________________________________________________________________________________

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

For The Quarterly Period

Ended September 30, 2007

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     o Non-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 November 7, 2007, there were 154,532,721 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 September 30, 2007 (unaudited) and December 31, 2006	1
		Consolidated Statement of Operations (unaudited) — For the Three and Nine Months Ended September 30, 2007 and 2006	2
		Consolidated Statement of Changes in Net Assets (unaudited) — For the Nine Months Ended September 30, 2007 and 2006	3
		Consolidated Statement of Cash Flows (unaudited) — For the Nine Months Ended September 30, 2007 and 2006	4
		Consolidated Statement of Investments as of September 30, 2007 (unaudited)	5
		Consolidated Statement of Investments as of December 31, 2006	16
		Notes to Consolidated Financial Statements	27
		Report of Independent Registered Public Accounting Firm	60
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		64
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		102
	Item 4. Controls and Procedures		103
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings		104
	Item 1A. Risk Factors		105
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		112
	Item 3. Defaults Upon Senior Securities		113
	Item 4. Submission of Matters to a Vote of Security Holders		113
	Item 5. Other Information		113
	Item 6. Exhibits		114
	Signatures		118
EX-10.20(h)
EX-15
EX-31.1
EX-31.2
EX-32.2

PART I: FINANCIAL INFORMATION

Item 1.  Financial Statements

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

				September 30,			December 31,
				2007			2006
(in thousands, except per share amounts)				(unaudited)
ASSETS
Portfolio at value:
	Private finance
		Companies more than 25% owned (cost: 2007-$1,571,149; 2006-$1,578,822)		$	1,236,844		$	1,490,180
		Companies 5% to 25% owned (cost: 2007-$434,164; 2006-$438,560)			397,930			449,813
		Companies less than 5% owned (cost: 2007-$2,601,101; 2006-$2,479,981)			2,572,354			2,437,908
			Total private finance (cost: 2007-$4,606,414; 2006-$4,497,363)		4,207,128			4,377,901
	Commercial real estate finance (cost: 2007-$96,115; 2006-$103,546)				119,739			118,183
			Total portfolio at value (cost: 2007-$4,702,529; 2006-$4,600,909)		4,326,867			4,496,084
Investments in money market and other securities					291,069			202,210
Accrued interest and dividends receivable					74,829			64,566
Other assets					153,940			122,958
Cash					14,816			1,687
			Total assets	$	4,861,521		$	4,887,505
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
	Notes payable and debentures (maturing within one year: 2007-$153,000; 2006-$—)			$	1,922,370		$	1,691,394
	Revolving line of credit				—			207,750
	Accounts payable and other liabilities				173,368			147,117
			Total liabilities		2,095,738			2,046,261
Commitments and contingencies
Shareholders’ equity:
	Common stock, $0.0001 par value, 400,000 shares authorized; 154,506 and 148,575 shares issued and outstanding at September 30, 2007, and December 31, 2006, respectively				15			15
	Additional paid-in capital				2,594,406			2,493,335
	Common stock held in deferred compensation trust				(37,079	)		(28,335	)
	Notes receivable from sale of common stock				(2,708	)		(2,850	)
	Net unrealized appreciation (depreciation)				(395,216	)		(123,084	)
	Undistributed earnings				606,365			502,163
			Total shareholders’ equity		2,765,783			2,841,244
			Total liabilities and shareholders’ equity	$	4,861,521		$	4,887,505
Net asset value per common share				$	17.90		$	19.12

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

1

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

				For the Three Months					For the Nine Months
				Ended September 30,					Ended September 30,
				2007			2006		2007			2006
(in thousands, except per share amounts)
				(unaudited)					(unaudited)
Interest and Related Portfolio Income:
	Interest and dividends
		Companies more than 25% owned		$	28,198		$	23,812	$	83,895		$	77,377
		Companies 5% to 25% owned			9,374			10,977		32,111			28,046
		Companies less than 5% owned			68,097			63,879		194,460			177,559
			Total interest and dividends		105,669			98,668		310,466			282,982
	Fees and other income
		Companies more than 25% owned			5,146			6,486		14,552			24,222
		Companies 5% to 25% owned			19			10		518			4,008
		Companies less than 5% owned			7,534			8,219		18,460			23,638
			Total fees and other income		12,699			14,715		33,530			51,868
			Total interest and related portfolio income		118,368			113,383		343,996			334,850
Expenses:
	Interest				33,744			26,109		98,368			72,455
	Employee				26,306			25,228		76,845			67,054
	Employee stock options				18,312			3,649		31,492			11,852
	Administrative				10,496			8,153		38,225			29,348
			Total operating expenses		88,858			63,139		244,930			180,709
Net investment income before income taxes					29,510			50,244		99,066			154,141
Income tax expense (benefit), including excise tax					11,192			1,586		16,073			13,988
Net investment income					18,318			48,658		82,993			140,153
Net Realized and Unrealized Gains (Losses):
	Net realized gains (losses)
		Companies more than 25% owned			201,582			394		267,359			528,793
		Companies 5% to 25% owned			(5,475	)		93		(5,171	)		(324	)
		Companies less than 5% owned			16,263			9,429		52,727			14,522
			Total net realized gains		212,370			9,916		314,915			542,991
	Net change in unrealized appreciation or depreciation				(327,156	)		19,312		(272,132	)		(471,942	)
			Total net gains (losses)		(114,786	)		29,228		42,783			71,049
Net increase (decrease) in net assets resulting from operations				$	(96,468	)	$	77,886	$	125,776		$	211,202
Basic earnings (loss) per common share				$	(0.63	)	$	0.54	$	0.83		$	1.50
Diluted earnings (loss) per common share				$	(0.62	)	$	0.53	$	0.81		$	1.47
Weighted average common shares outstanding — basic					154,025			144,163		151,979			141,002
Weighted average common shares outstanding — diluted					155,329			147,112		154,708			144,030

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

2

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

			For the Nine Months
			Ended September 30,
			2007			2006
(in thousands, except per share amounts)
			(unaudited)
Operations:
	Net investment income		$	82,993		$	140,153
	Net realized gains			314,915			542,991
	Net change in unrealized appreciation or depreciation			(272,132	)		(471,942	)
		Net increase in net assets resulting from operations		125,776			211,202
Shareholder distributions:
	Common stock dividends			(293,706	)		(255,430	)
		Net decrease in net assets resulting from shareholder distributions		(293,706	)		(255,430	)
Capital share transactions:
	Sale of common stock			93,784			218,882
	Issuance of common stock in lieu of cash distributions			12,447			11,050
	Issuance of common stock upon the exercise of stock options			13,307			11,108
	Cash portion of option cancellation payment			(52,833	)		—
	Stock option expense			32,069			12,088
	Net decrease in notes receivable from sale of common stock			142			1,005
	Purchase of common stock held in deferred compensation trust			(9,272	)		(7,226	)
	Distribution of common stock held in deferred compensation trust			528			656
	Other			2,297			—
		Net increase in net assets resulting from capital share transactions		92,469			247,563
		Total increase (decrease) in net assets		(75,461	)		203,335
Net assets at beginning of period				2,841,244			2,620,546
Net assets at end of period			$	2,765,783		$	2,823,881
Net asset value per common share			$	17.90		$	19.38
Common shares outstanding at end of period				154,506			145,722

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

3

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

				For the Nine Months Ended
				September 30,
				2007			2006
(in thousands)
				(unaudited)
Cash flows from operating activities:
	Net increase in net assets resulting from operations			$	125,776		$	211,202
	Adjustments:
		Portfolio investments			(1,236,671	)		(1,700,751	)
		Principal collections related to investment repayments or sales			1,086,513			885,872
		Change in accrued or reinvested interest and dividends			(22,812	)		1,820
		Net collection (amortization) of discounts and fees			(1,215	)		(3,644	)
		Redemption of (investments in) U.S. Treasury bills			—			(22,875	)
		Redemption of (investments in) money market securities			(82,219	)		7,581
		Stock option expense			32,069			12,088
		Changes in other assets and liabilities			13,943			33,897
		Depreciation and amortization			1,540			1,303
		Realized gains from the receipt of notes and other consideration from sale of investments, net of collections			(29,716	)		(209,049	)
		Realized losses			81,456			7,063
		Net change in unrealized (appreciation) or depreciation			272,132			471,942
			Net cash provided by (used in) operating activities		240,796			(303,551	)
Cash flows from financing activities:
	Sale of common stock				93,784			218,882
	Sale of common stock upon the exercise of stock options				13,307			11,108
	Collections of notes receivable from sale of common stock				142			1,005
	Borrowings under notes payable				230,000			450,000
	Repayments on notes payable and debentures				—			(53,500	)
	Net borrowings under (repayments on) revolving line of credit				(207,750	)		(91,750	)
	Cash portion of option cancellation payment				(52,833	)		—
	Purchase of common stock held in deferred compensation trust				(9,272	)		(7,226	)
	Other financing activities				(6,363	)		(4,674	)
	Common stock dividends and distributions paid				(288,682	)		(248,479	)
			Net cash provided by (used in) financing activities		(227,667	)		275,366
Net increase (decrease) in cash					13,129			(28,185	)
Cash at beginning of period					1,687			31,363
Cash at end of period				$	14,816		$	3,178

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

4

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Companies More Than 25% Owned
Alaris Consulting, LLC		Senior Loan (16.5%, Due 12/05 – 12/07)(6)	$	27,055	$	26,987	$	—
	(Business Services)	Equity Interests				5,189		—
		Guaranty ($1,100)
AllBridge Financial, LLC		Equity Interests				2,300		2,300
	(Financial Services)	Standby Letter of Credit ($30,000)
Allied Capital Senior Debt Fund, L.P.(5)		Equity Interests (See Note 3)				19,080		19,535
	(Private Debt Fund)
Avborne, Inc.(7)		Preferred Stock (12,500 shares)				611		850
	(Business Services)	Common Stock (27,500 shares)				—		—
Avborne Heavy Maintenance, Inc.(7)		Preferred Stock (1,568 shares)				2,401		973
	(Business Services)	Common Stock (2,750 shares)				—		—
		Guaranty ($2,401)
Aviation Properties Corporation		Common Stock (100 shares)				65		—
	(Business Services)	Guaranty ($1,000)
Border Foods, Inc.		Preferred Stock (100,000 shares)				12,721		2,473
	(Consumer Products)	Common Stock (148,838 shares)				3,847		—
Business Loan Express, LLC (Financial Services)		Class A Equity Interests(25.0% — See Note 3)(6)		95,822		95,822		95,822
		Class B Equity Interests				119,436		40,888
		Class C Equity Interests				109,301		—
		Guaranty ($252,007 — See Note 3)
		Standby Letters of Credit ($19,000 —   See Note 3)
Calder Capital Partners, LLC(5)		Senior Loan (8.5%, Due 5/09)(6)		2,218		2,218		2,218
	(Financial Services)	Equity Interests				2,235		347
Callidus Capital Corporation		Subordinated Debt (18.0%, Due 10/08)		6,575		6,575		6,575
	(Financial Services)	Common Stock (100 shares)				2,067		42,640
Coverall North America, Inc.		Unitranche Debt (12.0%, Due 7/11)		35,054		34,914		34,914
	(Business Services)	Subordinated Debt (15.0%, Due 7/11)		6,000		5,977		5,977
		Common Stock (884,880 shares)				16,648		23,018
CR Holding, Inc.		Subordinated Debt (16.6%, Due 2/13)		40,602		40,452		40,452
	(Consumer Products)	Common Stock (37,200,551 shares)				33,321		41,034
Direct Capital Corporation		Subordinated Debt (16.0%, Due 3/13)		37,676		37,515		37,515
	(Financial Services)	Common Stock (2,097,234 shares)				19,250		6,923
Financial Pacific Company		Subordinated Debt (17.4%, Due 2/12 – 8/12)		72,668		72,475		72,475
	(Financial Services)	Preferred Stock (10,964 shares)				10,276		18,454
		Common Stock (14,735 shares)				14,819		47,022
ForeSite Towers, LLC		Equity Interest				—		881
	(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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
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	$	7,576
	(Business Services)	Subordinated Debt (17.0%, Due 12/03 – 9/05)(6)		11,339		11,336		—
		Preferred Equity Interest				14,067		—
		Options				1,639		—
Gordian Group, Inc.		Senior Loan (10.0%, Due 12/08)(6)		2,625		2,625		—
	(Business Services)	Common Stock (1,000 shares)				6,942		—
Hot Stuff Foods, LLC		Senior Loan (8.6%, Due 2/11-2/12)		49,550		49,351		49,351
	(Consumer Products)	Subordinated Debt (13.8%, Due 8/12 – 2/13)		61,532		61,301		42,191
		Subordinated Debt (16.0%, Due 2/13)(6)		20,841		20,750		—
		Common Stock (1,147,453 shares)				56,187		—
Huddle House, Inc.		Subordinated Debt (15.0%, Due 12/12)		59,401		59,149		59,149
	(Retail)	Common Stock (415,328 shares)				41,533		44,262
Impact Innovations Group, LLC		Equity Interests in Affiliate				—		320
	(Business Services)
Insight Pharmaceuticals Corporation		Subordinated Debt (15.0%, Due 9/12)		44,257		44,129		44,804
	(Consumer Products)	Subordinated Debt (19.0%, Due 9/12)(6)		16,181		16,130		16,626
		Preferred Stock (25,000 shares)				25,000		1,845
		Common Stock (620,000 shares)				6,325		—
Jakel, Inc.		Subordinated Debt (15.5%, Due 3/08)(6)		1,575		1,575		1,575
	(Industrial Products)
Legacy Partners Group, Inc.		Senior Loan (14.0%, Due 5/09)(6)		3,843		3,843		3,843
	(Financial Services)	Equity Interests				4,261		1,271
Litterer Beteiligungs-GmbH(4)		Subordinated Debt (8.0%, Due 3/07)		748		748		748
	(Business Services)	Equity Interest				1,809		1,585
MVL Group, Inc.		Senior Loan (12.0%, Due 6/09 – 7/09)		30,674		30,633		30,633
	(Business Services)	Subordinated Debt (14.5%, Due 6/09 – 7/09)		39,937		39,651		39,651
		Common Stock (648,661 shares)				643		4,961
Old Orchard Brands, LLC		Subordinated Debt (18.0%, Due 7/14)		19,433		19,342		19,342
	(Consumer Products)	Equity Interests				18,767		19,602
Penn Detroit Diesel Allison, LLC		Subordinated Debt (15.5%, Due 8/13)		39,038		38,880		38,880
	(Business Services)	Equity Interests				21,128		28,795
Powell Plant Farms, Inc.		Senior Loan (15.0%, Due 12/07)(6)		1,350		1,350		1,350
	(Consumer 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.

