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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 0-22832
ALLIED CAPITAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
MARYLAND 52-1081052
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION) IDENTIFICATION NO.)
1919 PENNSYLVANIA AVENUE NW 20006
WASHINGTON, D.C. (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (202) 331-1112
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
NONE NONE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.0001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant as of March 15, 1999 was approximately
$1,009,487,531 based upon the last sale price for the registrant's common stock
on that date. As of March 15, 1999 there were 57,310,691 shares of the
registrant's common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Shareholders for the year ended
December 31, 1998 are incorporated by reference into Parts II and IV of this
Report. Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held on May 11, 1999 are incorporated by reference
into Part III of this Report.
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PART I
ITEM 1. BUSINESS OF THE COMPANY
Allied Capital Corporation, a Maryland corporation, is a closed-end management
investment company that has elected to be regulated as a business development
company ("BDC") under the Investment Company Act of 1940 ("1940 Act"). BDCs are
in the business of investing in primarily private business enterprises, and are
subject to 1940 Act regulation. Allied Capital Corporation's common stock is
traded on the Nasdaq National Market under the symbol "ALLC."
Allied Capital Corporation, referred to as the "Company" or "we," is a
value-added full-service lender. We invest in and lend to private, growing
businesses in a variety of industries and in diverse geographic locations
nationwide. We focus on investments in three primary areas:
- - mezzanine finance
- - commercial real estate finance, and
- - SBA 7(a) lending.
Our investment portfolio consists primarily of small and medium-sized
subordinated loans with equity features, small and medium-sized commercial
mortgage loans, and small senior loans. At December 31, 1998, our investment
portfolio totaled $800 million representing 733 borrower relationships in 39
states and the District of Columbia.
The investment objective of the Company is to achieve current income and capital
gains. We currently do not have a policy with respect to "concentrating" (i.e.,
investing 25% or more of our total assets) in any industry or group of
industries and currently our portfolio is not concentrated. We may or may not
concentrate in any industry or group of industries in the future.
THE 1997 MERGER
Allied Capital Corporation was formed through the merger of five affiliated
public companies, the oldest of which was founded in 1958. On December 31, 1997,
the predecessor companies, Allied Capital Corporation ("Allied I"), Allied
Capital Corporation II ("Allied II"), Allied Capital Commercial Corporation
("Allied Commercial"), and Allied Capital Advisers, Inc. ("Advisers") merged
with and into Allied Capital Lending Corporation ("Allied Lending") in a
stock-for-stock tax-free exchange. Immediately following the merger, Allied
Lending changed its name to Allied Capital Corporation. In this document, unless
otherwise indicated, the "Company", "ACC", "we", "us" or "our" refer to Allied
Capital Corporation. The five pre-merger companies are referred to as the
predecessor companies. All information in this document, unless otherwise
indicated, has been presented as if the predecessor companies had merged as of
the earliest period presented.
The merger provided numerous benefits and key competitive advantages:
- - INCREASED SIZE. We are now the largest BDC in the United States and are
significantly larger than any of the predecessor companies that merged in
terms of total assets, total equity capital and total market capitalization. A
larger asset base allows us to make larger investments in growing companies
while maintaining portfolio diversity. A larger market capitalization provides
our stockholders with better liquidity, and has increased our visibility in
the debt and equity capital markets. These improvements have provided the
Company with a better foundation for growth.
- - IMPROVED MIX OF INCOME. We now have a portfolio that produces a higher level
of recurring investment income since the five companies merged. In addition,
as a single company, we have been able to expand our existing businesses and
improve our asset and liability management.
- - EFFICIENCY. As one company, we now operate more efficiently. We have been able
to eliminate redundant processes and expenses, including financial reporting,
auditing, and corporate legal fees.
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- - SINGLE ENTITY FOCUSED ON HIGH RETURN INVESTMENTS. We now have one business
plan with a single investment goal of generating strong current income and
long-term capital gains. We are able to allocate both capital and human
resources more effectively to maximize our returns on shareholder equity.
- - INCREASED COMPETITIVENESS. Because of our increased size, focus, and
efficiency, we have become a formidable competitor in the mezzanine finance
marketplace. Our increased size has lowered our cost of capital and increased
our pricing competitiveness. Our increased size has also enabled us to finance
larger transactions while maintaining portfolio diversity. Our increased
efficiency has enabled us to grow both our sales and investment professional
headcount so that we can more aggressively compete in the marketplace.
As a result of the merger, we increased our annual loan originations and
improved the credit quality of our portfolio. We also increased our access to
capital, particularly our ability to borrow from lenders. During 1998, we
restructured our credit facilities and obtained unsecured debt financing at a
lower cost with more favorable financing terms. In addition, we believe our
larger market capitalization has increased our access to equity capital. Greater
access to capital at a lower cost has enabled us to price our loans to borrowers
more competitively.
MEZZANINE FINANCE
We provide mezzanine debt and equity financing in private transactions for
small- and medium-sized growth companies. We recognize that entrepreneurs need
an alternative to the high cost and dilutive nature of venture equity capital.
Therefore, our mezzanine finance activities target a market niche between the
senior debt financing provided by traditional lenders, such as banks and
insurance companies, and the equity capital provided by venture capitalists and
private equity investors.
Our mezzanine financing is generally used to fund growth, leveraged buyouts,
note purchases, loan restructurings, acquisitions, recapitalizations, and bridge
financings. We generally invest in private companies though, from time to time,
we may invest in thinly traded public companies that lack access to public
capital and whose securities are generally not marginable.
We originate and purchase investments ranging in size from $5 million to $25
million, with an emphasis on investments on the larger end of this range. Our
mezzanine investments are generally structured as a subordinated loan that
carries a relatively high fixed interest rate (12% to 18%), with interest-only
payments in the early years and payments of both principal and interest in the
later years, with maturities of five to ten years. Our mezzanine investments may
also include equity features, such as warrants or options to buy a minority
interest in the portfolio company. At December 31, 1998, approximately 98% of
the Company's mezzanine investments had fixed interest rates.
We seek to generate a return on assets ranging from 14% to 20%, including both
interest income and capital gains from the sale of our equity interests.
Historically, we had structured our mezzanine investments so that approximately
one-half of the potential return was earned through current interest payments,
and one-half was earned in capital gains, which would arise from the sale of our
equity interest in the portfolio company. We now structure our mezzanine
investments with more emphasis on current interest, and less emphasis on the
potential return from capital gains. At December 31, 1998, our mezzanine
portfolio had a weighted average yield of 14.6%, as compared to a weighted
average yield of 12.6% at December 31, 1997.
Our equity investments, which include warrants, options, and common and
preferred stock, generally do not produce a current return, but are held for
potential investment appreciation and ultimate capital gains. Generally,
warrants are exercisable after a three- to five-year period, and the exercise
price is usually nominal. The warrants often include registration rights, which
allows us to sell the securities if the portfolio company completes a public
offering. In many cases, the warrants have a put option that requires that the
borrower repurchase our equity position after a specified period of time at a
formula price or at its fair market value.
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At December 31, 1998, our mezzanine portfolio had $339.2 million in mezzanine
loans and debt securities, and $49.4 million in equity interests, which combined
represented 49% of our total investment portfolio. The geographic and industry
composition of the mezzanine portfolio at December 31, 1998 was as follows:
<TABLE>
<CAPTION>
GEOGRAPHIC REGION
-----------------
<S> <C>
Mid-Atlantic........................... 28%
Midwest................................ 27%
Southeast.............................. 23%
West................................... 11%
International.......................... 7%
Northeast.............................. 4%
---
Total........................ 100%
===
INDUSTRY
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Consumer products manufacturing........ 25%
Telecommunications..................... 14%
Business services...................... 11%
Retail................................. 9%
Broadcasting........................... 9%
Industrial products manufacturing...... 8%
Other.................................. 24%
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Total........................ 100%
===
</TABLE>
Private equity and mezzanine investment partnerships are our primary competitors
in the mezzanine finance business. We believe that we have certain structural
and operational advantages when compared to many of these competitors. Our scale
of operations, equity capital base, and successful track record as a mezzanine
lender has enabled us to borrow long-term capital to leverage our equity and
reduce our overall cost of capital. We use our lower cost of capital to price
our loans competitively. In addition, the perpetual nature of our corporate
structure enables us to be a better long-term partner for our borrowers than
traditional mezzanine partnerships, which typically have a limited life. We also
believe that high overhead, cumbersome regulatory structures and large size
hinder many traditional lenders from lending effectively to our niche of small-
and medium-sized businesses.
We hold a portion of our mezzanine investments in a wholly owned subsidiary,
Allied Investment Corporation. Allied Investment is a BDC and is licensed and
regulated by the Small Business Administration to operate as a small business
investment company ("SBIC"). See "Certain Government Regulations" below for
further information about SBIC regulation.
COMMERCIAL REAL ESTATE FINANCE
COMMERCIAL MORTGAGE LOANS. We originate and purchase mortgage loans to small and
medium-sized businesses secured by commercial real estate. We believe that we
successfully compete in the commercial real estate finance market due to our
creativity and flexible loan terms. We use an "enterprise value" approach to
assess new commercial mortgage loans, which requires an analysis of the
underlying cash flow of the real estate tenant or owner-occupant in addition to
more traditional real estate loan underwriting techniques, which may exclude the
impact of business cash flows from the underwriting considerations. We believe
that we are able to structure and finance more complicated loans than
traditional real estate lenders due to our significant expertise in this area,
and the experience of our investment professionals.
We generally price new commercial mortgage loans based on a fixed spread ranging
from 3% to 5% over five to ten year U.S. Treasury rates. During 1997 and 1998,
interest rates on U.S. Treasury bonds declined significantly, and the spreads
charged by commercial real estate lenders in the marketplace narrowed. As a
result, we began to reevaluate our strategy regarding commercial real estate
lending in light of declining interest rates. During the third quarter of 1998,
we significantly reduced our commercial mortgage loan origination activity for
our own portfolio, and began exploring opportunities to originate commercial
mortgage loans for sale to various financial institutions.
We are now pursuing various loan sale opportunities and we plan to continue to
originate commercial mortgage loans for sale. We can enhance the investment
return from our commercial mortgage loan portfolio by originating and selling
these lower-yielding loans, because we receive loan origination fees and cash
premiums on the sale from the purchaser. During 1998, we sold a total of $44.0
million of commercial mortgage loans.
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We focus on originating commercial mortgage loans for our own portfolio ranging
in size from $1 million to $25 million with maturities of five to ten years.
These loans are generally priced at higher interest rates and include
subordinated real estate loans and sale-leaseback financing. Subordinated loans
are priced similarly to our mezzanine loans and may be accompanied by an equity
interest in the real estate or in the underlying business.
At December 31, 1998, 68% of the Company's portfolio of commercial mortgage
loans carried a fixed interest rate, and 32% carried a floating rate tied to
various indices. These loans may require payments of interest only, or they may
require level payments of principal and interest calculated to amortize the
principal on a 10- to 30-year basis with a balloon payment at maturity.
We derive income from the (1) interest charged on the commercial mortgage loan
portfolio and (2) amortization of original issue and purchased discounts. The
weighted average stated interest rate on the commercial mortgage loan portfolio
at December 31, 1998 was 9.7% and the weighted average yield was 10.4%. The
effective yield on the mortgage loan portfolio is higher than the stated
interest rate due to the amortization of original issue discount and purchased
discount. At December 31, 1998, the average loan-to-value for the commercial
mortgage loan portfolio was 67.4%.
The Company's commercial mortgage loan portfolio totaled approximately $233.2
million at December 31, 1998, or 29% of the Company's total investment
portfolio. The geographic composition and the property types securing the
commercial mortgage loan portfolio at December 31, 1998 was as follows:
<TABLE>
<CAPTION>
GEOGRAPHIC REGION
-----------------
<S> <C>
Mid-Atlantic........................... 36%
Southeast.............................. 23%
West................................... 22%
Midwest................................ 13%
Northeast.............................. 6%
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Total........................ 100%
===
PROPERTY TYPE
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Hospitality............................ 42%
Office................................. 29%
Retail................................. 14%
Recreation............................. 5%
Other.................................. 10%
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Total........................ 100%
===
</TABLE>
We compete with banks, real estate conduits, equity and mortgage real estate
investment trusts ("REITs") and other lenders for the commercial mortgage loans
we originate. We believe we have earned a reputation in the commercial real
estate finance market as a specialist in credits that require more difficult
structuring or underwriting techniques, and that we compete successfully in this
niche.
COMMERCIAL MORTGAGE-BACKED SECURITIES. Turmoil in the real estate capital
markets during the fourth quarter of 1998 created a unique opportunity for the
Company to acquire non-investment grade commercial mortgage-backed securities
("CMBS") at attractive yields. In late 1998, the Company purchased $67.2 million
of non-investment grade bonds for $32.2 million, with an estimated yield to
maturity of 15%. We plan to continue to purchase CMBS as long as we can achieve
significant discounts and attractive yields on such purchases.
In January 1998, we completed a $295 million asset securitization in which we
retained a residual interest in securitized loans. We continue to service all of
the loans in the pool. This transaction provided liquidity to our investment
portfolio, and allowed us to reinvest the cash proceeds from the securitization
into higher yielding mezzanine and SBA 7(a) loans. We do not anticipate
significant future securitization activity; we will gain liquidity from our
lower yielding loans primarily through whole loan sales.
At December 31, 1998, the Company had $113.7 million in commercial
mortgage-backed securities, which represented approximately 14% of the Company's
total investment portfolio.
The CMBS in which we invest are non-investment grade, which means that
nationally recognized statistical rating organizations rate them below the top
four investment-grade rating categories. Non-investment grade securities usually
pay a higher interest rate than do investment-grade bonds, but with the higher
return comes greater risk. Non-investment grade securities are considered
speculative, and their capacity to pay principal and interest in accordance with
the terms of their issue is not ensured. They tend
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to react more to changes in interest rates than do higher-rated securities, have
a higher risk of default, tend to be less liquid, and may be more difficult to
value. When we evaluate a CMBS purchase, we use the same stringent underwriting
procedures and criteria for the pooled loans as we do for the loans we originate
and purchase. These underwriting procedures and criteria are described in detail
below. In addition, we believe that the underlying real estate collateral for
our purchased CMBS adequately secures our position. At December 31, 1998, the
average loan-to-value ratio for our commercial mortgage-backed securities
portfolio, including the residual interest in our securitized pool, was 67.1%.
SBA 7(a) LENDING
We participate in the SBA's 7(a) Guaranteed Loan Program through a wholly owned
subsidiary, Allied Capital SBLC Corporation. Allied SBLC is licensed by the SBA
as a Small Business Lending Company (SBLC). It is one of only fourteen non-bank
SBLCs operating in the United States.
Under the SBA 7(a) program, we extend senior secured loans that are partially
guaranteed by the SBA. Our SBA 7(a) loans are provided to small businesses for
the purposes of acquiring real estate, purchasing machinery or equipment, or
providing working capital. The loans are secured by a mortgage or other liens on
the assets of the borrower, and in all cases the owners of the business must
personally guarantee the repayment of the loan. We focus our SBA 7(a) loan
origination activity on loans secured by commercial real estate assets.
Our 7(a) loans typically range in size from $250,000 to $1 million. The SBA
guarantees 80% of any qualified loan up to $100,000 regardless of maturity, and
75% of any qualified loan over $100,000 regardless of maturity, to a maximum
guarantee of $750,000 for any one borrower. SBA regulations define qualified
small businesses generally as businesses with (1) no more than $5 million in
annual sales or (2) no more than 500 employees. The SBA stipulates that loans
used to acquire real estate may have a maximum maturity of 25 years; loans used
to purchase machinery and equipment may have a maximum maturity of 15 years;
loans used for working capital may have a maximum maturity of seven years.
We generally price our 7(a) loans with variable interest rates typically ranging
from 1.75% to 2.75% over the prime rate, adjusted monthly. Approximately 96% of
the Company's SBA 7(a) loan portfolio had variable interest rates as of December
31, 1998. Generally loans are payable in equal monthly installments of principal
and interest on the first day of the month following the month in which the loan
is funded, until maturity. Our post-Merger capital structure has allowed us to
lower our pricing on SBA 7(a) loans. As a result, we believe we now compete more
effectively in the marketplace, and we have increased our deal flow.
We routinely sell the guaranteed portion of our SBA 7(a) loans in the
well-established secondary market. We earn a premium on the sale of the
guaranteed portion of our SBA 7(a) loans. Typically our premiums on loan sales,
net of origination costs, range from 4% to 7.5% of the face amount of each loan
sold. This premium income enhances the return on our 25% retained investment in
the loan, and our retained portion is not subordinate to the guaranteed portion
sold. We continue to service 100% of each loan we originate.
For the fiscal year ended September 30, 1998, the federal government estimated
that SBA 7(a) loans originations would approximate $10.5 billion. Banks,
non-bank SBLCs, and certain state-sponsored non-bank lenders serve this large
market. We believe that we compete successfully in the 7(a) loan market because
we focus in certain regional markets and because we are a "Preferred Lender" in
the regional markets in which we compete. As an SBA Preferred Lender, we are
permitted to make 7(a) guaranteed loans without prior SBA credit approval, thus
simplifying and expediting our loan approval process and the related
disbursements. At December 31, 1998, Allied SBLC was a designated Preferred
Lender in sixteen markets; we plan to attain Preferred Lender status in
additional markets during 1999.
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Our SBA 7(a) loan portfolio totaled $56.3 million at December 31, 1998, or 7% of
our total investment portfolio. The SBA 7(a) portfolio includes loans to, among
others, hotels and motels, automotive shops and gas stations, restaurants,
manufacturers, broadcasting and communications companies, service providers,
retail shops, and other small businesses. The following tables show our 7(a)
loan portfolio by geographic region and industry at December 31, 1998:
<TABLE>
<CAPTION>
GEOGRAPHIC REGION
-----------------
<S> <C>
Midwest................................ 34%
Mid-Atlantic........................... 29%
Southeast.............................. 16%
West................................... 14%
Northeast.............................. 7%
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Total........................ 100%
===
INDUSTRY
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Retail................................. 41%
Hospitality............................ 30%
Consumer services...................... 6%
Consumer products manufacturing........ 6%
Business services...................... 4%
Broadcasting........................... 4%
Other.................................. 9%
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Total........................ 100%
===
</TABLE>
INVESTMENT ADVISORY SERVICES
The Company is a registered investment adviser, pursuant to the Investment
Advisers Act of 1940, and has several investment advisory agreements to manage
private investment funds. The revenue generated from these agreements is not
material to the Company's operations.
LOAN SOURCING
During 1997 and 1998, we significantly increased the scope of our sales and
marketing activity by opening regional offices in Chicago, San Francisco,
Detroit and Atlanta. We also developed a full-time sales and marketing staff
with ten individuals dedicated to identifying and pursuing mezzanine
investments, commercial mortgage loans, and SBA 7(a) loans. To source new
investment opportunities, we work with thousands of intermediaries including:
- - regional and boutique investment banks;
- - private mezzanine and equity investors;
- - business and mortgage brokers;
- - national retail financial services companies; and
- - banks, law firms and accountants.
We believe that our experience and reputation provide a competitive advantage in
originating new investment opportunities. We have established an extensive
network of investment referral relationships over our 40-year history. We are
recognized as a pioneer in the mezzanine finance industry, and have developed a
reputation in the commercial real estate finance market for our ability to
finance complex transactions.
ASSET APPROVAL AND UNDERWRITING PROCESS
In assessing new investment opportunities, we maintain rigorous credit standards
based on our underwriting guidelines, a thorough due diligence process, and a
credit approval process requiring committee review, all of which are described
below. The combination of conservative underwriting standards and our credit-
oriented culture has resulted in a record of minimal realized losses.
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GENERAL INVESTMENT CRITERIA. The following table highlights general
underwriting criteria for each product type. We use these criteria as general
guidelines only, and the characteristics of individual investments may vary
significantly depending upon each unique investment opportunity.
<TABLE>
<CAPTION>
MEZZANINE REAL ESTATE / SBA 7(a) LENDING
------------------------------ ------------------------------
<S> <C> <C>
INDUSTRY OR PROPERTY TYPE Consumer and industrial Full service hotels, office
products, business services buildings, manufacturing
(outsourcing), broadcasting, facilities, warehouses, retail
telecommunications, education, facilities, convenience
and other industries that have stores, gas stations, and
low vulnerability to changes other properties requiring
in economic cycles specialized underwriting
expertise
INVESTMENT CRITERIA Stable, growing companies, Amortization, collateral
strong cash flow, high returns coverage, cash flow coverage
on invested capital,
later-stage, strong management
LOAN SIZE $5 million to $25 million $0.2 million to $25 million
TERM 5 to 10 years 1 to 30 years
COLLATERAL Second lien on assets, if First lien on real estate,
available second lien on real estate,
personal guarantees
</TABLE>
LOAN UNDERWRITING PROCEDURES AND CRITERIA
MEZZANINE FINANCE. We generally consider financing companies that can
demonstrate strong market position, sales growth, positive cash flow, and
profitability. We emphasize the quality of management of our potential portfolio
companies, and specifically seek experienced entrepreneurs with a management
track record and relevant industry experience. We generally seek companies with
annual revenues of $20 million to $200 million, cash flow margins of greater
than 10% of revenues, operating histories of at least ten years, and seasoned
management teams who have a significant personal investment at risk in the
business. In addition, the business must generate a high return on its invested
capital, and must demonstrate a low level of vulnerability to changes in
economic cycles. The prospective portfolio company's total debt including our
loan is generally no greater than five times the company's current cash flow,
and the company's cash flow is generally no less than two times its total debt
service obligation to all of its lenders.
For each mezzanine financing, our investment professionals thoroughly review,
analyze and substantiate, through due diligence, the business plan and
operations of the potential portfolio company. Our financial due diligence,
which is often conducted with the assistance of an accounting firm, includes
analyzing the company's historical and projected financial information and
stress-testing the projections under adverse assumptions. Our business due
diligence, which is often conducted with the assistance of industry specialists
or consultants, thoroughly studies the industry and competitive landscape. We
assess the company's business plan and its cyclicality, to assess the borrower's
ability to weather economic cycles. In management due diligence, we conduct
numerous personal and professional reference checks, including employees, both
current and former, customers, suppliers and competitors. The typical mezzanine
financing will require two to three months of diligence and structuring before
funding occurs.
COMMERCIAL REAL ESTATE FINANCE AND SBA 7(a) LENDING. When we evaluate commercial
mortgage loans for origination or purchase, including CMBS purchases, we
generally receive an initial package of information that typically includes
underwriting information that was developed by the borrower or seller. Typical
underwriting information that we require from potential borrowers in order to
conduct appropriate due diligence includes: financial statements of the
borrower, appraisals, rent rolls and lease information, environmental reports,
structural and engineering reports, and any other information deemed appropriate
under the circumstances.
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In the case of purchased loans, the seller generally provides financial
statements of the borrower, property appraisals and any other original
underwriting information. The seller also generally provides loan documents and
payment histories. When we originate or purchase commercial mortgage loans, we
generally consider a variety of other factors, including the borrower's
estimated current cash flow coverage, the creditworthiness of the borrower, the
net worth and financial strength of the borrower, the estimated current
liquidation value of the related mortgaged property, and trends in the
borrower's industry and in real estate values in the borrower's geographic
region. The loan officer inspects the property during the due diligence process,
and he or she values the property using internally developed valuation analyses.
Small businesses with less than 500 employees or less than $5 million in annual
sales qualify for SBA 7(a) loans. Our underwriting criteria are otherwise very
similar to our commercial mortgage loan criteria. We generally seek SBA 7(a)
loans that are collateralized by real estate.
CREDIT APPROVAL PROCESS
All credit approval is obtained through a committee review process centralized
at the Company's headquarters in Washington, DC. All of our lending disciplines
are represented on the investment committee, which is comprised of our nine most
senior lenders. The members of the investment committee have an average of 17
years of investing experience.
No one individual has the ability to approve a credit. The asset approval
process not only benefits from the experience of the investment committee
members, but also from the experience of our other investment professionals who,
on average, have over 13 years of professional experience. This experienced
staff of investment professionals underwrites each new loan and subjects each
potential investment to a rigorous due diligence process, as is described above.
In certain instances where risk/return characteristics warrant and for every
transaction larger than $10 million, we require approval from the Executive
Committee of the Board of Directors in addition to the investment committee.
Even after all such approvals are received, due diligence must be successfully
completed with final investment committee approval before funds are disbursed to
a new borrower.
PORTFOLIO MANAGEMENT
LOAN SERVICING: Our staff is responsible for routine loan servicing, which
includes:
- - payment processing;
- - borrower inquiries;
- - escrow analysis and processing;
- - third-party reporting; and
- - insurance and tax administration.
In addition, our staff is responsible for special servicing activities including
delinquency monitoring and collection, workout administration and management of
foreclosed assets.
PORTFOLIO MONITORING AND VALUATION: We use a grading system in order to help us
monitor our portfolio. The grading system assigns grades to loans from 1 to 5 as
follows:
<TABLE>
<CAPTION>
GRADE DESCRIPTION
- ----- -----------
<C> <S>
1 Probable capital gain
2 Performing security
3 Close monitoring -- no loss of principal or interest
expected
4 Workout -- some loss of interest expected
5 Workout -- some loss of principal and interest expected.
Security is valued at net realized value
</TABLE>
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At December 31, 1998 Grade 1 investments totaled $104.4 million, or 13.0% of the
total portfolio at value; Grade 2 investments totaled $618.0 million, or 77.2%
of the total portfolio; Grade 3 investments totaled $53.2 million, or 6.7% of
the total portfolio; Grade 4 investments totaled $11.8 million, or 1.5% of the
total portfolio; and Grade 5 investments totaled $12.9 million or 1.6% of the
total portfolio.
As a BDC, the Board of Directors is required to value the portfolio on a
quarterly basis. In valuing each individual investment, we consider the
financial performance of each borrower, loan payment histories, indications of
potential equity realization events and current collateral values, and determine
whether the value of the asset should be increased through unrealized
appreciation or decreased through unrealized depreciation. After each investment
professional has made his or her determination of value, members of senior
management review the valuations. These valuations are then presented to the
Board of Directors for their review and approval.
As a general rule, the Company does not value its loans above cost, but loans
are subject to depreciation events when the asset is considered impaired. Also
as a general rule, equity securities may be assigned appreciation if
circumstances warrant. With respect to private equity securities, each
investment is valued using industry valuation benchmarks, and then the value is
assigned a discount reflecting the illiquid nature of the investment as well as
our minority, non-control position. When an external event such as a purchase
transaction, public offering, or subsequent equity sale occurs, the pricing
indicated by the external event is used to corroborate our private equity
valuation. Equity securities in public companies that carry certain restrictions
on sale are generally valued at a discount from the public market value of the
securities. Restricted and unrestricted publicly traded stocks may also be
valued at discounts, due to the size of our investment or market liquidity
concerns.
Delinquencies. We monitor loan delinquencies weekly. The following outlines the
treatment of each delinquency category:
<TABLE>
<S> <C>
30 DAYS PAST DUE Our loan servicing staff monitors loans and contacts
borrowers for collection.
60 DAYS PAST DUE We generally transfer loans to investment professionals
responsible for special servicing activity for monitoring,
collection, and development of a workout plan, if necessary.
90 DAYS PAST DUE Our accounting department reviews loans in conjunction with
the investment professional responsible for special
servicing to determine whether the loan should be placed on
a non-accrual status or whether a valuation adjustment is
required.
120 DAYS PAST DUE Generally, we place such loans on non-accrual status and the
loan is an active workout.
</TABLE>
At December 31, 1998, $13.7 million, or 1.7% of the Company's portfolio at
value, was 120 days or more past due. Included in this category are loans valued
at $9.9 million that are secured by real estate.
LOAN LOSSES. We have a history of low levels of loan losses, and have a
demonstrated track record of successfully resolving troubled credit situations
with minimal loss. The following table shows realized losses in the Company's
portfolio over the last five years:
<TABLE>
<CAPTION>
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Realized Losses $ 2,908 $ 4,679 $ 11,262 $ 5,100 $ 3,216
Total Assets 501,817 605,434 713,360 807,775 856,079
Realized Losses/Total Assets 0.6% 0.8% 1.6% 0.6% 0.4%
</TABLE>
10
<PAGE> 11
EMPLOYEES
At December 31, 1998, we employed 106 individuals including investment
professionals, operations professionals and administrative staff. All
individuals are located in the Washington, DC office, except for five
individuals in the Chicago office, four in the San Francisco office, four in the
Detroit office and one in the Atlanta office. We believe that our relations with
employees are excellent.
CERTAIN GOVERNMENT REGULATIONS
We operate in a highly regulated environment. The following discussion generally
summarizes certain regulations.
BUSINESS DEVELOPMENT COMPANY ("BDC"). A business development company is defined
and regulated by the Investment Company Act of 1940. It is a unique kind of
investment company that focuses on investing in or lending to small private
companies and making managerial assistance available to them. A BDC may use
capital provided by public shareholders and from other sources to invest in
long-term, private investments in growing small businesses. A BDC provides
shareholders the ability to retain the liquidity of a publicly traded stock,
while sharing in the possible benefits, if any, of investing in privately owned
growth companies.
As a BDC, we may not acquire any asset other than "Qualifying Assets" unless, at
the time it makes the acquisition, our Qualifying Assets represent at least 70%
of the value of our total assets (the "70% test"). The principal categories of
Qualifying Assets relevant to our business are:
(1) Securities purchased in transactions not involving any public offering,
the issuer of which is an eligible portfolio company. An eligible
portfolio company is defined to include any issuer that (a) is organized
and has its principal place of business in the United States, (b) is not
an investment company other than an SBIC wholly owned by a BDC (our
investments in Allied Investment, Allied SBLC and certain other
subsidiaries generally are Qualifying Assets), and (c) does not have any
class of publicly traded securities with respect to which a broker may
extend margin credit;
(2) Securities received in exchange for or distributed with respect to
securities described in (1) above or pursuant to the exercise of
options, warrants, or rights relating to such securities; and
(3) Cash, cash items, government securities, or high quality debt
securities (within the meaning of the 1940 Act), maturing in one year or
less from the time of investment.
