CDO/ CLO Assets on an individual security-by-security basis.

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

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

      Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the year, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. Net change in unrealized appreciation or depreciation also reflects the change in the value of U.S. Treasury bills and deposits of proceeds from sales of borrowed Treasury securities, and depreciation on accrued interest and dividends receivable and other assets where collection is doubtful.

Fee Income

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

28

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

Guarantees

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

Financing Costs

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

Dividends to Shareholders

      Dividends to shareholders are recorded on the record date.

Stock Compensation Plans

      The Company has a stock-based employee compensation plan. See Note 9. Effective January 1, 2006, the Company adopted the provisions of Statement No. 123 (Revised 2004),Share-Based Payment(the “Statement”). With respect to options granted prior to January 1, 2006, the Company has used the “modified prospective method” for adoption of the Statement. Under this method, the unamortized cost of previously awarded options that were unvested as of January 1, 2006, is recognized over the remaining service period in the statement of operations beginning in 2006. With respect to options granted on or after January 1, 2006, compensation cost is recognized over the related service period in the statement of operations. The effect of this adoption for the three and six months ended June 30, 2006, was as follows:

			For the Three		For the Six
			Months Ended		Months Ended
			June 30,		June 30,
			2006		2006
($ in millions, except per share amounts)
Employee Stock Option Expense:
	Previously awarded, unvested options as of January 1, 2006		$	3.3	$	6.7
	Options granted on or after January 1, 2006			1.3		1.5
		Total stock option expense	$	4.6	$	8.2
		Per basic share	$	0.03	$	0.06
		Per diluted share	$	0.03	$	0.06

      In addition to the employee stock option expense, for the three and six months ended June 30, 2006, administrative expense included $0.2 million of expense related to options granted to directors during the period. Options granted to non-officer directors vest on the grant date and therefore, the full expense is recorded on the grant date.

29

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

      Prior to January 1, 2006, the Company accounted for this plan under the recognition and measurement principles of APB Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations. Prior to January 1, 2006, no stock-based compensation cost was reflected in net increase in net assets resulting from operations, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net increase in net assets resulting from operations and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation, to stock-based compensation for the three and six months ended June 30, 2005.

		For the Three			For the Six
		Months Ended			Months Ended
		June 30,			June 30,
		2005			2005
($ in millions, except per share amounts)
Net increase in net assets resulting from operations as reported		$	311.9		$	431.5
Less total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects			(4.1	)		(7.0	)
Pro forma net increase in net assets resulting from operations available to common shareholders		$	307.8		$	424.5
Basic earnings per common share:
	As reported	$	2.33		$	3.23
	Pro forma	$	2.30		$	3.18
Diluted earnings per common share:
	As reported	$	2.29		$	3.17
	Pro forma	$	2.26		$	3.12

      The stock option expense for 2006 and the pro forma expense for 2005 shown in the tables above were based on the underlying value of the options granted by the Company. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model and expensed over the vesting period. The following assumptions were used to calculate the fair value of options granted during the three and six months ended June 30, 2006 and 2005:

	For the Three						For the Six
	Months Ended						Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
Risk-free interest rate		5.0	%		4.1	%		4.8	%		4.1	%
Expected life (in years)		5.0			5.0			5.0			5.0
Expected volatility		29.6	%		35.5	%		29.6	%		35.5	%
Dividend yield		9.0	%		9.0	%		9.0	%		9.0	%
Weighted average fair value per option	$	3.65		$	3.87		$	3.54		$	3.87

      The risk free rate was based on the U.S. Treasury bond yield curve at the date of grant. The expected life of the options granted represents the period of time that such options are expected to be outstanding. To determine the expected life of the options, the Company used historical data to

30

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

estimate option exercise time frames and option forfeitures, including considering employee terminations. Expected volatilities were determined based on the historical volatility of the Company’s common stock. The dividend yield was determined based on the Company’s historical dividend yield.

      The Company estimates that the employee-related stock option expense under the Statement that will be recorded in the Company’s statement of operations will be approximately $16.1 million, $10.1 million, and $3.2 million for the years ended December 31, 2006, 2007, and 2008, respectively, which includes approximately $2.6 million, $1.4 million, and $0.7 million, respectively, related to options granted in the first and second quarters of 2006. This estimate may change if the Company’s assumptions related to future option forfeitures change. This estimate does not include any expense related to future stock option grants as the fair value of those stock options will be determined at the time of grant. The aggregate total stock option expense remaining as of June 30, 2006, is expected to be recognized over an estimated weighted-average period of 1.38 years.

Federal and State Income Taxes and Excise Tax

      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”). ACC and any subsidiaries that qualify as a RIC or a REIT intend to distribute or retain through a deemed distribution all of their annual taxable income to shareholders; therefore, the Company has made no provision for income taxes for these entities. Income taxes for AC Corp are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

      If the Company does not distribute at least 98% of its annual taxable income in the year earned, the Company will generally be required to pay an excise tax equal to 4% of the amount by which 98% of the Company’s annual taxable income exceeds the distributions from such taxable income for the year. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes, if any, on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income.

Per Share Information

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

31

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

Use of Estimates in the Preparation of Financial Statements

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

      The consolidated financial statements include portfolio investments at value of $3.6 billion at both June 30, 2006, and December 31, 2005. At both June 30, 2006, and December 31, 2005, 90% of the Company’s total assets represented portfolio investments whose fair values have been determined by the Board of Directors in good faith in the absence of readily available market values. Because of the inherent uncertainty of valuation, the Board of Directors’ determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

Note 3. Portfolio

Private Finance

      At June 30, 2006, and December 31, 2005, the private finance portfolio consisted of the following:

			2006							2005
			Cost		Value		Yield(1)			Cost		Value		Yield(1)
($ in thousands)
Loans and debt securities:
	Senior loans		$	322,041	$	275,874		9.5	%	$	284,680	$	239,838		9.5	%
	Unitranche debt(2)			517,287		515,006		10.7	%		294,201		294,201		11.4	%
	Subordinated debt			1,769,369		1,700,324		13.9	%		1,610,228		1,560,851		13.8	%
		Total loans and debt securities(3)		2,608,697		2,491,204		12.7	%		2,189,109		2,094,890		13.0	%
Equity securities				979,553		969,222					917,314		1,384,400
		Total	$	3,588,250	$	3,460,426				$	3,106,423	$	3,479,290

(1)	The weighted average yield on loans and debt securities is computed as the (a) annual stated interest plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans and debt securities less the annual amortization of loan origination costs, divided by (b) total loans and debt securities at value. At June 30, 2006, and December 31, 2005, the cost and value of subordinated debt include the Class A equity interests in BLX and the guaranteed dividend yield on these equity interests is included in interest income. The weighted average yield is computed as of the balance sheet date.
(2)	Unitranche debt is a single debt investment that is a blend of senior and subordinated debt terms.
(3)	The total principal balance outstanding on loans and debt securities was $2,637.0 million and $2,216.3 million at June 30, 2006, and December 31, 2005, respectively. The difference between principal and cost is represented by unamortized loan origination fees and costs, original issue discounts, and market discounts totaling $28.3 million and $27.2 million at June 30, 2006, and December 31, 2005, respectively.

     The Company’s private finance investment activity principally involves providing financing through privately negotiated long-term debt and equity investments. The Company’s private finance

32

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

investments are generally issued by private companies and are generally illiquid and may be subject to certain restrictions on resale.

      The Company’s private finance debt 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. The annual stated interest rate is only one factor in pricing the investment relative to the Company’s rights and priority in the portfolio company’s capital structure, and will vary depending on many factors, including if the Company has received nominal cost equity or other components of investment return, such as loan origination fees or market discount. The stated interest rate may include some component of contractual payment-in-kind interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity.

      At June 30, 2006, 86% of the private finance loans and debt securities had a fixed rate of interest and 14% had a floating rate of interest. At December 31, 2005, 87% of the private finance loans and debt securities had a fixed rate of interest and 13% had a floating rate of interest. Senior loans generally carry a floating rate of interest, usually set as a spread over LIBOR. Senior loans generally have contractual maturities of three to six years and interest is generally paid to the Company monthly or quarterly. Loans other than senior loans generally carry a fixed rate of interest with contractual maturities of five to ten years. Loan and debt securities generally have interest-only payments in the early years and payments of both principal and interest in the later years, although maturities and principal amortization schedules may vary. Interest is generally paid to the Company quarterly.

      Equity securities consist primarily of securities issued by private companies and may be subject to certain restrictions on their resale and are generally illiquid. The Company may make equity investments for minority stakes in portfolio companies in conjunction with its debt investments. The Company may also invest in the equity (preferred and/or voting or non-voting common) of a portfolio company where the Company’s equity ownership may represent a significant portion of the equity, but may or may not represent a controlling interest. If the Company invests in non-voting equity in a buyout investment, the Company generally has the option to acquire a controlling stake in the voting securities of the portfolio company at fair market value. The Company may incur costs associated with making buyout investments that will be included in the cost basis of the Company’s equity investment. These include costs such as legal, accounting and other professional fees associated with diligence, referral and investment banking fees, and other costs. Equity securities generally do not produce a current return, but are held with the potential for investment appreciation and ultimate gain on sale.

      The Company’s largest investment at value at June 30, 2006, was in Business Loan Express, LLC (“BLX”). The Company’s largest investments at value at December 31, 2005, were in Advantage Sales & Marketing, Inc. (“Advantage”) and BLX. On March 29, 2006, the Company sold its majority equity interest in Advantage.

33

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

     Business Loan Express, LLC. The Company’s investment in BLX totaled $293.2 million at cost and $317.2 million at value at June 30, 2006, and $299.4 million at cost and $357.1 million at value at December 31, 2005. BLX is a small business lender that participates in the U.S. Small Business Administration’s 7(a) Guaranteed Loan Program. At June 30, 2006, and December 31, 2005, the Company owned 94.9% of the voting Class C equity interests. BLX has an equity appreciation rights plan for management which will dilute the value available to the Class C equity interest holders. BLX is headquartered in New York, NY.

      Total interest and related portfolio income earned from the Company’s investment in BLX for the three and six months ended June 30, 2006 and 2005, was as follows:

		For the Three				For the Six
		Months Ended				Months Ended
		June 30,				June 30,
		2006		2005		2006		2005
($ in millions)
Interest income on subordinated debt and Class A equity interests		$	4.0	$	3.5	$	7.8	$	6.9
Dividend income on Class B equity interests			—		3.0		—		5.0
Fees and other income			2.0		2.3		4.3		4.7
	Total interest and related portfolio income	$	6.0	$	8.8	$	12.1	$	16.6

      Interest income from BLX for the three and six months ended June 30, 2006 included interest income of $1.9 million and $3.7 million, respectively, which was paid in kind. Interest income from BLX for the three and six months ended June 30, 2005, included interest income of $1.7 million and $3.3 million, respectively, which was paid in kind. The interest paid in kind was paid to the Company through the issuance of additional Class A equity interests.

      Net change in unrealized appreciation or depreciation included a net decrease in unrealized appreciation on the Company’s investment in BLX of $10.9 million and $33.6 million for the three and six months ended June 30, 2006, respectively. Net change in unrealized appreciation or depreciation for the three and six months ended June 30, 2005, included a net increase in unrealized appreciation of $7.6 million and $1.3 million, respectively, on the Company’s investment in BLX.

      At December 31, 2005, the Company had a commitment to BLX of $30.0 million in the form of a subordinated revolving credit facility to provide working capital to BLX. There was $10.0 million outstanding under this facility at December 31, 2005. Outstanding borrowings under this facility were repaid in full and this facility matured on April 30, 2006.

      As a limited liability company, BLX’s taxable income flows through directly to its members. BLX’s annual taxable income generally differs from its book income for the fiscal year due to temporary and permanent differences in the recognition of income and expenses. The Company holds all of BLX’s Class A and Class B interests, and 94.9% of the Class C interests. BLX’s taxable income is first allocated to the Class A interests to the extent that dividends are paid in cash or in kind on such interests, with the remainder being allocated to the Class B and Class C interests. BLX may declare dividends on its Class B interests. If declared, BLX would determine the amount of such dividend considering its estimated annual taxable income allocable to such interests.

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      At the time of the corporate reorganization of BLX, Inc. from a C corporation to a limited liability company in 2003, for tax purposes BLX had a“built-in gain” representing the aggregate fair market value of its assets in excess of the tax basis of its assets. As a RIC, the Company will be subject to special built-in gain rules on the assets of BLX. Under these rules, taxes will be payable by the Company at the time and to the extent that the built-in gains on BLX’s assets at the date of reorganization are recognized in a taxable disposition of such assets in the10-year period following the date of the reorganization. At such time, the built-in gains realized upon the disposition of these assets will be included in the Company’s taxable income, net of the corporate level taxes paid by the Company on the built-in gains. At the date of BLX’s reorganization, the Company estimated that its future tax liability resulting from the built-in gains may total up to a maximum of $40 million. However, if these assets are disposed of after the 10-year period, there will be no corporate level taxes on these built-in gains. While the Company has no obligation to pay the built-in gains tax until these assets or its interests in BLX are disposed of in the future, it may be necessary to record a liability for these taxes in the future should the Company intend to sell the assets of or its interests in BLX within the 10-year period.

      At June 30, 2006, and December 31, 2005, the Company considered the increase in fair value of its investment in BLX due to BLX’s tax attributes as an LLC and has also considered the reduction in fair value of its investment due to these estimated built-in gain taxes in determining the fair value of its investment in BLX. At June 30, 2006, the Company estimated that thebuilt-in gain tax liability would be approximately $16 million.

      At December 31, 2005, BLX had a three-year $275.0 million revolving credit facility provided by third party lenders that was scheduled to mature in January 2007. As the controlling equity owner in BLX, the Company had provided an unconditional guaranty to the revolving credit facility lenders in an amount equal to 50% of the total obligations (consisting of principal, letters of credit issued under the facility, accrued interest, and other fees) of BLX under the revolving credit facility. The total obligation guaranteed by the Company at December 31, 2005, was $135.4 million.

      On March 17, 2006, BLX closed on a new three-year $500.0 million revolving credit facility that matures in March 2009, which replaced the existing facility. The revolving credit facility may be expanded through new or additional commitments up to $600.0 million at BLX’s option. This new facility provides for a sub-facility for the issuance of letters of credit for up to an amount equal to 25% of the committed facility. The Company has provided an unconditional guaranty to these BLX credit facility lenders in an amount equal to 50% of the total obligations (consisting of principal, letters of credit issued under the facility, accrued interest, and other fees) on this facility. The amount guaranteed by the Company at June 30, 2006, was $149.2 million. This guaranty can be called by the lenders only in the event of a default under the BLX credit facility, which includes certain defaults under the Company’s revolving credit facility. BLX has determined it was in compliance with the terms of this facility at June 30, 2006.

      At June 30, 2006, the Company had also provided four standby letters of credit totaling $32.0 million in connection with four term securitization transactions completed by BLX. In consideration for providing the revolving credit facility guaranty and the standby letters of credit, BLX paid the Company fees of $1.6 million and $1.5 million for the three months ended June 30, 2006 and 2005, respectively, and $3.1 million and $3.2 million for the six months ended June 30, 2006 and 2005, respectively.

35

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

     Advantage Sales and Marketing, Inc. In June 2004, the Company completed the purchase of a majority voting ownership in Advantage, which was subject to dilution by a management option pool. Advantage is a sales and marketing agency providing outsourced sales, merchandising, and marketing services to the consumer packaged goods industry. Advantage has offices across the United States and is headquartered in Irvine, CA.

      At December 31, 2005, the Company’s investment in Advantage totaled $257.7 million at cost and $660.4 million at value, which included unrealized appreciation of $402.7 million.

      On March 29, 2006, the Company sold its majority equity interest in Advantage. The Company was repaid its $184 million in subordinated debt outstanding and realized a gain on its equity investment sold of $433.7 million, subject to post-closing adjustments. As consideration for the common stock sold in the transaction, the Company received a $150 million subordinated note, with the balance of the consideration paid in cash. Approximately $34 million of the Company’s cash proceeds from the sale of the common stock were placed in escrow, subject to certain holdback provisions. In addition, there is potential for the Company to receive additional consideration through an earn-out payment that would be based on Advantage’s 2006 audited results. The Company’s realized gain of $433.7 million, subject topost-closing adjustments, excludes any earn-out amounts. In connection with the transaction, the Company retained an equity investment in the business valued at $15 million at closing as a minority shareholder.

      After the sale transaction, the Company’s investment in Advantage at June 30, 2006, which was composed of subordinated debt and a minority equity interest, totaled $152.1 million at cost and $165.1 million at value. This investment was included in companies 5% to 25% owned in the consolidated financial statements as the Company continues to hold a seat on Advantage’s board of directors.

      Total interest and related portfolio income earned from the Company’s investment in Advantage while the Company held a majority equity interest for the six months ended June 30, 2006 and 2005, was $14.1 million and $18.5 million, respectively.

      There was no net change in unrealized appreciation or depreciation for the three months ended June 30, 2006, related to the Company’s investment in Advantage. Net change in unrealized appreciation or depreciation for the six months ended June 30, 2006, included the reversal of $389.7 million of previously recorded unrealized appreciation associated with the realization of a gain on the sale of the Company’s majority equity interest in Advantage and for the three and six months ended June 30, 2005, included an increase in unrealized appreciation of $51.0 million and $119.9 million, respectively, related to the Company’s investment in Advantage.

     Collateralized Loan Obligations (“CLOs”) and Collateralized Debt Obligations (“CDOs”) At June 30, 2006, and December 31, 2005, the Company owned bonds and preferred shares/income

36

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

notes in collateralized loan obligations (CLOs) and a collateralized debt obligation (CDO) as follows:

		2006				2005
		Cost		Value		Cost		Value
($ in millions)
Callidus Debt Partners CDO Fund I, Ltd.		$	28.4	$	28.4	$	28.5	$	28.5
Callidus Debt Partners CLO Fund III, Ltd.			23.8		23.8		24.2		24.2
Callidus Debt Partners CLO Fund IV, Ltd.			12.9		12.9		—		—
Callidus MAPS CLO Fund I LLC			67.6		67.6		65.1		65.1
	Total	$	132.7	$	132.7	$	117.8	$	117.8

      These CLO and CDO investments are managed by Callidus Capital, a portfolio company controlled by the Company.

      The bonds, preferred shares and income notes of the CLOs and CDO in which the Company has invested are junior in priority for payment of interest and principal to the more senior notes issued by the CLOs and CDO. Cash flow from the underlying collateral assets in the CLOs and CDO is generally allocated first to the senior bonds in order of priority, then any remaining cash flow is generally distributed to the preferred shareholders and income note holders. To the extent there are defaults and unrecoverable losses on the underlying collateral assets that result in reduced cash flows, the preferred shares/income notes would bear this loss first and then the subordinated bonds would bear any loss after the preferred shares/income notes.

      At both June 30, 2006 and December 31, 2005, the face value of the CLO and CDO bonds held by the Company were subordinate to approximately 82% to 85% of the face value of the securities issued in these CLOs and CDO. At both June 30, 2006 and December 31, 2005, the face value of the CLO preferred shares/income notes held by the Company were subordinate to approximately 86% to 91% of the face value of the securities issued in these CLOs.

      At June 30, 2006, and December 31, 2005, the underlying collateral assets of these CLO and CDO investments, consisting primarily of senior debt, were issued by 413 issuers and 336 issuers, respectively, and had balances as follows:

		2006		2005
($ in millions)
Bonds		$	242.8	$	230.7
Syndicated Loans			1,304.9		704.0
Cash(1)			126.0		238.4
	Total underlying collateral assets	$	1,673.7	$	1,173.1

⁽¹⁾  Includes undrawn liability amounts.

     At June 30, 2006, and December 31, 2005, there were no delinquencies in the underlying collateral assets of the CLO and CDO issuances owned by the Company.

      The initial yields on the CLO and CDO bonds, preferred shares and income notes are based on the estimated future cash flows from the underlying collateral assets expected to be paid to these CLO and CDO classes. As each CLO and CDO bond, preferred share or income note ages, the

37

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

estimated future cash flows are updated based on the estimated performance of the underlying collateral assets, and the respective yield is adjusted as necessary. As future cash flows are subject to uncertainties and contingencies that are difficult to predict and are subject to future events that may alter current assumptions, no assurance can be given that the anticipated yields to maturity will be achieved.

