ALLIED CAPITAL CORP, POS 8C, 1999-11-12

ALLIED CAPITAL CORP
POS 8C, 1999-11-12

Previous: ALLIED CAPITAL CORP, 10-Q, 1999-11-12

Next: INDUSTRIAL SERVICES OF AMERICA INC /FL, 10-Q, 1999-11-12

<PAGE> 1

As filed with the Securities and Exchange Commission on November 10, 1999

REGISTRATION NO. 333-84973

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM N-2

REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

[ ] PRE-EFFECTIVE AMENDMENT NO.

[X] POST-EFFECTIVE AMENDMENT NO. 1

ALLIED CAPITAL CORPORATION
(Exact Name of Registrant as Specified in Charter)

1919 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20006-3434
(202) 331-1112
(Address and Telephone Number, including Area Code, of Principal Executive
Offices)

WILLIAM L. WALTON, CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
ALLIED CAPITAL CORPORATION
1919 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20006-3434
(Name and Address of Agent for Service)

Copies of information to:

STEVEN B. BOEHM
SUTHERLAND ASBILL & BRENNAN LLP
1275 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20004-2415

Approximate Date of Proposed Public Offering:
From time to time after the effective date of the Registration Statement.

If any securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. [X]

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8(a), MAY DETERMINE.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
PROSPECTUS
Allied Capital Logo

6,000,000 SHARES

ALLIED CAPITAL CORPORATION

COMMON STOCK

------------------------

Please read this prospectus, and the accompanying prospectus supplement, if any,
before investing, and keep it for future reference. It contains important
information about the Company.

To learn more about the Company, you may want to look at the Statement of
Additional Information dated November , 1999 (known as the "SAI"). For a free
copy of the SAI, contact us at:

Allied Capital Corporation
1919 Pennsylvania Avenue, N.W.
Washington, DC 20006
1-888-818-5298

The Company has filed the SAI with the U.S. Securities and Exchange Commission
and has incorporated it by reference into this prospectus. The SAI's table of
contents appears on page 70 of this prospectus.

The Commission maintains an Internet website (http://www.sec.gov) that contains
the SAI, material incorporated by reference and other information about the
Company.

We may offer, from time to time, up to 6,000,000 shares of common stock, par
value $0.0001 per share, on terms to be determined at the time of offering. The
shares may be offered at prices and on terms to be described in one or more
supplements to this prospectus, provided, however, that the offering price per
share, less any underwriting commissions or discounts, must equal or exceed the
net asset value per share of our common stock.

We are an internally managed closed-end management investment company that has
elected to be regulated as a business development company under the Investment
Company Act of 1940, as amended.

Our investment objective is to achieve current income and capital gains. We seek
to achieve our investment objective by investing primarily in private small and
middle-market businesses in a variety of industries and in diverse geographic
locations, primarily in the United States. No assurances can be given that we
will continue to achieve our objective.

Our common stock is traded on the Nasdaq National Market under the symbol
"ALLC." As of November , 1999, the last reported sales price for the common
stock was .

YOU SHOULD REVIEW THE INFORMATION INCLUDING THE RISK OF LEVERAGE, SET FORTH
UNDER "RISK FACTORS" ON PAGE 7 OF THIS PROSPECTUS BEFORE INVESTING IN COMMON
STOCK OF THE COMPANY.

------------------------

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATIONS TO THE CONTRARY
IS A CRIMINAL OFFENSE.

------------------------

November , 1999

<PAGE> 3

WE HAVE NOT AUTHORIZED ANY DEALER, SALESMAN OR OTHER PERSON TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS OR ANY ACCOMPANYING SUPPLEMENT TO
THIS PROSPECTUS. YOU MUST NOT RELY UPON ANY INFORMATION OR REPRESENTATION NOT
CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS OR THE ACCOMPANYING
PROSPECTUS SUPPLEMENT AS IF WE HAD AUTHORIZED IT. THIS PROSPECTUS AND ANY
PROSPECTUS SUPPLEMENT DO NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF
ANY OFFER TO BUY ANY SECURITY OTHER THAN THE REGISTERED SECURITIES TO WHICH THEY
RELATE, NOR DO THEY CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY SECURITIES IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO
MAKE SUCH AN OFFER OR SOLICITATION IN SUCH JURISDICTION. THE INFORMATION
CONTAINED IN THIS PROSPECTUS AND ANY PROSPECTUS SUPPLEMENT IS ACCURATE AS OF THE
DATES ON THEIR COVERS.
------------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.......................................... 1
Selected Consolidated Financial Data........................ 4
Risk Factors................................................ 7
The Company................................................. 12
Use of Proceeds............................................. 12
Price Range of Common Stock and Dividends................... 13
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 14
Senior Securities........................................... 32
Business.................................................... 36
Portfolio Companies......................................... 47
Determination of Net Asset Value............................ 52
Management.................................................. 53
Taxation.................................................... 59
Certain Government Regulations.............................. 61
Dividend Reinvestment Plan.................................. 63
Description of Capital Stock................................ 64
Plan of Distribution........................................ 68
Legal Matters............................................... 69
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. 69
Independent Public Accountants.............................. 69
Table of Contents of Statement of Additional Information.... 70
Index to Financial Statements............................... 71
</TABLE>

------------------------

(i)
<PAGE> 4

PROSPECTUS SUMMARY

The following summary contains basic information about this offering. It
likely does not contain all the information that is important to an investor.
For a more complete understanding of this offering, we encourage you to read
this entire document and the documents to which we have referred.

Our current business and investment portfolio resulted from the merger of
five affiliated companies on December 31, 1997. The companies that merged were
Allied Capital Corporation (old), Allied Capital Corporation II, Allied Capital
Advisers, Inc., Allied Capital Commercial Corporation and Allied Capital Lending
Corporation. The five companies are referred to as the predecessor companies.

All information in this prospectus, unless otherwise indicated, has been
presented as if the predecessor companies had merged as of the beginning of the
earliest period presented. In this prospectus or any accompanying prospectus
supplement, unless otherwise indicated, the "Company", "ACC", "we", "us" or
"our" refer to the post-merger Allied Capital Corporation and its subsidiaries.

THE COMPANY (Page 12)

We provide capital to small and middle-market companies in a variety of
different industries and in diverse geographic locations. We have been lending
to private growing businesses for over 40 years and have financed thousands of
borrowers nationwide. Our lending and investment activity is focused in three
areas:

- mezzanine finance,

- commercial real estate finance, including the purchase of commercial
mortgage-backed securities ("CMBS"), and

- small business and commercial real estate loans originated for sale under
our Allied Capital Express brand name.

Our principal loan products include:

- subordinated loans with equity features,

- commercial mortgage loans, and

- SBA 7(a) guaranteed loans.

We are a value-added full-service lender, and we source loans and
investments through our numerous relationships with:

- regional and boutique investment banks,

- mezzanine and private equity investors, and

- other intermediaries, including professional services firms.

In order to increase our sourcing and origination activities, we have regional
offices in Chicago, San Francisco and New York, and Allied Capital Express
offices in Detroit, Atlanta, Philadelphia, Chicago and Greenville, SC. We cen-
tralize our credit approval function and service our loans through an
experienced staff of professionals at our headquarters in Washington, DC. Our
common stock is quoted on the Nasdaq National Market under the symbol "ALLC."

We have an advantageous structure that allows for the "pass-through" of
income to our shareholders without the imposition of a corporate level of
taxation. See "Taxation."

We are an internally managed diversified closed-end management investment
company that has elected to be regulated as a business development company
("BDC") under the Investment Company Act of 1940, as amended ("1940 Act"). Our
investment objective is to achieve current income and capital gains. We seek to
achieve our investment objective by investing in growing businesses in a variety
of industries and in diverse geographic locations, primarily in the United
States.

THE OFFERING (Page 68)

We may offer, from time to time, up to 6,000,000 shares of common stock,
par value $0.0001 per share, on terms to be

1
<PAGE> 5

determined at the time of offering. Shares may be offered at prices and on terms
described in one or more supplements to this prospectus, provided, however, that
the offering price per share, less any underwriting commissions or discounts,
must equal or exceed the net asset value per share of our common stock.

We may offer shares directly to one or more purchasers, through agents we
designate, or to or through underwriters or dealers. If any agents or
underwriters are involved in the sale of shares, their names, and any applicable
purchase price, fee, commission or discount, will be described in an
accompanying prospectus supplement. We will not sell shares without delivering a
prospectus supplement describing the method and terms of the offering of such
shares.

USE OF PROCEEDS (Page 12)

Unless otherwise specified in the prospectus supplement accompanying this
prospectus, we intend to use the net proceeds from selling shares for general
corporate purposes, which may include investment in small and middle-market,
private growth companies in accordance with our investment objective, purchase
of CMBS, repayment of indebtedness, acquisitions and other general corporate
purposes.

DIVIDENDS (Page 13)

We pay quarterly dividends to shareholders. The amount of our quarterly
dividends is determined by the board of directors and is currently based upon
our estimate of annual taxable income.

DIVIDEND REINVESTMENT PLAN (Page 63)

We have adopted an "opt out" dividend reinvestment plan ("DRIP plan").
Under the DRIP plan, if your shares are registered in your name, your dividends
will be automatically reinvested in additional shares of common stock unless you
"opt out" of the DRIP plan.

PRINCIPAL RISK FACTORS (Page 7)

Investment in shares of common stock involves certain risks relating to our
structure and our investment objective that you should consider before
purchasing shares.

As a BDC, our consolidated portfolio includes securities primarily issued
by privately held companies. These investments may involve a high degree of
business and financial risk, and they are generally illiquid. A large number of
entities and individuals compete for the same kind of investment opportunities
as we do.

We borrow funds to make investments in and loans to small and middle-market
businesses. As a result, we are exposed to the risks of leverage, which may be
considered a speculative investment technique. Borrowings, also known as
leverage, magnify the potential for gain and loss on amounts invested and,
therefore increase the risks associated with investing in our securities.

Also, we are subject to certain risks associated with investing in
non-investment grade CMBS, valuing of our portfolio, changing interest rates,
accessing additional capital, fluctuating quarterly results, operating in a
regulated environment and assessing Year 2000 problems. In addition, the loss of
pass-through tax treatment could have a material adverse effect on our total
return, if any.

CERTAIN ANTI-TAKEOVER PROVISIONS (Page 65)

Our charter and bylaws, as well as certain statutory and regulatory
requirements, contain certain provisions that may have the effect of
discouraging a third party from making an acquisition proposal for the Company.
These anti-takeover provisions may inhibit a change in control in circumstances
that could give the holders of common stock the opportunity to realize a premium
over the market price for the common stock.

2
<PAGE> 6

FEES AND EXPENSES

This table describes the various costs and expenses that an investor in the
Company will bear directly or indirectly.

<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Sales load (as a percentage of offering price)(1)....... --%
Dividend reinvestment plan fees(2)...................... None
ANNUAL EXPENSES (AS A PERCENTAGE OF CONSOLIDATED NET ASSETS
ATTRIBUTABLE TO COMMON SHARES)(3)
Operating expenses(4)................................... 4.8%
Interest payments on borrowed funds(5).................. 6.4%
-----
Total annual expenses(6)........................... 11.2%
=====
</TABLE>

- -------------------------
(1) In the event that shares to which this prospectus relates are sold to or
through underwriters, a corresponding prospectus supplement will disclose
the applicable sales load.

(2) The expenses of the Company's DRIP plan are included in "Operating
expenses." The Company has no cash purchase plan. The participants in the
DRIP plan will bear a pro rata share of brokerage commissions incurred with
respect to open market purchases, if any. See "Dividend Reinvestment Plan."

(3) "Consolidated net assets attributable to common shares" equals net assets
(i.e., total assets less total liabilities and preferred stock) at September
30, 1999.

(4) "Operating expenses" represent the estimated operating expenses of the
Company for the year ended December 31, 1999 excluding interest on
indebtedness. Operating expenses exclude the formula and cut-off awards. See
"Management -- Compensation Plans."

(5) "Interest payments on borrowed funds" represent estimated interest payments
for the year ended December 31, 1999. The Company had outstanding borrowings
of $537.9 million at September 30, 1999. This percentage for the year ended
December 31, 1998 was 4.2%. See "Risk Factors."

(6) "Total annual expenses" is based on estimated expenses for the year ended
December 31, 1999. "Total annual expenses" as a percentage of consolidated
net assets attributable to common shares are higher than the total annual
expenses percentage would be for a company that is not leveraged. The
Company borrows money to leverage its net assets and increase its total
assets. The Securities and Exchange Commission requires that the "Total
annual expenses" percentage be calculated as a percentage of net assets,
rather than the total assets, including assets that have been funded with
borrowed money. If the "Total annual expenses" percentage were calculated
instead as a percentage of consolidated total assets, the "Total annual
expenses" percentage for the Company would be 5.7% of consolidated total
assets.

EXAMPLE

The following example, required by the Securities and Exchange Commission
(the "Commission"), demonstrates the projected dollar amount of total cumulative
expenses that would be incurred over various periods with respect to a
hypothetical investment in the Company. In calculating the following expense
amounts, we assumed we would have no additional leverage and that our operating
expenses would remain at the levels set forth in the table above. In the event
that shares to which this prospectus relates are sold to or through
underwriters, a corresponding prospectus supplement will restate this example to
reflect the applicable sales load.

<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000
investment, assuming a 5.0% annual return.......... $112 $334 $552 $1,085
</TABLE>

Although the example assumes (as required by the Commission) a 5.0% annual
return, our performance will vary and may result in a return of greater or less
than 5.0%. In addition, while the example assumes reinvestment of all dividends
and distributions at net asset value, participants in the DRIP plan may receive
shares that we issue at or above net asset value or are purchased by the
administrator of the DRIP plan, at the market price in effect at the time, which
may be higher than, at, or below net asset value. See "Dividend Reinvestment
Plan."

THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES, AND
THE ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
3
<PAGE> 7

SELECTED CONSOLIDATED FINANCIAL DATA

You should read the consolidated financial information below with the
Consolidated Financial Statements and Notes thereto included in this prospectus.
Financial information for the years ended December 31, 1998, 1997, 1996 and 1995
has been derived from audited financial statements. Financial information for
the year ended December 31, 1994 has been derived from the audited financial
statements of the individual predecessor companies. The selected financial data
reflects the operations of the Company with all periods restated as if the
predecessor companies had merged as of the beginning of the earliest period
presented. Quarterly financial information is derived from unaudited financial
data, but in the opinion of management, reflects all adjustments (consisting
only of normal recurring adjustments) which are necessary to present fairly the
results for such interim periods. Interim results at and for the nine months
ended September 30, 1999 are not necessarily indicative of the results that may
be expected for the year ending December 31, 1999. SEE "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" ON PAGE 14 FOR
MORE INFORMATION.

<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
----------------- -----------------------------------------------
(IN THOUSANDS, 1999 1998 1998 1997 1996 1995 1994
EXCEPT PER SHARE DATA) ------- ------- ------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Interest and related portfolio
income:
Interest..................... $84,419 $58,428 $79,921 $86,882 $77,541 $61,550 $47,065
Net premiums from loan
dispositions............... 9,032 2,913 5,949 7,277 4,241 2,796 2,380
Net gain on securitization of
commercial mortgage
loans...................... -- 14,812 14,812 -- -- -- --
Investment advisory fees and
other income............... 5,411 4,611 6,056 3,246 3,155 4,471 2,710
------- ------- ------- ------- ------- ------- -------
Total interest and
related portfolio
income................ 98,862 80,764 106,738 97,405 84,937 68,817 52,155
------- ------- ------- ------- ------- ------- -------
Expenses:
Interest on indebtedness..... 24,173 14,539 20,694 26,952 20,298 12,355 7,486
Salaries and employee
benefits................... 11,303 8,254 11,829 10,258 8,774 8,031 6,929
General and administrative... 8,476 8,970 11,921 8,970 8,289 6,888 7,170
Merger....................... -- -- -- 5,159 -- -- --
------- ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 43,952 31,763 44,444 51,339 37,361 27,274 21,585
Formula and cut-off
awards(1).................. 5,188 5,532 7,049 -- -- -- --
------- ------- ------- ------- ------- ------- -------
Portfolio income before net
realized and unrealized
gains...................... 49,722 43,469 55,245 46,066 47,576 41,543 30,570
------- ------- ------- ------- ------- ------- -------
Net realized and unrealized
gains:
Net realized gains........... 16,448 20,001 22,541 10,704 19,155 12,000 6,236
Net unrealized gains
(losses)................... 1,475 (437) 1,079 7,209 (7,412) 9,266 (2,244)
------- ------- ------- ------- ------- ------- -------
Total net realized and
unrealized gains...... 17,923 19,564 23,620 17,913 11,743 21,266 3,992
------- ------- ------- ------- ------- ------- -------
Income before minority interests
and income taxes............... 67,645 63,033 78,865 63,979 59,319 62,809 34,562
Minority interests............... -- -- -- 1,231 2,427 546 --
Income tax expense............... -- 1,585 787 1,444 1,945 1,784 672
------- ------- ------- ------- ------- ------- -------
Net increase in net assets
resulting from operations...... $67,645 $61,448 $78,078 $61,304 $54,947 $60,479 $33,890
======= ======= ======= ======= ======= ======= =======
</TABLE>

(footnotes appear on next page)
4
<PAGE> 8

<TABLE>
<CAPTION>
AT SEPTEMBER 30, AT DECEMBER 31,
---------------- ----------------------------------------------------
(IN THOUSANDS, 1999 1998 1997 1996 1995 1994
EXCEPT PER SHARE DATA) ---------------- -------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Portfolio at value......... $1,103,653 $800,274 $697,021 $607,368 $528,483 $443,316
Portfolio at cost.......... 1,098,111 796,389 690,720 613,276 526,979 451,078
Total assets............... 1,169,531 856,079 807,775 713,360 605,434 501,817
Total debt
outstanding(4)........... 537,850 334,350 347,663 274,997 200,339 130,236
Preferred stock issued to
SBA(4)................... 7,000 7,000 7,000 7,000 7,000 7,000
Shareholders' equity....... 593,833 485,117 420,060 402,134 367,192 344,043
Shareholders' equity per
common share............. $ 9.58 $ 8.68 $ 8.07 $ 8.34 $ 8.26 $ 8.02
Common shares outstanding
at period end(3)......... 61,972 55,919 52,047 48,238 44,479 42,890
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
----------------------- ------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
(IN THOUSANDS) ---------- ---------- ---------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER DATA:
Loan originations.... $ 534,017 $ 349,586 $ 524,530 $364,942 $283,295 $216,175 $215,843
Loan repayments...... 120,563 75,817 138,081 233,005 179,292 111,731 54,097
Loan sales(5)........ 120,871 28,957 81,013 53,912 27,715 29,726 30,160
Total assets managed
at period end(6)... 1,435,036 1,106,552 1,143,548 935,720 822,450 702,567 583,817
Realized gains....... 21,606 20,819 25,757 15,804 30,417 16,679 9,144
Realized losses...... (5,158) (818) (3,216) (5,100) (11,262) (4,679) (2,908)
</TABLE>

- -------------------------

(1) See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Results of Operations -- Comparison of Nine Months Ended
September 30, 1999 and 1998 and Fiscal Years Ended December 31, 1998, 1997
and 1996."

(2) Distributions are based on taxable income, which differs from income for
financial reporting purposes. In 1997, Allied Capital Corporation (old)
distributed $0.34 per common share representing the 844,914 shares of Allied
Capital Lending Corporation distributed in conjunction with the merger. The
distribution resulted in a partial return of capital. Also in conjunction
with the merger, the Company distributed $0.17 per common share representing
the undistributed earnings of the predecessor companies at December 31,
1997.

(3) Excludes 516,779 shares and 808,348 shares held in the deferred compensation
trust at or for the nine months ended September 30, 1999 and 1998,
respectively, and 810,456 shares held in the deferred compensation trust at
or for the year ended December 31, 1998.

(4) See "Senior Securities" on page 32 for more information regarding the
Company's level of indebtedness.

(5) Excludes loans sold through securitization in January 1998. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Comparison of Fiscal Years Ended
December 31, 1998, 1997 and 1996."

(6) Total assets managed includes the Company's assets and assets managed on
behalf of others.
5
<PAGE> 9

<TABLE>
<CAPTION>
1999 1998 1997
--------------------------- ------------------------------------- -------------------------------------
(IN THOUSANDS, QTR 3 QTR 2 QTR 1 QTR 4 QTR 3 QTR 2 QTR 1 QTR 4 QTR 3 QTR 2 QTR 1
EXCEPT PER SHARE DATA) ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
QUARTERLY DATA:
Total interest and
related portfolio
income............... $37,998 $33,186 $27,678 $25,974 $22,546 $21,321 $36,897 $25,984 $25,111 $24,911 $21,399
Portfolio income
before realized and
unrealized gains.... 19,273 16,619 13,830 11,776 9,401 9,148 24,920 7,910 12,093 14,095 11,968
Net increase in net
assets resulting from
operations.......... 26,944 22,121 18,580 16,631 14,906 14,476 32,065 13,216 17,146 18,296 12,646
Basic earnings per
common share........ 0.44 0.38 0.33 0.31 0.29 0.28 0.62(3) 0.25 0.35 0.37 0.27
Diluted earnings per
common share........ 0.44 0.38 0.33 0.31 0.29 0.28 0.61(3) 0.25 0.35 0.37 0.27
Net asset value per
common share(1)..... 9.58 9.11 8.98 8.68 8.13 8.14 8.23 8.07 8.42 8.50 8.39
Dividends declared per
common share........ 0.40 0.40 0.40 0.38 0.35 0.35 0.35 0.80(2) 0.31 0.30 0.30
</TABLE>

- -------------------------
(1) We determine net asset value per common share as of the last day of the
quarter. The net asset values shown are based on outstanding shares at the
end of each period, excluding common stock held in the Company's deferred
compensation trust.

(2) During the fourth quarter of 1997, the Company declared a quarterly dividend
of $0.61 per common share which included $0.34 per common share representing
the distribution of shares of Allied Capital Lending Corporation previously
held in Allied Capital Corporation's (old) portfolio. The Company also
declared an annual extra distribution of $0.02 per common share, and a
special distribution of previously undistributed earnings of $0.17 per
common share in conjunction with the merger.

(3) During the first quarter of 1998, the Company recorded a gain from a
securitization transaction of $14.8 million or $0.28 per share.

WHERE YOU CAN FIND
ADDITIONAL INFORMATION

We have filed with the Commission a registration statement and related
exhibits under the Securities Act of 1933, as amended (the "Securities Act").
The registration statement contains additional information about us and the
registered securities being offered by this prospectus. You may inspect the
registration statement and the exhibits without charge at the Securities and
Exchange Commission at 450 Fifth Street, NW, Washington, DC 20549. You may
obtain copies from the Commission at prescribed rates.

We file annual, quarterly and special reports, proxy statements and other
information with the Commission. You can inspect, without charge, at the public
reference facilities of the Commission at 450 Fifth Street, NW, Washington, DC
20549; Seven World Trade Center, New York, New York 10048; and 500 West Madison
Street, Chicago, Illinois 60661. The Commission also maintains a web site at
http://www.sec.gov that contains reports, proxy statements and other information
regarding public companies, including our Company. You can also obtain copies of
these materials from the public reference section of the Commission at 450 Fifth
Street, NW, Washington, DC 20549, at prescribed rates. Please call the
Commission at 1-800-SEC-0330 for further information on the public reference
room. You can also inspect reports and other information we file at the offices
of the Nasdaq Stock Market, 1735 K Street, NW, Washington, DC 20006.
6
<PAGE> 10

RISK FACTORS

Investing in the Company involves a number of significant risks and other
factors relating to the structure and investment objective of the Company. As a
result, there can be no assurance that the Company will achieve its investment
objective. In addition to the information contained in this prospectus, you
should consider carefully the following information before making investments in
the shares.

LENDING TO PRIVATE SMALL AND MIDDLE-MARKET COMPANIES INVOLVES A HIGH DEGREE OF
RISK.

Our portfolio consists primarily of loans to private small and
middle-market 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 and middle-market companies 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
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 repayment 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.

WE INVEST IN NON-INVESTMENT GRADE CMBS.

The commercial mortgage-backed securities ("CMBS") in which we invest are
non-investment grade, which means that nationally recognized statistical rating
organizations rate them below the top four investment-grade rating categories
(e.g., "AAA" through "BBB"). Non-investment grade securities usually provide a
higher yield than do

7
<PAGE> 11

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. The CMBS tend 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.