To include certain securities described above as Qualifying Assets for the
purpose of the 70% test, a BDC must make available to the issuer of those
securities significant managerial assistance such as providing significant
guidance and counsel concerning the management, operations, or business
objectives and policies of a portfolio company, or making loans to a portfolio
company. We will provide managerial assistance on a continuing basis to any
portfolio company that requests it, whether or not difficulties are perceived.
As a BDC, the Company is entitled to issue senior securities in the form of
stock or senior securities representing indebtedness, as long as each class of
senior security has an asset coverage of at least 200% immediately after each
such issuance. This limitation is not applicable to borrowings by our SBIC or
SBLC subsidiaries, and therefore any borrowings by these subsidiaries are not
included in this asset coverage test. See "Risk Factors."
We may not change the nature of our business so as to cease to be, or withdraw
our election as, a BDC unless authorized by vote of a "majority of the
outstanding voting securities," as defined in the 1940 Act, of our shares. Since
we made our BDC election, we have not made any substantial change in the nature
of our business.
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<PAGE> 12
REGULATED INVESTMENT COMPANY ("RIC"). Our status as a RIC enables us to avoid
the cost of federal and state taxation, and as a result achieve pre-tax
investment returns. We believe that this tax advantage enables us to achieve
strong equity returns without having to aggressively leverage our balance sheet.
In order to qualify as a RIC, the Company must, among other things:
(1) Derive at least 90% of its gross income from dividends, interest,
payments with respect to securities loans, gains from the sale of stock
or other securities or other income derived with respect to its
business of investing in such stock or securities.
(2) Diversify its holdings so that
(a) at least 50% of the value of the Company's assets consists of cash,
cash items, government securities and other securities if such other
securities of any one issuer do not represent more than 5% of the
Company's assets and 10% of the outstanding voting securities of the
issuer, and
(b) no more than 25% of the value of the Company's assets are invested
in securities of one issuer (other than U.S. government securities),
or of two or more issuers that are controlled by the Company.
(3) Distribute at least 90% of its "investment company taxable income" each
tax year to its shareholders. In addition, if a RIC distributes in a
timely manner (or treats as "deemed distributed") 98% of its capital
gain net income for each one year period ending on December 31 and
distributes 98% of its ordinary income for each calendar year, it will
not be subject to the 4% nondeductible federal excise tax on certain
undistributed income of RICs.
SBA REGULATIONS. Allied Investment is an SBIC and Allied SBLC is an SBLC.
SBIC REGULATIONS. Allied Investment, a wholly owned subsidiary of the Company,
is licensed by the SBA as an SBIC under Section 301(c) of the Small Business
Investment Act of 1958, as amended (the "1958 Act"), and has elected to be
regulated as a BDC. Allied Investment resulted from the merger of the Company's
two wholly owned SBIC subsidiaries in July 1998. Pursuant to this merger, the
Company's subsidiary that was then named Allied Investment Corporation merged
with and into Allied Capital Financial Corporation ("Allied Financial"). Allied
Financial then changed its name to Allied Investment Corporation ("Allied
Investment"). Prior to the merger, Allied Financial was licensed by the SBA as a
Specialized Small Business Investment Company ("SSBIC") under 301(d) of the 1958
Act. After the merger, Allied Investment could make SBIC eligible investments in
addition to SSBIC eligible investments.
SBICs are authorized to stimulate the flow of private equity capital to eligible
small businesses. Under present SBA regulations, eligible small businesses
include businesses that have a net worth not exceeding $18 million and have
average annual fully taxed net income not exceeding $6 million for the most
recent two fiscal years. In addition, an SBIC must devote 20% of its investment
activity to "smaller" concerns as defined by the SBA. A smaller concern is one
that has a net worth not exceeding $6 million and has average annual fully taxed
net income not exceeding $2 million for the most recent two fiscal years. SBA
regulations also provide alternative size standard criteria to determine
eligibility, which depend on the industry in which the business is engaged and
are based on such factors as the number of employees and gross sales. According
to SBA regulations, SBICs may make long-term loans to small businesses, invest
in the equity securities of such businesses, and provide them with consulting
and advisory services. Allied Investment provides long-term loans to qualifying
small businesses; equity investments and consulting and advisory services are
typically provided only in connection with such loans.
Allied Investment is periodically examined and audited by the SBA staff to
determine its compliance with SBIC regulations.
Allied Investment has the opportunity to sell to the SBA subordinated debentures
with a maturity of up to ten years, up to an aggregate principal amount of $101
million. This limit generally applies to all financial
12
<PAGE> 13
assistance provided by the SBA to any licensee and its "associates," as that
term is defined in SBA regulations. Historically, an SBIC was also eligible to
sell preferred stock to the SBA. Allied Investment had received $47.7 million of
subordinated debentures and $7.0 million of preferred stock investments from the
SBA at December 31, 1998; as a result of the $101 million limit, the Company is
limited on its ability to apply for additional financing from the SBA. Interest
rates on the SBA debentures currently outstanding have a weighted average
interest rate of 8.23%.
At December 31, 1998, we had an outstanding commitment from the SBA to purchase
up to $27.0 million in additional SBIC debentures. We may seek this additional
financing during 1999.
SBLC REGULATIONS. Allied SBLC is licensed to operate as an SBLC and is
periodically examined and audited by the SBA staff for purposes of determining
compliance with SBA regulations, including its participation in the Preferred
Lenders Program. See SBA 7(a) Lending, above.
RISK FACTORS
FORWARD-LOOKING STATEMENTS
You should read the information contained in this Form 10-K in conjunction with
the Company's 1998 Consolidated Financial Statements and Notes thereto contained
in the Company's 1998 Annual Report to Shareholders. The 1998 Annual Report to
Shareholders and this Form 10-K contain certain forward-looking statements.
These statements include management's plans and objectives for future operations
and financial objectives, loan portfolio growth and availability of funds. There
are inherent uncertainties in predicting future results and conditions, and
certain factors could cause actual results and conditions to differ materially
from those projected in these forward-looking statements. These factors are
described in this "Risk Factors" section. Other factors that could cause actual
results to differ materially include the uncertainties of economic, competitive
and market conditions, and future business decisions, all of which are difficult
or impossible to predict accurately and many of which are beyond our control.
Although we believe that the assumptions underlying the forward-looking
statements included or incorporated by reference in this document are
reasonable, any of the assumptions could be inaccurate and therefore, we cannot
assure you that the forward-looking statements included or incorporated by
reference in this document will prove to be accurate. Therefore, you should not
regard the inclusion of this information as an assurance that the Company's
plans and objectives will be achieved.
LENDING TO SMALL, PRIVATELY OWNED COMPANIES INVOLVES A HIGH DEGREE OF RISK
Our portfolio consists primarily of loans to small, privately owned companies.
There is generally no publicly available information about these companies, and
we rely on the diligence of our employees and agents to obtain information in
connection with the Company's investment decisions. Typically, small businesses
depend on the management talents and efforts of one person or a small group of
persons for their success. The death, disability or resignation of these persons
could have a material adverse impact on such a company. In addition, small
businesses frequently have smaller product lines and market shares than their
competition. Small companies may be more vulnerable to customer preferences,
market conditions and economic downturns and often need substantial additional
capital to expand or compete. Small companies may also experience substantial
variations in operating results, and frequently have highly leveraged capital
structures. Such factors can severely effect the return on, or the recovery of,
our investment in such businesses. Loans to small businesses, therefore, involve
a high degree of business and financial risk, which can result in substantial
losses and accordingly should be considered speculative.
OUR BORROWERS MAY DEFAULT ON THEIR PAYMENTS
We invest in and lend to small businesses that may have limited financial
resources and that may be unable to obtain financing from traditional sources.
Our borrowers may not meet net income, cash flow and other coverage tests
typically imposed by bank lenders. Numerous factors may affect a borrower's
ability to repay its loan, including the failure to meet its business plan, a
downturn in its industry or negative economic conditions. A deterioration in a
borrower's financial condition and prospects may be
13
<PAGE> 14
accompanied by deterioration in the collateral for the loan. We also make
unsecured, subordinated loans or invest in equity securities, which may involve
a higher degree of risk.
OUR PORTFOLIO OF INVESTMENTS IS ILLIQUID
We acquire most of our loans and equity securities directly from small
companies. Our portfolio of loans and equity securities are and will be subject
to restrictions on resale or otherwise have no established trading market. The
illiquidity of most of our portfolio may adversely affect our ability to dispose
of loans and securities at times when it may be advantageous for us to liquidate
such investments.
OUR PORTFOLIO IS RECORDED AT FAIR VALUE AS DETERMINED BY THE BOARD OF DIRECTORS
There is typically no public market for the loans and equity securities of the
small companies to which we make loans. As a result, our board of directors
estimates the value of these loans and equity securities. Unlike traditional
lenders, we do not establish reserves for anticipated loan losses. Instead, we
adjust quarterly the valuation of our portfolio to reflect the board of
directors' estimate of the current realizable value of our loan portfolio.
Without a readily ascertainable market value, the estimated value of our
portfolio of loans and equity securities may differ significantly from the
values that would be placed on the portfolio if there existed a ready market for
the loans and equity securities. Any changes in estimated net asset value are
recorded in the Company's statement of operations as "Net unrealized gains
(losses)."
WE BORROW MONEY WHICH MAY INCREASE THE RISK OF INVESTING IN OUR COMPANY
We borrow from, and issue senior debt securities to, banks and other lenders.
Lenders of these senior securities have fixed dollar claims on our consolidated
assets which are superior to the claims of our common shareholders.
Borrowings, also known as leverage, magnifies the potential for gain and loss on
amounts invested and, therefore, increases the risks associated with investing
in our securities. If the value of our consolidated assets increases, then
leveraging would cause the net asset value attributable to the Company's common
stock to increase more sharply than it would have had we not leveraged.
Conversely, if the value of our consolidated assets decreases, leveraging would
cause net asset value to decline more sharply than it otherwise would have had
we not leveraged. Similarly, any increase in our consolidated income in excess
of consolidated interest payable on the borrowed funds would cause our net
income to increase more than it would without the leverage, while any decrease
in our consolidated income would cause net income to decline more sharply than
it would have had we not borrowed. Such a decline could negatively affect our
ability to make common stock dividend payments, and, if asset coverage for a
class of senior security representing indebtedness declines to less than 200%,
we may be required to sell a portion of our investments when it is
disadvantageous to do so. Leverage is generally considered a speculative
investment technique.
As of December 31, 1998, the Company's debt as a percentage of total liabilities
and shareholders' equity was 39%. Our ability to achieve our investment
objective may depend in part on our continued ability to maintain a leveraged
capital structure by borrowing from banks or other lenders on favorable terms.
There can be no assurance that we will be able to maintain such leverage.
CHANGES IN INTEREST RATES MAY AFFECT OUR PROFITABILITY
Because we borrow money to make investments, our income is materially dependent
upon the "spread" between the rate at which we borrow funds and the rate at
which we loan these funds. In periods of sharply rising interest rates, our cost
of funds would increase and could reduce or eliminate the spread. We use a
combination of long-term and short-term borrowings to finance our lending
activities. We may use interest rate risk management techniques in an effort to
limit our exposure to interest rate fluctuations. Such techniques may include
various interest rate hedging activities to the extent permitted by the 1940
Act. There can be no assurance that we can maintain a positive net interest
spread or that a significant change in market interest rates will not have a
material adverse effect on our profitability.
14
<PAGE> 15
BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL CAPITAL
We will continue to need capital to fund loans. Historically, we have borrowed
from financial institutions and have issued equity securities. A reduction in
the availability of funds from financial institutions could have a material
adverse effect on the Company. We must distribute at least 90% of our net
operating income other than net realized long-term capital gains to our
stockholders to maintain our regulated investment company ("RIC") status under
the Code. As a result such earnings will not be available to fund loan
originations. We expect to borrow from financial institutions and sell
additional equity securities. If we fail to obtain funds from such sources or
from other sources to fund our loans, it could have a material adverse effect on
the Company's financial condition and our results. In addition, as a BDC, we are
generally required to maintain a ratio of at least 200% of total assets to total
borrowings, which may restrict our ability to borrow in certain circumstances.
OUR PORTFOLIO MAY NOT PRODUCE CAPITAL GAINS
Mezzanine loans are typically structured as debt securities with a relatively
high fixed rate of interest and with an equity feature such as conversion
rights, warrants or options. As a result, the potential return on the mezzanine
loans will generate interest income from the time they are made, and may also
produce a realized gain, from an accompanying equity feature. We cannot be sure
that our portfolio will generate a current return or capital gains.
LOSS OF PASS-THROUGH TAX TREATMENT WOULD SUBSTANTIALLY REDUCE NET ASSETS AND
INCOME AVAILABLE FOR DIVIDENDS
The Company qualifies as a RIC. If we meet certain diversification and
distribution requirements, the Company qualifies for pass-through tax treatment.
The Company would cease to qualify for pass-through tax treatment if it were
unable to comply with these requirements, or if it ceased to qualify as a BDC
under the 1940 Act. We also could be subject to a 4% excise tax (and, in certain
cases, corporate level income tax) if we fail to make certain distributions. If
the Company fails to qualify as a RIC, the Company would become subject to
federal income tax as if it were an ordinary corporation, which would
substantially reduce our net assets and the amount of income available for
distribution to our shareholders.
WE OPERATE IN A COMPETITIVE MARKET
We compete for investments with many other companies and individuals, some of
whom have greater resources than we do. Increased competition would make it more
difficult for us to purchase or originate loans at attractive prices. As a
result of this competition, sometimes we may be precluded from making otherwise
attractive investments.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT
We are regulated by the Commission and the SBA. In addition, changes in the laws
or regulations that govern BDCs, RICs, real estate investment trusts ("REITs"),
SBICs and SBLCs may significantly affect our business. Laws and regulations may
be changed from time to time, and the interpretations of the relevant laws and
regulations also are subject to change. Any change in the law or regulations
that govern our business could have a material impact on the Company or its
operations.
QUARTERLY RESULTS MAY FLUCTUATE FROM QUARTER TO QUARTER
The Company's quarterly operating results could fluctuate due to a number of
factors. These factors include, among others, the completion of a securitization
transaction in a particular calendar quarter, the interest rates on the
securities issued in connection with its securitization transactions, variations
in the loan origination volume, variation in timing of loan prepayments,
variations in and the timing of the recognition of realized and unrealized gains
or losses, the degree to which we encounter competition in our markets and
general economic conditions. As a result of these factors, you should not rely
on quarterly results to be indicative of the Company's performance in future
quarters.
15
<PAGE> 16
ITEM 2. PROPERTIES
Our principal offices are located on the third floor of 1919 Pennsylvania
Avenue, N.W., Washington, DC, a modern office building in the heart of
Washington's business and financial district. Our lease for approximately 32,000
square feet of office space at that location expires in July 2008. That office
is equipped with a network of personal computers for word processing, financial
analysis and accounting. We believe our office space is suitable for our needs
for the foreseeable future. The Company also maintains smaller offices in
Chicago, San Francisco, Detroit, Atlanta, and Frankfurt, Germany.
ITEM 3. LEGAL PROCEEDINGS
We are a party to certain lawsuits in the normal course of our business. While
the outcome of these legal proceedings cannot at this time be predicted with
certainty, we do not expect that these actions will have a material effect upon
our financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and positions of the executive
officers of the Company as of March 15, 1999, as well as certain other
information with respect to those persons:
<TABLE>
<CAPTION>
POSITIONS CURRENTLY HELD
NAME AGE WITH THE COMPANY PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
---- --- ------------------------ --------------------------------------------
<S> <C> <C> <C>
William L. Walton 49 President, Chairman and Employed by the Company since 1997; Chairman
Chief Executive Officer of Business Mortgage Investors, Inc.
("BMI"); CEO of Success Lab, Inc.
(children's educational services) from 1993
to 1996; CEO of Language Odyssey
(educational publishing and services) from
1992 to 1996; Managing Director of Butler
Capital Corporation from 1987 to 1991.
Joan M. Sweeney 39 Managing Director Employed by the Company since 1993; Managing
Director of BMI; Senior Manager at Ernst &
Young from 1990 to 1993.
G. Cabell Williams III 44 Managing Director Employed by the Company since 1981; Managing
Director of BMI.
John M. Scheurer 46 Managing Director Employed by the Company since 1991;
President of BMI.
Philip A. McNeill 39 Managing Director Employed by the Company since 1993. Managing
Director of BMI.
Penni F. Roll 33 Chief Financial Officer Employed by the Company since 1995; Chief
Financial Officer of BMI. Manager at KPMG
Peat Marwick LLP from 1993 to 1995.
</TABLE>
- ---------------
(1) Periods of employment by the Company include periods of employment by
predecessor companies prior to the 1997 merger.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information in response to this Item is incorporated herein by reference to the
"Stockholder Information" and to the "Selected Consolidated Financial Data"
section of the Company's Annual Report to
16
<PAGE> 17
Shareholders for the year ended December 31, 1998 (the "1998 Annual Report") as
well as Note 13, "Dividends and Distributions" from the Company's 1998 Notes to
the Consolidated Financial Statements. The quarterly stock prices quoted therein
represent interdealer quotations and do not include markups, markdowns, or
commissions and may not necessarily represent actual transactions. During 1998,
the Company issued a total of 241,482 shares of common stock pursuant to a
dividend reinvestment plan. This plan is not registered and relies on an
exemption from registration in the Securities Act of 1933. The Company also
issued 83,333 unregistered shares. In addition, during the fourth quarter, the
Company issued a total of 4,366,959 registered shares pursuant to a shelf
registration statement on file with the Commission. See Note 8, "Shareholders'
Equity" for additional information.
ITEM 6. SELECTED FINANCIAL DATA
Information in response to this Item is incorporated herein by reference to the
table in the "Selected Consolidated Financial Data" Section of the 1998 Annual
Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Information in response to this Item is incorporated herein by reference to the
"Management's Discussion and Analysis" section of the 1998 Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's business activities contain elements of risk. The Company
considers the principal types of market risk to be interest rate risk and
valuation risk. The Company considers the management of risk essential to
conducting its businesses and to maintaining profitability. Accordingly, the
Company's risk management systems and procedures are designed to identify and
analyze the Company's risks, to set appropriate policies and limits and to
continually monitor these risks and limits by means of reliable administrative
and information systems and other policies and programs.
The Company manages its market risk by maintaining a portfolio of equity
interests that is diverse by industry, geographic area, property type, size of
individual investment and borrower. The Company does not have a significant
exposure to public market price fluctuations as the Company primarily invests in
private business enterprises. Since there is typically no public market for the
equity interests of the small companies in which the Company invests, the
valuation of the equity interests in the Company's portfolio is subject to the
estimate of the Company's Board of Directors. In the absence of a readily
ascertainable market value, the estimated value of the Company's portfolio of
equity interests may differ significantly from the values that would be placed
on the portfolio if a ready market for the equity interests existed. Any changes
in estimated value are recorded in the Company's statement of operations as "Net
unrealized gains (losses)." Each hypothetical 1% increase or decrease in value
of the Company's portfolio of equity interests of $49.4 million at December 31,
1998 would have resulted in unrealized gains or losses and would have increased
or decreased net income in 1998 by less than 1%.
The Company's sensitivity to changes in interest rates is regularly monitored
and analyzed by measuring the characteristics of assets and liabilities. The
Company utilizes various methods to assess interest rate risk in terms of the
potential effect on interest income net of interest expense, the market value of
net assets and the value at risk in an effort to ensure that the Company is
insulated from any significant adverse effects from changes in interest rates.
Based on the model used for the sensitivity of interest income net of interest
expense, if the balance sheet were to remain constant and no actions were taken
to alter the existing interest rate sensitivity, a hypothetical immediate 100
basis point change in interest rates would have affected net income by less than
1% over a six month horizon. Although management believes that this measure is
indicative of the Company's sensitivity to interest rate changes, it does not
adjust for potential changes in credit quality, size and composition of the
balance sheet and other business developments that could affect net income.
Accordingly, no assurances can be given that actual results would not differ
materially from the potential outcome simulated by this estimate.
17
<PAGE> 18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information in response to this Item is incorporated by reference to the
Consolidated Financial Statements, Notes thereto, and Report of Independent
Public Accountants thereon contained in the 1998 Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company disclosed its change of accountants on a Form 8-K filed with the
Commission on December 16, 1997.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to this Item is incorporated by reference to the
identification of directors and nominees contained in the "Election of
Directors" section and the subsection captioned "Section 16(a) Beneficial
Ownership Reporting Compliance" of the Company's definitive proxy statement in
connection with its 1998 Annual Meeting of Shareholders, scheduled to be held on
May 11, 1999 (the "1999 Proxy Statement"), and from "Additional Item" in Part I.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to this Item is incorporated by reference to the
subsections captioned "Compensation of Executive Officers and Directors" of the
1999 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information in response to this Item is incorporated by reference to the
subsection captioned "Security Ownership of Management and Certain Beneficial
Owners" in the 1999 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information in response to this Item is incorporated by reference to the section
captioned "Certain Transactions" of the 1999 Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. A. The following financial statements are incorporated by reference
from the Consolidated Financial Statements, Notes thereto and Report of
Independent Public Accountants thereon contained in Allied Capital
Corporation's (the "Company") 1998 Annual Report, filed herewith.
Consolidated Balance Sheet as of December 31, 1998 and 1997.
Consolidated Statement of Operations for the years ended December 31,
1998, 1997 and 1996.
Consolidated Statement of Changes in Net Assets for the years ended
December 31, 1998, 1997 and 1996.
Consolidated Statement of Cash Flows for the years ended December 31,
1998, 1997 and 1996.
Consolidated Statement of Investments as of December 31, 1998.
Notes to Consolidated Financial Statements.
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B. The Report of Independent Public Accountants from Arthur Andersen
LLP is incorporated by reference to the Report of Independent Public
Accountants contained in the Company's 1998 Annual Report filed herewith.
2. No financial statement schedules are filed herewith because (i)
such schedules are not required or (ii) the information required has been
presented in the aforementioned financial statements.
3. The following exhibits are filed herewith or incorporated by
reference as set forth below:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
3(i)(1) Articles of Amendment and Restatement of the Articles of
Incorporation.
3(ii)(2) Articles of Merger.
3(iii)(3) By-laws.
4.1(6) Specimen certificate of the Company's Common stock, par
value $0.0001 per share. See exhibits 3(i), 3(ii) and 3(iii)
for other instruments defining the rights of security
holders.
4.2(4) Form of debenture between certain subsidiaries of the
Company and the U.S. Small Business Administration.
5 Not applicable.
9 Not applicable.
10.1(8) Second Amended and Restated Credit Agreement, dated as of
June 4, 1998 (the "1998 Agreement") between the Company, as
borrower, each of the financial institutions initially a
signatory thereto, as Lenders, and BankBoston, N.A., as
disbursing agent, First Union National Bank, as syndication
agent, and Riggs Bank, N.A., as managing agent, and
NationsBank of Texas, N.A., as Co-Agent.
10.2(8) Note Agreement dated as of April 30, 1998.
10.3(5) Loan Agreement between Allied I and Overseas Private
Investment Corporation, dated April 10, 1995. Letter dated
December 11, 1997 evidencing assignment of Loan Agreement
from Allied I to the Company.
10.5(9) Amended and restated Master Loan & Security Agreement dated
October 7, 1998 among the Company, BMI and Morgan Stanley
Mortgage Capital, Inc.
10.6(7) Sale and Servicing Agreement dated as of January 1, 1998
among Allied Capital CMT, Inc., Allied Capital Commercial
Mortgage Trust 1998-1 and the Company and LaSalle National
Bank Inc. and ABN AMRO Bank N.V.
10.7(7) Indenture dated as of January 1, 1998 between Allied Capital
Commercial Mortgage Trust 1998-1 and LaSalle National Bank
Inc.
10.8(7) Amended and Restated Trust Agreement dated January 1, 1998
between Allied Capital CMT, Inc., LaSalle National Bank Inc.
and Wilmington Trust Company.
10.9(7) Guaranty dated as of January 1, 1998 by the Company.
10.10(3) Employee Stock Ownership Plan, as amended on December 31,
1997.
10.10a(8) First Amendment to the Company's Employee Stock Ownership
Plan dated April 30, 1998.
10.11* Amended and Restated Deferred Compensation Plan dated
December 30, 1998.
10.12(10) Stock Option Plan.
10.13a(7) Form of Custody Agreement with Riggs Bank N.A. with respect
to safekeeping.
10.13b(7) Form of Custody Agreement with La Salle National Bank Inc.
10.18(3) Dividend Reinvestment Plan.
</TABLE>
19
<PAGE> 20
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
11 Statement regarding computation of per share earnings is
incorporated by reference to Note 9 to the Company's Notes
to the Consolidated Financial Statements contained in the
Company's 1998 Annual Report filed as Exhibit 13 herewith.
13* Excerpts from the 1998 Annual Report to Shareholders.
21 Subsidiaries of the Company and jurisdiction of
incorporation/organization:
Allied Investment Corporation Maryland
Allied Capital SBLC Corporation Maryland
Allied Capital REIT, Inc. Maryland
Allied Capital Holdings LLC Delaware
PC Acquisition Corporation Maryland
Allied Capital Beteiligungsberatung GmbH Germany
23* Consent of Arthur Andersen LLP, independent public
accountants.
27* Financial Data Schedule
</TABLE>
--------------------
* Filed herewith.
(1) Incorporated by reference to exhibit 3(i) with Allied Lending's Annual
Report on Form 10-K for the year ended December 31, 1996.
(2) Incorporated by reference from Appendix B to the Company's
registration statement on Form N-14 filed on the Company's behalf with
the Commission on September 26, 1997 (File No. 333-36459).
(3) Incorporated by reference to the exhibit of the same name filed with
the Company's Annual Report on Form 10-K for the year ended December
31, 1997.
(4) Incorporated by reference to the exhibit of the same name filed with
Allied I's Annual Report on Form 10-K for the year ended December 31,
1996.
(5) Incorporated by reference to Exhibit f5 of Allied I's Pre-Effective
Amendment No. 2 filed with the registration statement on Form N-2 on
January 24, 1996 (File No. 33-64629). Assignment to Company is
incorporated by reference to Exhibit 10.3 of the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
(6) Incorporated by reference to the exhibit of the same description to
the Company's registration statement on Form N-2 filed on the
Company's behalf with the Commission on May 5, 1998 (File No.
333-51899).
(7) Incorporated by reference to the exhibit of same description filed
with the Company's registration statement on Form N-2 on May 5, 1998
(File No. 333-51899).
(8) Incorporated by reference to the exhibit of the same name filed with
the Company's Quarterly Report on Form 10-Q for the period ended June
30, 1998.
(9) Incorporated by reference to the exhibit of the same name filed with
the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998.
(10) Incorporated by reference to Exhibit 4 of the Allied Capital
Corporation Stock Option Plan registration statement on Form S-8,
filed on behalf of such Plan on February 3, 1998 (File No. 333-45525).
(b) Reports on Form 8-K.
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1998.
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized on March 19, 1999.
/s/ WILLIAM L. WALTON
--------------------------------------
William L. Walton
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
TITLE
SIGNATURE (CAPACITY) DATE
--------- ---------- ----
<S> <C> <C>
/s/ WILLIAM L. WALTON Chairman, President, and March 17, 1999
- -------------------------------------------------------- Chief Executive Officer
William L. Walton
/s/ BROOKS H. BROWNE Director March 17, 1999
- --------------------------------------------------------
Brooks H. Browne
/s/ JOHN D. FIRESTONE Director March 17, 1999
- --------------------------------------------------------
John D. Firestone
/s/ ANTHONY T. GARCIA Director March 17, 1999
- --------------------------------------------------------
Anthony T. Garcia
/s/ LAWRENCE I. HEBERT Director March 17, 1999
- --------------------------------------------------------
Lawrence I. Hebert
/s/ JOHN I. LEAHY Director March 17, 1999
- --------------------------------------------------------
John I. Leahy
/s/ ROBERT E. LONG Director March 17, 1999
- --------------------------------------------------------
Robert E. Long
/s/ WARREN K. MONTOURI Director March 17, 1999
- --------------------------------------------------------
Warren K. Montouri
/s/ GUY T. STEUART II Director March 17, 1999
- --------------------------------------------------------
Guy T. Steuart II
/s/ T. MURRAY TOOMEY Director March 17, 1999
- --------------------------------------------------------
T. Murray Toomey
</TABLE>
21
<PAGE> 22
<TABLE>
<CAPTION>
TITLE
SIGNATURE (CAPACITY) DATE
--------- ---------- ----
<S> <C> <C>
/s/ LAURA W. VAN ROIJEN Director March 17, 1999
- --------------------------------------------------------
Laura W. van Roijen
/s/ GEORGE C. WILLIAMS Director March 17, 1999
- --------------------------------------------------------
George C. Williams
/s/ PENNI F. ROLL Principal, Treasurer and March 17, 1999
- -------------------------------------------------------- Chief Financial Officer
Penni F. Roll (Principal Financial and
Accounting Officer)
</TABLE>
22
<PAGE> 23
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
10.11 Amended and Restated Deferred Compensation Plan dated
December 30, 1998.