     Loans and Debt Securities on Non-Accrual Status. At June 30, 2006, and December 31, 2005, private finance loans and debt securities at value not accruing interest were as follows:

			2006		2005
($ in thousands)
Loans and debt securities in workout status (classified as Grade 4 or 5)
	Companies more than 25% owned		$	17,670	$	15,622
	Companies 5% to 25% owned			3,312		—
	Companies less than 5% owned			24,598		11,417
Loans and debt securities not in workout status
	Companies more than 25% owned			40,775		58,047
	Companies 5% to 25% owned			6,595		534
	Companies less than 5% owned			3,922		49,458
		Total	$	96,872	$	135,078

     Industry and Geographic Compositions. The industry and geographic compositions of the private finance portfolio at value at June 30, 2006, and December 31, 2005, were as follows:

		2006			2005
Industry
Business services			31	%		42	%
Consumer products			24			14
Financial services			14			14
Industrial products			9			10
Consumer services			7			6
Healthcare services			3			2
Retail			2			3
Energy services			2			2
Other(1)			8			7
	Total		100	%		100	%

⁽¹⁾  Includes investments in senior debt CDO and CLO funds. These funds invest in senior debt representing a variety of industries.

38

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

Geographic Region(1)
Mid-Atlantic		34	%	29	%
Midwest		26		21
West		20		34
Southeast		16		12
Northeast		4		4
	Total	100	%	100	%

⁽¹⁾  The geographic region for the private finance portfolio depicts the location of the headquarters for the Company’s portfolio companies. The portfolio companies may have a number of other locations in other geographic regions.

Commercial Real Estate Finance

      At June 30, 2006, and December 31, 2005, the commercial real estate finance portfolio consisted of the following:

		2006						2005
		Cost		Value		Yield(1)		Cost		Value		Yield(1)
($ in thousands)
Commercial mortgage loans		$	97,154	$	96,547		8.1%	$	103,878	$	102,569		7.6%
Real estate owned			13,090		14,553				14,240		13,932
Equity interests			17,504		21,951				13,577		10,564
	Total	$	127,748	$	133,051			$	131,695	$	127,065

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

    Commercial Mortgage Loans and Equity Interests.The commercial mortgage loan portfolio contains loans that were originated by the Company or were purchased from third-party sellers. At both June 30, 2006, and December 31, 2005, approximately 97% and 3% of the Company’s commercial mortgage loan portfolio was composed of fixed and adjustable interest rate loans, respectively. At June 30, 2006, and December 31, 2005, loans with a value of $15.7 million and $20.8 million, respectively, were not accruing interest. Loans greater than 120 days delinquent generally do not accrue interest.

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

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      The property types and the geographic composition securing the commercial mortgage loans and equity interests at value at June 30, 2006, and December 31, 2005, were as follows:

		2006			2005
Property Type
Hospitality			36	%		37	%
Housing			27			30
Office			18			11
Retail			15			16
Other			4			6
	Total		100	%		100	%
Geographic Region
Mid-Atlantic			33	%		31	%
Southeast			30			25
West			16			18
Midwest			15			21
Northeast			6			5
	Total		100	%		100	%

Note 4. Debt

      At June 30, 2006, and December 31, 2005, the Company had the following debt:

			2006							2005
							Annual								Annual
			Facility		Amount		Interest			Facility			Amount		Interest
			Amount		Drawn		Cost(1)			Amount			Drawn		Cost(1)
($ in thousands)
Notes payable and debentures:
	Unsecured notes payable		$	1,190,637	$	1,190,637		6.2	%	$	1,164,540		$	1,164,540		6.2	%
	SBA debentures			16,500		16,500		7.4	%		28,500			28,500		7.5	%
												��
		Total notes payable and debentures		1,207,137		1,207,137		6.2	%		1,193,040			1,193,040		6.3	%
Revolving line of credit				922,500		1,750		6.4	%(2)		772,500			91,750		5.6	%(2)
	Total debt		$	2,129,637	$	1,208,887		6.6	%(3)	$	1,965,540		$	1,284,790		6.5	%(3)

(1)	The weighted average annual interest cost is computed as the (a) annual stated interest on the debt plus the annual amortization of commitment fees, other facility fees and amortization of debt financing costs that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.
(2)	The annual interest cost reflects the interest rate payable for borrowings under the revolving line of credit. In addition to the current interest rate payable, there were annual costs of commitment fees, other facility fees and amortization of debt financing costs of $3.8 million and $3.3 million at June 30, 2006, and December 31, 2005, respectively.
(3)	The annual interest cost for total debt includes the annual cost of commitment fees, other facility fees and amortization of debt financing costs on the revolving line of credit regardless of the amount outstanding on the facility as of the balance sheet date.

40

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued

  Notes Payable and Debentures

     Unsecured Notes Payable. The Company has issued unsecured long-term notes to institutional investors. The notes require semi-annual interest payments until maturity and have original terms of five or seven years. At June 30, 2006, the notes had maturities from October 2006 to May 2013. The notes may be prepaid in whole or in part, together with an interest premium, as stipulated in the note agreement.

      On May 1, 2006, the Company issued $50 million of seven-year, unsecured notes with a fixed interest rate of 6.75%. This debt matures in May 2013. The proceeds from the issuance of the notes were used to repay $25 million of 7.49% unsecured long-term notes that matured on May 1, 2006, with the remainder being used to fund new portfolio investments and for general corporate purposes.

      On July 25, 2006, the Company completed a public issuance of $400 million of five-year, unsecured notes with a fixed interest rate of 6.625%. This debt matures on July 15, 2011. The Company has the option to redeem these notes in whole or in part, together with a redemption premium, as stipulated in the notes. The Company has certain financial and operating covenants that will be required by this public debt issuance, including that the Company will maintain a minimum ratio of 200% of total assets to total borrowings, as required by the Investment Company Act of 1940, as amended, while these notes are outstanding.

     SBA Debentures. At June 30, 2006, and December 31, 2005, the Company had debentures payable to the SBA with original terms of ten years and at fixed interest rates ranging from 5.9% to 6.3% and 5.9% to 6.4%, respectively. At June 30, 2006, the debentures had remaining maturities of five to six years. The debentures require semi-annual interest-only payments with all principal due upon maturity. The SBA debentures are subject to prepayment penalties if paid prior to the fifth anniversary date of the notes. During the first half of 2006 and 2005, the Company repaid $12.0 million and $31.0 million, respectively, of the SBA debentures.

     Scheduled Maturities. Scheduled future maturities of notes payable and debentures at June 30, 2006, were as follows:

Year		Amount Maturing
		($ in thousands)
2006		$	150,000
2007			—
2008			153,000
2009			268,137
2010			408,000
Thereafter			228,000
	Total	$	1,207,137

Revolving Line of Credit

      At December 31, 2005, the Company had an unsecured revolving line of credit with a committed amount of $772.5 million that expires on September 30, 2008. In May 2006, the Company expanded the committed amount to $922.5 million. The revolving line of credit is now fully

41

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued

committed. At the Company’s option, borrowings under the revolving line of credit generally bear interest at a rate equal to (i) LIBOR (for the period the Company selects) plus 1.05% or (ii) the higher of the Federal Funds rate plus 0.50% or the Bank of America, N.A. prime rate. The revolving line of credit requires the payment of an annual commitment fee equal to 0.20% of the committed amount (whether used or unused). The revolving line of credit generally requires payments of interest at the end of each LIBOR interest period, but no less frequently than quarterly, on LIBOR based loans and monthly payments of interest on other loans. All principal is due upon maturity.

      The annual cost of commitment fees, other facility fees and amortization of debt financing costs was $3.8 million and $3.3 million at June 30, 2006 and December 31, 2005, respectively.

      The revolving credit facility provides for a sub-facility for the issuance of letters of credit for up to an amount equal to 16.66% of the committed facility or $153.7 million. The letter of credit fee is 1.05% per annum on letters of credit issued, which is payable quarterly.

      The average debt outstanding on the revolving line of credit was $201.7 million and $64.4 million for the six months ended June 30, 2006 and 2005, respectively. The maximum amount borrowed under this facility and the weighted average stated interest rate for the six months ended June 30, 2006 and 2005, were $540.3 million and 6.0%, respectively, and $263.3 million and 4.4%, respectively. As of June 30, 2006, the amount available under the revolving line of credit was $882.5 million, net of amounts committed for standby letters of credit of $38.3 million issued under the credit facility.

Covenant Compliance

      The Company has various financial and operating covenants required by the notes payable and debentures and the revolving line of credit outstanding at June 30, 2006. These covenants require the Company to maintain certain financial ratios, including debt to equity and interest coverage, and a minimum net worth. These credit facilities provide for customary events of default, including, but not limited to, payment defaults, breach of representations or covenants, cross-defaults, bankruptcy events, failure to pay judgments, attachment of our assets, change of control and the issuance of an order of dissolution. Certain of these events of default are subject to notice and cure periods or materiality thresholds. The Company’s credit facilities limit its ability to declare dividends if the Company defaults under certain provisions. As of June 30, 2006, and December 31, 2005, the Company was in compliance with these covenants.

Note 5. Guarantees and Commitments

      In the ordinary course of business, the Company has issued guarantees and has extended standby letters of credit through financial intermediaries on behalf of certain portfolio companies. All standby letters of credit have been issued through Bank of America, N.A. As of June 30, 2006, and December 31, 2005, the Company had issued guarantees of debt, rental obligations, and lease obligations aggregating $163.3 million and $148.6 million, respectively, and had extended standby letters of credit aggregating $38.3 million and $37.1 million, respectively. Under these arrangements, the Company would be required to make payments to third-party beneficiaries if the portfolio companies were to default on their related payment obligations. The maximum amount of potential future payments was $201.6 million and $185.7 million at June 30, 2006, and December 31, 2005, respectively. At June 30, 2006, and December 31, 2005, $2.6 million and $2.5 million, respectively,

42

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 5. Guarantees, continued

had been recorded as a liability for the Company’s guarantees and no amounts had been recorded as a liability for the Company’s standby letters of credit.

      As of June 30, 2006, the guarantees and standby letters of credit expire as follows:

		Total		2006		2007		2008		2009		2010		After 2010
(in millions)
Guarantees		$	163.3	$	2.5	$	0.7	$	3.0	$	151.6	$	—	$	5.5
Standby letters of credit(1)			38.3		0.1		—		38.2		—		—		—
	Total	$	201.6	$	2.6	$	0.7	$	41.2	$	151.6	$	—	$	5.5

⁽¹⁾  Standby letters of credit are issued under the Company’s revolving line of credit that expires in September 2008. Therefore, unless a standby letter of credit is set to expire at an earlier date, it is assumed that the standby letters of credit will expire contemporaneously with the expiration of the Company’s line of credit in September 2008.

     In the ordinary course of business, the Company enters into agreements with service providers and other parties that may contain provisions for the Company to indemnify such parties under certain circumstances.

      At June 30, 2006, the Company had outstanding commitments to fund investments totaling $362.1 million, including $352.7 million related to private finance investments and $9.4 million related to commercial real estate finance investments. In addition, during the fourth quarter of 2004 and the first quarter of 2005, the Company sold certain commercial mortgage loans that the Company may be required to repurchase under certain circumstances. These recourse provisions expire by April 2007. The aggregate outstanding principal balance of these sold loans was $11.2 million at June 30, 2006.

Note 6. Shareholders’ Equity

      Sales of common stock for the six months ended June 30, 2006 and 2005, were as follows:

		2006		2005(1)
(in thousands)
Number of common shares			3,000		—
Gross proceeds		$	87,750	$	—
Less costs, including underwriting fees			4,780		—
	Net proceeds	$	82,970	$	—

⁽¹⁾  The Company did not sell any common stock during the six months ended June 30, 2005.

     On July 24, 2006, the Company sold 4.5 million shares of its common stock for proceeds of $118.1 million, net of underwriting discounts and estimated offering expenses. On August 1, 2006, the Company completed the sale of 0.7 million shares of common stock pursuant to the underwriter’s over-allotment option for net proceeds, after the underwriting discount and estimated offering expenses, of $17.8 million.

      The Company issued 0.3 million shares of common stock with a value of $7.2 million as consideration for an additional investment in Mercury Air Centers, Inc. during the six months ended June 30, 2005.

43

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 6. Shareholders’ Equity, continued

      The Company issued 0.4 million and 0.6 million shares of common stock upon the exercise of stock options during the six months ended June 30, 2006 and 2005, respectively.

      The Company has a dividend reinvestment plan, whereby the Company may buy shares of its common stock in the open market or issue new shares in order to satisfy dividend reinvestment requests. If the Company issues new shares, the issue price is equal to the average of the closing sale prices reported for the Company’s common stock for the five consecutive trading days immediately prior to the dividend payment date. For the six months ended June 30, 2006 and 2005, the Company issued new shares in order to satisfy dividend reinvestment requests.

      Dividend reinvestment plan activity for the six months ended June 30, 2006 and 2005, was as follows:

	For the Six Months
	Ended June 30,
	2006		2005
(in thousands, except per share amounts)
Shares issued		243		151
Average price per share	$	29.63	$	27.58

Note 7. Earnings Per Common Share

      Earnings per common share for the three and six months ended June 30, 2006 and 2005, were as follows:

	For the Three Months				For the Six Months
	Ended June 30,				Ended June 30,
	2006		2005		2006		2005
(in thousands, except per share amounts)
Net increase in net assets resulting from operations available to common shareholders	$	33,729	$	311,885	$	133,316	$	431,506
Weighted average common shares outstanding — basic		140,024		133,701		139,395		133,493
Dilutive options outstanding		3,189		2,680		3,071		2,489
Weighted average common shares outstanding — diluted		143,213		136,381		142,466		135,982
Basic earnings per common share	$	0.24	$	2.33	$	0.96	$	3.23
Diluted earnings per common share	$	0.24	$	2.29	$	0.94	$	3.17

Note 8. Employee Compensation Plans

      The Company has a deferred compensation plan. Amounts deferred by participants under the deferred compensation plan are funded to a trust, which is administered by trustees. The accounts of the deferred compensation trust are consolidated with the Company’s accounts. The assets of the

44

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 8. Employee Compensation Plans, continued

trust are classified as other assets and the liability to the plan participants is included in other liabilities in the accompanying financial statements. The deferred compensation plan accounts at June 30, 2006, and December 31, 2005, totaled $17.1 million and $16.6 million, respectively.

      The Company has an Individual Performance Award (“IPA”) plan, which was established as a long-term incentive compensation program for certain officers. In conjunction with the program, the Board of Directors has approved a non-qualified deferred compensation plan (“DCP II”), which is administered through a trust by a third-party trustee. The administrator of the DCP II is the Compensation Committee of the Company’s Board of Directors (“DCP II Administrator”).

      The IPA is generally determined annually at the beginning of each year but may be adjusted throughout the year. The IPA is deposited in the trust in four equal installments, generally on a quarterly basis, in the form of cash. The Compensation Committee of the Board of Directors designed the DCP II to require the trustee to use the cash to purchase shares of the Company’s common stock in the open market. During both the six months ended June 30, 2006 and 2005, 0.2 million shares were purchased in the DCP II.

      All amounts deposited and then credited to a participant’s account in the trust, based on the amount of the IPA received by such participant, are credited solely for purposes of accounting and computation and remain assets of the Company and subject to the claims of the Company’s general creditors. Amounts credited to participants under the DCP II are immediately vested and generally non-forfeitable once deposited by the Company into the trust. A participant’s account shall generally become distributable only after his or her termination of employment, or in the event of a change of control of the Company. Upon the participant’s termination of employment, one-third of the participant’s account will be immediately distributed in accordance with the plan, one-half of the then current remaining balance will be distributed on the first anniversary of his or her employment termination date and the remainder of the account balance will be distributed on the second anniversary of the employment termination date. Distributions are subject to the participant’s adherence to certain non-solicitation requirements. All DCP II accounts will be distributed in a single lump sum in the event of a change of control of the Company. To the extent that a participant has an employment agreement, such participant’s DCP II account will be fully distributed in the event that such participant’s employment is terminated for good reason as defined under that participant’s employment agreement. Sixty days following a distributable event, the Company and each participant may, at the discretion of the Company and subject to the Company’s trading window during that time, redirect the participant’s account to other investment options.

      During any period of time in which a participant has an account in the DCP II, any dividends declared and paid on shares of the Company’s common stock allocated to the participant’s account shall be reinvested by the trustee as soon as practicable in shares of the Company’s common stock purchased in the open market.

      The IPA amounts are contributed into the DCP II trust and invested in the Company’s common stock. The accounts of the DCP II are consolidated with the Company’s accounts. The common stock is classified as common stock held in deferred compensation trust in the accompanying financial statements and the deferred compensation obligation, which represents the amount owed to the employees, is included in other liabilities. Changes in the value of the Company’s common stock held in the deferred compensation trust are not recognized. However, the liability is marked to market

45

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 8. Employee Compensation Plans, continued

with a corresponding charge or credit to employee compensation expense. At June 30, 2006, and December 31, 2005, common stock held in DCP II was $24.0 million and $19.5 million, respectively, and the IPA liability was $26.4 million and $22.3 million, respectively. At June 30, 2006, and December 31, 2005, the DCP II held 0.9 million and 0.7 million shares, respectively, of the Company’s common stock.

      The IPA expenses for the three and six months ended June 30, 2006 and 2005, were as follows:

		For the Three					For the Six
		Months Ended					Months Ended
		June 30,					June 30,
		2006			2005		2006			2005
($ in millions)
IPA contributions		$	2.1		$	1.9	$	3.8		$	3.8
IPA mark to market expense (benefit)			(1.5	)		1.8		(0.6	)		1.9
	Total IPA expense	$	0.6		$	3.7	$	3.2		$	5.7

      The Company also has an individual performance bonus (“IPB”) plan which is distributed in cash to award recipients in equalbi-weekly installments as long as the recipient remains employed by the Company. If a recipient terminated employment during the year, any remaining cash payments under the IPB would be forfeited. For the three months ended June 30, 2006 and 2005, the IPB expense was $2.2 million and $2.0 million, respectively. For both the six months ended June 30, 2006 and 2005, the IPB expense was $3.6 million. The IPA and IPB expenses are included in employee expenses.

Note 9. Stock Option Plan

      The purpose of the stock option plan (“Option Plan”) is to provide officers and non-officer directors of the Company with additional incentives. Options are exercisable at a price equal to the fair market value of the shares on the day the option is granted. Each option states the period or periods of time within which the option may be exercised by the optionee, which may not exceed ten years from the date the option is granted. The options granted generally vest ratably over a three-to five-year period. Options granted tonon-officer directors vest on the grant date.

      All rights to exercise options terminate 60 days after an optionee ceases to be (i) a non-officer director, (ii) both an officer and a director, if such optionee serves in both capacities, or (iii) an officer (if such officer is not also a director) of the Company for any cause other than death or total and permanent disability. In the event of a change of control of the Company, all outstanding options will become fully vested and exercisable as of the change of control.

      There are 32.2 million shares authorized under the Option Plan. At June 30, 2006, and December 31, 2005, the number of shares available to be granted under the Option Plan was 1.8 million and 3.0 million, respectively.

46

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 9. Stock Option Plan, continued

      Information with respect to options granted, exercised and forfeited under the Option Plan for the six months ended June 30, 2006, was as follows:

				Weighted		Weighted
				Average		Average		Aggregate
				Exercise		Contractual		Intrinsic Value
				Price Per		Remaining		at June 30,
	Shares			Share		Term (Years)		2006(1)
(in thousands, except per share amounts)
Options outstanding at January 1, 2006		22,259		$	24.52
Granted		1,505		$	29.75
Exercised		(373	)	$	22.09
Forfeited		(277	)	$	27.68
Outstanding at June 30, 2006		23,114		$	24.86		6.78	$	92,792
Exercisable at June 30, 2006		16,848		$	23.71		6.11	$	86,399
Exercisable and expected to be exercisable at June 30, 2006(2)		22,442		$	24.77		6.73	$	92,101

(1)	Represents the difference between the market value of the options at June 30, 2006, and the cost for the option holders to exercise the options.
(2)	The amount of options expected to be exercisable at June 30, 2006, is calculated based on an estimate of expected forfeitures.

     The fair value of the shares vested during the six months ended June 30, 2006 and 2005, was $16.1 million for both periods. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005, was $2.9 million and $4.1 million, respectively.