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 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 each investment in our
portfolio. Without a readily ascertainable market value, the estimated value of
our portfolio of loans and equity securities may differ significantly from the
values that would be placed on the portfolio if there existed a ready market for
the loans and equity securities. Any changes in estimated value are recorded in
the Company's statement of operations as "Net unrealized gains (losses)."

WE BORROW MONEY WHICH MAY INCREASE THE RISK OF INVESTING IN OUR COMPANY.

We borrow from, and issue senior debt securities to, banks 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, magnify the potential for gain and loss
on amounts invested and, therefore, increase the risks associated with investing
in our securities. If the value of our consolidated assets increases, then
leveraging would cause the net asset value attributable to the Company's common
stock to increase more sharply than it would have had we not leveraged.
Conversely, if the value of our consolidated assets decreases, leveraging would
cause net asset value to decline more sharply than it otherwise would have had
we not leveraged. Similarly, any increase in our consolidated income in excess
of consolidated interest payable on the borrowed funds would cause our net
income to increase more than it would without the leverage, while any decrease
in our consolidated income would cause net income to decline more sharply than
it would have had we not borrowed. Such a decline could negatively affect our
ability to make common stock dividend payments, and, if asset coverage for a
class of senior security representing indebtedness declines to less than 200%,
we may be required to sell a portion of our investments when it is
disadvantageous to do so. Leverage is generally considered a speculative
investment technique.

As of September 30, 1999, the Company's debt as a percentage of total
liabilities and shareholders' equity was 46%. Our ability to achieve our
investment objective may depend in part on our continued ability to maintain a
leveraged capital structure by borrowing from banks or other lenders on
favorable terms. There can be no assurance that we will be able to maintain such
leverage.

At September 30, 1999, the Company had $537.9 million of outstanding
indebtedness, bearing a weighted annual interest cost, excluding closing costs,
of 7.4%. In order for us to cover annual interest payments on indebtedness, we
must achieve annual returns of at least 3.4% on our portfolio.

Illustration. The following table illustrates the effect of leverage on
returns from an investment in our common stock assuming various annual returns,
net of expenses. The

8
<PAGE> 12

calculations in the table below are hypothetical and actual returns may be
higher or lower than those appearing below.

ASSUMED RETURN ON THE COMPANY'S PORTFOLIO
(NET OF EXPENSES)

<TABLE>
<CAPTION>
-20% -10% -5% 0% 5% 10% 20%
------ ------ ------ ----- ---- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Corresponding return to shareholder(1)........ -46.1% -26.4% -16.6% -6.7% 3.1% 13.0% 32.7%
</TABLE>

- -------------------------

(1) The calculation assumes (i) $1,169.5 million in total assets, (ii) an
average cost of funds of 7.4%, (iii) $537.9 million in debt outstanding and
(iv) $593.8 million of shareholders' equity.

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.

BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL CAPITAL.

We will continue to need capital to fund investments. 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. As a
result such earnings will not be available to fund loan originations. We expect
to continue to borrow from financial institutions and sell additional equity
securities. If we fail to obtain funds from such sources or from other sources
to fund our 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, 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

9
<PAGE> 13

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, 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.

POTENTIAL YEAR 2000 PROBLEMS MAY ADVERSELY AFFECT OUR BUSINESS.

The Year 2000 issue is the result of computer programs and embedded
hardware systems having been developed using two digits rather than four to
define the applicable year. These computer programs or hardware that have
date-sensitive software or embedded chips may recognize a date using "00" as the
Year 1900 rather than the Year 2000. This could result in system failures or
miscalculations causing disruptions or failure of our operations, including
among other things, a temporary inability to transact new business or
communicate with our customers.

We depend on our computer software programs and operating systems in
operating our business. We also depend on the proper functioning of computer
systems of third parties, such as service providers and portfolio companies. The
failure of any of these systems to appropriately interpret the upcoming calendar
Year 2000 could have a material adverse effect on our business and financial
condition. All vendors providing critical software and hardware have indicated
that their programs and systems are Year 2000 compliant. We have tested most of
our critical software applications and the test results

10
<PAGE> 14

have indicated the software and systems are Year 2000 compliant. We continue to
monitor and test critical software and systems as they are updated.

We continue to monitor all of our critical service providers as they work
toward Year 2000 compliance. We are not aware of any critical service provider
that will not be Year 2000 compliant. However, we cannot assure you that the
service providers will be Year 2000 compliant, or that no interruption of
business will occur as a result of their non-compliance.

We have sent Year 2000 questionnaires to our portfolio companies to assess
their awareness and to evaluate their Year 2000 readiness. Based on the
responses to the Year 2000 questionnaires that we have received to date, the
portfolio companies have represented that they expect to be Year 2000 compliant
by December 31, 1999. We will continue to monitor the progress of our portfolio
companies that are working toward Year 2000 compliance. However, no assurance
can be given that some of the Company's portfolio companies will not suffer
material adverse effects from Year 2000 issues, and if such adverse effects
impact such companies' ability to repay their loans, our operating results and
financial condition could be affected.

Throughout 1999, we will continue to address any issues of Year 2000 non-
compliance. In addition, we have developed our contingency plan to ensure the
continuance of business operations in the event of systems failure in the Year
2000. We cannot assure you that our Year 2000 compliance program will be
effective or that our estimates about the cost of completing our program will be
accurate. While Allied Capital 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 by the Company, its critical service providers or its portfolio
companies could result in a material adverse effect on our financial condition
and results from operations.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS, AND
THE ACCOMPANYING PROSPECTUS SUPPLEMENT, IF ANY, MAY CONTAIN "FORWARD-LOOKING
STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995, WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH
AS "MAY," "WILL," "EXPECT," "INTEND," "ANTICIPATE," "ESTIMATE" OR "CONTINUE" OR
THE NEGATIVE THEREOF OR OTHER VARIATIONS OR SIMILAR WORDS OR PHRASES. THE
MATTERS DESCRIBED IN "RISK FACTORS" AND CERTAIN OTHER FACTORS NOTED THROUGHOUT
THIS PROSPECTUS, AND THE ACCOMPANYING PROSPECTUS SUPPLEMENT, IF ANY, AND IN ANY
EXHIBITS TO THE REGISTRATION STATEMENT OF WHICH THIS PROSPECTUS, AND THE
ACCOMPANYING PROSPECTUS SUPPLEMENT, IF ANY, IS A PART, CONSTITUTE CAUTIONARY
STATEMENTS IDENTIFYING IMPORTANT FACTORS WITH RESPECT TO ANY SUCH FORWARD-
LOOKING STATEMENTS, INCLUDING CERTAIN RISKS AND UNCERTAINTIES, THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING
STATEMENTS.

11
<PAGE> 15

THE COMPANY

Our company is principally engaged in lending to and investing in private
small and middle-market companies. The Company is organized in the state of
Maryland and is an internally managed closed-end management investment company
that has elected to be regulated as a business development company (as defined
above, a "BDC") under the 1940 Act.

We have two wholly owned subsidiaries that have also elected to be
regulated as BDCs. Allied Investment Corporation ("Allied Investment") is
licensed by the Small Business Administration ("SBA") as a Small Business
Investment Company ("SBIC"). Allied Capital SBLC Corporation ("Allied SBLC") is
licensed by the SBA as a Small Business Lending Company ("SBLC") and is a
participant in the SBA Section 7(a) Guaranteed Loan Program. In addition, we
have a real estate investment trust subsidiary, Allied Capital REIT, Inc.
("Allied REIT").

Our executive offices are located at 1919 Pennsylvania Avenue, NW,
Washington, DC 20006 and our telephone number is (202) 331-1112. In addition, we
maintain regional offices in Chicago, San Francisco and New York, and Allied
Capital Express offices in Detroit, Atlanta, Philadelphia, Chicago and
Greenville, SC. We also have an office in Frankfurt, Germany.

USE OF PROCEEDS

Unless otherwise specified in the prospectus supplement accompanying this
prospectus, we intend to use the net proceeds from selling shares for general
corporate purposes, which may include investment in small and middle-market
companies in accordance with our investment objective, purchase of commercial
mortgage-backed securities, repayment of indebtedness, acquisitions and other
general corporate purposes.

We anticipate that substantially all of the net proceeds of any offering of
shares will be used, as described above, within six months, but in no event
longer than two years. Pending investment, we intend to invest the net proceeds
of any offering of shares in time deposits, income-producing securities with
maturities of three months or less that are issued or guaranteed by the federal
government or an agency of the federal government, and high quality debt
securities maturing in one year or less from the time of investment. Our ability
to achieve our investment objective may be limited to the extent that the net
proceeds of any offering, pending full investment, are held in time deposits and
other short-term instruments.

12
<PAGE> 16

PRICE RANGE OF COMMON STOCK AND DIVIDENDS

Our common stock is traded on the Nasdaq National Market under the symbol
"ALLC." The following table lists the high and low closing sales prices for the
Company's stock in 1998 and 1999 and for Allied Capital Lending Corporation's
stock, the predecessor company to the Company, in 1997. The stock quotations are
interdealer quotations and do not include markups, markdowns or commissions. On
November , 1999, the last reported closing sale price of the common stock was
$ per share.

<TABLE>
<CAPTION>
CLOSING SALE PRICE
------------------
HIGH LOW
------- -------
<S> <C> <C>
ALLIED CAPITAL LENDING CORPORATION
YEAR ENDED DECEMBER 31, 1997
First Quarter............................. $17.000 $14.875
Second Quarter............................ 16.625 13.875
Third Quarter............................. 16.750 14.500
Fourth Quarter............................ 22.750 15.750
ALLIED CAPITAL CORPORATION
YEAR ENDED DECEMBER 31, 1998
First Quarter............................. $27.688 $21.000
Second Quarter............................ 29.000 21.750
Third Quarter............................. 24.813 14.938
Fourth Quarter............................ 18.875 12.500
YEAR ENDING DECEMBER 31, 1999
First Quarter............................. $20.000 $16.750
Second Quarter............................ 24.000 17.031
Third Quarter............................. 23.250 20.500
Fourth Quarter (through November ,
1999)..................................
</TABLE>

Allied Capital Lending Corporation's common stock historically traded at
prices in excess of its net asset value. Our common stock continues to trade in
excess of net asset value. There can be no assurance, however, that we will
maintain a premium to net asset value.

We pay quarterly dividends to stockholders. The Company has indicated that
it expects to distribute four regular quarterly dividends of $0.40 per share
during 1999, for total dividends of $1.60 per share for 1999. The amount of our
quarterly dividends is determined by the board of directors and is currently
based upon an estimate of annual taxable income. The Company's dividend policy
currently is to annually distribute substantially all of its net taxable income,
including net capital gains, if any. See "Taxation." We cannot assure that we
will achieve investment results or maintain a tax status that will permit any
particular level of dividend payment.

Our credit facilities limit our ability to declare dividends if we default
under certain provisions.

13
<PAGE> 17

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 Selected Consolidated Financial Data and the Company's Consolidated
Financial Statements and Notes thereto.

OVERVIEW

The Company provides capital to small and middle-market companies in a
variety of different industries and in diverse geographic locations. Our lending
and investment activity is focused in three areas:

- Mezzanine finance

- Commercial real estate finance, including the purchase of CMBS, and

- Small business and commercial real estate loans originated for sale
under our Allied Capital Express brand name.

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 and loan
originations, and the Company's ability to secure financing for its investment
activities.

The total portfolio at value was $1,103.7 million at September 30, 1999 and
$800.3 million, $697.0 million and $607.4 million at December 31, 1998, 1997 and
1996, respectively. During the nine months ended September 30, 1999, the Company
invested a total of $534.0 million. After total repayments of $120.6 million,
loan sales of $120.9 million and valuation changes, the Company's investment
portfolio increased by 38% since December 31, 1998. The portfolio increased
approximately 15% for each of the years ended December 31, 1998, 1997 and 1996.

<TABLE>
<CAPTION>
AT AT DECEMBER 31,
SEPTEMBER 30, -------------------
ASSET COMPOSITION 1999 1998 1997 1996
----------------- ------------- ---- ---- -----
<S> <C> <C> <C> <C>
Mezzanine Investments................ 47% 46% 25% 27%
Commercial Mortgage-Backed
Securities*........................ 25% 13% -- --
Commercial Mortgage Loans............ 16% 27% 56% 52%
SBA 7(a) Loans....................... 6% 7% 5% 6%
Cash and Other Assets................ 6% 7% 14% 15%
---- ---- ---- ----
100% 100% 100% 100%
==== ==== ==== ====
</TABLE>

- -------------------------

* Includes Purchased CMBS totaling 18% and 4% of total assets at September 30,
1999 and December 31, 1998, respectively.

14
<PAGE> 18

MEZZANINE

Mezzanine loans, debt securities and equity interests were $546.0 million,
$388.6 million, $207.7 million and $191.2 million at September 30, 1999 and
December 31, 1998, 1997 and 1996, respectively. The effective yield on the
mezzanine loans and debt securities was 14.0%, 14.6%, 12.6%, and 13.2% at
September 30, 1999 and December 31, 1998, 1997 and 1996, respectively. Mezzanine
loan originations and purchases were $237.6 million and $127.2 million for the
nine months ended September 30, 1999 and 1998, 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 were $86.5 million and $23.9 million for the nine months ended
September 30, 1999 and 1998, respectively. Mezzanine repayments and sales were
$41.3 million, $64.9 million, and $67.3 million for the years ended December 31,
1998, 1997 and 1996, respectively.

COMMERCIAL MORTGAGE-BACKED SECURITIES

Commercial mortgage-backed securities (CMBS) were $296.2 million and $113.7
million at September 30, 1999 and December 31, 1998. The portfolio at September
30, 1999 consisted of $213.4 million of purchased CMBS ("Purchased CMBS") and
$82.8 million of CMBS retained primarily from a $295 million asset
securitization the Company completed on January 30, 1998 ("Residual CMBS").
During the first nine months of 1999, the Company acquired Purchased CMBS with a
face value of $373.2 million for a cost of $183.4 million. At September 30, 1999
and December 31, 1998, the estimated yield to maturity on the Purchased CMBS and
the Residual CMBS was 14.2% and 9.9%, and 15.0% and 9.7%, respectively. At
September 30, 1999 and December 31, 1998, the weighted average yield on the
entire CMBS portfolio was 13.0% and 11.2%, respectively. The weighted average
loan-to-value and debt service coverage of the loans securing the total CMBS
portfolio at September 30, 1999 were 69.9% and 1.4, respectively.

Acquisitions of Purchased CMBS have had, and will continue to have, the
full scrutiny of the Company's 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. The Company will
continue to bid on similar CMBS offerings as long as we can achieve significant
discounts and attractive yields on the purchase of such offerings. However, we
will limit our Purchased CMBS acquisitions in order to maintain a balanced
portfolio.

COMMERCIAL MORTGAGE LOANS

Commercial mortgage loans were $185.5 million at September 30, 1999 and
$233.2 million, $447.2 million and $373.7 million at December 31, 1998, 1997 and
1996, respectively. The weighted average current stated interest rate on the
commercial mortgage loan portfolio at September 30, 1999 was 9.6% and 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 9.8% at
September 30, 1999 and 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.

15
<PAGE> 19

In the first quarter of 1998, the Company reduced its commercial mortgage
loan portfolio through the securitization of $295 million in commercial real
estate loans. In addition the Company slowed its origination activity in early
1998 due to pricing conditions in the market. The Company has also continued to
sell commercial mortgage loans in order to reduce the portfolio. As a result,
the commercial mortgage loan portfolio decreased by 20% and 48%, respectively,
for the nine months ended September 30, 1999 and the year ended December 31,
1998. In prior years, the Company had been actively expanding its commercial
real estate portfolio and as a result the portfolio had increased by 20% and 35%
for the years ended December 31, 1997 and 1996, respectively.

ALLIED CAPITAL EXPRESS

During the second quarter of 1999, the Company combined its commercial real
estate loan origination activity with its SBA 7(a) lending activity in order to
increase its loans originated for sale business under the Allied Capital Express
brand name. Through Allied Capital Express, the Company provides small business
and commercial real estate loans up to $3 million. The majority of the loans
originated in this area are originated for sale, generally at premiums of up to
10% of the loan amount. A summary of Allied Capital Express loan origination and
sale activity for the nine months ended September 30, 1999 and 1998 is as
follows:

<TABLE>
<CAPTION>
FOR THE NINE
MONTHS
ENDED SEPTEMBER 30,
--------------------
1999 1998
-------- ---------
<S> <C> <C>
(in thousands)
Loan Originations:
SBA 7(a).................................................. $64,650 $ 39,600
Other..................................................... 48,426 182,700
Loan Sales:
SBA 7(a).................................................. 45,075 26,800
Other..................................................... 75,796 --
</TABLE>

On a comparative basis, SBA 7(a) loan origination activity has increased
due to the opening of new office locations and due to increased emphasis that is
being placed on the Allied Capital Express product area. Non-SBA 7(a) loan
origination activity has decreased due to the reduction of middle-market
commercial real estate lending activity that occurred in 1998 as discussed under
"Commercial Mortgage Loans." Allied Capital Express targets small commercial
real estate loans that are in many cases originated in conjunction with SBA 7(a)
loans. The 1999 and 1998 non-SBA 7(a) activity is not comparable because of the
shift from larger real estate loans originated for the portfolio to smaller
commercial real estate loans originated primarily for sale. 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 NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998

Net increase in net assets resulting from operations (NIA) was $67.6
million, or $1.14 per share, and $61.4 million, or $1.19 per share, for the nine
months ended September 30, 1999 and 1998, 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.
The NIA for the nine months ended

16
<PAGE> 20

September 30, 1998 also includes a one-time gain of $14.8 million, or $0.28 per
share, resulting from a commercial mortgage loan securitization transaction that
was completed in January 1998.

Total interest and related portfolio income was $98.9 million and $80.8
million for the nine months ended September 30, 1999 and 1998, respectively.
Total interest and related portfolio income is primarily a function of the level
of interest income earned and the balance of portfolio assets. In addition,
total interest and related portfolio income includes net premiums from loan
dispositions, prepayment premiums, and investment advisory fees and other
income. 1998 total interest and related portfolio income includes a one-time
gain on sale of $14.8 million resulting from a commercial mortgage loan
securitization transaction that was completed in January 1998. Excluding the
1998 gain on sale, total interest and related portfolio income increased in the
first nine months of 1999 by 50% as compared to the first nine months of 1998.

Interest income totaled $84.4 million and $58.4 million for the nine months
ended September 30, 1999 and 1998, respectively. Interest income increased $26.0
million or 44% compared to the same period in the prior year. The increase in
interest income earned results primarily from continued growth of the Company's
investment portfolio and the Company's focus on increasing its overall portfolio
yield. The Company's investment portfolio, excluding non-interest bearing equity
interests in portfolio companies, increased by 49% to $1,033.6 million at
September 30, 1999 from $692.9 million at September 30, 1998. The weighted
average yield on the interest bearing investments in the portfolio at September
30, 1999 was 12.5% as compared to 11.8% at September 30, 1998.

Net premiums from loan dispositions were $9.0 million and $2.9 million for
the nine months ended September 30, 1999 and 1998, 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 $5.2
million and $2.2 million for the nine months ended September 30, 1999 and 1998,
respectively. This premium income results primarily from the premium paid by
purchasers of the guaranteed portion of the Company's SBA 7(a) loans sold into
the secondary market and the commercial real estate loans sold to third parties,
less the origination commissions associated with the loans sold.

Prepayment premiums were $3.8 million and $0.7 million for the nine months
ended September 30, 1999 and 1998, respectively. 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 $5.4 million and $4.6
million for the nine months ended September 30, 1999 and 1998, respectively.
Investment advisory fees are received from the private funds managed by the
Company.

Total operating expenses were $44.0 million and $31.8 million for the nine
months ended September 30, 1999 and 1998, 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 $24.2 million and $14.5 million for the nine months ended September 30,
1999 and 1998,

17
<PAGE> 21

respectively. Interest expense increased $9.6 million, or 66%, compared to the
same period in the prior year. The increase is attributable to an increase in
borrowings by the Company and its subsidiaries under various credit facilities.
The Company's total borrowings were $537.9 million and $361.7 million at
September 30, 1999 and 1998, respectively. Average outstanding indebtedness for
the nine months ended September 30, 1999 and 1998 was $414.1 million and $252.5
million, respectively. The Company's weighted average interest cost, excluding
closing costs, on outstanding borrowings at September 30, 1999 and 1998 was 7.4%
and 7.2%, respectively.

Salaries and employee benefits totaled $11.3 million and $8.3 million for
the nine months ended September 30, 1999 and 1998, respectively. Total employees
were 124 and 96 at September 30, 1999 and 1998, 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 has been an active recruiter throughout 1998 and 1999 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 leases for the Company's
headquarters in Washington, DC, and its regional offices. General and
administrative expenses also include travel costs, stock record expenses,
directors' fees, legal and accounting fees and various other expenses. General
and administrative expenses totaled $8.5 million and $9.0 million for the nine
months ended September 30, 1999 and 1998, respectively. The decrease in general
and administrative expenses was partially due to certain post-Merger integration
expenses incurred in the first quarter of 1998, totaling $0.2 million. The post-
Merger integration expenses included primarily the costs of legal and accounting
advice as well as the use of certain outside consultants. The remaining decrease
results from the timing of incurring expenses in 1999 and 1998.

For the nine months ended September 30, 1999 and 1998, operating expenses
excluding interest on indebtedness as a percent of total interest and related
portfolio income less interest expense plus net realized and unrealized capital
gains was 21% and 20%, respectively. For the years ended December 31, 1998, 1997
and 1996 this ratio was 22%.

The formula award and cut-off award totaled $5.2 million and $5.5 million,
or $0.09 per share and $0.11 per share, for the nine months ended September 30,
1999 and 1998, respectively.

The formula award expense totaled $4.7 million for each of the nine months
ended September 30, 1999 and 1998. The formula award was designed as an
incentive compensation program that would replace canceled stock options that
were canceled as a result of the Company's 1997 Merger and would balance share
ownership among key officers. The formula award vests over a three-year period,
on the anniversary date of the Merger, beginning on December 31, 1998. 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 $6.2 million.

The cut-off award expense totaled $0.5 million and $0.8 million for the
nine months ended September 30, 1999 and 1998, respectively. 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 will only be

18
<PAGE> 22

payable if the award recipient is employed by the Company on a future vesting
date. Total cut-off award that will vest in 1999 is estimated at $0.5 million.

Net realized gains were $16.4 million and $20.0 million for the nine months
ended September 30, 1999 and 1998, 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
sale and early repayment of mezzanine and commercial mortgage loans, offset by
losses on investments.

Realized gains totaled $21.6 million and $20.8 million for the nine months
ended September 30, 1999 and 1998, respectively. Realized gains during 1999
primarily resulted from transactions involving three portfolio companies, Radio
One, Inc. ($10.5 million), COHR, Inc. ($5.3 million), and Precision Industries
Co. ($3.3 million). The Company reversed previously recorded unrealized
appreciation of $8.3 million when these gains were realized in 1999. Realized
losses totaled $5.2 million and $0.8 million for the nine months ended September
30, 1999 and 1998, respectively. Realized losses during 1999 resulted primarily
from the liquidation of one portfolio investment, CeraTech Holdings Corporation
($2.5 million). Losses realized in 1999 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 $4.7 million in 1999 when
the related losses were realized.

The Company recorded net unrealized gains of $1.5 million for the nine
months ended September 30, 1999 and net unrealized losses of $0.4 million for
the nine months ended September 30, 1998. Net unrealized gains for 1999 and net
unrealized losses for 1998 consisted of valuation changes resulting from the
Board of Directors' valuation of the Company's assets and the effect of
reversals of net unrealized appreciation resulting from net realized gains. At
September 30, 1999, net unrealized appreciation in the portfolio totaled $3.9
million, and was composed of unrealized appreciation of $31.8 million resulting
primarily from appreciated equity interests in portfolio companies, and
unrealized depreciation of $27.9 million resulting primarily from
underperforming loan and equity investments in the portfolio. At September 30,
1998, net unrealized appreciation in the portfolio totaled $0.9 million and was
composed of unrealized appreciation of $28.0 million and unrealized depreciation
of $27.1 million.

The Company employs a standard grading system for the entire portfolio.
Grade 1 is used for those investments from which a capital gain is expected.
Grade 2 is used for investments performing in accordance with plan. Grade 3 is
used for investments that require closer monitoring; however, no loss of
interest or principal is expected. Grade 4 is used for investments for which
some loss of contractually due interest is expected, but no loss of principal is
expected. Grade 5 is used for investments for which some loss of principal is
expected and the investment 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.