13 Excerpts from the 1998 Annual Report to Shareholders.
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
</TABLE>
23
<PAGE> 1
EXHIBIT 10.11
THE ALLIED CAPITAL CORPORATION
NON-QUALIFIED DEFERRED COMPENSATION PLAN
Amended and Restated December 30, 1998
<PAGE> 2
THE ALLIED CAPITAL CORPORATION
NON-QUALIFIED DEFERRED COMPENSATION PLAN
Table of Contents
<TABLE>
<CAPTION>
Page
----
<S> <C>
ARTICLE I - GENERAL
Section 1.1 Effective Date.......................................................................................2
--------------
Section 1.2 Purpose..............................................................................................2
-------
Section 1.3 Intent...............................................................................................2
------
ARTICLE II - DEFINITIONS AND USAGE
Section 2.1 Definitions..........................................................................................3
-----------
Section 2.2 Usage................................................................................................5
-----
ARTICLE III - ELIGIBILITY AND PARTICIPATION
Section 3.1 Eligibility..........................................................................................6
-----------
Section 3.2 Participation........................................................................................6
-------------
ARTICLE IV - PLAN BENEFIT
Section 4.1 Plan Benefit.........................................................................................7
------------
Section 4.2 Accounts.............................................................................................7
--------
Section 4.3 Multiple Accounts....................................................................................7
-----------------
Section 4.4 Formula Award Accounts...............................................................................7
----------------------
Section 4.5 Participant's Deferral Election......................................................................7
-------------------------------
Section 4.6 Investment Procedure.................................................................................9
--------------------
Section 4.7 Valuation of Accounts................................................................................9
---------------------
Section 4.8 Participant Deferral Agreement......................................................................10
------------------------------
ARTICLE V - VESTING AND DISTRIBUTION
Section 5.1 Vesting.............................................................................................11
-------
Section 5.2 Distributable Events................................................................................11
--------------------
Section 5.3 Amount of Plan Benefits.............................................................................12
-----------------------
Section 5.4 Plan Benefit Payment Options........................................................................12
----------------------------
Section 5.5 Commencement of Benefit Payments....................................................................12
--------------------------------
Section 5.6 Form of Benefit Payments............................................................................12
------------------------
Section 5.7 Plan Benefit Payment Election Procedures............................................................13
----------------------------------------
Section 5.8 Form of Benefit Payments Upon Death.................................................................13
-----------------------------------
Section 5.9 Designation of Beneficiary..........................................................................13
--------------------------
Section 5.10 Distributions in the Case of Unforeseeable Emergency................................................13
----------------------------------------------------
</TABLE>
<PAGE> 3
THE ALLIED CAPITAL CORPORATION
NON-QUALIFIED DEFERRED COMPENSATION PLAN
Table of Contents (continued)
<TABLE>
<CAPTION>
Page
----
<S> <C>
ARTICLE VI - ADMINISTRATION
Section 6.1 General.............................................................................................15
-------
Section 6.2 Administrative Rules................................................................................15
--------------------
Section 6.3 Duties..............................................................................................15
------
Section 6.4 Fees................................................................................................16
----
ARTICLE VII - CLAIMS PROCEDURE
Section 7.1 General.............................................................................................17
-------
Section 7.2 Denials.............................................................................................17
-------
Section 7.3 Notice..............................................................................................17
------
Section 7.4 Appeals Procedure...................................................................................17
-----------------
Section 7.5 Review..............................................................................................17
------
ARTICLE VIII - CHANGE IN CONTROL
Section 8.1 In General..........................................................................................18
----------
Section 8.2 Definition of "Change in Control"...................................................................18
---------------------------------
ARTICLE IX - TRUST
Section 9.1 Trust...............................................................................................19
-----
Section 9.2 Contributions and Expenses..........................................................................19
--------------------------
Section 9.3 Trustee Duties......................................................................................19
--------------
Section 9.4 Reversion to the Employer...........................................................................19
-------------------------
ARTICLE X - MISCELLANEOUS PROVISIONS
Section 10.1 Amendment...........................................................................................20
---------
Section 10.2 Termination.........................................................................................20
-----------
Section 10.3 No Assignment.......................................................................................20
-------------
Section 10.4 Successors and Assigns..............................................................................20
----------------------
Section 10.5 Governing Law.......................................................................................20
-------------
Section 10.6 No Guarantee of Employment..........................................................................20
--------------------------
Section 10.7 Severability........................................................................................20
------------
Section 10.8 Notification of Addresses...........................................................................20
-------------------------
Section 10.9 Bonding.............................................................................................21
-------
</TABLE>
<PAGE> 4
THE ALLIED CAPITAL CORPORATION
NON-QUALIFIED DEFERRED COMPENSATION PLAN
PREAMBLE
WHEREAS, the Employer recognizes the unique qualifications of its executive
Employees or Consultants and the valuable services that they have provided to or
for the Employer; and
WHEREAS, the Employer now desires to adopt the amended and restated
Non-Qualified Deferred Compensation Agreement of Allied Capital Corporation; and
WHEREAS, the Employer desires to provide retirement benefits to its executives
and consultants based upon compensation earned by its key employees in excess of
the compensation limit imposed on qualified retirement plans by section
401(a)(17) of the Internal Revenue Code but without regard to the limitation on
benefits or contributions under section 415 of the Internal Revenue Code; and
NOW, THEREFORE, in consideration of the premises and of the provisions
hereinafter set forth, the Allied Capital Corporation Non-Qualified Deferred
Compensation Plan (the "Plan") shall be and hereby is restated as follows:
1
<PAGE> 5
ARTICLE I
GENERAL
SECTION 1.1 Effective Date. The provisions of this Plan, as amended and
restated, shall be effective as of December 30, 1998. The rights, if any, of any
person whose status as an Employee or Consultant of the Employer has terminated
shall be determined pursuant to the Plan as in effect on the date such Employee
or Consultant terminated, unless a subsequently adopted provision of the Plan is
made specifically applicable to such person.
SECTION 1.2 Purpose. The purpose of the Plan is to provide retirement income to
a Participant based upon his Compensation from the Company in excess of the
amount of Compensation that may be taken into account by a qualified retirement
plan described in section 401(a) of the Code but without regard to the
limitation on benefits or contributions under section 415 of the Code.
SECTION 1.3 Intent. The Plan is intended to be an unfunded plan for the purpose
of providing deferred compensation to a select group of management or highly
compensated employees as such group is described under Sections 201(2) and
301(a)(3) of ERISA, and a select group of consultants. The Plan is not intended
to be a plan described in Section 401(a)(1) of the Code. The obligation of the
Company to make payments under this Plan constitutes nothing more than an
unsecured promise of the Company to make such payments and any property of the
Company that may be set aside for the payment of benefits under the Plan shall
in the event of the Company's bankruptcy or insolvency, remain subject to the
claims of the Company's general creditors until such benefits are distributed in
accordance with Article V herein.
2
<PAGE> 6
ARTICLE II
DEFINITIONS AND USAGE
SECTION 2.1 Definitions. Wherever used in the Plan, the following words and
phrases shall have the meaning set forth below unless the context plainly
requires a different meaning:
"Account" means the account established on behalf of each Participant as
described in Section 4.2 of the Plan.
"Administrator" means the person or persons described in Article VI.
"Beneficiary" means those persons designated as a Beneficiary by the
Participant in the Participant Deferral Agreement.
"Board" means the Board of Directors of Allied Capital Corporation.
"Bonus" means any amount paid to an Employee which is designated by the
Employer as a bonus, or any amount paid to a Consultant.
"Bonus Deferral Election" means an election made pursuant to Section
4.5(b) of the Plan.
"Change in Control" of the Company shall be defined in accordance with
Section 8.2 of the Plan.
"Code" means the Internal Revenue Code of 1986, as amended from time to
time.
"Compensation" means "Compensation" as defined under the Retirement Plan.
However, for purposes of this Plan "Compensation" shall not include
Bonuses and shall be determined without regard to the limitations imposed
by Code Section 401(a)(17).
"Compensation Committee" means the Compensation Committee of the Board of
Directors of Allied Capital Corporation.
"Compensation Deferral Election" means an election made pursuant to
Section 4.5(a) of the Plan.
"Consultant" means any individual providing services for the Employer in
a capacity other than as a common law employee of the Employer.
"Disability" means a physical or mental condition of a Participant
resulting from a bodily injury, disease, or mental disorder which renders
him incapable of
3
<PAGE> 7
continuing his usual and customary employment with the Employer. The
Disability of the Participant shall be determined by a licensed physician
chosen by the Administrator. The determination shall be applied uniformly
to all Participants.
"Employee" means any common law employee of the Employer.
"Employer" means Allied Capital Corporation, its successors and its
subsidiaries.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended from time to time.
"Excess Recognized Compensation" means the excess, if any, of a
Participant's recognized Compensation for the Plan Year, but without any
reduction to reflect the $160,000 limit (as adjusted from time to time
for cost of living increases) of Section 401(a)(17) of the Code or
amounts deferred to this plan over $160,000 (as adjusted from time to
time for cost of living increases).
"Formula Award" means the formula bonus award provided by the Employer in
conjunction with the merger of the Allied Capital Companies effective
December, 31, 1997 to compensate employees and consultants from the point
when the unvested options in the Allied Capital stock option plans would
cease to appreciate in value (the merger announcement date), until the
time in which they would be able to receive option awards in Allied
Capital Corporation (after the merger becomes effective).
"Formula Award Account" means the account established on behalf of each
Participant as described in Section 4.4.
"Formula Award Deferral Election" means an election made pursuant to
Section 4.5(e) of the Plan.
"Insolvency" means the Employer (a) is unable to pay its debts as they
become due, or (b) is subject to a pending proceeding as a debtor under
the United States Bankruptcy Code.
"Normal Retirement Age" means age sixty (60).
"Participant" means an eligible Employee or Consultant of the Employer
designated by the Board for participation in the Plan, or a person who
was such a Participant at the time of retirement, death, disability or
resignation, or a Beneficiary who is presently entitled to benefits under
the Plan in accordance with its terms.
4
<PAGE> 8
"Participant Deferral Agreement" means an agreement entered into between
a Participant and the Employer for the Purposes set forth in Articles IV
and V.
"Plan" means the Allied Capital Corporation Non-Qualified Deferred
Compensation Plan, as amended from time to time.
"Plan Benefit" means the benefit of a Participant as determined under
Article IV of the Plan.
"Plan Year" means the calendar year.
"Retirement" means the date on or after a Participant reaches Normal
Retirement Age on which such Participant retires from the Employer.
"Trust" means a trust which may be established by the Employer in
accordance with Article IX to provide the benefits described in this
Plan.
"Trustee" means the corporation or individual(s) selected by the Employer
to serve as trustee for the Trust.
SECTION 2.2 Usage. Except where otherwise indicated by the context, any
masculine terminology used herein shall also include the feminine and vice
versa, and the definition of any term herein in the singular shall also include
the plural and vice versa.
5
<PAGE> 9
ARTICLE III
ELIGIBILITY AND PARTICIPATION
SECTION 3.1 Eligibility. Any Employee or Consultant of the Employer shall be
eligible to participate in the Plan at such time and for such period as
designated by the Board; provided however, that all such employees are members
of a select group of management or highly compensated employees as such group is
described under sections 201(2), 301(a)(3), and 401(a)(1) of ERISA as
interpreted by the Department of Labor.
SECTION 3.2 Participation. An Employee or Consultant who is eligible to
participate in the Plan pursuant to Section 3.1 shall become a Participant at
such time and for the period so designated by the Board. The participation of
any Participant may be suspended or terminated by the Committee, at any time. An
employee shall cease to be a Participant when he terminates employment with the
Company and the balance in his Account is distributed to him or on his behalf.
If, at any time, an Employee or Consultant is determined or reasonably believed,
based on a judicial or administrative determination or opinion of counsel, not
to qualify as "management" or a "highly compensated employee" under ERISA
Sections 201(2), 301(a)(3), and 401(a)(1), or as a select consultant, the
Employee or Consultant shall cease participation in the Plan as of the date of
that determination and the Plan Benefit to which he is entitled will be
distributed to him as soon as administratively possible in a single lump-sum
payment, notwithstanding any other provision of the Plan.
6
<PAGE> 10
ARTICLE IV
PLAN BENEFIT
SECTION 4.1 Plan Benefit. A Participant's Plan Benefit shall be equal to the
total amount credited to the Participant's Account under this Article IV. Such
Plan Benefit shall become nonforfeitable and payable to the Participant as
provided under Article V.
SECTION 4.2 Accounts. For each Participant, the Administrator shall establish
and maintain a Participant Account. All amounts which are credited to the
Account shall be credited solely for purposes of accounting and computation, and
shall remain assets of the Employer subject to the claims of the Employer's
general creditors. A Participant's Account shall be reduced by an amount equal
to any Plan Benefit previously distributed to him pursuant to Article V. A
Participant's Account shall include amounts credited under the Plan for the Plan
Year beginning January 1, 1997.
SECTION 4.3 Multiple Accounts. At the discretion of the Board, a Participant may
have more than one account, as in the case of a former Employee who may be a
Participant because of serving in the capacity of a Consultant. Contributions to
each such Account shall be determined by deferral elections made under separate
Participant Deferral Agreements, as described in Section 4.5 of the Plan. The
determination as to the period for the commencement of the distribution of Plan
Benefits under Article V of the Plan shall be made separately with respect to
each such Account.
SECTION 4.4 Formula Award Accounts. For each Participant, the Administrator
shall establish and maintain a separate record-keeping account which contains
both the vested and unvested balances of a Participant's Formula Award.
SECTION 4.5 Participant's Deferral Elections. For each Plan Year, each eligible
Participant may make the following deferral elections:
(a) Compensation Deferral Election. Prior to the beginning of the Plan
Year, or prior to the date of entry as a Participant under the
Plan, an eligible Participant may authorize the Employer to reduce
his or her Compensation by any specific amount or percentage as
specified in a Participant Deferral Agreement in effect for each
Plan Year (in lieu of receiving cash Compensation), and to have
such amount credited to the Participant's Account under this
Article IV. The Participant Deferral Agreement shall be effective
only with respect to Compensation earned after the agreement
becomes effective. No more than one Compensation Deferral Election
may be made during each Plan Year. However, a Participant may
terminate the election at any time with respect to Compensation
not yet earned.
7
<PAGE> 11
(b) Bonus Deferral Election. Prior to the end of the Plan Year in
which the Bonus is earned, an eligible Participant may authorize
the Employer to reduce his or her Bonus by any specific amount or
percentage as specified in a Participant Deferral Agreement in
effect for each Plan Year (in lieu of receiving a cash Bonus), and
to have such amount credited to the Participant's Account under
this Article IV.
(c) Compensation Increases. Prior to the Beginning of the Plan Year in
which a Compensation increase will be earned, an eligible
Participant may authorize the Employer to defer such increase
entirely or by any specific amount or percentage as specified in a
Participant Deferral Agreement in effect for each Plan Year (in
lieu of receiving such increase), and to have such amount credited
to the Participant's Account under this Article IV.
(d) Investment in Employer Stock for Salary or Bonus Deferrals.
Effective 12/31/98, no new salary or bonus deferrals may be
invested in Allied Capital Corporation Common Stock. With respect
to Participant Deferral Elections pursuant to Section 4.5 (a) and
(b) which are invested in Employer stock, effective 6/1/98, no
dividend shall be allocated to Employer Stock held in a
Participant Account established pursuant to Section 4.2 of the
Plan. Any dividend awarded prior to 6/1/98 with respect to
Employer stock held in such Participant Account shall be used
exclusively to purchase additional shares of Employer stock.
(e) Formula Award Deferral Election. Participants deemed eligible for
the Formula Award by the Board of Directors of Allied Capital
Corporation, will receive a Formula Award as of December 31, 1997
that will be posted to a separate record-keeping account
maintained by the Trustee or other designee ("the Formula Award
Account"). Amounts funded by the Employer to the Formula Award
Account will vest over a three-year period in equal installments
on the anniversaries of December 31, 1997. Amounts funded in the
Formula Award Account will be used to purchase shares of Allied
Capital Corporation common stock in the open market, as directed
by the Administrator. Amounts funded or unfunded in the Formula
Award Account will vest immediately upon a change in control as
defined in Section 8.2. Effective 1/1/98, no dividend shall be
allocated to a Formula Award Account, established pursuant to
Section 4.4, with respect to Employer stock held in such account.
Any dividend awarded prior to 1/1/98 with respect to Employer
stock held in a Formula Award Account shall be used exclusively to
purchase additional shares of Employer stock.
(f) The Employer, in its discretion, shall contribute from time to
time a sum based on the amount designated in the Qualified Plan to
the account of each Participant based upon the Excess Recognized
Compensation. The
8
<PAGE> 12
Employer shall also contribute such sums to the Plan from time to
time as it deems appropriate.
SECTION 4.6 Investment Procedure. The Employer and each Employee or Consultant
who is eligible to participate in the Plan may, at the discretion of the
Employer, execute an agreement which reflects the deemed investment of the
portion of the Participant's Compensation and Bonus which shall be applied to
the payment of the Participant's Plan Benefit under the Plan. The Administrator
shall retain overriding discretion over the selection of investment vehicles and
the Administrator may change, alter or modify its investment policy as it deems
appropriate, from time to time, to maximize benefits under the Plan. Any such
change, alteration or modification shall be communicated to the Participants
under procedures adopted by the Administrator.
The Formula Award Account may only be invested in the common stock of Allied
Capital Corporation until such time as a distributable event (as listed in
section 5.2) occurs. At that time, the Participant may choose other Plan
investment options for the balance of his Account while he remains in
distribution status.
SECTION 4.7 Valuation of Accounts. The value of a Participant's Account shall be
determined from time to time by the Trustee in the following manner.
(a) During any period of time in which a Participant's Account is
deemed invested in whole or in part pursuant to the agreement with
the Participant (in the manner described in Section 4.6), the
income and expenses, gains and losses, both realized and
unrealized, from such deemed investments shall be determined by
the Trustee. The amount so determined shall be credited to the
Account of the Participant proportionately in accordance with
procedures established by the Administrator.
(b) All benefits and deferrals on behalf of a Participant shall be
credited to the Account of the Participant in accordance with this
Article IV.
(c) Each Participant's Account shall be valued as of the last day of
each Plan Year or more frequently as determined by the
Administrator.
(d) All credits to a Participant's Account under this Section 4.7
shall be deemed to have been made on the applicable valuation date
in the order of priority set forth in this Section 4.7, even
though actually determined at a later date.
(e) Each Participant's Account shall include amounts previously
credited under the Plan prior to the effective date of this
amendment and restatement, December 30, 1998.
9
<PAGE> 13
SECTION 4.8 Participant Deferral Agreement. To be eligible to make a
Participant's Deferral Election under the terms of this Plan, a Participant,
with the consent of the Company, shall enter into a Participant Deferral
Agreement effective for the stated Plan Year, setting forth the amount or
percentage of eligible Compensation, Bonuses or other amounts to be deferred.
(a) Compensation Deferrals. A Participant, with the consent of the
company, may modify a previous election to defer Compensation by
terminating such election or by reducing the amount or percentage
deferred with respect to Compensation not yet Earned. "Earned"
means that a Participant has performed the services necessary to
receive payment and such payment is immediately due.
(b) Modification Procedure. The Participant Deferral Agreement in
effect for a Plan Year shall be modified only upon a valid written
agreement entered into with the consent of both the Company and
the Participant pursuant to established Plan procedures.
10
<PAGE> 14
ARTICLE V
VESTING AND DISTRIBUTION
SECTION 5.1 Vesting.
(a) Compensation and Bonus Deferral All Participant's Deferral
Election Amounts, except for Formula Award Accounts deferred
pursuant to section 4.5(e) of the Plan, credited under Article IV
of the Plan shall at all times be 100% vested and nonforfeitable.
(b) Formula Award Deferral amounts shall, generally, be subject to the
three-year vesting period provided in Section 4.5(e).
(i) Upon termination of a Participant's Employee or Consultant
relationship with the Company for any reason other than
Death or Disability, the unvested balance of a
Participant's Formula Award Account shall be forfeited.
(ii) In the event of the Death or Disability of a Participant,
the unvested balance of that Participant's Formula Award
Account shall become immediately vested.
SECTION 5.2 Distributable Events. Except as otherwise provided in this Plan, a
Participant's Plan Benefit shall become distributable upon the occurrence of one
of the following events:
1. Separation from service (other than on account of Retirement,
death, or Disability)
2. Retirement
3. Disability
4. Death
5. Insolvency
6. Change in Control (as defined in Section 8.2)
7. Future determined date (at least 2 years from the signing date of
the Participant Deferral Agreement)
8. Termination of the Plan
11
<PAGE> 15
9. Unforeseeable emergency as defined in Section 5.10.
10. Discretionary payment of a Formula Award as determined by the
Compensation Committee.
SECTION 5.3 Amount of Plan Benefits. A Participant's Plan Benefit shall equal
the total amount credited to the Participant's Account in accordance with
Article IV.
SECTION 5.4 Plan Benefit Payment Options. Subject to the provisions of Section
5.7, a Participant may elect one of the following Plan Benefit payment options:
(a) Lump-sum - A Participant may elect to receive his Plan Benefit in
a single lump-sum distribution. This lump-sum payment shall be the
Plan's default option, i.e., if no signed election form is on
file.
(b) Installments - Alternatively, for all non-Formula Award accounts,
a Participant may elect to receive his Plan Benefit in equal
annual installments over a period of not less than three years and
not greater than ten years.
(c) Formula Award Account - With respect to the Formula Award Account,
shares of Allied Capital Corporation stock will be distributed in
stock at the discretion of the Compensation Committee.
SECTION 5.5 Commencement of Benefit Payments. At the election of the Participant
or Beneficiary, if applicable, the payment of Plan Benefits shall commence no
earlier than one month and no later than six months from the most recent
valuation date determined by the Administrator. In the event of a distribution
on account of unforeseeable emergency, as defined in Section 5.10, the payment
of Plan Benefits shall commence as soon as administratively feasible from the
date the Administrator determines that a Participant is entitled to a
distribution on account of unforeseeable emergency under the Plan.
SECTION 5.6 Form of Benefit Payments. Plan Benefits will be paid in the form of
cash. If a Participant has invested his Account balance in Allied Capital
Corporation common stock, Plan Benefits may be paid in the form of Allied
Capital Corporation common stock equal to the value of the Plan Benefit payable
as of the valuation date as determined by the Administrator. Effective 1/1/98,
with respect to Benefits payable from a Formula Award Account, such Benefits
shall be paid solely in the form of common stock of Allied Capital Corporation.
The election may, if consented to by the Company, be modified once; provided
that, such modification shall not be effective for a period of three years after
such modification is executed. Once modified, the election shall become
irrevocable.
12
<PAGE> 16
SECTION 5.7 Plan Benefit Payment Election Procedures. For purposes of making the
elections provided in Section 5.4 and 5.5, each Participant and Beneficiary, if
applicable, shall be provided with an election form prepared by the
Administrator. If an election form is not properly executed as provided herein,
the Participant will be deemed (a) in the case of the elections provided in
Section 5.4 and 5.5 to have elected to receive his or her Plan Benefits in a
lump sum or (b) in the case of the Formula Award, vested balances shall be
distributed to participants at the discretion of the Compensation Committee.
SECTION 5.8 Form of Benefit Payments Upon Death. Upon the death of a Participant
who has not yet begun to receive benefits under this Plan, the Participant's
Beneficiary or Beneficiaries may elect to receive the Plan Benefit in accordance
with Section 5.4. Upon the death of a Participant who has already begun to
receive his Plan Benefit under this Plan in the form of installments, the
Participant's Beneficiaries will receive the remaining Plan Benefits in equal
annual installments in the same manner elected by the Participant.
SECTION 5.9 Designation of Beneficiary. A Participant may, in the Participant
Deferral Agreement, designate one or more primary and contingent Beneficiaries
to receive the Plan Benefit which may be payable hereunder following the
Participant's death, and may designate the proportions in which such
Beneficiaries are to receive such payments. A Participant may change such
designations from time to time, and the last written designation filed with the
Administrator prior to the Participant's death shall control. If a Participant
fails to specifically designate a Beneficiary or, if no designated Beneficiary
survives the Participant, payment shall be made to the Participant's estate in a
single lump-sum, notwithstanding any other provision of this Plan.
SECTION 5.10 Distributions in the Case of Unforeseeable Emergency A distribution
in an amount no greater than a Participant's Account balance may be made to, and
at the election of, a Participant in the event of an unforeseeable emergency. An
unforeseeable emergency is defined as a severe financial hardship to the
Participant resulting from (i) sudden and unexpected illness or accident of the
Participant or of a dependent, (ii) loss of the Participant's property due to
casualty, or (iii) other similar extraordinary and unforeseeable circumstances
arising as a result of events beyond the control of the Participant. This
determination shall be made by the Compensation Committee and such distributions
shall only be made out of the Participant's Compensation Deferral contributions
and deemed earnings thereon. Distributions should be limited to the amount
necessary to satisfy the emergency (which amount necessary may be considered to
include any taxes due because of the distribution occurring because of this
section).
The circumstances that will constitute an unforeseeable emergency will depend
upon the facts of each case, but, in any case, payment may not be made to the
extent that such hardship is or may be relieved (i) through reimbursement or
compensation by insurance or otherwise, (ii) by liquidation of the Participant's
assets, other than hardship
13
<PAGE> 17
withdrawals from the Company's qualified plan, if any, to the extent the
liquidation of such assets would not itself cause severe financial hardship, or
(iii) by cessation of deferrals under the Plan.
14
<PAGE> 18
ARTICLE VI
ADMINISTRATION
SECTION 6.1 General. The Administrator shall be the Board, or such other person
or persons as designated by the Board. Except as otherwise specifically provided
in the Plan, the Administrator shall be responsible for administration of the
Plan. The Administrator shall be the "named fiduciary" within the meaning of
Section 402(c)(2) of ERISA.
SECTION 6.2 Administrative Rules. The Administrator may adopt such rules of
procedure as it deems desirable for the conduct of its affairs, except to the
extent that such rules conflict with the provisions of the Plan.
SECTION 6.3 Duties. The Administrator shall have the following rights, powers
and duties:
(a) The decision of the Administrator in matters within its
jurisdiction shall be final, binding and conclusive upon the
Employer and upon any other person affected by such decision,
subject to the claims procedure hereinafter set forth.
(b) The Administrator shall have the duty and authority to interpret
and construe the provisions of the Plan, to decide any question
which may arise regarding the rights of Employees or Consultants,
Participants, and Beneficiaries, and the amount of their
respective interests, to adopt such rules and to exercise such
powers as the Administrator may deem necessary for the
administration of the Plan, and to exercise any other rights,
powers or privileges granted to the Administrator by the terms of
the Plan.
(c) The Administrator shall maintain full and complete records of its
decisions. Its records shall contain all relevant data pertaining
to the Participant and his rights and duties under the Plan. The
Administrator shall have the duty to maintain Account records of
all Participants. The Administrator shall also have the duty to
report pertinent information regarding Participant Accounts to
Participants at least annually.
(d) The Administrator shall cause the principal provisions of the Plan
to be communicated to the Participants, and a copy of the Plan and
other documents shall be available at the principal office of the
Employer for inspection by the Participants at reasonable times
determined by the Administrator.
15
<PAGE> 19
(e) The Administrator shall periodically report to the Board with
respect to the status of the Plan.
SECTION 6.4 Fees. No fee or compensation shall be paid to any person for
services as the Administrator.
16
<PAGE> 20
ARTICLE VII
CLAIMS PROCEDURE
SECTION 7.1 General. Any claim for Plan Benefits under the Plan shall be filed
by the Participant or Beneficiary ("claimant") on the form prescribed for such
purpose with the Administrator.
SECTION 7.2 Denials. If a claim for Plan Benefits under the Plan is wholly or
partially denied, notice of the decision shall be furnished to the claimant by
the Administrator within sixty days after receipt of the claim by the
Administrator, unless special circumstances require an extension of time of
sixty days (for a total of 120 days).
SECTION 7.3 Notice. Any claimant who is denied a claim for Plan Benefits shall
be furnished written notice setting forth:
(a) the specific reason or reasons for the denial;
(b) specific reference to the pertinent provision of the Plan upon
which the denial is based;
(c) a description of any additional material or information necessary
for the claimant to perfect the claim; and
(d) an explanation of the claim review procedure under Section 7.5.
SECTION 7.4 Appeals Procedure. In order that a claimant may appeal a denial of a
claim, the claimant or the claimant's duly authorized representative may:
(a) request a review by written application to the Administrator, or
its designate, no later than sixty days after receipt by the
claimant of written notification of denial of a claim;
(b) review pertinent documents; and
(c) submit issues and comments in writing.
SECTION 7.5 Review. A decision on review of a denied claim shall be made not
later than sixty days after receipt of a request for review, unless special
circumstances require an extension of time for processing, in which case a
decision shall be rendered within a reasonable period of time, but not later
than 120 days after receipt of a request for review. The decision on review
shall be in writing and shall include the specific reason(s) for the decision
and the specific reference(s) to the pertinent provisions of the Plan on which
the decision is based.
17
<PAGE> 21
ARTICLE VIII
CHANGE IN CONTROL
SECTION 8.1. In General. Unless otherwise set forth in the applicable Award
agreement, in the event of a "Change in Control" as defined in Section 8.2 of
the Plan, all amounts in all Participant Accounts including the Formula Award
Account, will be 100% vested and will be immediately distributed to the
Participants.