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

6

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance			(unaudited)
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Service Champ, Inc.		Subordinated Debt (15.5%, Due 4/12)	$	28,262	$	28,165	$	28,165
	(Business Services)	Common Stock (63,888 shares)				13,662		26,355
Staffing Partners Holding
	Company, Inc.	Subordinated Debt (13.5%, Due 1/07)(6)		541		541		544
	(Business Services)
Startec Equity, LLC		Equity Interests				230		440
	(Telecommunications)
Sweet Traditions, Inc.		Senior Loan (9.0%, Due 9/08 – 8/11)(6)		39,692		36,052		36,673
	(Retail)	Preferred Stock (961 Shares)				950		—
		Common Stock (10,000 Shares)				50		—
Triview Investments, Inc.(8)		Senior Loan (10.0%, Due 12/07)		433		433		433
	(Broadcasting & Cable/Business	Subordinated Debt (12.9%, Due 1/10 – 6/17)		42,784		42,590		42,590
	Services/Consumer Products)	Subordinated Debt (12.5%, Due 11/07 – 3/08) (6)		1,400		1,400		1,534
		Common Stock (202 shares)				119,836		82,777
		Guaranty ($900)
		Standby Letter of Credit ($200)
Worldwide Express Operations, LLC		Subordinated Debt (14.0%, Due 2/14)		2,800		2,624		2,624
	(Business Services)	Equity Interests				12,900		12,900
		Warrants				163		163
Total companies more than 25% owned					$	1,571,149	$	1,236,844
Companies 5% to 25% Owned
Advantage Sales & Marketing, Inc.		Subordinated Debt (12.0%, Due 3/14)	$	154,642	$	154,041	$	154,041
	(Business Services)	Equity Interests				—		11,000
Air Medical Group Holdings LLC		Senior Loan (7.9%, Due 3/11)		1,920		1,866		1,866
	(Healthcare Services)	Equity Interests				3,470		10,800
Alpine ESP Holdings, Inc.		Preferred Stock (622 shares)				622		719
	(Business Services)	Common Stock (13,513 shares)				14		300
Amerex Group, LLC		Subordinated Debt (12.0%, Due 1/13)		8,400		8,400		8,400
	(Consumer Products)	Equity Interests				3,509		15,657
BB&T Capital Partners/Windsor
	Mezzanine Fund, LLC (5)	Equity Interests				5,873		5,607
	(Private Equity Fund)
Becker Underwood, Inc.		Subordinated Debt (14.5%, Due 8/12)		24,707		24,636		24,636
	(Industrial Products)	Common Stock(5,073 shares)				5,813		4,200
BI Incorporated		Subordinated Debt (13.5%, Due 2/14)		30,615		30,495		30,495
	(Business Services)	Common Stock (40,000 shares)				4,000		7,400

(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. has a cost basis of $164.3 million and holds investments in Longview Cable & Data, LLC (Broadcasting & Cable) with a value of $6.9 million, Triax Holdings, LLC (Consumer Products) with a value of $62.2 million, and Crescent Hotels & Resorts, LLC and affiliates (Business Services) with a value of $58.2 million.

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

7

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
CitiPostal, Inc. and Affiliates		Senior Loan (11.1%, Due 8/13-11/14)	$	22,208	$	22,115	$	22,115
	(Business Services)	Equity Interests				4,543		6,900
Creative Group, Inc.		Subordinated Debt (14.0%, Due 9/13)(6)		15,000		13,686		9,259
	(Business Services)	Warrant				1,387		—
Drew Foam Companies, Inc.		Preferred Stock (722 shares)				722		396
	(Business Services)	Common Stock (7,287 shares)				7		—
MedBridge Healthcare, LLC		Senior Loan (8.0%, Due 8/09)(6)		7,164		7,164		7,164
	(Healthcare Services)	Subordinated Debt (10.0%, Due 8/14)(6)		5,184		5,184		1,723
		Convertible Subordinated Debt (2.0%, Due 8/14)(6)		2,970		984		—
		Equity Interests				1,416		—
MHF Logistical Solutions, Inc.		Subordinated Debt (11.5%, Due 6/12)(6)		33,600		33,448		10,585
	(Business Services)	Subordinated Debt (18.0%, Due 6/13)(6)		11,211		11,154		—
		Common Stock (20,934 shares)(12)				20,942		—
		Warrants(12)				—		—
Multi-Ad Services, Inc.		Unitranche Debt (11.3%, Due 11/11)		19,850		19,748		19,748
	(Business Services)	Equity Interests				2,000		942
PresAir LLC		Senior Loan (7.5%, Due 12/10)(6)		5,702		5,384		800
	(Industrial Products)	Equity Interests				1,341		—
Progressive International
	Corporation	Subordinated Debt (16.0%, Due 12/09)		3,985		3,970		3,970
	(Consumer Products)	Preferred Stock (500 shares)				500		1,017
		Common Stock (197 shares)				13		5,100
		Warrants				—		—
Regency Healthcare Group, LLC		Senior Loan (11.1%, Due 6/12)		500		484		484
	(Healthcare Services)	Unitranche Debt (11.1%, Due 6/12)		12,000		11,953		11,953
		Equity Interests				1,500		1,685
SGT India Private Limited(4)		Common Stock (109,524 shares)				4,098		2,625
	(Business Services)
Soteria Imaging Services, LLC		Subordinated Debt (12.0%, Due 11/10)		14,500		13,702		13,702
	(Healthcare Services)	Equity Interests				2,170		2,641
Universal Environmental Services, LLC		Equity Interests				1,810		—
	(Business Services)
Total companies 5% to 25% owned					$	434,164	$	397,930
Companies Less Than 5% Owned
3SI Security Systems, Inc.		Subordinated Debt (14.5%, Due 8/13)	$	27,651	$	27,547	$	27,547
	(Consumer Products)
AgData, L.P.		Senior Loan (10.3%, Due 7/12)		526		496		496
	(Consumer Services)
Axium Healthcare Pharmacy, Inc.		Unitranche Debt (12.0%, Due 12/12)		10,950		10,877		10,877
	(Healthcare Services)	Common Stock (26,500 shares)				2,650		1,100
Baird Capital Partners IV Limited Partnership(5) (Private Equity Fund)		Limited Partnership Interest				1,967		1,856

(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.
(12)	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.

8

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
BenefitMall, Inc.		Unitranche Debt (13.3%, Due 8/12)	$	110,030	$	109,699	$	109,699
	(Business Services)	Common Stock (45,528,000 shares)(12)				45,528		60,376
		Warrants(12)				—		—
		Standby Letters of Credit ($7,986)
Broadcast Electronics, Inc.		Senior Loan (9.4%, Due 7/12)		4,925		4,897		4,897
	(Business Services)
Bushnell, Inc.		Subordinated Debt (12.3%, Due 2/14)		41,325		39,685		39,685
	(Consumer Products)
Callidus Debt Partners
	CDO Fund I, Ltd.(4)(10)	Class C Notes (12.9%, Due 12/13)		18,800		18,935		18,988
	(CDO/CLO)	Class D Notes (17.0%, Due 12/13)		9,400		9,467		9,494
Callidus Debt Partners
	CLO Fund III, Ltd. (4)(10)	Preferred Shares (23,600,000 shares,
	(CDO/CLO)	15.0%)(11)				21,980		20,702
Callidus Debt Partners
	CLO Fund IV, Ltd.(4)(10)	Income Notes (13.5%)(11)				12,373		10,758
	(CDO/CLO)
Callidus Debt Partners
	CLO Fund V, Ltd. (4)(10)	Income Notes (20.0%)(11)				13,988		14,649
	(CDO/CLO)
Callidus Debt Partners
	CLO Fund VI, Ltd.(4)(10)	Income Notes (19.8%)(11)				25,662		25,662
	(CDO/CLO)
Callidus MAPS CLO Fund I LLC(10)		Class E Notes (10.7%, Due 12/17)		17,000		17,000		16,401
	(CDO/CLO)	Income Notes (8.7%)(11)				50,090		41,673
Callidus MAPS CLO Fund II, Ltd. (4)(10)		Income Notes (14.8%)(11)				18,061		18,061
	(CDO/CLO)
Camden Partners Strategic Fund II,
	L.P.(5)	Limited Partnership Interest				997		2,382
	(Private Equity Fund)
Carlisle Wide Plank Floors, Inc.		Unitranche Debt (10.0%, Due 6/11)		3,161		3,123		3,123
	(Consumer Products)	Preferred Stock (400,000 Shares)				400		500
Catterton Partners V, L.P.(5)		Limited Partnership Interest				3,510		4,038
	(Private Equity Fund)
Catterton Partners VI, L.P.(5)		Limited Partnership Interest				1,795		1,656
	(Private Equity Fund)
Centre Capital Investors IV, LP(5)		Limited Partnership Interest				2,079		2,170
	(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.
(10)	The fund is managed by Callidus Capital, a portfolio company of Allied Capital.
(11)	Represents the effective interest yield earned on the cost basis of these preferred equity investments and income notes. The yield is included in interest income from companies less than 5% owned in the consolidated statement of operations.
(12)	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.