19
<PAGE> 23

At September 30, 1999, the Company's portfolio was graded as follows:

<TABLE>
<CAPTION>
INVESTMENTS PERCENTAGE OF
GRADE AT VALUE TOTAL PORTFOLIO
----- ------------- ---------------
(IN MILLIONS)
<S> <C> <C>
1............................................ $ 114.8 10.4%
2............................................ 916.0 83.0
3............................................ 35.4 3.2
4............................................ 19.4 1.8
5............................................ 18.1 1.6
-------- -----
$1,103.7 100.0%
======== =====
</TABLE>

Grade 5 mezzanine investments totaled $11.8 million at value at September
30, 1999, or 1.1%, of the Company's total portfolio based on the valuation of
the Board of Directors. The value of these Grade 5 mezzanine investments has
been reduced from an aggregate cost of $31.8 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 the expected full amount of the potential loss when
such exposure is identified. Grade 5 mezzanine investments at December 31, 1998
totaled $6.4 million at value, or 0.8% of the Company's total portfolio.

At September 30, 1999, there were no Grade 5 commercial mortgage loans.
Grade 5 commercial mortgage loans at December 31, 1998 totaled $0.1 million at
value.

Grade 5 SBA 7(a) loans totaled $6.3 million at value at September 30, 1999.
The value of these loans has been reduced from an aggregate cost basis of $7.3
million, which includes $4.9 million at cost that is guaranteed by the SBA.
Grade 5 SBA 7(a) loans at December 31, 1998 totaled $6.3 million at value.

For the total portfolio, loans greater than 120 days delinquent were $28.6
million at value at September 30, 1999, or 2.6% of the total portfolio. Included
in this category are loans valued at $18.7 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, 1998 were $13.7
million at value, or 1.7% of the total portfolio, which includes $9.9 million
that are fully secured by real estate.

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. The Company's dividend
policy currently is to annually distribute substantially all of its net taxable
income, including net capital gains, if any. Annual tax distributions may differ
from NIA for the fiscal year due to timing differences in the recognition of
income and expenses, returns of capital and net unrealized appreciation or
depreciation, which are not included in taxable income. The Company's current
regular quarterly dividend was determined based on estimated 1999 taxable
income.

20
<PAGE> 24

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 ordinary 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.

Certain of the Company's credit facilities limit the Company's ability to
declare dividends, should the Company default under certain provisions of the
respective credit agreements.

The weighted average common shares outstanding used to compute basic
earnings per share were 59.1 million and 51.5 million for the nine months ended
September 30, 1999 and 1998, respectively. The increases in the weighted average
shares reflect the issuance of new shares and the issuance of shares pursuant to
a dividend reinvestment plan.

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 59.2 million and 51.7 million for the nine months ended
September 30, 1999 and 1998, respectively.

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").

21
<PAGE> 25

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.

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 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 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 sale of the guaranteed portion of the

22
<PAGE> 26

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. 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, 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.

23
<PAGE> 27

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, 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.

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

24
<PAGE> 28

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.

CUT-OFF AWARD. The cut-off 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.

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 sale and 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 Allied Capital Advisers Inc. prior to the 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

25
<PAGE> 29

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>
INVESTMENTS PERCENTAGE OF
AT VALUE TOTAL PORTFOLIO
------------- ---------------
(IN MILLIONS)
<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>

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

26
<PAGE> 30

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 underlying 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 Allied Capital Advisers
Inc. 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 Allied Capital Advisers Inc. 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.

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
Capital Corporation in 1997, a partial return of capital resulting from the
distribution of Allied Capital Corporation's ownership of Allied Capital Lending
Corporation'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 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 Allied
Capital Advisers Inc. 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 Capital Lending
Corporation held in Allied Capital Corporation's portfolio. Allied Capital
Corporation declared and paid a dividend equal to 0.107448 shares of Allied
Capital Lending Corporation for each share of Allied Capital Corporation 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.

27
<PAGE> 31

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.

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 Capital Corporation's
ownership of Allied Capital Lending Corporation 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 September 30, 1999, the Company had $15.4 million in cash and cash
equivalents. The Company 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 September 30, 1999 as follows:

<TABLE>
<CAPTION>
ANNUAL
PORTFOLIO RETURN TO
AMOUNT ANNUAL COVER INTEREST
CLASS OUTSTANDING INTEREST RATE(1) PAYMENTS(2)
----- -------------- ---------------- -------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Debentures and notes
payable:
Master loan and
security
agreement.......... $ 34,500 6.40% 0.19%
Unsecured long-term
notes payable...... 317,000 7.30% 1.98%
SBA debentures....... 47,650 8.22% 0.33%
OPIC loan............ 5,700 6.57% 0.03%
--------
Total debentures
and notes
payable...... $404,850 7.32% 2.53%
========
Revolving line of
credit.................. $133,000 7.69% 0.87%
========
</TABLE>

- ---------------
(1) The annual interest rate includes the cost of commitment fees and other
facility fees.

(2) The annual portfolio return to cover interest payments ("Annual Return") is
calculated as total estimated 1999 annual interest or dividend payments per
class of financing, divided by total assets at September 30, 1999. The total
Annual Return needed to cover all classes of financing at September 30, 1999
combined is 3.4%.

28
<PAGE> 32

MASTER LOAN AND SECURITY AGREEMENT. The Company had a facility to borrow
up to $250 million, of which $100 million was committed, using its commercial
mortgage loans as collateral. The agreement generally required interest-only
payments with all principal due at maturity. The agreement charged interest at
one-month London Inter-Bank Offered Rate ("LIBOR") plus 1.0%. The facility
matured on October 7, 1999, and has been extended through October 28, 2000, with
a total committed facility up to $100 million.

UNSECURED LONG-TERM NOTES PAYABLE. At September 30, 1999, the Company has
$317 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 a weighted average rate
of 7.3%. The notes require payment of interest only semiannually, and all
principal is due upon maturity.

The Company is in the process of negotiating terms for additional long term
notes totaling approximately $100 million. The Company plans to complete this
financing during the fourth quarter of 1999.

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 two-year, $340 million
unsecured revolving line of credit which expires in March, 2001. This facility
may be expanded up to $400 million. At the Company's option, the credit facility
bears interest at a rate equal to (i) LIBOR plus 1.25% or (ii) the higher of (a)
the NationsBank, N.A. prime rate and (b) the Federal Funds rate plus 0.50%. The
credit facility requires monthly payments of interest, and all principal is due
upon maturity. The credit facility also requires an annual facility fee equal to
0.25% of the committed amount, regardless of the amount outstanding under the
facility, which is payable quarterly in arrears.

EQUITY CAPITAL AND DIVIDENDS

During the first nine months of 1999, the Company raised $106.5 million in
new equity primarily through the sale of shares from its shelf registration
statement. At September 30, 1999, total shareholders' equity had increased to
$593.8 million.

The Company expects to distribute four regular quarterly dividends of $0.40
per share during 1999, for total dividends of $1.60 per share for 1999. During
the first, second and third quarters of 1999, the board of directors declared
and the Company paid regular quarterly dividends of $0.40 per share.

The Company's dividend policy currently is to annually distribute
substantially all of its net taxable income, including net capital gains, if
any. The Company's taxable income can differ from its financial reporting income
due to differences in the timing of revenue and expense recognition. The
Company's current regular dividend was determined based on estimated 1999
taxable income. Dividends for 1998 totaled $1.43 per share.

29
<PAGE> 33

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 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
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 "Risk Factors" and also include
other factors such as changes in the economy, competitive and market conditions,
and future business decisions.

YEAR 2000 COMPLIANCE

The Company has a Year 2000 compliance committee which is responsible for
assessing the Company's Year 2000 readiness and preparing the Company's Year
2000 contingency plan by focusing on three main areas: the Company's information
technology ("IT") and other operating systems, critical 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 are Year 2000 compliant. The Company
has tested its critical software applications and the test results have
indicated that the software and systems are Year 2000 compliant. In addition to
the testing performed by Company personnel, the Company 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.
The test results revealed that the Company's loan accounting software is
currently Year 2000 compliant. Implementation of tested software and IT systems
has been completed. The Company currently has service and maintenance contracts
with all its critical software vendors, therefore, no additional costs were
incurred by the Company for the upgrades needed to become compliant.

In addition to our testing prior to Year 2000, all computer software
programs and operating systems will be tested again on January 1, 2000 to
determine that they are operating normally and that the software programs are
accurately processing transactions

30
<PAGE> 34

that are date sensitive. If the computer hardware or software does not
accurately perform its intended functions, the respective vendors will be
contacted immediately and our management information systems group will work
with the vendors to correct any problems. In the event that our computer systems
are not operational due to specific problems encountered at our headquarters in
Washington, DC, we have the option to transfer our operations to our disaster
recovery site. In addition, all critical company data will be printed from the
computer system prior to January 1, 2000 so that it will be available for use
after that date as needed.

The second area of focus is the Company's critical service providers. The
Company continues to monitor all of its critical service providers as they work
toward Year 2000 compliance. 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 noncompliance. We have
communicated with each of our critical service providers to identify contacts
and establish contingency plans in the event that they have a business
disruption resulting from a Year 2000 problem.

The Company has sent Year 2000 questionnaires to its portfolio companies to
assess their awareness and to evaluate their Year 2000 readiness. Based on the
responses to the Year 2000 questionnaires, the portfolio companies have
represented that they expect to be Year 2000 compliant by December 31, 1999. The
Company will continue to monitor the progress of its portfolio companies that
are working toward Year 2000 compliance. 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 such companies' ability to repay
their loans, the Company's operating results and financial condition could be
affected.

We will be closely monitoring the performance of each of our portfolio
companies during the Year 2000 by reviewing their loan payment performance and
financial statements. Borrowers will be contacted immediately in the event of
non-payment or if their operating results indicate that they may not be able to
make required principal and/or interest payments.

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) incurring additional costs 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.

31
<PAGE> 35

SENIOR SECURITIES

Information about our senior securities is shown in the following tables as
of the fiscal year ended December 31, unless otherwise noted. The "--" indicates
information which the Commission expressly does not require to be disclosed for
certain types of senior securities.

UNSECURED LONG-TERM NOTES
PAYABLE
1989........................ $ 0 $ 0 $-- N/A
1990........................ 0 0 -- N/A
1991........................ 0 0 -- N/A
1992........................ 0 0 -- N/A
1993........................ 0 0 -- N/A
1994........................ 0 0 -- N/A
1995........................ 0 0 -- N/A
1996........................ 0 0 -- N/A
1997........................ 0 0 -- N/A
1998........................ 180,000,000 2,734 -- N/A
1999 (as of September 30)... 317,000,000 2,226 -- N/A

SBA DEBENTURES(5)
1989........................ $ 25,350,000 $4,015 $-- N/A
1990........................ 40,450,000 3,397 -- N/A
1991........................ 49,800,000 3,834 -- N/A
1992........................ 49,800,000 5,789 -- N/A
1993........................ 49,800,000 6,013 -- N/A
1994........................ 54,800,000 3,695 -- N/A
1995........................ 61,300,000 2,868 -- N/A
1996........................ 61,300,000 2,485 -- N/A
1997........................ 54,300,000 2,215 -- N/A
1998........................ 47,650,000 2,734 -- N/A
1999 (as of September 30)... 47,650,000 2,226 -- N/A
</TABLE>

32
<PAGE> 36

<TABLE>
<CAPTION>
TOTAL AMOUNT
OUTSTANDING INVOLUNTARY
EXCLUSIVE OF ASSET LIQUIDATING AVERAGE
TREASURY COVERAGE PREFERENCE MARKET VALUE
CLASS AND YEAR SECURITIES(1) PER UNIT(2) PER UNIT(3) PER UNIT(4)
-------------- ------------- ----------- ----------- --------------
<S> <C> <C> <C> <C>
OVERSEAS PRIVATE INVESTMENT
CORPORATION LOAN
1989........................ $ 0 $ 0 $-- N/A
1990........................ 0 0 -- N/A
1991........................ 0 0 -- N/A
1992........................ 0 0 -- N/A
1993........................ 0 0 -- N/A
1994........................ 0 0 -- N/A
1995........................ 0 0 -- N/A
1996........................ 8,700,000 2,485 -- N/A
1997........................ 8,700,000 2,215 -- N/A
1998........................ 5,700,000 2,734 -- N/A
1999 (as of September 30)... 5,700,000 2,226 -- N/A
REVOLVING LINES OF CREDIT
1989........................ $ 0 $ 0 $-- N/A
1990........................ 0 0 -- N/A
1991........................ 0 0 -- N/A
1992........................ 0 0 -- N/A
1993........................ 0 0 -- N/A
1994........................ 32,226,000 3,695 -- N/A
1995........................ 20,414,000 2,868 -- N/A
1996........................ 45,099,000 2,485 -- N/A
1997........................ 38,842,000 2,215 -- N/A
1998........................ 95,000,000 2,734 -- N/A
1999 (as of September 30)... 133,000,000 2,226 -- N/A
SENIOR NOTE PAYABLE(6)
1989........................ $ 0 $ 0 $-- N/A
1990........................ 0 0 -- N/A
1991........................ 0 0 -- N/A
1992........................ 20,000,000 5,789 -- N/A
1993........................ 20,000,000 6,013 -- N/A
1994........................ 20,000,000 3,695 -- N/A
1995........................ 20,000,000 2,868 -- N/A
1996........................ 20,000,000 2,485 -- N/A
1997........................ 20,000,000 2,215 -- N/A
1998........................ 0 0 -- N/A
1999 (as of September 30)... 0 0 -- N/A
BONDS PAYABLE
1989........................ $ 0 $ 0 $-- N/A
1990........................ 0 0 -- N/A
1991........................ 0 0 -- N/A
1992........................ 0 0 -- N/A
1993........................ 0 0 -- N/A
1994........................ 0 0 -- N/A
1995........................ 98,625,000 2,868 -- N/A
1996........................ 54,123,000 2,485 -- N/A
1997........................ 0 0 -- N/A
1998........................ 0 0 -- N/A
1999 (as of September 30)... 0 0 -- N/A
</TABLE>

33
<PAGE> 37

<TABLE>
<CAPTION>
TOTAL AMOUNT
OUTSTANDING INVOLUNTARY
EXCLUSIVE OF ASSET LIQUIDATING AVERAGE
TREASURY COVERAGE PREFERENCE MARKET VALUE
CLASS AND YEAR SECURITIES(1) PER UNIT(2) PER UNIT(3) PER UNIT(4)
-------------- ------------- ----------- ----------- --------------
<S> <C> <C> <C> <C>
REVERSE REPURCHASE AGREEMENTS(7)
1989........................ $ 29,386,000 $4,015 $-- N/A
1990........................ 28,361,000 3,397 -- N/A
1991........................ 2,761,000 3,834 -- N/A
1992........................ 0 0 -- N/A
1993........................ 0 0 -- N/A
1994........................ 0 0 -- N/A
1995........................ 0 0 -- N/A
1996........................ 0 0 -- N/A
1997........................ 0 0 -- N/A
1998........................ 0 0 -- N/A
1999 (as of September 30)... 0 0 -- N/A
REDEEMABLE CUMULATIVE PREFERRED STOCK(5)
1989........................ $ 0 $ 0 $ 0 N/A
1990........................ 1,000,000 308 100 N/A
1991........................ 1,000,000 338 100 N/A
1992........................ 1,000,000 526 100 N/A
1993........................ 1,000,000 546 100 N/A
1994........................ 1,000,000 351 100 N/A
1995........................ 1,000,000 277 100 N/A
1996........................ 1,000,000 242 100 N/A
1997........................ 1,000,000 217 100 N/A
1998........................ 1,000,000 267 100 N/A
1999 (as of September 30)... 1,000,000 223 100 N/A
NON-REDEEMABLE CUMULATIVE PREFERRED
STOCK(5)
1989........................ $ 6,000,000 $ 362 $100 N/A
1990........................ 6,000,000 308 100 N/A
1991........................ 6,000,000 338 100 N/A
1992........................ 6,000,000 526 100 N/A
1993........................ 6,000,000 546 100 N/A
1994........................ 6,000,000 351 100 N/A
1995........................ 6,000,000 277 100 N/A
1996........................ 6,000,000 242 100 N/A
1997........................ 6,000,000 217 100 N/A
1998........................ 6,000,000 267 100 N/A
1999 (as of September 30)... 6,000,000 223 100 N/A
</TABLE>

- -------------------------
(1) Total amount of each class of senior securities outstanding at the end
of the period presented.

(2) The asset coverage ratio for a class of senior securities representing
indebtedness is calculated as the Company's consolidated total assets,
less all liabilities and indebtedness not represented by senior
securities, divided by senior securities representing indebtedness. This
asset coverage ratio is multiplied by $1,000 to determine the Asset
Coverage Per Unit. The asset coverage ratio for a class of senior
securities that is preferred stock is calculated as the Company's
consolidated total assets, less all liabilities and indebtedness not
represented by senior securities, divided by senior securities
representing indebtedness, plus the involuntary liquidation preference
of the preferred stock (see footnote 3). The Asset Coverage Per Unit for
preferred stock is expressed in terms of dollar amounts per share.

(3) The amount to which such class of senior security would be entitled upon
the involuntary liquidation of the issuer in preference to any security
junior to it.

34
<PAGE> 38

(4) Not applicable, as senior securities are not registered for public
trading.

(5) Issued by the Company's SBIC subsidiary to the SBA. These categories of
senior securities are not subject to the asset coverage requirements of
the 1940 Act. See "Certain Government Regulations -- SBA Regulations."

(6) The Company was the obligor on $15 million of the senior notes. The
Company's SBIC subsidiaries were the obligors on the remaining $5
million, which is not subject to the asset coverage requirements of the
1940 Act.

(7) U.S. government agency guaranteed loans sold under agreements to
repurchase. The Company was advised by the Staff of the Commission that
these reverse repurchase agreements were not considered a class of
senior security representing indebtedness and thus were not subject to
the asset coverage requirements of the 1940 Act.

35
<PAGE> 39

BUSINESS

We provide capital to small and middle-market companies in a variety of
different industries and in diverse geographic locations. We have been lending
to growing businesses for over 40 years and have financed thousands of borrowers
nationwide. Our lending and investment activity is focused in three areas:

- Mezzanine finance

- Commercial real estate finance, including the purchase of CMBS, and

- Small business and commercial real estate loans originated for sale under
our Allied Capital Express brand name.

Our investment portfolio consists primarily of subordinated loans with
equity features, commercial mortgage loans, commercial mortgage-backed
securities, and small senior loans. At September 30, 1999, our investment
portfolio totaled $1,103.7 million representing 639 borrower relationships in 40
states and the District of Columbia.

The Company's investment objective 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, on December 31,
1997, of five affiliated public companies, the "predecessor companies", the
oldest of which was founded in 1958. 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.

- 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

36
<PAGE> 40

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 have 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 and
1999, we have increased 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 middle-market companies. 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
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 generally ranging in size from $5
million to $25 million. 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 September 30,
1999, approximately 97% of the Company's mezzanine investments had fixed
interest rates.

We seek to generate a return on mezzanine 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 approximately one-half was earned in capital gains, which
would arise from the sale of our equity interest in the portfolio company. Since
early 1998, we have begun to structure many of our mezzanine investments with
more emphasis on current interest, and less emphasis on the potential return
from capital gains.

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, our
warrants expire five years after the related debt is repaid, and the exercise
price is usually nominal. The warrants often include registration rights, which
allow 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.

37
<PAGE> 41

At September 30, 1999, our mezzanine portfolio had $476.0 million in
mezzanine loans and debt securities, and $70.0 million in equity interests,
which combined represented 47% of our total assets. The geographic and industry
composition of the mezzanine portfolio at September 30, 1999 was as follows:

<TABLE>
<CAPTION>
GEOGRAPHIC REGION
-----------------
<S> <C>
Mid-Atlantic.................. 26%
Midwest....................... 25%
Southeast..................... 20%
West.......................... 13%
Northeast..................... 11%
International................. 5%
----
Total.................... 100%
====
<CAPTION>
INDUSTRY
--------
<S> <C>
Business services............. 26%
Consumer products............. 20%
Telecommunications............ 14%
Industrial products........... 14%
Broadcasting.................. 6%
Education..................... 6%
Other......................... 14%
----
Total.................... 100%
====
</TABLE>

Private 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 middle-market 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 have been a commercial real estate lender to
small and middle-market companies for many years, and maintain a commercial
mortgage loan portfolio. During 1998, we significantly reduced our middle-market
commercial real estate lending activities, because we believed that the market
was under-pricing commercial real estate loans, and that the returns on senior
commercial real estate loans were below a level that would result in a fair
return on equity for our shareholders. We, however, continue to see a strong
demand for small commercial mortgage loans that can be attractively priced for
sale to banks and other financial institutions. As a result of this market
demand, we have combined small real estate lending with our SBA lending activity
to form our Allied Capital Express product line, which is discussed below.

We continue to seek unique opportunities for commercial mortgage loans for
our portfolio when our return objectives can be achieved. These loans are
generally priced at higher interest rates and include subordinated real estate
loans. 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.

38
<PAGE> 42

At September 30, 1999, 80% of the Company's portfolio of commercial
mortgage loans carried a fixed interest rate, and 20% 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 September 30, 1999 was 9.6% and the weighted average yield was
9.8%. 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 September 30, 1999, the weighted average loan-to-value
for the commercial mortgage loan portfolio was 70.0%.

The Company's commercial mortgage loan portfolio totaled approximately
$185.5 million at September 30, 1999, or 16% of the Company's total assets. The
geographic composition and the property types securing the commercial mortgage
loan portfolio at September 30, 1999 were as follows:

<TABLE>
<CAPTION>
GEOGRAPHIC REGION
-----------------
<S> <C>
Mid-Atlantic.................. 43%
Southeast..................... 27%
West.......................... 19%
Midwest....................... 8%
Northeast..................... 3%
----
Total.................... 100%
====
<CAPTION>
PROPERTY TYPE
-------------
<S> <C>
Hospitality................... 35%
Office........................ 31%
Retail........................ 13%
Recreation.................... 11%
Other......................... 10%
----
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 for investment. We believe we have earned a reputation in the
commercial real estate finance market as a specialist in credits that require
more difficult structuring or underwriting techniques, and that we compete
successfully in this niche.

COMMERCIAL MORTGAGE-BACKED SECURITIES. The same pricing pressures that
caused us to reduce our origination of commercial mortgage loans for
middle-market companies in 1998 created significant liquidity problems for many
other real estate lenders who had remained active lenders as pricing declined
throughout 1998. Many of these lenders experienced severe valuation decreases in
their portfolios and as a result defaulted on their secured credit facilities.
This turmoil in the real estate capital markets during the fourth quarter of
1998 created a unique opportunity for our Company to acquire non-investment
grade commercial mortgage-backed securities ("Purchased CMBS") at attractive
yields. However, we will limit our Purchased CMBS purchasing activity in order
to maintain a balanced portfolio.

The Purchased CMBS in which we invest are non-investment grade, which means
that nationally recognized statistical rating organizations rate them below the
top four investment-grade rating categories (i.e., "AAA" through "BBB"), and are
sometimes referred to as "junk bonds."

Unlike most "junk bonds," which are typically unsecured debt instruments,
the non-investment grade Purchased CMBS in which we invest are secured by
mortgage loans with real estate collateral, and the loans securing the Purchased
CMBS have an average loan-

39
<PAGE> 43

to-value of approximately 71.4% and a weighted average cost-to-value of 68.7% at
September 30, 1999.

Non-investment grade securities usually provide a higher yield than do
investment-grade bonds, but with the higher return comes greater risk.
Non-investment grade securities are considered speculative, and their capacity
to pay principal and interest in accordance with the terms of their issue is not
ensured. They tend 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. We invest in non-investment grade CMBS
represented by the "BB" to non-rated tranches of a CMBS issuance. Due to the
underlying structure of the CMBS issuances that offer the non-investment grade
securities, our CMBS tranches receive principal payments only after the
securities that are senior to our securities are repaid. Thus, if losses are
incurred in the underlying mortgage loan collateral pool, we would experience
these losses.

To mitigate this risk, we perform extensive due diligence prior to the
acquisition of the Purchased CMBS. When we evaluate a CMBS purchase, we use the
same 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
September 30, 1999, the weighted average loan-to-value ratio for the loans
securing our Purchased CMBS portfolio was 71.4% and a weighted average
cost-to-value of 68.7%.

At September 30, 1999, the Company had $213.4 million in Purchased CMBS,
which represented 18.3% of the Company's total assets. The Purchased CMBS
portfolio had a weighted average yield to maturity of 14.2%. These securities
were all acquired at significant discounts from face. The face amount of these
securities at September 30, 1999 was $434.5 million.