SECTION 8.2. Definition of "Change in Control". For purposes of Section 8.1 of
the Plan, a "Change in Control" means (i) the sale of all or substantially all
of the Employer's assets, (ii) the acquisition, whether directly, indirectly,
beneficially (within the meaning of Rule 13d-3 of the 1934 Act), or of record,
or securities of the Company representing twenty-five percent (25%) or more of
the aggregate voting power of the Employer's outstanding common stock by any
person (within the meaning of Section 13(d) and 14(d) of the 1934 Act),
including any corporation or group of associated persons acting in concert,
other than (A) the Employer or its subsidiaries and / or (B) any employee
pension benefit plan (within the meaning of Section 3(2) of the Employee
Retirement Income Security Act of 1974) of the Employer or its subsidiaries,
including a trust established pursuant to any such plan, or (iii) a merger or
consolidation of the Employer with another entity unless the Employer is the
surviving company in such merger or consolidation. For purposes of this Plan, a
Change in Control shall not be deemed to occur upon the merger of Allied Capital
Corporation, Allied Capital Corporation II, Allied Capital Commercial
Corporation, and Allied Capital Advisers, Inc., with and into Allied Capital
Lending Corporation.
18
<PAGE> 22
ARTICLE IX
TRUST
SECTION 9.1 Trust. A trust to be known as the Allied Capital Corporation
Deferred Compensation Trust (the "Trust") has been established by the execution
of a Trust agreement with one or more Trustees and is intended to be maintained
as a "grantor trust" under Code Section 677. The assets of the Trust will be
held, invested and disposed of by the Trustee, in accordance with the terms of
the Trust, for the purpose of providing Plan Benefits for the Participants.
Notwithstanding any provision of the Plan or the Trust to the contrary, the
assets of the Trust shall at all times be subject to the claims of the
Employer's general creditors in the event of insolvency or bankruptcy.
SECTION 9.2 Contributions and Expenses. The Employer, in its sole discretion,
and from time to time, may make contributions to the Trust. All Plan Benefits
under the Plan and expenses chargeable to the Plan, to the extent not paid
directly by the Employer, shall be paid from the Trust.
SECTION 9.3 Trustee Duties. The powers, duties and responsibilities of the
Trustee shall be as set forth in the Trust agreement and nothing contained in
the Plan, either expressly or by implication, shall impose any additional
powers, duties or responsibilities upon the Trustee.
SECTION 9.4 Reversion to the Employer. The Employer shall have no beneficial
interest in the Trust and no part of the Trust shall ever revert or be repaid to
the Employer, directly or indirectly, except with respect to any unvested
amounts in a Participant's Formula Award Account, or as otherwise provided in
Section 8.1 or the Trust agreement.
19
<PAGE> 23
ARTICLE X
MISCELLANEOUS PROVISIONS
SECTION 10.1 Amendment. The Employer reserves the right to amend the Plan in any
manner that it deems advisable, by a resolution of the Board. No amendment
shall, without the Participant's consent, affect the amount of the Participant's
Plan Benefit at the time the amendment becomes effective or the right of the
Participant to receive a Plan Benefit.
SECTION 10.2 Termination. The Employer reserves the right to terminate the Plan
at any time by resolution of its Board. No termination shall, without the
Participant's consent, affect the amount of the Participant's Plan Benefit prior
to the termination or the right of the Participant to receive a Plan Benefit.
SECTION 10.3 No Assignment. The Participant shall not have the power to pledge,
transfer, assign, anticipate, mortgage or otherwise encumber or dispose of in
advance any interest in amounts payable hereunder or any of the payments
provided for herein, nor shall any interest in amounts payable hereunder or in
any payments be subject to seizure for payments of any debts, judgments, alimony
or separate maintenance, or be reached or transferred by operation of law in the
event of bankruptcy, insolvency or otherwise.
SECTION 10.4 Successors and Assigns. The provisions of the Plan are binding upon
and inure to the benefit of the Employer, its successors and assigns, and the
Participant, his Beneficiaries, heirs, legal representatives and assigns.
SECTION 10.5 Governing Law. The Plan shall be subject to and construed in
accordance with the laws of the Commonwealth of Virginia to the extent not
preempted by the provisions of ERISA.
SECTION 10.6 No Guarantee of Employment. Nothing contained in the Plan shall be
construed as a contract of employment or deemed to give any Participant the
right to be retained in the employ of an Employer or any equity or other
interest in the assets, business or affairs of the Employer. No Participant
hereunder shall have a security interest in assets of the Employer used to make
contributions or pay Plan Benefits.
SECTION 10.7 Severability. If any provision of the Plan shall be held illegal or
invalid for any reason, such illegality or invalidity shall not affect the
remaining provisions of the Plan, but the Plan shall be construed and enforced
as if such illegal or invalid provision had never been included herein.
SECTION 10.8 Notification of Addresses. Each Participant and each Beneficiary
shall file with the Administrator, from time to time, in writing, the post
office address of the Participant, the post office address of each Beneficiary,
and each change of post office address. Any communication, statement or notice
addressed to the last post office
20
<PAGE> 24
address filed with the Administrator (or if no such address was filed with the
Administrator, then to the last post office address of the Participant or
Beneficiary as shown on the Employer's records) shall be binding on the
Participant and each Beneficiary for all purposes of the Plan and neither the
Administrator nor the Employer shall be obligated to search for or ascertain the
whereabouts of any Participant or Beneficiary.
SECTION 10.9 Bonding. The Administrator and all agents and advisors employed by
it shall not be required to be bonded, except as otherwise required by ERISA.
The undersigned, pursuant to the approval of the Board, does hereby execute the
Allied Capital Corporation Deferred Compensation Plan on this 30th day of
December, 1998.
ALLIED CAPITAL CORPORATION
Attest:/s/ Suzanne V. Sparrow By:/s/ Kelly A. Anderson
---------------------- ---------------------
(Signature) (Signature)
Suzanne V. Sparrow Kelly A. Anderson
----------------- ------------------------
(Print Name) (Print Name)
21
<PAGE> 1
ALLIED CAPITAL CORPORATION 1998 ANNUAL REPORT
ALLIED CAPITAL CORPORATION [LOGO] 1998 ANNUAL REPORT
<PAGE> 2
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
FOR THE YEARS ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1998 1997
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Total portfolio at value $ 800,274 $ 697,021
Total assets $ 856,079 $ 807,775
Total debt outstanding $ 334,350 $ 347,663
Shareholders' equity $ 485,117 $ 420,060
Total interest and related portfolio income $ 106,738 $ 97,405
Portfolio income before net realized and unrealized gains $ 55,245 $ 46,066
Total net realized and unrealized gains $ 23,620 $ 17,913
Net increase in net assets resulting from operations $ 78,078 $ 61,304
Basic earnings per common share $ 1.50 $ 1.24
Diluted earnings per common share $ 1.50 $ 1.24
Basic earnings per common share excluding merger expenses $ 1.50 $ 1.35
Tax distributions per common share $ 1.43 $ 1.71
Weighted average common shares outstanding - basic 51,941 49,218
Weighted average common shares outstanding - diluted 51,974 49,251
</TABLE>
<TABLE>
<CAPTION>
Net Increase in Net Assets (NIA) (in millions)
<S> <C>
1994 $33.9
1995 $60.5
1996 $54.9
1997 $61.3
1998 $78.1
</TABLE>
<TABLE>
<CAPTION>
Portfolio Income Before Net Realized and
Unrealized Gains (in millions)
<S> <C>
1994 $30.6
1995 $41.5
1996 $47.6
1997 $46.1
1998 $55.2
</TABLE>
Earnings and Dividends Per Share
[BAR GRAPH]
<TABLE>
<CAPTION>
Investment Originations and Repayments (in millions)
Originations Repayments
<S> <C> <C>
1994 $215.8 $ 54.1
1995 $216.2 $111.7
1996 $283.3 $179.3
1997 $364.9 $233.0
1998 $524.5 $138.1
</TABLE>
<TABLE>
<CAPTION>
Earning and Dividend Table
Earnings per share Dividends per share
<S> <C> <C>
1994 $0.79 $0.94
1995 $1.37 $1.09
1996 $1.17 $1.23
1997* $1.24 $1.20
1998 $1.50 $1.43
</TABLE>
* Excludes merger-related dividends of approximately
$0.51 per share
<PAGE> 3
A LEADER IN PRIVATE FINANCE
Allied Capital Corporation has been a leader in the finance of private emerging
growth companies for over 40 years. Our company has been the principal lender
to thousands of businesses nationwide.
Allied Capital pioneered the mezzanine finance industry in the late 1950s, and
has developed national recognition in the financial markets as the lender of
choice for unsecured, subordinated debt financings. Bridging the gap between
senior secured loans and equity venture capital, Allied Capital's subordinated
debt investments have provided the additional capital necessary to make
acquisitions, recapitalizations, growth financings and management buyouts a
reality for thousands of outstanding entrepreneurs nationwide.
Allied Capital also provides senior loans through its commercial real
estate finance activity. We provide commercial mortgage loans to businesses
with real estate as collateral. We are a value-added lender with significant
underwriting expertise and can analyze a variety of property types, as well as
business operations, in order to understand the needs of complex borrowers.
4 OUR BUSINESS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 4
FINANCING GROWING BUSINESSES
MEZZANINE FINANCE
Allied Capital is the premiere provider of unsecured, subordinated long-term
loans for private, growing businesses in the United States. In general, our
mezzanine loans range in size from $5 million to $25 million and bear current
interest at fixed rates ranging between 12% and 18%. In many transactions,
Allied Capital receives warrants to purchase equity of the growing business at
a nominal cost. When the equity is later sold, the resulting gain, if any, adds
to Allied Capital's investment return.
In assessing a mezzanine loan, we have no tolerance for loss of
principal, and we structure each loan to emphasize return of our capital
investment. The prospective portfolio company's total debt, including our loan,
is generally no greater than five times the company's current cash flow, and
the company's cash flow is generally no less than two times its total debt
service obligation to all of its lenders.
COMMERCIAL REAL ESTATE FINANCE
Allied Capital's commercial mortgage loans are secured by a variety of real
estate property types, including office, hospitality, retail, recreational, and
housing. We can provide senior secured financing for up to $25 million, or
generally 75% of the value of the collateral property. In many cases, we can
also provide a subordinated loan for up to 90% of the collateral value if more
financing is required. Allied Capital's senior loans bear interest at either
fixed or floating rates, and are generally priced at 300 to 500 basis points
over the five- to ten-year U.S. Treasury rates. Subordinated loans are priced
similarly to our mezzanine loans and may be accompanied by an equity interest in
the real estate or in the underlying business. Loan origination points and other
fees enhance our total investment return.
We sell many of our senior loans to other lenders through our
merchant banking activities because the rates charged on these loans do not
meet our investment return requirements. We can earn origination points and
premiums from the sales of these loans, which then enhance our overall portfolio
return. For loans of less than $2 million, we may originate the commercial real
estate loan through our SBA Section 7(a) guaranteed loan program. This program
provides a 75% government guarantee on loans of up to $1 million. To enhance our
return, we sell the guaranteed portion of the loan for a premium.
OUR BUSINESS 5
ALLIED CAPITAL CORPORATION 1998
<PAGE> 5
[PHOTO]
SCHWINN / GT
- - YEAR FOUNDED 1895
- - EMPLOYEES 850
- - CORE BUSINESS MANUFACTURER AND WORLDWIDE DISTRIBUTOR OF A FULL LINE OF
BICYCLES, INCLUDING MOUNTAIN BIKES, ROAD BIKES, CRUISERS, BMX AND JUVENILE
BIKES, AS WELL AS A COMPLETE LINE OF HOME FITNESS EQUIPMENT, INCLUDING
TREADMILLS AND STATIONARY BIKES.
- - CUSTOMER BASE THE LEADING SUPPLIER TO INDEPENDENT BIKE DEALERS NATIONWIDE,
AND A MAJOR SUPPLIER TO THE CLUB AND HOME FITNESS MARKET.
- - BUSINESS OPPORTUNITY TO MERGE SCHWINN CYCLING AND FITNESS, INC. WITH GT, THE
COUNTRY'S LEADING MOUNTAIN BIKE AND BMX MANUFACTURER, AND WITH HEBB INDUSTRIES,
A LEADER IN THE HOME FITNESS MARKET.
Schwinn / GT
Portfolio Strategy
Schwinn's legendary brand name, the strength of its market position and its
opportunities for growth following the merger made this a very attractive
investment for us. Schwinn/GT expects to achieve significant synergies and
increased profitability with the transaction. With a strong equity sponsor
invested in the company, we provided $10 million of subordinated debt and
received warrants to purchase a portion of the company's equity.
[SCHWINN LOGO]
Boulder, Colorado
$10,000,000
Subordinated Debt with Warrants Buyout
Manufacturer and distributor of bicycle
and fitness equipment
October 1998
6 OUR BUSINESS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 6
PORTFOLIO STRATEGY
Portfolio diversification and strong underwriting standards are the primary
elements of Allied Capital's portfolio strategy. Industry, geographic and
investment size diversification are maintained to provide the portfolio with
stability and resilience to changes in the general economy.
From an industry perspective, we look for industries that offer
strong candidates for mezzanine finance opportunities, primarily industries in
which companies achieve high returns on invested capital and, thus, strong cash
flow from operations. We are currently focusing our lending activity in high
growth, high return industries such as consumer products, outsourcing,
telecommunications and education.
We generally limit our investment exposure to a single borrower to no
more than 5% of our total loan portfolio in the aggregate. In addition, with
offices in Washington, D.C., Chicago, San Francisco, Detroit, and Atlanta, our
investment portfolio reflects a geographic diversity that provides stability
against regional economic fluctuations.
Allied Capital's underwriting standards are well known in the
financial community. In order for a new borrower to be selected for Allied
Capital's portfolio, it must meet certain key business, financial and operating
criteria. In our mezzanine finance operations, we generally seek companies with
annual revenues of $20 million to $200 million, cash flow margins of greater
than 10% of revenues, operating histories of at least ten years and seasoned
management teams who have a significant personal investment at risk in the
business. In addition, the business must generate a high return on its invested
capital and must demonstrate a low level of vulnerability to economic cycles.
The results of Allied Capital's highly selective underwriting standards have
been borne out in its ability to maintain a strong performing portfolio of
investments over its 40-year history.
OUR BUSINESS 7
ALLIED CAPITAL CORPORATION 1998
<PAGE> 7
SIGNIFICANT OPPORTUNITIES FOR GROWTH
There are limitless opportunities to provide capital for private, emerging
growth companies in the capital markets today. Every day, middle market
companies seek capital to finance acquisitions, expansions, recapitalizations,
and management buyouts. Our objective is to become the dominant mezzanine
finance provider for the very best companies and to identify and capture an
increasing share of the private finance market.
Our contact network, developed over 40 years, is a critical success
factor in sourcing and selecting the best investments for our portfolio. Above
all else, we aim to be the mezzanine lender of choice among private equity
firms. We have learned from extensive experience that the best mezzanine
transactions are those that are sponsored by a strong private equity investor
with a significant financial investment in the portfolio company. For this
reason, we continue to commit significant resources to developing these
industry relationships. During 1998, Allied Capital was chosen to provide
mezzanine financing by some of the country's premiere private equity firms. We
expect this positive momentum to continue into 1999.
We also focus our marketing activity on numerous intermediaries
looking for private investment capital for their clients. These intermediaries
include investment banks, merchant banks, mortgage brokers, business brokers,
accountants, attorneys and many others.
We continue to develop our industry expertise in areas that we
believe provide the most opportunities for high growth and high return
mezzanine finance candidates. We have significant investment expertise in a
number of industries, which allows us to select the best emerging growth
businesses for our portfolio.
We also continue to expand our financing reach beyond mezzanine loans
to include both senior loans and equity investments, which would allow us to
control more transactions. We are currently expanding our merchant banking
activity to provide a broader outlet to sell and syndicate those financial
instruments that do not meet Allied Capital's investment return requirements.
The expansion of our merchant banking activities should complement our
principal investment business, enhance our loan origination activity and
increase our portfolio returns through the generation of fees and cash
premiums.
ENHANCING SHAREHOLDER VALUE
For more than four decades, Allied Capital's business and portfolio strategy
has provided shareholders with a strong current income stream paid in the form
of quarterly dividends, combined with long-term growth. We believe the
significant opportunities we have to grow and expand our business will, over
time, be reflected in the market value of the company. We will continue to grow
and manage the portfolio with prudence, while maximizing opportunities to
increase shareholder value.
8 OUR BUSINESS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 8
Portfolio Strategy
WITH A 35% MARKET SHARE THAT CONTINUES TO GROW, ENTERPRISE SOFTWARE (NASDAQ:
ENSW) IS A LEADER IN THIS MARKET NICHE. WE LIKED THE COMPANY'S ESTABLISHED
CUSTOMER BASE AND THE LONG-TERM NATURE OF ITS SERVICE CONTRACTS. ENTERPRISE
SOFTWARE HAS DEMONSTRATED IT IS A NON-CYCLICAL BUSINESS WITH STRONG, RECURRING
CASH FLOW.
Enterprise
Software
[ENTERPRISE SOFTWARE LOGO]
Colorado Springs, Colorado
$6,000,000
Subordinated Debt with Warrants Follow-on/Acquisition
Software for the broadcast industry
October 1998
Portfolio Strategy
ENTERPRISE SOFTWARE, INC
- - YEAR FOUNDED 1977 - EMPLOYEES 310 - CORE BUSINESS TRAFFIC MANAGEMENT
SYSTEMS THAT ALLOW BROADCASTERS TO MANAGE ALL ASPECTS OF ON-AIR ADVERTISING,
INCLUDING SALES, PRICING, SCHEDULING, BILLING AND REPORTING.
- - CUSTOMER BASE BROADCAST TELEVISION STATIONS, RADIO STATIONS AND CABLE
SYSTEMS
- - BUSINESS OPPORTUNITY TO REFINANCE A PORTION OF THE COMPANY'S SENIOR AND
CONVERTIBLE DEBT WITH SUBORDINATED DEBT COMBINED WITH WARRANTS TO ALLOW FOR
FUTURE GROWTH THROUGH ACQUISITIONS.
OUR BUSINESS 9
ALLIED CAPITAL CORPORATION 1998
<PAGE> 9
[AVBORNE LOGO]
Miami, Florida
$12,500,000
Subordinated Debt with Warrants Acquisition
Aviation services
October 1998
Avborne, Inc.
WITH INCREASING AIR PASSENGER AND CARGO TRAFFIC AND THE INDUSTRY TRENDS TOWARD
MAINTENANCE OUTSOURCING, WE LIKED AVBORNE'S BUSINESS PLAN IN THIS GROWING
INDUSTRY. THE COMPANY'S STRONG REVENUE GROWTH, STABLE CUSTOMER BASE, ITS HIGHLY
REGARDED MANAGEMENT TEAM WITH OVER 200 YEARS OF COLLECTIVE INDUSTRY EXPERIENCE,
AND THE SPONSORSHIP OF A STRONG PRIVATE EQUITY FIRM ALL CONTRIBUTED TO OUR
DECISION TO FINANCE THIS OUTSTANDING COMPANY.
AVBORNE, INC.
YEAR FOUNDED 1982 - EMPLOYEES 700 - CORE BUSINESS AVIATION SERVICE COMPANY
SPECIALIZING IN THE MAINTENANCE, REPAIR AND OVERHAUL OF PASSENGER AND CARGO
AIRCRAFT AND COMPONENTS. - CUSTOMER BASE MAJOR AIRLINES, REGIONAL AIRLINES,
CARGO CARRIERS AND PARTS BROKERAGE FIRMS - BUSINESS OPPORTUNITY TO ACQUIRE A
COMPANY IN ORDER TO EXPAND THE COMPANY'S SERVICES TO INCLUDE HEAVY MAINTENANCE
FOR COMMERCIAL AIRCRAFT AND PASSENGER TO CARGO CONVERSION SERVICES.
10 OUR BUSINESS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 10
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
For the Years Ended December 31,
(in thousands, except per share amounts) 1998 1997* 1996 1995 1994
<S> <C> <C> <C> <C> <C>
DIVIDENDS AND DISTRIBUTIONS
Total tax distributions $75,087 $85,678 $57,398 $47,920 $39,947
Total tax distributions per common share:
Ordinary income $0.94 $0.79 $0.89 $0.86 $0.70
Net capital gains 0.49 0.62 0.34 0.23 0.22
Return of capital -- 0.13 -- -- 0.02
Special undistributed earnings distribution -- 0.17 -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total tax distributions per common share $1.43 $1.71 $1.23 $1.09 $0.94
==================================================================================================================================
OPERATIONS
Total interest and related portfolio income $106,738 $97,405 $84,937 $68,817 $52,155
Total expenses excluding merger expenses $44,444 $46,180 $37,361 $27,274 $21,585
Merger expenses $ -- $5,159 $ -- $ -- $ --
Portfolio income before realized and unrealized gains (losses) $55,245 $46,066 $47,576 $41,543 $30,570
Net realized gains $22,541 $10,704 $19,155 $12,000 $6,236
Net unrealized gains (losses) $1,079 $7,209 $(7,412) $9,266 $(2,244)
Total net realized and unrealized gains $23,620 $17,913 $11,743 $21,266 $3,992
Net increase in net assets resulting from operations $78,078 $61,304 $54,947 $60,479 $33,890
Basic earnings per common share $1.50 $1.24 $1.19 $1.38 $0.80
Diluted earnings per common share $1.50 $1.24 $1.17 $1.37 $0.79
Basic earnings per common share excluding merger expenses $1.50 $1.35 $1.19 $1.38 $0.80
Weighted average common shares outstanding - basic 51,941 49,218 46,172 43,697 42,463
Weighted average common shares outstanding - diluted 51,974 49,251 46,733 44,010 42,737
BALANCE SHEET
Portfolio at value $800,274 $697,021 $607,368 $528,483 $443,316
Portfolio at cost $796,389 $690,720 $613,276 $526,979 $451,078
Total assets $856,079 $807,775 $713,360 $605,434 $501,817
Total debt outstanding $334,350 $347,663 $274,997 $200,339 $130,236
Preferred stock issued to SBA $7,000 $7,000 $7,000 $7,000 $7,000
Shareholders' equity $485,117 $420,060 $402,134 $367,192 $344,043
Shareholders' equity per common share $8.68 $8.07 $8.34 $8.26 $8.02
Common share market value at end of year** $17.31 $22.25 $15.25 $13.25 $10.38
Common shares outstanding at end of year 55,919 52,047 48,238 44,479 42,890
Total assets managed at period end $1,143,548 $935,720 $822,450 $702,567 $583,817
</TABLE>
The Selected Consolidated Financial Data schedule reflects the operations of
the Company with all periods restated as if the Companies had merged as of the
beginning of the earliest period presented.
* In 1997, Allied I distributed $0.34 per common share representing the
844,914 shares of Allied Lending distributed in conjunction with the
Merger. This distribution resulted in a partial return of capital.
Also in conjunction with the Merger, the Company distributed $0.17 per
share representing the undistributed earnings of the merged companies
at December 31, 1997.
** The stock prices prior to 1998 are those of Allied Capital Lending
Corporation, the surviving company in the merger of the five Allied
Capital Companies, which was completed on December 31, 1997.
SELECTED FINANCIAL DATA 11
ALLIED CAPITAL CORPORATION 1998
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information contained in this section should be read in conjunction with
the Company's 1998 Consolidated Financial Statements and Notes thereto. In
addition, this Annual Report, which includes Management's Discussion and
Analysis, contains certain forward-looking statements. These statements include
the plans and objectives of management for future operations and financial
objectives, loan portfolio growth and availability of funds. These
forward-looking statements are subject to the inherent uncertainties in
predicting future results and conditions. Certain factors that could cause
actual results and conditions to differ materially from those projected in
these forward-looking statements are set forth below in the Investment
Considerations section. Other factors that could cause actual results to
differ materially include the uncertainties of economic, competitive and market
conditions, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of
the Company. Although the Company believes that the assumptions underlying the
forward-looking statements included herein are reasonable, any of the
assumptions could be inaccurate and therefore, there can be no assurance that
the forward-looking statements included herein will prove to be accurate.
Therefore, the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
OVERVIEW
The Company's primary business is investing in and lending to private small and
medium-sized businesses in three areas: mezzanine finance, commercial real
estate finance, and 7(a) lending.
The Company's earnings depend primarily on the level of interest and
related portfolio income and net realized and unrealized gain income earned on
the Company's investment portfolio after deducting interest paid on borrowed
capital and operating expenses. Interest income results from the stated
interest rate earned on a loan, the amortization of loan origination points and
original issue discount, and the amortization of any market discount arising
from purchased loans. The level of interest income is directly related to the
balance of the investment portfolio multiplied by the effective yield on the
portfolio. The Company's ability to generate interest income is dependent on
economic, regulatory and competitive factors that influence interest rates,
loan originations, and the Company's ability to secure financing for its
investment activities.
The total portfolio at value was $800.3 million, $697.0 million and
$607.4 million at December 31, 1998, 1997 and 1996, respectively. During the
year ended December 31, 1998, the Company originated investments totaling
$524.5 million and received repayments and sold loans totaling $219.1 million.
In addition, the Company's portfolio was reduced by approximately $223 million
as a result of an asset securitization of commercial mortgage loans in January
1998. As a result, the total portfolio increased by 15% from December 31, 1997
to December 31, 1998. The portfolio increased approximately 15% for each of the
years ended December 31, 1997 and 1996.
12 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 12
<TABLE>
<CAPTION>
1998
<S> <C>
Mezzanine Investments 46%
Commercial Mortgage Loans 27%
SBA 7(a) Loans 7%
Commercial Mortgage-Backed Securities 13%
Cash and Other Assets 7%
</TABLE>
MEZZANINE Mezzanine loans, debt securities and equity interests were $388.6
million, $207.7 million and $191.2 million at December 31, 1998, 1997 and 1996,
respectively. The effective yield on the mezzanine loans and debt securities
was 14.6%, 12.6%, and 13.2% at December 31, 1998, 1997 and 1996, respectively.
Mezzanine loan originations and purchases were $236.0 million, $66.7 million
and $66.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Mezzanine repayments and sales were $41.3 million for the year
ended December 31, 1998. During the two years ended December 31, 1997,
mezzanine repayments and sales of equity interests were approximately equal to
originations, which kept the level of the portfolio relatively constant.
During 1998, excluding certain high yield debt purchases, the Company
made 19 new mezzanine investments with an average investment size of $10.6
million. On average, these new portfolio companies had revenues of $81.3
million, cash flows of $9.4 million, and had been in business for approximately
22 years.
During 1998, the Company also made two discounted purchases of high
yield debt investments for its mezzanine portfolio with an aggregate purchase
price of $22.2 million. This discounted debt is estimated to have an average
effective yield of 15%.
<TABLE>
<CAPTION>
1997
<S> <C>
Mezzanine Investments 25%
Commercial Mortgage Loans 56%
SBA 7(a) Loans 5%
Cash and Other Assets 14%
</TABLE>
Prior to the Merger, mezzanine loan originations were made through
Allied I and Allied II, which originated small ($2 million - $10 million)
mezzanine loans in order to maintain appropriate portfolio diversity for
regulated investment company purposes. Pursuant to the terms of a Securities
and Exchange Commission exemptive order, Allied I and Allied II loan
originations were made pursuant to a co-investment formula, based on relative
total assets, which required identical terms for each loan originated. As a
result, Allied I and Allied II were unable to originate larger loans or price
loans based on their own capital structures. These inefficiencies limited the
ability of Allied I and Allied II to compete effectively in the marketplace.
<TABLE>
<CAPTION>
1996
<S> <C>
Mezzanine Investments 27%
Commercial Mortgage Loans 52%
SBA 7(a) Loans 6%
Cash and Other Assets 15%
</TABLE>
Subsequent to the Merger, the Company's larger overall portfolio size
enables it to compete for larger mezzanine loans while maintaining adequate
diversity within the portfolio. As a result, the Company has been and will
continue to actively pursue mezzanine loans in sizes ranging from $5 million to
$25 million. The Company also is able to price its mezzanine loans using a
single capital structure, which enables the Company to price its loans more
competitively. The Company believes that its post-Merger strategies have been
successful in increasing mezzanine loan origination activity during 1998 and
will enable the Company to increase mezzanine loan originations in 1999.
M D & A 13
ALLIED CAPITAL CORPORATION 1998
<PAGE> 13
COMMERCIAL MORTGAGE LOANS Commercial mortgage loans were $233.2 million, $447.2
million and $373.7 million at December 31, 1998, 1997 and 1996, respectively.
The commercial mortgage loan portfolio declined by 48% during the year ended
December 31, 1998 due to the sale through securitization of approximately $295
million in commercial mortgage loans, and the sale of whole loans to third
parties aggregating approximately $44.0 million. For the year ended December
31, 1998, the Company originated and purchased new commercial mortgage loans of
$198.6 million and received repayments of $96.7 million. The commercial
mortgage loan portfolio increased by 20% and 35% for the years ended December
31, 1997 and 1996, respectively. Commercial mortgage loan originations and
purchases were $249.0 million and $176.3 million, and repayments were $154.5
million and $87.5 million for 1997 and 1996, respectively.
The weighted average current stated interest rate on the commercial
mortgage loan portfolio at December 31, 1998, 1997 and 1996 was 9.7%, 9.6% and
10.3%, respectively. The weighted average yield on the commercial mortgage loan
portfolio was 10.4%, 11.4% and 13.4% at December 31, 1998, 1997 and 1996,
respectively. The effective yield on the commercial mortgage loan portfolio is
higher than the stated interest rate due to the amortization of market discount
on purchased loans and original issue discount.
The Company generally prices its commercial mortgage loans based on a
fixed spread over comparable U.S. Treasury rates given the term of the loan.