Note 10. Dividends and Distributions and Taxes

      The Company’s Board of Directors declared and the Company paid a dividend of $0.59 and $0.60 per common share for the first and second quarters of 2006, respectively, and $0.57 per common share for each of the first and second quarters of 2005. These dividends totaled $166.6 million and $152.3 million for the six months ended June 30, 2006 and 2005, respectively. The Company declared an extra cash dividend of $0.03 per share during 2005 and this was paid to shareholders on January 27, 2006.

      The Company’s Board of Directors also declared a dividend of $0.61 per common share for the third quarter of 2006.

      The Company will generally be required to pay a nondeductible excise tax equal to 4% of the amount by which 98% of the Company’s annual taxable income exceeds the distributions for the year. The Company currently estimates that its 2006 annual taxable income will be in excess of its dividend distributions from such taxable income in 2006, and that such estimated excess taxable income will be carried over for distribution in 2007. The Company accrues an excise tax on the estimated excess taxable income earned for the respective periods. For the three and six months ended June 30, 2006, the Company accrued an excise tax of $3.2 million and $11.6 million, respectively. There was no excise tax accrual for the three months ended March 31, 2005, and the Company accrued an excise tax of $4.0 million for the three months ended June 30, 2005.

47

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 11. Supplemental Disclosure of Cash Flow Information

      For the six months ended June 30, 2006 and 2005, the Company paid $46.0 million and $40.1 million, respectively, for interest.

      Principal collections related to investment repayments or sales included the collection of discounts previously amortized into interest income and added to the cost basis of a loan or debt security totaling $0.2 million and $7.6 million for the six months ended June 30, 2006 and 2005, respectively.

      Non-cash operating activities for the six months ended June 30, 2006, included the following:

•  a note received as consideration from the sale of the Company’s equity investment in Advantage of $150.0 million;

•  a note received as consideration from the sale of the Company’s equity investment in STS Operating, Inc. of $30.0 million;

•  the exchange of existing debt securities and accrued interest of S.B. Restaurant Company with a cost basis of $29.2 million for new debt securities; and

•  the exchange of existing preferred stock and common stock of Redox Brands, Inc. with a cost basis of $10.2 million for common stock in CR Brands, Inc.

      Non-cash operating activities for the six months ended June 30, 2005, included the following:

•  the exchange of existing subordinated debt securities and accrued interest of BLX with a cost basis of $44.8 million for additional Class B equity interests;

•  the exchange of debt securities and accrued interest of Coverall North America, Inc. with a cost basis of $24.2 million for new debt securities and warrants with a total cost basis of $26.8 million;

•  the exchange of debt securities of Garden Ridge Corporation with a cost basis of $25.0 million for a new loan with a cost basis of $22.5 million; and

•  the contribution to capital of existing debt securities of GAC Investments, Inc. (GAC) with a cost basis of $11.0 million, resulting in a decrease in the Company’s debt cost basis and an increase in the Company’s common stock cost basis in GAC. During the third quarter of 2005, GAC changed its name to Triview Investments, Inc.

      For the six months ended June 30, 2006 and 2005, the Company’s non-cash financing activities included $7.2 million and $4.2 million, respectively, related to the issuance of common stock in lieu of cash distributions. In addition, the non-cash financing activities for the six months ended June 30, 2005, also included the issuance of $7.2 million of the Company’s common stock as consideration for an additional investment in Mercury Air Centers, Inc.

Note 12. Hedging Activities

      The Company has invested in commercial mortgage loans that were purchased at prices that were based in part on comparable Treasury rates. The Company has entered into transactions with one or more financial institutions to hedge against movement in Treasury rates on certain of these

48

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 12. Hedging Activities, continued

commercial mortgage loans. These transactions, referred to as short sales, involve the Company receiving the proceeds from the short sales of borrowed Treasury securities, with the obligation to replenish the borrowed Treasury securities at a later date based on the then current market price. Borrowed Treasury securities and the related obligations to replenish the borrowed Treasury securities at value, including accrued interest payable on the obligations, as of June 30, 2006, and December 31, 2005, consisted of the following:

($ in thousands)
Description of Issue	2006		2005
5-year Treasury securities, due April 2010	$	17,156	$	17,666

      As of June 30, 2006, and December 31, 2005, the total obligations to replenish borrowed Treasury securities had decreased since the related original sale dates due to changes in the yield on the borrowed Treasury securities, resulting in unrealized appreciation on the obligations of $0.9 million and $0.4 million, respectively.

      The net proceeds related to the sales of the borrowed Treasury securities were $17.9 million at both June 30, 2006, and December 31, 2005. Under the terms of the transactions, the Company had received cash payments of $0.7 million and $0.2 million at June 30, 2006, and December 31, 2005, respectively, for the difference between the net proceeds related to the sales of the borrowed Treasury securities and the obligations to replenish the securities.

      The Company has deposited the proceeds related to the sales of the borrowed Treasury securities and the additional cash collateral with Wachovia Capital Markets, LLC under repurchase agreements. The repurchase agreements are collateralized by U.S. Treasury securities and are settled weekly. As of June 30, 2006, the repurchase agreements were due on July 5, 2006, and had an interest rate of 4.6%. The interest rate on the repurchase agreements as of December 31, 2005, was 3.3%.

49

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 13. Financial Highlights

		At and for the
		Six Months Ended						At and for the
		June 30,						Year Ended
								December 31,
		2006(1)			2005			2005
Per Common Share Data
Net asset value, beginning of period		$	19.17		$	14.87		$	14.87
	Net investment income(2)		0.64			0.40			1.00
	Net realized gains(2)(3)		3.74			1.60			1.99
	Net investment income plus net realized gains(2)		4.38			2.00			2.99
	Net change in unrealized appreciation or depreciation(2)(3)		(3.44	)		1.17			3.37
Net increase in net assets resulting from operations(2)			0.94			3.17			6.36
Net decrease in net assets from shareholder distributions			(1.19	)		(1.14	)		(2.33	)
Net increase in net assets from capital share transactions(2)			0.25			0.11			0.27
Net asset value, end of period		$	19.17		$	17.01		$	19.17
Market value, end of period		$	28.77		$	29.11		$	29.37
Total return(4)			1.9	%		17.4	%		23.5	%
Ratios and Supplemental Data ($ and shares in thousands, except per share amounts)
Ending net assets		$	2,690,019		$	2,281,287		$	2,620,546
Common shares outstanding at end of period			140,312			134,131			136,697
Diluted weighted average common shares outstanding			142,466			135,982			137,274
Employee, stock option and administrative expenses/average net assets			2.66	%		3.91	%		6.58	%
Total operating expenses/average net assets			4.38	%		5.79	%		9.99	%
Net investment income/average net assets			3.41	%		2.57	%		6.08	%
Net increase in net assets resulting from operations/ average net assets			4.97	%		20.57	%		38.68	%
Portfolio turnover rate			21.20	%		21.76	%		47.72	%
Average debt outstanding		$	1,395,791		$	1,097,851		$	1,087,118
Average debt per share(2)		$	9.80		$	8.07		$	7.92

(1)	The results for the six months ended June 30, 2006, are not necessarily indicative of the operating results to be expected for the full year.
(2)	Based on diluted weighted average number of common shares outstanding for the period.
(3)	Net realized gains and net change in unrealized appreciation or depreciation can fluctuate significantly from period to period. As a result, quarterly comparisons may not be meaningful.
(4)	Total return assumes the reinvestment of all dividends paid for the periods presented.

Note 14. Litigation

      On June 23, 2004, the Company was notified by the SEC that the SEC is conducting an informal investigation of the Company. On December 22, 2004, the Company received letters from the U.S. Attorney for the District of Columbia requesting the preservation and production of information regarding the Company and Business Loan Express, LLC in connection with a criminal investigation. Based on the information available to the Company at this time, the inquiries appear to

50

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 14. Litigation, continued

primarily pertain to matters related to portfolio valuation and the Company’s portfolio company, Business Loan Express, LLC. To date, the Company has produced materials in response to requests from both the SEC and the U.S. Attorney’s office, and certain current and former employees have provided testimony and have been interviewed by the staff of the SEC and the U.S. Attorney’s Office. The Company is voluntarily cooperating with these investigations.

      In addition, the Company is party to certain 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 the outcome of these proceedings will have a material effect upon the Company’s financial condition or results of operations.

51

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Allied Capital Corporation:

      We have reviewed the accompanying consolidated balance sheet of Allied Capital Corporation and subsidiaries, including the consolidated statement of investments, as of June 30, 2006, the related consolidated statements of operations for the three- and six-month periods ended June 30, 2006 and 2005, and the consolidated statement of changes in net assets and cash flows and the financial highlights (included in Note 13) for the six-month periods ended June 30, 2006 and 2005. These consolidated financial statements and financial highlights are the responsibility of the Company’s management.

      We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

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

      We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Allied Capital Corporation and subsidiaries, including the consolidated statement of investments, as of December 31, 2005, and the related consolidated statements of operations, changes in net assets and cash flows (not presented herein), and the financial highlights, for the year then ended; and in our report dated March 9, 2006, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2005, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Washington, D.C.

August 9, 2006

52

Schedule 12-14

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

SCHEDULE OF INVESTMENTS IN AND ADVANCES TO AFFILIATES

			Amount of Interest or
			Dividends
PRIVATE FINANCE
Portfolio Company			Credited					December 31, 2005		Gross		Gross			June 30, 2006
(in thousands)		Investment(1)	to Income(6)			Other(2)		Value		Additions(3)		Reductions(4)			Value
Companies More Than 25% Owned
Acme Paging, L.P.		Senior Loan(5)						$	—	$	—	$	—		$	—
	(Telecommunications)	Subordinated Debt(5)							—		—		—			—
		Common Stock							—		—		—			—
Advantage Sales &		Subordinated Debt	$	1,712					59,787		213		(60,000	)		—
	Marketing, Inc.(7)	Subordinated Debt		5,555					124,000		374		(124,374	)		—
	(Business Services)	Common Stock							476,578		—		(476,578	)		—
Alaris Consulting, LLC		Senior Loan(5)		(32	)				—		32		(32	)		—
	(Business Services)	Equity Interests							—		—		—			—
American Healthcare Services,   Inc. and Affiliates		Senior Loan(5)				$	1		4,097		328		(96	)		4,329
	(Healthcare Services)
Avborne, Inc.		Preferred Stock							892		—		(119	)		773
	(Business Services)	Common Stock							—		—		—			—
Avborne Heavy Maintenance,   Inc.		Preferred Stock							—		—		—			—
	(Business Services)	Common Stock							—		—		—			—
Business Loan Express, LLC		Subordinated Debt		38					10,000		15,000		(25,000	)		—
	(Financial Services)	Class A Equity
		Interests		7,807					60,693		3,734		—			64,427
		Class B Equity Interests							146,910		—		(16,020	)		130,890
		Class C Equity Interests							139,521		—		(17,621	)		121,900
Callidus Capital Corporation		Senior Loan		399					600		8,705		(7,655	)		1,650
	(Financial Services)	Subordinated Debt		464					4,832		444		—			5,276
		Common Stock							7,968		4,125		—			12,093
Cambridge Capital Partners		Senior Debt(5)							—		250		—			250
	(Financial Services)	Equity Interests							—		1,751		—			1,751
CR Brands, Inc.		Senior Loan		1,109					—		37,219		(37,219	)		—
	(Consumer Products)	Subordinated Debt		2,344					—		38,712		—			38,712
		Common Stock							—		37,431		—			37,431
Diversified Group		Preferred Stock		33					728		14		(14	)		728
	Administrators, Inc.	Preferred Stock							841		—		—			841
	(Business Services)	Common Stock		68					502		69		(249	)		322
Financial Pacific Company		Subordinated Debt		6,176					69,904		726		—			70,630
	(Financial Services)	Preferred Stock							13,116		1,344		—			14,460
		Common Stock							44,180		749		(511	)		44,418
ForeSite Towers, LLC		Equity Interests		161					9,750		3,068		—			12,818
	(Tower Leasing)
Global Communications, LLC		Senior Loan(5)							15,957		—		—			15,957
	(Business Services)	Subordinated Debt(5)							11,198		138		(1,688	)		9,648
		Preferred Equity
		Interest							4,303		—		(4,303	)		—
		Options							—		—		—			—
Gordian Group, Inc.		Senior Loan(5)		(10	)				4,161		400		(4,561	)		—
	(Business Services)	Common Stock							—		220		(220	)		—
Healthy Pet Corp.		Senior Loan		772					4,086		12,652		(800	)		15,938
	(Consumer Services)	Subordinated Debt		3,258					38,535		4,776		(186	)		43,125
		Common Stock							25,766		5,174		(2,788	)		28,152
HMT, Inc.		Preferred Stock							2,637		—		—			2,637
	(Energy Services)	Common Stock							5,343		2,599		—			7,942
		Warrants							2,057		1,001		—			3,058
Impact Innovations Group, LLC		Equity Interests in
	(Business Services)	Affiliate							742		128		—			870

See related footnotes at the end of this schedule.

53

			Amount of Interest or
			Dividends
PRIVATE FINANCE
Portfolio Company			Credited				December 31, 2005		Gross		Gross			June 30, 2006
(in thousands)		Investment(1)	to Income(6)		Other(2)		Value		Additions(3)		Reductions(4)			Value
Insight Pharmaceuticals		Subordinated Debt	$	4,790			$	58,298	$	769	$	—		$	59,067
	Corporation	Preferred Stock						26,791		1,473		(2,015	)		26,249
	(Consumer Products)	Common Stock						236		218		(236	)		218
Jakel, Inc.		Subordinated Debt(5)						—		2,533		—			2,533
	(Industrial Products)	Preferred Stock						—		—		—			—
		Common Stock						—		—		—			—
Legacy Partners Group, LLC		Senior Loan (5)						5,029		93		(74	)		5,048
	(Financial Services)	Subordinated Debt(5)						—		—		—			—
		Equity Interests						—		18		(18	)		—
Litterer Beteiligungs-GmbH		Subordinated Debt		21				621		37		—			658
	(Business Services)	Equity Interest						2,226		763		(1,374	)		1,615
Mercury Air Centers, Inc.		Senior Loan		1,231				31,720		4,000		(35,720	)		—
	(Business Services)	Subordinated Debt		4,028				46,519		4,679		(3,000	)		48,198
		Common Stock						88,898		4,702		(412	)		93,188
MVL Group, Inc.		Senior Loan		1,742				27,218		79		(973	)		26,324
	(Business Services)	Subordinated Debt		2,506				32,417		1,504		—			33,921
		Common Stock						3,211		—		(1,949	)		1,262
Pennsylvania Avenue		Equity Interests						1,864		1,193		(3,057	)		—
	Investors, L.P.
	(Private Equity Fund)
Powell Plant Farms, Inc.		Senior Loan		2,390				23,792		6,075		(8,225	)		21,642
	(Consumer Products)	Subordinated Debt(5)						7,364		1,093		(8,457	)		—
		Preferred Stock						—		—		—			—
		Warrants						—		—		—			—
Redox Brands, Inc.		Preferred Stock		363				12,097		1,708		(13,805	)		—
	(Consumer Products)	Warrants						500		84		(584	)		—
Service Champ, Inc.		Subordinated Debt		2,138				26,906		354		—			27,260
	(Business Services)	Common Stock						13,319		3,003		—			16,322
Staffing Partners Holding		Subordinated Debt(5)			$	355		6,343		—		(5,183	)		1,160
	Company, Inc.	Preferred Stock						1,812		—		(1,812	)		—
	(Business Services)	Common Stock						—		—		—			—
		Warrants						—		—		—			—
Startec Global Communications
	Corporation	Senior Loan		1,197				21,685		3,540		(3,299	)		21,926
	(Telecommunications)	Common Stock						—		6,480		—			6,480
STS Operating, Inc.		Subordinated Debt		328				6,593		123		(6,716	)		—
	(Industrial Products)	Common Stock						64,963		32,039		(97,002	)		—
		Options						560		292		(852	)		—
Triview Investments, Inc.		Senior Loan		587				7,449		6,852		—			14,301
	(Broadcasting & Cable/	Subordinated Debt		2,390				30,845		6,842		—			37,687
	Consumer Products)	Subordinated Debt(5)						19,520		—		—			19,520
		Common Stock						29,171		5,011		(1,656	)		32,526
Total companies more than 25% owned			$	53,565			$	1,887,651						$	1,188,131
Companies 5% to 25% Owned
Advantage Sales &		Subordinated Debt	$	4,732				—	$	150,056	$	—		$	150,056
	Marketing, Inc.(7)	Equity Interests						—		15,000		—			15,000
	(Business Services)
Air Medical Group Holdings LLC		Senior Loan		714				—		1,512		—			1,512
	(Healthcare Services)	Subordinated Debt		2,145				42,267		34,950		(42,627	)		34,590
		Equity Interests		1,694				4,025		2,372		(2,197	)		4,200
Amerex Group, LLC		Subordinated Debt		154				—		8,400		—			8,400
	(Consumer Products)	Equity Interests						—		3,583		—			3,583
Aspen Pet Products, Inc.		Subordinated Debt		1,130				19,959		399		(20,358	)		—
	(Consumer Products)	Preferred Stock		29				1,638		516		(2,154	)		—
		Common Stock						17		123		(140	)		—
		Warrants						—		—		—			—
BB&T Capital		Equity Interests						—		5,867		—			5,867
	Partners/Windsor
	Mezzanine Fund, LLC
	(Private Equity Fund)
Becker Underwood, Inc.		Subordinated Debt		1,747				23,543		307		—			23,850
	(Industrial Products)	Common Stock						2,200		900		(700	)		2,400

See related footnotes at the end of this schedule.

54

			Amount of Interest or
			Dividends
PRIVATE FINANCE
Portfolio Company			Credited				December 31, 2005		Gross		Gross			June 30, 2006
(in thousands)		Investment(1)	to Income(6)		Other(2)		Value		Additions(3)		Reductions(4)			Value
wBI Incorporated		Senior Loan	$	125			$	—	$	15,000	$	(15,000	)	$	—
	(Business Services)	Subordinated Debt		1,390				—		29,856		—			29,856
		Common Stock						—		4,000		—			4,000
The Debt Exchange Inc.		Preferred Stock						3,219		—		(3,219	)		—
	(Business Services)
MedBridge Healthcare, LLC		Senior Loan(5)						7,093		1,512		(2,010	)		6,595
	(Healthcare Services)	Subordinated Debt(5)						534		1,364		(1,898	)		—
		Convertible
		Subordinated Debt(5)						—		—		—			—
		Equity Interests						—		501		(501	)		—
Nexcel Synthetics, LLC		Subordinated Debt		788				10,588		193		—			10,781
	(Consumer Products)	Equity Interests						1,367		363		—			1,730
Pres Air Trol LLC		Unitranche Debt(5)			$	184		5,820		10		(2,518	)		3,312
	(Industrial Products)	Equity Interests						318		11		(329	)		—
Progressive International
	Corporation	Subordinated Debt		603				7,376		78		—			7,454
	(Consumer Products)	Preferred Stock						884		36		—			920
		Common Stock						13		487		—			500
		Warrants						—		—		—			—
Regency Healthcare Group, LLC		Senior Loan						—		980		—			980
	(Healthcare Services)	Unitranche Debt						—		19,900		—			19,900
		Equity Interests						—		1,500		—			1,500
SGT India Private Limited		Common Stock						—		3,608		—			3,608
	(Business Services)
wSoteria Imaging Services, LLC		Subordinated Debt		959				13,447		2,058		—			15,505
	(Healthcare Services)	Equity Interests						2,308		92		—			2,400
Universal Environmental
	Services, LLC	Unitranche Debt		859				10,862		94		—			10,956
	(Business Services)	Equity Interests						1,328		651		(278	)		1,701
Total companies 5% to 25% owned			$	17,069			$	158,806						$	371,156

This schedule should be read in conjunction with the Company’s consolidated financial statements, including the consolidated statement of investments and Note 3 to the consolidated financial statements. Note 3 includes additional information regarding activities in the private finance portfolio.