In addition to our Purchased CMBS portfolio, we maintain in our CMBS
portfolio a residual interest resulting primarily from our January 1998 $295
million commercial real estate loan securitization ("the Residual CMBS"). We
continue to service all of the loans in the pool. This transaction provided
liquidity from our investment portfolio, and allowed us to reinvest the cash
proceeds from the commercial real estate loan securitization into higher
yielding mezzanine and SBA 7(a) loans. We do not anticipate significant future
commercial mortgage loan securitization activity; we intend to gain liquidity
from our lower yielding commercial mortgage loans primarily through whole loan
sales. At September 30, 1999, the Company had $82.8 million in Residual CMBS,
which represented 7.1% of the Company's total assets. The Residual CMBS had a
weighted average yield to maturity of 9.7%.

The geographic composition and the property types securing the total CMBS
portfolio at September 30, 1999 were as follows:

<TABLE>
<CAPTION>
GEOGRAPHIC REGION
-----------------
<S> <C>
West.......................... 29%
Mid-Atlantic.................. 23%
Midwest....................... 22%
Southeast..................... 21%
Northeast..................... 5%
----
Total.................... 100%
====
<CAPTION>
PROPERTY TYPE
-------------
<S> <C>
Retail........................ 33%
Housing....................... 30%
Office........................ 20%
Hospitality................... 8%
Industrial.................... 8%
Other......................... 1%
----
Total.................... 100%
====
</TABLE>

40
<PAGE> 44

ALLIED CAPITAL EXPRESS

We originate small business and commercial real estate loans, primarily for
sale, under our brand name of Allied Capital Express. The loans we originate in
this program are generally for financings of up to $3 million in size and the
loans are sold to banks and other financial institutions. The loans we sell are
sold for premiums ranging from 5% to 10% of the loan amount sold. We also may
sell these loans for a retained servicing spread that can range from 1% to 5% of
the outstanding loan balance for the period that the loan remains outstanding.
We began using a separate brand name for these smaller loans in the second
quarter of 1999, to distinguish this program from our core mezzanine finance
activity and avoid confusion in the market place.

Many of the loans originated under the Allied Capital Express brand name
are through our participation in the SBA's 7(a) Guaranteed Loan Program. One of
our subsidiaries is a Small Business Lending Company ("SBLC") and is one of only
fourteen non-bank SBLCs operating in the United States. Under the SBA 7(a)
program, we extend senior secured loans that are partially guaranteed by the
SBA. Our 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
98% of the Company's SBA 7(a) loan portfolio had variable interest rates as of
September 30, 1999. 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 of banks and other institutional buyers. We earn a
premium on the sale of the guaranteed portion of our SBA 7(a) loans. Typically
our premiums on guaranteed SBA 7(a) 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 also may sell
these loans for a retained servicing spread that generally ranges from 1% to 5%
of the loan balance for the period that the loan remains outstanding. We
continue to service 100% of each loan we originate.

41
<PAGE> 45

Our SBA 7(a) loan portfolio totaled $68.9 million at September 30, 1999, or
6% of our total assets. 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 September 30, 1999:

<TABLE>
<CAPTION>
GEOGRAPHIC REGION
-----------------
<S> <C>
Midwest....................... 35%
Mid-Atlantic.................. 35%
Southeast..................... 15%
West.......................... 10%
Northeast..................... 5%
----
Total.................... 100%
====
</TABLE>

<TABLE>
<CAPTION>
INDUSTRY
--------
<S> <C>
Retail........................ 40%
Hospitality................... 29%
Consumer products............. 12%
Consumer services............. 5%
Business services............. 4%
Broadcasting.................. 3%
Other......................... 7%
----
Total.................... 100%
====
</TABLE>

In addition to SBA 7(a) loans, we originate small commercial real estate
loans for sale to banks and other institutional buyers. These loans are often
originated in conjunction with SBA 7(a) loans. The small commercial real estate
loans generally are priced and structured such that we can receive premiums for
the sale of these loans to banks and other financial institutions. Our range of
net premiums on these loan sales is generally between 4% to 7% of the loan
balance sold.

We believe that there is significant opportunity to originate these small
business and commercial real estate loans. The SBA 7(a) program is estimated to
provide over $10.5 billion to small businesses on an annual basis. Recently,
there has been significant merger and consolidation activity among the major
non-bank SBA lenders, and this consolidation has created a market opportunity to
expand our Allied Capital Express program. We are currently recruiting
additional business development professionals in several markets. Since the
first of the year, we have added new business development professionals in
Atlanta, Philadelphia, Chicago, Washington, DC and Greenville, SC. We have also
increased our loan underwriting and loan closing staffs. We have made
significant progress in automating our loan origination process and are actively
pursuing an Internet strategy to increase our marketing and business development
activities.

INVESTMENT ADVISORY SERVICES

We are a registered investment adviser, pursuant to the Investment Advisers
Act of 1940, and have certain investment advisory agreements to manage private
investment funds. The revenue generated from these agreements is not material to
the Company's operations. See "Management's Discussion and Analysis -- Results
of Operations."

LOAN SOURCING

Over the last 18 months, we significantly increased the scope of our sales
and marketing activity by opening regional offices in Chicago, San Francisco and
New York. We have also opened Allied Capital Express offices in Detroit,
Atlanta, Philadelphia, Chicago and Greenville, SC. We have a full-time sales and
marketing staff dedicated to identifying and pursuing mezzanine investments,
commercial mortgage loans, and

42
<PAGE> 46

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.

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 Consumer and industrial Office buildings, full service
PROPERTY products, business services hotels, manufacturing
TYPE (outsourcing), broadcasting, facilities, warehouses, retail
telecommunications, education, facilities, convenience stores,
and other industries that have gas stations, and other
low vulnerability to changes in properties requiring
economic cycles specialized underwriting
expertise

INVESTMENT Stable, growing companies, Amortization, collateral
CRITERIA 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 or
available equipment, second lien on real
estate, personal guarantees
</TABLE>

43
<PAGE> 47

LOAN UNDERWRITING PROCEDURES AND CRITERIA

MEZZANINE FINANCING. We generally require that the companies in which we
invest demonstrate strong market position, sales growth, positive cash flow, and
profitability. We emphasize the quality of management, and 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 significant personal
investments 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.

In a typical mezzanine financing, we thoroughly review, analyze and
substantiate, through due diligence, the business plan and operations of the
potential portfolio company. We perform financial due diligence, often with
assistance of an accounting firm; perform operational due diligence often with
the assistance of an industry specialist consultant; study the industry and
competitive landscape; and conduct numerous reference checks with employees,
both current and former, customers, suppliers and competitors. The typical
mezzanine financing requires two to three months of diligence and structuring
before funding occurs.

PURCHASED CMBS. We receive extensive packages of information regarding the
mortgage loans comprising a CMBS pool. We work with the issuer, the investment
bank, and the rating agencies in performing our diligence on a CMBS purchase.
The typical CMBS purchase takes between two to three months to complete because
of the breadth and depth of our diligence procedures.

We perform a detailed review of all of the underlying commercial mortgage
loans securing the CMBS. We recompute the estimate of underwriteable cash flow
and challenge necessary carve-outs, such as replacement reserves. We study the
trends of the industry and geographic location of each property, and assess our
own estimate of the anticipated cash flow over the period of the loan. Our loan
officers physically inspect most of the collateral properties, and assess
appraised values based on our own opinion of comparable market values.

We formulate our bid to achieve an effective yield on our investment over a
ten-year period to approximate 13.5% to 15%. In computing estimated yield, we
assume a 1% loss rate on the entire underlying mortgage pool. We look for an
overall weighted average debt service coverage of 1.25 to 1.4, and a
loan-to-value ratio of approximately 70%.

COMMERCIAL REAL ESTATE FINANCE. When we evaluate commercial mortgage
loans, we generally receive an initial package of information that typically
includes underwriting information that was developed by the borrower. Typical
underwriting information that is required from potential borrowers in order to
conduct appropriate due diligence includes: financial statements of the
borrower, appraisals, rent rolls and lease information, environmental reports,
structural and engineering reports, and any other information deemed appropriate
under the circumstances.

Our underwriting process includes assessing the borrower's estimated
earnings and current cash flow coverage, the creditworthiness of the borrower,
the net worth and financial strength of the borrower, the estimated current
liquidation value of the related mortgaged property and any other collateral. We
also study trends in the borrower's industry and in real estate values in the
borrower's geographic region. Our loan officers

44
<PAGE> 48

inspect the property during the due diligence process, and value the property
using internally developed valuation analyses.

SBA 7(a) LENDING. SBA 7(a) loans made to qualifying small businesses are
generally secured by a mortgage and other liens on the assets of the borrower
and, frequently, by the assets of principals. The entrepreneur must personally
guarantee the payment of interest and principal on the loans. The SBA has
established certain financial ratios and guidelines that generally govern SBA
7(a) loans. Factors to be considered include the debt service coverage ratio,
value of the collateral, and the net worth of the borrower. We generally follow
the same underwriting procedures and criteria for SBA 7(a) loans as we do for
our commercial real estate loans.

CREDIT APPROVAL PROCESS

All credit approval is obtained through a committee review process
centralized at our headquarters in Washington, DC. For mezzanine and CMBS
transactions, all of our lending disciplines are represented on the investment
committee, which is comprised of our most senior lenders. For Allied Capital
Express transactions, a committee comprised of small business and real estate
lenders meet to approve all loans.

No one individual has the ability to approve a credit. The asset approval
process not only benefits from the experience of the committee members, but also
from the experience of our other investment professionals who together with the
committee members, on average, have over 14 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 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.

45
<PAGE> 49

PORTFOLIO MONITORING AND VALUATION: We use a grading system in order to
help us monitor our portfolio. The grading system assigns grades to investments
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 expected. Security is
valued at net realized value.
</TABLE>

At September 30, 1999 Grade 1 investments totaled $114.8 million, or 10% of
the total portfolio at value; Grade 2 investments totaled $916.0 million, or 83%
of the total portfolio; Grade 3 investments totaled $35.4 million, or 3% of the
total portfolio; Grade 4 investments totaled $19.4 million, or 2% of the total
portfolio; and Grade 5 investments totaled $18.1 million or 2% 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, we do not value our loans above cost, but loans are
subject to depreciation events when the asset is considered impaired. Also as a
general rule, equity securities may be assigned appreciation if circumstances
warrant. With respect to private equity securities, each investment is valued
using industry valuation benchmarks, and then the value is assigned a discount
reflecting the illiquid nature of the 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:

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.

46
<PAGE> 50

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.

At September 30, 1999, $28.6 million, or 2.6% of the Company's portfolio at
value was 120 days or more past due. Included in this category are loans valued
at $18.7 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>
NINE MONTHS
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
--------------------- ----------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
---------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Realized Losses...... $ 5,158 $ 818 $ 3,216 $ 5,100 $ 11,262 $ 4,679 $ 2,908
Total Assets..... 1,169,531 815,477 856,079 807,775 713,360 605,434 501,817
Realized Losses/Total
Assets............. 0.4% 0.1% 0.4% 0.6% 1.6% 0.8% 0.6%
</TABLE>

EMPLOYEES

At September 30, 1999, we employed 124 individuals including investment
professionals, operations professionals and administrative staff. The majority
of these individuals are located in the Washington, DC office. We believe that
our relations with employees are excellent.

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 proceedings will have a material
effect upon our financial condition or results of operations.

PORTFOLIO COMPANIES

The following is a listing of our portfolio companies in which we had an
equity investment at September 30, 1999. We make available significant
managerial assistance to our portfolio companies. Other than loans to the
portfolio company, our only relationship with each portfolio company is our
investment. For information relating to the amount and

47
<PAGE> 51

general terms of our loans to portfolio companies, see the Consolidated
Statement of Investments and Notes thereto at September 30, 1999 at pages F-5 to
F-10.

<TABLE>
<CAPTION>
PERCENTAGE
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES OF CLASS
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Acme Paging, L.P. ................ Paging Services Partnership Interests 1.8%
1336 Basswood, Suite F
Schaumburg, IL 60173
Allied Office Products............ Office Product Warrants to Purchase 2.1%
75 Route 17 South Retailer Common Stock
Hasbrouck Heights, NJ 07604
American Barbecue & Grill,
Inc. ........................... Restaurant Chain Warrants to Purchase 17.3%
7300 W. 110th Street, Suite 570 Common Stock
Overland Park, KS 66210
ASW Holding Corporation........... Steel Wool Manufacturer Warrants to Purchase 5.0%
2825 W. 31st Street Common Stock
Chicago, IL 60623
Aurora Communications, LLC........ Radio Station Redeemable Preferred 3.3%
3 Stamford Landing, Suite 210 Stock
46 Southfield Avenue
Stamford, CT 06902
Avborne, Inc. .................... Aviation Services Warrants to Purchase 2.5%
c/o Trivest, Inc. Company Common Stock
2665 S. Bayshore Dr., Suite 800
Miami, FL 33133-5462
CampGroup, LLC.................... Recreational Camp Warrants to Purchase 2.6%
4 New King Street Operator Common Stock
White Plains, NY 10604
Candlewood Hotel Company.......... Extended Stay Series A Convertible 5.3%
9342 East Central Facilities Preferred Stock
Wichita, KS 67206
Celebrities, Inc. ................ Radio Stations Warrants to Purchase 25.0%
408-412 W. Oakland Park Common Stock
Boulevard
Ft. Lauderdale, FL 33311-1712
Cherry Tree Toys, Inc. ........... Direct Marketer of Common Stock 19.8%
7601 France Avenue South, #225 Woodcrafts
Edina, MN 55435
Convenience Corporation of
America......................... Convenience Store Chain Series A Preferred Stock 10.0%
711 N. 108th Court Warrants to Purchase 4.5%
Omaha, NE 68154 Common Stock
Cooper Natural Resources, Inc. ... Sodium Sulfate Producer Warrants to Purchase 25.3%
P.O. Box 1477 Common Stock
Seagraves, TX 79360
Cosmetic Manufacturing............ Cosmetic Manufacturer Options to Purchase 17.5%
Resources, LLC Shares
11312 Penrose Street
Sun Valley, CA 91352
Csabai Canning Factory Rt. ....... Food Processing Hungarian Quotas 9.2%
5600 Bekescasba
Bekis: vt 52-54 Hungary
DEH Printed Circuits, Inc. ....... Circuit Board Warrants to Purchase 12.5%
840 Church Road Manufacturer Common Stock
Elgin, IL 60123
DeVlieg-Bullard, Inc. ............ Tool Manufacturer Warrants to Purchase 1.7%
One Gorham Island Common Stock
Westport, CT 06680
</TABLE>

48
<PAGE> 52

<TABLE>
<CAPTION>
PERCENTAGE
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES OF CLASS
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Directory Investment
Corporation....................... Telephone Directories Common Stock 50.0%
1919 Pennsylvania Avenue, N.W.
Washington, DC 20006
Directory Lending Corporation..... Telephone Directories Common Stock 50.0%
1919 Pennsylvania Avenue, N.W.
Washington, DC 20006
Drilltec Patents & Technologies
Company, Inc.................... Drill Pipe Packager Warrants to Purchase 15%
10875 Kempwood Drive, Suite 2 Common Stock
Houston, TX 77043
EDM Consulting, LLC............... Environmental Common Stock 25.0%
14 Macopin Avenue Consulting
Montclair, NJ 07043
Esquire Communications Ltd. ...... Court Reporting Warrants to Purchase 3.0%
216 E. 45th Street, 8th floor Services Common Stock
New York, NY 10017
ExTerra Credit Recovery, Inc. .... Consumer Finance Preferred Stock 0.9%
35 Lennon Lane, Suite 200 Common Stock 0.7%
Walnut Creek, CA 94598 Warrants to Purchase 0.7%
Common Stock
Executive Greetings, Inc. ........ Personalized Business Warrants to Purchase 1.5%
120 Industrial Park Access Road Products Common Stock
New Hartford, CT 06057
Fairchild Industrial Products
Company......................... Industrial Controls Warrants to Purchase 21.5%
3920 Westpoint Boulevard Manufacturer Common Stock
Winston-Salem, NC 27013
FTI Consulting, Inc. ............. Litigation Support Warrants to Purchase 5.0%
2021 Research Drive Services Common Stock
Annapolis, MD 21401
Galaxy American Communications,
LLC............................. Cable Television Warrants to Purchase 6.0%
1220 N. Main Street Operator Common Stock
Sikeston, MO 63801
Genesis Worldwide, Inc. .......... Manufacturers of Common Stock 1.1%
2600 Kettering Tower Metal Working
P.O. Box 668 Machinery
Dayton, OH 45423
Gibson Guitar Corporation ........ Guitar Manufacturer Warrants to Purchase 3.0%
1818 Elm Hill Pike Common Stock
Nashville, TN 37210
Ginsey Industries, Inc. .......... Toilet Seat Convertible Debentures 7.0%
281 Benigno Boulevard Manufacturer Warrants to Purchase 16.0%
Bellmawr, NJ 08031 Common Stock
Global Communications I, LLC...... Communications and Preferred Stock 60%
201 East 69th Street Media Businesses
New York, NY 10021
Golden Eagle/Satellite
Archery, LLC.................... Sporting Equipment Convertible Debentures 26.9%
1733 Gunn Highway Manufacturer
Odessa, FL 33556
Grant Broadcasting System II...... Television Stations Warrants to Purchase 40.0%
919 Middle River Drive, Common Stock
Suite 409 Warrants to Purchase 40.0%
Ft. Lauderdale, FL 33304 Common Stock in
Affiliate Company
</TABLE>

49
<PAGE> 53

<TABLE>
<CAPTION>
PERCENTAGE
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES OF CLASS
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Grant Television, Inc. ........... Television Stations Warrants to Purchase 20.0%
(See Grant Broadcasting System II) Common Stock
Hotelevision, Inc. ............... Hotel Cable-TV Preferred Stock 14.2%
599 Lexington Avenue Network
Suite 2300
New York, NY 10022
Jack Henry & Associates, Inc. .... Commercial Banking Common Stock 0.5%
663 Highway 60 Software Development
P.O. Box 807
Monett, MO 65708
JRI Industries, Inc. ............. Machinery Manufacturer Warrants to Purchase 7.5%
2958 East Division Common Stock
Springfield, MO 65803
Julius Koch USA, Inc. ............ Cord Manufacturer Warrants to Purchase 45.0%
387 Church Street Common Stock
New Bedford, MA 02745
Kirker Enterprises, Inc. ......... Nail Enamel Warrants to Purchase 22.5%
55 East 6th Street Manufacturer Common Stock
Paterson, NJ 07524 Equity Interest in 5.0%
Affiliate Company
Kirkland's, Inc. ................. Home Furnishing Warrants to Purchase 5.0%
P.O. Box 7222 Retailer Common Stock
Jackson, TN 38308-7222
Kyrus Corporation................. Value-Added Reseller, Warrants to Purchase 8.0%
25 Westridge Market Place Computer Systems Common Stock
Chandler, NC 28715
Liberty-Pittsburgh Systems,
Inc. ........................... Business Forms Printing Common Stock 20.0%
265 Executive Drive
Plainview, NY 11803
Love Funding Corporation.......... Mortgage Services Series D Preferred Stock 26.0%
1220 19th Street, NW, Suite 801
Washington, DC 20036
Master Plan, Inc. ................ Healthcare Outsourcing Common Stock 15.6%
21540 Plummer Street
Chatsworth, CA 91311
Med Assets.com, Inc. ............. Healthcare Outsourcing Series B Convertible 8.5%
21540 Plummer Street Preferred Stock
Chatsworth, CA 91311 Warrants to Purchase 5.3%
Preferred Stock
Midview Associates, L.P. ......... Residential Land Options to purchase 35.0%
2 Eaton Street, Suite 1101 Development partnership interests
Hampton, VA 23669
Monitoring Solutions, Inc. ....... Air Emissions Common Stock 25.0%
4303 South High School Road Monitoring Warrants to Purchase 40.0%
Indianapolis, IN 46241 Common Stock
Morton Industrial Group........... Friction Materials Common Stock 0.2%
5305 Oakbrook Parkway Manufacturer
Norcross, GA 30093
MVL Group......................... Market Research Warrants to Purchase 8.0%
1061 E. Indiantown Road Service Common Stock
Suite 300
Jupiter, FL 33477
NET-Tel Communications, Inc. ..... Integrated Series B Convertible 2.5%
1023 31st Street, N.W. Communications Preferred Stock
Washington, DC 20007 Provider Warrants to Purchase 1.8%
Common Stock
</TABLE>

50
<PAGE> 54

<TABLE>
<CAPTION>
PERCENTAGE
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES OF CLASS
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Nobel Learning Communities,
Inc. ............................. Educational Services Series D Convertible 100%
1400 N. Providence Road, Preferred Stock
Suite 3055 Warrants to Purchase 13.1%
Media, PA 19063 Common Stock
Nursefinders, Inc. ............... Home Healthcare Warrants to Purchase 3.5%
1200 Copeland Road, Suite 200 Providers Common Stock
Arlington, TX 76011
Opinion Research Corporation...... Corporate Marketing Warrants to Purchase 8.0%
P.O. Box 183 Research Firm Common Stock
Princeton, NJ 08542
Panera Bread Company ............. Restaurant Chain Warrants to Purchase 1.8%
19 Fid Kennedy Avenue Common Stock
Boston, MA 02210
Pico Products, Inc. .............. Satellite/Television Common Stock 5.0%
12500 Foothill Boulevard Component Warrants to Purchase 15.0%
Lakeview Terr., CA 91342 Manufacturer Common Stock
Polaris Pool Systems, Inc. ....... Pool Cleaner Warrants to Purchase 2.3%
P.O. Box 1149 Manufacturer Common Stock
San Marcos, CA 92079-1149
Progressive International
Corporation .................... Retail Kitchenware Common Stock 0.0%
6111 S. 228th Street Redeemable Preferred 6.2%
P.O. Box 97045 Stock
Kent, WA 98064 Warrants to Purchase 8.0%
Common Stock
Quality Software Products
Holdings, PLC................... Accounting Software Common Stock 0.1%
Talipot House 5th Avenue Developer
Gateshead Tyne & Wear, NE110XA
UNITED KINGDOM
Schwinn/GT........................ Bicycle Manufacturer/ Warrants to Purchase 0.7%
1690 38th Street Distributor Common Stock
Boulder, CO 80301
Seasonal Expressions, Inc......... Decorative Ribbon Series A Preferred Stock 100.0%
230 5th Avenue, Suite 1007 Manufacturer
New York, NY 10001
Soff-Cut Holdings, Inc............ Concrete Sawing Common Stock 2.7%
1112 Olympic Drive Equipment Manufacturer Series A Preferred Stock 4.0%
Corona, CA 91719 Warrants to Purchase 6.7%
Common Stock
Southwest PCS, LP................. Wireless Telephone Options to Purchase 6.0%
5 North McCormick Carrier Common Stock
Oklahoma City, OK 73127
Spa Lending Corporation........... Health Spas Series A Preferred Stock 100.0%
1919 Pennsylvania Avenue, N.W. Series B Preferred Stock 68.4%
Washington, DC 20006 Series C Preferred Stock 46.3%
Common Stock 62.1%
Sydran Food Services II, LP....... Operator of Fast Options to Purchase 2.5%
Bishop Ranch 8 Food Restaurants Common Stock
3000 Executive Parkway
Ste. 515
San Ramon, CA 94583-4254
Teknekron Infoswitch
Corporation..................... Telecommunications Warrants to Purchase 5.5%
4425 Cambridge Road Software Provider Common Stock
Fort Worth, TX 76155-2692
</TABLE>

51
<PAGE> 55

- ---------------
(1) Percentages shown for warrants and options held represent the percentage of
class of security we may own, on a fully diluted basis, assuming we exercise
our warrants or options.

DETERMINATION OF NET ASSET VALUE

We determine the net asset value per share of our common stock quarterly.
The net asset value per share is equal to the value of our total assets minus
liabilities and preferred stock divided by the total number of common shares
outstanding.

Portfolio assets are carried at fair value as determined by the board of
directors under our valuation policy. As a general rule, we do not value the
Company's 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.

Determination of fair value involves subjective judgments that cannot be
substantiated by auditing procedures. Accordingly, under current standards, the
accountants' opinion on the Company's financial statements in our annual report
refers to the uncertainty with respect to the possible effect on the financial
statements of such valuation.

52
<PAGE> 56

MANAGEMENT

The board of directors supervises the management of our Company. The
responsibilities of each director include, among other things, the oversight of
the loan approval process, the quarterly valuation of our assets, and oversight
of our financing arrangements. The board of directors maintains an Executive
Committee, Audit Committee, Compensation Committee, and Nominating Committee,
and may establish additional committees in the future. All of the Company's
directors also serve as directors of its subsidiaries.