During 1997 and 1998, interest rates on U.S. Treasury bonds declined
significantly, and the spreads charged by commercial real estate lenders in the
marketplace narrowed. As a result, the Company began to reevaluate its strategy
regarding commercial real estate lending as pricing for this type of loan
became increasingly inexpensive in the marketplace. Early in the third quarter
of 1998, the Company significantly reduced its commercial mortgage loan
origination activity for its own portfolio, and began exploring opportunities
to originate commercial real estate loans for sale to third parties. During the
fourth quarter of 1998, the Company sold $39.4 million in commercial mortgage
loans to other lenders realizing net premiums of approximately 2.1%. Additional
loan sales from the Company's existing commercial real estate portfolio are
expected to continue. The Company anticipates that it will continue to
originate and sell commercial real estate loans that do not meet its portfolio
yield requirements.
COMMERCIAL MORTGAGE-BACKED SECURITIES Commercial Mortgage-Backed Securities
(CMBS) were $113.7 million at December 31, 1998. The portfolio consists of
$67.2 million of Subordinated CMBS, purchased on December 30, 1998 for $32.2
million, and $81.5 million of Residual CMBS retained from a $295 million asset
securitization the Company completed on January 30, 1998 (discussed below). As
of December 31, 1998, the estimated yield to maturity on the Subordinated CMBS
and the Residual CMBS was 15.0% and 9.7%, respectively. As of December 31,
1998, the weighted average yield on the entire CMBS portfolio was 11.2%.
The Company believes that it took advantage of a unique market
opportunity to acquire Subordinated CMBS at a significant discount at the end
of the fourth quarter. Recent turmoil in the CMBS market created a lack of
liquidity for the traditional buyers of the non-investment grade bonds. The
Company plans to continue to opportunistically purchase bonds at significant
discounts throughout the first quarter of 1999. The discounted purchases of the
Subordinated CMBS have had, and will continue to have, the full scrutiny of the
Company's stringent underwriting processes. The Company re-underwrites the
majority of the loans securing the bonds, including determining its own
assessment of cash flow available for debt service and appraisal value, and
visits most of the collateral properties.
SBA 7(A) LOANS The SBA 7(a) loan portfolio was $56.3 million, $40.7 million and
$42.1 million at December 31, 1998, 1997 and 1996, respectively. SBA 7(a) loan
originations
14 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 14
were $57.7 million, $49.2 million and $40.8 million for the years ended
December 31, 1998, 1997 and 1996, respectively. Sales of the guaranteed
portions of SBA 7(a) loans were $37.0 million, $43.4 million and $25.0 million
for the years ended December 31, 1998, 1997 and 1996, respectively. SBA 7(a)
loans are originated with variable interest rates priced at spreads ranging
from 1.75% to 2.75% over the prime lending rate.
RESULTS OF OPERATIONS
COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 Net increase
in net assets resulting from operations (NIA) was $78.1 million, or $1.50 per
share, $61.3 million, or $1.24 per share, and $54.9 million, or $1.17 per
share, for the years ended December 31, 1998, 1997 and 1996, respectively. NIA
results from total interest and related portfolio income earned, less total
expenses incurred in the operations of the Company, plus net realized and
unrealized gains or losses. NIA, as a percentage of average shareholders'
equity, which is also known as return on equity, was 17%, 15% and 14% for 1998,
1997 and 1996, respectively. NIA, excluding the formula and cut-off awards in
1998, as a percentage of average shareholders' equity for 1998 was 18.8%. NIA,
excluding Merger expenses, as a percentage of average shareholders' equity for
1997 was 16%.
A key element of the Company's post-Merger strategy was to allocate
more of its capital resources to the Company's higher yielding mezzanine and
7(a) lending activities and reduce its lower yielding commercial mortgage loan
portfolio. As a result, the Company completed a commercial mortgage loan
securitization transaction in January 1998, in order to effectively liquidate
$223 million of its lower yielding commercial mortgage loans. The Company
securitized $295 million in loans and received cash proceeds, net of costs, of
$223 million. The Company retained a trust certificate for its residual
interest in mortgage securitization (the "Residual CMBS") in the loan pool
sold, and will receive interest income from this Residual CMBS as well as
receive the net spread of the interest earned on the loans sold less the
interest paid on the bonds over the life of the bonds (the "Residual
Securitization Spread").
The Company accounted for the securitization in accordance with
Statement of Financial Accounting Standards No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." As a
result, the Company recorded a gain of $14.8 million, or $0.28 per share, net
of the costs of the securitization and the cost of settlement of interest rate
swaps. The gain arises from the difference between the carrying amount of the
loans and the fair market value of the assets received (i.e., cash, Residual
Securitization Spread, Residual CMBS and a servicing asset). The Company will
continue to earn interest income from the Residual CMBS, and will receive the
actual net spread from the portion of the loans sold represented by the bonds
issued. As the net spread is received, a portion will be allocated to interest
income with the remainder applied to reduce the carrying amount of the Residual
Securitization Spread. The Residual CMBS and the Residual Securitization Spread
have been and will continue to be valued each quarter using updated prepayment,
interest rate and loss estimates. As of December 31, 1998, the mortgage loan
pool had an approximate weighted average stated interest rate of 9.4%. The
value of the Residual Securitization Spread of $10.7 million was determined
based on a constant prepayment rate of 7% and a discount rate of 12%. The value
of the Residual CMBS of $70.8 million was determined using a discount rate
equal to the average stated interest rate of the underlying mortgage loans. The
Company completed the securitization as a means to improve its liquidity for
investment in high yielding mezzanine and 7(a) loans. The Company does not
anticipate significant future securitization activity.
Total interest and related portfolio income was $106.7 million, $97.4
million and $84.9 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Total interest and related portfolio income is primarily a
function of the level of interest income earned and the balance of
M D & A 15
ALLIED CAPITAL CORPORATION 1998
<PAGE> 15
portfolio assets. In addition, total interest and related portfolio income
includes premiums from loan sales, prepayment premiums, and advisory fee and
other income.
Interest income totaled $79.9 million, $86.9 million and $77.5
million for the years ended December 31, 1998, 1997 and 1996, respectively.
Interest income decreased 8% and increased 12% for 1998 and 1997, respectively.
The decrease and increase in interest income earned results primarily from
changes in the amount of loans outstanding during the periods presented. The
Company's loan portfolio decreased by 4% to $628.6 million at December 31, 1998
from $655.8 million at December 31, 1997, and the loan portfolio increased by
13% to $655.8 million at December 31, 1997 from $580.9 million at December 31,
1996. During 1998, the Company originated or purchased loans and other
investments totaling $524.5 million. This increase was offset by the sale
through securitization of $295 million in commercial mortgage loans, whole loan
sales of commercial mortgage loans of $44.0 million, and the sale of the
guaranteed portion of SBA 7(a) loans totaling $37.0 million. In addition, the
Company received loan repayments totaling $138.1 million.
The Company's efforts to reduce its lower yielding commercial
mortgage loan portfolio in 1998 had the effect of reducing gross interest
income in 1998 when compared to 1997. The reduction in this portfolio, however,
has increased the overall weighted average yield on the portfolio, and should
have the impact of increasing interest income prospectively, as well as
increasing the Company's overall return on assets net of interest expense and
return on equity capital. The weighted average yield on the total loan
portfolio at December 31, 1998 was 12.5%, as compared to 11.7% and 13.1% at
December 31, 1997 and 1996, respectively.
Net premiums from loan dispositions were $6.0 million, $7.3 million
and $4.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Included in net premiums from loan dispositions are premiums from
loan sales and premiums received on the early repayment of loans. Premiums from
loan sales were $3.8 million, $3.2 million and $2.6 million for the years ended
December 31, 1998, 1997 and 1996, respectively. This premium income results
primarily from the cash gain on the sale of the guaranteed portion of the
Company's SBA 7(a) loans into the secondary market and commercial real estate
loans sold to third parties, less the origination costs associated with the
loans sold.
Prepayment premiums were $2.2 million, $4.1 million and $1.6 million
for the years ended December 31, 1998, 1997 and 1996, respectively. Commercial
mortgage loan repayments of $154.5 million in 1997 were primarily responsible
for the large level of prepayment premiums experienced in 1997. While the
scheduled maturity of mezzanine and commercial mortgage loans ranges from five
to ten years, it is not unusual for the Company's borrowers to refinance or pay
off their debts to the Company ahead of schedule. Because the Company seeks to
finance primarily seasoned, performing companies, such companies at times can
secure lower cost financing as their balance sheets strengthen, or as more
favorable interest rates become available. Therefore, the Company generally
structures its loans to require a prepayment premium for the first three to
five years of the loan.
Investment advisory fees and other income were $6.1 million, $3.2
million and $3.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Investment advisory fees are received from the private funds
managed by the Company. Three of the Company's private, managed funds are no
longer making new investments, and are returning capital to their investors as
their assets pay off. In January 1998, the Company entered into an investment
advisory agreement with Kreditanstalt fur Wiederaufbau (KfW), the state-owned
public development bank of Germany, to manage a fund of approximately DM 160
million (approximately $95.4 million at December 31, 1998). For its services
related to sourcing, structuring, investing, monitoring and disposing of its
investments in small, private and medium-sized German businesses, the Company
will receive a 3% per annum fee on total committed capital,
16 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 16
payable quarterly. The increase in advisory fees and other income in 1998 is
primarily the result of the advisory fees earned from KfW of approximately $2.7
million.
Total operating expenses were $44.4 million, $51.3 million ($46.2
million without Merger expenses) and $37.4 million for the years ended December
31, 1998, 1997 and 1996, respectively. Operating expenses include interest on
indebtedness, salaries and employee benefits, and general and administrative
expenses.
The Company's single largest expense is interest on indebtedness,
which totaled $20.7 million, $27.0 million and $20.3 million for the years
ended December 31, 1998, 1997 and 1996, respectively. Interest expense
decreased 23% for 1998 and increased 33% and 64% for 1997 and 1996,
respectively. The increases and decreases are attributable to increases and
decreases in borrowings by the Company and its subsidiaries under various
credit facilities. Again, the Company's efforts to decrease the commercial
mortgage loan portfolio during 1998 had the effect of reducing the overall
level of the Company's outstanding borrowings throughout the year. The
Company's total borrowings were $334.4 million, $347.7 million and $275.0
million at December 31, 1998, 1997 and 1996, respectively. Total borrowings
decreased 4% for 1998 and increased 26% and 37% in 1997 and 1996, respectively.
The Company's weighted average interest cost on outstanding borrowings at
December 31, 1998, 1997 and 1996 was 7.5%, 7.3% and 7.6%, respectively.
Salaries and employee benefits totaled $11.8 million, $10.3 million
and $8.8 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Total employees were 106, 80 and 66 at December 31, 1998, 1997
and 1996, respectively. The increase in salaries and employee benefits reflects
the increase in total employees, combined with wage increases and the
experience level of employees hired. The Company was an active recruiter in
1998 for experienced investment and operational personnel and the Company will
continue to actively recruit and hire new professionals in 1999 to support
anticipated portfolio growth.
General and administrative expenses include the lease for the
Company's headquarters in Washington, DC, leases established in 1997 for the
Company's offices in Chicago and San Francisco, leases established in 1998 for
the Company's new offices in Atlanta and Detroit, travel costs, stock record
expenses, directors' fees, legal and accounting fees and various other
expenses. General and administrative expenses totaled $11.9 million, $9.0
million and $8.3 million, respectively, for the years ended December 31, 1998,
1997 and 1996. The increase in general and administrative expenses was
partially due to twelve full months of costs associated with the two new
offices that were established in the third and fourth quarters of 1997.
In 1997, the Company incurred Merger expenses totaling $5.2 million,
which consisted primarily of investment banking fees of $3.1 million, legal
fees of $1.0 million and costs associated with the solicitation of proxies of
approximately $0.6 million.
Total operating expenses excluding interest on indebtedness and
Merger expenses represented approximately 2.9%, 2.5% and 2.6% of the Company's
average assets for the years ended December 31, 1998, 1997 and 1996,
respectively.
During 1998, the Company began to expense a portion of the formula
and cut-off awards that were established in connection with the Merger. Prior
to the Merger, each of the Predecessor Companies had a stock option plan (the
"Old Plans"). In preparation for the Merger, the Compensation Committees of the
Predecessor Companies determined that the Old Plans should be terminated upon
the Merger, so that the new merged Company would be able to develop a new
incentive compensation plan for all officers and directors with a single equity
security. The existence of the Old Plans had resulted in certain inequities in
option grants among the various officers of the Predecessor Companies simply
because of the differences in the underlying equity securities.
To balance stock option awards among the employees, and to account
for the deviations caused by the existence of five plans supported by five
different publicly traded stocks,
M D & A 17
ALLIED CAPITAL CORPORATION 1998
<PAGE> 17
the Company developed two special awards to be granted in lieu of options under
the Old Plans that would be foregone upon the cancellation of the Old Plans.
CUT-OFF AWARD. The first award established a cut-off dollar amount as of August
14, 1997 (the Merger announcement date) that would be computed for all
outstanding, but unvested options that would be canceled as of the date of the
Merger. The cut-off award was designed to cap the appreciated value in unvested
options at the Merger announcement date in order to set the foundation to
balance option awards upon the Merger. The cut-off award was designed to be
equal to the difference between the market prices of the shares of stock
underlying the canceled options under the Old Plans at August 14, 1997, less
the exercise prices of the options. The cut-off award was computed to be $2.9
million in the aggregate and will be payable for each canceled option as the
canceled options would have vested. The cut-off award will only be payable if
the award recipient is employed by the Company on a future vesting date. The
cut-off award expense totaled $0.8 million, or $0.02 per share, for 1998.
FORMULA AWARD. The formula award was designed to compensate officers from the
point in time when their unvested options would cease to appreciate in value
pursuant to the mechanics of the cut-off award (i.e., August 14, 1997) up until
the time in which they would be able to receive option awards in the Company
after the Merger became effective. In the aggregate, the formula award equaled
6% of the difference between the combined aggregate market capitalizations of
the Predecessor Companies as of the close of the market on December 30, 1997,
and the combined aggregate market capitalizations of the Predecessor Companies
on August 14, 1997.
The formula award was designed as a long-term incentive compensation
program that would replace canceled stock options and would balance share
ownership among key officers for past and prospective service.
The terms of the formula award require that the award be contributed
to the Company's deferred compensation plan, and be used to purchase shares of
the Company in the open market. The formula award vests over a three-year
period, on the anniversary date of the Merger, beginning on December 31, 1998.
In the aggregate, the market capitalizations of the Predecessor
Companies increased by approximately $319 million from August 14, 1997 to
December 30, 1997, and the total formula award was computed to be $19.0
million. The total expense recorded as a result of the formula awards during
1998 was $6.2 million, or approximately $0.12 per share. Assuming all officers
who received a formula award remain with the Company over the remaining vesting
period, the Company will expense the remaining formula award during 1999 and
2000 in an annual amount of approximately $6.4 million.
Net realized gains were $22.5 million, $10.7 million and $19.2
million for the years ended December 31, 1998, 1997 and 1996, respectively.
These gains resulted from the sale of equity securities associated with certain
mezzanine and commercial mortgage loans and the realization of unamortized
discount resulting from the early repayment of mezzanine and commercial
mortgage loans, offset by losses on investments.
Realized gains totaled $25.8 million, $15.8 million and $30.4 million
for the years ended December 31, 1998, 1997 and 1996, respectively. Realized
gains during 1998 primarily resulted from transactions involving ten portfolio
companies: ARS ($1.1 million), Calendar Broadcasting ($1.1 million), Arlington
Square Associates ($1.9 million), DMI Furniture ($0.6 million), Virginia Beach
Associates ($2.4 million), Labor Ready, Inc. ($5.0 million), Broadcast
Holdings, Inc. ($1.1 million), Waterview Limited Partnership ($3.0 million),
Z-Spanish Radio Network, Inc. ($2.7 million) and El Dorado Communications, Inc.
($0.8 million). Gains resulting from investments in these ten companies totaled
$19.7 million. The Company also realized a gain of $4.0 million from the sale
of an office building owned by Advisers prior to the
18 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 18
Merger and incurred an income tax liability related to that gain of $0.8
million. Realized gains in 1997 resulted from transactions involving 83
portfolio companies.
Realized losses in 1998, 1997 and 1996 totaled $3.3 million, $5.1
million and $11.2 million and represented 0.4%, 0.6% and 1.6% of the Company's
total assets, respectively. Realized losses in 1998 resulted primarily from the
full or partial liquidation of three portfolio investments: SunStates
Refrigerated Services, Inc. ($1.8 million), R-Tex Decoratives Company, Inc.
($0.6 million), and Pines Hotel ($0.3 million). These three investments
resulted in realized losses of $2.7 million. Realized losses in 1997 resulted
primarily from the full or partial liquidation of four investments: Taco Tico,
Inc. ($1.1 million), SunStates Refrigerated Services, Inc. ($0.8 million),
Enviroplan, Inc. ($0.8 million), and Vineyard Sycamore Plaza Associates ($0.4
million). Realized losses resulting from these four investments totaled $3.1
million. Realized losses in 1996 included $6.6 million in losses from the
liquidation of two portfolio investments. The Company made loans to these two
borrowers in the late 1980s and early 1990s, and each borrower encountered
significant difficulties during the recession of the early 1990's. Losses
realized in 1998, 1997 and 1996 had been recognized in NIA over time as
unrealized depreciation when the Company determined that the respective
portfolio security's value had become impaired. Thus, the Company reversed
previously recorded unrealized depreciation totaling $3.6 million, $9.7 million
and $7.5 million when the related losses were realized in 1998, 1997 and 1996,
respectively.
The Company recorded net unrealized gains of $1.1 million and $7.2
million for the years ended December 31, 1998 and 1997, respectively, and net
unrealized losses of $7.4 million for the year ended December 31, 1996. Net
unrealized gains for 1998 consisted of valuation changes resulting from the
Board of Directors' valuation of the Company's assets, the effect of valuation
of interest rate swap agreements, and the effect of reversals of net unrealized
appreciation resulting from net realized gains. At December 31, 1998, net
unrealized appreciation in the portfolio totaled $2.4 million, and was composed
of unrealized appreciation of $27.3 million resulting primarily from
appreciated equity interests in portfolio companies, and unrealized
depreciation of $24.9 million resulting primarily from underperforming loan and
equity investments in the portfolio. At December 31, 1997, net unrealized
appreciation in the portfolio totaled $1.3 million and was composed of
unrealized appreciation of $19.2 million and unrealized depreciation of $17.9
million. At December 31, 1996, net unrealized depreciation in the portfolio
totaled $5.9 million.
The Company employs a standard grading system for the entire
portfolio. Grade 1 is used for those loans from which a capital gain is
expected. Grade 2 is used for loans performing in accordance with plan. Grade 3
is used for loans that require closer monitoring; however, no loss of interest
or principal is expected. Grade 4 is used for loans for which some loss of
contractually due interest is expected, but no loss of principal is expected.
Grade 5 is used for loans for which some loss of principal and interest is
expected and the loan is written down to net realizable value. During 1998, the
Company began to grade its commercial mortgage and 7(a) loan portfolios using
the same grading system used for its mezzanine loan portfolio, so that the
Company's entire portfolio would have a uniform grading system. Prior to this,
the commercial real estate portfolio used a different grading system and the
7(a) loan portfolio was not graded.
At December 31, 1998, the Company's portfolio was graded as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
PORTFOLIO BY GRADE
- ----------------------------------------------------------------
INVESTMENTS
AT VALUE PERCENTAGE OF
GRADE (IN MILLIONS) TOTAL PORTFOLIO
- ----------------------------------------------------------------
<S> <C> <C>
1 $ 104.4 13.0%
2 618.0 77.2%
3 53.2 6.7%
4 11.8 1.5%
5 12.9 1.6%
- ----------------------------------------------------------------
$ 800.3 100.0%
================================================================
- ----------------------------------------------------------------
</TABLE>
M D & A 19
ALLIED CAPITAL CORPORATION 1998
<PAGE> 19
Grade 5 mezzanine investments totaled $6.4 million at value at
December 31, 1998, or 0.8% of the Company's total portfolio based on the
valuation of the Board of Directors. The value of these Grade 5 investments has
been reduced from an aggregate cost of $22.7 million in order to reflect the
Company's estimate of the net realizable value of these investments upon
disposition. This reduction in value has been recorded previously as unrealized
depreciation over several years in the Company's earnings. The Company
continues to follow its historical practices of working with a troubled
portfolio company in order to recover the maximum amount of the Company's
investment, but records unrealized depreciation for a substantial amount of the
potential exposure when such exposure is identified. During 1998, Grade 5
mezzanine investments decreased by $6.5 million from $12.9 million at December
31, 1997.
At December 31, 1998, commercial real estate Grade 5 loans totaled
$0.1 million at value. The value of these Grade 5 loans approximates cost
because of the estimated value of the underylying collateral securing the
loans. A Grade 5 classification for a commercial real estate loan prior to the
use of the uniform grading system meant that the loan was in workout. Because
of the collateral securing these loans, however, few previous Grade 5 loans
were ever expected to result in loss of principal. Of the loans included in
Grade 5 at December 31, 1997, only one loan totaling $0.3 million at cost was
expected to incur any loss of principal, and this loan was valued at $0.2
million.
Grade 5 SBA 7(a) loans totaled $6.3 million at value at December 31,
1998, and have been reduced from an aggregate cost basis of $7.9 million. The
SBA 7(a) loan portfolio was not graded at December 31, 1997.
For the total portfolio, loans greater than 120 days delinquent were
$13.7 million at value at December 31, 1998, or 1.7% of the total portfolio.
Included in this category are loans valued at $9.9 million that are fully
secured by real estate. Loans greater than 120 days delinquent generally do not
accrue interest. Loans greater than 120 days delinquent at December 31, 1997,
were $20.2 million at value or 2.9% of the total portfolio.
The Company incurred income tax expense of $0.8 million for the year
ended December 31, 1998, which resulted from the taxation of a net built-in
gain realized from the sale of an office building owned by Advisers prior to
the Merger. The Company incurred income tax expense of $1.4 million and $1.9
million, respectively, for the years ended December 31, 1997 and 1996 resulting
from the operations of Advisers. Because the Company has elected to be taxed as
a regulated investment company ("RIC") under Subchapter M of the Code, the
Company is not taxed on its investment company taxable income and realized
capital gains, to the extent that such income and gains are distributed to
shareholders.
In order to maintain its RIC status, the Company must, in general,
(1) derive at least 90% of its gross income from dividends, interest and gains
from the sale of securities; (2) meet investment diversification requirements
as defined in the Code; and (3) distribute to shareholders at least 90% of its
investment company taxable income annually. The Company intends to take all
steps necessary to continue to meet the RIC qualifications. However, there can
be no assurance that the Company will continue to elect or qualify for such
treatment in future years.
During 1998, 1997 and 1996, the Company or the Predecessor Companies
declared dividends to their shareholders representing all of each company's
ordinary taxable income, taxable net capital gains, and, in the case of Allied
I in 1997, a partial return of capital resulting from the distribution of
Allied I's ownership of Allied Lending's shares. Tax distributions differ from
NIA due to timing differences in the recognition of income and expenses,
returns of capital and net unrealized appreciation, which is not included in
taxable income. Total tax distributions declared were $75.1 million, $85.7
million and $57.4 million for 1998, 1997 and
20 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 20
1996, respectively. Tax distributions per share were $1.43, $1.71 and $1.23 for
the three years ended December 31, 1998, 1997 and 1996, respectively. The per
share distributions for 1997 and 1996 have been exchange adjusted for the
Merger and include the exchange-adjusted shares of Advisers for which no tax
distributions had historically been declared or paid.
Included in 1997 tax distributions was $18 million, or $0.34 per
share, representing a non-cash dividend of the shares of Allied Lending held in
Allied I's portfolio. Allied I declared and paid a dividend equal to 0.107448
shares of Allied Lending for each share of Allied I held on the record date for
such dividend. These shares had a market value of $21.25 per share on December
30, 1997, the distribution date.
Also included in 1997 tax distributions was a special, one-time
dividend equal to $8.8 million, or $0.17 per share, representing all of the
retained earnings and profits of the Predecessor Companies at December 31,
1997. The special dividend was declared in conjunction with the Merger in order
for the Company to maintain its RIC status.
Certain of the Company's credit facilities limit the Company's
ability to declare dividends if the Company has defaulted under certain
provisions of the credit agreement.
The weighted average common shares outstanding used to compute basic
earnings per share were 51.9 million, 49.2 million and 46.2 million for the
years ended December 31, 1998, 1997 and 1996, respectively. The increases in
the weighted average shares reflect the issuance of new shares, the exercise of
employee stock options to purchase shares of the Company and the issuance of
shares pursuant to a dividend reinvestment plan. Allied I's ownership of Allied
Lending during the periods presented has been eliminated in consolidation.
All per share amounts included in management's discussion and
analysis have been computed using the weighted average shares used to compute
diluted earnings per share, which were 52.0 million, 49.3 million and 46.7
million for the years ended December 31, 1998, 1997 and 1996, respectively.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS At December 31, 1998, the Company had $25.1 million
in cash and cash equivalents. ACC invests otherwise uninvested cash in U.S.
government or agency-issued or guaranteed securities that are backed by the
full faith and credit of the United States, or in high quality, short-term
repurchase agreements fully collateralized by such securities. The Company's
objective is to manage to a low cash balance and fund new originations with its
lines of credit.
INDEBTEDNESS The Company had outstanding indebtedness at December 31, 1998 as
follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
AMOUNT ANNUAL
OUTSTANDING INTEREST
CLASS (IN THOUSANDS) RATE(1)
- --------------------------------------------------------------------
<S> <C> <C>
Debentures and notes payable:
Master loan and security agreement $ 6,000 6.63%
Unsecured long-term notes payable 180,000 7.21%
SBA debentures 47,650 8.22%
OPIC loan 5,700 6.57%
- --------------------------------------------------------------------
Total debentures and notes payable $ 239,350 7.38%
====================================================================
Revolving line of credit $ 95,000 7.66%
====================================================================
(1) The annual interest rate includes the cost of commitment fees
and other facility fees.
- --------------------------------------------------------------------
</TABLE>
MASTER LOAN AND SECURITY AGREEMENT. The Company, in conjunction with BMI, has a
facility to borrow up to $250 million, of which $100 million is committed,
using its commercial mortgage loans as collateral. The agreement generally
requires interest-only payments with all principal due at maturity. The
agreement bears interest at one-month London Inter-Bank Offered Rate ("LIBOR")
plus 1.0%. The facility matures on October 7, 1999.
M D & A 21
ALLIED CAPITAL CORPORATION 1998
<PAGE> 21
UNSECURED LONG-TERM NOTES PAYABLE. The Company obtained $180 million in
financing through the issuance of unsecured long-term notes with private
institutional lenders, primarily insurance companies. The terms of the notes
include five- or seven-year maturities, priced at approximately 7.2%. The notes
require payment of interest semiannually, and all principal is due upon
maturity.
SBA DEBENTURES. The Company, through its SBIC subsidiary, has debentures
totaling $47.7 million payable to the SBA, at interest rates ranging from 6.9%
to 9.6% with scheduled maturity dates as follows: 1999 -- $0; 2000 -- $17.3
million; 2001 -- $9.4 million; 2002 -- $0; 2003 -- $0; and $21.0 million
thereafter. The debentures require semi-annual interest-only payments with all
principal due upon maturity. During 1997, Congress increased the maximum
leverage available to an SBIC to $101.0 million, and the Company intends to
continue to borrow under the SBIC program as the situation warrants. The
Company currently has a commitment from the SBA for an additional $27.0 million
of debt.
REVOLVING LINE OF CREDIT. The Company has a $200 million unsecured revolving
line of credit. The facility bears interest at LIBOR plus 1.25% and requires a
commitment fee equal to 0.2% of the committed unused amount. The facility also
has a facility fee equal to 0.15% of the initial commitment. The line of credit
requires monthly payments of interest, and all principal is due upon maturity.
The facility matures on June 30, 1999. The Company has plans to increase the
capacity of its revolving line of credit in 1999, as well as extend the
maturity date. The Company is currently negotiating with its lenders in order
to accomplish these changes.
FUTURE DEBT OR EQUITY OFFERINGS
The Company plans to secure additional debt and equity capital for continued
investment in growing businesses. Because the Company is a RIC, it distributes
substantially all of its income and requires external capital for growth.
Because the Company is a business development company, it is limited in the
amount of debt capital it may use to fund its growth, since it is generally
required to maintain a ratio of 200% of total assets to total borrowings.
The Company's cash flow from operations was $68.9 million, $58.9
million and $45.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively. The Company plans to maintain a strategy of financing its
operations, dividend requirements and future investments with cash from
operations, through borrowing under short- or long-term credit facilities,
through asset sales or securitizations, or through obtaining new equity
capital. The Company will utilize its short-term credit facilities only as a
means to bridge to long-term financing. The Company evaluates its interest rate
exposure on an ongoing basis and may hedge variable and short-term interest
rate exposure through interest rate swaps, Treasury locks and other techniques
when appropriate. The Company believes that it has access to capital
sufficient to fund its ongoing investment and operating activities, and from
which to pay dividends.
FINANCIAL OBJECTIVES
The Company has set forth certain financial objectives that it intends to use
in allocating its resources and in selecting new investment opportunities.
Management's goal is to increase NIA annually by 15% to 20% and to result in a
ratio of NIA to average shareholders' equity, or return on equity, of 19% to
22%. Management believes that the Company will be able to achieve these goals
over the next three to five years. Factors that may impede the achievement of
these objectives include those described under "Investment Considerations" and
also include other factors such as changes in the economy, competitive and
market conditions, and future business decisions.
YEAR 2000
The Company has a Year 2000 compliance committee, which is responsible for
assessing the Company's Year 2000
22 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 22
readiness by focusing on three main areas: the Company's information technology
("IT") and other operating systems, service providers and portfolio companies.