(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted. The principal amount for loans and debt securities and the number of shares of common stock and preferred stock is shown in the consolidated statement of investments as of June 30, 2006.
(2)	Other includes interest, dividend, or other income which was applied to the principal of the investment and therefore reduced the total investment. These reductions are also included in the Gross Reductions for the investment, as applicable.
(3)	Gross additions include increases in the cost basis of investments resulting from new portfolio investments, paid-in-kind interest or dividends, the amortization of discounts and closing fees, the exchange of one or more existing securities for one or more new securities and the movement of an existing portfolio company into this category from a different category. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation.
(4)	Gross reductions include decreases in the cost basis of investments resulting from principal collections related to investment repayments or sales, the exchange of one or more existing securities for one or more new securities and the movement of an existing portfolio company out of this category into a different category. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation.
(5)	Loan or debt security is on non-accrual status at June 30, 2006, and is therefore considered non-income producing. Loans or debt securities on non-accrual status at the end of the period may or may not have been on non-accrual status for the full period.
(6)	Represents the total amount of interest or dividends credited to income for the portion of the year an investment was included in the companies more than 25% owned or companies 5% to 25% owned categories, respectively.
(7)	Included in the companies more than 25% owned category while the Company held a majority equity interest. On March 29, 2006, the Company sold its majority equity interest in Advantage. The Company’s investment in Advantage after the sale transaction is included in the companies 5% to 25% owned category. See Note 3 to the consolidated financial statements for further information.

55

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

     The following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto included herein and in the Company’s annual report on Form 10-K for the year ended December 31, 2005. In addition, this quarterly report on Form 10-Q contains certain forward-looking statements. These statements include the plans and objectives of management for future operations and financial objectives and can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth below in the Risk Factors section. Other factors that could cause actual results to differ materially include:

•  changes in the economy and general economic conditions;

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

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

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

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

OVERVIEW

      As a business development company, we are in the private equity business. Specifically, we provide long-term debt and equity investment capital to companies in a variety of industries. Our lending and investment activity has generally been focused on private finance and commercial real estate finance, which included primarily the investment in non-investment grade commercial mortgage-backed securities, which we refer to as CMBS, and collateralized debt obligation bonds and preferred shares, which we refer to as CDOs.

      On May 3, 2005, we completed the sale of our portfolio of CMBS and real estate related CDO investments. Upon the completion of this transaction, our lending and investment activity has been focused primarily on private finance investments. Our private finance activity principally involves providing financing to middle market U.S. companies through privately negotiated long-term debt and equity investment capital. Our financing is generally used to fund growth, acquisitions, buyouts, recapitalizations, note purchases, bridge financings, and other types of financings. We generally invest in private companies though, from time to time, we may invest in companies that are public but lack access to additional public capital. Our investment objective is to achieve current income and capital gains.

56

      Our portfolio composition at June 30, 2006 and 2005, and at December 31, 2005, was as follows:

	June 30,
							December 31,
	2006			2005			2005
Private finance		96	%		95	%		96	%
Commercial real estate finance		4	%		5	%		4	%

      Our earnings depend primarily on the level of interest and dividend income, fee and other income, and net realized and unrealized gains or losses on our investment portfolio after deducting interest expense on borrowed capital, operating expenses and income taxes including excise tax. Interest income results from the stated interest rate earned on a loan or debt security and the amortization of loan origination fees and discounts. The level of interest income is directly related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. Our ability to generate interest income is dependent on economic, regulatory, and competitive factors that influence new investment activity, interest rates on the types of loans we make, the level of repayments in the portfolio, the amount of loans and debt securities for which interest is not accruing and our ability to secure debt and equity capital for our investment activities.

      Because we are a regulated investment company for tax purposes, we intend to distribute substantially all of our annual taxable income as dividends to our shareholders. See “Other Matters” below.

PORTFOLIO AND INVESTMENT ACTIVITY

      The total portfolio at value, investment activity, and the yield on interest-bearing investments at and for the three and six months ended June 30, 2006 and 2005, and at and for the year ended December 31, 2005, were as follows:

	At and for the						At and for the						At and for the
	Three Months Ended						Six Months Ended						Year Ended
	June 30,						June 30,						December 31,
	2006			2005			2006			2005			2005
($ in millions)
Portfolio at value	$	3,593.5		$	2,714.3		$	3,593.5		$	2,714.3		$	3,606.4
Investments funded(1)	$	453.4		$	389.3		$	1,251.2		$	654.9		$	1,675.8
Change in accrued or reinvested interest and dividends(2)	$	(7.0	)	$	(14.1	)	$	(9.1	)	$	(3.6	)	$	6.6
Principal collections related to investment repayments or sales	$	429.2		$	932.6		$	769.6		$	1,090.8		$	1,503.4
Yield on interest-bearing investments(3)		12.6	%		13.2	%		12.6	%		13.2	%		12.8	%

(1)	Investments funded for the six months ended June 30, 2006, included a $150 million subordinated debt investment in Advantage Sales & Marketing, Inc. received in conjunction with the sale of Advantage and a $30 million subordinated debt investment in STS Operating, Inc. received in conjunction with the sale of STS. See discussion below.
(2)	Includes changes in accrued or reinvested interest of $0.6 million and $1.7 million for the three and six months ended June 30, 2006, respectively, related to our investments in money market securities.
(3)	The weighted average yield on interest-bearing investments is computed as the (a)��annual stated interest plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing interest-bearing investments less the annual amortization of loan origination costs, divided by (b) total interest-bearing investments at value. The weighted average yield is computed as of the balance sheet date.

57

Private Finance

      The private finance portfolio at value, investment activity, and the yield on loans and debt securities at and for the three and six months ended June 30, 2006 and 2005, and at and for the year ended December 31, 2005, were as follows:

				At and for the											At and for the											At and for the
				Three Months Ended											Six Months Ended											Year Ended
				June 30,											June 30,											December 31,
				2006						2005					2006						2005					2005
				Value			Yield(2)			Value		Yield(2)			Value			Yield(2)			Value		Yield(2)			Value		Yield(2)
($ in millions)
Portfolio at value:
	Loans and debt securities:
		Senior loans		$	275.9			9.5	%	$	203.3		10.0	%	$	275.9			9.5	%	$	203.3		10.0	%	$	239.8		9.5	%
		Unitranche debt			515.0			10.7	%		67.3		13.3	%		515.0			10.7	%		67.3		13.3	%		294.2		11.4	%
		Subordinated debt			1,700.3			13.9	%		1,362.4		14.2	%		1,700.3			13.9	%		1,362.4		14.2	%		1,560.9		13.8	%
			Total loans and debt securities	$	2,491.2			12.7	%	$	1,633.0		13.7	%	$	2,491.2			12.7	%	$	1,633.0		13.7	%	$	2,094.9		13.0	%
	Equity securities				969.2						937.5					969.2						937.5					1,384.4
Total portfolio				$	3,460.4					$	2,570.5				$	3,460.4					$	2,570.5				$	3,479.3
Investments funded(1)				$	441.5					$	298.0				$	1,237.3					$	466.3				$	1,462.3
Change in accrued or reinvested interest and dividends				$	(7.1	)				$	6.5				$	(11.3	)				$	14.4				$	24.6
Principal collections related to investment repayments or sales				$	415.7					$	178.8				$	752.4					$	330.0				$	703.9

(1)

Investments funded for the six months ended June 30, 2006, included a $150 million subordinated debt investment in Advantage Sales & Marketing, Inc. received in conjunction with the sale of Advantage and a $30 million subordinated debt investment in STS Operating, Inc. received in conjunction with the sale of STS. See discussion below.

(2)

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

     Our investment activity is focused on making long-term investments in the debt and equity of primarily private middle market companies. Debt investments may include senior loans, unitranche debt (a single debt investment that is a blend of senior and subordinated debt), or subordinated debt (with or without equity features). The junior debt that we invest in that is lower in repayment priority than senior debt is also known as mezzanine debt. Equity investments may include a minority equity stake in connection with a debt investment or a substantial equity stake in connection with a buyout transaction. In a buyout transaction, we generally invest in senior and/or subordinated debt and equity (preferred and/or voting or non-voting common) where our equity ownership represents a significant portion of the equity, but may or may not represent a controlling interest.

      In addition, we may fund most or all of the debt and equity capital upon the closing of certain buyout transactions, which may include investments in lower-yielding senior debt. Subsequent to the closing, the portfolio company may refinance all or a portion of the lower-yielding senior debt, which would reduce our investment. Senior loans at June 30, 2006, included approximately $30.1 million of senior loans that are currently in the process of being refinanced. Repayments include repayments of senior debt funded by us that was subsequently refinanced or repaid by the portfolio companies.

      We intend to take a balanced approach to private equity investing that emphasizes a complementary mix of debt investments and buyout investments. The combination of these two types of investments provides current interest and related portfolio income and the potential for future capital gains. To address the current market, our strategy is to focus on buyout and recapitalization transactions where we can manage risk through the structure and terms of our debt and equity investments and where we can potentially realize more attractive total returns from both current interest and fee income and future capital gains. We are also focusing our debt investing on smaller middle market companies where we can provide both senior and subordinated debt or unitranche debt, where our combined current yield may be lower than traditional subordinated debt only. We

58

believe that providing both senior and subordinated debt or unitranche debt provides us with greater protection in the capital structures of our portfolio companies.

     Investments Funded. Investments funded and the weighted average yield on investments funded for the six months ended June 30, 2006 and 2005, and for the year ended December 31, 2005, consisted of the following:

			For the Six Months Ended June 30, 2006
			Debt Investments					Buyout Investments					Total
					Weighted					Weighted					Weighted
					Average					Average					Average
			Amount		Yield(1)			Amount		Yield(1)			Amount		Yield(1)
($ in millions)
Loans and debt securities:
	Senior loans(4)		$	149.4		9.3	%	$	121.6		8.8	%	$	271.0		9.1	%
	Unitranche debt(2)			255.9		10.6	%		—		—			255.9		10.6	%
	Subordinated debt(3)			374.8		13.0	%		189.1		13.7	%		563.9		13.2	%
		Total loans and debt securities		780.1		11.5	%		310.7		11.8	%		1,090.8		11.5	%
Equity				54.6					91.9					146.5
	Total		$	834.7				$	402.6				$	1,237.3

			For the Six Months Ended June 30, 2005
			Debt Investments					Buyout Investments					Total
					Weighted					Weighted					Weighted
					Average					Average					Average
			Amount		Yield(1)			Amount		Yield(1)			Amount		Yield(1)
($ in millions)
Loans and debt securities:
	Senior loans		$	19.5		12.1	%	$	77.7		5.9	%	$	97.2		7.1	%
	Unitranche debt(2)			59.2		10.8	%		—		—			59.2		10.8	%
	Subordinated debt			140.0		12.9	%		110.6		13.2	%		250.6		13.0	%
		Total loans and debt securities		218.7		12.3	%		188.3		10.2	%		407.0		11.3	%
Equity				15.5					43.8					59.3
	Total		$	234.2				$	232.1				$	466.3

(1)	The weighted average yield on interest-bearing investments is computed as the (a) annual stated interest on accruing interest-bearing investments, divided by (b) total interest-bearing investments funded.
(2)	Unitranche debt is a single debt investment that is a blend of senior and subordinated debt terms. The yield on a unitranche investment reflects the blended yield of senior and subordinated debt combined.
(3)	Debt investments for the six months ended June 30, 2006, included a $150 million, 12.0% subordinated debt investment in Advantage Sales & Marketing, Inc. received in conjunction with the sale of Advantage and a $30 million, 15.0% subordinated debt investment in STS Operating, Inc. received in conjunction with the sale of STS. See discussion below.
(4)	Senior loans funded for the six months ended June 30, 2006, included $163.6 million that was repaid during the six months ended June 30, 2006.

59

			For the Year Ended December 31, 2005
			Debt Investments					Buyout Investments					Total
					Weighted					Weighted					Weighted
					Average					Average					Average
			Amount		Yield(1)			Amount		Yield(1)			Amount		Yield(1)
($ in millions)
Loans and debt securities:
	Senior loans(3)		$	76.8		10.0	%	$	250.2		6.4	%	$	327.0		7.2	%
	Unitranche debt(2)			259.5		10.5	%		—		—			259.5		10.5	%
	Subordinated debt			296.9		12.3	%		330.9		12.5	%		627.8		12.4	%
		Total loans and debt securities		633.2		11.3	%		581.1		9.9	%		1,214.3		10.6	%
Equity				82.5					165.5					248.0
	Total		$	715.7				$	746.6				$	1,462.3

(1)	The weighted average yield on interest-bearing investments is computed as the (a) annual stated interest on accruing interest-bearing investments, divided by (b) total interest-bearing investments funded.
(2)	Unitranche debt is a single debt investment that is a blend of senior and subordinated debt terms. The yield on a unitranche investment reflects the blended yield of senior and subordinated debt combined.
(3)	Buyout senior loans funded included $174.9 million that was repaid during the year.

     In July 2006, we funded private finance investments totaling $274.8 million.

      We generally fund new investments using cash. In addition, we may acquire securities in exchange for our common equity. Also, we may acquire new securities through 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.

      The level of investment activity for investments funded and principal repayments for private finance investments can vary substantially from period to period depending on the number and size of investments that we make or that we exit and many other factors, including the amount of debt and equity capital available to middle market companies, the level of merger and acquisition activity for such companies, the general economic environment, and the competitive environment for the types of investments we make. We believe that merger and acquisition activity in the middle market is strong, which has resulted in an increase in private finance investment opportunities, as well as increased repayments. We continue to have an active pipeline of new investments under consideration. We believe that merger and acquisition activity for middle market companies will remain strong for the remainder of 2006.

      Through our wholly owned subsidiary, AC Finance LLC (AC Finance), we generally originate, underwrite and arrange senior loans. Senior loans originated and underwritten by AC Finance may or may not be funded by us at closing. When these senior loans are closed, we may fund all or a portion of the underwritten commitment pending sale of the loan to other investors, which may include loan sales to Callidus Capital Corporation (Callidus) or funds managed by Callidus, a portfolio company controlled by us. After completion of the sale process, we may or may not retain a position in these senior loans. AC Finance generally earns a fee on the senior loans originated and underwritten whether or not we fund the underwritten commitment.

     Portfolio Yield. The weighted average yield on private finance loans and debt securities was 12.7% at June 30, 2006, as compared to 13.7% and 13.0% at June 30, 2005, and December 31, 2005, respectively. The weighted average yield on the private finance loans and debt securities may fluctuate from period to period depending on the yield on new loans and debt securities funded, the yield on loans and debt securities repaid, the amount of loans and debt securities for which interest is not accruing and the amount of lower-yielding senior or unitranche debt in the portfolio at the end of the period. The yield on the private finance portfolio has declined partly due to our strategy to pursue more buyout and recapitalization transactions, which may include investing in lower-yielding senior debt, and unitranche investments.

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     Outstanding Investment Commitments. At June 30, 2006, we had outstanding private finance investment commitments totaling $352.7 million, including the following:

•  $88.3 million in the form of revolving senior debt facilities to nineteen companies.

•  $50.7 million in the form of equity to fifteen private equity and venture capital funds.

•  $24.2 million in the form of debt to Promo Works, LLC.

•  $23.9 million in the form of debt to S.B. Restaurant Company.

•  $9.0 million in the form of debt to Integrity Interactive Corp.

•  $7.6 million in the form of debt to Carlisle Wide Plank Floors, Inc.

•  $6.5 million in co-investment commitments to Pine Creek Equity Partners, LLC.

•  We have various commitments to Callidus Capital Corporation (Callidus), which owns 80% (subject to dilution) of Callidus Capital Management, LLC, an asset management company that structures and manages collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), and other related investments. Our commitment to Callidus consisted of the following at June 30, 2006:

						Amount
		Committed		Amount		Available
		Amount		Drawn		to be Drawn
($ in millions)
Subordinated debt to support warehouse facilities & warehousing activities(1)		$	36.0	$	—	$	36.0
Revolving line of credit for working capital			4.0		1.6		2.4
	Total	$	40.0	$	1.6	$	38.4

⁽¹⁾  Callidus has a secured warehouse credit facility with a third party for up to $240 million. The facility is used primarily to finance the acquisition of loans pending securitization through a CDO or CLO. In conjunction with this warehouse credit facility, we have agreed to designate our $36 million subordinated debt commitment for Callidus to draw upon to provide first loss capital as needed to support the warehouse facility.

In addition, at June 30, 2006, we had a commitment to Callidus to purchase preferred equity in future CLO transactions of $77.0 million.

      In addition to these outstanding investment commitments at June 30, 2006, we may be required to fund additional amounts under earn-out arrangements primarily related to buyout transactions in the future if those companies meet agreed-upon performance targets. We also had commitments to private finance portfolio companies in the form of standby letters of credit and guarantees totaling $194.7 million. See “Financial Condition, Liquidity and Capital Resources.”

      Our largest investment at value at June 30, 2006, was in Business Loan Express, LLC (BLX) and our largest investments at value at December 31, 2005, were in Advantage Sales & Marketing, Inc. (Advantage) and BLX.

     Business Loan Express, LLC.     At June 30, 2006, our investment in BLX totaled $293.2 million at cost and $317.2 million at value, or 7.9% of our total assets, which includes unrealized appreciation of $24.0 million. We acquired BLX in 2000.

      Total interest and related portfolio income earned from the Company’s investment in BLX for the six months ended June 30, 2006 and 2005, was as follows:

		2006		2005
($ in millions)
Interest income		$	7.8	$	6.9
Dividend income			—		5.0
Fees and other income			4.3		4.7
	Total interest and related portfolio income	$	12.1	$	16.6

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      Interest income from BLX for the six months ended June 30, 2006 and 2005, included interest income of $3.7 million and $3.3 million, respectively, which was paid in kind. The interest paid in kind was paid to us through the issuance of additional Class A equity interests. Accrued interest and dividends receivable at June 30, 2006, included accrued interest due from BLX totaling $2.5 million, of which $2.1 million was paid in cash in July 2006.

      Net change in unrealized appreciation or depreciation included a net decrease in unrealized appreciation on our investment in BLX of $33.6 million for the six months ended June 30, 2006, and a net increase in unrealized appreciation on our investment in BLX of $1.3 million for the six months ended June 30, 2005. See “Results of Operations” for a discussion of the net change in unrealized appreciation or depreciation related to this investment.

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

      As a limited liability company, BLX’s taxable income flows through directly to its members. BLX’s annual taxable income generally differs from its book income for the fiscal year due to temporary and permanent differences in the recognition of income and expenses. We hold all of BLX’s Class A and Class B interests, and 94.9% of the Class C interests. BLX’s taxable income is first allocated to the Class A interests to the extent that dividends are paid in cash or in kind on such interests, with the remainder being allocated to the Class B and C interests. BLX may declare dividends on its Class B interests. If declared, BLX would determine the amount of such dividend considering its estimated annual taxable income allocable to such interests.

      At December 31, 2005, BLX had a three-year $275.0 million revolving credit facility provided by third party lenders that was scheduled to mature in January 2007. As the controlling equity owner in BLX, we had provided an unconditional guaranty to the revolving credit facility lenders in an amount equal to 50% of the total obligations (consisting of principal, letters of credit issued under the facility, accrued interest, and other fees) of BLX under the revolving credit facility. At December 31, 2005, the principal amount of loans outstanding on the revolving credit facility was $228.2 million and letters of credit issued under the facility were $41.7 million. The total obligation guaranteed by us at December 31, 2005, was $135.4 million.

      On March 17, 2006, BLX closed on a new three-year $500.0 million revolving credit facility that matures in March 2009, which replaced the existing facility. The revolving credit facility may be expanded through new or additional commitments up to $600.0 million at BLX’s option. This new facility provides for a sub-facility for the issuance of letters of credit for up to an amount equal to 25% of the committed facility. We have provided an unconditional guaranty to these revolving credit facility lenders in an amount equal to 50% of the total obligations (consisting of principal, letters of credit issued under the facility, accrued interest, and other fees) of BLX under this facility. At June 30, 2006, the principal amount outstanding on the revolving credit facility was $238.7 million and letters of credit issued under the facility were $56.7 million. The total obligation guaranteed by us at June 30, 2006, was $149.2 million. This guaranty can be called by the lenders only in the event of a default under the BLX credit facility, which includes certain defaults under our revolving credit facility. BLX has determined it was in compliance with the terms of this facility at June 30, 2006.

      At June 30, 2006, we had also provided four standby letters of credit totaling $32.0 million in connection with four term securitization transactions completed by BLX. In consideration for providing the revolving credit facility guaranty and the standby letters of credit, BLX paid us fees of $3.1 million and $3.2 million for the six months ended June 30, 2006 and 2005, respectively, which were included in fees and other income above.

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     Advantage Sales & Marketing, Inc.     At December 31, 2005, our investment in Advantage totaled $257.7 million at cost and $660.4 million at value, or 16.4% of our total assets, which included unrealized appreciation of $402.7 million. We completed the purchase of a majority ownership in Advantage in June 2004.