9

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
CK Franchising, Inc.		Senior Loan (11.0%, Due 7/12)	$	30,150	$	29,959	$	29,959
	(Consumer Services)	Subordinated Debt (15.0%, Due 7/17)		1,000		1,000		1,000
		Preferred Stock (1,486,004 shares)				1,486		1,486
		Common Stock (8,793,408 shares)				8,793		8,793
Commercial Credit Group, Inc.		Subordinated Debt (14.8%, Due 2/11)		12,000		12,025		12,025
	(Financial Services)	Preferred Stock (74,978 shares)				18,018		19,469
		Warrants				—		—
Community Education Centers, Inc.		Subordinated Debt (13.5%, Due 11/13)		34,878		34,800		34,800
	(Education Services)
Compass Group Diversified Holdings, LLC(3)		Senior Loan (8.0%, Due 11/11)		2,000		1,896		1,896
	(Financial Services)
Component Hardware Group, Inc.		Subordinated Debt (13.5%, Due 1/13)		18,363		18,290		18,290
	(Industrial Products)
Cook Inlet Alternative Risk, LLC		Unitranche Debt (10.8%, Due 4/13)		100,000		99,507		99,507
	(Business Services)	Equity Interests				640		1,700
Cortec Group Fund IV, L.P.(5)		Limited Partnership Interest				3,383		2,906
	(Private Equity)
CSAV, Inc.		Subordinated Debt (11.7%, Due 6/13)		37,500		37,500		37,500
	(Business Services)
Diversified Mercury
Communications, LLC		Senior Loan (9.0%, Due 3/13)		233		217		217
	(Business Services)
Digital VideoStream, LLC		Unitranche Debt (11.0%, Due 2/12)		17,677		17,586		17,586
	(Business Services)	Convertible Subordinated Debt
		(10.0%, Due 2/16)		4,017		4,003		4,100
Distant Lands Trading Co.		Senior Loan (10.3%, Due 11/11)		10,000		9,963		9,963
	(Consumer Products)	Unitranche Debt (11.0%, Due 11/11)		42,375		42,216		42,216
		Common Stock (4,000 shares)				4,000		2,652
Driven Brands, Inc.		Senior Loan (8.9%, Due 6/11)		36,070		35,942		35,942
	d/b/a Meineke and Econo Lube	Subordinated Debt (12.1%, Due 6/12 – 6/13)		83,000		82,736		82,736
	(Consumer Services)	Common Stock (11,675,331 shares)(12)				29,455		17,977
		Warrants(12)				—		—
Dynamic India Fund IV (4)(5)		Equity Interests				6,050		6,215
	(Private Equity Fund)
EarthColor, Inc.		Subordinated Debt (15.0%, Due 11/13)		127,000		126,440		126,440
	(Business Services)	Common Stock (73,540 shares)(12)				73,540		42,884
		Warrants(12)				—		—
eCentury Capital Partners, L.P.(5)		Limited Partnership Interest				6,899		2,615
	(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.
(12)	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.

10

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Elexis Beta GmbH(4)		Options			$	426	$	50
	(Industrial Products)
Farley’s & Sathers Candy Company, Inc.		Subordinated Debt (11.4%, Due 3/11)	$	8,000		7,978		7,978
	(Consumer Products)
FCP-BHI Holdings, LLC		Subordinated Debt (12.8%, Due 9/13)		24,000		23,882		23,882
	d/b/a Bojangles’	Equity Interests				1,000		1,000
	(Consumer Products)
Fidus Mezzanine Capital, L.P.(5)		Limited Partnership Interest				3,294		3,294
	(Private Equity Fund)
Frozen Specialties, Inc.		Warrants				435		230
	(Consumer Products)
Garden Ridge Corporation (Retail)		Subordinated Debt (7.0%, Due 5/12)(6)		20,500		20,500		20,500
Geotrace Technologies, Inc.		Subordinated Debt (10.0%, Due 6/09)		7,347		7,167		7,167
	(Energy Services)	Warrants				2,350		3,000
Grant Broadcasting Systems II		Subordinated Debt (5.0%, Due 6/11)		3,005		3,005		3,005
	(Broadcasting & Cable)
Grotech Partners, VI, L.P.(5)		Limited Partnership Interest				8,808		6,970
	(Private Equity Fund)
Havco Wood Products LLC		Senior Loan (9.9%, Due 8/11)		1,150		1,134		1,134
	(Industrial Products)	Unitranche Debt (11.5%, Due 8/11)		7,600		6,740		6,740
		Equity Interests				1,055		3,200
Haven Eldercare of New England, LLC		Subordinated Debt (12.0%, Due 8/09)		1,927		1,927		1,927
	(Healthcare Services)
HealthASPex Services Inc.		Senior Loan (8.0%, Due 7/08)(6)		500		500		133
	(Business Services)
Higginbotham Insurance Agency, Inc.		Senior Loan (7.9%, Due 8/12)		15,196		15,099		15,099
	(Business Services)	Subordinated Debt (13.6%, Due 8/13 – 8/14)		46,855		46,626		46,626
		Common Stock (28,277 shares)(12)				26,522		26,522
		Warrant(12)				—		—
The Hillman Companies, Inc.(3)		Subordinated Debt (10.0%, Due 9/11)		44,580		44,450		44,450
	(Consumer Products)
The Homax Group, Inc.		Senior Loan (9.1%, Due 10/12)		11,027		11,027		11,027
	(Consumer Products)	Subordinated Debt (12.0%, Due 4/14)		14,000		13,225		13,225
		Preferred Stock (89 shares)				89		74
		Common Stock (28 shares)				6		—
		Warrants				1,106		909
Ideal Snacks Corporation		Senior Loan (9.5%, Due 6/10)		35		35		35
	(Consumer Products)
Integrity Interactive Corporation		Unitranche Debt (10.5%, Due 2/12)		12,434		12,331		12,331
	(Business Services)
International Fiber Corporation		Subordinated Debt (14.0%, Due 6/12)		24,447		24,354		24,354
	(Industrial Products)	Preferred Stock (25,000 shares)				2,500		2,200

(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.
(12)	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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Jones Stephens Corporation		Senior Loan (8.9%, Due 9/12)	$	5,558	$	5,545	$	5,545
	(Consumer Products)
K2 Advisors Subsidiary Holdings, LLC		Senior Loan (8.7%, Due 4/13)		9,836		9,836		9,836
	(Business Services)
Kodiak Fund LP(5)		Equity Interests				9,423		2,853
	(Private Equity Fund)
Line-X, Inc.		Senior Loan (12.0%, Due 8/11)		1,100		1,084		1,084
	(Consumer Products)	Unitranche Debt (12.0% Due 8/11)		48,355		48,185		48,185
		Standby Letter of Credit ($1,500)
MedAssets, Inc.		Preferred Stock (227,865 shares)				2,049		3,845
	(Business Services)	Common Stock (50,000 shares)				—		100
Mid-Atlantic Venture Fund IV, L.P. (5)		Limited Partnership Interest				6,975		2,861
	(Private Equity Fund)
NetShape Technologies, Inc.		Senior Loan (8.9%, Due 2/13)		5,661		5,630		5,630
	(Industrial Products)
Network Hardware Resale, Inc.		Unitranche Debt (10.5%, Due 12/11)		20,805		20,913		20,913
	(Business Services)	Convertible Subordinated Debt (9.8%, Due 12/15)		13,242		13,304		14,959
Norwesco, Inc.		Subordinated Debt (12.6%, Due 1/12 – 7/12)		82,812		82,546		82,546
	(Industrial Products)	Common Stock (559,603 shares)(12)				38,313		118,118
		Warrants(12)				—		—
Novak Biddle Venture Partners III, L.P.(5)		Limited Partnership Interest				1,910		1,983
	(Private Equity Fund)
Oahu Waste Services, Inc.		Stock Appreciation Rights				239		1,000
	(Business Services)
Odyssey Investment Partners Fund III, LP(5)		Limited Partnership Interest				1,542		2,162
	(Private Equity Fund)
Passport Health
	Communications, Inc.	Preferred Stock (651,381 shares)				2,000		2,398
	(Healthcare Services)	Common Stock (19,680 shares)				48		48
Pendum, Inc.		Subordinated Debt (17.0%, Due 1/11)(6)		34,028		34,028		—
	(Business Services)	Preferred Stock (82,715 shares)				—		—
		Warrants				—		—
Performant Financial Corporation		Common Stock (478,816 shares)				734		—
	(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.
(12)	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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Postle Aluminum Company, LLC		Unitranche Debt (11.0%, Due 10/12)	$	61,750	$	61,489	$	61,489
	(Industrial Products)	Equity Interests				2,500		3,100
Pro Mach, Inc.		Subordinated Debt (13.0%, Due 6/12)		14,525		14,466		14,466
	(Industrial Products)	Equity Interests				1,500		1,600
Promo Works, LLC		Unitranche Debt (10.3%, Due 12/11)		26,215		25,995		25,995
	(Business Services)	Guaranty ($600)
S.B. Restaurant Company		Unitranche Debt (9.8%, Due 4/11)		29,001		28,739		28,739
	(Retail)	Preferred Stock (54,125 shares)				135		135
		Warrants				619		2,100
		Standby Letters of Credit ($2,540)
SBBUT, LLC		Equity Interests				—		—
	(Consumer Products)
Service Center Metals, LLC		Subordinated Debt (15.5%, Due 9/11)		5,000		4,980		4,980
	(Industrial Products)	Equity Interests				313		337
Snow Phipps Group, L.P.(5)		Limited Partnership Interest				2,317		2,317
	(Private Equity Fund)
SPP Mezzanine Funding, L.P.(5)		Limited Partnership Interest				2,364		2,928
	(Private Equity Fund)
SPP Mezzanine Funding II, L.P.(5)		Limited Partnership Interest				2,750		2,409
	(Private Equity Fund)
Stag-Parkway, Inc.		Unitranche Debt (10.8%, Due 7/12)		51,000		50,799		50,799
	(Business Services)
STS Operating, Inc.		Subordinated Debt (11.0%, Due 1/13)		30,386		30,268		30,268
	(Industrial Products)
Summit Energy Services, Inc.		Senior Loan (10.4%, Due 8/13)		60,000		59,824		59,824
	(Business Services)	Common Stock (89,406 shares)				2,000		2,000
Tappan Wire and Cable Inc.		Senior Loan (15.0%, Due 8/14)		24,100		23,970		23,970
	(Business Services)	Common Stock (15,000 shares)(12)				2,250		2,250
		Warrant(12)				—		—
The Step2 Company, LLC		Unitranche Debt (11.0%, Due 4/12)		96,041		95,672		95,672
	(Consumer Products)	Equity Interests				2,483		3,003
Tradesmen International, Inc.		Subordinated Debt (12.0%, Due 12/09)		9,136		8,668		8,668
	(Business Services)
TransAmerican Auto Parts, LLC		Subordinated Debt (14.0%, Due 11/12)		23,955		23,746		23,746
	(Consumer Products)	Equity Interests				1,198		1,016
Trover Solutions, Inc.		Senior Loan (11.3%, Due 5/12 – 11/12)		77,000		76,725		76,725
	(Business Services)
Universal Air Filter Company		Senior Loan (12.0%, Due 11/12)		14,875		14,810		14,810
	(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.
(12)	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.

13

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			September 30, 2007
Private Finance
Portfolio Company			(unaudited)
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Updata Venture Partners II, L.P.(5)		Limited Partnership Interest			$	4,727	$	6,148
	(Private Equity Fund)
Venturehouse-Cibernet Investors, LLC		Equity Interest				—		54
	(Business Services)
Venturehouse Group, LLC(5)		Equity Interest				—		1,381
	(Private Equity Fund)
VICORP Restaurants, Inc.		Warrants				33		—
	(Retail)
Walker Investment Fund II, LLLP(5)		Limited Partnership Interest				1,330		358
	(Private Equity Fund)
WMA Equity Corporation and Affiliates		Subordinated Debt (13.6%, Due 4/13)	$	125,000		123,971		123,971
	d/b/a Wear Me Apparel	Subordinated Debt (9.0%, Due 4/14)(6)		13,033		13,033		13,033
	(Consumer Products)	Common Stock (100 shares)				46,046		14,428
Webster Capital II, L.P.(5)		Limited Partnership Interest				538		538
	(Private Equity Fund)
Woodstream Corporation		Subordinated Debt (12.0%,
	(Consumer Products)	Due 2/15)		90,000		89,560		89,560
		Common Stock (7,500 shares)				7,500		7,500
		Warrants				—		—
York Insurance Services Group, Inc.		Subordinated Debt (14.5%, Due 1/14)		44,916		44,734		44,734
	(Business Services)	Common Stock (15,000 shares)				1,500		2,000
Other companies		Other debt investments(6)		6,516		6,516		6,511
		Other equity investments				8		—
Total companies less than 5% owned					$	2,601,101	$	2,572,354
Total private finance (151 portfolio investments)					$	4,606,414	$	4,207,128

(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.

14

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

Commercial Real Estate Finance

(in thousands, except number of loans)

							September 30, 2007
			Interest		Number of		(unaudited)
			Rate Ranges		Loans		Cost		Value
Commercial Mortgage Loans
				Up to 6.99%		3	$	20,388	$	19,838
				7.00%–8.99%		8		21,623		21,623
				9.00%–10.99%		3		8,371		8,371
				11.00%–12.99%		1		10,453		10,453
			15.00% and above			2		3,970		3,970
		Total commercial mortgage loans(13)				17	$	64,805	$	64,255
Real Estate Owned							$	15,568	$	21,979
Equity Interests(2) — Companies more than 25% owned							$	15,742	$	33,505
	Guarantees ($6,871)
	Standby Letter of Credit ($1,295)
		Total commercial real estate finance					$	96,115	$	119,739
Total portfolio							$	4,702,529	$	4,326,867

			Yield		Cost		Value
Liquidity Portfolio(14)
	American Beacon Money Market Select FD Fund			5.4%	$	126,410	$	126,410
	American Beacon Money Market Fund			5.2%		40,102		40,102
	SEI Daily Income Tr Prime Obligation Fund			5.2%		34,151		34,151
		Total liquidity portfolio			$	200,663	$	200,663
Other Investments in Money Market Securities(14)
	Columbia Treasury Reserves Money Market Fund			5.3%	$	90,406	$	90,406

 ⁽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.