The committee reports periodically to the Board of Directors and to executive
management.
The Company's IT systems consist of third-party software and
relatively new hardware systems. All vendors providing critical software and
hardware have indicated that their programs and systems would be Year 2000
compliant by the end of the first quarter of 1999. The Company's testing of all
critical software and IT systems is scheduled to be completed by the end of
first quarter 1999. In addition to the testing performed by Company personnel,
the Company has also contracted with its loan accounting software vendor to
perform independent validation tests, using the Company's data, to verify that
this software will be Year 2000 compliant. Implementation of tested software
and IT systems is scheduled to be completed by the end of the second quarter
1999. The Company currently has service and maintenance contracts with all of
its critical software vendors; therefore, no additional costs are expected to
be incurred by the Company for the upgrades needed to become compliant.
The second area of focus is the Company's service providers. The
Company is in the process of obtaining compliance certificates from all
critical service providers, which include banks and utility companies. The
Company is not aware of any critical service provider that will not be Year
2000 compliant. However, the Company cannot give any assurance that the service
providers will be Year 2000 compliant and that no interruption of business will
occur as a result of their non-compliance.
The Company has sent Year 2000 questionnaires to its portfolio
companies to assess their awareness and to evaluate their Year 2000 readiness.
The Company plans to complete its survey and evaluation of its portfolio
companies by the end of the first quarter of 1999 and will follow-up with any
portfolio companies that may have material exposure and inadequate contingency
plans. During 1998, the Company began to evaluate each new portfolio company's
Year 2000 compliance as part of the due diligence process. No assurance can be
given that certain of the Company's portfolio companies will not suffer
material adverse effects from Year 2000 issues, and if such adverse effects
impact those companies' ability to repay their loans, the Company's operating
results and financial condition could be affected.
The Company estimates its operating costs to reach Year 2000
compliance will be approximately $100,000, and these costs are included in the
Company's 1999 budget. This includes time allocated to this task by Company
personnel and costs incurred in the testing phase.
While the Company believes that it is taking the necessary steps to
be Year 2000 compliant, it is difficult to fully predict the impact on the
Company of non-compliance in any of the above-mentioned areas. Significant
non-compliance could result in a material adverse effect on the Company's
financial conditions and results from operations. The Company believes that the
worst-case Year 2000 scenarios may include 1) additional costs incurred to
maintain the Company's books and records and to service the Company's
investment portfolio, 2) the inability of the Company to access or transfer
cash needed to pay its bills or fund new investments, 3) an increase in
delinquencies and/or losses due to Year 2000 problems with the Company's
portfolio companies, or 4) disruption in the capital markets resulting in a
lack of liquidity to the Company. The degree of impact resulting from any of
these worst-case scenarios cannot be determined at this time. The Company is
currently assessing its contingency plan, taking into consideration these
worst-case scenarios. This plan will be finalized after the Year 2000
compliance tests and surveys described above are completed.
INVESTMENT CONSIDERATIONS
RISKS OF LENDING TO SMALL, PRIVATELY OWNED COMPANIES The portfolio of the
Company consists primarily of loans to small, privately owned companies. There
is generally no publicly available
MD&A 23
ALLIED CAPITAL CORPORATION 1998
<PAGE> 23
information about such companies, and the Company must rely on the diligence of
its employees and agents to obtain information in connection with the Company's
investment decisions. Typically, small businesses depend on the management
talents and efforts of one person or a small group of persons for their
success. The death, disability or resignation of one or more of these persons
could have a material adverse impact on such a company. Moreover, small
businesses frequently have smaller product lines and market shares than their
competition. Small companies may be more vulnerable to customer preferences,
market conditions and economic downturns and often need substantial additional
capital to expand or compete. Such companies may also experience substantial
variations in operating results, and frequently have highly leveraged capital
structures. Such factors can severely affect the return on, or the recovery of,
the Company's investment in such businesses. Loans to small businesses,
therefore, involve a high degree of business and financial risk, which can
result in substantial losses and accordingly should be considered speculative.
RISK OF PAYMENT DEFAULT The Company invests in and lends to small businesses
that may have limited financial resources and that may be unable to obtain
financing from traditional sources. The Company's borrowers may not meet net
income, cash flow and other coverage tests typically imposed by bank lenders. A
borrower's ability to repay its loan may be adversely affected by numerous
factors, including the failure to meet its business plan, a downturn in its
industry or negative economic conditions. A deterioration in a borrower's
financial condition and prospects may be accompanied by deterioration in the
collateral for the loan. The Company also has the ability to make unsecured,
subordinated loans or invest in equity securities, which may involve a higher
degree of risk.
ILLIQUIDITY OF PORTFOLIO INVESTMENTS Most of the investments of the Company are
or will be loans and equity securities acquired directly from small companies.
The Company's portfolio of loans and equity securities is and will be subject
to restrictions on resale or otherwise have no established trading market. The
illiquidity of most of the Company's portfolio of loans and equity securities
may adversely affect the ability of the Company to dispose of such loans and
securities at times when it may be advantageous for the Company to liquidate
such investments.
VALUATION OF PORTFOLIO There is typically no public market for the loans and
equity securities of the small companies to which the Company makes loans. As a
result, the valuation of the loans and equity securities in the Company's
portfolio is subject to the estimate of the Company's Board of Directors.
Unlike traditional lenders, the Company does not establish reserves for
anticipated loan losses, but adjusts quarterly the valuation of its portfolio
to reflect the estimate of the Company's Board of Directors as to the current
realizable value of the loan portfolio. In the absence of a readily
ascertainable market value, the estimated value of the Company's portfolio of
loans and equity securities may differ significantly from the values that would
be placed on the portfolio if a ready market for the loans and equity
securities existed. Any changes in estimated net asset value are recorded in
the Company's statement of operations as "Net unrealized gains (losses)."
RISKS OF LEVERAGE The Company borrows from, and issues senior debt securities
to, banks and other lenders. Lenders of these senior securities have fixed
dollar claims on the Company's consolidated assets, which are superior to the
claims of the Company's shareholders.
Leverage magnifies the potential for gain and loss on amounts
invested and, therefore, increases the risks associated with investing in the
Company's securities. If the value of the Company's consolidated assets
increases, then such leveraging techniques would cause the net asset value
attributable to the Company's common stock to increase more sharply than it
would have had the techniques not
24 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 24
been utilized. Conversely, if the value of the Company's consolidated assets
decreases, leveraging would cause net asset value to decline more sharply than
it otherwise would if the amounts had not been borrowed. Similarly, any
increase in the Company's consolidated income in excess of consolidated
interest payable on the borrowed funds would cause its net income to increase
more than it would without the leverage, while any decrease in its consolidated
income would cause net income to decline more sharply than it would have had
the funds not been borrowed. Such a decline could negatively affect the
Company's ability to make common stock dividend payments, and, if asset
coverage for a class of senior security representing indebtedness declines to
less than 200%, the Company may be required to sell a portion of its
investments when it is disadvantageous to do so. Leverage is generally
considered a speculative investment technique.
As of December 31, 1998, the Company's debt as a percentage of total
liabilities and shareholders' equity was 39%. The Company's ability to achieve
its investment objective may depend in part on its continued ability to
maintain a leveraged capital structure by borrowing from banks or other lenders
on favorable terms, and there can be no assurance that such leverage can be
maintained.
INTEREST RATE RISK Because the Company borrows money to make investments, its
income is materially dependent upon the "spread" between the rate at which it
borrows funds and the rate at which it loans these funds. In periods of sharply
rising interest rates, the Company's cost of funds would increase and could
reduce or eliminate the spread. The Company uses a combination of long-term and
short-term borrowings to finance its lending activities and engages in interest
rate risk management techniques in an effort to limit its exposure to interest
rate fluctuations. Such techniques may include various interest rate hedging
activities to the extent permitted by the 1940 Act. There can be no assurance
that the Company can maintain a positive net interest spread or that a
significant change in market interest rates will not have a material adverse
effect on the Company's profitability.
AVAILABILITY OF FUNDS The Company has a continuing need for capital to fund
loans. Historically, the Company's capital needs have been met by borrowing
from financial institutions and through the issuance of equity securities. A
reduction in the availability of funds from financial institutions could have a
material adverse effect on the Company. The Company must distribute to its
stockholders at least 90% of its net operating income other than net realized
long-term capital gains to maintain its RIC status under the Code and currently
intends to distribute net realized long-term capital gains on an annual basis.
As a result such earnings will not be available to fund loan originations. The
Company expects to obtain capital to fund loans through borrowings from
financial institutions and the sale of its securities. A failure by the Company
to obtain funds from such sources or from other sources to fund its loans could
have a material adverse effect on the financial condition and results of the
Company. In addition, as a BDC, the Company will be generally required to
maintain a ratio of at least 200% of total assets to total borrowings, which
may restrict its ability to borrow in certain circumstances.
REALIZATION OF CAPITAL GAINS Mezzanine loans are typically structured as debt
securities with a relatively high fixed rate of interest and with an equity
feature such as conversion rights, warrants or options. As a result, the
potential return on the mezzanine loans will generate interest income from the
time they are made, and also may produce a realized gain, if any, from an
accompanying equity feature. There can be no assurance that a current return or
capital gains will actually be realized.
LOSS OF PASS-THROUGH TAX TREATMENT The Company qualifies as a RIC under
Subchapter M of the Code. If the Company meets certain diversification and
M D & A 25
ALLIED CAPITAL CORPORATION 1998
<PAGE> 25
distribution requirements under the Code, it qualifies for pass-through tax
treatment. The Company would cease to qualify for pass-through tax treatment if
it were unable to comply with these requirements, or if it ceased to qualify as
a BDC under the 1940 Act. The Company also could be subject to a 4% excise tax
(and, in certain cases, corporate level income tax) if it fails to make certain
distributions. If the Company fails to qualify as a RIC, the Company would
become subject to federal income tax as if it were an ordinary corporation,
which would result in a substantial reduction in the Company's net assets and
the amount of income available for distribution to the Company's shareholders.
COMPETITIVE MARKET FOR INVESTMENT OPPORTUNITIES Many entities and individuals
compete for investments similar to those made by the Company, some of whom have
greater resources than the Company. Increased competition would make it more
difficult for the Company to purchase or originate loans at attractive prices.
As a result of this competition, the Company may from time to time be precluded
from making otherwise attractive investments on terms considered to be prudent
in light of the risks assumed.
GOVERNMENT REGULATIONS The Company is subject to regulation by the Commission
and the SBA. In addition, the Company's business may be significantly impacted
by changes in the laws or regulations that govern BDCs, RICs, real estate
investment trusts ("REITs"), small business investment companies ("SBICs") and
small business lending companies ("SBLCs"). Laws and regulations may be changed
from time to time and the interpretations of the relevant law and regulations
also are subject to change. Any change in the laws or regulations that govern
the Company could have a material impact on the Company or its operations.
FLUCTUATIONS IN QUARTERLY RESULTS The Company's quarterly operating results
could fluctuate due to a number of factors. These include, among others, the
completion of a securitization transaction in a particular calendar quarter,
the interest rates on the securities issued in connection with its
securitization transactions, variations in the volume of loans originated by
the Company, variation in timing of prepayment of loans, variations in and the
timing of the recognition of realized and unrealized gains or losses, the
degree to which the Company encounters competition in its markets and general
economic conditions. As a result of these factors, results for any one quarter
should not be relied upon as being indicative of performance in future
quarters.
26 M D & A
1998 ALLIED CAPITAL CORPORATION
<PAGE> 26
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
(in thousands, except number of shares) 1998 1997
<S> <C> <C>
ASSETS
Portfolio at value:
Mezzanine loans and debt securities (cost: 1998 - $354,870; 1997 - $181,184) $339,163 $167,842
Commercial mortgage loans (cost: 1998 - $232,745; 1997 - $446,114) 233,186 447,244
Commercial mortgage-backed securities (cost: 1998 - $115,174; 1997 - $0) 113,674 --
Small Business Administration 7(a) loans (cost: 1998 - $57,651; 1997 - $41,103) 56,285 40,709
Equity interests in portfolio companies (cost: 1998 - $27,618; 1997 - $20,050) 49,391 39,906
Other portfolio assets (cost: 1998 - $8,331; 1997 - $2,269) 8,575 1,320
- ---------------------------------------------------------------------------------------------------------------
Total portfolio at value 800,274 697,021
- ---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 25,075 70,437
U.S. government securities -- 11,091
Other assets 30,730 29,226
- ---------------------------------------------------------------------------------------------------------------
Total assets $856,079 $807,775
===============================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable $239,350 $308,821
Revolving lines of credit 95,000 38,842
Accounts payable and other liabilities 27,912 23,984
Dividends and distributions payable 1,700 9,068
- ---------------------------------------------------------------------------------------------------------------
Total liabilities 363,962 380,715
===============================================================================================================
Commitments and Contingencies
Preferred stock issued to Small Business Administration 7,000 7,000
Shareholders' equity:
Common stock, $0.0001 par value, 100,000,000 shares authorized;
56,729,502 and 52,047,318 issued and outstanding
at December 31, 1998 and 1997, respectively 6 5
Additional paid-in capital 526,824 451,044
Common stock held in deferred compensation trust (810,456 shares) (19,431) --
Notes receivable from sale of common stock (23,735) (29,611)
Net unrealized appreciation on portfolio 2,380 1,301
Distributions in excess of earnings (927) (2,679)
- ---------------------------------------------------------------------------------------------------------------
Total shareholders' equity 485,117 420,060
- ---------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $856,079 $807,775
===============================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
CONSOLIDATED FINANCIAL STATEMENTS 27
ALLIED CAPITAL CORPORATION 1998
<PAGE> 27
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
(in thousands, except per share amounts) 1998 1997 1996
<S> <C> <C> <C>
INTEREST AND RELATED PORTFOLIO INCOME
Interest $79,921 $86,882 $77,541
Net premiums from loan dispositions 5,949 7,277 4,241
Net gain on securitization of commercial mortgage loans 14,812 -- --
Investment advisory fees and other income 6,056 3,246 3,155
- -------------------------------------------------------------------------------------------------------------------------------
Total interest and related portfolio income 106,738 97,405 84,937
===============================================================================================================================
EXPENSES
Interest on indebtedness 20,694 26,952 20,298
Salaries and employee benefits 11,829 10,258 8,774
General and administrative 11,921 8,970 8,289
Merger -- 5,159 --
- -------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 44,444 51,339 37,361
===============================================================================================================================
Formula and cut-off awards 7,049 -- --
===============================================================================================================================
Portfolio income before net realized and unrealized gains 55,245 46,066 47,576
===============================================================================================================================
NET REALIZED AND UNREALIZED GAINS
Net realized gains 22,541 10,704 19,155
Net unrealized gains (losses) 1,079 7,209 (7,412)
- -------------------------------------------------------------------------------------------------------------------------------
Total net realized and unrealized gains 23,620 17,913 11,743
===============================================================================================================================
Income before minority interests and income taxes 78,865 63,979 59,319
===============================================================================================================================
Minority interests -- 1,231 2,427
Income tax expense 787 1,444 1,945
- -------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations $78,078 $61,304 $54,947
===============================================================================================================================
Basic earnings per common share $1.50 $1.24 $1.19
===============================================================================================================================
Diluted earnings per common share $1.50 $1.24 $1.17
===============================================================================================================================
Weighted average common shares outstanding - basic 51,941 49,218 46,172
- -------------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding - diluted 51,974 49,251 46,733
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
28 CONSOLIDATED FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 28
CONSOLIDATED STATEMENT OF CHANGES
IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
(in thousands, except per share amounts) 1998 1997 1996
<S> <C> <C> <C>
OPERATIONS
Portfolio income before realized and unrealized gains $55,245 $46,066 $47,576
Net realized gains 22,541 10,704 19,155
Net unrealized gains (losses) 1,079 7,209 (7,412)
Minority interests and income tax expense (787) (2,675) (4,372)
- -------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 78,078 61,304 54,947
===============================================================================================================================
SHAREHOLDER DISTRIBUTIONS
Portfolio income (49,397) (38,751) (39,030)
Excess of portfolio income -- (605) (2,533)
Net capital gains (24,976) (15,172) (11,546)
Excess of net capital gains (714) -- --
Return of capital -- (22,302) (4,289)
Undistributed earnings -- (8,848) --
Preferred stock dividend (230) (220) (220)
- -------------------------------------------------------------------------------------------------------------------------------
Net decrease in net assets resulting from shareholder distributions (75,317) (85,898) (57,618)
===============================================================================================================================
CAPITAL SHARE TRANSACTIONS
Sale of common stock 69,675 -- 22,365
Net decrease (increase) in notes receivable from sale of common stock 5,576 (14,120) (8,176)
Issuance of common stock upon the exercise of stock options 221 28,426 12,176
Issuance of common stock in lieu of cash distributions 6,184 26,612 11,986
Purchase of common stock by deferred compensation trust (19,431) -- --
Other 71 1,602 (738)
- -------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from capital share transactions 62,296 42,520 37,613
- -------------------------------------------------------------------------------------------------------------------------------
Total increase in net assets $65,057 $17,926 $34,942
===============================================================================================================================
Net assets at beginning of year $420,060 $402,134 $367,192
- -------------------------------------------------------------------------------------------------------------------------------
Net assets at end of year $485,117 $420,060 $402,134
- -------------------------------------------------------------------------------------------------------------------------------
Net asset value per common share $8.68 $8.07 $8.34
- -------------------------------------------------------------------------------------------------------------------------------
Common shares outstanding at end of year 55,919 52,047 48,238
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
CONSOLIDATED FINANCIAL STATEMENTS 29
ALLIED CAPITAL CORPORATION 1998
<PAGE> 29
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
(in thousands) 1998 1997 1996
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in net assets resulting from operations $78,078 $61,304 $54,947
Adjustments
Net unrealized (gains) losses (1,079) (7,209) 7,412
Net gain on securitization of commercial mortgage loans (14,812) -- --
Depreciation and amortization 702 450 393
Amortization of loan discounts and fees (6,032) (10,804) (9,027)
Deferred income taxes -- 1,087 (381)
Minority interests -- 1,231 2,427
Changes in other assets and liabilities 11,998 12,881 (10,606)
- -------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 68,855 58,940 45,165
===============================================================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in small business concerns (524,530) (364,942) (283,295)
Collections of investment principal 138,081 233,005 179,292
Proceeds from loan sales 81,013 53,912 27,715
Proceeds from securitization of commercial mortgage loans 223,401 -- --
Net redemption (purchase) of U.S. government securities 11,091 (10,301) --
Collections of notes receivable from sale of common stock 5,591 6,534 2,199
Other investing activities (2,539) (182) 2,635
- -------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (67,892) (81,974) (71,454)
===============================================================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock 69,896 8,615 24,166
Purchase of common stock by deferred compensation trust (19,431) -- --
Common dividends and distributions paid (69,536) (58,194) (47,089)
Special undistributed earnings distribution paid (8,848) -- --
Preferred stock dividends (450) (220) (220)
Net (payments on) borrowings under debentures
and notes payable (69,471) 78,923 (35,202)
Net borrowings under (payments on) revolving
lines of credit 56,158 (6,257) 110,460
Other financing activities (4,643) (1,237) (3,029)
- -------------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (46,325) 21,630 49,086
===============================================================================================================================
Net (decrease) increase in cash and cash equivalents $(45,362) $(1,404) $22,797
===============================================================================================================================
Cash and cash equivalents at beginning of year $70,437 $71,841 $49,044
===============================================================================================================================
Cash and cash equivalents at end of year $25,075 $70,437 $71,841
===============================================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
30 CONSOLIDATED FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 30
CONSOLIDATED STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1998
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares)
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
<S> <C> <C> <C>
Acme Paging, L.P. Debt Securities $6,273 $6,273
Partnership Interest 1,456 2,600
- ------------------------------------------------------------------------------------------------------------------------------------
American Barbecue & Grill, Inc. Loans 1,475 1,475
Debt Securities 2,084 2,084
Warrants 125 125
- ------------------------------------------------------------------------------------------------------------------------------------
AMF Bowling, Inc. (1) High Yield Debt 5,086 5,086
- ------------------------------------------------------------------------------------------------------------------------------------
Arnold Moving Co., Inc. Loans 570 570
- ------------------------------------------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- ------------------------------------------------------------------------------------------------------------------------------------
Au Bon Pain Co., Inc. (1) Debt Securities 7,427 7,427
Warrants 227 8
- ------------------------------------------------------------------------------------------------------------------------------------
Avborne, Inc. Debt Securities 12,510 12,510
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Brazos Sportswear, Inc. (1) Common Stock (342,938 shares) 330 --
- ------------------------------------------------------------------------------------------------------------------------------------
Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250
- ------------------------------------------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 339 339
Warrants 12 12
- ------------------------------------------------------------------------------------------------------------------------------------
CeraTech Holdings Corporation Debt Securities 1,991 50
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,557 1,557
Common Stock (220 shares) 1 --
- ------------------------------------------------------------------------------------------------------------------------------------
Convenience Corporation of America Debt Securities 8,391 2,774
Series A Preferred Stock (31,521 shares) 334 --
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Inc. Debt Securities 3,450 3,450
Warrants -- 1,138
- ------------------------------------------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC Loan 5,860 5,860
- ------------------------------------------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Resources, LLC Debt Securities 2,948 2,948
Options -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Coverall North America Loan 8,915 8,915
- ------------------------------------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 700
- ------------------------------------------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 250
- ------------------------------------------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc. (1) Warrants 350 133
- ------------------------------------------------------------------------------------------------------------------------------------
Directory Investment Corporation Common Stock (470 shares) -- 148
- ------------------------------------------------------------------------------------------------------------------------------------
Directory Lending Corporation Series A Common Stock (1,031 shares) -- --
Series B Common Stock (188 shares) 235 161
Series C Common Stock (292 shares) 656 449
Series A Preferred Stock (214 shares) 307 210
Series B Preferred Stock (175 shares) 931 638
Series C Preferred Stock (58 shares) 58 40
- ------------------------------------------------------------------------------------------------------------------------------------
Drilltec Patents & Technologies Company, Inc. Loan 10,020 10,020
- ------------------------------------------------------------------------------------------------------------------------------------
ECM Enterprises Loan 31 4
- ------------------------------------------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 30 30
Debt Securities 1,875 680
Common Stock (100 shares) 250 --
- ------------------------------------------------------------------------------------------------------------------------------------
El Dorado Communications, Inc. Loans 306 306
- ------------------------------------------------------------------------------------------------------------------------------------
Enterprise Software, Inc. (1) Debt Securities 14,880 14,880
Common Stock (147,975 shares) 1,176 683
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 29 29
- ------------------------------------------------------------------------------------------------------------------------------------
Esquire Communications Ltd. (1) Warrants 6 --
- ------------------------------------------------------------------------------------------------------------------------------------
Everything Yogurt Loan 34 34
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS AND EQUITY
INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
CONSOLIDATED FINANCIAL STATEMENTS 31
ALLIED CAPITAL CORPORATION 1998
<PAGE> 31
CONSOLIDATED STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1998
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Ex Terra Credit Recovery, Inc. Series A Preferred Stock (500 shares) $497 $497
Common Stock (2,500 shares) 3 3
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Company Debt Securities 5,702 5,702
Warrants 280 3,629
- ------------------------------------------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loans 200 200
- ------------------------------------------------------------------------------------------------------------------------------------
Galaxy American Communications, LLC Debt Securities 30,703 30,703
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Gibson Guitar Corporation Debt Securities 15,080 15,080
Warrants 525 1,000
- ------------------------------------------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Archery, LLC Loans 1,390 1,390
Convertible Debentures 2,248 2,242
- ------------------------------------------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 3,600
- ------------------------------------------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 9,154 9,154
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Han Hie Loan 510 510
- ------------------------------------------------------------------------------------------------------------------------------------
H.B.N. Communications, Inc. Loan 233 233
- ------------------------------------------------------------------------------------------------------------------------------------
Hotelevision, Inc. Preferred Stock (1,000,000 shares) 1,000 1,000
- ------------------------------------------------------------------------------------------------------------------------------------
In the Dough, Inc. Loan 2 2
- ------------------------------------------------------------------------------------------------------------------------------------
Jack Henry & Associates, Inc. (1) Common Stock (90,438 shares) 26 4,193
- ------------------------------------------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 93 93
- ------------------------------------------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,111 2,111
Warrants 74 74
- ------------------------------------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 4,692 4,692
Warrants 324 2,100
- ------------------------------------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Loans 3,739 3,739
Debt Securities 2,609 2,609
Warrants 348 3,500
Equity Interest 3 3
- ------------------------------------------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,283 6,283
Warrants 96 2,850
- ------------------------------------------------------------------------------------------------------------------------------------
Kyrus Corporation Debt Securities 7,601 7,601
Warrants 348 348
- ------------------------------------------------------------------------------------------------------------------------------------
KZSF Broadcasting, Inc. Loans 884 884
- ------------------------------------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc. Debt Securities 3,403 3,403
Common Stock (64,535 shares) 142 142
- ------------------------------------------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 207 207
- ------------------------------------------------------------------------------------------------------------------------------------
Liqui-Dri Foods, Inc. Loans 10,291 10,291
- ------------------------------------------------------------------------------------------------------------------------------------
The Loewen Group, Inc. (1) High Yield Debt 15,002 15,002
- ------------------------------------------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213
- ------------------------------------------------------------------------------------------------------------------------------------
May Investments Loan 47 --
- ------------------------------------------------------------------------------------------------------------------------------------
Meigher Communications, L.P. Loan 2,918 2,918
- ------------------------------------------------------------------------------------------------------------------------------------
Mid Atlantic Telecom Plus, LLC Loan 10,434 10,434
- ------------------------------------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities 197 197
Options -- --
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS AND EQUITY
INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
32 CONSOLIDATED FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 32
CONSOLIDATED STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1998
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares)
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------------
Mihadas Loan $287 $287
- ------------------------------------------------------------------------------------------------------------------------------------
Mill-It Striping, Inc. Common Stock (18 shares) 250 --
- ------------------------------------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 17 17
Debt Securities 1,823 219
Common Stock (33,333 shares) -- --
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Morton Industrial Group (1) Common Stock (5,835 shares) 241 82
- ------------------------------------------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 61 61
- ------------------------------------------------------------------------------------------------------------------------------------
Nobel Education Dynamics, Inc. (1) Debt Securities 9,419 9,419
Series D Convertible
Preferred Stock (265,957 shares) 2,000 2,000
Warrants 575 575
- ------------------------------------------------------------------------------------------------------------------------------------
Norman's Yogurt, Inc. Loan 8 8
- ------------------------------------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, L.P. Debt Securities 415 415
- ------------------------------------------------------------------------------------------------------------------------------------
Nursefinders,Inc. Debt Securities 10,841 10,841
Warrants 900 900
- ------------------------------------------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 589 140
Warrants 77 --
- ------------------------------------------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 229 229
- ------------------------------------------------------------------------------------------------------------------------------------
David Peters Loan 164 55
- ------------------------------------------------------------------------------------------------------------------------------------
PIATL Holdings, Inc. Loan 31 31
Preferred Stock (276 shares) 160 222
Common Stock (24 shares) -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Pico Products, Inc. (1) Debt Securities 4,091 4,091
Common Stock (208,000 shares) 59 33
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Precision Industries Co. Debt Securities 9,580 9,580
Common Stock (132,507 shares) 1,050 1,616
- ------------------------------------------------------------------------------------------------------------------------------------
Progressive International Corporation Debt Securities 3,680 3,680
Preferred Stock (500 shares) 500 500
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Quality Software Products Holdings, PLC (1) Common Stock (94,479 shares) 901 557
- ------------------------------------------------------------------------------------------------------------------------------------
Radio One of Atlanta, Inc. Loans 2,000 2,000
Debt Securities 9,972 9,972
Common Stock (1,430 shares) -- 3,000
- ------------------------------------------------------------------------------------------------------------------------------------
Randhawa Brothers Enterprises, Inc. Loan 117 117
- ------------------------------------------------------------------------------------------------------------------------------------
R.L. Singletary Loan 98 98
- ------------------------------------------------------------------------------------------------------------------------------------
Schwinn/GT Debt Securities 9,605 9,605
Warrants 395 395
- ------------------------------------------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc. Series A Preferred Stock (1,000 shares) 993 993
- ------------------------------------------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 399 306
Common Stock (6,208 shares) 24 --
- ------------------------------------------------------------------------------------------------------------------------------------
SunStates Refrigerated Services, Inc. Loans 1,830 341
Debt Securities 2,445 676
- ------------------------------------------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P. Debt Securities 11,881 11,881
Options -- --
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS AND EQUITY
INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
CONSOLIDATED FINANCIAL STATEMENTS 33
ALLIED CAPITAL CORPORATION 1998
<PAGE> 33
CONSOLIDATED STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1998
PORTFOLIO COMPANY INVESTMENT (2) COST VALUE
(in thousands, except number of shares)
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities $1,562 $106
Common Stock (910 shares) 57 --
- ------------------------------------------------------------------------------------------------------------------------------------
Unitel, Inc. Debt Securities 3,579 3,579
Warrants 360 360
- ------------------------------------------------------------------------------------------------------------------------------------
Vianova Resins GmbH Debt Securities 1,812 1,812
Warrants -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Vidon, Inc. Loan 259 259
- ------------------------------------------------------------------------------------------------------------------------------------
William R. Dye Loan 265 265
- ------------------------------------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Company Warrants 24 322
- ------------------------------------------------------------------------------------------------------------------------------------
Wilton Industries, Inc. Loan 12,000 12,000
- ------------------------------------------------------------------------------------------------------------------------------------
WYCB Acquisition Corporation Loan 3,812 3,812
- ------------------------------------------------------------------------------------------------------------------------------------
Wyo-Tech Acquisition Corporation Debt Securities 15,094 15,094
Common Stock (99 shares) 100 100
Preferred Stock (100 shares) 3,700 3,700
- ------------------------------------------------------------------------------------------------------------------------------------
Total mezzanine loans and debt securities and
equity interests in portfolio companies (94 investments) $382,488 $388,554
====================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
INTEREST NUMBER OF
RATE RANGES INVESTMENTS COST VALUE
COMMERCIAL MORTGAGE LOANS
<S> <C> <C> <C> <C>
Up to 6.99% 3 $1,327 $1,327
7.00%-8.99% 43 104,872 104,872
9.00%-10.99% 102 69,635 70,076
11.00%-12.99% 31 44,424 44,424
13.00%-14.99% 4 12,362 12,362
15.00% and above 1 125 125
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial mortgage loans 184 $232,745 $233,186
====================================================================================================================================
COMMERCIAL MORTGAGE-BACKED SECURITIES
Subordinated CMBS 1 $32,221 $32,221
Residual CMBS 1 70,771 70,771
Residual securitization spread 1 12,182 10,682
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial mortgage-backed securities 3 $115,174 $113,674
====================================================================================================================================
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 12 $160 $115
7.00%-8.99% 12 134 57
9.00%-10.99% 364 51,925 51,343
11.00%-12.99% 53 5,148 4,592
13.00%-14.99% 5 284 178
15.00% and above -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Small Business Administration 7(a) loans 446 $57,651 $56,285
====================================================================================================================================
Other portfolio assets 6 $8,331 $8,575
====================================================================================================================================
Total portfolio at value 733 $796,389 $800,274
====================================================================================================================================
</TABLE>
(1) PUBLIC COMPANY; (2) COMMON STOCK, PREFERRED STOCK, WARRANTS AND EQUITY
INTERESTS ARE GENERALLY NON-INCOME PRODUCING AND RESTRICTED.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
34 CONSOLIDATED FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. MERGER
On December 31, 1997, Allied Capital Corporation ("Allied I"), Allied Capital
Corporation II ("Allied II"), Allied Capital Commercial Corporation ("Allied
Commercial"), and Allied Capital Advisers ("Advisers"), merged with and into
Allied Capital Lending Corporation ("Allied Lending") (each a "Predecessor
Company" and collectively the "Predecessor Companies") pursuant to an Agreement
and Plan of Merger, dated as of August 14, 1997, as amended and restated as of
September 19, 1997 in a stock-for-stock exchange (the "Merger"). Immediately
following the Merger, Allied Lending changed its name to Allied Capital
Corporation ("ACC" or the "Company").