      On March 29, 2006, we sold our majority equity interest in Advantage. We were repaid our $184 million in subordinated debt outstanding and realized a gain on our equity investment sold of $433.7 million, subject to post-closing adjustments. As consideration for the common stock sold in the transaction, we received a $150 million subordinated note, with the balance of the consideration paid in cash. Approximately $34 million of our cash proceeds from the sale of the common stock were placed in escrow, subject to certain holdback provisions. In addition, there is potential for us to receive additional consideration through an earn-out payment that would be based on Advantage’s 2006 audited results. Our realized gain of $433.7 million, subject topost-closing adjustments, excludes any earn-out amounts. For tax purposes, the receipt of the $150 million subordinated note as part of our consideration for the common stock sold will allow us, through installment treatment, to defer the recognition of taxable income for a portion of our realized gain until the note is collected. In connection with the transaction, we retained an equity investment in the business valued at $15 million at closing as a minority shareholder.

      Total interest and related portfolio income earned from our investment in Advantage while we held a majority equity interest was $14.1 million for the six months ended June 30, 2006, which included a prepayment premium of $5.0 million, and $18.5 million for the six months ended June 30, 2005. In addition, we earned structuring fees of $2.3 million on our new $150 million subordinated debt investment in Advantage upon the closing of the sale transaction.

      After the sale transaction, our investment in Advantage at June 30, 2006, which was composed of subordinated debt and a minority equity interest, totaled $152.1 million at cost and $165.1 million at value, which included unrealized appreciation of $13.0 million. Subsequent to the completion of the sale transaction, our interest income from our subordinated debt investment in Advantage for the three months ended June 30, 2006, was $4.6 million.

      Advantage is a sales and marketing agency providing outsourced sales, merchandising, and marketing services to the consumer packaged goods industry. Advantage has offices across the United States and is headquartered in Irvine, CA.

Commercial Real Estate Finance

      The commercial real estate finance portfolio at value, investment activity, and the yield on interest-bearing investments at and for the three and six months ended June 30, 2006 and 2005, and at and for the year ended December 31, 2005, were as follows:

		At and for the										At and for the
		Three Months Ended June 30,										Six Months Ended June 30,									At and for
																					the Year Ended
																					December 31,
		2006					2005					2006				2005					2005
		Value			Yield(1)		Value			Yield(1)		Value		Yield(1)		Value			Yield(1)		Value			Yield(1)
($ in millions)
Portfolio at value:
	Commercial mortgage loans	$	96.5			8.1%	$	116.1			6.7%	$	96.5		8.1%	$	116.1			6.7%	$	102.6			7.6%
	Real estate owned		14.6					16.6					14.6				16.6					13.9
	Equity interests		22.0					11.1					22.0				11.1					10.6
Total portfolio		$	133.1				$	143.8				$	133.1			$	143.8				$	127.1
Investments funded		$	11.9				$	91.3				$	13.9			$	188.6				$	213.5
Change in accrued or reinvested interest		$	(0.5	)			$	(20.6	)			$	0.5			$	(18.0	)			$	(18.0	)
Principal collections related to investment repayments or sales(2)		$	13.5				$	753.8				$	17.2			$	760.8				$	799.5

(1)

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

(2)

Principal collections related to investment repayments or sales for the year ended December 31, 2005, included $718.1 million related to the sale of our CMBS and CDO portfolio in May 2005.

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     Our commercial real estate investments funded for the six months ended June 30, 2006 and 2005, and for the year ended December 31, 2005, was as follows:

		Face					Amount
		Amount		Discount			Funded
($ in millions)
For the Six Months Ended June 30, 2006
Commercial mortgage loans		$	7.4	$	—		$	7.4
Equity interests			6.5		—			6.5
	Total	$	13.9	$	—		$	13.9
For the Six Months Ended June 30, 2005
CMBS bonds (4 new issuances)(1)		$	211.5	$	(90.5	)	$	121.0
Commercial mortgage loans			67.1		(0.9	)		66.2
Equity interests			1.4		—			1.4
	Total	$	280.0	$	(91.4	)	$	188.6
For the Year Ended December 31, 2005
CMBS bonds (4 new issuances)(1)		$	211.5	$	(90.5	)	$	121.0
Commercial mortgage loans			88.5		(0.8	)		87.7
Equity interests			4.8		—			4.8
	Total	$	304.8	$	(91.3	)	$	213.5

(1)  The CMBS bonds invested in during 2005 were sold on May 3, 2005.

     At June 30, 2006, we had outstanding funding commitments related to commercial mortgage loans and equity interests of $9.4 million and commitments in the form of standby letters of credit and guarantees related to equity interests of $6.9 million.

     Sale of CMBS Bonds and Collateralized Debt Obligation Bonds and Preferred Shares.     On May 3, 2005, we completed the sale of our portfolio of commercial mortgage-backed securities (CMBS) and real estate related collateralized debt obligation (CDO) bonds and preferred shares to affiliates of Caisse de dépôt et placement du Québec (the Caisse) for cash proceeds of $976.0 million and a net realized gain of $227.7 million, after transaction and other costs of $7.8 million. Transaction costs included investment banking fees, legal and other professional fees, and other transaction costs. The CMBS and CDO assets sold had a cost basis at closing of $739.8 million, including accrued interest of $21.7 million. Upon the closing of the sale, we settled all the hedge positions relating to these assets, which resulted in a net realized loss of $0.7 million, which was included in the net realized gain on the sale.

      Simultaneous with the sale of our CMBS and CDO portfolio, we entered into a platform assets purchase agreement with CWCapital Investments LLC, an affiliate of the Caisse (CWCapital), pursuant to which we agreed to sell certain commercial real estate related assets, including servicer advances, intellectual property, software and other platform assets, subject to certain adjustments. Under this agreement, we have agreed not to invest in CMBS and real estate-related CDOs and refrain from certain other real estate-related investing or servicing activities for a period of three years, or through May 2008, subject to certain limitations and excluding our existing portfolio and related activities.

      The real estate securities purchase agreement, under which we sold the CMBS and CDO portfolio, and the platform asset purchase agreement contain customary representations and warranties, and require us to indemnify the affiliates of the Caisse that are parties to the agreements for certain liabilities arising under the agreements, subject to certain limitations and conditions.

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Hedging Activities

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

      The total obligations to replenish borrowed Treasury securities, including accrued interest payable on the obligations, were $17.2 million and $17.7 million at June 30, 2006, and December 31, 2005, respectively. The net proceeds related to the sales of the borrowed Treasury securities plus or minus the additional cash collateral provided or received under the terms of the transactions were $17.2 million and $17.7 million at June 30, 2006, and December 31, 2005, respectively. The amount of the hedge will vary from period to period depending upon the amount of commercial mortgage loans that we own and have hedged as of the balance sheet date.

OTHER ASSETS

      Other assets is composed primarily of fixed assets, assets held in deferred compensation trusts, deferred financing and offering costs, and accounts receivable, which includes amounts received in connection with the sale of portfolio companies, including amounts held in escrow, and other receivables from portfolio companies. At June 30, 2006, and December 31, 2005, other assets totaled $124.4 million and $87.9 million, respectively. The increase since year end was primarily the result of amounts received in connection with the sales of Advantage and STS Operating, Inc., that are being held in escrow. See “— Portfolio and Investment Activity — Private Finance” above.

PORTFOLIO ASSET QUALITY

     Portfolio by Grade.We employ a grading system for our entire portfolio. Grade 1 is used for those investments from which a capital gain is expected. Grade 2 is used for investments performing in accordance with plan. Grade 3 is used for investments that require closer monitoring; however, no loss of investment return or principal is expected. Grade 4 is used for investments that are in workout and for which some loss of current investment return is expected, but no loss of principal is expected. Grade 5 is used for investments that are in workout and for which some loss of principal is expected.

      At June 30, 2006, and December 31, 2005, our portfolio was graded as follows:

	2006					2005
	Portfolio		Percentage of			Portfolio		Percentage of
Grade	at Value		Total Portfolio			at Value		Total Portfolio
($ in millions)
1	$	1,241.2		34.5	%	$	1,643.0		45.6	%
2		2,177.8		60.6			1,730.8		48.0
3		93.1		2.6			149.1		4.1
4		27.4		0.8			26.5		0.7
5		54.0		1.5			57.0		1.6
	$	3,593.5		100.0	%	$	3,606.4		100.0	%

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      The amount of the portfolio in each grading category may vary substantially from period to period resulting primarily from changes in the composition of the portfolio as a result of new investment, repayment, and exit activity, changes in the grade of investments to reflect our expectation of performance, and changes in investment values.

      Total Grade 3, 4 and 5 portfolio assets were $174.5 million and $232.6 million, respectively, or were 4.9% and 6.4%, respectively, of the total portfolio at value at June 30, 2006, and December 31, 2005.

      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 private equity business is working with troubled portfolio companies to improve their businesses and protect our investment. The number of portfolio companies and related investment amount included in Grade 4 and 5 may fluctuate from period to period. We continue to follow our historical practice of working with such companies in order to recover the maximum amount of our investment.

     Loans and Debt Securities on Non-Accrual Status.At June 30, 2006, and December 31, 2005, loans and debt securities at value not accruing interest for the total investment portfolio were as follows:

			2006		2005
($ in millions)
Loans and debt securities in workout status (classified as Grade 4 or 5)(1)
	Private finance
		Companies more than 25% owned	$	17.7	$	15.6
		Companies 5% to 25% owned		3.3		—
		Companies less than 5% owned		24.6		11.4
	Commercial real estate finance			2.9		12.9
Loans and debt securities not in workout status
	Private finance
		Companies more than 25% owned		40.8		58.0
		Companies 5% to 25% owned		6.6		0.5
		Companies less than 5% owned		3.9		49.5
	Commercial real estate finance			12.8		7.9
		Total	$	112.6	$	155.8
		Percentage of total portfolio		3.1%		4.3%

⁽¹⁾  Workout loans and debt securities exclude equity securities that are included in the total Grade 4 and 5 assets above.

    Loans and Debt Securities Over 90 Days Delinquent.Loans and debt securities greater than 90 days delinquent at value at June 30, 2006, and December 31, 2005, were as follows:

		2006		2005
($ in millions)
Private finance		$	47.2	$	74.6
Commercial mortgage loans			3.7		6.1
	Total	$	50.9	$	80.7
	Percentage of total portfolio		1.4%		2.2%

      In general, interest is not accrued on loans and debt securities if we have doubt about interest collection or where the enterprise value of the portfolio company may not support further accrual. In addition, interest may not accrue on loans to portfolio companies that are more than 50% owned by us depending on such company’s capital requirements. To the extent interest payments are received on a loan that is not accruing interest, we may use such payments to reduce our cost basis in the investment in lieu of recognizing interest income.

      As a result of these and other factors, the amount of the portfolio that is greater than 90 days delinquent or on non-accrual status may vary from period to period. Loans and debt securities on non-accrual status and over

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90 days delinquent should not be added together as they are two separate measures of portfolio asset quality. Loans and debt securities that are in both categories (i.e., on non-accrual statusand over 90 days delinquent) totaled $50.9 million and $60.7 million at June 30, 2006, and December 31, 2005, respectively.

PORTFOLIO RETURNS

      Since our merger on December 31, 1997, through June 30, 2006, our combined aggregate cash flow Internal Rate of Return (IRR) has been approximately 22% for private finance and CMBS/CDO investments exited during this period. The IRR is calculated using the aggregate portfolio cash flow for all investments exited over this period. For investments exited during this period, we invested capital totaling $3.7 billion. The weighted average holding period of these investments was 35 months. Investments are considered to be exited when the original investment objective has been achieved through the receipt of cash and/or non-cash consideration upon the repayment of our debt investment or sale of an equity investment, or through the determination that no further consideration was collectible and, thus, a loss may have been realized. The aggregate cash flow IRR for private finance investments was approximately 21% and for CMBS/CDO investments was approximately 24% for the same period. The weighted average holding period of the private finance and CMBS/CDO investments was 47 months and 22 months, respectively, for the same period. These IRR results represent historical results. Historical results are not necessarily indicative of future results.

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RESULTS OF OPERATIONS

Comparison of Three and Six Months Ended June 30, 2006 and 2005

      The following table summarizes the Company’s operating results for the three and six months ended June 30, 2006 and 2005.

			For the Three Months											For the Six Months
			Ended June 30,											Ended June 30,
											Percentage											Percentage
			2006			2005		Change			Change			2006			2005		Change			Change
($ in thousands, except per share amounts)
			(unaudited)											(unaudited)
Interest and Related Portfolio Income
	Interest and dividends		$	95,433		$	71,330	$	24,103			34	%	$	184,314		$	156,275	$	28,039			18	%
	Loan prepayment premiums			1,745			853		892			105	%		7,031			2,530		4,501			178	%
	Fees and other income			13,278			14,024		(746	)		(5	)%		30,122			22,321		7,801			35	%
		Total interest and related portfolio income		110,456			86,207		24,249			28	%		221,467			181,126		40,341			22	%
Expenses
	Interest			21,607			19,154		2,453			13	%		45,907			39,379		6,528			17	%
	Employee			20,398			22,877		(2,479	)		(11	)%		41,826			38,333		3,493			9	%
	Stock options			4,597			—		4,597			100	%		8,203			—		8,203			100	%
	Administrative			9,861			23,048		(13,187	)		(57	)%		21,380			43,802		(22,422	)		(51	)%
		Total operating expenses		56,463			65,079		(8,616	)		(13	)%		117,316			121,514		(4,198	)		(3	)%
Net investment income before income taxes				53,993			21,128		32,865			156	%		104,151			59,612		44,539			75	%
Income tax expense, including excise tax				3,798			5,861		(2,063	)		(35	)%		12,656			5,593		7,063			126	%
Net investment income				50,195			15,267		34,928			229	%		91,495			54,019		37,476			69	%
Net Realized and Unrealized Gains (Losses)
	Net realized gains			100,240			207,496		(107,256	)		*			533,075			217,781		315,294			*
	Net change in unrealized appreciation or depreciation			(116,706	)		89,122		(205,828	)		*			(491,254	)		159,706		(650,960	)		*
		Total net gains		(16,466	)		296,618		(313,084	)		*			41,821			377,487		(335,666	)		*
Net income			$	33,729		$	311,885	$	(278,156	)		(89	)%	$	133,316		$	431,506	$	(298,190	)		(69	)%
Diluted earnings per common share			$	0.24		$	2.29	$	(2.05	)		(90	)%	$	0.94		$	3.17	$	(2. 23	)		(70	)%
Weighted average common shares outstanding — diluted				143,213			136,381		6,832			5	%		142,466			135,982		6,484			5	%

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

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

     Interest and Dividends. Interest and dividend income for the three and six months ended June 30, 2006 and 2005, was composed of the following:

			For the Three				For the Six
			Months Ended				Months Ended
			June 30,				June 30,
			2006		2005		2006		2005
($ in millions)
Interest
	Private finance loans and debt securities		$	88.6	$	53.1	$	171.2	$	109.9
	CMBS and CDO portfolio			—		7.3		—		29.4
	Commercial mortgage loans			2.1		2.0		4.8		3.5
	Cash and cash equivalents, U.S. Treasury bills and other			2.9		3.6		5.9		4.1
		Total interest		93.6		66.0		181.9		146.9
Dividends				1.8		5.3		2.4		9.4
		Total interest and dividends	$	95.4	$	71.3	$	184.3	$	156.3

      Our interest income from our private finance loans and debt securities has increased period over period as a result of the growth in this portfolio as shown below. In addition, during the six months ended June 30, 2006, we resumed accruing interest on loans to two private finance portfolio companies. Such additional interest income totaled $2.4 million and $6.2 million for the three and six months ended June 30, 2006, respectively. In addition, one of these portfolio companies paid off during the second quarter and the accrued interest was collected.

      There was no interest income from the CMBS and CDO portfolio in 2006 as we sold this portfolio on May 3, 2005. The CMBS and CDO portfolio sold had a cost basis of $718.1 million and a weighted average yield on the cost basis of the portfolio of approximately 13.8%. We generally reinvested the principal proceeds from the CMBS and CDO portfolio into our private finance portfolio.

      The level of portfolio-related interest income, which includes interest paid in cash and in kind, is directly related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The interest-bearing investments in the portfolio at value and the yield on the interest-bearing investments in the portfolio at June 30, 2006 and 2005, were as follows:

		2006					2005
		Value		Yield(1)			Value		Yield(1)
($ in millions)
Private finance loans and debt securities		$	2,491.2		12.7	%	$	1,633.0		13.7	%
CMBS and CDO portfolio(2)			—		—			—		—
Commercial mortgage loans			96.5		8.1	%		116.1		6.7	%
	Total	$	2,587.7		12.6	%	$	1,749.1		13.2	%

(1)

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

(2)

The CMBS and CDO portfolio was sold on May 3, 2005. See discussion above.

     The private finance portfolio yield at June 30, 2006, of 12.7% as compared to the private finance portfolio yield of 13.7% at June 30, 2005, reflects the mix of debt investments in the private finance portfolio. The weighted average yield varies from period to period based on the current stated interest on interest-bearing investments and the amount of loans and debt securities for which interest is not accruing. See the discussion of

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the private finance portfolio yield above under the caption “— Portfolio and Investment Activity — Private Finance.”

      Dividend income results from the dividend yield on preferred equity interests, if any, or the declaration of dividends by a portfolio company on preferred or common equity interests. Dividend income will vary from period to period depending upon the timing and amount of dividends that are declared or paid by a portfolio company on preferred or common equity interests. Dividend income for the three and six months ended June 30, 2006, did not include any dividends from BLX. Dividend income for the three and six months ended June 30, 2005, included $3.0 million and $5.0 million, respectively, of dividends from BLX on the Class B equity interests held by us, which were paid in cash. See the discussion of BLX above under the caption “— Portfolio and Investment Activity — Private Finance.”

     Loan Prepayment Premiums. Loan prepayment premiums were $1.7 million and $0.9 million for the three months ended June 30, 2006 and 2005, respectively, and $7.0 million and $2.5 million for the six months ended June 30, 2006 and 2005, respectively. Loan prepayment premiums for the six months ended June 30, 2006, included $5.0 million related to the repayment of our subordinated debt in connection with the sale of our majority equity interest in Advantage on March 29, 2006. See “—Portfolio and Investment Activity” above for further discussion. While the scheduled maturities of private finance and commercial real estate loans generally 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. Therefore, we generally structure our loans to require a prepayment premium for the first three to five years of the loan. Accordingly, the amount of prepayment premiums will vary depending on the level of repayments and the age of the loans at the time of repayment.

     Fees and Other Income. Fees and other income primarily include fees related to financial structuring, diligence, transaction services, management and consulting services to portfolio companies, commitments, guarantees, and other 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, but is not limited to, management and consulting services related to corporate finance, marketing, human resources, personnel and board member recruiting, business operations, corporate governance, risk management and other general business matters.

      Fees and other income for the three and six months ended June 30, 2006 and 2005, included fees relating to the following:

		For the Three				For the Six
		Months Ended				Months Ended
		June 30,				June 30,
		2006		2005		2006		2005
($ in millions)
Structuring and diligence		$	8.0	$	7.5	$	19.0	$	8.9
Management, consulting and other services provided to portfolio companies			2.3		3.6		6.4		6.8
Commitment, guaranty, transaction and other fees from portfolio companies			2.9		2.0		4.6		4.8
Other income			0.1		0.9		0.1		1.8
	Total fees and other income	$	13.3	$	14.0	$	30.1	$	22.3

      Fees and other income are generally related to specific transactions or services and therefore may vary substantially from period to period depending on the level of investment activity and types of services provided. Loan origination fees that represent yield enhancement on a loan are capitalized and amortized into interest income over the life of the loan.

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      Structuring and diligence fees for the six months ended June 30, 2006, included structuring fees from Advantage Sales and Marketing, Cook Inlet Alternative Risk, CR Brands, Hot Stuff Foods, MHF Logistical Solutions, the Step 2 Company, and 3SI Security Systems totaling $13.0 million. Structuring and diligence fees may vary substantially from period to period based on the level of new investment originations and the market rates for these types of fees. Private finance investments funded were $1.2 billion for the six months ended June 30, 2006, as compared to $466.3 million for the six months ended June 30, 2005.

      Management fees for the six months ended June 30, 2006, included $1.8 million in management fees from Advantage prior to its sale on March 29, 2006. See “—Portfolio and Investment Activity” above for further discussion.

      Fees and other income related to the CMBS and CDO portfolio for the six months ended June 30, 2005, were $4.1 million. As noted above, we sold our CMBS and CDO portfolio on May 3, 2005.