For our mezzanine and CMBS transactions, our investment decisions are made
by an investment committee comprised of the Company's most senior investment
professionals. For Allied Capital Express transactions, a committee comprised of
small business and real estate lenders meet to approve all loans. Committee
approval is required to approve all loan transactions. No one person is
primarily responsible for making recommendations to a committee.

The Company is internally managed and our investment professionals manage
our portfolio and the portfolios of companies for which we serve as investment
adviser. These investment professionals have extensive experience in managing
investments in private growing businesses in a variety of industries and in
diverse geographic locations, and are familiar with our approach of lending and
investing. Because the Company is internally managed, we pay no investment
advisory fees, but instead we pay the operating costs associated with employing
investment management professionals.

STRUCTURE OF BOARD OF DIRECTORS

The Company's board of directors is classified into three approximately
equal classes with three-year terms, with only one of the three classes expiring
each year. Directors serve until their successors are elected and qualified.

DIRECTORS

Information regarding the board of directors is as follows:

<TABLE>
<CAPTION>
DIRECTOR EXPIRATION
NAME AGE POSITION SINCE(1) OF TERM
- ---- --- -------- -------- ----------
<S> <C> <C> <C> <C>
William L. Walton*........... 50 Chairman, Chief Executive
Officer and President 1986 2001
George C. Williams, Jr.*..... 73 Chairman Emeritus 1964 2001
Brooks H. Browne............. 50 Director 1990 2001
John D. Firestone............ 55 Director 1993 2002
Anthony T. Garcia............ 43 Director 1991 2002
Lawrence I. Hebert........... 53 Director 1989 2002
John I. Leahy................ 69 Director 1994 2000
Robert E. Long............... 68 Director 1972 2001
Warren K. Montouri........... 70 Director 1986 2000
Guy T. Steuart II............ 68 Director 1984 2000
T. Murray Toomey, Esq........ 75 Director 1959 2000
Laura W. van Roijen.......... 47 Director 1992 2002
</TABLE>

- ---------------
* Interested persons of the Company, as defined in the 1940 Act.

(1) Includes service as a director of any of the predecessor companies.

53
<PAGE> 57

EXECUTIVE OFFICERS

Information regarding the Company's executive officers is as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
William L. Walton............ 50 Chairman, Chief Executive Officer and President
Philip A. McNeill............ 40 Managing Director
John M. Scheurer............. 47 Managing Director
Joan M. Sweeney.............. 39 Managing Director
G. Cabell Williams, III ..... 45 Managing Director
Penni F. Roll................ 33 Principal and Chief Financial Officer
</TABLE>

BIOGRAPHICAL INFORMATION

DIRECTORS

William L. Walton has been the Chairman, Chief Executive Officer and
President of the Company since 1997. Mr. Walton was President of Allied II from
1996 to 1997. Mr. Walton is the Chairman of Business Mortgage Investors, Inc
("BMI"), and is a director of Nobel Learning Communities, Inc. (a portfolio
company). Mr. Walton was Chief Executive Officer of Success Lab, Inc.
(children's educational services) from 1993 to 1996, and Chief Executive Officer
of Language Odyssey (educational publishing and services) from 1992 to 1996. Mr.
Walton was Managing Director of Butler Capital Corporation from 1987 to 1991.
Prior to that, Mr. Walton served as the investment advisor to William S. Paley,
founder and Chairman of CBS, from 1985 to 1987, and was an investment banker
with Lehman Brothers Kuhn Loeb from 1982 to 1985.

George C. Williams, Jr. is Chairman Emeritus of the Company. Mr. Williams
was an officer of the predecessor companies from the later of 1959 or the
inception of the relevant entity and President or Chairman and Chief Executive
Officer of the predecessor companies from the later of 1964 or each entity's
inception until 1991. Mr. Williams is a director of BMI. Mr. Williams is the
father of G. Cabell Williams III, an executive officer of the Company.

Brooks H. Browne has been the President of Environmental Enterprises
Assistance Fund since 1993. Mr. Browne was the President, Executive Vice
President or Senior Vice President of Advisers from 1984 to 1993. Mr. Browne is
a director of SEAF, Corporation Financiera Ambiental (Panama), Empresas
Ambientales de Centro America (Costa Rica) and Yayasan Bina Usaha Lingkungan
(Indonesia) (environmental nonprofit or investment funds).

John D. Firestone has been a Partner of Secor Group (venture capital) since
1978. Mr. Firestone is a director of BMI and Security Storage Company of
Washington, DC, and is a senior advisor to Gilbert Capital, Inc.

Anthony T. Garcia has been General Manager of Breen Capital Group (investor
in tax liens) since 1997. Mr. Garcia was a Senior Vice President of Lehman
Brothers Inc. from 1985 to 1996.

Lawrence I. Hebert has been a director of Riggs National Corporation since
1988. He also serves as a director of Riggs Investment Management Corporation
and Riggs Bank Europe Limited (indirect subsidiaries of Riggs National
Corporation). Mr. Hebert is the President and a director of Perpetual
Corporation (owner of Allbritton Communications Company and Allnewsco, Inc.) and
the Chairman and Chief Executive Officer of

54
<PAGE> 58

Allbrittan Communications Company (owner of television stations). Mr. Hebert is
a director of Allnewsco, Inc., the President of Westfield News Advertiser, Inc.,
and a trustee of The Allbritton Foundation. Mr. Hebert was Vice President of
University Bancshares, Inc. (a Texas bank holding company) from 1975 to 1997.

John I. Leahy has been the President of Management and Marketing Associates
(a management consulting firm) since 1986. Mr. Leahy was the President and Group
Executive Officer, Western Hemisphere of Black & Decker Corporation from 1982 to
1985. Mr. Leahy is a director of Kar Kraft Systems, Inc., Cavanaugh Capital,
Inc., Acorn Products, Inc., The Wills Group, Thulman-Eastern Company and
Gallagher Fluid Seals, Inc.

Robert E. Long is the Managing Director of Goodwyn & Long Investment
Management, Inc. Mr. Long has been the President and Chief Executive Officer of
Business News Network, Inc. since 1995, was the Chairman and Chief Executive
Officer of Southern Starr Broadcasting Group, Inc. from 1991 to 1995, and a
director and the President of Potomac Asset Management, Inc. from 1983 to 1991.
Mr. Long is a director of Ambase Inc., AHL Shipping Company, Inc., CSC
Scientific, Inc., and Global Travel, Inc.

Warren K. Montouri has been a Partner of Montouri & Roberson (real estate
investment firm) since 1980. Mr. Montouri was a director of C&S/Sovran Bank from
1970 to 1990, a director of Sovran Financial Corporation from 1989 to 1990, a
director of NationsBank, N.A. from 1990 to 1996, a trustee of Suburban Hospital
from 1991 to 1994, and a trustee of The Audubon Naturalist Society from 1979 to
1985. He has been a director of Franklin National Bank since 1996.

Guy T. Steuart II has been a director and President of Steuart Investment
Company (manages, operates, and leases real and personal property and holds
stock in operating subsidiaries engaged in various businesses) since 1960. Mr.
Steuart is Trustee Emeritus of Washington and Lee University.

T. Murray Toomey, Esq. has been an attorney at law since 1949. Mr. Toomey
is a director of The National Capital Bank of Washington, and Federal Center
Plaza Corporation. He is also a trustee of The Catholic University of America.

Laura W. van Roijen has been a private real estate investor since 1992. Ms.
van Roijen was the Chairman of CWV & Associates (RTC qualified contracting firm)
from 1991 to 1994, a director and the Treasurer of Black Possum Inc. (retail
concern) from 1994 to 1996, the President of Volta Place, Inc. (real estate
advisory firm) from 1991 to 1994, and Vice President (from 1986 to 1991) and
Market Director (from 1989 to 1991) of Citicorp Real Estate, Inc.

EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS

Philip A. McNeill, Managing Director, has been employed by the Company
since 1993.

John M. Scheurer, Managing Director, has been employed by the Company since
1991. Mr. Scheurer is also President of BMI.

Joan M. Sweeney, Managing Director, has been employed by the Company since
1993. Ms. Sweeney is also a Managing Director of BMI.

G. Cabell Williams, III, Managing Director, has been employed by the
Company since 1981. Mr. Williams is also a Managing Director of BMI.

55
<PAGE> 59

Penni F. Roll, Principal and Chief Financial Officer, has been employed by
the Company since 1995. Ms. Roll is also Principal and Chief Financial Officer
of BMI. Ms. Roll was a Manager at KPMG Peat Marwick, LLP from 1993 to 1995.

COMPENSATION PLANS

STOCK OPTION PLAN

The Company's stock option plan (the "New Plan") is intended to encourage
stock ownership in the Company by officers, thus giving them a proprietary
interest in the Company's performance. The Company's shareholders approved the
New Plan at the Special Meeting of Shareholders of Allied Lending held on
November 26, 1997. The principal objective of the Company's compensation
committee in awarding stock options to the Chief Executive Officer and other
eligible officers of the Company is to align each officer's interests with the
success of the Company and the financial interests of its shareholders. The
committee believes that the New Plan achieves this objective because it links a
portion of each executive's compensation with the performance of the Company's
stock and the value delivered to shareholders.

The committee grants stock options under the New Plan at a price not less
than the prevailing market value, and such options will have value only if the
Company's stock price increases. The committee determines the amount and
features of the stock options, if any, to be awarded to the Company's officers.
Historically, when granting stock options, the committee evaluated a number of
factors, including the recipient's current stock holdings, years of service,
position with the Company, and other factors. The committee has not applied a
formula assigning specific weights to any of these factors when making its
determination.

For the nine months ended September 30, 1999 and for the year ended
December 31, 1998, the Company's compensation committee granted a total of
553,921 and 5,189,944 options, respectively, to certain officers and non-officer
directors of the Company. These options generally vest over a five-year period.
See "Control Persons and Principal Holders of Securities" in the SAI for
currently exercisable options granted to certain executive officers.

The Company filed an application with the Commission to request approval to
grant options under the New Plan to non-officer directors, and on September 8,
1999, the Company received such approval. On that date, each incumbent
non-officer director received options to purchase 10,000 shares, and pursuant to
the Commission order, each will receive options to purchase 5,000 shares each
year thereafter. New directors will receive options to purchase 10,000 shares
upon election to the board, and options to purchase 5,000 shares each year
thereafter.

The New Plan is designed to satisfy the conditions of Section 422 of the
Code so that options granted under the New Plan may qualify as "incentive stock
options." To qualify as "incentive stock options," options may not become
exercisable for the first time in any year if the number of incentive options
first exercisable in that year multiplied by the exercise price exceeds
$100,000.

FORMULA AWARD AND CUT-OFF AWARD

Prior to the merger, each of the five predecessor companies had a stock
option plan (each, an "Old Plan" and collectively, the "Old Plans"). Each
predecessor company's compensation committee had granted options under the
applicable Old Plan to various

56
<PAGE> 60

employees of Advisers, who were also officers of that predecessor company. In
preparation for the merger, the Advisers' compensation committee in conjunction
with the compensation committees of the other predecessor companies, determined
that the five Old Plans should be terminated upon the merger, so that the new
merged Company would be able to develop a new plan that would incent 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 employees,
and to account for the deviations caused by the existence of five plans
supported by five different publicly traded stocks, two special awards were
developed to be granted in lieu of options under the Old Plans that were forgone
upon completion of the merger and the cancellation of the Old Plans.

FORMULA AWARD. The Formula Award was designed to compensate officers from
the point when their unvested options ceased to appreciate in value pursuant to
the Cut-Off Award (i.e., August 14, 1997) up until the time in which they are
able to receive option awards in the Company after the merger became effective.
In the aggregate, the Formula Award equaled six percent (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. In total, the combined aggregate market capitalization of the predecessor
companies increased by $319 million from August 14, 1997 to December 30, 1997,
and the aggregate Formula Award was approximately $19 million.

The Formula Award was designed as a long-term incentive compensation
program to be a replacement for canceled stock options and to balance share
ownership among key officers for past and prospective service. The terms of the
Formula Award required that the award be contributed to the Company's deferred
compensation plan, as discussed below, and be used to purchase shares of the
Company in the open market.

The Formula Award vests and accrues equally over a three-year period, on
the anniversary of the merger date (December 31, 1997), and vests automatically
in the event of a change of control of the Company. If an officer terminates
employment with the Company prior to the vesting of any part of the Formula
Award, that amount will be forfeited to the Company. Assuming all officers meet
the vesting requirement, the Company will accrue the Formula Award over the
three-year period in equal amounts of approximately $6.2 million less any
forfeitures. For the nine months ended September 30, 1999 and for the year ended
December 31, 1998, $4.7 million and $6.2 million, respectively, was expensed for
the Formula Award. A table indicating the Formula Award for certain officers,
and the related vesting schedule, is contained in the SAI. For the nine months
ended September 30, 1999 and for the year ended December 31, 1998, $61,000 and
$270,000, respectively, of the Formula Award was forfeited.

On January 4, 1999, the trust that holds the deferred compensation plan
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.
These shares are held in restricted accounts at a brokerage firm.

CUT-OFF AWARD. The Cut-Off Award established a cut-off dollar amount as of
the date of the announcement of the merger (August 14, 1997) that was computed
for all outstanding, but unvested options that were 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

57
<PAGE> 61

the merger. The Cut-Off Award, in the aggregate, was computed to be $2.9
million, and is equal to the difference between the market price 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 is payable for each
canceled option as the canceled option would have vested, and vests
automatically in the event of a change of control. The Cut-Off Award is payable
only if the award recipient is employed by the Company on the future vesting
date. A table indicating the Cut-Off Award for certain officers, and the related
vesting schedule, is contained in the SAI.

EMPLOYEE STOCK OWNERSHIP PLAN

In connection with the merger, the Company adopted an amended and restated
Employee Stock Ownership Plan, or ESOP. All eligible employees (i.e., employees
with one (1) year of service who are at least 21 years of age) of the Company
are eligible participants in the ESOP. Pursuant to this qualified plan, during
1998 the Company contributed 5% of each eligible participant's total cash
compensation for the year, up to $160,000, to a plan account on the
participant's behalf, which fully vests over a two-year period. The contribution
with respect to compensation in excess of $160,000 is made to the deferred
compensation plan. The ESOP has used substantially all of these cash
contributions to purchase shares of the Company, thus aligning every employee's
interest with those of the Company and its shareholders. At September 30, 1999,
the ESOP held 0.5% of the outstanding shares of the Company, and the majority of
these shares had been allocated to participants' plan accounts.

In October 1999, the Board of Directors amended the ESOP in order to begin
the process of terminating the ESOP. It is expected that the Company will make a
final contribution to each eligible participant's account for 1999. Participants
will have the opportunity to roll their respective ESOP balances to the
Company's 401(k) plan. See "401(k) Plan."

401(K) PLAN

In October 1999, the Company established a 401(k) plan (the "401(k) Plan"),
which will replace the existing ESOP. All employees who are at least 21 years of
age have the opportunity to contribute pre-tax salary deferrals into the 401(k)
Plan up to $10,500, and to direct the investment of these contributions. The
401(k) Plan allows eligible participants to invest in shares of the Company's
common stock. In addition, beginning in 2000, the Company expects to contribute
to each eligible participant (i.e., employees with one (1) year of service) 5%
of each participant's total cash compensation for the year, up to $170,000, to
each participant's plan account on the participant's behalf, which would be
fully vested at the time of contribution. This contribution would replace any
contribution to the ESOP.

DEFERRED COMPENSATION PLAN

Pursuant to the merger, the Company succeeded to the deferred compensation
plan of Advisers (the "Deferred Compensation Plan"), and subsequently adopted
such plan as amended and restated. The Deferred Compensation Plan is a funded
plan that provides for the deferral of compensation by the Company's employees
and consultants. Any employee or consultant of the Company is eligible to
participate in the plan at such time and for such period as the board of
directors designates. The Deferred Compensation Plan is administered through a
trust, and the Company funds this plan through cash contributions. The Deferred
Compensation Plan holds the unvested shares of the Company's common stock
purchased in connection with the Formula Award.

58
<PAGE> 62

TAXATION

The following discussion is a general summary of the material federal
income tax considerations applicable to the Company and to an investment in the
common stock and does not purport to be a complete description of the income tax
considerations applicable to such an investment. The discussion is based upon
the Code, Treasury Regulations, and administrative and judicial interpretations
each as of the date of this prospectus and, all of which are subject to change.
You should consult your own tax advisor with respect to tax considerations which
pertain to your purchase of common stock.

This summary assumes that the investors in the Company hold shares as
capital assets. This summary does not discuss all aspects of federal income
taxation relevant to holders of the common stock in light of particular
circumstances, or to certain types of holders subject to special treatment under
federal income tax laws, including dealers in securities and financial
institutions. This summary does not discuss any aspects of foreign, state or
local tax laws.

TAXATION AS A RIC

The Company intends to be treated for tax purposes as a "regulated
investment company" or "RIC" within the meaning of Section 851 of the Code. If
the Company qualifies as a RIC and distributes to its shareholders in a timely
manner at least 90% of its "investment company taxable income," as defined in
the Code (the "90% Distribution Requirement"), each year, it will not be subject
to federal income tax on the portion of its taxable income and gains it
distributes to 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 (pursuant to Section
4982(e)(4)(A) of the Code), 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. The Company generally endeavors to
distribute to shareholders all of its investment company taxable income and its
net capital gain, if any, for each taxable year so that it will not incur income
and excise taxes on its earnings.

In order to qualify as a RIC for federal income tax purposes, the Company
must, among other things: (1) continue to qualify as a BDC under the 1940 Act;
(2) derive in each taxable year 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; and (3) diversify its holdings so that
at the end of each quarter of the taxable year (a) at least 50% of the value of
its assets consists of cash, cash items, U.S. government securities, securities
of other RICs, and other securities if such other securities of any one issuer
do not represent more than 5% of the Company's assets or 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 securities of other RICs), or of two or more issuers
that are controlled by the Company and are engaged in the same or similar or
related trades or businesses. The failure of one or more of the Company's
subsidiaries to continue to qualify as RICs could adversely affect the Company's
ability to satisfy foregoing diversification requirements.

59
<PAGE> 63

case, all of the Company's distributions to its shareholders will be
characterized as ordinary income (to the extent of the Company's current and
accumulated earnings and profits). In contrast, as is explained below, if the
Company qualifies as a RIC, a portion of its distributions may be characterized
as long-term capital gain in the hands of shareholders.

TAXATION OF SHAREHOLDERS

Distributions of the Company generally are taxable to shareholders as
ordinary income or capital gains. Shareholders receive notification from the
Company at the end of each year as to the amount and nature of the income or
gains distributed to them for that year. The distributions from the Company to a
particular shareholder may be subject to the alternative minimum tax under the
provisions of the Code. Shareholders not subject to tax on income will not be
required to pay tax on amounts the Company distributed to them.

The Company's distributions of the ordinary income and net short-term
capital gain generally are taxable to shareholders as ordinary income.
Distributions of net capital gain, if any, that the Company designates as
capital gain dividends generally are taxable to shareholders as long-term
capital gain, regardless of the length of time a shareholder has held the
shares. All distributions are taxable, whether invested in additional shares or
received in cash. Dividends that the Company declares and are payable to
shareholders of record in October, November or December of a given year that are
paid during the following January, will be treated as having been received by
shareholders on December 31 of the year of declaration.

If certain conditions are met, the Company's ordinary income dividends to
its corporate shareholders may qualify for the dividends received deduction to
the extent that the Company receives qualifying dividend income during the
taxable year. Capital gain dividends distributed by the Company are not eligible
for the dividends received deduction.

In general, any gain or loss realized upon a taxable disposition of shares
of the Company, or upon receipt of a liquidating distribution, will be treated
as capital gain or loss. If gain is realized, it will be subject to taxation at
various tax rates depending on the length of time the taxpayer has held such
shares and other factors. The gain or loss will be short-term capital gain or
loss if the shares have been held for one year or less. If a shareholder has
received any capital gain dividends with respect to such shares, any loss
realized upon a taxable disposition of shares treated under the Code as having
been held for six months or less, to the extent of such capital gain dividends,
will be treated as a long-term capital loss. All or a portion of any loss
realized upon a taxable disposition of shares of the Company may be disallowed
if other shares of the Company are purchased (under a DRIP plan or otherwise)
within 30 days before or after the disposition.

A shareholder that is not a "United States person" within the meaning of
the Code (a "Non-U.S. shareholder") generally will be subject to a withholding
tax of 30% (or lower applicable treaty rate) on dividends from the Company
(other than capital gain dividends) that are not "effectively connected" with a
United States trade or business carried on by such shareholder. Accordingly,
investment in the Company is likely to be appropriate for a Non-U.S. shareholder
only if such person can utilize a foreign tax credit or corresponding tax
benefit in respect of such United States withholding tax. Non-effectively
connected capital gain dividends and gains realized from the sale of Shares will
not be subject to United States federal income tax in the case of (i) a Non-
U.S. shareholder that is a corporation and (ii) a Non-U.S. shareholder that is
not present in the United States for more than 182 days during the taxable year
(assuming that

60
<PAGE> 64

certain other conditions are met). See "Tax Status -- Non-U.S. Stockholders" in
the SAI. Prospective foreign investors should consult their U.S. tax advisors
concerning the tax consequences to them of an investment in shares.

The Company is required to withhold and remit to the Internal Revenue
Service (the "IRS") 31% of the dividends paid to any shareholder who (i) fails
to furnish the Company with a certified taxpayer identification number; (ii) has
underreported dividend or interest income to the IRS; or (iii) fails to certify
to the Company that he, she or it is not subject to backup withholding.

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 we make 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

61
<PAGE> 65

continuing basis to any portfolio company that requests it, whether or not
difficulties are perceived.

As a BDC, the Company is entitled to issue senior securities in the form of
stock or senior securities representing indebtedness, as long as each class of
senior security has an asset coverage of at least 200% immediately after each
such issuance. This limitation is not applicable to borrowings by our SBIC or
SBLC subsidiaries, and therefore any borrowings by these subsidiaries are not
included in this asset coverage test. See "Risk Factors."

We may not change the nature of our business so as to cease to be, or
withdraw our election as, a BDC unless authorized by vote of a "majority of the
outstanding voting securities," as defined in the 1940 Act, of our shares. Since
we made our BDC election, we have not made any substantial change in the nature
of our business.

REGULATED INVESTMENT COMPANY ("RIC"). Our status as a RIC enables us to
avoid the cost of federal and state taxation, and as a result achieve pre-tax
investment returns. We believe that this tax advantage enables us to achieve
strong equity returns without having to aggressively leverage our balance sheet.

In order to qualify as a RIC, the Company must, among other things:

(1) Derive at least 90% of its gross income from dividends, interest,
payments with respect to securities loans, gains from the sale of stock
or other securities or other income derived with respect to its
business of investing in such stock or securities.

(2) Diversify its holdings so that

(a) at least 50% of the value of the Company's assets consists of cash,
cash items, 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

62
<PAGE> 66

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 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 September 30, 1999; as a result of the $101 million limit, the Company is
limited on its ability to apply for additional financing from the SBA. Interest
rates on the SBA debentures currently outstanding have a weighted average
interest rate of 8.22%.

At September 30, 1999, 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.

DIVIDEND REINVESTMENT PLAN

We have adopted an "opt out" dividend reinvestment plan ("DRIP plan").
Under the DRIP plan, if you own shares registered in your own name, our transfer
agent, acting as reinvestment plan agent, will automatically reinvest any
dividend in additional shares of common stock. Shareholders may change
enrollment status in the DRIP plan at any time by contacting either the plan
agent or the Company.

A shareholder's ability to participate in a DRIP plan may be limited
according to how the shares are registered. A nominee may preclude beneficial
owners holding shares in street name from participating in the DRIP plan.
Shareholders who wish to participate in a

63
<PAGE> 67

DRIP plan may need to register their shares in their own name. Shareholders will
be informed of their right to opt out of the DRIP plan in the Company's annual
and quarterly reports to shareholders. Shareholders who hold shares in the name
of a nominee should contact the nominee for details.

All distributions to investors who do not participate (or whose nominee
elects not to participate) in the DRIP plan will be paid by check mailed
directly, or through the nominee, to the record holder by or under the
discretion of the plan agent. The plan agent is American Stock Transfer and
Trust Company, 40 Wall Street, New York, New York 10005. Their telephone number
is 800-937-5449.