The Merger was treated as a tax-free reorganization under Section 368
(a)(1)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). For
federal income tax purposes, the Predecessor Companies carried forward the
historical cost basis of their assets and liabilities to the surviving entity
(ACC). For financial reporting purposes, the Predecessor Companies also carried
forward the historical cost basis of their respective assets and liabilities at
the time the Merger was effected. The consolidated financial statements reflect
the operations of ACC with the years ended December 31, 1997 and 1996 restated
as if the Predecessor Companies had merged as of the beginning of the earliest
period presented.
Prior to the Merger, Allied I owned approximately 16 percent of
Allied Lending's total shares outstanding. These shares were distributed to the
Allied I shareholders in a dividend immediately prior to the Merger at a rate
of 0.107448 shares of Allied Lending for each share of Allied I held on the
record date. For financial reporting purposes, Allied I's ownership of Allied
Lending has been eliminated for all periods presented.
NOTE 2. ORGANIZATION
Allied Capital Corporation, a Maryland corporation, is a closed-end management
investment company that has elected to be regulated as a business development
company ("BDC") under the Investment Company Act of 1940 ("1940 Act"). The
Company has two wholly owned subsidiaries that have also elected to be
regulated as BDCs. Allied Investment Corporation is licensed under the Small
Business Investment Act of 1958 as a Small Business Investment Company
("SBIC"). Allied Investment Corporation is the result of the merger of the
Company's two wholly owned SBIC subsidiaries in July 1998 whereby Allied
Investment Corporation merged with and into Allied Capital Financial
Corporation ("Allied Financial"). Allied Financial then changed its name to
Allied Investment Corporation ("Allied Investment"). Allied Capital SBLC
Corporation ("Allied SBLC") is licensed by the Small Business Administration
("SBA") as a Small Business Lending Company and is a participant in the SBA
Section 7(a) Guaranteed Loan Program. In addition, the Company has also
established a real estate investment trust subsidiary, Allied Capital REIT,
Inc. ("Allied REIT"). The Company also has several single-member limited
liability companies established primarily to hold real estate properties.
Allied Capital Corporation and its subsidiaries, collectively, are
hereinafter referred to as the "Company" or "ACC."
The investment objective of the Company is to achieve current income
and capital gains. In order to achieve this objective, the Company invests
primarily in private, growing businesses in a variety of industries and in
diverse geographic locations (primarily in the United States).
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The consolidated financial statements for the periods
presented have been restated to include the accounts of the Predecessor
Companies for all periods presented. Transaction fees and expenses related to
the Merger were expensed in the fourth quarter of 1997. The consolidated
financial statements include the accounts of the Company or its wholly owned or
majority owned subsidiaries. All intercompany accounts and transactions have
been eliminated in consolidation. Certain reclassifications have been made to
the 1997 and 1996 balances to conform with the 1998 financial statement
presentation.
VALUATION OF PORTFOLIO INVESTMENTS. Portfolio assets are carried at fair value
as determined by the Board of Directors under the Company's valuation policy.
LOAN AND DEBT SECURITIES. The values of loans and debt securities are
considered to be amounts which could be realized in the normal course of
business which, generally, anticipates the Company holding the loan to maturity
and realizing the face value of the loan. For loans and debt securities, value
normally corresponds to cost unless the borrower's condition or external
factors lead to a determination of value at a lower amount.
Interest income is recorded on the accrual basis to the extent that
such amounts are expected to be collected. Loan origination fees, original
issue discount, and market discount are amortized into interest income using
the effective interest method.
EQUITY SECURITIES. Equity interests in portfolio companies for which there is
no public market are valued based on various factors including a history of
positive cash flow from operations, the market value of comparable publicly
traded companies and other pertinent factors, such as recent offers to purchase
a portfolio company's securities or other liquidation events. The determined
values are generally
NOTES TO FINANCIAL STATEMENTS 35
ALLIED CAPITAL CORPORATION 1998
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
discounted to account for liquidity issues and minority control positions.
The Company's equity interests in public companies that carry certain
restrictions on sale are typically valued at a discount from the public market
value of the security at the balance sheet date. Restricted and unrestricted
publicly traded stocks may also be valued at a discount due to the investment
size or market liquidity concerns.
COMMERCIAL MORTGAGE-BACKED SECURITIES. Commercial mortgage-backed securities
consist of subordinated commercial mortgage-backed securities ("Subordinated
CMBS"), residual interest in mortgage securitization ("Residual CMBS") and
residual securitization spread.
SUBORDINATED CMBS. The Subordinated CMBS is carried at fair value. The Company
recognizes income from Subordinated CMBS using the effective interest method,
using the anticipated yield over the projected life of the investment. Changes
in estimated yields are due to revisions in estimates of future credit losses,
actual losses incurred and actual prepayment speeds. Changes in estimated yield
are currently recognized as an adjustment to the estimated yield over the
remaining life of the Subordinated CMBS. The Company recognizes unrealized
depreciation on its Subordinated CMBS whenever it determines that the value of
its Subordinated CMBS is less than the carrying amount.
RESIDUAL CMBS. The Company values its residual interest in securitization and
recognizes income using the same accounting policies used for the Subordinated
CMBS.
RESIDUAL SECURITIZATION SPREAD (INTEREST-ONLY STRIP). The residual
securitization spread is carried at fair value based on the amortized cost of
the residual securitization spread and the estimated future cash flows. The
Company recognizes income using the effective interest method. At each
reporting date, the effective yield is recalculated and used to recognize income
until the next reporting date.
NET REALIZED AND UNREALIZED GAINS. Realized gains or losses are measured by
the difference between the net proceeds from the sale and the cost basis of the
investment without regard to unrealized gains or losses previously recognized,
and include investments charged off during the year, net of recoveries.
Unrealized gains or losses reflect the change in portfolio investment values
during the reporting period.
DEFERRED FINANCING COSTS. Financing costs are based on actual costs incurred in
obtaining financing and are deferred and amortized as part of interest expense
over the term of the related debt instrument.
DERIVATIVE FINANCIAL INSTRUMENTS. The Company may use derivative financial
instruments to reduce interest rate risk. The Company has established policies
and procedures for risk assessment and the approval, reporting and monitoring
of derivative financial instrument activities. The Company does not hold or
issue derivative financial instruments for trading purposes.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents include cash in banks and
all highly liquid investments with original maturities of three months or less.
DISTRIBUTIONS TO SHAREHOLDERS. Distributions to shareholders are recorded on
the record date.
FEDERAL AND STATE INCOME TAXES. With the exception of Advisers, the Predecessor
Companies qualified as regulated investment companies ("RIC") or a real estate
investment trust ("REIT"); however, Advisers was a corporation subject to
federal and state income taxes. Income tax expense reported on the consolidated
statement of operations relates to the operations of Advisers for all periods
presented.
The Company and its wholly owned subsidiaries intend to comply with
the requirements of the Code that are applicable to RICs and REITs. The Company
and its wholly owned subsidiaries intend to distribute annually all of their
taxable income to shareholders; therefore, the Company has made no provision
for income taxes.
PER SHARE INFORMATION. Basic earnings per share is calculated using the
weighted average number of shares outstanding for the period presented. Diluted
earnings per share reflects the potential dilution that could occur if options
to issue common stock were exercised into common stock. Earnings per share is
computed after subtracting dividends on Preferred Shares.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS. The preparation of
financial statements in conformity with 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.
NOTE 4. PORTFOLIO
The Company's lending operations are conducted in three primary areas:
mezzanine finance, commercial real estate finance, and SBA Section 7(a)
guaranteed lending.
36 NOTES TO FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MEZZANINE FINANCE. Mezzanine investments are generally structured as loans that
carry a relatively high fixed rate of interest, which may be combined with
equity features, such as conversion privileges, warrants or options to purchase
a portion of the portfolio company's equity at a nominal price. Such an
investment would typically have a maturity of five to ten years, with
interest-only payments in the early years and payments of both principal and
interest in the later years, although loan maturities and principal
amortization schedules vary.
Equity investments consist primarily of securities issued by
privately owned companies and may be subject to restrictions on their resale or
otherwise illiquid. Equity securities generally do not produce a current
return, but are held for investment appreciation and ultimate gain on sale.
At December 31, 1998 and 1997, approximately 98 percent of the
Company's mezzanine loan portfolio was composed of fixed interest rate loans.
The weighted average yield (at value) on the mezzanine portfolio at December
31, 1998 and 1997 was 14.6 percent, and 12.6 percent, respectively. At December
31, 1998 and 1997, mezzanine loans and debt securities with a cost basis of
$20,977,000 and $13,661,000, respectively, were not accruing interest.
The geographic and industry composition of the mezzanine portfolio at December
31, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
GEOGRAPHIC REGION 1998 1997
<S> <C> <C>
Mid-Atlantic 28% 29%
Midwest 27 17
Southeast 23 27
West 11 13
International 7 6
Northeast 4 8
- ----------------------------------------------------
Total 100% 100%
====================================================
INDUSTRY
Consumer Products
Manufacturing 25% 25%
Telecommunications 14 7
Business Services 11 7
Retail 9 14
Broadcasting 9 23
Industrial Products
Manufacturing 8 9
Other 24 15
- ----------------------------------------------------
Total 100% 100%
====================================================
</TABLE>
COMMERCIAL REAL ESTATE FINANCE. The commercial mortgage loan portfolio contains
loans that were originated by the Company or were purchased from the Resolution
Trust Corporation, the Federal Deposit Insurance Corporation and other third
party sellers including life insurance companies and banks.
At December 31, 1998 and 1997, approximately 68 percent and 32 percent, and 73
percent and 27 percent of the Company's commercial mortgage loan portfolio was
composed of fixed and adjustable interest rate loans, respectively. The
weighted average yield (at value) on the real estate portfolio as of December
31, 1998 and 1997 equaled 10.4 percent and 11.4 percent, respectively. As of
December 31, 1998 and 1997, loans with a cost basis of $5,443,000 and
$11,987,000, respectively, were not accruing interest.
The geographic composition and the property types securing the
commercial mortgage loan portfolio at December 31, 1998 and 1997 was as
follows:
<TABLE>
<CAPTION>
GEOGRAPHIC REGION 1998 1997
<S> <C> <C>
Mid-Atlantic 36% 38%
Southeast 23 14
West 22 18
Midwest 13 18
Northeast 6 12
- ----------------------------------------------------
Total 100% 100%
====================================================
PROPERTY TYPE
Hospitality 42% 34%
Office 29 32
Retail 14 17
Recreation 5 4
Other 10 13
- ----------------------------------------------------
Total 100% 100%
====================================================
</TABLE>
COMMERCIAL MORTGAGE-BACKED SECURITIES. In December 1998, the Company purchased
$67 million of Subordinated Commercial Mortgage Backed Securities
("Subordinated CMBS") for $32 million. The bonds owned by the Company of
non-investment grade and unrated tranches are junior in priority for payment of
principal to the more senior tranches of the related commercial securitization.
Cash flow from the underlying mortgages generally is allocated first to the
senior tranches, with the most senior tranches having a priority right to the
cash flow. Then, any remaining cash flow is allocated, generally, among the
other tranches in order of their relative seniority. To the extent there are
defaults and unrecoverable losses on the underlying mortgages resulting in
reduced cash flows, the subordinate tranche will bear this loss first.
NOTES TO FINANCIAL STATEMENTS 37
ALLIED CAPITAL CORPORATION 1998
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 1998, the estimated yield to maturity on the
Subordinated CMBS was approximately 15 percent. The Company's estimated returns
on its Subordinated CMBS are based upon a number of assumptions that are
subject to certain business and economic uncertainties and contingencies.
Examples include the timing and magnitude of credit losses on the mortgage
loans underlying the Subordinated CMBS that are a result of the general
condition of the real estate market (including competition for tenants and
their related credit quality) and changes in market rental rates. As these
uncertainties and contingencies are difficult to predict and are subject to
future events which may alter these assumptions, no assurance can be given that
the anticipated yields to maturity, will be achieved.
On January 30, 1998, the Company in conjunction with Business
Mortgage Investors, Inc. ("BMI"), a private REIT managed by the Company,
completed a $310 million asset securitization, whereby bonds totaling $239
million were sold in three classes rated "AAA", "AA" and "A" by Standard &
Poor's Rating Services and Fitch IBCA, Inc. in a private placement. The three
bond classes sold had an aggregate weighted average interest rate of
approximately 6.38 percent.
To effect the securitization, the Company and BMI sold a pool of 97
commercial mortgage loans totaling $310 million to a special purpose,
bankruptcy remote entity which transferred the assets to a trust which issued
the bonds. The Company contributed approximately 95%, or $295 million, of the
total assets securitized, and received cash proceeds, net of costs of
approximately $223 million. The Company retained a trust certificate for its
residual interest (the "Residual CMBS") in the loan pool sold, and will receive
interest income from this Residual CMBS as well as the net spread of the
interest earned on the loans sold less the interest paid on the bonds over the
life of the bonds (the "Residual Securitization Spread").
The Company accounted for the securitization in accordance with
Statement of Financial Accounting Standards No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." As a
result, the Company recorded a gain of $14.8 million net of the costs of the
securitization and the cost of settlement of interest rate swaps. The gain
arises from the difference between the carrying amount of the loans and the
fair market value of the assets received (i.e., cash, Residual Securitization
Spread, Residual CMBS and a servicing asset). As of December 31, 1998, the
mortgage loan pool had an approximate weighted average stated interest rate of
9.4 percent. The value of the Residual CMBS was determined using a discount
rate equal to the average interest rate of the underlying mortgage loans. The
value of the Residual Securitization Spread was determined based on a constant
prepayment rate of 7 percent and a discount rate of 12 percent.
SBA SECTION 7(a) GUARANTEED LENDING. The Company, through its wholly owned
subsidiary, Allied SBLC, participates in the SBA's Section 7(a) Guaranteed Loan
Program ("7(a) loans").
Pursuant to Section 7(a) of the Small Business Act of 1958, the SBA
will guarantee 80 percent of any qualified loan up to $100,000 regardless of
maturity, and 75 percent of any such loan over $100,000 regardless of maturity,
to a maximum guarantee of $750,000 for any one borrower. SBA regulations define
qualified small businesses generally as businesses with no more than $5 million
in annual sales or no more than 500 employees.
The Company charges interest on the 7(a) loans at a variable rate,
typically 1.75 percent to 2.75 percent above the prime rate, as published in
The Wall Street Journal or other financial newspaper, adjusted monthly. All
loans are payable in equal monthly installments of principal and interest from
the date on which the loan was made to its maturity. At December 31, 1998 and
1997, approximately 96 percent and 92 percent of the Company's portfolio of
7(a) loans were variable interest rate loans.
As permitted by SBA regulations, the Company sells to investors,
without recourse, the guaranteed portion of its loans while retaining the right
to service 100 percent of such loans.
As of December 31, 1998 and 1997, 7(a) loans with a cost basis of
$11,227,000 and $4,346,000, respectively, were not accruing interest.
The geographic and industry composition of the SBA 7(a) portfolio at
December 31, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
GEOGRAPHIC REGION 1998 1997
<S> <C> <C>
Midwest 34% 36%
Mid-Atlantic 29 29
Southeast 16 18
West 14 7
Northeast 7 10
- ---------------------------------------------------
Total 100% 100%
===================================================
INDUSTRY
Retail 41% 37%
Hospitality 30 26
Consumer Services 6 4
Consumer Products
Manufacturing 6 7
Business Services 4 6
Broadcasting 4 8
Other 9 12
- ---------------------------------------------------
Total 100% 100%
===================================================
</TABLE>
38 NOTES TO FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. DEBT
At December 31, 1998 and 1997, the Company had the following credit facilities:
<TABLE>
<CAPTION>
1998 1997
FACILITY AMOUNT FACILITY AMOUNT
(IN THOUSANDS) AMOUNT DRAWN AMOUNT DRAWN
<S> <C> <C> <C> <C>
Debentures and notes payable:
Master loan and security agreement $250,000 $6,000 $250,000 $23,116
Unsecured long-term notes payable 180,000 180,000 -- --
SBA debentures 74,650 47,650 54,300 54,300
OPIC loan 5,700 5,700 20,000 8,700
Master repurchase agreement 250,000 -- 250,000 202,705
Senior note payable -- -- 20,000 20,000
=====================================================================================================================
Total debentures and notes payable 760,350 239,350 594,300 308,821
=====================================================================================================================
Revolving lines of credit 200,000 95,000 80,000 38,842
=====================================================================================================================
Total Debt $960,350 $334,350 $674,300 $347,663
=====================================================================================================================
</TABLE>
MASTER LOAN AND SECURITY AGREEMENT. The Company, and BMI, established a
facility to borrow up to $250,000,000, of which $100,000,000 is committed,
using commercial mortgage loans as collateral under the agreement. The Company
pledges commercial mortgage loans as collateral for the facility such that the
amount borrowed is approximately equal to 80 percent to 90 percent of the value
of the collateral pledged. The agreement generally requires interest only
payments with all principal due at maturity. Principal may be repaid at any
time without penalty. The agreement bears interest at the one-month London
Inter Bank Offer Rate ("LIBOR") plus 1.0 percent, or 6.6 percent and 6.7
percent, at December 31, 1998 and 1997, respectively. Average debt outstanding,
maximum amount borrowed, and weighted average interest rate charged on this
facility for the years ended December 31, 1998 and 1997 were $21,932,000 and
$17,899,000; $56,000,000 and $23,116,000; and 6.5 percent and 6.7 percent;
respectively. The agreement matures on October 7, 1999.
UNSECURED LONG-TERM NOTES PAYABLE. In June 1998 the Company issued three
classes of unsecured long-term notes held by private institutional investors.
The notes have terms of 5 or 7 years with an aggregate principal balance of
$180,000,000. The weighted average interest rate on the notes is 7.2 percent
and interest only is payable semi-annually until maturity. The notes may be
prepaid in whole or in part together with an interest premium as stipulated in
the note agreement.
SBA DEBENTURES. At December 31, 1998 and 1997, the Company had drawn debentures
totaling $47,650,000 and $54,300,000, respectively, payable to the SBA at
interest rates ranging from 6.9 percent to 9.6 percent. Scheduled maturity
dates are as follows: 1999 - $0; 2000 - $17,300,000; 2001 - $9,350,000; 2002 -
$0; 2003 - $0; and $21,000,000 thereafter. The debentures require semi-annual
interest-only payments with all principal due upon maturity. The SBA debentures
are subject to prepayment penalties if paid prior to maturity.
OVERSEAS PRIVATE INVESTMENT CORPORATION (OPIC) LOAN. The Company has a loan
agreement with OPIC to provide financing for international projects involving
qualifying U.S. small businesses. Loans under this agreement bear interest at
the U.S. Treasury rate plus 0.5 percent for the applicable period of the
borrowing, or 6.6 percent and 6.8 percent at December 31,1998 and 1997,
respectively. In addition, OPIC is entitled to receive from the Company a
contingent fee at maturity of the loan equal to 5 percent of the return
generated by the OPIC-related investments in excess of 7 percent. There are no
required principal payments until the OPIC loans mature in January 2006.
MASTER REPURCHASE AGREEMENT. The Company and BMI can borrow up to $250,000,000,
of which $100,000,000 is committed, through repurchase agreements using
commercial mortgage loans as collateral. The Company pledges commercial
mortgage loans as collateral for the facility such that the amount borrowed is
approximately equal to 80 percent to 90 percent of the value of the collateral
pledged. The terms of the master repurchase agreement require interest only
payments with all principal due at maturity. Principal may be repaid at any
time without penalty. The master repurchase agreement bears interest at the
one-month
NOTES TO FINANCIAL STATEMETNS 39
ALLIED CAPITAL CORPORATION 1998
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LIBOR plus 1.13 percent, or 6.8 percent at December 31, 1998 and 1997. Average
debt outstanding, maximum amount borrowed, and weighted average interest rate
charged on the master repurchase agreement for the years ended December 31,
1998 and 1997 were $16,927,000 and $166,362,000; and $202,705,000 and
$209,591,000; and 6.8 percent and 6.6 percent; respectively. The master
repurchase agreement matured on January 31, 1999, and was not renewed by the
Company.
SENIOR NOTE PAYABLE. At December 31, 1997, the Company had a $20,000,000
unsecured senior note payable to an insurance company with an interest rate of
9.15 percent, payable semi-annually.The note was paid-off in June 1998.
REVOLVING LINES OF CREDIT. Subsequent to the Merger, the Company repaid all of
its previous unsecured revolving lines of credit and entered into a new
$200,000,000 unsecured revolving line of credit. The new facility bears
interest at LIBOR plus 1.25 percent, or 6.9 percent at December 31, 1998, and
requires a commitment fee equal to 0.2 percent of the committed amount, and a
facility fee equal to 0.15 percent of the initial commitment. The new line
expires June 30, 1999. The line of credit requires monthly payments of interest
and all principal is due upon its expiration.
The average debt outstanding on the revolving lines were $51,904,000 and
$30,033,000 for the years ended December 31, 1998 and 1997, respectively. The
maximum amount borrowed under these facilities and the weighted average
interest rate for the years ended December 31, 1998 and 1997 were $105,000,000
and $45,759,000, and 6.8 percent and 8.1 percent, respectively.
The Company has plans to increase the capacity of its revolving line of
credit in 1999, as well as extend the maturity date. The Company is currently
negotiating with its lenders in order to accomplish these changes.
NOTE 6. INCOME TAXES
For the years ended December 31, 1998, 1997 and 1996, the Company's effective
tax rate was 1.0 percent, 2.3 percent and 3.5 percent, respectively.
For the year ended December 31, 1998, the Company incurred income tax
expense of $787,000 which resulted from the realization of a taxable net
built-in gain associated with property owned by Advisers prior to the Merger.
For the years ended December 31, 1997 and 1996, the Company's income
subject to federal and state taxes related to the income generated by the
pre-Merger operations of Advisers. The income generated by the other
Predecessor Companies is not subject to federal and state income taxes because
these companies qualified as regulated investment companies or a real estate
investment trust.
NOTE 7. PREFERRED STOCK
Allied Investment has outstanding a total of 60,000 shares of $100 par value, 3
percent cumulative preferred stock and 10,000 shares of $100 par value, 4
percent redeemable cumulative preferred stock issued to the SBA pursuant to
Section 303(c) of the Small Business Investment Act of 1958, as amended. The 3
percent cumulative preferred stock does not have a required redemption date.
Allied Investment has the option to redeem in whole or in part the preferred
stock by paying the SBA the par value of such securities and any dividends
accumulated and unpaid to the date of redemption. The 4 percent redeemable
cumulative preferred stock has a required redemption date of June 4, 2005.
NOTE 8. SHAREHOLDERS' EQUITY
In 1998, the Company sold 3,565,000 shares of its common stock through an
underwriter for net proceeds of $56,776,000, after costs of $3,384,000 which
included a 5.0 percent fee paid to the underwriter. In 1998, the Company also
sold 801,959 shares of its common stock to an institutional investor in two
transactions. The net proceeds from the transactions were $12,899,000, after
costs of $677,000 which included a weighted average discount of 4.0 percent.
In 1996, the Company completed two non-transferable subscription
rights offerings to common shareholders. The Company issued 1,433,414 shares of
common stock pursuant to these offerings raising net proceeds to the Company of
$17,147,000, after costs including a 2.5 percent fee paid to eligible
broker/dealers.
In 1996, the Company also sold 400,000 shares of its common stock
through an underwriter for net proceeds of $5,218,000.
The Company has a dividend reinvestment plan, whereby the Company may
buy shares of its common stock in the open market or issue new shares in order
to satisfy dividend reinvestment requests. If the Company issues new shares,
the issue price is equal to the average of the closing sales prices reported
for the Company's common stock for the five days on which trading in the shares
takes place immediately prior to the dividend payment date. For the years
ended December 31, 1998 , 1997 and 1996 the Company issued 241,482, 550,971 and
913,206 shares, respectively, at an average price per share of $20.35, $15.67
and $13.13, respectively.
40 NOTES TO FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. EARNINGS PER COMMON SHARE
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) PER
COMMON
SHARE
1998 INCOME SHARES AMOUNT
<S> <C> <C> <C>
Net increase in net assets resulting from operations $78,078
Less: Preferred stock dividends (230)
-------
Income available to common shareholders $77,848
=======
BASIC EARNINGS PER COMMON SHARE 51,941 $1.50
=====
Options outstanding to officers 33
------
DILUTED EARNINGS PER COMMON SHARE 51,974 $1.50
====== =====
1997
Net increase in net assets resulting from operations $61,304
Less: Preferred stock dividends (220)
-------
Income available to common shareholders $61,084
=======
BASIC EARNINGS PER COMMON SHARE 49,218 $1.24
=====
Options outstanding to officers 33
------
DILUTED EARNINGS PER COMMON SHARE 49,251 $1.24
====== =====
1996
Net increase in net assets resulting from operations $54,947
Less: Preferred stock dividends (220)
-------
Income available to common shareholders $54,727
=======
BASIC EARNINGS PER COMMON SHARE 46,172 $1.19
Options outstanding to officers 561 =====
------
DILUTED EARNINGS PER COMMON SHARE 46,733 $1.17
====== =====
</TABLE>
NOTE 10. EMPLOYEE STOCK OWNERSHIP PLAN
AND DEFERRED COMPENSATION PLAN
The Company has an employee stock ownership plan ("ESOP"). Pursuant to the
ESOP, the Company is obligated to contribute 5 percent of each eligible
participant's total cash compensation for the year to a plan account on the
participant's behalf, which vests over a two-year period. ESOP contributions
are used to purchase shares of the Company's common stock.
As of December 31, 1998 and 1997, the ESOP held 282,500 shares and
433,047 shares, respectively, of the Company's common stock, all of which had
been allocated to participants' accounts. The plan is funded annually and the
total ESOP contribution expense for the years ended December 31, 1998, 1997,
and 1996 was $489,000, $351,000 and $1,018,000, respectively, net of
forfeitures of $4,000, $0 and $36,000, respectively.
The Company also has a deferred compensation plan (the "DC Plan").
Eligible participants in the DC Plan may elect to defer some of their
compensation and have such compensation credited to a participant account. All
amounts credited to a participant's account shall be credited solely for
purposes of accounting and computation and remain assets of the Company and
subject to the claims of the Company's general creditors. Amounts credited to
participants under the DC Plan are at all times 100 percent vested and
non-forfeitable except for amounts credited to participants' accounts related
to the Formula Award (see Note 12). A participant's account shall become
distributable upon his or her separation from service, retirement, disability,
death, or at a future determined date. All DC Plan accounts will be distributed
in the event of a change of control of the Company or in the event of the
Company's insolvency. Amounts deferred by participants under the DC Plan are
funded to a trust, the trustee of which administers the DC Plan on behalf of
the Company.
NOTE 11. STOCK OPTION PLAN
In conjunction with the Merger, all stock option plans that existed for Allied
Lending and the Predecessor Companies before the Merger ("Old Plans") were
cancelled on December 31, 1997, and at a special meeting of shareholders on
November 26, 1997, the Company's shareholders approved a new stock option plan
("ACC Plan") for the Company to be effected post-Merger.