     BLX and Advantage. BLX was our largest investment at value at June 30, 2006, and represented 7.9% of our total assets. Advantage and BLX were our largest investments at June 30, 2005, and together represented 22.2% of our total assets.

      Total interest and related portfolio income from these investments for the three and six months ended June 30, 2006 and 2005, was as follows:

	For the Three				For the Six
	Months Ended				Months Ended
	June 30,				June 30,
	2006		2005		2006		2005
($ in millions)
BLX	$	6.0	$	8.8	$	12.1	$	16.6
Advantage(1)	$	—	$	9.4	$	14.1	$	18.5

⁽¹⁾  Includes income from the period we held a majority equity interest only. See “—Portfolio and Investment Activity” above for further discussion.

    Operating Expenses. Operating expenses include interest, employee, stock options, and administrative expenses.

     Interest Expense. The fluctuations in interest expense during the three and six months ended June 30, 2006 and 2005, were primarily attributable to changes in the level of our borrowings under various notes payable and debentures and our revolving line of credit. Our borrowing activity and weighted average cost of debt, including fees and debt financing costs, at and for the three and six months ended June 30, 2006 and 2005, were as follows:

	At and for the						At and for the
	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
($ in millions)
Total outstanding debt	$	1,208.9		$	986.5		$	1,208.9		$	986.5
Average outstanding debt	$	1,301.1		$	1,071.0		$	1,395.8		$	1,097.9
Weighted average cost(1)		6.6	%		6.8	%		6.6	%		6.8	%

⁽¹⁾  The weighted average annual interest cost is computed as the (a) annual stated interest rate on the debt plus the annual amortization of commitment fees, other facility fees and debt financing costs that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.

     In addition, interest expense includes interest on our obligations to replenish borrowed Treasury securities related to our hedging activities of $0.2 million and $0.5 million for the three months ended June 30, 2006 and 2005, respectively, and $0.4 million and $1.1 million for the six months ended June 30, 2006 and 2005, respectively.

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     Employee Expense. Employee expenses for the three and six months ended June 30, 2006 and 2005, were as follows:

		For the Three					For the Six
		Months Ended					Months Ended
		June 30,					June 30,
		2006			2005		2006			2005
($ in millions)
Salaries and employee benefits		$	17.6		$	11.7	$	35.0		$	23.5
Transition compensation, net			—			5.5		—			5.5
Individual performance award (IPA)			2.1			1.9		3.8			3.8
IPA mark to market expense (benefit)			(1.5	)		1.8		(0.6	)		1.9
Individual performance bonus (IPB)			2.2			2.0		3.6			3.6
	Total employee expense	$	20.4		$	22.9	$	41.8		$	38.3
Number of employees at end of period			166			152		166			152

      The change in salaries and employee benefits reflects the effect of wage increases and the change in mix of employees given their area of responsibility and relevant experience level. Salaries and employee benefits expense has generally increased due to changes in the composition of our employee resources and compensation increases. Salaries and employee benefits include an accrual for employee bonuses, which are generally paid annually after the completion of the fiscal year. The quarterly accrual is based upon an estimate of annual bonuses and is subject to change. The amount of the current year bonuses will be finalized by the Compensation Committee and the Board of Directors at the end of the year. Salaries and employee benefits include accrued bonuses of $9.0 million and $3.4 million for the three months ended June 30, 2006 and 2005, respectively, and $16.9 million and $7.1 million for the six months ended June 30, 2006 and 2005, respectively.

      Transition compensation costs were $6.4 million for the six months ended June 30, 2005, including $3.7 million of costs under retention agreements and $2.7 million of transition services bonuses awarded to certain employees in the commercial real estate group as a result of the sale of the CMBS and CDO portfolio. Transition compensation expenses were reduced by $0.9 million for salary reimbursements from CWCapital under the transition services agreement resulting in net expense related to the sale of the CMBS and CDO portfolio of $5.5 million. See the caption “— Portfolio and Investment Activity — Commercial Real Estate Finance” for additional information.

      The Individual Performance Award (IPA) is a long-term incentive compensation program for certain officers. The IPA, which is generally determined annually at the beginning of each year, is deposited into a deferred compensation trust generally in four equal installments, on a quarterly basis, in the form of cash. The accounts of the trust are consolidated with our accounts. We are required to mark to market the liability of the trust and this adjustment is recorded to the IPA compensation expense. Because the IPA is deferred compensation, the cost of this award is not a current expense for purposes of computing our taxable income. The expense is deferred for tax purposes until distributions are made from the trust.

      As a result of changes in regulation by the Jobs Creation Act of 2004 associated with deferred compensation arrangements, as well as an increase in the competitive market for recruiting talent in the private equity industry, the Compensation Committee and the Board of Directors determined that for 2005 and 2006 a portion of the IPA should be replaced with an individual performance bonus (IPB). The IPB is distributed in cash to award recipients in equalbi-weekly installments (beginning in February of each respective year) as long as the recipient remains employed by us.

      The Compensation Committee and the Board of Directors have determined the IPA and the IPB for 2006. We currently estimate the IPA and IPB to be approximately $8.1 million each; however, the Compensation Committee may adjust the IPA or IPB as needed, or make new awards as new officers are hired. If a recipient

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terminates employment during the year, any further cash contribution for the IPA or remaining cash payments under the IPB would be forfeited.

      In connection with our 2006 Annual Meeting of Stockholders, the stockholders approved the issuance of up to 2.5 million shares of our common stock in exchange for the cancellation of vested“in-the-money” stock options granted to certain officers and directors under our Amended Stock Option Plan. Under the initiative, which has been reviewed and approved by our Board of Directors, all optionees who hold vested stock options with exercise prices below the market value of the stock (or“in-the-money” options), would be offered the opportunity to receive an Option Cancellation Payment (OCP) equal to the “in-the-money” value of the stock options cancelled, which would be paid one-half in cash and one-half in shares of our common stock, in exchange for their voluntary cancellation of their vested stock options. As part of this initiative, the Board of Directors has adopted a target ownership structure that establishes minimum ownership levels for our senior officers and continues to further align the interests of our officers with those of our stockholders.

      Unlike the accounting treatment typically associated with a stock option exercise, the OCP would be recorded as an expense for financial reporting purposes, and the expense may be significant. Based on the 13 million vested options outstanding and the market price of $30.50 of our stock on March 10, 2006, the date used for disclosure in our 2006 proxy, the expense related to the OCP would be approximately $106 million if all option holders choose to cancel all vestedin-the-money options in exchange for the OCP. As of June 30, 2006, there were 17 million vested options outstanding, of which 13 million options werein-the-money. Using the market price of $28.77 of our stock on June 30, 2006, the expense related to the OCP would be approximately $86 million if all option holders chose to cancel all vested in-the-money options in exchange for the OCP. For income tax purposes, our tax expense resulting from the OCP would be similar to the tax expense that would result from an exercise of stock options in the market. Any tax deduction for us resulting from the OCP or an exercise of stock options in the market would be limited by Section 162(m) of the Code for persons subject to Section 162(m).

     Employee Stock Options Expense. In December 2004, the FASB issued Statement No. 123 (Revised 2004),Share-Based Payment(the “Statement”), which requires companies to recognize the grant-date fair value of stock options and other equity-based compensation issued to employees in the income statement. The Statement was effective January 1, 2006, and it applies to our stock option plan. Our stock options are typically granted with ratable vesting provisions, and we amortize the compensation cost over the related service period. With respect to options granted prior to January 1, 2006, we have used the “modified prospective method” for adoption of the Statement. Under this method, the unamortized cost of previously awarded options that were unvested as of January 1, 2006, is recognized over the remaining service period in the statement of operations beginning in 2006. With respect to options granted on or after January 1, 2006, compensation cost is recognized in the statement of operations over the service period. The effect of this adoption for the six months ended June 30, 2006, was as follows:

			For the Three		For the Six
			Months Ended		Months Ended
			June 30,		June 30,
($ in millions)			2006		2006
Employee Stock Option Expense:
	Previously awarded, unvested options as of January 1, 2006		$	3.3	$	6.7
	Options granted on or after January 1, 2006			1.3		1.5
		Total stock option expense	$	4.6	$	8.2

      In addition to the employee stock option expense, for the three and six months ended June 30, 2006, administrative expense included $0.2 million of expense related to options granted to directors during the period. Options granted to non-officer directors vest on the grant date and therefore, the full expense is recorded on the grant date.

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      We estimate that the employee-related stock option expense under the Statement that will be recorded in our statement of operations will be approximately $16.1 million, $10.1 million, and $3.2 million for the years ended December 31, 2006, 2007, and 2008, respectively, which includes approximately $2.6 million, $1.4 million, and $0.7 million, respectively, related to options granted in the first and second quarters of 2006. This estimate may change if our assumptions related to future option forfeitures change. This estimate does not include any expense related to future stock option grants as the fair value of those stock options will be determined at the time of grant.

     Administrative Expense. Administrative expenses include legal and accounting fees, valuation assistance fees, insurance premiums, the cost of leases for our headquarters in Washington, DC, and our regional offices, portfolio origination and development expenses, stock record expenses, directors’ fees, and various other expenses. Administrative expenses for the three and six months ended June 30, 2006 and 2005, were as follows:

		For the Three				For the Six
		Months Ending				Months Ending
		June 30,				June 30,
		2006		2005		2006		2005
($ in millions)
Administrative expenses		$	9.4	$	9.6	$	18.0	$	18.1
Investigation related costs			0.5		13.5		3.4		25.7
	Total administrative expenses	$	9.9	$	23.1	$	21.4	$	43.8

      Investigation related costs include costs associated with requests for information in connection with two government investigations. These expenses remain difficult to predict. See “Legal Proceedings” under Item 1 of Part II.

     Income Tax Expense, Including Excise Tax.     Income tax expense for the three and six months ended June 30, 2006 and 2005, was as follows:

		For the Three				For the Six
		Months Ended				Months Ended
		June 30,				June 30,
		2006		2005		2006		2005
($ in millions)
Income tax expense, net		$	0.6	$	1.9	$	1.1	$	1.6
Excise tax expense			3.2		4.0		11.6		4.0
	Income tax expense, including excise tax	$	3.8	$	5.9	$	12.7	$	5.6

      Our wholly owned subsidiary, A.C. Corporation, is a corporation subject to federal and state income taxes and records a benefit or expense for income taxes as appropriate based on its operating results in a given period. In addition, our estimated annual taxable income for 2006 currently exceeds our estimated dividend distributions to shareholders from such taxable income in 2006, and such estimated excess taxable income will be distributed in 2007. Therefore, we will be required to pay a 4% excise tax on the excess of 98% of our taxable income over the amount of actual distributions from such taxable income. Accordingly, we have accrued an estimated excise tax of $3.2 million and $11.6 million for the three and six months ended June 30, 2006, respectively, based upon our estimated excess taxable income earned for the period. We currently expect that the excise tax accrual in the first half of the year, which included accruals for the estimated taxable income earned from the gains realized on the sale of our equity investments in Advantage and STS Operating, Inc., will be materially higher than that accrued in the second half of the year. See “Financial Condition, Liquidity and Capital Resources.”

     Realized Gains and Losses.Net realized gains primarily result from the sale of equity securities associated with certain private finance investments, the sale of CMBS bonds and CDO bonds and preferred shares, and the realization of unamortized discount resulting from the sale and early repayment of private finance loans and

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commercial mortgage loans, offset by losses on investments. Net realized gains for the three and six months ended June 30, 2006 and 2005, were as follows:

	For the Three						For the Six
	Months Ended						Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
($ in millions)
Realized gains	$	101.0		$	244.7		$	537.5		$	259.4
Realized losses		(0.8	)		(37.2	)		(4.4	)		(41.6	)
Net realized gains	$	100.2		$	207.5		$	533.1		$	217.8

      When we exit an investment and realize a gain or loss, we make an accounting entry to reverse any unrealized appreciation or depreciation, respectively, we had previously recorded to reflect the appreciated or depreciated value of the investment. For the three and six months ended June 30, 2006 and 2005, we reversed previously recorded unrealized appreciation or depreciation when gains or losses were realized as follows:

		For the Three						For the Six
		Months Ended						Months Ended
		June 30,						June 30,
($ in millions)		2006			2005			2006			2005
Reversal of previously recorded unrealized appreciation associated with realized gains		$	(95.6	)	$	(16.6	)	$	(489.2	)	$	(26.5	)
Reversal of previously recorded unrealized depreciation associated with realized losses			0.5			37.1			3.2			41.9
	Total reversal	$	(95.1	)	$	20.5		$	(486.0	)	$	15.4

      Realized gains for the three months ended June 30, 2006 and 2005, were as follows:

($ in millions)

2006
Portfolio Company		Amount
Private Finance:
STS Operating, Inc.		$	94.8
United Site Services, Inc.			3.3
MHF Logistical Solutions, Inc.			1.2
Advantage Sales & Marketing, Inc.			0.6
Other			1.1
	Total private finance		101.0
Total gross realized gains		$	101.0

2005
Portfolio Company		Amount
Private Finance:
Master Plan, Inc.		$	3.7
Ginsey Industries, Inc.			2.8
E-Talk Corporation			1.6
Professional Paint, Inc.			1.0
Other			1.0
	Total private finance		10.1
Commercial Real Estate:
CMBS/CDO asset net(1)			227.7
Other			6.9
	Total commercial real estate		234.6
Total gross realized gains		$	244.7

⁽¹⁾  Net of net realized losses from related hedges of $0.7 million for the three months ended June 30, 2005.

    STS Operating, Inc.In the second quarter of 2006, we completed the sale of STS Operating, Inc. (STS). We were repaid our $6.8 million in subordinated debt outstanding and we realized a gain on the sale of our common stock in STS of $94.8 million, subject to post-closing adjustments. The cost basis of our equity was $3.5 million. As part of the consideration for the sale of our equity investment, we received a $30 million subordinated note. Approximately $11.2 million of our proceeds are subject to certain holdback provisions and

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post-closing adjustments. For tax purposes, the receipt of the $30 million subordinated note as part of our consideration for the common stock sold will allow us, through installment treatment, to defer the recognition of taxable income for a portion of our realized gain until the note is collected.

      Realized losses for the three months ended June 30, 2006 and 2005, were as follows:

($ in millions)

2006
Portfolio Company			Amount
Private Finance:
Other			$	0.3
	Total private finance			0.3
Commercial Real Estate:
Other				0.5
		Total commercial real estate		0.5
Total gross realized losses			$	0.8

2005
Portfolio Company		Amount
Private Finance:
Norstan Apparel Shops, Inc.		$	18.5
E-Talk Corporation			9.0
Garden Ridge Corporation			7.1
Other			0.3
	Total private finance		34.9
Commercial Real Estate:
Other			2.3
	Total commercial real estate		2.3
Total gross realized losses		$	37.2

      Realized gains for the six months ended June 30, 2006 and 2005, were as follows:

($ in millions)

2006
Portfolio Company		Amount
Private Finance:
Advantage Sales & Marketing, Inc.		$	433.7
STS Operating, Inc.			94.8
United Site Services, Inc.			3.3
Nobel Learning Communities, Inc.			1.5
MHF Logisitical Solutions, Inc.			1.2
The Debt Exchange, Inc.			1.1
Other			1.3
	Total private finance		536.9
Commercial Real Estate:
Other			0.6
	Total commercial real estate		0.6
Total gross realized gains		$	537.5

2005
Portfolio Company		Amount
Private Finance:
Polaris Pool System, Inc.		$	7.4
Master Plan, Inc.			3.7
U.S. Security Holdings, Inc.			3.3
Ginsey Industries, Inc.			2.8
E-Talk Corporation			1.6
Professional Paint, Inc.			1.0
Oriental Trading Company, Inc.			1.0
Other			3.5
	Total private finance		24.3
Commercial Real Estate:
CMBS/CDO assets, net(1)			227.7
Other			7.4
	Total commercial real estate		235.1
Total gross realized gains		$	259.4

⁽¹⁾  Net of net realized losses from related hedges of $0.7 million for the six months ended June 30, 2005.

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     Realized losses for the six months ended June 30, 2006 and 2005, were as follows:

($ in millions)

2006
Portfolio Company			Amount
Private Finance:
Aspen Pet Products, Inc.			$	1.6
Nobel Learning Communities, Inc.				1.4
Other				0.6
	Total private finance			3.6
Commercial Real Estate:
Other				0.8
		Total commercial real estate		0.8
Total gross realized losses			$	4.4

2005
Portfolio Company		Amount
Private Finance:
Norstan Apparel Shops, Inc.		$	18.5
E-Talk Corporation			9.0
Garden Ridge Corporation			7.1
Alderwoods Group, Inc.			0.8
Other			0.7
	Total private finance		36.1
Commercial Real Estate:
Other			5.5
	Total commercial real estate		5.5
Total gross realized losses		$	41.6

     Change in Unrealized Appreciation or Depreciation.We determine the value of each investment in our portfolio on a quarterly basis, and changes in value result in unrealized appreciation or depreciation being recognized in our statement of operations. Value, as defined in Section 2(a)(41) of the Investment Company Act of 1940, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by the Board of Directors pursuant to our valuation policy and a consistently applied valuation process. At June 30, 2006, portfolio investments recorded at fair value were approximately 90% of our total assets. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the Board of Directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

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

      As a business development company, we have invested in illiquid securities including debt and equity securities of companies. 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 may be subject to certain 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.

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

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

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

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

      As a participant in the private equity business, we invest primarily in private middle market companies for which there is generally no publicly available information. Because of the private nature of these businesses, there is a need to maintain the confidentiality of the financial and other information that we have for the private companies in our portfolio. We believe that maintaining this confidence is important, as disclosure of such information could disadvantage our portfolio companies and could put us at a disadvantage in attracting new investments. Therefore, we do not intend to disclose financial or other information about our portfolio companies, unless required, because we believe doing so may put them at an economic or competitive disadvantage, regardless of our level of ownership or control.

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      We will continue to work with third-party consultants to obtain assistance in determining fair value for a portion of the private finance portfolio each quarter. We work with these consultants to obtain assistance as additional support in the preparation of our internal valuation analysis. In addition, we may receive third-party assessments of a particular private finance portfolio company’s value in the ordinary course of business, most often in the context of a prospective sale transaction or in the context of a bankruptcy process. The valuation analysis prepared by management using these third-party valuation resources, when applicable, is submitted to our Board of Directors for its determination of fair value of the portfolio in good faith.

      For 2006 and 2005, we received third-party valuation assistance from Duff & Phelps, LLC (Duff & Phelps) and Houlihan Lokey Howard and Zukin (Houlihan Lokey) for our private finance portfolio as follows:

	2006						2005
	Q1			Q2			Q1			Q2
Number of private finance portfolio companies reviewed		78			78			36			72
Percentage of private finance portfolio reviewed at value		87.0	%		89.6	%		74.5	%		83.0	%

      Professional fees for third-party valuation assistance were $1.4 million for the year ended December 31, 2005, and are estimated to be approximately $1.5 million for 2006.

     Valuation Methodology — CDO and CLO Bonds and Preferred Shares/Income Notes (“CDO/CLO Assets”).CDO/CLO Assets are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar bonds and preferred shares/income notes, when available. We recognize unrealized appreciation or depreciation on our CDO/CLO Assets as comparable yields in the market change and/ or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each bond ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool is updated and the revised cash flows are used in determining the fair value of the bonds. We determine the fair value of our CDO/CLO Assets on an individual security-by-security basis. If we were to sell a group of these CDO/CLO Assets in a pool in one or more transactions, the total value received for that pool may be different than the sum of the fair values of the individual bonds or preferred shares/income notes.

     Net Change in Unrealized Appreciation or Depreciation. Net change in unrealized appreciation or depreciation for the three and six months ended June 30, 2006 and 2005, consisted of the following:

	For the Three						For the Six
	Months Ended						Months Ended
	June 30,						June 30,
	2006(1)			2005(1)			2006(1)			2005(1)
($ in millions)
Net unrealized appreciation or depreciation	$	(21.6	)	$	68.6		$	(5.3	)	$	144.3
Reversal of previously recorded unrealized appreciation associated with realized gains		(95.6	)		(16.6	)		(489.2	)		(26.5	)
Reversal of previously recorded unrealized depreciation associated with realized losses		0.5			37.1			3.2			41.9
Net change in unrealized appreciation or depreciation	$	(116.7	)	$	89.1		$	(491.3	)	$	159.7

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

     At June 30, 2006, our largest investment was in BLX. The following is a summary of the methodology that we used to determine the fair value of this investment.