⁽¹³⁾       Commercial mortgage loans totaling $19.1 million at value were on non-accrual status and therefore were considered non-income producing.

⁽¹⁴⁾       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.

15

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Companies More Than 25% Owned
Alaris Consulting, LLC		Senior Loan (16.5%, Due 12/05 – 12/07)(6)	$	27,055	$	26,987	$	—
	(Business Services)	Equity Interests				5,305		—
		Guaranty ($1,100)
Avborne, Inc.(7)		Preferred Stock (12,500 shares)				610		918
	(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)
Border Foods, Inc.		Preferred Stock (100,000 shares)				12,721		—
	(Consumer Products)	Common Stock (148,838 shares)				3,848		—
Business Loan Express, LLC		Class A Equity Interests(25.0%)(6)		66,622		66,622		66,622
	(Financial Services)	Class B Equity Interests				119,436		79,139
		Class C Equity Interests				109,301		64,976
		Guaranty ($189,706 — See Note 3)
		Standby Letters of Credit ($25,000 —   See Note 3)
Calder Capital Partners, LLC(5)		Senior Loan (8.0%, Due 5/09)(6)		975		975		975
	(Financial Services)	Equity Interests				2,076		2,076
Callidus Capital Corporation		Subordinated Debt (18.0%, Due 10/08)		5,762		5,762		5,762
	(Financial Services)	Common Stock (100 shares)				2,058		22,550
Coverall North America, Inc.		Unitranche Debt (12.0%, Due 7/11)		36,500		36,333		36,333
	(Business Services)	Subordinated Debt (15.0%, Due 7/11)		6,000		5,972		5,972
		Common Stock (884,880 shares)				16,649		19,619
CR Brands, Inc.		Subordinated Debt (16.6%, Due 2/13)		39,573		39,401		39,401
	(Consumer Products)	Common Stock (37,200,551 shares)				33,321		25,738
Financial Pacific Company		Subordinated Debt (17.4%, Due 2/12 – 8/12)		71,589		71,362		71,362
	(Financial Services)	Preferred Stock (10,964 shares)				10,276		15,942
		Common Stock (14,735 shares)				14,819		65,186
ForeSite Towers, LLC		Equity Interests				7,620		12,290
	(Tower Leasing)
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		11,237
		Preferred Equity Interest				14,067		—
		Options				1,639		—
Gordian Group, Inc.		Senior Loan (10.0%, Due 6/06 – 12/08)(6)		11,792		11,803		—
	(Business Services)	Common Stock (1,000 shares)				6,762		—

(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.

16

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Healthy Pet Corp.		Senior Loan (9.9%, Due 8/10)	$	27,038	$	27,038	$	27,038
	(Consumer Services)	Subordinated Debt (15.0%, Due 8/10)		43,720		43,579		43,579
		Common Stock (30,142 shares)				30,142		28,921
HMT, Inc.		Preferred Stock (554,052 shares)				2,637		2,637
	(Energy Services)	Common Stock (300,000 shares)				3,000		8,664
		Warrants				1,155		3,336
Huddle House, Inc.		Senior Loan (8.9%, Due 12/11)		19,950		19,950		19,950
	(Retail)	Subordinated Debt (15.0%, Due 12/12)		58,484		58,196		58,196
		Common Stock (415,328 shares)				41,662		41,662
Impact Innovations Group, LLC		Equity Interests in Affiliate				—		873
	(Business Services)
Insight Pharmaceuticals Corporation		Subordinated Debt (16.1%, Due 9/12)		60,049		59,850		59,850
	(Consumer Products)	Preferred Stock (25,000 shares)				25,000		7,845
		Common Stock (620,000 shares)				6,325		—
Jakel, Inc.		Subordinated Debt (15.5%, Due 3/08)(6)		15,192		15,192		6,655
	(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		4,843
	(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)		692		692		692
	(Business Services)	Equity Interest				1,809		1,199
Mercury Air Centers, Inc.		Subordinated Debt (16.0%, Due 4/09 –
	(Business Services)	11/12)		49,358		49,217		49,217
		Common Stock (57,970 shares)				35,053		195,019
		Standby Letters of Credit ($1,581)
MVL Group, Inc.		Senior Loan (12.0%, Due 6/09 – 7/09)		27,299		27,245		27,245
	(Business Services)	Subordinated Debt (14.5%, Due 6/09)		35,846		35,478		35,478
		Common Stock (648,661 shares)				643		—
Penn Detroit Diesel Allison, LLC		Subordinated Debt (15.5%, Due 8/13)		38,173		37,994		37,994
	(Business Services)	Equity Interests				21,128		25,949
Powell Plant Farms, Inc.		Senior Loan (15.0%, Due 12/07)(6)		35,040		26,192		26,192
	(Consumer Products)	Subordinated Debt (20.0%, Due 6/03)(6)		19,291		19,223		962
		Preferred Stock (1,483 shares)				—		—
		Warrants				—		—
Service Champ, Inc.		Subordinated Debt (15.5%, Due 4/12)		27,733		27,619		27,619
	(Business Services)	Common Stock (63,888 shares)				13,662		16,786

(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.

17

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Staffing Partners Holding
	Company, Inc.	Subordinated Debt (13.5%, Due 1/07)(6)	$	540	$	540	$	486
	(Business Services)
Startec Global Communications
	Corporation	Senior Loan (10.0%, Due 5/07 – 5/09)		15,965		15,965		15,965
	(Telecommunications)	Common Stock (19,180,000 shares)				37,256		11,232
Sweet Traditions, LLC		Senior Loan (9.0%, Due 8/11)		39,022		35,172		35,172
	(Retail)	Equity Interests				450		450
		Standby Letter of Credit ($120)
Triview Investments, Inc.(8)		Senior Loan (9.6%, Due 6/07 – 12/07)		14,758		14,747		14,747
	(Broadcasting & Cable/Business	Subordinated Debt (16.0%, Due 9/11 – 7/12)		56,288		56,008		56,008
	Services/Consumer Products)	Subordinated Debt (7.9%, Due 11/07 – 7/08)(6)		4,327		4,327		4,342
		Common Stock (202 shares)				98,604		31,322
		Guaranty ($800)
		Standby Letter of Credit ($200)
Total companies more than 25% owned					$	1,578,822	$	1,490,180
Companies 5% to 25% Owned
Advantage Sales & Marketing, Inc.		Subordinated Debt (12.0%, Due 3/14)	$	152,320	$	151,648	$	151,648
	(Business Services)	Equity Interests				—		11,000
Air Medical Group Holdings LLC		Senior Loan (9.9%, Due 3/11)		1,828		1,763		1,763
	(Healthcare Services)	Subordinated Debt (14.0%, Due 11/12)		35,180		35,128		35,128
		Equity Interests				3,470		5,950
Alpine ESP Holdings, Inc.		Preferred Stock (622 shares)				622		602
	(Business Services)	Common Stock (13,513 shares)				14		—
Amerex Group, LLC		Subordinated Debt (12.0%, Due 1/13)		8,400		8,400		8,400
	(Consumer Products)	Equity Interests				3,546		13,823
BB&T Capital Partners/Windsor
	Mezzanine Fund, LLC (5)	Equity Interests				5,873		5,554
	(Private Equity Fund)
Becker Underwood, Inc.		Subordinated Debt (14.5%, Due 8/12)		24,244		24,163		24,163
	(Industrial Products)	Common Stock (5,073 shares)				5,813		3,700
BI Incorporated		Subordinated Debt (13.5%, Due 2/14)		30,269		30,135		30,135
	(Business Services)	Common Stock (40,000 shares)				4,000		4,100

(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.
(8)	Triview Investments, Inc. holds investments in Longview Cable & Data, LLC (Broadcasting & Cable) with a cost of $67.3 million and a value of $7.5 million, Triax Holdings, LLC (Consumer Products) with a cost of $98.9 million and a value of $91.5 million, and Crescent Hotels & Resorts, LLC and affiliates (Business Services) with a cost of $7.5 million and a value of $7.3 million.

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

18

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
CitiPostal, Inc. and Affiliates		Senior Loan (11.1%, Due 8/13-11/14)	$	20,670	$	20,569	$	20,569
	(Business Services)	Equity Interests				4,447		4,700
Creative Group, Inc.		Subordinated Debt (12.0%, Due 9/13)		15,000		13,656		13,656
	(Business Services)	Warrant				1,387		1,387
Drew Foam Companies, Inc.		Preferred Stock (722 shares)				722		722
	(Business Services)	Common Stock (7,287 shares)				7		7
MedBridge Healthcare, LLC		Senior Loan (6.0%, Due 8/09)(6)		7,164		7,164		7,164
	(Healthcare Services)	Subordinated Debt (10.0%, Due 8/14)(6)		5,184		5,184		1,813
		Convertible Subordinated Debt (2.0%, Due 8/14)(6)		2,970		984		—
		Equity Interests				1,306		—
Multi-Ad Services, Inc.		Unitranche Debt (11.3%, Due 11/11)		20,000		19,879		19,879
	(Business Services)	Equity Interests				2,000		2,000
Nexcel Synthetics, LLC		Subordinated Debt (14.5%, Due 6/09)		10,998		10,978		10,978
	(Consumer Products)	Equity Interests				1,755		1,486
PresAir LLC		Senior Loan (7.5%, Due 12/10)(6)		5,810		5,492		2,206
	(Industrial Products)	Equity Interests				1,336		—
Progressive International
	Corporation	Subordinated Debt (16.0%, Due 12/09)		7,553		7,533		7,533
	(Consumer Products)	Preferred Stock (500 shares)				500		1,024
		Common Stock (197 shares)				13		2,300
		Warrants				—		—
Regency Healthcare Group, LLC		Senior Loan (11.1%, Due 6/12)		1,250		1,232		1,232
	(Healthcare Services)	Unitranche Debt (11.1%, Due 6/12)		20,000		19,908		19,908
		Equity Interests				1,500		1,616
SGT India Private Limited(4)		Common Stock (109,524 shares)				3,944		3,346
	(Business Services)
Soteria Imaging Services, LLC		Subordinated Debt (11.6%, Due 11/10)		18,500		17,569		17,569
	(Healthcare Services)	Equity Interests				2,163		2,541
Universal Environmental Services, LLC		Unitranche Debt (14.5%, Due 2/09)		10,989		10,962		10,211
	(Business Services)	Equity Interests				1,795		—
Total companies 5% to 25% owned					$	438,560	$	449,813
Companies Less Than 5% Owned
3SI Security Systems, Inc.		Subordinated Debt (14.5%, Due 8/13)	$	26,857	$	26,740	$	26,740
	(Consumer Products)
AgData, L.P.		Unitranche Debt (10.3%, Due 7/12)		11,330		11,269		11,269
	(Consumer Services)
Anthony, Inc.		Subordinated Debt (13.3%, Due 8/11 –
	(Industrial Products)	9/12)		14,818		14,768		14,768
Axium Healthcare Pharmacy, Inc.		Senior Loan (12.0%, Due 12/12)		200		161		161
	(Healthcare Services)	Unitranche Debt (12.0%, Due 12/12)		9,000		8,956		8,956
		Common Stock (26,500 shares)				2,650		2,650
Baird Capital Partners IV Limited Partnership(5) (Private Equity Fund)		Limited Partnership Interest				876		876

(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.