THE ACC PLAN. The purpose of the ACC Plan is to provide officers and
non-officer directors of the Company with additional incentives. Options may be
granted from time to time on up to 6,250,000 shares, which represents
approximately 11 percent of the outstanding shares as of December 31, 1998.
NOTES TO FINANCIAL STATEMENTS 41
ALLIED CAPITAL CORPORATION 1998
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Options are exercisable at a price equal to the fair market value of
the shares on the day the option is granted. Each option states the period or
periods of time within which the option may be exercised by the optionee, which
may not exceed ten years from the date the option is granted.
All rights to exercise options terminate 60 days after an optionee
ceases to be (i) a non-officer director, (ii) both an officer and a director,
if such optionee serves in both capacities, or (iii) an officer (if such
officer is not also a director) of the Company for any cause other than death
or total and permanent disability. If an optionee dies or becomes totally and
permanently disabled before expiration of the options without fully exercising
them, he or she or the executors or administrators or legatees or distributees
of the estate shall, as may be provided at the time of the grant, have the
right, within one year after the optionee's death or total and permanent
disability, to exercise the options in whole or in part before the expiration
of their term. In the event of a change of control of the Company, all
outstanding options will become fully vested and exercisable as of the change
of control. For the year ended December 31, 1998, the Company's compensation
committee granted a total of 5,189,944 options to officers of the Company under
the ACC Plan. The options awarded to officers were generally non-qualified
stock options that vest over a five-year period from the grant date. The stock
options have been granted at the market price on the date of grant with a
weighted average exercise price equal to $20.14 per share. At December 31,
1998, options for 1,465,768 shares were vested. Options were exercised for
10,408 shares, and options were canceled for 65,638 shares during the year
ended December 31, 1998.
OLD PLAN ACTIVITY. During 1997 and 1996, the Predecessor Companies granted
1,474,000 and 866,000 options, respectively, under the Old Plans at exercise
prices ranging from $9.53 to $22.58 per share. Total shares issued pursuant to
the exercise of stock options totaled 2,395,000 and 1,051,000 during 1997 and
1996, respectively.
NOTES RECEIVABLE FROM THE SALE OF COMMON STOCK. The Company provides loans to
officers for the exercise of options. The loans have varying terms not
exceeding ten years, bear interest at the applicable federal interest rate in
effect at the date of issue and have been recorded as a reduction to
shareholders' equity. For the years ended December 31, 1998, 1997 and 1996, the
Company had outstanding loans to officers of $23,735,000, $29,611,000 and
$15,491,000, respectively. Officers with outstanding loans repaid principal of
$5,591,000, $6,534,000, and $2,199,000 for the years ended December 31, 1998,
1997 and 1996, respectively. The Company recognized interest income from these
loans of $1,600,000, $1,031,000 and $529,000, respectively, during these same
periods.
The Company accounts for its stock options as required by the
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees," and no compensation cost has been recognized. Had compensation cost
for the plan been determined consistent with SFAS No. 123 "Accounting for Stock
Based Compensation," the Company's net increase in net assets resulting from
operations and basic and diluted earnings per common share would have been
reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
(in thousands, except per share amounts) 1998 1997 1996
<S> <C> <C> <C>
Net increase in net assets resulting from operations:
As reported $78,078 $61,304 $54,947
Pro forma $72,684 $60,656 $53,372
Basic earnings per common share:
As reported $1.50 $1.24 $1.19
Pro forma $1.39 $1.23 $1.16
Diluted earnings per common share:
As reported $1.50 $1.24 $1.17
Pro forma $1.39 $1.23 $1.14
</TABLE>
Pro forma expenses are based on the underlying value of the options granted
by the Company and the Predecessor Companies. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option pricing
model.
42 NOTES TO FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. CUT-OFF AWARD AND FORMULA AWARD
The Predecessor Companies' existing stock option plans were canceled and the
Company established a cut-off dollar amount for all existing, but unvested
options as of the date of the Merger (the "Cut-off Award"). The Cut-off Award
is computed for each unvested option as of the Merger date. The Cut-off Award
is equal to the difference between the market price on August 14, 1997 (the
Merger announcement date) of the shares of stock underlying the option less the
exercise price of the option. The Cut-off Award is payable for each unvested
option upon the future vesting date of that option. The Cut-off Award was
designed to cap the appreciated value in unvested options at the Merger
announcement date, in order to set the foundation to balance option awards upon
the Merger. The Cut-off Award approximates $2.9 million in the aggregate and is
expensed as the Cut-off Award vests. For the year ended December 31, 1998,
$807,000 of the Cut-off Award vested.
The Formula Award was established to compensate employees from the point
when their unvested options would cease to appreciate in value (the Merger
announcement date), up until the time at which they would be able to receive
option awards in ACC post-Merger. In the aggregate, the Formula Award equaled
6 percent of the difference between an amount equal to the combined aggregated
market capitalizations of the Predecessor Companies as of the close of the
market on the day before the Merger date (December 30, 1997), less an amount
equal to the combined aggregate market capitalizations of Allied Lending and
the Predecessor Companies as of the close of the market on the Merger
announcement date. Advisers' compensation committee allocated the Formula Award
to individual officers on December 30, 1997. The amount of the Formula Award as
computed at December 30, 1997 was $18,994,000. This amount was contributed to
the Company's deferred compensation trust under the DC Plan (see Note10) and
was used to purchase shares of the Company's stock (included in common stock
held in deferred compensation trust). The Formula Award vests equally in three
installments on December 31, 1998, 1999 and 2000; provided, however, that such
Formula Award vests immediately upon a change in control of the Company. The
Formula Award will be expensed in each year in which it vests. For the year
ended December 31, 1998, $6,242,000 was expensed as a result of the Formula
Award. Vested Formula Awards are distributable to recipients at the Company's
discretion, however, sale of the Company's stock by the recipients is
restricted. Unvested Formula Awards are forfeited upon a recipient's separation
from service and the related Company stock is retired. During 1998, $270,000 of
the Formula Award was forfeited.
On January 4, 1999, the Company distributed shares of the Company's common
stock with a value of $4,062,000 representing the portion of the Formula Award
that vested on December 31, 1998.
NOTES TO FINANCIAL STATEMENTS 43
ALLIED CAPITAL CORPORATION 1998
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13. DIVIDENDS AND DISTRIBUTIONS
For the years ended December 31, 1998, 1997 and 1996, the Company declared the
following distributions:
<TABLE>
<CAPTION>
1998 1997 1996
TOTAL TOTAL PER TOTAL TOTAL PER TOTAL TOTAL PER
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
<S> <C> <C> <C> <C> <C> <C>
First quarter $18,025 $0.35 $14,347 $0.30 $11,158 $0.25
Second quarter 17,966 0.35 14,795 0.30 11,911 0.26
Third quarter 17,976 0.35 15,548 0.31 12,743 0.27
Fourth quarter 19,444 0.35 31,022 0.61 13,678 0.29
Annual extra distribution 1,676 0.03 1,118 0.02 7,908 0.16
Special undistributed earnings distribution -- -- 8,848 0.17 -- --
==================================================================================================================================
Total distributions to common shareholders $75,087 $1.43 $85,678 $1.71 $57,398 $1.23
==================================================================================================================================
</TABLE>
For income tax purposes, distributions for 1998, 1997 and 1996 were comprised
of the following:
<TABLE>
<CAPTION>
1998 1997 1996
TOTAL TOTAL PER TOTAL TOTAL PER TOTAL TOTAL PER
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
<S> <C> <C> <C> <C> <C> <C>
Ordinary income $49,397 $0.94 $39,356 $0.79 $41,563 $0.89
Long-term capital gains 25,690 0.49 31,037 0.62 15,835 0.34
Return of capital (tax) -- -- 6,437 0.13 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total distributions before special distribution 75,087 1.43 76,830 1.54 57,398 1.23
==================================================================================================================================
Special undistributed earnings distribution -- -- 8,848 0.17 -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total distributions to common shareholders $75,087 $1.43 $85,678 $1.71 $57,398 $1.23
==================================================================================================================================
</TABLE>
The following table summarizes the differences between financial statement net
income and taxable income for the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
(IN THOUSANDS) 1998 1997 1996
<S> <C> <C> <C>
Financial statement net income $78,078 $61,304 $54,947
Adjustments:
Net unrealized (gains) losses (1,079) (7,209) 7,412
Amortization of discount 2,207 (1,124) (2,779)
Net gain on securitization of commercial mortgage loans (14,812) -- --
Interest income from securitized commercial mortgage loans 4,910 -- --
Gains from disposition of portfolio assets 1,177 17,890 874
Expenses not deductible for tax:
Merger expenses -- 5,159 --
Formula award 6,242 -- --
Other 1,393 853 2,306
Other (3,029) (9,050) (1,372)
Income tax expense -- 1,444 1,945
- --------------------------------------------------------------------------------------------------------------------------------
Taxable income $75,087 $69,267 $63,333
================================================================================================================================
</TABLE>
44 NOTES TO FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14. CONCENTRATIONS OF CREDIT RISK
The Company places its cash with financial institutions and, at times, cash
held in checking accounts in financial institutions may be in excess of the
Federal Deposit Insurance Corporation insured limit. At December 31, 1998 and
1997, cash and cash equivalents consisted of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS) 1998 1997
<S> <C> <C>
Cash and cash equivalents $31,833 $76,791
Less escrows held (6,758) (6,354)
- --------------------------------------------------------
Total $25,075 $70,437
========================================================
</TABLE>
NOTE 15. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
During 1998, 1997 and 1996, the Company paid $21,708,000, $26,874,000 and
$21,391,000, respectively, for interest and income taxes. During 1998, 1997
and 1996, the Company's non-cash financing activities totaled $6,237,000,
$48,207,000 and $22,361,000, respectively, related primarily to common stock
issuances resulting from stock option exercises and dividend reinvestment
shares issued. During 1998, 1997 and 1996, the Company's non-cash investing
activities totaled $1,265,000, $12,022,000 and $2,004,000 respectively.
NOTE 16. SELECTED QUARTERLY DATA (UNAUDITED)
<TABLE>
<CAPTION>
1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) QTR 1 QTR 2 QTR 3 QTR 4
<S> <C> <C> <C> <C>
Total interest and related portfolio income $36,897 $21,321 $22,546 $25,974
Portfolio income before realized and unrealized gains $24,920 $9,148 $9,401 $11,776
Net increase in net assets resulting from operations $32,065 $14,476 $14,906 $16,631
Basic earnings per common share $0.62 $0.28 $0.29 $0.31
Diluted earnings per common share $0.61 $0.28 $0.29 $0.31
</TABLE>
<TABLE>
<CAPTION>
1997
QTR 1 QTR 2 QTR 3 QTR 4
<S> <C> <C> <C> <C>
Total interest and related portfolio income $21,399 $24,911 $25,111 $25,984
Portfolio income before realized and unrealized gains $11,968 $14,095 $12,093 $ 7,910
Net increase in net assets resulting from operations $12,646 $18,296 $17,146 $13,216
Basic earnings per common share $0.27 $0.37 $0.35 $0.25
Diluted earnings per common share $0.27 $0.37 $0.35 $0.25
</TABLE>
NOTES TO FINANCIAL STATEMENTS 45
ALLIED CAPITAL CORPORATION 1998
<PAGE> 45
CONSOLIDATING BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, 1998
ALLIED ALLIED CONSOLIDATED
(in thousands) ACC INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
ASSETS
<S> <C> <C> <C> <C> <C>
Portfolio at value:
Mezzanine loans and debt securities $264,968 $74,195 $ -- $ -- $ -- $339,163
Commercial mortgage loans 206,463 -- -- 26,723 -- 233,186
Commercial mortgage-backed securities 32,221 -- -- 81,453 -- 113,674
Small Business Administration 7(a) loans -- -- 56,285 -- -- 56,285
Equity interests in portfolio companies 27,641 21,750 -- -- -- 49,391
Investments in subsidiaries 159,945 -- -- (335) (159,610) --
Other portfolio assets 277 -- 50 8,248 -- 8,575
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio at value 691,515 95,945 56,335 116,089 (159,610) 800,274
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 5,308 15,068 2,776 1,923 -- 25,075
Intercompany notes and receivables 90,194 1,824 90 -- (92,108) --
Other assets 16,822 1,932 9,360 2,734 (118) 30,730
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $803,839 $114,769 $68,561 $120,746 $(251,836) $856,079
===================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable $191,700 $ 47,650 $ -- $ -- $ -- $239,350
Revolving lines of credit 95,000 -- -- -- -- 95,000
Accounts payable and other liabilities 25,003 858 1,655 396 -- 27,912
Dividends and distributions payable 1,700 5,085 5,594 -- (10,679) 1,700
Intercompany notes and payables 5,319 98 46,116 30,001 (81,534) --
- -----------------------------------------------------------------------------------------------------------------------------------
318,722 53,691 53,365 30,397 (92,213) 363,962
- -----------------------------------------------------------------------------------------------------------------------------------
Commitments and Contingencies
Preferred stock issued to Small Business Administration -- 7,000 -- -- -- 7,000
Shareholders' equity:
Common stock 6 -- -- 1 (1) 6
Additional paid-in capital 526,824 38,604 17,563 82,294 (138,461) 526,824
Common stock held in deferred compensation trust (19,431) -- -- -- -- (19,431)
Notes receivable from sale of common stock (23,735) -- -- -- -- (23,735)
Net unrealized appreciation (depreciation) on portfolio 2,380 1,486 (2,072) (1,503) 2,089 2,380
Undistributed (distributions in excess of) earnings (927) 13,988 (295) 9,557 (23,250) (927)
- -----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 485,117 54,078 15,196 90,349 (159,623) 485,117
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $803,839 $114,769 $68,561 $120,746 $(251,836) $856,079
===================================================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
46 NOTES TO FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 46
CONSOLIDATING STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
ALLIED ALLIED CONSOLIDATED
(in thousands) ACC INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
INTEREST AND RELATED PORTFOLIO INCOME
<S> <C> <C> <C> <C> <C> <C>
Interest $51,247 $11,836 $6,257 $10,581 $ -- $79,921
Intercompany interest income 4,846 -- -- -- (4,846) --
Net premiums from loan dispositions 2,920 240 2,789 -- -- 5,949
Net gain on securitization of commercial mortgage loans -- -- -- 14,812 -- 14,812
Income from investments in wholly owned subsidiaries 48,873 -- -- -- (48,873) --
Investment advisory fees and other income 4,343 9 837 867 -- 6,056
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest and related portfolio income 112,229 12,085 9,883 26,260 (53,719) 106,738
- -----------------------------------------------------------------------------------------------------------------------------------
EXPENSES
Interest on indebtedness 15,092 4,651 711 240 -- 20,694
Intercompany interest on indebtedness -- 503 2,693 1,643 (4,839) --
Salaries and employee benefits 11,829 -- -- -- -- 11,829
General and administrative 9,417 437 944 1,123 -- 11,921
- -----------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 36,338 5,591 4,348 3,006 (4,839) 44,444
- -----------------------------------------------------------------------------------------------------------------------------------
Formula and cut-off awards 7,049 -- -- -- -- 7,049
- -----------------------------------------------------------------------------------------------------------------------------------
Portfolio income before realized and unrealized gains (losses) 68,842 6,494 5,535 23,254 (48,880) 55,245
- -----------------------------------------------------------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAINS
Net realized gains (losses) 8,156 10,407 (39) 4,017 -- 22,541
Net unrealized gains (losses) 956 (3,502) (1,679) (1,377) 6,681 1,079
- -----------------------------------------------------------------------------------------------------------------------------------
Total net realized and unrealized gains (losses) 9,112 6,905 (1,718) 2,640 6,681 23,620
===================================================================================================================================
Income before minority interests and income taxes 77,954 13,399 3,817 25,894 (42,199) 78,865
- -----------------------------------------------------------------------------------------------------------------------------------
Minority interests -- -- -- -- -- --
Income tax expense -- -- -- 787 -- 787
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations $77,954 $13,399 $3,817 $25,107 $(42,199) $78,078
===================================================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
NOTES TO FINANCIAL STATEMENTS 47
ALLIED CAPITAL CORPORATION 1998
<PAGE> 47
CONSOLIDATING STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
ALLIED ALLIED CONSOLIDATED
(in thousands) ACC INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in net assets resulting from operations $77,954 $ 13,399 $3,817 $25,107 $(42,199) $ 78,078
Adjustments
Net unrealized (gains) losses (956) 3,502 1,679 1,377 (6,681) (1,079)
Net gain on securitization of commercial mortgage loans -- -- -- (14,812) -- (14,812)
Depreciation and amortization 702 -- -- -- -- 702
Amortization of loan discounts and fees (4,741) (583) (708) -- -- (6,032)
Changes in other assets and liabilities 3,267 908 (2,329) 10,152 -- 11,998
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 76,226 17,226 2,459 21,824 (48,880) 68,855
===================================================================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in small business concerns (426,797) (18,870) (57,725) (25,333) 4,195 (524,530)
Collections of investment principal 112,535 21,210 4,183 153 -- 138,081
Proceeds from loan sales 44,063 -- 36,950 -- -- 81,013
Proceeds from securitization of commercial mortgage loans 223,401 -- -- -- -- 223,401
Net (purchase) redemption of U.S. government securities -- 11,091 -- -- -- 11,091
Collections (advances) under intercompany notes (42,170) (19,756) 34,468 27,468 -- --
Collections of notes receivable from sale of common stock 5,591 -- -- -- -- 5,591
Other investing activities (2,539) -- -- -- -- (2,539)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash (used in ) provided by investing activities (85,916) (6,325) 17,866 2,288 4,195 (67,892)
===================================================================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock 69,896 -- -- -- -- 69,896
Purchase of common stock by deferred
compensation trust (19,431) -- -- -- -- (19,431)
Purchase of common stock of subsidiaries (5,000) -- 5,000 -- -- --
Common dividends and distributions paid (69,536) -- -- -- -- (69,536)
Special undistributed earnings distribution paid (8,848) -- -- -- -- (8,848)
Dividends paid to parent company -- (22,204) (5,594) (16,887) 44,685 --
Preferred stock dividends -- (450) -- -- -- (450)
Net payments on debentures and notes payable (53,871) (15,600) -- -- -- (69,471)
Net borrowings under revolving lines of credit 74,706 -- (18,548) -- -- 56,158
Other financing activities 1,124 -- -- (5,767) -- (4,643)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (10,960) (38,254) (19,142) (22,654) 44,685 (46,325)
===================================================================================================================================
Net (decrease) increase in cash and cash equivalents $(20,650) $(27,353) $ 1,183 $ 1,458 $ -- $(45,362)
===================================================================================================================================
Cash and cash equivalents at beginning of year $ 25,958 $ 42,421 $1,593 $ 465 $ -- $ 70,437
===================================================================================================================================
Cash and cash equivalents at end of year $ 5,308 $ 15,068 $2,776 $ 1,923 $ -- $ 25,075
===================================================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
48 NOTES TO FINANCIAL STATEMENTS
1998 ALLIED CAPITAL CORPORATION
<PAGE> 48
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
of Allied Capital Corporation and Subsidiaries:
We have audited the consolidated balance sheet of Allied Capital Corporation
and subsidiaries as of December 31, 1998 and 1997, including the consolidated
statement of investments as of December 31, 1998, and the related consolidated
statements of operations, changes in net assets and cash flows for each of the
three years in the period ended December 31, 1998. These consolidated financial
statements and supplementary consolidating financial information referred to
below are the responsibility of the Company's management. Our responsibility is
to express an opinion on these consolidated financial statements and
supplementary consolidating financial information referred to below based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. These
procedures included physical counts of investments. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Allied Capital
Corporation and subsidiaries as of December 31, 1998 and 1997, and the
consolidated results of their operations, changes in net assets and cash flows
for each of the three years in the period then ended in conformity with
generally accepted accounting principles.
As discussed in Note 3, the consolidated financial statements include
investments valued at $800,274,000 as of December 31, 1998 and $697,021,000 as
of December 31, 1997, (93 percent and 86 percent, respectively, of total
assets) whose values have been estimated by the board of directors in the
absence of readily ascertainable market values. We have reviewed the procedures
used by the board of directors in arriving at its estimate of value of such
investments and have inspected the underlying documentation, and in the
circumstances we believe the procedures are reasonable and the documentation
appropriate. However, because of the inherent uncertainty of valuation, the
board of directors' estimate of 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.
Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The supplementary
consolidating balance sheet and related consolidating statements of operations
and cash flows are presented for purposes of additional analysis and are not a
required part of the basic financial statements. This information has been
subjected to the auditing procedures applied in our audit of the basic
consolidated financial statements and in our opinion, is fairly stated in all
material respects in relation to the basic financial statements taken as a
whole.
/s/ ARTHUR ANDERSEN LLP
Vienna, Virginia
February 18, 1999
AUDITOR'S REPORT 49
ALLIED CAPITAL CORPORATION 1998
<PAGE> 49
BOARD OF DIRECTORS AND MANAGEMENT
DIRECTORS
(1) EXECUTIVE COMMITTEE
(2) NOMINATING COMMITTEE
(3) COMPENSATION COMMITTEE
(4) AUDIT COMMITTEE
WILLIAM L. WALTON (1,2)
Chairman and Chief Executive Officer, Allied Capital Corporation
GEORGE C. WILLIAMS, JR. (1)
Chairman Emeritus, Allied Capital Corporation
BROOKS H. BROWNE (3,4)
President, Environmental Enterprises Assistance Fund
JOHN D. FIRESTONE (3)
Partner, Secor Group
ANTHONY T. GARCIA (3)
General Manager, Breen Capital Group
LAWRENCE I. HEBERT (2)
Director and President, Perpetual Corporation
JOHN I. LEAHY (1,4)
President, Management and Marketing Associates
ROBERT E. LONG (1,3)
Managing Director, Goodwyn & Long Investment Management, Inc.
WARREN K.MONTOURI (1)
Partner, Montouri & Roberson
GUY T. STEUART, II (2,4)
Director and President, Steuart Investment Corporation
T. MURRAY TOOMEY, ESQ. (2)
Attorney at Law
LAURA W. VAN ROIJEN (2)
Private Real Estate Investor
EXECUTIVE MANAGEMENT
WILLIAM L. WALTON
Chairman and Chief Executive Officer
GEORGE C. WILLIAMS, JR.
Chairman Emeritus
PHILIP A. MCNEILL
Managing Director
JOHN M. SCHEURER
Managing Director
JOAN M. SWEENEY
Managing Director
G. CABELL WILLIAMS, III
Managing Director
PRINCIPALS
KELLY A. ANDERSON
SCOTT S. BINDER
ARTHUR S. COOPER
ROBERT J. CORRY
TRICIA B. DANIELS
RICHARD E. FEARON, JR.
MICHAEL J. GRISIUS
JOHN J. HALL, JR.
PATRICK J. HARRINGTON
J. BENJAMIN H. NYE
MARY E. OLSON
CARR T. PRESTON
PENNI F. ROLL
JAMES P. SHEVLIN
SUZANNE V.SPARROW
THOMAS H. WESTBROOK
50 BOARD AND MANAGEMENT
1998 ALLIED CAPITAL CORPORATION
<PAGE> 50
STOCKHOLDER INFORMATION
CORPORATE OFFICES
Washington, DC--Headquarters
1919 Pennsylvania Avenue, NW
Washington, DC 20006
Telephone: 202.331.1112 Fax: 202.659.2053
www.alliedcapital.com
e-mail: [email protected]
ATLANTA
2970 Peachtree Road, Suite 825
Atlanta, GA 30305
Telephone: 404.760.0566 Fax: 404.760.0526
CHICAGO
401 North Michigan Avenue, Suite 1620
Chicago, IL 60611
Telephone: 312.828.0330 Fax: 312.828.0909
DETROIT
2250 Butterfield Drive, Suite 210
Troy, MI 48084
Telephone: 248.273.2200 Fax: 248.649.2087
SAN FRANCISCO
One Maritime Plaza, Suite 1750
San Francisco, CA 94111
Telephone: 415.399.2980 Fax: 415.986.8922
FRANKFURT, GERMANY
c/o Allied Capital Beteiligungsberatung GmbH
Ulmenstrasse 37
60325 Frankfurt, Germany
Telephone: +49 69 97 20 04 0 Fax: +49 69 97 20 04 15
MARKET LISTING
ALLIED CAPITAL CORPORATION common stock is quoted on the Nasdaq National Market
under the trading symbol ALLC. The abbreviation often used in newspaper stock
listings is "AldCap." There were approximately 4,500 shareholders of record
and 37,000 beneficial shareholders of the Company as of December 31, 1998.
STOCK TRANSFER AGENT AND REGISTRAR
Investors with questions concerning account information, issuing new
certificates, replacing lost or stolen certificates, transferring securities,
participating in the Dividend Reinvestment Plan, dividend payments, requesting
direct deposit information or processing a change of address should contact:
AMERICAN STOCK TRANSFER & TRUST COMPANY
40 Wall Street, 46th Floor
New York, NY 10005
Telephone: 800.937.5449 or 212.936.5100
INVESTOR RELATIONS CONTACT
SUZANNE V. SPARROW,
PRINCIPAL, INVESTOR RELATIONS
Telephone: 888.818.5298 Fax: 202.659.2053
e-mail: [email protected]
FORM 10-K
ALLIED CAPITAL CORPORATION'S Annual Report on Form 10-k, as filed with the
Securities and Exchange Commission, will be furnished without charge to
shareholders upon written request to the investor relations Department at the
Company's corporate headquarters. This information is also available on the
company's web site at www.Alliedcapital.Com.
INDEPENDENT PUBLIC ACCOUNTANTS
ARTHUR ANDERSEN LLP
Vienna, VA
CORPORATE COUNSEL
SUTHERLAND, ASBILL & BRENNAN LLP
Washington, DC
ANNUAL MEETING OF STOCKHOLDERS
The Company's Annual Meeting of Stockholders will be held at 10:00 AM on
Tuesday, May 11, 1999, at The Carlton Hotel, 923 16th Street, NW, Washington,
DC. All stockholders are welcome to attend.
QUARTERLY STOCK PRICES FOR 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
------------------------------------------------- -------------------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High $17.00 $16.63 $16.75 $22.75 $27.69 $29.00 $24.81 $18.88
Low $14.88 $13.88 $14.50 $15.75 $21.00 $21.75 $14.94 $12.50
Close $16.25 $14.75 $16.00 $22.25 $27.69 $24.50 $17.75 $17.31
</TABLE>
PRICES INDICATED FOR 1997 REFLECT THOSE OF ALLIED CAPITAL LENDING CORPORATION,
THE SURVIVING COMPANY IN THE MERGER OF THE FIVE ALLIED CAPITAL COMPANIES, WHICH
WAS COMPLETED ON DECEMBER, 31, 1997.
STOCKHOLDER INFORMATION 51
ALLIED CAPITAL CORPORATION 1998
<PAGE> 51
[ALLIED CAPITAL LOGO]
1919 PENNSYLVANIA AVENUE, NW
WASHINGTON, DC 20006
<PAGE> 1
EXHIBIT 23(i)
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in this Form 10-K of our report dated February 18, 1999 included in
Allied Capital Corporation's Annual Report to security holders. It should be
noted that we have not audited any financial statements of the company
subsequent to December 31, 1998 or performed any audit procedures subsequent to
the date of our report.
/s/ ARTHUR ANDERSEN LLP
Vienna, Virginia
March 22, 1999
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ALLIED
CAPITAL CORPORATION AND SUBSIDIARIES' CONSOLIDATED BALANCE SHEET AND
CONSOLIDATED STATEMENTS OF OPERATIONS, CHANGES IN NET ASSETS AND CASH FLOWS AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
INCORPORATED BY REFERENCE IN FORM 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<INVESTMENTS-AT-COST> 796,389
<INVESTMENTS-AT-VALUE> 800,274
<RECEIVABLES> 0
<ASSETS-OTHER> 30,730
<OTHER-ITEMS-ASSETS> 25,075
<TOTAL-ASSETS> 856,079
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 239,350
<OTHER-ITEMS-LIABILITIES> 124,612
<TOTAL-LIABILITIES> 363,962
<SENIOR-EQUITY> 6
<PAID-IN-CAPITAL-COMMON> 526,824
<SHARES-COMMON-STOCK> 55,919
<SHARES-COMMON-PRIOR> 52,047
<ACCUMULATED-NII-CURRENT> (927)
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 2,380
<NET-ASSETS> 485,117
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 79,921
<OTHER-INCOME> 26,817
<EXPENSES-NET> 51,493
<NET-INVESTMENT-INCOME> 55,245
<REALIZED-GAINS-CURRENT> 22,541
<APPREC-INCREASE-CURRENT> 1,079
<NET-CHANGE-FROM-OPS> 78,078
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 49,627
<DISTRIBUTIONS-OF-GAINS> 25,690
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 4,374
<NUMBER-OF-SHARES-REDEEMED> 810
<SHARES-REINVESTED> 241
<NET-CHANGE-IN-ASSETS> 65,057
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 2,679
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 3,123
<INTEREST-EXPENSE> 20,694
<GROSS-EXPENSE> 51,493
<AVERAGE-NET-ASSETS> 452,588
<PER-SHARE-NAV-BEGIN> 8.07
<PER-SHARE-NII> 1.06
<PER-SHARE-GAIN-APPREC> 0.45
<PER-SHARE-DIVIDEND> 1.43
<PER-SHARE-DISTRIBUTIONS> 0.00
<RETURNS-OF-CAPITAL> 0.00
<PER-SHARE-NAV-END> 8.68
<EXPENSE-RATIO> 0.11
<AVG-DEBT-OUTSTANDING> 372,388
<AVG-DEBT-PER-SHARE> 7.16
</TABLE>