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     Business Loan Express, LLC.To determine the value of our investment in BLX at June 30, 2006, we performed four separate valuation analyses to determine a range of values: (1) analysis of comparable public company trading multiples, (2) analysis of BLX’s value assuming an initial public offering, (3) analysis of merger and acquisition transactions for financial services companies, and (4) a discounted dividend analysis. We received valuation assistance from Duff & Phelps for our investment in BLX at June 30, 2006, and December 31, 2005.

      With respect to the analysis of comparable public company trading multiples and the analysis of BLX’s value assuming an initial public offering, we compute a median trailing and forward price earnings multiple to apply to BLX’s pro-forma net income adjusted for certain capital structure changes that we believe would likely occur should the company be sold. Each quarter we evaluate which public commercial finance companies should be included in the comparable group. The comparable group at June 30, 2006, was made up of CIT Group, Inc., Financial Federal Corporation, GATX Corporation, and Marlin Business Services Corporation, which is consistent with the comparable group at March 31, 2006, and December 31, 2005.

      Our investment in BLX at June 30, 2006, was valued at $317.2 million. This fair value was within the range of values determined by the four valuation analyses. Unrealized appreciation on our investment was $24.0 million at June 30, 2006. We decreased unrealized appreciation for the three and six months ended June 30, 2006, by $10.9 million and $33.6 million, respectively. The decrease resulted from a reduction in enterprise value at June 30, 2006, of approximately 6% as compared to the enterprise value at December 31, 2005. BLX has experienced higher loan prepayments in recent months, which BLX management believes is due to a robust economy and increased competition from banks. BLX management has scaled back their traditional loan originations to remain selective in this competitive lending environment, and is also developing new loan products.

     Per Share Amounts.All per share amounts included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section have been computed using the weighted average common shares used to compute diluted earnings per share, which were 143.2 million and 136.4 million for the three months ended June 30, 2006 and 2005, respectively, and were 142.5 million and 136.0 million for the six months ended June 30, 2006 and 2005, respectively.

OTHER MATTERS

     Regulated Investment Company Status.We have elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986. As long as we qualify as a regulated investment company, we are not taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to shareholders on a timely basis.

      Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash.

      Dividends declared and paid by us in a year generally differ from taxable income for that year as such dividends may include the distribution of current year taxable income, the distribution of prior year taxable income carried over into and distributed in the current year, or returns of capital. We are generally required to distribute 98% of our taxable income during the year the income is earned to avoid paying an excise tax. If this requirement is not met, the Internal Revenue Code imposes a nondeductible excise tax equal to 4% of the

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amount by which 98% of the current year’s taxable income exceeds the distribution for the year. The taxable income on which an excise tax is paid is generally carried over and distributed to shareholders in the next tax year. Depending on the level of taxable income earned in a tax year, we may choose to carry over taxable income in excess of current year distributions from such taxable income into the next tax year and pay a 4% excise tax on such income, as required. See “Financial Condition, Liquidity and Capital Resources” below.

      In order to maintain our status as a regulated investment company and obtain regulated investment company tax benefits, 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 asset diversification requirements as defined in the Internal Revenue Code; and (4) timely distribute to shareholders at least 90% of our annual 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.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Dividends and Distributions

      Dividends to common shareholders for the six months ended June 30, 2006 and 2005, were $166.6 million and $152.3 million, respectively, or $1.19 per common share for the first half of 2006 and $1.14 per common share for the first half of 2005. An extra cash dividend of $0.03 per common share was declared during 2005 and was paid to shareholders on January 27, 2006.

      The Board of Directors has declared a dividend of $0.61 per common share for the third quarter of 2006.

      Dividends are generally determined based upon an estimate of annual taxable income and the amount of taxable income carried over from the prior year for distribution in the current year. Taxable income includes our taxable interest, dividend and fee income, as well as taxable net capital gains. As discussed above, taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends and the amortization of discounts and fees. Cash collections of income resulting from contractual payment-in-kind interest or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation and amortization expense.

      Our Board of Directors reviews the dividend rate quarterly, and may adjust the quarterly dividend throughout the year. Dividends are declared based upon our estimate of annual taxable income available for distribution to shareholders and the amount of taxable income carried over from the prior year for distribution in the current year. Our goal is to declare what we believe to be sustainable increases in our regular quarterly dividends. To the extent that we earn annual taxable income in excess of dividends paid from such taxable income for the year, we may carry over the excess taxable income into the next year and such excess taxable income will be available for distribution in the next year as permitted under the Internal Revenue Code of 1986. Excess taxable income carried over and paid out in the next year is generally subject to a 4% excise tax. See “Other Matters — Regulated Investment Company Status” above. We believe that carrying over excess taxable income into future periods may provide increased visibility with respect to taxable earnings available to pay the regular quarterly dividend. We currently estimate that the taxable income carried over from 2005 for distribution to shareholders in 2006 is $163.8 million. However, our taxable income for 2005 is an estimate and will not be finally determined until we file our 2005 tax return in September 2006, and therefore, the amount of excess taxable income carried over from 2005 into 2006 may be different from this estimate.

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      We currently expect that our estimated annual taxable income for 2006 will be in excess of our estimated dividend distributions to shareholders in 2006 from such taxable income, and, therefore, we expect to carry over excess taxable income for distribution to shareholders in 2007. We expect that we will generally be required to pay a 4% excise tax on the excess of 98% of our taxable income for 2006 over the amount of actual distributions from such taxable income in 2006. Accordingly, for the six months ended June 30, 2006, we have accrued an excise tax of $11.6 million. Excise taxes are accrued based upon estimated excess taxable income as estimated taxable income is earned, therefore, the excise tax accrued to date in 2006 may be adjusted as appropriate in the remainder of 2006 to reflect changes in our estimate of the carry over amount and additional excise tax may be accrued during the remainder of 2006 as additional excess taxable income is earned, if any. Our ability to earn the estimated annual taxable income for 2006 depends on many factors, including our ability to make new investments at attractive yields, the level of repayments in the portfolio, the realization of gains or losses from portfolio exits, and the level of operating expenses incurred. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.”

      In addition to excess taxable income available to be carried over from the current tax year for distribution in the following tax year, we currently estimate that we have deferred taxable income related to installment sale gains of approximately $33 million as of December 31 2005, and approximately $170 million for the six months ended June 30, 2006, for a total of approximately $203 million as of June 30, 2006 . These gains have been recognized for financial reporting purposes in the respective years they were realized, but will be deferred for tax purposes until the notes or other amounts received from the sale of the related investments are collected in cash. These installment sale gains are estimates and will not be finally determined until we file our tax returns for the respective years. See “Other Matters — Regulated Investment Company Status” above.

      Because we are a regulated investment company, we distribute our taxable income and, therefore, from time to time we will raise new debt or equity capital in order to fund our investments and operations.

Liquidity and Capital Resources

      At June 30, 2006, and December 31, 2005, our liquidity portfolio (see below), cash and investments in money market and other securities, total assets, total debt outstanding, total shareholders’ equity, debt to equity ratio and asset coverage for senior indebtedness were as follows:

($ in millions)	2006			2005
Liquidity portfolio (including money market and other securities: 2006-$75.3; 2005-$100.0)	$	201.2		$	200.3
Cash and investments in money market and other securities (including money market and other securities: 2006-$22.5; 2005-$22.0)	$	25.6		$	53.3
Total assets	$	4,011.2		$	4,025.9
Total debt outstanding	$	1,208.9		$	1,284.8
Total shareholders’ equity	$	2,690.0		$	2,620.5
Debt to equity ratio		0.45			0.49
Asset coverage ratio(1)		326	%		309	%

⁽¹⁾  As a business development company, we are generally required to maintain a minimum ratio of 200% of total assets to total borrowings.

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     We have a liquidity portfolio that is composed of U.S. Treasury bills, money market securities and a certificate of deposit. At June 30, 2006, and December 31, 2005, the value and yield of the securities in the liquidity portfolio were as follows:

		2006				2005
($ in millions)		Value		Yield		Value		Yield
U.S. Treasury bills(1)		$	125.9		4.9%	$	100.3		4.3%
Money market securities			55.3		5.0%		100.0		4.1%
Certificate of Deposit(1)			20.0		5.6%		—		—
	Total	$	201.2		5.0%	$	200.3		4.2%

⁽¹⁾  The Treasury bills and certificate of deposit mature in 2006.

     The liquidity portfolio was established to provide a pool of liquid assets within our balance sheet. Our investment portfolio is primarily composed of private, illiquid assets for which there is no readily available market. Our portfolio’s liquidity was reduced when we sold our portfolio of CMBS assets in May 2005, particularly BB rated bonds, which were generally more liquid than assets in our private finance portfolio. We will assess the amount held in and the composition of the liquidity portfolio throughout the year.

      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 securities. We place our cash with financial institutions and, at times, cash held in checking accounts in financial institutions may be in excess of the Federal Deposit Insurance Corporation insured limit.

      During the six months ended June 30, 2006, we sold equity of $83.0 million. We did not sell new equity in a public offering during the six months ended June 30, 2005, or for the year ended December 31, 2005. In addition, shareholders equity increased by $15.9 million, $17.1 million and $77.5 million through the exercise of employee options, the collection of notes receivable from the sale of common stock, and the issuance of shares through our dividend reinvestment plan for the six months ended June 30, 2006 and 2005, and the year ended December 31, 2005, respectively.

      We employ an asset-liability management approach that focuses on matching the estimated maturities of our investment portfolio to the estimated maturities of our borrowings. We use our revolving line of credit facility as a means to bridge to long-term financing in the form of debt or equity capital, which may or may not result in temporary differences in the matching of estimated maturities. Availability on the revolving line of credit, net of amounts committed for standby letters of credit issued under the line of credit facility, was $882.5 million on June 30, 2006. We evaluate our interest rate exposure on an ongoing basis. Generally, we seek to fund our primarily fixed-rate investment portfolio with fixed-rate debt or equity capital. To the extent deemed necessary, we may hedge variable and short-term interest rate exposure through interest rate swaps or other techniques.

      On July 24, 2006, we sold 4.5 million shares of our common stock for proceeds of $118.1 million, net of underwriting discounts and estimated offering expenses. In addition, on August 1, 2006, we sold 0.7 million shares of our common stock for proceeds of $17.8 million, net of underwriting discounts and estimated offering expenses, pursuant to the underwriters over-allotment option related to the sale of the 4.5 million shares.

      On July 25, 2006, we completed a public issuance of $400 million of five-year, unsecured notes with a fixed interest rate of 6.625%. This debt matures on July 15, 2011. We have the option to redeem these notes in whole or in part, together with a redemption premium, as stipulated in the notes. We have certain financial and operating covenants that will be required by this public debt issuance, including that we will maintain a minimum ratio of 200% of total assets to total borrowings, as required by the Investment Company Act of 1940, as amended, while these notes are outstanding.

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      The net proceeds from the debt and equity issuances were used to reduce borrowings under our revolving line of credit, with the remainder being used to fund new portfolio investments and for general corporate purposes. We currently have no borrowings outstanding on our revolving line of credit.

      As a result of the equity and debt issuances in the third quarter of 2006, we expect that our leverage ratio will increase by the end of the third quarter of 2006 from the 0.45:1.00 level at June 30, 2006. We currently target a debt to equity ratio ranging between 0.50:1.00 to 0.70:1.00 because we believe that it is prudent to operate with a larger equity capital base and less leverage.

      At June 30, 2006, we had outstanding debt as follows:

							Annual
			Facility		Amount		Interest
			Amount		Outstanding		Cost(1)
($ in millions)
Notes payable and debentures:
	Unsecured notes payable		$	1,190.6	$	1,190.6		6.2%
	SBA debentures			16.5		16.5		7.4%
		Total notes payable and debentures		1,207.1		1,207.1		6.2%
Revolving line of credit				922.5		1.8		6.4%	(2)
		Total debt	$	2,129.6	$	1,208.9		6.6%	(3)

(1)	The weighted average annual interest cost is computed as the (a) annual stated interest on the debt plus the annual amortization of commitment fees, other facility fees and the amortization of debt financing costs that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.
(2)	The annual interest cost reflects the interest rate payable for borrowings under the revolving line of credit. In addition to the current interest rate payable, there were annual costs of commitment fees, other facility fees and the amortization of debt financing costs of $3.8 million at June 30, 2006.
(3)	The annual interest cost for total debt includes the annual cost of commitment fees, other facility fees and the amortization of debt financing costs on the revolving line of credit regardless of the amount outstanding on the facility as of the balance sheet date.

    Unsecured Notes Payable.We have issued unsecured long-term notes to institutional investors, primarily insurance companies. The notes have five- or seven-year maturities, with maturity dates beginning in 2006 and generally have fixed rates of interest. The notes generally require payment of interest only semi-annually, and all principal is due upon maturity.

      On May 1, 2006, we issued $50.0 million of long-term debt with a fixed interest rate of 6.75%. This debt matures in May 2013. The proceeds of this issuance were used to repay $25 million of 7.49% unsecured long-term debt that matured on May 1, 2006, with the remainder being used to fund new portfolio investments and for general corporate purposes.

     Small Business Administration Debentures.Through our small business investment company subsidiary, we have debentures payable to the Small Business Administration (SBA) with contractual maturities of ten years. The notes require payment of interest only semi-annually, and all principal is due upon maturity. During the first half of 2006 and 2005, we repaid $12.0 million and $31.0 million, respectively, of this outstanding debt. We intend to repay the SBA in the third quarter of 2006 for the remaining outstanding borrowings of $16.5 million. The prepayment penalty upon repayment will be approximately $0.2 million. We currently do not have plans to borrow additional amounts from the SBA.

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     Revolving Line of Credit.At December 31, 2005, we had an unsecured revolving line of credit with a committed amount of $772.5 million that expires on September 30, 2008. In May 2006, we expanded the committed amount to 922.5 million. The revolving line of credit is now fully committed. The revolving line of credit generally bears interest at a rate equal to (i) LIBOR (for the period we select) plus 1.05% or (ii) the higher of the Federal Funds rate plus 0.50% or the Bank of America N.A. prime rate. The revolving line of credit requires the payment of an annual commitment fee equal to 0.20% of the committed amount. The revolving line of credit generally requires payments of interest at the end of each LIBOR interest period, but no less frequently than quarterly, on LIBOR based loans and monthly payments of interest on other loans. All principal is due upon maturity.

      At June 30, 2006, there was $1.8 million outstanding on our unsecured revolving line of credit. The amount available under the line at June 30, 2006, was $882.5 million, net of amounts committed for standby letters of credit of $38.3 million. Net repayments under the revolving line of credit for the six months ended June 30, 2006, were $90.0 million.

      We have various financial and operating covenants required by the revolving line of credit and notes payable and debentures outstanding at June 30, 2006. These covenants require us to maintain certain financial ratios, including debt to equity and interest coverage, and a minimum net worth. These credit facilities provide for customary events of default, including, but not limited to, payment defaults, breach of representations or covenants, cross-defaults, bankruptcy events, failure to pay judgments, attachment of our assets, change of control and the issuance of an order of dissolution. Certain of these events of default are subject to notice and cure periods or materiality thresholds. Our credit facilities also limit our ability to declare dividends if we default under certain provisions. As of June 30, 2006, we were in compliance with these covenants.

      The following table shows our significant contractual obligations for the repayment of debt and payment of other contractual obligations as of June 30, 2006.

					Payments Due By Year
															After
			Total		2006		2007		2008		2009		2010		2010
($ in millions)
Notes payable and debentures:
	Unsecured long-term notes payable		$	1,190.6	$	150.0	$	—	$	153.0	$	268.1	$	408.0	$	211.5
	SBA debentures			16.5		—		—		—		—		—		16.5
Revolving line of credit(1)				1.8		—		—		1.8		—		—		—
Operating leases				26.7		2.2		4.4		4.5		4.6		4.4		6.6
		Total contractual obligations	$	1,235.6	$	152.2	$	4.4	$	159.3	$	272.7	$	412.4	$	234.6

⁽¹⁾  At June 30, 2006, $882.5 million remained unused and available, net of amounts committed for standby letters of credit of $38.3 million issued under the credit facility.

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Off-Balance Sheet Arrangements

      The following table shows our contractual commitments that may have the effect of creating, increasing, or accelerating our liabilities as of June 30, 2006.

				Amount of Commitment Expiration Per Year
														After
		Total		2006		2007		2008		2009		2010		2010
($ in millions)
Guarantees		$	163.3	$	2.5	$	0.7	$	3.0	$	151.6	$	—	$	5.5
Standby letters of credit(1)			38.3		0.1		—		38.2		—		—		—
	Total commitments	$	201.6	$	2.6	$	0.7	$	41.2	$	151.6	$	—	$	5.5

⁽¹⁾  Standby letters of credit are issued under our revolving line of credit that expires in September 2008. Therefore, unless a standby letter of credit is set to expire at an earlier date, we have assumed that the standby letters of credit will expire contemporaneously with the expiration of our line of credit in September 2008.

     In addition, we had outstanding commitments to fund investments totaling $362.1 million at June 30, 2006. We intend to fund these commitments and prospective investment opportunities with existing cash, through cash flow from operations before new investments, through borrowings under our line of credit or other long-term debt agreements, or through the sale or issuance of new equity capital.

CRITICAL ACCOUNTING POLICIES

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

        Valuation of Portfolio Investments.As a business development company, we invest in illiquid securities including debt and equity securities of companies and CDO and CLO bonds and preferred shares/ income notes. Our investments may be subject to certain 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 determining the fair value of the portfolio. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investments. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has also appreciated in value. The value of investments in publicly traded securities is determined using quoted market prices discounted for restrictions on resale, if any.

        Loans and Debt Securities.For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value, overall financial condition or other factors lead to a determination of fair value at a different amount. The value of loan and debt securities may be greater than our cost basis if the amount that would be repaid on the loan or debt security upon the sale of the portfolio company is greater than our cost basis.

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      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. In general, interest is not accrued on loans and debt securities if we have doubt about interest collection or where the enterprise value of the portfolio company may not support further accrual. Loans in workout status that are classified as Grade 4 or 5 assets under our internal grading system do not accrue interest. In addition, interest may not accrue on loans or debt securities to portfolio companies that are more than 50% owned by us depending on such company’s capital requirements. Loan origination fees, original issue discount, and market discount are capitalized and then amortized into interest income using a method that approximates the effective interest method. Upon the prepayment of a loan or debt security, any unamortized loan origination fees are recorded as interest income and any unamortized original issue discount or market discount is recorded as a realized gain. Prepayment premiums are recorded on loans and debt securities when received.

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

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

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

     Collateralized Debt Obligations (“CDO”) and Collateralized Loan Obligations (“CLO”). CDO and CLO bonds and preferred shares/ income notes (“CDO/CLO Assets”) are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar bonds and preferred shares/income notes, when available. We recognize unrealized appreciation or depreciation on its CDO/CLO Assets as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. We determine the fair value of its CDO/CLO Assets on an individual security-by-security basis.

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

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     Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation.Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the year, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. Net change in unrealized appreciation or depreciation also reflects the change in the value of U.S. Treasury bills and deposits of proceeds from sales of borrowed Treasury securities, and depreciation on accrued interest and dividends receivable and other assets where collection is doubtful.

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

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

      There has been no material change in quantitative or qualitative disclosures about market risk since December 31, 2005.

Item 4.  Controls and Procedures

      (a) As of the end of the period covered by this quarterly report on Form 10-Q, the Company’s chief executive officer and chief financial officer conducted an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15 and15d-15 of the Securities Exchange Act of 1934). Based upon this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective to allow timely decisions regarding required disclosure of any material information relating to the Company that is required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934.

      (b) There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2006, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1.     Legal Proceedings

      On June 23, 2004, we were notified by the SEC that they are conducting an informal investigation of us. On December 22, 2004, we received letters from the U.S. Attorney for the District of Columbia requesting the preservation and production of information regarding us and Business Loan Express, LLC in connection with a criminal investigation. Based on the information available to us at this time, the inquiries appear to primarily pertain to matters related to portfolio valuation and our portfolio company, Business Loan Express, LLC. To date, we have produced materials in response to requests from both the SEC and the U.S. Attorney’s office, and certain current and former employees have provided testimony and have been interviewed by the staff of the SEC and the U.S. Attorney’s Office. We are voluntarily cooperating with these investigations.