Under the DRIP plan, we may issue new shares unless the market price of the
outstanding shares is less than 110% of the last reported net asset value.
Alternatively, the plan agent may buy shares in the market. We value newly
issued shares for the DRIP plan at the average of the reported last sale prices
of the outstanding shares on the last five trading days prior to the payment
date of the distribution, but not less than 95% of the opening bid price on such
date. The price in the case of shares bought in the market will be the average
actual cost of such shares, including any brokerage commissions. There are no
other fees charged to shareholders in connection with the DRIP plan. Any
distributions reinvested under the plan will nevertheless remain taxable to the
shareholders.

DESCRIPTION OF CAPITAL STOCK
COMMON STOCK

The Company is authorized to issue 100,000,000 shares of common stock, par
value $0.0001. At November 5, 1999, there were 62,491,777 shares of common stock
outstanding and 5,307,073 shares of Common Stock reserved for issuance under the
New Plan. The following are the authorized classes of securities of the Company
as of November 5, 1999:

<TABLE>
<CAPTION>
(4)
(3) AMOUNT
AMOUNT HELD OUTSTANDING
(2) BY COMPANY EXCLUSIVE OF
(1) AMOUNT OR FOR ITS AMOUNTS SHOWN
TITLE OF CLASS AUTHORIZED ACCOUNT* UNDER(3)
-------------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Allied Capital
Corporation.......... Common Stock 100,000,000 516,779 61,974,998
</TABLE>

- -------------------------
* Represents shares of the Company held in a trust for the Deferred Compensation
Plan. See "Management -- Compensation Plans."

All shares of common stock have equal rights as to earnings, assets,
dividends, and voting privileges and all outstanding shares of common stock are
fully paid and non-assessable. Our common stock has no preemptive, conversion,
or redemption rights and are freely transferable. In the event of liquidation,
each share of common stock is entitled to its proportion of our assets after
debts and expenses. Each share is entitled to one vote and does not have
cumulative voting rights, which means that holders of a majority of the shares,
if they so choose, could elect all of the directors, and holders of less than a
majority of the shares would, in that case, be unable to elect any director. All
shares offered hereby will be, when issued and paid for, fully paid and
non-assessable.

64
<PAGE> 68

The board of directors may classify and reclassify any unissued shares of
capital stock of the Company by setting or changing in one or more respects the
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications, terms or conditions or redemption
or other rights of such shares of capital stock.

LIMITATION ON LIABILITY OF DIRECTORS

The Company has adopted provisions in its charter and bylaws limiting the
liability of directors and officers of the Company for monetary damages. The
effect of these provisions in the charter and bylaws is to eliminate the rights
of the Company and its shareholders (through shareholders' derivative suits on
behalf of the Company) to recover monetary damages against a director or
officers for breach of the fiduciary duty of care as a director or officer
(including breaches resulting from negligent or grossly negligent behavior)
except in certain limited situations. These provisions do not limit or eliminate
the rights of the Company or any shareholder to seek non-monetary relief such as
an injunction or rescission in the event of a breach of a director's or
officer's duty of care. These provisions will not alter the liability of
directors or officers under federal securities laws.

CERTAIN ANTI-TAKEOVER PROVISIONS

The charter and bylaws of the Company and certain statutory and regulatory
requirements contain certain provisions that could make more difficult the
acquisition of the Company by means of a tender offer, a proxy contest or
otherwise. These provisions are expected to discourage certain types of coercive
takeover practices and inadequate takeover bids and to encourage persons seeking
to acquire control of the Company to negotiate first with the board of
directors. We believe that the benefits of these provisions outweigh the
potential disadvantages of discouraging such proposals because, among other
things, negotiation of such proposals might result in an improvement of their
terms. The description set forth below is intended as a summary only and is
qualified in its entirety by reference to the charter and the bylaws.

CLASSIFIED BOARD OF DIRECTORS

The charter provides for the board of directors to be divided into three
classes of directors serving staggered three-year terms, with each class to
consist as nearly as possible of one-third of the directors then elected to the
board. A classified board may render more difficult a change in control of the
Company or removal of incumbent management. We believe, however, that the longer
time required to elect a majority of a classified board of directors helps to
ensure continuity and stability of the Company's management and policies.

ISSUANCE OF PREFERRED STOCK

The board of directors of the Company, without shareholder approval, has
the authority to reclassify common stock as preferred stock and to issue
preferred stock. Such stock could be issued with voting, conversion or other
rights designed to have an anti-takeover effect.

65
<PAGE> 69

MARYLAND CORPORATE LAW

The Company is subject to the Maryland Business Combination Statute and the
Control Share Acquisition Statute, as defined below. The partial summary of the
foregoing statutes contained in this prospectus is not intended to be complete
and reference is made to the full text of such states for their entire terms.

BUSINESS COMBINATION STATUTE. Certain provisions of the Maryland Law
establish special requirements with respect to "business combinations" between
Maryland corporations and "interested shareholders" unless exemptions are
applicable (the "Business Combination Statute"). Among other things, the
Business Combination Statute prohibits for a period of five years a merger or
other specified transactions between a company and an interested shareholder and
requires a super majority vote for such transactions after the end of such
five-year period.

"Interested shareholders" are all persons owning beneficially, directly or
indirectly, 10% or more of the outstanding voting stock of a Maryland
corporation. "Business combinations" include certain mergers or similar
transactions subject to a statutory vote and additional transactions involving
transfer of assets or securities in specified amounts to interested shareholders
or their affiliates.

Unless an exemption is available, a "business combination" may not be
consummated between a Maryland corporation and an interested shareholder or its
affiliates for a period of five years after the date on which the shareholder
first became an interested shareholder and thereafter may not be consummated
unless recommended by the board of directors of the Maryland corporation and
approved by the affirmative vote of at least 80% of the votes entitled to be
cast by all holders of outstanding shares of voting stock and 66 2/3% of the
votes entitled to be cast by all holders of outstanding shares of voting stock
other than the interested shareholder or its affiliates or associates, unless,
among other things, the corporation's shareholders receive a minimum price (as
defined in the Business Combination Statute) for their shares and the
consideration is received in cash or in the same form as previously paid by the
interested shareholder for its shares.

A business combination with an interested shareholder which is approved by
the board of directors of a Maryland corporation at any time before an
interested shareholder first becomes an interested shareholder is not subject to
the five-year moratorium or special voting requirements. An amendment to a
Maryland corporation charter electing not to be subject to the foregoing
requirements must be approved by the affirmative vote of at least 80% of the
votes entitled to be cast by all holders of outstanding shares of voting stock
and 66 2/3% of the votes entitled to be cast by holders of outstanding shares of
voting stock who are not interested shareholders. Any such amendment is not
effective until 18 months after the vote of shareholders and does not apply to
any business combination of a corporation with a shareholder who became an
interested shareholder on or prior to the date of such vote.

CONTROL SHARE ACQUISITION STATUTE. The Maryland Law imposes limitations on
the voting rights of shares acquired in a "control share acquisition." The
control share statute defines a "control share acquisition" to mean the
acquisition, directly or indirectly, of "control shares" subject to certain
exceptions. "Control shares" of a Maryland corporation are defined to be voting
shares of stock which, if aggregated with all other shares of stock previously
acquired by the acquiror, would entitle the acquiror to exercise voting power in
electing directors with one of the following ranges of voting power:

66
<PAGE> 70

(1) one-fifth or more but not less than one-third;

(2) one-third or more but less than a majority; or

(3) a majority of all voting power.

Control shares do not include shares which the acquiring person is entitled
to vote as a result of having previously obtained shareholder approval. Control
shares of a Maryland corporation acquired in a control share acquisition have no
voting rights except to the extent approved by a vote of two-thirds of the votes
entitled to be cast by shareholders in the election of directors, excluding
shares of stock as to which the acquiring person, officers of the corporation
and directors of the corporation who are employees of the corporation are
entitled to exercise or direct the exercise of the voting power of the shares in
the election of the directors.

The control share statute also requires Maryland corporations to hold a
special meeting at the request of an actual or proposed control share acquiror
generally within 50 days after a request is made with the submission of an
"acquiring person statement," but only if the acquiring person:

(1) gives a written undertaking and, if required by the directors of the
issuing corporation, posts a bond for the cost of the meeting; and

(2) submits definitive financing agreements for the acquisition of the
control shares to the extent that financing is not provided by the
acquiring person.

In addition, unless the issuing corporation's charter or bylaws provide
otherwise, the control share statute provides that the issuing corporation,
within certain time limitations, shall have the right to redeem control shares
(except those for which voting rights have previously been approved) for "fair
value" as determined pursuant to the control share statue in the event:

(1) there is a shareholder vote and the grant of voting rights is not
approved; or

(2) an "acquiring person statement" is not delivered to the target within
10 days following a control share acquisition.

Moreover, unless the issuing corporation's charter or bylaws provide
otherwise, the control share statute provides that if, before a control share
acquisition occurs, voting rights are accorded to control shares which result in
the acquiring person having majority voting power, then all shareholders other
than the acquiring person have appraisal rights as provided under the Maryland
Law. An acquisition of shares may be exempted from the control share statute
provided that a charter or bylaw provision is adopted for such purpose prior to
the control share acquisition by any person with respect to the Company. The
control share acquisition statute does not apply to shares acquired in a merger,
consolidation or share exchange to which the corporation is a party.

REGULATORY RESTRICTIONS

Allied Investment is an SBIC and Allied SBLC is an SBLC, and both are
wholly owned subsidiaries of the Company. The SBA prohibits, without prior SBA
approval, a "change of control" or transfers which would result in any person
(or group of persons acting in concert) owning 10% or more of any class of
capital stock of an SBIC. A "change of control" is any event which would result
in a transfer of the power, direct or

67
<PAGE> 71

indirect, to direct the management and policies of an SBIC or SBLC, whether
through ownership, contractual arrangements or otherwise.

PLAN OF DISTRIBUTION

We may sell shares through underwriters or dealers, directly to one or more
purchasers, through agents or through a combination of any such methods of sale.
Any underwriter or agent involved in the offer and sale of shares will be named
in the applicable prospectus supplement.

The distribution of shares may be effected from time to time in one or more
transactions at a fixed price or prices, which may be changed, at prevailing
market prices at the time of sale, at prices related to such prevailing market
prices, or at negotiated prices, provided, however, that the offering price per
share, less any commissions or discounts, must equal or exceed the net asset
value ("NAV") per share of our common stock.

In connection with the sale of shares, underwriters or agents may receive
compensation from the Company or from purchasers of shares, for whom they may
act as agents, in the form of discounts, concessions or commissions.
Underwriters may sell shares to or through dealers and such dealers may receive
compensation in the form of discounts, concessions or commissions from the
underwriters and/or commissions from the purchasers for whom they may act as
agents. Underwriters, dealers and agents that participate in the distribution of
shares may be deemed to be underwriters under the Securities Act, and any
discounts and commissions they receive from the Company and any profit realized
by them on the resale of shares may be deemed to be underwriting discounts and
commissions under the Securities Act. Any such underwriter or agent will be
identified and any such compensation received from the Company will be described
in the applicable prospectus supplement.

Any shares sold pursuant to a prospectus supplement will be quoted on the
Nasdaq National Market, or another exchange on which the shares are traded.

Under agreements into which the Company may enter, underwriters, dealers
and agents who participate in the distribution of shares may be entitled to
indemnification by the Company against certain liabilities, including
liabilities under the Securities Act.

Underwriters, dealers and agents may engage in transactions with, or
perform services for, the Company in the ordinary course of business.

If so indicated in the applicable prospectus supplement, the Company will
authorize underwriters or other persons acting as the Company's agents to
solicit offers by certain institutions to purchase shares from the Company
pursuant to contracts providing for payment and delivery on a future date.
Institutions with which such contracts may be made include commercial and
savings banks, insurance companies, pension funds, investment companies,
educational and charitable institutions and others, but in all cases such
institutions must be approved by the Company. The obligations of any purchaser
under any such contract will be subject to the condition that the purchase of
shares shall not at the time of delivery be prohibited under the laws of the
jurisdiction to which such purchaser is subject. The underwriters and such other
agents will not have any responsibility in respect of the validity or
performance of such contracts. Such contracts will be subject only to those
conditions set forth in the prospectus supplement, and the

68
<PAGE> 72

prospectus supplement will set forth the commission payable for solicitation of
such contracts.

In order to comply with the securities laws of certain states, if
applicable, shares offered hereby will be sold in such jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
states, the shares may not be sold unless they have been registered or qualified
for sale in the applicable state or an exemption from the registration or
qualification requirement is available and is complied with.

LEGAL MATTERS

Certain legal matters with respect to the validity of the shares of common
stock offered hereby will be passed upon for the Company by Sutherland Asbill &
Brennan LLP, Washington, D.C. Certain legal matters will be passed upon for
underwriters, if any, by the counsel named in the prospectus supplement.

SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT
AND REGISTRAR

The Company's and its subsidiaries' investments are held in safekeeping by
Riggs Bank, N.A. at 808 17th Street, N.W., Washington, D.C. 20006. LaSalle
National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk Grove
Village, Illinois 60007, serves as trustee with respect to assets of the Company
held for securitization purposes. American Stock Transfer and Trust Company, 40
Wall Street, 46th Floor, New York, New York 10005 acts as the Company's
transfer, dividend paying and reinvestment plan agent and registrar.

INDEPENDENT PUBLIC ACCOUNTANTS

The financial statements included in this prospectus and elsewhere in the
registration statement to the extent and for the periods indicated in their
report have been audited by Arthur Andersen LLP, independent public accountants,
and is included herein in reliance upon the authority of said firm as experts in
giving said report.

69
<PAGE> 73

TABLE OF CONTENTS OF
STATEMENT OF ADDITIONAL INFORMATION

<TABLE>
<S> <C>
General Information and History............................. B-2
Investment Objective and Policies........................... B-2
Management.................................................. B-2
Compensation of Executive Officers and Directors....... B-2
Compensation of Directors.............................. B-3
Stock Option Awards.................................... B-4
Formula Award and Cut-off Award........................ B-4
Committees of the Board of Directors................... B-6
Control Persons and Principal Holders of Securities......... B-7
Investment Advisory Services................................ B-8
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. B-8
Accounting Services......................................... B-8
Brokerage Allocation and Other Practices.................... B-8
Tax Status.................................................. B-9
</TABLE>

70
<PAGE> 74

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Balance Sheet -- September 30, 1999 (unaudited)
and December 31, 1998 and 1997............................ F-1
Consolidated Statement of Operations -- For the Nine Months
Ended September 30, 1999 and 1998 (unaudited) and for the
Years Ended December 31, 1998, 1997 and 1996.............. F-2
Consolidated Statement of Changes in Net Assets -- For the
Nine Months Ended September 30, 1999 and 1998 (unaudited)
and for the Years Ended December 31, 1998, 1997 and
1996...................................................... F-3
Consolidated Statement of Cash Flows -- For the Nine Months
Ended September 30, 1999 and 1998 (unaudited) and for the
Years Ended December 31, 1998, 1997 and 1996.............. F-4
Consolidated Statement of Investments -- September 30, 1999
(unaudited) and December 31, 1998......................... F-5
Notes to Consolidated Financial Statements.................. F-16
Report of Independent Public Accountants.................... F-38
</TABLE>

71
<PAGE> 75

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- -------------------
1999 1998 1997
------------- -------- --------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Portfolio at value:
Mezzanine loans and debt securities (cost:
1999-$495,169; 1998-$354,870; 1997-$181,184)........ $ 476,003 $339,163 $167,842
Commercial mortgage-backed securities (cost:
1999-$297,656; 1998-$115,174; 1997-$0).............. 296,156 113,674 --
Commercial mortgage loans (cost: 1999-$185,128;
1998-$232,745; 1997-$446,114)....................... 185,481 233,186 447,244
Small Business Administration 7(a) loans (cost:
1999-$69,394; 1998-$57,651; 1997-$41,103)........... 68,912 56,285 40,709
Equity interests in portfolio companies (cost:
1999-$43,192; 1998-$27,618; 1997-$20,050)........... 70,031 49,391 39,906
Other portfolio assets (cost: 1999-$7,572;
1998-$8,331; 1997-$2,269)........................... 7,070 8,575 1,320
---------- -------- --------
Total portfolio at value.......................... 1,103,653 800,274 697,021
---------- -------- --------
Cash and cash equivalents................................... 15,376 25,075 70,437
U.S. government securities.................................. -- -- 11,091
Other assets................................................ 50,502 30,730 29,226
---------- -------- --------
Total assets...................................... $1,169,531 $856,079 $807,775
========== ======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable.......................... $ 404,850 $239,350 $308,821
Revolving lines of credit............................. 133,000 95,000 38,842
Accounts payable and other liabilities................ 30,848 27,912 23,984
Dividends and distributions payable................... -- 1,700 9,068
---------- -------- --------
Total liabilities................................. 568,698 363,962 380,715
---------- -------- --------
Commitments and Contingencies
Preferred stock issued to Small Business Administration..... 7,000 7,000 7,000
Shareholders' equity:
Common stock, $0.0001 par value, 100,000,000 shares
authorized; 62,488,443, 56,729,502 and 52,047,318
issued and outstanding at September 30, 1999,
December 31, 1998 and 1997, respectively............ 6 6 5
Additional paid-in capital............................ 637,096 526,824 451,044
Common stock held in deferred compensation trust
(516,779 shares and 810,456 shares at September 30,
1999 and December 31, 1998, respectively)........... (13,128) (19,431) --
Notes receivable from sale of common stock............ (27,276) (23,735) (29,611)
Net unrealized appreciation on portfolio.............. 3,855 2,380 1,301
Distributions in excess of earnings................... (6,720) (927) (2,679)
---------- -------- --------
Total shareholders' equity........................ 593,833 485,117 420,060
---------- -------- --------
Total liabilities and shareholders' equity........ $1,169,531 $856,079 $807,775
========== ======== ========
</TABLE>

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

F-1
<PAGE> 76

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, FOR THE YEARS ENDED DECEMBER 31,
------------------- ---------------------------------
1999 1998 1998 1997 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- -------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Interest and related portfolio income:
Interest.............................................. $84,419 $58,428 $79,921 $86,882 $77,541
Net premiums from loan dispositions................... 9,032 2,913 5,949 7,277 4,241
Net gain on securitization of commercial mortgage
loans............................................... -- 14,812 14,812 -- --
Investment advisory fees and other income............. 5,411 4,611 6,056 3,246 3,155
------- ------- ------- ------- -------
Total interest and related portfolio income....... 98,862 80,764 106,738 97,405 84,937
------- ------- ------- ------- -------
Expenses:
Interest on indebtedness.............................. 24,173 14,539 20,694 26,952 20,298
Salaries and employee benefits........................ 11,303 8,254 11,829 10,258 8,774
General and administrative............................ 8,476 8,970 11,921 8,970 8,289
Merger................................................ -- -- -- 5,159 --
------- ------- ------- ------- -------
Total operating expenses.......................... 43,952 31,763 44,444 51,339 37,361
Formula and cut-off awards............................ 5,188 5,532 7,049 -- --
------- ------- ------- ------- -------
Portfolio income before net realized and unrealized gains... 49,722 43,469 55,245 46,066 47,576
------- ------- ------- ------- -------
Net realized and unrealized gains:
Net realized gains.................................... 16,448 20,001 22,541 10,704 19,155
Net unrealized gains (losses)......................... 1,475 (437) 1,079 7,209 (7,412)
------- ------- ------- ------- -------
Total net realized and unrealized gains........... 17,923 19,564 23,620 17,913 11,743
------- ------- ------- ------- -------
Income before minority interests and income taxes........... 67,645 63,033 78,865 63,979 59,319
Minority interests.......................................... -- -- -- 1,231 2,427
Income tax expense.......................................... -- 1,585 787 1,444 1,945
------- ------- ------- ------- -------
Net increase in net assets resulting from operations........ $67,645 $61,448 $78,078 $61,304 $54,947
======= ======= ======= ======= =======
Basic earnings per common share............................. $ 1.14 $ 1.19 $ 1.50 $ 1.24 $ 1.19
======= ======= ======= ======= =======
Diluted earnings per common share........................... $ 1.14 $ 1.19 $ 1.50 $ 1.24 $ 1.17
======= ======= ======= ======= =======
Weighted average common shares outstanding -- basic......... 59,077 51,502 51,941 49,218 46,172
======= ======= ======= ======= =======
Weighted average common shares outstanding -- diluted....... 59,239 51,712 51,974 49,251 46,733
======= ======= ======= ======= =======
</TABLE>

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

F-2
<PAGE> 77

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, FOR THE YEARS ENDED DECEMBER 31,
------------------- ---------------------------------
1999 1998 1998 1997 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- -------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operations:
Portfolio income before realized and
unrealized gains................... $ 49,722 $ 43,469 $ 55,245 $ 46,066 $ 47,576
Net realized gains................... 16,448 20,001 22,541 10,704 19,155
Net unrealized gains (losses)........ 1,475 (437) 1,079 7,209 (7,412)
Minority interests and income tax
expense............................ -- 1,585 (787) (2,675) (4,372)
-------- -------- -------- -------- --------
Net increase in net assets
resulting from operations..... 67,645 61,448 78,078 61,304 54,947
-------- -------- -------- -------- --------
Shareholder distributions:
Portfolio income..................... (71,800) (54,727) (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............. (165) (165) (230) (220) (220)
-------- -------- -------- -------- --------
Net decrease in net assets
resulting from shareholder
distributions................. (71,965) (54,892) (75,317) (85,898) (57,618)
-------- -------- -------- -------- --------
Capital share transactions:
Sale of common stock................. 103,022 -- 69,675 -- 22,365
Net decrease (increase) in notes
receivable from sale of common
stock.............................. (3,540) 5,711 5,576 (14,120) (8,176)
Issuance of common stock upon the
exercise of stock options.......... 3,753 222 221 28,426 12,176
Issuance of common stock in lieu of
cash distributions................. 3,498 4,097 6,184 26,612 11,986
Purchase of common stock by deferred
compensation trust................. -- (19,431) (19,431) -- --
Distribution of common stock by
deferred compensation trust........ 6,303 -- -- -- --
Other................................ -- 1,500 71 1,602 (738)
-------- -------- -------- -------- --------
Net increase (decrease) in net
assets resulting from capital
share transactions............ 113,036 (7,901) 62,296 42,520 37,613
-------- -------- -------- -------- --------
Total increase (decrease) in net assets... $108,716 $ (1,345) $ 65,057 $ 17,926 $ 34,942
-------- -------- -------- -------- --------
Net assets at beginning of period......... $485,117 $420,060 $420,060 $402,134 $367,192
-------- -------- -------- -------- --------
Net assets at end of period............... $593,833 $418,715 $485,117 $420,060 $402,134
======== ======== ======== ======== ========
Net asset value per common share.......... $ 9.58 $ 8.13 $ 8.68 $ 8.07 $ 8.34
======== ======== ======== ======== ========
Common shares outstanding at end of
period.................................. 61,972 51,490 55,919 52,047 48,238
======== ======== ======== ======== ========
</TABLE>

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

F-3
<PAGE> 78

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, FOR THE YEARS ENDED DECEMBER 31,
--------------------- ---------------------------------
1999 1998 1998 1997 1996
(IN THOUSANDS) --------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net increase in net assets resulting from
operations................................ $ 67,645 $ 61,448 $ 78,078 $ 61,304 $ 54,947
Adjustments
Net unrealized (gains) losses............. (1,475) (286) (1,079) (7,209) 7,412
Net gain on securitization of commercial
mortgage loans.......................... -- (14,812) (14,812) -- --
Depreciation and amortization............. 599 523 702 450 393
Amortization of loan discounts and fees... (6,195) (3,237) (6,032) (10,804) (9,027)
Deferred income taxes..................... -- -- -- 1,087 (381)
Minority interests........................ -- -- -- 1,231 2,427
Changes in other assets and liabilities... (11,518) 6,206 11,998 12,881 (10,606)
--------- --------- --------- --------- ---------
Net cash provided by operating
activities........................... 49,056 49,842 68,855 58,940 45,165
--------- --------- --------- --------- ---------
Cash flows from investing activities:
Investments in small business concerns...... (534,017) (349,586) (524,530) (364,942) (283,295)
Collections of investment principal......... 120,563 75,817 138,081 233,005 179,292
Proceeds from loan sales.................... 120,871 28,957 81,013 53,912 27,715
Proceeds from securitization of commercial
mortgage loans............................ -- 223,401 223,401 -- --
Net redemption (purchase) of U.S. government
securities................................ -- 11,091 11,091 (10,301) --
Collections of notes receivable from sale of
common stock.............................. 212 5,411 5,591 6,534 2,199
Other investing activities.................. (2,738) (1,431) (2,539) (182) 2,635
--------- --------- --------- --------- ---------
Net cash (used in) provided by investing
activities........................... (295,109) (6,340) (67,892) (81,974) (71,454)
--------- --------- --------- --------- ---------
Cash flows from financing activities:
Sale of common stock........................ 103,079 222 69,896 8,615 24,166
Purchase of common stock by deferred
compensation trust........................ -- (19,431) (19,431) -- --
Common dividends and distributions paid..... (70,003) (51,107) (69,536) (58,194) (47,089)
Special undistributed earnings distribution
paid...................................... -- (8,261) (8,848) -- --
Preferred stock dividends................... (165) (385) (450) (220) (220)
Net borrowings under (payments on)
debentures and notes payable.............. 165,500 (17,171) (69,471) 78,923 (35,202)
Net borrowings under (payments on) revolving
lines of credit........................... 38,000 31,158 56,158 (6,257) 110,460
Other financing activities.................. (57) (5,342) (4,643) (1,237) (3,029)
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities........................... 236,354 (70,317) (46,325) 21,630 49,086
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash
equivalents................................. $ (9,699) $ (26,815) $ (45,362) $ (1,404) $ 22,797
Cash and cash equivalents at beginning of
period...................................... $ 25,075 $ 70,437 $ 70,437 $ 71,841 $ 49,044
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of period.... $ 15,376 $ 43,622 $ 25,075 $ 70,437 $ 71,841
========= ========= ========= ========= =========
</TABLE>