19

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Bantek West, Inc.		Subordinated Debt (11.6%, Due 1/11)(6)	$	30,000	$	30,000	$	21,463
	(Business Services)
Benchmark Medical, Inc.		Warrants				18		—
	(Healthcare Services)
BenefitMall, Inc.		Unitranche Debt (13.3%, Due 8/12)		110,030		109,648		109,648
	(Business Services)	Common Stock (45,528,000 shares)(11)				45,528		43,578
		Warrants(11)				—		—
		Standby Letters of Credit ($9,981)
Breeze-Eastern Corporation(3)		Senior Loan (10.1%, Due 5/11)		10,000		10,000		10,000
	(Industrial Products)
Broadcast Electronics, Inc.		Senior Loan (9.1%, Due 7/12)		4,963		4,930		4,930
	(Business Services)
C&K Market, Inc.		Subordinated Debt (14.0%, Due 12/08)		27,819		27,738		27,738
	(Retail)
Callidus Debt Partners
	CDO Fund I, Ltd. (4)(9)	Class C Notes (12.9%, Due 12/13)		18,800		18,951		18,951
	(CDO/CLO)	Class D Notes (17.0%, Due 12/13)		9,400		9,476		9,476
Callidus Debt Partners
	CLO Fund III, Ltd.(4)(9) (CDO/CLO)	Preferred Shares (23,600,000 shares, 12.7%) (12)				23,285		23,010
Callidus Debt Partners
	CLO Fund IV, Ltd. (4)(9)	Income Notes (13.8%)(12)				12,986		12,986
	(CDO/CLO)
Callidus Debt Partners
	CLO Fund V, Ltd.(4)(9)	Income Notes (15.8%)(12)				13,769		13,769
	(CDO/CLO)
Callidus MAPS CLO Fund I LLC(9)		Class E Notes (10.9%, Due 12/17)		17,000		17,000		17,155
	(CDO/CLO)	Income Notes (15.9%)(12)				50,960		47,421
Camden Partners Strategic Fund II,
	L.P.(5)	Limited Partnership Interest				2,141		2,873
	(Private Equity Fund)
Carlisle Wide Plank Floors, Inc.		Unitranche Debt (10.5%, Due 6/11)		14,000		13,900		13,900
	(Consumer Products)	Preferred Stock (400,000 Shares)				400		400
Catterton Partners V, L.P.(5)		Limited Partnership Interest				3,306		3,412
	(Private Equity Fund)
Catterton Partners VI, L.P.(5)		Limited Partnership Interest				531		531
	(Private Equity Fund)
Centre Capital Investors IV, LP(5)		Limited Partnership Interest				1,991		1,889
	(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.
(9)	The fund is managed by Callidus Capital, a portfolio company of Allied Capital.
(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.
(12)	Represents the effective yield earned on these preferred equity investments. The yield is included in interest income from companies less than 5% owned in the consolidated statement of operations.

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

20

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Commercial Credit Group, Inc.		Subordinated Debt (14.8%, Due 2/11)	$	5,000	$	4,959	$	4,959
	(Financial Services)	Preferred Stock (32,500 shares)				3,900		3,900
		Warrants				—		—
Community Education Centers, Inc.		Subordinated Debt (16.0%, Due 12/10)		34,158		34,067		34,067
	(Education Services)
Compass Group Diversified
	Holdings LLC(3)	Senior Loan (8.4%, Due 11/11)		8,500		8,375		8,375
	(Financial Services)
Component Hardware Group, Inc.		Subordinated Debt (13.5%, Due 1/13)		18,158		18,075		18,075
	(Industrial Products)
Cook Inlet Alternative Risk, LLC		Unitranche Debt (10.0%, Due 4/12)		67,500		67,146		67,146
	(Business Services)	Equity Interests				2,000		2,300
Cortec Group Fund IV, L.P.(5)		Limited Partnership Interest				1,137		1,137
	(Private Equity)
CSAV, Inc.		Subordinated Debt (11.9%, Due 6/13)		37,500		37,500		37,500
	(Business Services)
DCWV Acquisition Corporation		Senior Loan (8.9%, Due 7/12)		2,074		2,060		2,060
	(Consumer Products)	Unitranche Debt (11.0%, Due 7/12)		16,788		16,694		16,694
Deluxe Entertainment Services Group, Inc.		Subordinated Debt (13.6%, Due 7/11)		30,000		30,000		30,000
	(Business Services)
Distant Lands Trading Co.		Senior Loan (10.6%, Due 11/11)		2,700		2,656		2,656
	(Consumer Products)	Unitranche Debt (11.0%, Due 11/11)		54,375		54,130		54,130
		Common Stock (4,000 shares)				4,000		2,975
Drilltec Patents & Technologies
	Company, Inc.	Subordinated Debt (18.0%, Due 8/06)		4,119		4,119		4,119
	(Energy Services)	Subordinated Debt (16.5%, Due 8/06)(6)		10,994		10,918		9,121
Driven Brands, Inc.		Senior Loan (8.9%, Due 6/11)		37,070		36,918		36,918
	d/b/a Meineke and Econo Lube	Subordinated Debt (12.1%, Due 6/12 – 6/13)		83,000		82,684		82,684
	(Consumer Services)	Common Stock (11,675,331 shares)(11)				29,455		19,702
		Warrants(11)				—		—
Digital VideoStream, LLC		Unitranche Debt (11.0%, Due 2/12)		19,127		19,021		19,021
	(Business Services)	Convertible Subordinated Debt (10.0%, Due 2/16)		3,730		3,714		3,714
Dynamic India Fund IV(4)(5)		Equity Interests				3,850		3,850
	(Private Equity Fund)
EarthColor, Inc.		Senior Loan (7.4%, Due 11/11)		35,000		35,000		35,000
	(Business Services)	Subordinated Debt (15.0%, Due 11/13)		107,000		106,478		106,478
		Common Stock (53,540 shares)(11)				53,540		53,540
		Warrants(11)				—		—
eCentury Capital Partners, L.P.(5)		Limited Partnership Interest				6,274		2,090
	(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.

21

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Elexis Beta GmbH(4)		Options			$	426	$	50
	(Industrial Products)
Farley’s & Sathers Candy Company, Inc.		Subordinated Debt (11.4%, Due 3/11)	$	20,000		19,931		19,931
	(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		22,500
Geotrace Technologies, Inc.		Subordinated Debt (10.0%, Due 6/09)		23,945		22,481		22,481
	(Energy Services)	Warrants				2,350		1,900
Ginsey Industries, Inc.		Subordinated Debt (12.5%, Due 3/07)		2,743		2,743		2,743
	(Consumer Products)
Grant Broadcasting Systems II		Subordinated Debt (5.0%, Due 6/11)		3,005		3,005		3,005
	(Broadcasting & Cable)
Grotech Partners, VI, L.P.(5)		Limited Partnership Interest				8,223		6,088
	(Private Equity Fund)
Havco Wood Products LLC		Unitranche Debt (11.1%, Due 8/11)		19,654		18,615		18,615
	(Industrial Products)	Equity Interests				1,049		3,000
Haven Eldercare of New England, LLC (10)		Subordinated Debt (12.0%, Due 8/09)		2,827		2,827		2,827
	(Healthcare Services)
Haven Healthcare Management, LLC(10)		Subordinated Debt (18.0%, Due 4/07)		140		140		140
	(Healthcare Services)
HealthASPex Services Inc.		Senior Loan (4.0%, Due 7/08)		500		500		500
	(Business Services)
The Hillman Companies, Inc.(3)		Subordinated Debt (10.0%, Due 9/11)		44,580		44,427		44,427
	(Consumer Products)
The Homax Group, Inc.		Senior Loan (9.2%, Due 10/12)		12,485		12,485		12,485
	(Consumer Products)	Subordinated Debt (12.0%, Due 4/14)		14,000		13,171		13,171
		Preferred Stock (89 shares)				89		89
		Common Stock (28 shares)				6		6
		Warrants				1,106		1,106
Hot Stuff Foods, LLC		Senior Loan (8.9%, Due 2/11-2/12)		48,580		48,351		48,351
	(Consumer Products)	Subordinated Debt (13.7%, Due 8/12 – 2/13)		60,606		60,353		60,353
		Subordinated Debt (16.0%, Due 2/13)(6)		20,841		20,749		8,460
		Common Stock (1,122,452 shares)(11)				56,186		—
		Warrants(11)				—		—
Ideal Snacks Corporation		Senior Loan (9.0%, Due 6/10)		5,850		5,815		5,815
	(Consumer Products)
Integrity Interactive Corporation		Unitranche Debt (10.5%, Due 2/12)		29,500		29,314		29,314
	(Business Services)
International Fiber Corporation		Subordinated Debt (14.0%, Due 6/12)		21,986		21,914		21,914
	(Industrial Products)	Preferred Stock (25,000 shares)				2,500		2,200

(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.
(10)	Haven Eldercare of New England, LLC and Haven Healthcare Management, LLC are affiliated companies.
(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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Kodiak Fund LP(5)		Equity Interests			$	4,700	$	4,656
	(Private Equity Fund)
Line-X, Inc.		Senior Loan (9.1%, Due 8/11)	$	2,000		1,981		1,981
	(Consumer Products)	Unitranche Debt (10.0% Due 8/11)		48,509		48,306		48,306
		Standby Letter of Credit ($1,500)
MedAssets, Inc.		Preferred Stock (227,865 shares)				2,049		3,623
	(Business Services)	Common Stock (50,000 shares)				—		250
MHF Logistical Solutions, Inc.		Subordinated Debt (11.5%, Due 6/12)		33,600		33,448		33,448
	(Business Services)	Subordinated Debt (18.0%, Due 6/13)(6)		11,211		11,155		8,719
		Common Stock (20,934 shares)(11)				20,942		—
		Warrants(11)				—		—
Mid-Atlantic Venture Fund IV, L.P.(5)		Limited Partnership Interest				6,974		3,221
	(Private Equity Fund)
Mogas Energy, LLC		Subordinated Debt (9.5%, Due 3/12 – 4/12)		16,336		15,100		16,318
	(Energy Services)	Warrants				1,774		6,250
Network Hardware Resale, Inc.		Unitranche Debt (10.5%, Due 12/11)		37,154		37,357		37,357
	(Business Services)	Convertible Subordinated Debt (9.8%, Due 12/15)		12,000		12,068		12,559
Norwesco, Inc.		Subordinated Debt (12.6%, Due 1/12 – 7/12)		82,486		82,172		82,172
	(Industrial Products)	Common Stock (559,603 shares)(11)				38,313		83,329
		Warrants(11)				—		—
Novak Biddle Venture Partners III, L.P.(5)		Limited Partnership Interest				1,834		1,947
	(Private Equity Fund)
Oahu Waste Services, Inc.		Stock Appreciation Rights				239		800
	(Business Services)
Odyssey Investment Partners Fund III,
	LP(5)	Limited Partnership Interest				1,883		1,744
	(Private Equity Fund)
Palm Coast Data, LLC		Senior Loan (8.9%, Due 8/10)		15,306		15,243		15,243
	(Business Services)	Subordinated Debt (15.5%, Due 8/12 – 8/15)		30,396		30,277		30,277
		Common Stock (21,743 shares)(11)				21,743		41,707
		Warrants(11)				—		—
Passport Health
	Communications, Inc.	Subordinated Debt (14.0%, Due 4/12)		10,145		10,101		10,101
	(Healthcare Services)	Preferred Stock (651,381 shares)				2,000		2,189
Performant Financial Corporation		Common Stock (478,816 shares)				734		—
	(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.
(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.

23

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Postle Aluminum Company, LLC		Unitranche Debt (11.0%, Due 10/12)	$	57,500	$	57,189	$	57,189
	(Industrial Products)	Equity Interests				2,500		2,500
Pro Mach, Inc.		Subordinated Debt (12.5%, Due 6/12)		14,471		14,402		14,402
	(Industrial Products)	Equity Interests				1,500		2,200
Promo Works, LLC		Unitranche Debt (10.3%, Due 12/11)		31,000		30,727		30,727
	(Business Services)	Guaranty ($1,200)
S.B. Restaurant Company		Unitranche Debt (9.8%, Due 4/11)		41,501		41,094		41,094
	(Retail)	Preferred Stock (54,125 shares)				135		135
		Warrants				619		1,200
		Standby Letters of Credit ($2,611)
SBBUT, LLC		Equity Interests				—		—
	(Consumer Products)
Service Center Metals, LLC		Subordinated Debt (15.5%, Due 9/11)		5,000		4,976		4,976
	(Industrial Products)	Equity Interests				312		318
Soff-Cut Holdings, Inc.		Preferred Stock (300 shares)				300		300
	(Industrial Products)	Common Stock (2,000 shares)				200		180
SPP Mezzanine Funding, L.P.(5)		Limited Partnership Interest				2,551		2,825
	(Private Equity Fund)
SPP Mezzanine Funding II, L.P.(5)		Limited Partnership Interest				326		326
	(Private Equity Fund)
Stag-Parkway, Inc.		Unitranche Debt (10.8%, Due 7/12)		63,000		62,711		62,711
	(Business Services)
STS Operating, Inc.		Subordinated Debt (15.0%, Due 1/13)		30,156		30,021		30,021
	(Industrial Products)
The Step2 Company, LLC		Unitranche Debt (10.5%, Due 4/12)		67,898		67,457		67,457
	(Consumer Products)	Equity Interests				2,000		1,763
Tradesmen International, Inc.		Subordinated Debt (12.0%, Due 12/09)		15,000		14,468		14,468
	(Business Services)	Warrants				710		3,300
TransAmerican Auto Parts, LLC		Subordinated Debt (14.0%, Due 11/12)		12,947		12,892		12,892
	(Consumer Products)	Equity Interests				1,190		747
Universal Air Filter Company		Unitranche Debt (11.0%, Due 11/11)		19,117		19,026		19,026
	(Industrial Products)
Updata Venture Partners II, L.P.(5)		Limited Partnership Interest				5,477		5,158
	(Private Equity Fund)
Venturehouse-Cibernet Investors, LLC		Equity Interest				42		42
	(Business Services)
Venturehouse Group, LLC(5)		Equity Interest				598		365
	(Private Equity Fund)
VICORP Restaurants, Inc.		Warrants				33		—
	(Retail)

(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.