      In addition to the above matters, we are party to certain lawsuits in the normal course of business.

      While the outcome of these legal proceedings and other matters cannot at this time be predicted with certainty, we do not expect that the outcome of these matters will have a material effect upon our financial condition or results of operations.

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Item 1A.  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.

     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 subject to certain 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 we may need to or 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 could be significantly less than the current value of such investments.

     Investing in private companies involves a high degree of risk. Our portfolio primarily consists of long-term loans to and investments in middle market private companies. Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses for us in those investments 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. If we are unable to identify all material information about these companies, among other factors, we may fail to receive the expected return on our investment or lose some or all of the money invested in these companies. In addition, these businesses may have shorter operating histories, narrower product lines, smaller market shares and less experienced management than their competition and may be more vulnerable to customer preferences, market conditions, loss of key personnel, or economic downturns, which may adversely affect the return on, or the recovery of, our investment in such businesses. As an investor, we are subject to the risk that a portfolio company may make a business decision that does not serve our interest, which could decrease the value of our investment. Deterioration in a portfolio company’s financial condition and prospects may be accompanied by deterioration in any collateral for the loan.

     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 June 30, 2006, portfolio investments recorded at fair value were 90% of our total assets. Pursuant to the requirements of the 1940 Act, we value substantially all of our investments at fair value as determined in good faith by our Board of Directors on a quarterly basis. Since there is typically no readily available market value for the investments in our portfolio, our Board of Directors determines in good faith the fair value of these investments pursuant to a valuation policy and a consistently applied valuation process.

      There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses; we are instead required by the 1940 Act to specifically value each individual investment on a quarterly basis and record

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unrealized depreciation for an investment that we believe has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has appreciated in value. Without a readily available market value and because of the inherent uncertainty of valuation, the fair value of our investments determined in good faith by the Board of Directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material. Our net asset value could be affected if our determination of the fair value of our investments is materially different than the value that we ultimately realize.

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

     Economic recessions or downturns could impair our portfolio companies and harm our operating results. Many of the companies in which we have made or will make investments may be susceptible to economic slowdowns or recessions. An economic slowdown may affect the ability of a company to repay our loans or engage in a liquidity event such as a sale, recapitalization, or initial public offering. Our nonperforming assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions also may decrease the value of any collateral securing some of our loans. 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 or a slowdown in middle market merger and acquisition activity 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 timing of exit events in our portfolio and could negatively affect the amount of gains or losses upon exit.

     Our borrowers may default on their payments, which may have a negative effect on our financial performance. We primarily 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, may be highly leveraged and 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. A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans or foreclosure on its secured assets, which could trigger cross defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the loans or debt securities that we hold. In addition, our portfolio companies may have, or may be permitted to incur, other debt that ranks senior to or equally with our securities. This means that payments on such senior-ranking securities may have to be made before we receive any payments on

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our loans or debt securities. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in any related collateral and may have a negative effect on our financial results.

     Our private finance investments may not produce current returns or capital gains. Our private finance investments are typically structured as unsecured debt securities with a relatively high fixed rate of interest and with equity features such as conversion rights, warrants, or options, or as buyouts of companies where we invest in debt and equity securities. As a result, our 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 a significant portfolio investment fails to perform as expected. Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. At June 30, 2006, our largest investment at value was in Business Loan Express, LLC (BLX), which represented 7.9% of our total assets and 5.5% of our total interest and related portfolio income for the six months ended June 30, 2006. BLX is a lender under the Small Business Administration 7(a) Guaranteed Loan Program. Our financial results could be negatively affected if government funding for, or regulations related to, this program change.

     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 or investors. Holders 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. We and, indirectly, our stockholders will bear the cost associated with our leverage activity. Our revolving line of credit, notes payable and debentures contain financial and operating covenants that could restrict our business activities, including our ability to declare dividends if we default under certain provisions.

      At June 30, 2006, we had $1.2 billion of outstanding indebtedness bearing a weighted average annual interest cost of 6.6%. If our portfolio of investments fails to produce adequate returns, we may be unable to make interest or principal payments on our indebtedness when they are due. In order for us to cover annual interest payments on indebtedness, we must achieve annual returns on our assets of at least 2.0% as of June 30, 2006.

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     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, insurance companies or other lenders or investors 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 June 30, 2006, our asset coverage for senior indebtedness was 326%.

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

      Assuming that the balance sheet as of June 30, 2006, 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 net income by approximately 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 net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate.

     We will continue to need additional capital to grow because we must distribute our income. We will continue to need capital to fund growth in our investments. Historically, we have borrowed from financial institutions and have issued equity securities to grow our portfolio. A reduction in the availability of new debt or equity capital could limit our ability to grow. We must distribute at least 90% of our taxable ordinary income, which excludes realized net long-term capital gains, to our shareholders to maintain our eligibility for the tax benefits available to regulated investment companies. As a result, such earnings will not be available to fund investment originations. 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. We expect to continue to borrow from financial institutions or other investors and issue additional debt and equity securities. If we fail to obtain funds from such sources or from other sources to fund our investments, it could limit our ability to grow, which could have a material adverse effect on the value of our common stock.

     Loss of regulated investment company tax treatment would substantially reduce net assets and income available for debt service and dividends. We have operated so as to

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qualify as a regulated investment company under Subchapter M of the Code. If we meet source of income, asset diversification, and distribution requirements, we will not be subject to corporate-level income taxation on income we timely distribute to our stockholders as dividends. We would cease to qualify for such 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 debt service and distributions 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. If we do not distribute at least 98% of our annual taxable income in the year earned, we generally will be required to pay an excise tax on amounts carried over and distributed to shareholders in the next year equal to 4% of the amount by which 98% of our annual taxable income exceeds the distributions from such income for the current year.

     There is a risk that our common stockholders 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, certain of 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 the tax benefits available to us as a regulated investment company. In addition, in accordance with U.S. generally accepted accounting principles 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, or the accrual of original issue discount. The increases in loan balances as a result of contractual payment-in-kind arrangements are included in income in advance of receiving cash payment and are separately included in the change in accrued or reinvested interest and dividends in our consolidated statement of cash flows. Since we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our investment company taxable income to obtain tax benefits 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, other business development companies, investment banks, other equity and non-equity based investment funds, and other sources of financing, including specialty finance companies and traditional financial services companies such as commercial banks. Some of our competitors may 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.

     Our business depends on our 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

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our operations and lost business opportunities, which could have a negative effect on our business.

     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, which may have a material effect on our operations.

     Our ability to invest in private companies may be limited in certain circumstances. If we are to maintain our status as a business development company, we must not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets. If we acquire debt or equity securities from an issuer that has outstanding marginable securities at the time we make an investment, these acquired assets cannot be treated as qualifying assets. This result is dictated by the definition of “eligible portfolio company” under the 1940 Act, which in part looks to whether a company has outstanding marginable securities.

      Amendments promulgated in 1998 by the Federal Reserve expanded the definition of a marginable security under the Federal Reserve’s margin rules to include any non-equity security. Thus, any debt securities issued by any entity are marginable securities under the Federal Reserve’s current margin rules. As a result, the staff of the SEC has raised the question as to whether a private company that has outstanding debt securities would qualify as an “eligible portfolio company” under the 1940 Act.

      Until the question raised by the staff of the SEC pertaining to the Federal Reserve’s 1998 change to its margin rules has been addressed by legislative, administrative or judicial action, we intend to treat as qualifying assets only those debt and equity securities that are issued by a private company that has no marginable securities outstanding at the time we purchase such securities or those that otherwise qualify as an “eligible portfolio company” under the 1940 Act.

      In November 2004, the SEC issued proposed rules to correct the unintended consequence of the Federal Reserve’s 1998 margin rule amendments of apparently limiting the investment opportunities of business development companies. In general, the SEC’s proposed rules would define an eligible portfolio company as any company that does not have securities listed on a national securities exchange or association. We currently do not believe that these proposed rules will have a material adverse effect on our operations.

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

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     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 paid by stockholders, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include, but are not limited to, 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 laws or regulatory policies or tax guidelines with respect to business development companies or regulated investment companies;

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

•  general economic conditions and trends;

•  loss of a major funding source; or

•  departures of key personnel.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

      During the three months ended June 30, 2006, we issued a total of 122,755 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 $3.6 million.

Issuer Purchases of Equity Securities

      The following table provides information for the quarter ended June 30, 2006, regarding shares of our common stock that were purchased under The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan I (2005 DCP I) and The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan II (2005 DCP II),

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which are administered by third-party trustees. The administrator of the 2005 DCP I and the 2005 DCP II is the Compensation Committee of our Board of Directors.

		Total Number
		of Shares		Average Price
		Purchased		Paid Per Share
2005 DCP I(1)
	4/1/2006 to 4/31/2006		78	$	30.31
	5/1/2006 to 5/28/2006		—	$	—
	6/1/2006 to 6/31/2006		—	$	—
2005 DCP II(2)
	4/1/2006 to 4/31/2006		14,149	$	30.31
	5/1/2006 to 5/28/2006		—	$	—
	6/1/2006 to 6/31/2006		70,500	$	29.75
Total			84,727	$	29.84

(1)

The 2005 DCP I is an unfunded plan, as defined by the Internal Revenue Code of 1986, that provides for the deferral of compensation by our directors, employees, and consultants. In addition, we may make contributions to 2005 DCP I on compensation deemed ineligible for a 401(k) contribution. Our directors, employees, or consultants are eligible to participate in the plan at such time and for such period as designated by the Board of Directors. The 2005 DCP I is administered through a trust by a third-party trustee, and we fund this plan through cash contributions. Directors may choose to defer director’s fees through the 2005 DCP I, and may choose to invest such deferred income in shares of our common stock. To the extent a director elects to invest in our common stock, the trustee of the 2005 DCP I will be required to use such deferred director’s fees to purchase shares of our common stock in the market.

(2)

We have established a long-term incentive compensation program whereby we will generally determine an individual performance award for certain officers annually at the beginning of each year. The Compensation Committee may adjust the individual performance awards as needed, or make new awards as new officers are hired. In conjunction with the program, we instituted the 2005 DCP II, which is an unfunded plan as defined by the Internal Revenue Code of 1986 that is administered through a trust by a third-party trustee. The individual performance awards are deposited in the trust in four equal installments, generally on a quarterly basis in the form of cash and the 2005 DCP II requires the trustee to use the cash exclusively to purchase shares of our common stock in the market. In addition, cash dividends received on the Allied Capital shares held in the trust are used by the trustee to purchase shares of our common stock in the open market.

Item 3.  Defaults Upon Senior Securities

      Not applicable.

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

      On May 16, 2006, we held our Annual Meeting of Shareholders in Washington, DC. Shareholders voted on three matters; the substance of these matters and the results of the voting of each such matter are described below. There were no broker non-votes for items 1 and 2 below.

1.  Election of Directors: Shareholders elected five directors of the Company, who will serve for three years, or until their successors are elected and qualified. Votes were cast as follows:

	For		Withheld
Ann Torre Bates		127,731,421		1,713,989
Edwin L. Harper		126,434,463		3,010,946
John I. Leahy		127,186,384		2,259,025
Alex J. Pollock		127,529,783		1,915,626
Guy T. Steuart II		127,424,088		2,021,321

The following directors are continuing as directors of the Company for their respective terms — Brooks H. Browne, John D. Firestone, Anthony T. Garcia, Lawrence I. Hebert, Robert E. Long, Marc F. Racicot, Laura W. van Roijen, Joan M. Sweeney, and William L. Walton.

2.  Ratification of the selection of KPMG LLP to serve as independent registered public accounting firm for the year ending December 31, 2006. Votes were cast as follows:

For		Against		Abstain
	127,953,628		739,269		752,510

3.  Approval of the issuance of up to 2,500,000 shares of common stock in exchange for the cancellation of vested in-the-money options granted to certain officers and directors in connection with a stock ownership initiative. Votes were cast as follows:

For		Against		Abstain		Broker Non-Votes
	53,152,866		15,428,444		2,307,157		58,556,940

Item 5.  Other Information

      None.

Item 6.  Exhibits

      (a) List of Exhibits

Exhibit
Number			Description
	3	.1	Restated Articles of Incorporation.(Incorporated by reference to Exhibit a.1 filed with Allied Capital’s Post-Effective Amendment No. 2 to registration statement on Form N-2 (File No. 333-67336) filed on March 22, 2002).
	3	.2	Amended and Restated Bylaws.(Incorporated by reference to Exhibit 3.1. filed with Allied Capital’s Form 8-K on January 24, 2006).

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Exhibit
Number			Description
	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).
	4	.3	Form of Note under the Indenture relating to the issuance of debt securities.(Contained in Exhibit 4.4). (Incorporated by reference to Exhibit d.1 filed with Allied Capital’s Form N-2/ A (File No. 333-133755) filed on June 21, 2006).
	4	.4	Indenture by and between Allied Capital Corporation and The Bank of New York, dated June 16, 2006.(Incorporated by reference to Exhibit d.2 filed with Allied Capital’s Form N-2/ A (File No. 333-133755) filed on June 21, 2006).
	4	.5	Statement of Eligibility of Trustee on Form T-1.(Incorporated by reference to Exhibit d.3 filed with Allied Capital’s Form N-2 (File No. 333-133755) filed on May 3, 2006).
	4	.6	Form of First Supplemental Indenture by and between Allied Capital Corporation and the Bank of New York, dated as of July 25, 2006.(Incorporated by reference to Exhibit d.4 filed with Allied Capital’s Form N-2/A (File No. 333-133755) filed on July 25, 2006).
	4	.7	Form of 6.625% Note due 2011.(Incorporated by reference to Exhibit d.4 filed with Allied Capital’s Form N-2/A (File No. 333-133755) filed on July 25, 2006).
	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	Credit Agreement, dated September 30, 2005.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K on October 3, 2005).
	10	.2(a)	First Amendment to Credit Agreement, dated November 4, 2005.(Incorporated by reference to Exhibit 10.2(a) filed with Allied Capital’s Form 10-Q for the period ended September 30, 2005).
	10	.2(b)	Second Amendment to Credit Agreement, dated May 11, 2006.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on May 12, 2006).
	10	.2(c)	Third Amendment to Credit Agreement, dated May 19, 2006.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on May 23, 2006).
	10	.3	Note Agreement, dated October 13, 2005.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K on October 14, 2005).
	10	.4	Note Agreement, dated May 1, 2006.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K on May 1, 2006).
	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).

99

Exhibit
Number			Description
	10	.13	Note Agreement, dated as of October 15, 2001.(Incorporated by reference to Exhibit f.10 filed with Allied Capital’s Post-Effective Amendment No. 1 to registration statement on Form N-2 (File No. 333-67336) filed on November 14, 2001).
	10	.15	Control Investor Guaranty Agreement, dated as of March 17, 2006, between Allied Capital and CitiBank, N.A. and Business Loan Express, LLC.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Post-Effective Amendment No. 3 to registration statement on Form 8-K filed on March 23, 2006).
	10	.17	The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan II.(Incorporated by reference to Exhibit 10.2 filed with Allied Capital’s Form 8-K filed on December 21, 2005).
	10	.17(a)	Amendment to The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan II, dated January 20, 2006.(Incorporated by reference to Exhibit 10.17(a) filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
	10	.18	The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on December 21, 2005).
	10	.18(a)	Amendment to The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan, dated January 20, 2006.(Incorporated by reference to Exhibit 10.18(a) filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
	10	.19	Amended Stock Option Plan.(Incorporated by reference to Exhibit B of Allied Capital’s definitive proxy statement for Allied Capital’s 2004 Annual Meeting of Stockholders filed on March 30, 2004).
	10	.20(a)	Allied Capital Corporation 401(k) Plan, dated September 1, 1999.(Incorporated by reference to Exhibit 4.4 filed with Allied Capital’s registration statement on Form S-8 (File No. 333-88681) filed on October 8, 1999).
	10	.20(b)	Amendment to Allied Capital Corporation 401(k) Plan, dated April 15, 2004.(Incorporated by reference to Exhibit 10.20(b) filed with Allied Capital’s Form 10-Q for the period ended June 30, 2004).
	10	.20(c)	Amendment to Allied Capital Corporation 401(k) plan, dated November 1, 2005.(Incorporated by reference to Exhibit 10.20(c) filed with Allied Capital’s Form 10-Q for the quarter ended September 30, 2005).
	10	.20(d)	Amendment to Allied Capital Corporation 401(k) plan, dated April 21, 2006.(Incorporated by reference to Exhibit i.4(c) filed with Allied Capital’s Form N-2 (File No. 333-133755) filed on May 3, 2006).
	10	.21	Employment Agreement, dated January 1, 2004, between Allied Capital and William L. Walton.(Incorporated by reference to Exhibit 10.21 filed with Allied Capital’s Form 10-K for the year ended December 31, 2003).
	10	.22	Employment Agreement, dated January 1, 2004, between Allied Capital and Joan M. Sweeney.(Incorporated by reference to Exhibit 10.22 filed with Allied Capital’s Form 10-K for the year ended December 31, 2003).
	10	.23	Recission of Retention Agreement, dated October 27, 2005, between Allied Capital and John M. Scheurer.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s current report on Form 8-K filed on November 1, 2005).

100

Exhibit
Number			Description
	10	.25	Form of Custody Agreement with Riggs Bank N.A., which was assumed by PNC Bank through merger.(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	Custodian Agreement with Chevy Chase Trust.(Incorporated by reference to Exhibit 10.26 filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
	10	.27	Custodian Agreement with Bank of America.(Incorporated by reference to Exhibit 10.27 filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
	10	.28	Code of Ethics.(Incorporated by reference to Exhibit 10.28 filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
	10	.29*	Custodian Agreement with Union Bank of California.
	10	.30*	Custodian Agreement with M&T Bank.
	10	.31	Note Agreement, dated as of May 14, 2003.(Incorporated by reference to Exhibit 10.31 filed with Allied Capital’s Form 10-Q for the quarter ended March 31, 2003).
	10	.32	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of April 30, 1998.(Incorporated by reference to Exhibit 10.32 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10	.33	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of May 1, 1999.(Incorporated by reference to Exhibit 10.33 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10	.35	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of October 15, 2000.(Incorporated by reference to Exhibit 10.35 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10	.36	Amendment, dated as of April 30, 2003, to Note Agreement, dated as of October 15, 2001.(Incorporated by reference to Exhibit 10.36 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2003).
	10	.37	Form of Indemnification Agreement between Allied Capital and its directors and certain officers.(Incorporated by reference to Exhibit 10.37 filed with Allied Capital’s Form 10-K for the year ended December 31, 2003).
	10	.38	Note Agreement, dated as of March 25, 2004.(Incorporated by reference to Exhibit 10.38 filed with Allied Capital’s Form 10-Q for the period ended March 31, 2004.)
	10	.39	Note Agreement, dated as of November 15, 2004. (Incorporated by reference to Exhibit 99.1 filed with Allied Capital’s current report on Form 8-K filed on November 18, 2004.)
	10	.40	Real Estate Securities Purchase Agreement.(Incorporated by reference to Exhibit 2.1 filed with Allied Capital’s Form 8-K filed on May 4, 2005.)
	10	.41	Platform Assets Purchase Agreement.(Incorporated by reference to Exhibit 2.2 filed with Allied Capital’s Form 8-K filed on May 4, 2005.)
	10	.42	Transition Services Agreement.(Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on May 4, 2005.)
	11		Statement regarding computation of per share earnings is included in Note 7 to Allied Capital’s Notes to the Consolidated Financial Statements.
	15	.*	Letter regarding Unaudited Interim Financial Information

101

Exhibit
Number			Description
	31	.1*	Certification of Chief Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
	31	.2*	Certification of Chief Financial Officer Pursuant Rule 13a-14 of the Securities Exchange Act of 1934.
	32	.1*	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
	32	.2*	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.

*     Filed herewith.

102

SIGNATURES

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

ALLIED CAPITAL CORPORATION

               (Registrant)

Dated: August 9, 2006	/s/William L. Walton William L. Walton Chairman and Chief Executive Officer
	/s/Penni F. Roll Penni F. Roll Chief Financial Officer

103

EXHIBIT INDEX

Exhibit
Number			Description
	10	.29*	Custodian Agreement with Union Bank of California.
	10	.30*	Custodian Agreement with M&T Bank.
	15	.*	Letter regarding Unaudited Interim Financial Information
	31	.1*	Certification of Chief Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
	31	.2*	Certification of Chief Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
	32	.1*	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
	32	.2*	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.

*     Filed herewith.