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

F-4
<PAGE> 79

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INVESTMENTS

ACE Products, Inc. Debt Securities $ 13,171 $ 13,171
- -----------------------------------------------------------------------------------------------------
Acme Paging, L.P. Debt Securities 6,525 6,525
Partnership Interest 1,456 2,100
- -----------------------------------------------------------------------------------------------------
Allied Office Products Debt Securities 9,952 9,952
Warrants -- --
- -----------------------------------------------------------------------------------------------------
American Barbecue & Grill, Inc. Warrants 125 125
- -----------------------------------------------------------------------------------------------------
AMF Bowling, Inc. (1) High Yield Debt 5,479 5,479
- -----------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -----------------------------------------------------------------------------------------------------
Aurora Communications Inc. Loans 13,365 13,365
Preferred Stock 1,500 1,500
- -----------------------------------------------------------------------------------------------------
Avborne, Inc. Debt Securities 11,934 11,934
Warrants 1,180 1,180
- -----------------------------------------------------------------------------------------------------
CampGroup, LLC Debt Securities 2,450 2,450
Warrants 220 220
- -----------------------------------------------------------------------------------------------------
Candlewood Hotel Company (1) Preferred Stock (3,250 shares) 3,250 3,250
- -----------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 318 318
Warrants 12 12
- -----------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,610 850
Common Stock (220 shares) 1 --
- -----------------------------------------------------------------------------------------------------
Convenience Corporation of Debt Securities 8,391 2,774
America Series A Preferred Stock (31,521 shares) 334 --
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Cooper Natural Resources, Inc. Debt Securities 3,458 3,458
Warrants -- 1,138
- -----------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC Loan 5,921 5,921
- -----------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Debt Securities 5,809 5,809
Resources, LLC Options 87 87
- -----------------------------------------------------------------------------------------------------
Coverall North America Loan 9,296 9,296
- -----------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 --
- -----------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 --
- -----------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc. (1) Warrants 350 49
- -----------------------------------------------------------------------------------------------------
Directory Investment Corporation Common Stock (470 shares) -- --
- -----------------------------------------------------------------------------------------------------
Directory Lending Corporation Series A Common Stock (34 shares) -- --
Series B Common Stock (6 shares) 8 --
Series C Common Stock (10 shares) 22 --
- -----------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>

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

F-5
<PAGE> 80

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Drilltec Patents & Technologies Loan $ 10,908 $ 8,752
Company, Inc. Debt Securities 426 426
Warrants -- --
- -----------------------------------------------------------------------------------------------------
ECM Enterprises Loan 28 4
- -----------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 14 14
Debt Securities 1,875 343
Common Stock (100 shares) 250 --
- -----------------------------------------------------------------------------------------------------
El Dorado Communications, Inc. Loans 306 306
- -----------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 29 29
- -----------------------------------------------------------------------------------------------------
Esquire Communications Ltd. (1) Warrants 6 --
- -----------------------------------------------------------------------------------------------------
Everything Yogurt Loan 8 8
- -----------------------------------------------------------------------------------------------------
Ex Terra Credit Recovery, Inc. Series A Preferred Stock (500 shares) 500 500
Common Stock (2,500 shares) -- --
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Executive Greetings, Inc. Debt Securities 15,736 15,736
Warrants 360 360
- -----------------------------------------------------------------------------------------------------
Fairchild Industrial Products Debt Securities 5,740 5,740
Company Warrants 280 3,628
- -----------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loans 200 200
- -----------------------------------------------------------------------------------------------------
FTI Consulting, Inc. (1) Debt Securities 11,874 11,874
Warrants 970 970
- -----------------------------------------------------------------------------------------------------
Galaxy American Debt Securities 30,731 30,731
Communications, LLC Warrants -- 750
- -----------------------------------------------------------------------------------------------------
Genesis Worldwide, Inc. (1) Loan 1,328 1,328
Common Stock (41,644 shares) 214 151
- -----------------------------------------------------------------------------------------------------
Genoa Mine Acquisition Loan 242 242
Corporation
- -----------------------------------------------------------------------------------------------------
Gibson Guitar Corporation Debt Securities 15,572 15,572
Warrants 525 1,000
- -----------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- 154
- -----------------------------------------------------------------------------------------------------
Global Communications I, LLC Debt Securities 1,863 1,863
Preferred Stock 5,667 5,667
- -----------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 1,390 840
Archery, LLC Convertible Debentures 2,248 2,008
- -----------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 8,500
- -----------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 9,171 9,171
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Han Hie Loan 504 504
- -----------------------------------------------------------------------------------------------------
Hotelevision, Inc. Preferred Stock (1,000,000 shares) 1,000 1,000
- -----------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>

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

F-6
<PAGE> 81

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Jack Henry & Associates, Inc. (1) Common Stock (90,498 shares) $ 26 $ 3,079
- -----------------------------------------------------------------------------------------------------
Jakel, Inc. Loan 17,938 17,938
- -----------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 62 62
- -----------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,130 2,130
Warrants 74 74
- -----------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 3,801 3,801
Warrants 324 4,100
- -----------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Warrants 348 3,495
Equity Interest 4 9
- -----------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,309 6,309
Warrants 96 1,500
- -----------------------------------------------------------------------------------------------------
Kyrus Corporation Debt Securities 7,648 7,648
Warrants 348 348
- -----------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc. Debt Securities 3,430 3,430
Common Stock (64,535 shares) 142 142
- -----------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 207 207
- -----------------------------------------------------------------------------------------------------
Liqui-Dri Foods, Inc. Loans 10,782 10,782
- -----------------------------------------------------------------------------------------------------
The Loewen Group, Inc. (1) High Yield Debt 15,150 15,150
- -----------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213
- -----------------------------------------------------------------------------------------------------
Master Plan, Inc. Common Stock (156 shares) 42 3,042
- -----------------------------------------------------------------------------------------------------
May Investments Loan 47 --
- -----------------------------------------------------------------------------------------------------
MedAssets.com, Inc. Loans 3,803 3,803
Series B Convertible Preferred Stock 2,049 2,049
(227,665 shares)
Warrants 136 136
- -----------------------------------------------------------------------------------------------------
Meigher Communications, L.P. Loan 2,933 2,933
- -----------------------------------------------------------------------------------------------------
Mid Atlantic Telecom Plus, LLC Loan 10,936 10,936
- -----------------------------------------------------------------------------------------------------
Midview Associates, L.P. Warrants -- --
- -----------------------------------------------------------------------------------------------------
Mihadas Loan 285 285
- -----------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 17 17
Debt Securities 1,823 370
Common Stock (33,333 shares) -- --
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Morton Industrial Group (1) Common Stock (5,835 shares) 241 82
- -----------------------------------------------------------------------------------------------------
MVL Group Debt Securities 13,768 13,768
Warrants 849 849
- -----------------------------------------------------------------------------------------------------
NET-Tel Communications, Inc. Debt Securities 9,479 9,479
Series B Convertible Preferred Stock 5,000 5,000
(647 shares)
Warrants 500 500
- -----------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 23 23
- -----------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>

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

F-7
<PAGE> 82

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- --------------------------------- --------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Nobel Learning Communities, Debt Securities $ 9,473 $ 9,473
Inc. (1) Series D Convertible Preferred Stock 2,000 2,000
(265,957 shares)
Warrants 575 575
- -----------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, Debt Securities 391 391
L.P.
- -----------------------------------------------------------------------------------------------------
Nursefinders, Inc. Debt Securities 10,902 10,902
Warrants 900 900
- -----------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 140 --
- -----------------------------------------------------------------------------------------------------
Opinion Research Corporation(1) Debt Securities 13,864 13,864
Warrants 996 996
- -----------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 210 210
- -----------------------------------------------------------------------------------------------------
Panera Bread Company (1) Warrants 227 58
- -----------------------------------------------------------------------------------------------------
Pico Products, Inc. (1) Debt Securities 4,591 2,591
Common Stock (208,000 shares) 59 12
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Polaris Pool Systems, Inc. Debt Securities 7,425 7,425
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Powell Plant Farms, Inc. Loan 14,850 14,850
- -----------------------------------------------------------------------------------------------------
Progressive International Debt Securities 3,937 3,937
Corporation Common Stock (197 shares) 13 13
Preferred Stock (500 shares) 500 500
Warrants -- --
- -----------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (14,000 shares) 133 123
Holdings, PLC (1)
- -----------------------------------------------------------------------------------------------------
R.L. Singletary Loan 89 89
- -----------------------------------------------------------------------------------------------------
Schwinn/GT Debt Securities 9,884 9,884
Warrants 395 395
- -----------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc. Series A Preferred Stock (1,000 shares) 993 271
- -----------------------------------------------------------------------------------------------------
Soff-Cut Holdings, Inc. Debt Securities 8,121 8,121
Common Stock (2,000 shares) 200 200
Preferred Stock (300 shares) 300 300
Warrants 446 446
- -----------------------------------------------------------------------------------------------------
Southwest PCS, LP Debt Securities 7,359 7,359
Options -- --
- -----------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 335 223
Common Stock (6,208 shares) 25 18
- -----------------------------------------------------------------------------------------------------
SunStates Refrigerated Services, Loans 6,130 4,641
Inc. Debt Securities 2,445 676
- -----------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P. Debt Securities 11,666 11,666
Options 266 266
- -----------------------------------------------------------------------------------------------------
Techniplas, Inc. Loan 1,396 1,396
- -----------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing
and restricted.
</TABLE>

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

F-8
<PAGE> 83

<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
INTEREST NUMBER OF -----------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE-BACKED SECURITIES
Purchased CMBS 6 $ 213,371 $ 213,371
- --------------------------------------------------------------------------------------------------
Residual CMBS 1 75,808 75,808
- --------------------------------------------------------------------------------------------------
Residual securitization spread 1 8,477 6,977
- --------------------------------------------------------------------------------------------------
Total commercial mortgage-backed securities 8 $ 297,656 $ 296,156
- --------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 6 $ 2,033 $ 2,033
7.00%- 8.99% 19 79,535 79,535
9.00%-10.99% 48 41,774 42,127
11.00%-12.99% 23 48,428 48,428
13.00%-14.99% 4 12,365 12,365
15.00% and above 1 993 993
- --------------------------------------------------------------------------------------------------
Total commercial mortgage loans 101 $ 185,128 $ 185,481
- --------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
</TABLE>

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

F-9
<PAGE> 84

<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
INTEREST NUMBER OF -----------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 3 $ 113 $ 113
7.00%- 8.99% 5 54 42
9.00%-10.99% 121 31,677 31,989
11.00%-12.99% 287 37,370 36,605
13.00%-14.99% 3 180 163
15.00% and above -- -- --
- --------------------------------------------------------------------------------------------------
Total Small Business Administration 7(a) loans 419 $ 69,394 $ 68,912
- --------------------------------------------------------------------------------------------------
Other portfolio assets 9 $ 7,572 $ 7,070
- --------------------------------------------------------------------------------------------------
Total portfolio at value 639 $1,098,111 $1,103,653
- --------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally
non-income producing and restricted.
</TABLE>

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

F-10
<PAGE> 85

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INVESTMENTS

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
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, Loans 1,475 1,475
Inc.
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 Debt Securities 8,391 2,774
America Series A Preferred Stock (31,521 shares) 334 --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Debt Securities 3,450 3,450
Inc.
Warrants -- 1,138
- -------------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC Loan 5,860 5,860
- -------------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Debt Securities 2,948 2,948
Resources, LLC 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 Common Stock (470 shares) -- 148
Corporation
- -------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>

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

F-11
<PAGE> 86

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
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 & Loan 10,020 10,020
Technologies Company, Inc.
- -------------------------------------------------------------------------------------------------------
ECM Enterprises Loan 31 4
- -------------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 30 30
Debt Securities 1,875 680
Common Stock (100 shares) 250 --
- -------------------------------------------------------------------------------------------------------
El Dorado Communications, Loans 306 306
Inc.
- -------------------------------------------------------------------------------------------------------
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. Warrants 6 --
(1)
- -------------------------------------------------------------------------------------------------------
Everything Yogurt Loan 34 34
- -------------------------------------------------------------------------------------------------------
Ex Terra Credit Recovery, Series A Preferred Stock (500 shares) 497 497
Inc.
Common Stock (2,500 shares) 3 3
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Debt Securities 5,702 5,702
Company Warrants 280 3,629
- -------------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loans 200 200
- -------------------------------------------------------------------------------------------------------
Galaxy American Debt Securities 30,703 30,703
Communications, LLC 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 Loans 1,390 1,390
Archery, LLC 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
- -------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>

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

F-12
<PAGE> 87

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Jack Henry & Associates, Inc. Common Stock (90,438 shares) $ 26 $ 4,193
(1)
- -------------------------------------------------------------------------------------------------------
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, Debt Securities 3,403 3,403
Inc.
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, Loan 10,434 10,434
LLC
- -------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities 197 197
Options -- --
- -------------------------------------------------------------------------------------------------------
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 Learning Communities, Debt Securities 9,419 9,419
Inc. (1) Series D Convertible Preferred Stock (265,957 2,000 2,000
shares)
Warrants 575 575
- -------------------------------------------------------------------------------------------------------
Norman's Yogurt, Inc. Loan 8 8
- -------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>

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

F-13
<PAGE> 88

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Northeast Broadcasting Group, Debt Securities $ 415 $ 415
L.P.
- -------------------------------------------------------------------------------------------------------
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 Debt Securities 3,680 3,680
Corporation Preferred Stock (500 shares) 500 500
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (94,479 shares) 901 557
Holdings, PLC (1)
- -------------------------------------------------------------------------------------------------------
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 Loan 117 117
Enterprises, Inc.
- -------------------------------------------------------------------------------------------------------
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 Loans 1,830 341
Services, Inc. Debt Securities 2,445 676
- -------------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P. Debt Securities 11,881 11,881
Options -- --
- -------------------------------------------------------------------------------------------------------
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 -- --
- -------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income producing and
restricted.
</TABLE>

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

F-14
<PAGE> 89

<TABLE>
<CAPTION>
DECEMBER 31, 1998
INTEREST NUMBER OF -------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- -------- --------
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE-BACKED SECURITIES
Purchased 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
- ------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE LOANS
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
- ------------------------------------------------------------------------------------------------
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>

<TABLE>
<S> <C>
(1) Public company.
(2) Common stock, preferred stock, warrants and equity interests are generally non-income
producing and restricted.
</TABLE>

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

F-15
<PAGE> 90

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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).

F-16
<PAGE> 91
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 1998, 1997 and 1996 balances to
conform with the 1999 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
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 purchased commercial
mortgage-backed securities ("Purchased CMBS"), residual interest in mortgage
securitization ("Residual CMBS") and residual securitization spread.

PURCHASED CMBS

The Purchased CMBS is carried at fair value. The Company recognizes income
from Purchased CMBS using the effective interest method, using the anticipated
yield over the projected life of the

F-17
<PAGE> 92
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

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 Purchased CMBS. The Company
recognizes unrealized depreciation on its Purchased CMBS whenever it determines
that the value of its Purchased 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 Purchased 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

F-18
<PAGE> 93
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
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.

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 September 30, 1999, December 31, 1998 and 1997, approximately 97
percent, 98 percent and 98 percent, respectively, 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 September 30, 1999, December 31,
1998 and 1997 was 14.0 percent, 14.6 percent, and 12.6 percent, respectively. At
September 30, 1999, December 31, 1998 and 1997, mezzanine loans and debt
securities with a cost basis of $35,911,000, $20,977,000 and $13,661,000,
respectively, were not accruing interest.

F-19
<PAGE> 94
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED

The geographic and industry composition of the mezzanine portfolio at
September 30, 1999, December 31, 1998 and 1997 was as follows:

<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
GEOGRAPHIC REGION
Mid-Atlantic................................................ 26% 28% 29%
Midwest..................................................... 25 27 17
Southeast................................................... 20 23 27
West........................................................ 13 11 13
Northeast................................................... 11 4 8
International............................................... 5 7 6
--- --- ---
Total............................................. 100% 100% 100%
=== === ===

INDUSTRY
Business Services........................................... 26% 11% 7%
Consumer Products........................................... 20 25 25
Telecommunications.......................................... 14 14 7
Industrial Products......................................... 14 8 9
Education................................................... 6 8 1
Broadcasting................................................ 6 9 23
Retail...................................................... 4 9 14
Other....................................................... 10 16 14
--- --- ---
Total............................................. 100% 100% 100%
=== === ===
</TABLE>

COMMERCIAL MORTGAGE-BACKED SECURITIES

In December 1998, the Company purchased $67 million of Purchased Commercial
Mortgage-Backed Securities ("Purchased CMBS") for $32 million. For the nine
months ended September 30, 1999, the Company purchased for a price of $183.4
million, Purchased CMBS with a face value of $373.2 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.

As of September 30, 1999 and December 31, 1998, the estimated yield to
maturity on the Purchased CMBS was approximately 14.2 percent and 15.0 percent,
respectively. The Company's estimated returns on its Purchased 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 Purchased 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.

F-20
<PAGE> 95
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED

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 September 30, 1999, 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 14 percent.

The geographic composition and the property types securing the commercial
mortgage-backed securities at September 30, 1999 and December 31, 1998 were as
follows:

<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
GEOGRAPHIC REGION
West........................................................ 29% 17%
Mid-Atlantic................................................ 23 32
Midwest..................................................... 22 19
Southeast................................................... 21 25
Northeast................................................... 5 7
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Retail...................................................... 33% 32%
Housing..................................................... 30 13
Office...................................................... 20 21
Hospitality................................................. 8 23
Other....................................................... 9 11
--- ---
Total............................................. 100% 100%
=== ===
</TABLE>

F-21
<PAGE> 96
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED
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 September 30, 1999, December 31, 1998 and 1997, approximately 80 percent
and 20 percent, 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 September 30, 1999, December 31, 1998
and 1997 equaled 9.8 percent, 10.4 percent and 11.4 percent, respectively. As of
September 30, 1999, December 31, 1998 and 1997, loans with a cost basis of
$5,042,000, $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 September 30, 1999, December 31, 1998 and 1997 were
as follows:

<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
GEOGRAPHIC REGION
Mid-Atlantic................................................ 43% 37% 38%
Southeast................................................... 27 26 14
West........................................................ 19 24 18
Midwest..................................................... 8 9 18
Northeast................................................... 3 4 12
--- --- ---
Total............................................. 100% 100% 100%
=== === ===

PROPERTY TYPE
Hospitality................................................. 35% 47% 34%
Office...................................................... 31 20 32
Retail...................................................... 13 14 17
Recreation.................................................. 11 7 4
Other....................................................... 10 12 13
--- --- ---
Total............................................. 100% 100% 100%
=== === ===
</TABLE>

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

F-22
<PAGE> 97
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED

interest from the date on which the loan was made to its maturity. At September
30, 1999, December 31, 1998 and 1997, approximately 98 percent, 96 percent and
92 percent, respectively 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 September 30, 1999, December 31, 1998 and 1997, 7(a) loans with a
cost basis of $13,133,000, $11,227,000 and $4,346,000, respectively, were not
accruing interest.

The geographic and industry composition of the SBA 7(a) portfolio at
September 30, 1999, December 31, 1998 and 1997 was as follows:

<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
GEOGRAPHIC REGION
Midwest..................................................... 35% 34% 36%
Mid-Atlantic................................................ 35 29 29
Southeast................................................... 15 16 18
West........................................................ 10 14 7
Northeast................................................... 5 7 10
--- --- ---
Total............................................. 100% 100% 100%
=== === ===

INDUSTRY
Retail...................................................... 40% 41% 37%
Hospitality................................................. 29 30 26
Consumer Products........................................... 12 6 7
Consumer Services........................................... 5 6 4
Business Services........................................... 4 4 6
Broadcasting................................................ 3 4 8
Other....................................................... 7 9 12
--- --- ---
Total............................................. 100% 100% 100%
=== === ===
</TABLE>

F-23
<PAGE> 98
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5. DEBT

At September 30, 1999, December 31, 1998 and 1997, the Company had the
following credit facilities:

<TABLE>
<CAPTION>
1999 1998 1997
------------------- ------------------- -------------------
FACILITY AMOUNT FACILITY AMOUNT FACILITY AMOUNT
AMOUNT DRAWN AMOUNT DRAWN AMOUNT DRAWN
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Debentures and notes payable:
Master loan and security
agreement.............. $250,000 $ 34,500 $250,000 $ 6,000 $250,000 $ 23,116
Unsecured long-term notes
payable................ 317,000 317,000 180,000 180,000 -- --
SBA debentures........... 74,650 47,650 74,650 47,650 54,300 54,300
OPIC loan................ 5,700 5,700 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..... 647,350 404,850 760,350 239,350 594,300 308,821
-------- -------- -------- -------- -------- --------
Revolving lines of credit..... 340,000 133,000 200,000 95,000 80,000 38,842
-------- -------- -------- -------- -------- --------
Total Debt.......... $987,350 $537,850 $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 Interbank Offer Rate ("LIBOR") plus 1.0
percent, or 6.4 percent, 6.6 percent and 6.7 percent, at September 30, 1999,
December 31, 1998 and 1997, respectively. Average debt outstanding, maximum
amount borrowed, and weighted average interest rate charged on this facility for
the nine months ended September 30, 1999 and for the years ended December 31,
1998 and 1997 were $40,323,000, $21,932,000 and $17,899,000; $84,392,000,
$56,000,000 and $23,116,000; and 6.1 percent, 6.5 percent and 6.7 percent;
respectively. The agreement matured on October 7, 1999 and the Company, without
BMI, extended the facility through October 30, 2000, with a total committed
facility up to $100,000,000.

UNSECURED LONG-TERM NOTES PAYABLE

In June 1998 and May 1999 the Company issued unsecured long-term notes held
by private institutional investors. The notes have terms of 5 or 7 years with an
aggregate principal balance of $317,000,000. The weighted average interest rate
on the notes is 7.3 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.

F-24
<PAGE> 99
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5. DEBT, CONTINUED
SBA DEBENTURES

At September 30, 1999, December 31, 1998 and 1997, the Company had drawn
debentures totaling $47,650,000, $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, 6.6 percent and 6.8 percent
at September 30, 1999, 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.

REVOLVING LINES OF CREDIT

In May 1999, the Company increased its unsecured revolving line of credit
to $340,000,000 from $315,000,000. The facility bears interest at LIBOR plus
1.25 percent, or 6.6 percent and 6.9 percent at September 30, 1999 and December
31, 1998, respectively, and requires a commitment fee equal to 0.25 percent of
the committed amount. The new line expires in March 2001. 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 $83,253,000,
$51,904,000 and $30,033,000 for the nine months ended September 30, 1999 and 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
nine months ended September 30, 1999 and for the years ended December 31, 1998
and 1997 were $174,000,000, $105,000,000 and $45,759,000, and 6.4 percent, 6.8
percent and 8.1 percent, respectively.

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.
The Company incurred no income tax for the nine months ended September 30, 1999.

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.

F-25
<PAGE> 100
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

During the nine months ended September 30, 1999, the Company sold 3,803,000
shares of its common stock through underwriters for net proceeds of $73,321,000,
after costs of $3,608,000 which included a weighted average discount of 3.8
percent. In addition, the Company sold 1,604,119 shares of its common stock to
an institutional investor in three transactions. The net proceeds from the
transactions were $29,758,000, after costs of $1,169,000 which included a
discount of 3.0 percent.