24

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment(1)(2)	Principal		Cost		Value
Walker Investment Fund II, LLLP(5)		Limited Partnership Interest			$	1,329	$	458
	(Private Equity Fund)
Wear Me Apparel Corporation		Subordinated Debt (15.0%, Due 12/10)	$	40,000		39,407		39,407
	(Consumer Products)	Warrants				1,219		5,120
Wilton Industries, Inc.		Subordinated Debt (16.0%, Due 6/08)		2,400		2,400		2,400
	(Consumer Products)
Woodstream Corporation		Subordinated Debt (13.5%, Due 11/12 – 5/13)		53,114		52,989		52,989
	(Consumer Products)	Common Stock (180 shares)				673		3,885
		Warrants				—		2,815
York Insurance Services Group, Inc.		Subordinated Debt (14.5%, Due 1/14)		44,249		44,045		44,045
	(Business Services)	Common Stock (15,000 shares)				1,500		1,500
Other companies		Other debt investments(6)		223		223		218
		Other equity investments				8		—
Total companies less than 5% owned					$	2,479,981	$	2,437,908
Total private finance (145 portfolio investments)					$	4,497,363	$	4,377,901

(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.

25

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)

Commercial Real Estate Finance

(in thousands, except number of loans)

						December 31, 2006
		Interest		Number of
		Rate Ranges		Loans		Cost		Value
Commercial Mortgage Loans
			Up to 6.99%		3	$	20,470	$	19,692
			7.00%–8.99%		9		24,092		24,073
			9.00%–10.99%		4		24,117		24,117
		15.00% and above			2		3,970		3,970
	Total commercial mortgage loans(13)				18	$	72,649	$	71,852
Real Estate Owned						$	15,708	$	19,660
Equity Interests(2) — Companies more than 25% owned (Guarantees — $6,871)						$	15,189	$	26,671
	Total commercial real estate finance					$	103,546	$	118,183
Total portfolio						$	4,600,909	$	4,496,084

			Yield		Cost		Value
Liquidity Portfolio
	American Beacon Money Market Select FD Fund(14)			5.3%	$	85,672	$	85,672
	Certificate of Deposit (Due March 2007)(14)			5.6%		40,565		40,565
	American Beacon Money Market Fund(14)			5.2%		40,384		40,384
	SEI Daily Income Tr Prime Obligation Fund(14)			5.2%		34,671		34,671
	Blackrock Liquidity Funds(14)			5.2%		476		476
		Total liquidity portfolio			$	201,768	$	201,768
Other Investments in Money Market Securities(14)
	Columbia Treasury Reserves Money Market Fund			5.2%	$	441	$	441
	Columbia Money Market Reserves			5.2%	$	1	$	1

 ⁽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.

⁽¹³⁾       Commercial mortgage loans totaling $18.9 million at value were on non-accrual status and therefore were considered non-income producing.

⁽¹⁴⁾       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.

26

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information at and for the three and nine months ended September 30, 2007 and 2006 is unaudited)

Note 1. Organization

      Allied Capital Corporation, a Maryland corporation, is a closed-end, non-diversified 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 real estate investment trust subsidiary, Allied Capital REIT, Inc. (“Allied REIT”), and several subsidiaries that are single member limited liability companies established for specific purposes, including holding real estate properties. ACC also has a subsidiary, A.C. Corporation (“AC Corp”), that generally provides diligence and structuring services, as well as transaction, management, consulting, and other services, including underwriting and arranging senior loans, to the Company and its portfolio companies.

      ACC and its subsidiaries, collectively, are referred to as the “Company.” The Company consolidates the results of its subsidiaries for financial reporting purposes.

      Pursuant to Article 6 of Regulation S-X, the financial results of the Company’s portfolio investments are not consolidated in the Company’s financial statements. Portfolio investments are held for purposes of deriving investment income and future capital gains.

      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 debt and equity securities of private companies in a variety of industries.

Note 2. Summary of Significant Accounting Policies

  Basis of Presentation

      The consolidated financial statements include the accounts of ACC and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2006 balances to conform with the 2007 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 September 30, 2007, the results of operations for the three and nine months ended September 30, 2007 and 2006, and changes in net assets and cash flows for the nine months ended September 30, 2007 and 2006. The results of operations for the three and nine months ended September 30, 2007, 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% of the outstanding voting securities of such portfolio company or where the Company controls the portfolio company’s board of directors 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

27

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

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, including investments in money market and other securities, 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

      The Company’s loans and debt securities generally do not trade. The Company typically exits its loans and debt securities upon the sale or recapitalization of the portfolio company. Therefore, the Company generally determines the enterprise value of the portfolio company and then allocates that value to the loans and debt securities in order of the legal priority of contractual obligations, with the remaining value, if any, going to the portfolio company’s outstanding equity 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 or recapitalization of the portfolio company is greater than the Company’s cost basis.

      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

28

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

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 on loans and debt securities 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 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.

      The weighted average yield on loans and debt securities is computed as the (a) annual stated interest on accruing loans and debt securities 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, multiples at which private companies are bought and sold, 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 the company has a minority ownership position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.

      The value of the Company’s equity investments in private debt and equity funds are generally valued at the fund’s net asset value. 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 securities is recorded on the record date for private companies or on the ex-dividend date for publicly traded companies.

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Note 2. Summary of Significant Accounting Policies, continued

     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, re-investment 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, re-investment 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 interest income on the preferred shares/income notes using the effective interest method, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the preferred share/income notes from the date the estimated yield was changed. CDO and CLO bonds have stated interest rates.

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 period, 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 loan prepayment premiums, 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. Loan prepayment premiums are recognized at the time of prepayment. 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.

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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. Guarantees made on behalf of portfolio companies are considered in determining the fair value of the Company’s investments. 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 are recorded as a reduction to the proceeds from the sale of common stock. Financing costs generally include underwriting, accounting and legal fees, and printing costs.

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 FASB Statement No. 123 (Revised 2004), Share-Based Payment (the “SFAS 123R”). The SFAS 123R was adopted using the modified prospective method of application, which required the Company to recognize compensation costs on a prospective basis beginning January 1, 2006. Accordingly, the Company did not restate prior year financial statements. 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, using the fair value amounts determined for pro forma disclosure under the SFAS 123R. With respect to options granted on or after January 1, 2006, compensation cost based on estimated grant date fair value is recognized over the related service period in the consolidated statement of operations. The stock option expense for the three and nine months ended September 30, 2007 and 2006, was as follows:

				For the Three				For the Nine
				Months				Months
				Ended				Ended
				September 30,				September 30,
				2007		2006		2007		2006
($ in millions, except per share amounts)
Employee Stock Option Expense:
	Options granted:
		Previously awarded, unvested options as of January 1, 2006		$	1.7	$	3.2	$	8.2	$	9.9
		Options granted on or after January 1, 2006			2.2		0.4		8.9		2.0
			Total options granted		3.9		3.6		17.1		11.9
	Options cancelled in connection with tender offer (see Note 9)				14.4		—		14.4		—
			Total employee stock option expense	$	18.3	$	3.6	$	31.5	$	11.9
		Per basic share		$	0.12	$	0.03	$	0.21	$	0.08
		Per diluted share		$	0.12	$	0.02	$	0.20	$	0.08

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Note 2. Summary of Significant Accounting Policies, continued

      Options Granted. In addition to the employee stock option expense for options granted, for both the nine months ended September 30, 2007 and 2006, administrative expense included $0.2 million of expense related to options granted to directors during each respective period. Options were granted to non-officer directors in the second quarters of 2007 and 2006. Options granted to non-officer directors vest on the grant date and therefore, the full expense is recorded on the grant date.

      The stock option expense for options granted shown in the table above was 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 weighted average assumptions were used to calculate the fair value of options granted during the three and nine months ended September 30, 2007 and 2006:

	For the Three						For the Nine
	Months Ended						Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
Expected term (in years)		5.0			5.0			5.0			5.0
Risk-free interest rate		4.6	%		4.7	%		4.6	%		4.8	%
Expected volatility		24.4	%		26.8	%		26.4	%		29.1	%
Dividend yield		8.9	%		9.0	%		8.9	%		9.0	%
Weighted average fair value per option	$	2.51		$	3.12		$	2.96		$	3.47

      The expected term of the options granted represents the period of time that such options are expected to be outstanding. To determine the expected term of the options, the Company used historical data to estimate option exercise time frames, including considering employee terminations. The risk free rate was based on the U.S. Treasury bond yield curve at the date of grant. Expected volatilities were determined based on the historical volatility of the Company’s common stock over a historical time period consistent with the expected term. The dividend yield was determined based on the Company’s historical dividend yield over a historical time period consistent with the expected term.

      To determine the stock options expense for options granted, the calculated fair value of the options granted is applied to the options granted, net of assumed future option forfeitures. The Company estimates that the employee-related stock option expense under SFAS 123R that will be recorded in the Company’s statement of operations, excluding the expense related to the options cancelled in connection with the tender offer, will be approximately $21.0 million, $9.5 million, and $2.8 million for the years ended December 31, 2007, 2008, and 2009, respectively, which includes approximately $10.9 million, $6.6 million, and $2.8 million, respectively, related to options granted since adoption of SFAS 123R (January 1, 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 September 30, 2007, is expected to be recognized over an estimated weighted-average period of 1.2 years.

      Options Cancelled in Connection with Tender Offer. As discussed in Note 9, the Company completed a tender offer in July 2007, whereby the Company accepted for cancellation 10.3 million vested options held by employees and non-officer directors of the Company in exchange for an option cancellation payment (“OCP”). The OCP was equal to the “in-the-money” value of the stock

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

options cancelled, determined using the Weighted Average Market Price of $31.75, and was paid one-half in cash and one-half in unregistered shares of the Company’s common stock. In accordance with the terms of the tender offer, the Weighted Average Market Price represented the volume weighted average price of the Company’s common stock over the fifteen trading days preceding the first day of the offer period, or June 20, 2007. Because the Weighted Average Market Price at the commencement of the tender offer on June 20, 2007, was higher than the market price of the Company’s common stock at the close of the offer on July 18, 2007, SFAS 123R required the Company to record employee-related stock option expense of $14.4 million and administrative expense related to stock options cancelled that were held by non-officer directors of $0.4 million. The same amounts were recorded as an increase to additional paid-in capital and, therefore, had no effect on the Company’s net asset value. The portion of the OCP paid in cash of $52.8 million reduced the Company’s additional paid-in capital and therefore reduced the Company’s net asset value. For income tax purposes, the Company’s tax deduction resulting from the OCP will be similar to the tax deduction that would have resulted from an exercise of stock options in the market. Any tax deduction for the Company resulting from the OCP or an exercise of stock options in the market is limited by Section 162(m) of the Code for persons subject to Section 162(m).

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 exclusive of excise taxes for these entities.

      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 during the year earned. 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 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.

      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.

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.

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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 $4.3 billion and $4.5 billion at September 30, 2007, and December 31, 2006, respectively. At September 30, 2007, and December 31, 2006, 89% and 92%, respectively, of the Company’s total assets represented portfolio investments whose fair values had 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.

Recent Accounting Pronouncements

      In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The adoption of this interpretation did not have a significant effect on the Company’s consolidated financial position or its results of operations.

      In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently analyzing the effect of adoption of this statement on its consolidated financial position and results of operations.

      In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value. This statement applies to all reporting entities, and contains financial statement presentation and disclosure requirements for assets and liabilities reported at fair value as a consequence of the election. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently analyzing the effect of adoption of this statement on its consolidated financial position and results of operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio

Private Finance

      At September 30, 2007, and December 31, 2006, the private finance portfolio consisted of the following:

			2007							2006
			Cost		Value		Yield(1)			Cost		Value		Yield(1)
($ in millions)
Loans and debt securities:
	Senior loans		$	523.9	$	481.6		9.3	%	$	450.0	$	405.2		8.4	%
	Unitranche debt(2)			698.1		698.1		11.5	%		800.0		799.2		11.2	%
	Subordinated debt			2,052.7		1,927.1		12.6	%		2,038.3		1,980.8		12.9	%
		Total loans and debt securities(3)		3,274.7		3,106.8		11.8	%		3,288.3		3,185.2		11.9	%
Equity securities:
	Preferred shares/income notes of CLOs (4)			142.2		131.5		15.1	%		101.1		97.2		15.5	%
	Other equity securities			1,189.5		968.8					1,108.0		1,095.5
		Total equity securities		1,331.7		1,100.3					1,209.1		1,192.7
		Total	$	4,606.4	$	4,207.1				$	4,497.4	$	4,377.9

(1)	The weighted average yield on loans and debt securities is computed as the (a) annual stated interest on accruing loans and debt securities 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 September 30, 2007, and December 31, 2006, the cost and value of subordinated debt included the Class A equity interests in BLX and the guaranteed dividend yield on these equity interests, to the extent it was accrued, was included in interest income. During the fourth quarter of 2006, the Class A equity interests were placed on non-accrual status. The weighted average yield on the preferred shares/income notes of CLOs is calculated as the (a) effective interest yield on the preferred shares/income notes of CLOs, divided by (b) total preferred shares/income notes of CLOs at value. The weighted average yields are computed as of the balance sheet date. The yield on the CLO assets represents the yield used for recording interest income. The market yield used in the valuation of the CLO assets may be different than the interest yields.
(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 $3,298.5 million and $3,322.3 million at September 30, 2007, and December 31, 2006, respectively. The difference between principal and cost is represented by unamortized loan origination fees and costs, original issue discounts, and market discounts totaling $23.8 million and $34.0 million at September 30, 2007, and December 31, 2006, respectively.
(4)	Investments in the preferred shares/income notes of CLOs earn a current return that is included in interest income in the accompanying consolidated statement of operations.

     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 debt and equity 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,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

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 September 30, 2007, and December 31, 2006, 89% and 86%, respectively, of the private finance loans and debt securities had a fixed rate of interest and 11% and 14%, respectively, had a floating rate of interest. Senior loans may carry a fixed rate of interest or a floating rate of interest, usually set as a spread over LIBOR, and may require payments of both principal and interest throughout the life of the loan. Senior loans generally have contractual maturities of three to six years and interest is generally paid to the Company monthly or quarterly. Unitranche debt generally carries a fixed rate of interest and may require payments of both principal and interest throughout the life of the loan. Unitranche debt generally has contractual maturities of five to six years and interest is generally paid to the Company quarterly. Subordinated debt generally carries a fixed rate of interest generally with contractual maturities of five to ten years and generally has 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 or may receive equity features, such as nominal cost warrants, 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.

      Business Loan Express, LLC. BLX originates, sells, and services primarily real estate secured loans, including real estate secured conventional loans, loans under the Small Business Administration’s 7(a) Guaranteed Loan Program, and small commercial real estate loans. BLX is headquartered in New York, NY.

      The Company’s investment in BLX totaled $324.6 million at cost and $136.7 million at value, which included unrealized depreciation of $187.9 million, at September 30, 2007, and $295.3 million at cost and $210.7 million at value, which included unrealized depreciation of $84.6 million, at December 31, 2006. In the first half of 2007, the Company increased its investment in BLX by $29.2 million by acquiring additional Class A equity interests. In addition, in the first quarter of 2007, the chief executive officer of BLX invested $3.0 million in the form of Class A equity interests in BLX. The Company plans to purchase these interests from him in conjunction with a restructuring of BLX’s operations. The purpose of these additional investments was to fund payments to the SBA in the first quarter of 2007 discussed below and to provide additional equity capital to BLX.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      Total interest and related portfolio income earned from the Company’s investment in BLX for the three and nine months ended September 30, 2007 and 2006, was as follows:

		For the Three				For the Nine
		Months Ended				Months Ended
		September 30,				September 30,
		2007		2006		2007		2006
($ in millions)
Interest income on subordinated debt and Class A equity interests		$	—	$	4.1	$	—	$	11.9
Fees and other income			1.3		2.0		4.1		6.3
	Total interest and related portfolio income	$	1.3	$	6.1	$	4.1	$	18.2

      Interest and dividend income from BLX for the three and nine months ended September 30, 2006, included interest income of $2.0 million and $5.7 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. In the fourth quarter of 2006, the Company placed its investment in BLX’s 25% Class A equity interests on non-accrual status. As a result, there was no interest income from the Company’s investment in BLX for the three or nine months ended September 30, 2007.

      In consideration for providing a guaranty on BLX’s revolving credit facility and standby letters of credit (discussed below), the Company earned fees of $1.3 million and $4.1 million for the three and nine months ended September 30, 2007, respectively, and $1.5 million and $4.6 million for the three and nine months ended September 30, 2006, respectively, which were included in fees and other income. As of September 30, 2007, BLX had not yet paid the $4.1 million in such fees earned by the Company in 2007 and, as a result, such fees were included as a receivable in other assets. The remaining fees and other income in 2006 relate to management fees from BLX. The Company has not charged BLX management fees in 2007.

      Net change in unrealized appreciation or depreciation included a net decrease of $84.1 million and $103.2 million for the three and nine months ended September 30, 2007, respectively. Net change in unrealized appreciation or depreciation for the three and nine months ended September 30, 2006, included a net decrease of $34.3 million and $67.9 million, respectively, on the Company’s investment in BLX.

      BLX is a national, non-bank lender that currently participates in the SBA’s 7(a) Guaranteed Loan Program and its wholly-owned subsidiary is licensed by the SBA as a Small Business Lending Company (SBLC). The Office of the Inspector General of the SBA (OIG) and the United States Secret Service are conducting ongoing investigations of allegedly fraudulently obtained SBA-guaranteed loans issued by BLX. Specifically, on or about January 9, 2007, BLX became aware of an indictment captioned as the United States v. Harrington, No. 2:06-CR-20662 pending in the United States District Court for the Eastern District of Michigan. The indictment alleged that a former BLX employee in the Detroit office engaged in the fraudulent origination of loans guaranteed, in substantial part, by the SBA. The Company understands that BLX is working cooperatively with the U.S. Attorney’s Office and the investigating agencies with respect to this matter. On October 1, 2007, the former BLX employee pled guilty to one count of conspiracy to fraudulently originate SBA-guaranteed loans and one count of making a false statement before a grand jury. The OIG and the U.S. Department of Justice are also conducting a civil investigation of BLX’s lending practices in

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

various jurisdictions. As an SBA lender, BLX is also subject to other SBA and OIG audits, investigations, and reviews. In addition, the Office of the Inspector General of the U.S. Department of Agriculture is conducting an investigation of BLX’s lending practices under the Business and Industry Loan (B&I) program. These investigations, audits and reviews are ongoing.

      These investigations, audits and reviews, 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 the Company’s financial results. The Company has considered BLX’s current regulatory issues and ongoing investigations and litigation in performing the valuation of BLX at September 30, 2007. The Company is monitoring the situation.

      On March 6, 2007, BLX entered into an agreement with the SBA. According to the agreement, BLX remains a preferred lender in the SBA 7(a) Guaranteed Loan Program and retains the ability to sell loans into the secondary market. As part of this agreement, BLX agreed to the immediate payment of approximately $10 million to the SBA to cover amounts paid by the SBA with respect to some of the SBA-guaranteed loans that have been the subject of the charges by the U.S. Attorney’s Office for the Eastern District of Michigan against Mr. Harrington. As part of the SBA’s increased oversight, the agreement provides that any loans originated and closed by BLX during the term of the agreement will be reviewed by an independent third party selected by the SBA prior to the sale of such loans into the secondary market. The agreement also requires BLX to repurchase the guaranteed portion of certain loans that default after having been sold into the secondary market, and subjects such loans to a similar third party review prior to any reimbursement of BLX by the SBA. In connection with this agreement, BLX also entered into an escrow agreement with the SBA and an escrow agent in which BLX agreed to deposit $10 million with the escrow agent for any additional payments BLX may be obligated to pay to the SBA in the future. BLX remains subject to SBA rules and regulations and as a result may be required to make additional payments to the SBA in the ordinary course of business. The agreement states that nothing in the agreement shall affect the rights of BLX to securitize or service its loans. Notwithstanding the foregoing, in October 2007, BLX received a notice from the SBA that outlines certain conditions to the SBA’s authorization for BLX to securitize the unguaranteed portions of SBA loans.

      BLX has a separate non-recourse warehouse facility to enable it to securitize the unguaranteed portion of its SBA loans. BLX has been receiving temporary extensions of the warehouse facility, and the current extension expires on December 31, 2007. BLX is in negotiations with the warehouse facility providers to renew and amend the facility. If the current facility were to expire without renewal, the warehouse facility notes would become due and payable, and substantially all collections on the unguaranteed interests that currently are in the warehouse facility would be applied to repay the outstanding amounts owing to the warehouse providers until the warehouse providers were paid in full, similar to an amortizing term loan. In this event, the warehouse providers would not have recourse to BLX for repayment of the warehouse facility notes. In addition, BLX would not have the right to sell additional unguaranteed interests in SBA loans into this facility. In the event that BLX is unable to meet the SBA’s conditions for securitization of the unguaranteed portions of SBA loans discussed above or if the warehouse providers do not agree to an extension of the warehouse facility,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

BLX will be required to seek alternative sources of capital to finance SBA loan originations and could incur higher capital costs.

      At September 30, 2007, BLX had a three-year $500.0 million revolving credit facility provided by third-party lenders that matures in March 2009. The revolving credit facility may be expanded to $600.0 million through new or additional commitments at BLX’s option. This 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. Upon the closing of this revolving credit facility in January 2006, the Company agreed to provide 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. On September 27, 2007, the Company increased the guaranty amount to 60% of the total obligations in connection with an amendment to and waivers under the facility as discussed below. At September 30, 2007, the principal amount outstanding on the revolving credit facility was $322.5 million and letters of credit issued under the facility were $89.5 million. The total obligation guaranteed by the Company at September 30, 2007, was $249.0 million. At September 30, 2007, the Company had also provided four standby letters of credit totaling $19.0 million in connection with four term securitization transactions completed by BLX.

      The guaranty on the BLX revolving line of credit facility can be called by the lenders in the event of a default, which includes the occurrence of certain defaults under the Company’s revolving credit facility. Among other requirements, the BLX facility requires that BLX maintain compliance with certain financial covenants such as interest coverage, maximum debt to net worth, asset coverage, and maintenance of certain asset quality metrics. In addition, BLX would have an event of default if BLX failed to maintain its lending status with the SBA and such failure could reasonably be expected to result in a material adverse effect on BLX, or if BLX failed to maintain certain financing programs for the sale or long-term funding of BLX’s loans. In September 2007, BLX received waivers until January 31, 2008, from its lenders with respect to non-compliance with certain facility covenants, and amended certain facility covenants through January 31, 2008. In addition, BLX previously received waivers from its lenders with respect to certain other covenants to permit BLX to comply with its obligations under its agreement with the SBA. BLX’s agreement with the SBA has reduced BLX’s liquidity due to the working capital required to comply with the agreement. BLX is in negotiations with its lenders to amend the credit facility covenants, but there can be no assurance that such negotiations will be successful. If the credit facility lenders do not agree to amend the covenants or to waive compliance with the covenants in periods subsequent to January 31, 2008, BLX would be in default under the credit facility.

      On or about January 16, 2007, BLX and its subsidiary Business Loan Center LLC (BLC) became aware of a lawsuit titled, United States, ex rel James R. Brickman and Greenlight Capital, Inc. v. Business Loan Express LLC f/k/a Business Loan Express, Inc.; Business Loan Center LLC f/k/a Business Loan Center, Inc.; Robert Tannenhauser; Matthew McGee; and George Harrigan, 05-CV-3147 (JEC), that is pending in the United States District Court for the Northern District of Georgia. The complaint includes allegations arising under the False Claims Act and relating to alleged fraud in connection with SBA guarantees on shrimp vessel loans made by BLX and BLC. On April 9, 2007, BLX, BLC and the other defendants filed motions to dismiss the complaint in its entirety. The motions are pending.

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      At December 31, 2006, the Company held all of BLX’s Class A and Class B equity interests, and 94.9% of the Class C equity interests. At September 30, 2007, the Company held 97.1% of the Class A equity interests, all of the Class B equity interests and 94.9% of the Class C equity interests. BLX has an equity appreciation rights plan for management that may dilute the value available to the Class C equity interest holders. 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. BLX’s taxable income is first allocated to the Class A equity interests to the extent that guaranteed dividends are paid in cash or in kind on such interests, with the remainder being allocated to the Class B and C equity interests.

      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 the 10-year period following the date of the reorganization. At such time, the built-in gains realized upon the disposition of these assets will be included in the Company’s taxable income, net of the corporate level taxes paid by the Company on the built-in gains. 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, if any, in the future should the Company intend to sell the assets of or its interests in BLX within the 10-year period. At September 30, 2007, and December 31, 2006, the Company considered the impact on the fair value of its investment in BLX due to BLX’s tax attributes as an LLC and has also considered the impact on the fair value of its investment due to estimated built-in gain taxes, if any, in determining the fair value of its investment in BLX.

      Mercury Air Centers, Inc. In April 2004, the Company completed the purchase of a majority ownership in Mercury Air Centers, Inc. (“Mercury”).

      At December 31, 2006, the Company’s investment in Mercury totaled $84.3 million at cost and $244.2 million at value, which included unrealized appreciation of $159.9 million.

      In August 2007, the Company completed the sale of its majority equity interest in Mercury and realized a gain of $259.5 million, subject to post-closing adjustments. Approximately $11 million of the Company’s proceeds from the sale of its equity is subject to certain holdback provisions. In addition, the Company was repaid approximately $51 million of subordinated debt outstanding to Mercury at closing.

      Mercury owned and operated fixed base operations generally under long-term leases from local airport authorities, which consisted of terminal and hangar complexes that serviced the needs of the general aviation community. Mercury was headquartered in Richmond Heights, OH.

40

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      Total interest and related portfolio income earned from the Company’s investment in Mercury for the three and nine months ended September 30, 2007 and 2006, was as follows:

		For the Three				For the Nine
		Months Ended				Months Ended
		September 30,				September 30,
		2007		2006		2007		2006
($ in millions)
Interest income		$	1.0	$	2.0	$	5.1	$	7.3
Fees and other income			—		0.1		0.2		0.4
	Total interest and related portfolio income	$	1.0	$	2.1	$	5.3	$	7.7

      Net change in unrealized appreciation or depreciation for the three months ended September 30, 2007, included the reversal of $234.8 million of previously recorded unrealized appreciation associated with the realization of a gain on the sale of the Company’s majority equity interest in Mercury. Net change in unrealized appreciation or depreciation for the nine months ended September 30, 2007, included an increase in unrealized appreciation totaling $74.9 million for the first half of 2007 and the reversal of $234.8 million associated with the sale of the Company’s majority equity interest in the third quarter of 2007. Net change in unrealized appreciation or depreciation for the three and nine months ended September 30, 2006, included an increase in unrealized appreciation of $59.8 million and $64.1 million, respectively, related to the Company’s investment in Mercury.

      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.

      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 at closing on its equity investment sold of $433.1 million, subject to post-closing adjustments. Subsequent to closing on this sale, the Company realized additional gains in 2006 resulting from post-closing adjustments totaling $1.3 million. The Company’s realized gain was $434.4 million for the year ended December 31, 2006, subject to post-closing adjustments and excluding any earn-out amounts. In addition, the Company was entitled to receive additional consideration through an earn-out payment based on Advantage’s 2006 audited results. The earn-out payment totaled $3.1 million, subject to potential post-determination adjustments, and was recorded as a realized gain in the second quarter of 2007.

      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. In addition, a portion of the Company’s cash proceeds from the sale of the common stock were placed in escrow, subject to certain holdback provisions. At September 30, 2007, the amount of the escrow included in other assets in the accompanying consolidated balance sheet was approximately $25 million.

      Total interest and related portfolio income earned from the Company’s investment in Advantage while the Company held a majority equity interest for the nine months ended September 30, 2006, was $14.1 million. Net change in unrealized appreciation or depreciation for the nine months ended

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

September 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 in the first quarter of 2006.

      In connection with the sale transaction, the Company retained an equity investment in the business valued at $15 million at closing as a minority shareholder. During the fourth quarter of 2006, Advantage made a distribution on this minority equity investment, which reduced the Company’s cost basis to zero and resulted in a realized gain of $4.8 million.

      The Company’s investment in Advantage, which was composed of subordinated debt and a minority equity interest, totaled $154.0 million at cost and $165.0 million at value at September 30, 2007, and $151.6 million at cost and $162.6 million at value at December 31, 2006. 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.

      Collateralized Loan Obligations (“CLOs”) and Collateralized Debt Obligations (“CDOs”). At September 30, 2007, and December 31, 2006, the Company owned bonds and preferred shares/income notes in CLOs and a CDO as follows:

			2007						2006
			Cost		Value		Yield(1)		Cost		Value		Yield(1)
($ in millions)
Bonds(2):
Callidus Debt Partners CDO Fund I, Ltd.			$	28.4	$	28.5		14.2%	$	28.4	$	28.4		14.3%
Callidus MAPS CLO Fund I LLC				17.0		16.4		11.1%		17.0		17.2		10.8%
	Total bonds			45.4		44.9		13.1%		45.4		45.6		12.9%
Preferred Shares/ Income Notes(3):
Callidus Debt Partners CLO Fund III, Ltd.				22.0		20.7		15.9%		23.3		23.0		12.8%
Callidus Debt Partners CLO Fund IV, Ltd.				12.4		10.8		15.6%		13.0		13.0		13.8%
Callidus Debt Partners CLO Fund V, Ltd.				14.0		14.6		19.1%		13.8		13.8		15.8%
Callidus MAPS CLO Fund I LLC				50.1		41.7		10.4%		51.0		47.4		17.1%
Callidus MAPS CLO Fund II, Ltd.				18.0		18.0		14.8%		—		—		—
Callidus Debt Partners CLO Fund VI, Ltd.				25.7		25.7		19.8%		—		—		—
	Total preferred shares/ income notes			142.2		131.5		15.1%		101.1		97.2		15.5%
		Total	$	187.6	$	176.4			$	146.5	$	142.8

(1)	The yield on these debt and equity securities is included in interest income in the accompanying consolidated statement of operations. The weighted average yield is calculated as the (a) annual stated interest on the accruing bonds or the effective interest yield on the preferred shares/income notes, divided by (b) CLO and CDO assets at value. The market yield used in the valuation of the CLO and CDO assets may be different than the interest yields shown above.
(2)	These securities are included in private finance subordinated debt.
(3)	These securities are included in private finance equity securities.

     The initial yields on the cost basis of the CLO 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 classes. As each CLO preferred share or income note ages, the estimated future cash flows are updated based on the estimated performance of the underlying collateral assets, and the respective yield on the cost basis is adjusted as necessary. As future cash flows are subject to uncertainties and contingencies that are difficult to predict and are subject to

42

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

future events that may alter current assumptions, no assurance can be given that the anticipated yields to maturity will be achieved.

      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 will bear this loss first and then the subordinated bonds would bear any loss after the preferred shares/income notes.

      At September 30, 2007, and December 31, 2006, the face value of the CLO and CDO bonds held by the Company were subordinate to approximately 82% to 84% and 82% to 85%, respectively, of the face value of the securities issued in these CLOs and CDO. At September 30, 2007, and December 31, 2006, the face value of the CLO preferred shares/income notes held by the Company were subordinate to approximately 86% to 94% and 86% to 92%, respectively, of the face value of the securities issued in these CLOs.

      At September 30, 2007, and December 31, 2006, the underlying collateral assets of these CLO and CDO investments, consisting primarily of senior debt, were issued by 486 issuers and 465 issuers, respectively, and had balances as follows:

		2007		2006
($ in millions)
Bonds		$	273.3	$	245.4
Syndicated loans			2,471.8		1,769.9
Cash(1)			33.1		59.5
	Total underlying collateral assets	$	2,778.2	$	2,074.8

⁽¹⁾  Includes undrawn liability amounts.

     At September 30, 2007, there was one defaulted obligor that was included in the underlying collateral assets of Callidus Debt Partners CLO Fund III, Ltd., Callidus Debt Partners CLO Fund IV, Ltd. and Callidus MAPS CLO Fund I LLC. At December 31, 2006, there was one defaulted obligor in the underlying collateral assets of Callidus MAPS CLO Fund I LLC. There were no other delinquencies in the underlying collateral assets in the other CLO and CDO issuances owned by the Company. At September 30, 2007, and December 31, 2006, the total face value of defaulted obligations was $6.4 million and $9.6 million, respectively, or approximately 0.2% and 0.5% of the total underlying collateral assets, respectively.

      Allied Capital Senior Debt Fund, L.P. The Company is a special limited partner in the Allied Capital Senior Debt Fund, L.P. (“the Fund”), a private fund that generally invests in senior, unitranche and second lien debt. The Company has committed $31.8 million to the Fund, which is a portfolio company, of which $19.1 million has been funded. At September 30, 2007, the Company’s investment in the Fund totaled $19.1 million at cost and $19.5 million at value. The Fund has closed on $125 million in equity capital commitments. As a special limited partner, the Company expects to earn an incentive allocation of 20% of the annual net income of the Fund, subject to certain

43

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

performance benchmarks. The value of the Company’s investment in the Fund is based on the net asset value of the Fund, which reflects the capital invested plus its allocation of the net earnings of the Fund, including the incentive allocation.

      AC Corp is the investment manager to the Fund. Callidus Capital Corporation, a portfolio investment controlled by the Company, acts as special manager to the Fund. An affiliate of the Company is the general partner of the Fund, and AC Corp serves as collateral manager to a warehouse financing vehicle associated with the Fund. AC Corp will earn a management fee of up to 2% of the net asset value of the Fund and will pay Callidus 25% of that management fee to compensate Callidus for its role as special manager.

      In connection with the Fund’s formation in June 2007, the Company sold an initial portfolio of approximately $183 million of seasoned assets with a weighted average yield of 10.3% to a warehouse financing vehicle associated with the Fund. In the third quarter of 2007, the Company sold $14.8 million of seasoned assets with a weighted average yield of 8.6% to the warehouse financing vehicle. The Company may sell additional loans to the Fund or the warehouse financing vehicle. In addition, during the third quarter of 2007, the Company repurchased one asset totaling $12.0 million from the Fund, which the Company had sold to the Fund in June 2007.

      Loans and Debt Securities on Non-Accrual Status. At September 30, 2007, and December 31, 2006, private finance loans and debt securities at value not accruing interest were as follows:

			2007		2006
($ in millions)
Loans and debt securities in workout status
	Companies more than 25% owned		$	51.6	$	51.1
	Companies 5% to 25% owned			13.1		4.0
	Companies less than 5% owned			20.7		31.6
Loans and debt securities not in workout status
	Companies more than 25% owned			116.2		87.1
	Companies 5% to 25% owned			16.4		7.2
	Companies less than 5% owned			13.0		38.9
		Total	$	231.0	$	219.9

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      Industry and Geographic Compositions. The industry and geographic compositions of the private finance portfolio at value at September 30, 2007, and December 31, 2006, were as follows:

		2007			2006
Industry
Business services			37	%		39	%
Consumer products			24			20
Industrial products			11			9
Financial services			10			9
Retail			5			6
Consumer services			4			6
CLO/CDO(1)			4			3
Healthcare services			2			3
Energy services			—			2
Other			3			3
	Total		100	%		100	%
Geographic Region(2)
Mid-Atlantic			36	%		31	%
Midwest			29			30
Southeast			19			18
West			14			17
Northeast			2			4
	Total		100	%		100	%

(1)	These funds invest in senior debt representing a variety of industries and are managed by Callidus Capital, a portfolio company of Allied Capital.
(2)	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 September 30, 2007, and December 31, 2006, the commercial real estate finance portfolio consisted of the following:

		2007						2006
		Cost		Value		Yield(1)		Cost		Value		Yield(1)
($ in millions)
Commercial mortgage loans		$	64.8	$	64.2		6.4%	$	72.6	$	71.9		7.5%
Real estate owned			15.6		22.0				15.7		19.6
Equity interests			15.7		33.5				15.2		26.7
	Total	$	96.1	$	119.7			$	103.5	$	118.2

⁽¹⁾  The weighted average yield on the commercial mortgage loans is computed as the (a) annual stated interest on accruing loans plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans 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.

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

      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 September 30, 2007, and December 31, 2006, approximately 87% and 96%, respectively, of the Company’s commercial mortgage loan portfolio was composed of fixed rate loans and approximately 13% and 4%, respectively, was composed of adjustable rate loans. At September 30, 2007, and December 31, 2006, loans with a value of $19.1 million and $18.9 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.

      The property types and the geographic composition securing the commercial mortgage loans and equity interests at value at September 30, 2007, and December 31, 2006, were as follows:

	2007			2006
Property Type
Hospitality		44	%		45	%
Office		21			20
Retail		19