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 nine months ended
September 30, 1999 and for the years ended December 31, 1998, 1997 and 1996 the
Company issued 169,588, 241,482, 550,971 and 913,206 shares, respectively, at an
average price per share of $19.80, $20.35, $15.67 and $13.13, respectively.

F-26
<PAGE> 101
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 9. EARNINGS PER COMMON SHARE

<TABLE>
<CAPTION>
PER COMMON
INCOME SHARES SHARE AMOUNT
-------- ------- -------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED)
Net increase in net assets resulting from operations... $67,645
Less: Preferred stock dividends (165)
-------
Income available to common shareholders................ $67,480
=======
BASIC EARNINGS PER COMMON SHARE........................ 59,077 $1.14
=====
Options outstanding to officers........................ 162
------
DILUTED EARNINGS PER COMMON SHARE...................... 59,239 $1.14
====== =====
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
Net increase in net assets resulting from operations... $61,448
Less: Preferred stock dividends........................ (165)
-------
Income available to common shareholders................ $61,283
=======
BASIC EARNINGS PER COMMON SHARE........................ 51,502 $1.19
=====
Options outstanding to officers........................ 210
------
DILUTED EARNINGS PER COMMON SHARE...................... 51,712 $1.19
====== =====
1998
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>

Basic earnings per common share was computed by dividing the net increase
in net assets resulting from operations, after deducting preferred stock
dividends, by the weighted average number of common shares outstanding each
period.

F-27
<PAGE> 102
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 9. EARNINGS PER COMMON SHARE, CONTINUED

Diluted earnings per common share was computed by dividing the net increase
in net assets resulting from operations, after deducting preferred stock
dividends, by the weighted average number of common shares outstanding plus
common shares issuable upon assumed exercise of stock options outstanding each
period.

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 September 30, 1999, December 31, 1998 and 1997, the ESOP held 299,998
shares, 282,500 shares and 433,047 shares, respectively, of the Company's common
stock, the majority 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. 401(k) PLAN

In October 1999, the Company established a 401(k) plan, which will replace
the existing ESOP. All employees who are at least 21 years of age have the
opportunity to contribute pre-tax salary deferrals into the 401(k) Plan up to
$10,500, and to direct the investment of these contributions. In addition,
beginning in 2000, the Company expects to contribute to each eligible
participant 5% of each participant's total cash compensation for the year, up to
$170,000, to each participant's plan account on the participant's behalf, which
would be fully vested at the time of contribution. This contribution would
replace any contribution to the ESOP.

NOTE 12. 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

F-28
<PAGE> 103
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 12. STOCK OPTION PLAN, CONTINUED

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.

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 nine months
ended September 30, 1999 and for the year ended December 31, 1998, the Company's
compensation committee granted a total of 553,921 options and 5,189,944 options,
respectively, to officers and non-officer directors 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 $20.33 per share. At September 30, 1999, options for
1,460,111 shares were vested. 191,135 options were exercised and 149,611 options
were cancelled during the nine months ended September 30, 1999. 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. As of September 30, 1999 and
December 31, 1998, 1997 and 1996, the Company had outstanding loans to officers
of $27,276,000, $23,735,000, $29,611,000 and $15,491,000, respectively. Officers
with outstanding loans repaid principal of $255,000, $5,591,000, $6,534,000, and
$2,199,000 for the nine months ended September 30, 1999 and for the years ended
December 31, 1998, 1997 and 1996, respectively. The

F-29
<PAGE> 104
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 12. STOCK OPTION PLAN, CONTINUED

Company recognized interest income from these loans of $1,115,000, $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,
-----------------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<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.

NOTE 13. FORMULA AWARD AND CUT-OFF AWARD

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 Note 10) 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 nine
months ended September 30, 1999 and for the year ended December 31, 1998,
$4,681,000 and $6,242,000, respectively 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

F-30
<PAGE> 105
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 13. FORMULA AWARD AND CUT-OFF AWARD, CONTINUED

Company stock is retired. For the nine months ended September 30, 1999 and for
the year ended December 31, 1998, $61,000 and $270,000, respectively, 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.

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 nine months ended September 30,
1999 and for the year ended December 31, 1998, $507,000 and $807,000,
respectively, of the Cut-off Award vested.

F-31
<PAGE> 106
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 14. DIVIDENDS AND DISTRIBUTIONS

The Company's Board of Directors declared and the Company paid a $1.20 per
common share dividend, or $71,800,000, for the nine months ended September 30,
1999.

For the years ended December 31, 1998, 1997 and 1996, the Company declared
the following distributions:

<TABLE>
<CAPTION>
1998 1997 1996
--------------- --------------- ---------------
TOTAL TOTAL TOTAL
TOTAL PER TOTAL PER TOTAL PER
AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
------- ----- ------- ----- ------- -----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<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 TOTAL
TOTAL PER TOTAL PER TOTAL PER
AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
------- ----- ------- ----- ------- -----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<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>

F-32
<PAGE> 107
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 14. DIVIDENDS AND DISTRIBUTIONS, CONTINUED

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>
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<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>

NOTE 15. 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 September 30, 1999 and
December 31, 1998 and 1997, cash and cash equivalents consisted of the
following:

<TABLE>
<CAPTION>
SEPTEMBER 30,
1999 1998 1997
------------- ------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents..................... $22,455 $31,833 $76,791
Less escrows held............................. (7,079) (6,758) (6,354)
------- ------- -------
Total......................................... $15,376 $25,075 $70,437
======= ======= =======
</TABLE>

NOTE 16. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

For the nine months ended September 30, 1999 and for the years ended
December 31, 1998, 1997 and 1996, the Company paid $16,707,000, $21,708,000,
$26,874,000 and $21,391,000, respectively, for interest and income taxes. During
1999, 1998, 1997 and 1996, the Company's non-cash financing activities totaled
$7,250,000, $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 1999, 1998, 1997 and 1996, the
Company's non-cash investing activities totaled $2,226,000, $1,265,000,
$12,022,000 and $2,004,000, respectively.

F-33
<PAGE> 108
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 17. SELECTED QUARTERLY DATA (UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
1998
-------------------------------------
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>

F-34
<PAGE> 109

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEET

<TABLE>
<CAPTION>
DECEMBER 31, 1998
------------------------------------------------------------------------
ALLIED ALLIED CONSOLIDATED
ACC INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
-------- ---------- ------- -------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
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.
F-35
<PAGE> 110

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATING STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
-----------------------------------------------------------------------
ALLIED ALLIED CONSOLIDATED
ACC INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
-------- ---------- ------- ------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest and related portfolio
income:
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.

F-36
<PAGE> 111

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATING STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
--------------------------------------------------------------------------
ALLIED ALLIED CONSOLIDATED
ACC INVESTMENT SBLC OTHERS ELIMINATIONS TOTAL
--------- ---------- -------- -------- ------------ ------------
(IN THOUSANDS)
<S> <C> <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) 34,458 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.
F-37
<PAGE> 112

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 Anderson

Vienna, Virginia
February 18, 1999

F-38
<PAGE> 113

ALLIED CAPITAL CORPORATION

STATEMENT OF ADDITIONAL INFORMATION

NOVEMBER , 1999

-------------------------

This Statement of Additional Information ("SAI") is not a prospectus, and
should be read in conjunction with the prospectus dated November , 1999
relating to this offering and the accompanying prospectus supplement, if any.
You can obtain a copy of the prospectus by calling Allied Capital Corporation at
1-888-818-5298 and asking for Investor Relations. Terms not defined herein have
the same meaning as given to them in the prospectus.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE IN THE LOCATION
STATEMENT OF RELATED
OF ADDITIONAL DISCLOSURE IN
INFORMATION THE PROSPECTUS
------------- --------------
<S> <C> <C>
General Information and History............................. B-2 1;12;36
Investment Objective and Policies........................... B-2 1;12;36
Management.................................................. B-2 53
Compensation of Executive Officers and Directors....... B-2 56
Compensation of Directors.............................. B-3 56
Stock Option Awards.................................... B-4 56
Formula Award and Cut-Off Award........................ B-4 56
Committees of the Board of Directors................... B-6 N/A
Control Persons and Principal Holders of Securities......... B-7 N/A
Investment Advisory Services................................ B-8 53
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. B-8 69
Accounting Services......................................... B-8 69
Brokerage Allocation and Other Practices.................... B-8 N/A
Tax Status.................................................. B-9 59
</TABLE>

-------------------------
B-1
<PAGE> 114

GENERAL INFORMATION AND HISTORY

This SAI contains information with respect to Allied Capital Corporation
(the "Company"). The Company changed its name from "Allied Capital Lending
Corporation" to "Allied Capital Corporation," effective upon the merger, which
was consummated on December 31, 1997. The Company is a registered investment
adviser. The Company was initially organized as a corporation in the District of
Columbia in 1976 and was reincorporated in the state of Maryland in 1990.

INVESTMENT OBJECTIVE AND POLICIES

The investment objective of the Company is to achieve current income and
capital gains. The Company seeks to achieve its investment objective by lending
to and investing primarily in private, growing businesses in a variety of
industries and in diverse geographic locations primarily in the United States.
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 middle-market subordinated loans with equity features,
small and middle-market commercial mortgage loans, commercial mortgage-backed
securities, and small senior loans. At September 30, 1999, our investment
portfolio totaled $1,103.7 million. A discussion of the selected financial data,
supplementary financial information and management's discussion and analysis of
financial condition and results of operations is included in the prospectus. In
addition to its core lending business, the Company also provides advisory
services to private investment funds.

MANAGEMENT

COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS

Under Commission rules applicable to BDCs, we are required to set forth
certain information regarding the compensation of certain executive officers and
directors. The following table sets forth compensation paid by the Company in
all capacities during the year ended December 31, 1998, to the directors and the
three highest paid executive officers of the Company (collectively, the
"Compensated Persons").

B-2
<PAGE> 115

COMPENSATION TABLE

<TABLE>
<CAPTION>
PENSION OR
AGGREGATE SECURITIES RETIREMENT BENEFITS DIRECTORS FEES
COMPENSATION FROM UNDERLYING ACCRUED AS PART OF PAID BY THE
NAME AND POSITION THE COMPANY(1) OPTIONS/SARS(4) COMPANY EXPENSES COMPANY(5)
----------------- ----------------- --------------- ------------------- --------------
<S> <C> <C> <C> <C>
William L. Walton, Chairman and Chief
Executive Officer(2)*.................. $2,158,599 754,188 $ -- $17,667
Joan M. Sweeney, Managing
Director(2).......................... 1,178,920 374,275 -- 0
G. Cabell Williams III, Managing
Director(2).......................... 896,873 278,403 -- 0
Brooks H. Browne, Director............. 10,500 -- -- 10,500
John D. Firestone, Director............ 11,500 -- -- 11,500
Anthony T. Garcia, Director............ 12,500 -- -- 12,500
Lawrence I. Hebert, Director........... 8,500 -- -- 8,500
John I. Leahy, Director................ 17,167 -- -- 17,167
Robert E. Long, Director............... 18,667 -- -- 18,667
Warren K. Montouri, Director........... 15,667 -- -- 15,667
Guy T. Steuart II, Director............ 11,000 -- -- 11,000
T. Murray Toomey, Director............. 7,500 -- -- 7,500
Laura W. van Roijen, Director.......... 8,500 -- -- 8,500
George C. Williams, Jr. Director,
Chairman Emeritus(3)*................ 626,206 151,395 -- 18,167
</TABLE>

- -------------------------
* Interested persons of the Company, as defined in the 1940 Act.
(1) There were no perquisites paid by the Company in excess of the lesser of
$50,000 or 10% of the Compensated Person's total salary and bonus for the
year.
(2) The following table provides detail for 1998 as to the aggregate
compensation of the three highest paid executive officers of the Company.

<TABLE>
<CAPTION>
VESTED DEFERRED
FORMULA CUT-OFF ESOP COMPENSATION DIRECTORS
SALARY BONUS AWARD AWARD CONTRIBUTION CONTRIBUTION FEES
-------- -------- ---------- -------- ------------ ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Mr. Walton............ $351,517 $525,000 $1,056,683 $170,156 $8,000 $29,576 $17,667
Ms. Sweeney........... 222,191 275,000 619,154 38,965 8,000 15,610 --
G. Cabell Williams
III................. 225,327 275,000 287,523 88,257 8,000 12,766 --
</TABLE>

The Formula Award, which totaled approximately $19 million in the aggregate,
vests in three equal installments on December 31, 1998, 1999, and 2000, and
will be expensed for financial reporting purposes similarly. The amount of
the Formula Award expensed in 1998 for financial reporting purposes for Mr.
Walton, Ms. Sweeney and Mr. Williams was $1,472,451, $862,761 and $400,664,
respectively. The amount expensed was based on the value of the Formula Award
contribution to the deferred compensation plan in January 1998. On January 4,
1999, the first vested installment of the Formula Award was generally
distributed to participants at the market value of the Company's common stock
on that day. The distribution amount for Mr. Walton, Ms. Sweeney and Mr.
Williams was $1,056,683, $619,154 and $287,523, respectively. The Company
distributed the vested shares to brokerage accounts for the participants that
restrict the sale of the vested shares.

The Cut-Off Award, which totaled $2.9 million in the aggregate, will be paid
to individuals on the respective vesting date of any options under the Old
Plans which were canceled in connection with the merger. See "-- Cut-Off
Award and Formula Award."

(3) In addition to director's fees, Mr. Williams received $144,000 in consulting
fees, $32,686 in Cut-Off Award and $431,353 in vested Formula Award. The
amount of the Formula Award expensed in 1998 for Mr. Williams was $601,068.
(4) See "Stock Option Awards" for terms of options granted in 1998. The Company
does not maintain a restricted stock plan or a long-term incentive plan.
(5) Consists only of directors' fees paid by the Company during 1998. Such fees
are also included in the column titled "Aggregate Compensation from the
Company."

COMPENSATION OF DIRECTORS

During the first quarter of 1998, each director received a fee of $1,000
for each meeting of the board of directors or any separate committee meeting
attended, and $500 for each committee meeting attended on the same day as a
board of directors meeting. Beginning in April 1998, each director received
$1,000 for each board or committee meeting attended, except with respect to the
members

B-3
<PAGE> 116

of the executive committee, who each received an annual retainer of $10,000 in
lieu of fees paid for each executive committee meeting attended. For 1998, this
annual retainer was prorated. Non-officer directors are eligible for stock
option awards under the Company's current stock option plan pursuant to an
exemptive order from the Commission, which was granted on September 8, 1999. On
that date, each incumbent director received options to purchase 10,000 shares,
and will receive options to purchase 5,000 shares each year thereafter. See
"-- Stock Option Awards" and "Management -- Compensation Plans -- Stock Option
Plan" in the prospectus.

STOCK OPTION AWARDS

The following table sets forth the details relating to option grants in
1998 to the Company's Compensated Persons and the potential realizable value of
each grant, as prescribed to be calculated by the Commission.

OPTION GRANTS DURING 1998

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED ANNUAL
NUMBER OF PERCENT RATES OF
SECURITIES OF TOTAL EXERCISE STOCK APPRECIATION
UNDERLYING OPTIONS PRICE OVER 10-YEAR TERM(3)
OPTIONS GRANTED PER EXPIRATION ------------------------
NAME GRANTED(1) IN 1998(2) SHARE DATE 5% 10%
---- ---------- ---------- -------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
William L. Walton......... 659,188 12.7% $21.375 1/8/08 $8,861,216 $22,456,060
95,000 1.8 $17.875 12/8/08 $1,067,942 $ 2,706,374
Joan M. Sweeney........... 319,275 6.2 $21.375 1/8/08 $4,291,893 $10,876,500
55,000 1.1 $17.875 12/8/08 $ 618,282 $ 1,566,848
G. Cabell Williams III.... 223,403 4.3 $21.375 1/8/08 $3,003,122 $ 7,610,501
55,000 1.1 $17.875 12/8/08 $ 618,282 $ 1,566,848
George C. Williams,
Jr. .................... 141,395 2.7 $21.375 1/8/08 $1,900,720 $ 4,816,797
10,000 0.2 $17.875 12/8/08 $ 112,415 $ 284,881
</TABLE>

- -------------------------
(1) Options granted in 1998 generally vest in six equal installments beginning
on the date of grant, with full vesting occurring on the fifth anniversary
of the grant date or change of control of the Company.

(2) In 1998, the Company granted options to purchase a total of 5,189,944
shares.

(3) Potential realizable value is calculated on 1998 options granted, and is net
of the option exercise price but before any tax liabilities that may be
incurred. These amounts represent certain assumed rates of appreciation, as
mandated by the Commission. Actual gains, if any, or stock option exercises
are dependent on the future performance of the shares, overall market
conditions, and the continued employment by the Company of the option
holder. The potential realizable value will not necessarily be realized.

FORMULA AWARD AND CUT-OFF AWARD

As discussed in the prospectus, prior to the merger options had been
granted under the Old Plans to various employees of Advisers, who were also
officers of the predecessor companies. In preparation for the merger, the
compensation committee of Advisers, in conjunction with the compensation
committee of the other predecessor companies, determined that the five Old Plans
should be terminated upon the merger, so that the new merged Company would be
able to develop a new plan that would incent 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 employees, and to account for the
deviations caused by the existence of five plans by five different publicly
traded stocks, two special awards were developed to be granted in lieu of
options under the Old Plans that were foregone upon the merger and the
cancellation of the Old Plans.

B-4
<PAGE> 117

Formula Award. The Formula Award was designed to compensate officers from
the point when their unvested options ceased to appreciate in value pursuant to
the Cut-Off Award (i.e., August 14, 1997) up until the time at which they would
be able to receive option awards in the Company after the merger became
effective. In the aggregate, the Formula Award equaled six percent (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. In total, the combined aggregate market capitalization of the
predecessor companies increased by $319 million from August 14, 1997 to December
30, 1997, and the aggregate Formula Award was approximately $19 million.

The Formula Award was designed as a long-term incentive compensation
program to be a replacement for canceled stock options and to balance share
ownership among key officers for past and prospective service. The terms of the
Formula Award required 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 and accrues equally over a three-year period, on
the anniversary of the merger date (December 31, 1997), and vests automatically
in the event of a change of control of the Company. If an officer terminates
employment with the Company prior to the vesting of any part of the Formula
Award, that amount will be forfeited to the Company. Assuming all officers meet
the vesting requirement, the Company will accrue the Formula Award over the
three-year period in equal amounts of approximately $6.4 million, less any
forfeitures. For the year ended December 31, 1998, $6.2 million, net of
forfeitures of $0.3 million, was expensed for the Formula Award. The following
table indicates the Formula Award for each Compensated Person, and the related
vesting schedule.

<TABLE>
<CAPTION>
FORMULA AWARD RECIPIENT 1998 1999 2000
----------------------- ---------- ---------- ----------
<S> <C> <C> <C>
William L. Walton..................................... $1,472,451 $1,472,451 $1,472,451
Joan M. Sweeney....................................... 862,761 862,761 862,761
G. Cabell Williams III................................ 400,664 400,664 400,664
George C. Williams, Jr................................ 601,068 601,068 601,068
</TABLE>

On January 4, 1999, the portion of the Formula Award that vested on
December 31, 1998 was generally distributed to participants in the form of
shares of the Company's common stock. These shares are held in restricted
accounts at a brokerage firm.

Cut-Off Award. The Cut-Off Award established a cut-off dollar amount as of
the date of the announcement of the merger (August 14, 1997) that was computed
for all outstanding, but unvested options that were canceled as of the date of
the merger. The Cut-Off Award was designed to cap the appreciated value in
unvested options as of the merger announcement date in order to set the
foundation to balance option awards upon the merger. The Cut-Off Award, in the
aggregate, was computed to be $2.9 million, and is equal to the difference
between the market price 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 is payable for each canceled option as the canceled options
would have vested and will vest automatically in the event of a change of
control. The Cut-Off Award is only payable if the award recipient is employed by
the Company on the future vesting date. The

B-5
<PAGE> 118

following table indicates the Cut-Off Award for each Compensated Person, and the
related vesting schedule.

<TABLE>
<CAPTION>
CUT-OFF AWARD
RECIPIENT 1998 1999 2000 2001 2002
- ---------------------------------------------- -------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
William L. Walton............................. $170,157 $170,157 $170,157 $ 0 $ 0
Joan M. Sweeney............................... 38,964 37,678 36,602 2,026 0
G. Cabell Williams III........................ 88,257 46,802 39,677 21,152 18,916
George C. Williams, Jr........................ 32,686 4,688 52,373 0 0
</TABLE>

COMMITTEES OF THE BOARD OF DIRECTORS

The Company's board of directors has established an Executive Committee, an
Audit Committee, a Nominating Committee and a Compensation Committee.

The Executive Committee has and may exercise those rights, powers and
authority of the board of directors as the board of directors may from time to
time grant to it, except where action by the board of directors is required by
statute, an order of the Commission or the Company's charter or bylaws. In
addition, the Executive Committee is authorized to approve all investments over
$10 million, or any investment that possesses unusual risk/reward
characteristics. The Executive Committee consists of Messrs. Walton, Leahy,
Long, Montouri, and Williams. The Executive Committee met sixteen times during
1998.

The Audit Committee recommends the selection of independent public
accountants for the Company, reviews with such independent public accountants
the planning, scope and results of their audit of the Company's financial
statements and the fees for services performed, reviews with the independent
public accountants the adequacy of internal control systems, reviews the annual
financial statements and receives the Company's audit reports and financial
statements. The Audit Committee consists of Messrs. Browne, Leahy and Steuart.
The Audit Committee met twice during 1998.

The Compensation Committee determines the compensation for the Company's
executive officers and the amount of salary and bonus to be included in the
compensation package for each of the Company's officers and employees. In
addition, the Compensation Committee approves stock option grants for the
Company's officers under the Company's Stock Option Plan. The Compensation
Committee consists of Messrs. Browne, Long, Firestone and Garcia. The
Compensation Committee met four times during 1998.

The Nominating Committee recommends candidates for election as directors.
The Nominating Committee consists of Messrs. Walton, Hebert, Toomey and Steuart,
and Ms. van Roijen. The Nominating Committee met once in 1998.

B-6
<PAGE> 119

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of November 5, 1999, there were no persons that owned 25% or more of the
Company's outstanding voting securities, and no person would be deemed to
control the Company, as such term is defined in the 1940 Act.

The following table sets forth, at November 5, 1999, the beneficial
ownership of the shareholders owning 5% or more of the common stock outstanding
as well as each current director, the Chief Executive Officer, the Company's
executive officers, and the executive officers and directors as a group. The
address for each director and executive officer is 1919 Pennsylvania Avenue, NW,
Washington, DC 20006. Unless otherwise indicated, the Company believes that each
beneficial owner set forth in the table has sole voting and investment power.

<TABLE>
<CAPTION>
NAME OF NUMBER OF SHARES PERCENTAGE OF
BENEFICIAL OWNER OWNED BENEFICIALLY CLASS (1)
- ------------------------------------------------------ ------------------ -------------
<S> <C> <C>
Wallace R. Weitz and Company 1125 South 103rd Street
Omaha, NE 68124 3,167,000 5.1%
DIRECTORS:
William L. Walton................................... 812,952(2,3) 1.3%
Brooks H. Browne.................................... 50,168 *
John D. Firestone................................... 30,876 *
Anthony T. Garcia................................... 62,507 *
Lawrence I. Hebert.................................. 26,800 *
John I. Leahy....................................... 26,818 *
Robert E. Long...................................... 19,796 *
Warren K. Montouri.................................. 216,182 *
Guy T. Steuart II................................... 328,180(4) *
T. Murray Toomey, Esq. ............................. 42,666(5) *
Laura W. van Roijen................................. 38,412 *
George C. Williams, Jr.............................. 381,944 *
EXECUTIVE OFFICERS:
Philip A. McNeill................................... 197,741(2) *
Penni F. Roll....................................... 73,721(2) *
John M. Scheurer.................................... 372,294(2) *
Joan M. Sweeney..................................... 321,409(2) *
G. Cabell Williams III.............................. 749,514(2,3) 1.2%
All directors and executive officers as a group
(17 in number)................................... 3,390,301(6) 5.5%
</TABLE>

- -------------------------
* Less than 1%

(1) Based on a total of 62,491,777 shares of the Company's common stock issued
and outstanding on November 5, 1999 and shares of the Company's common stock
issuable upon the exercise of immediately exercisable stock options held by
each individual executive officer and non-officer director.

(2) Share ownership for the following directors and executive officers includes:

<TABLE>
<CAPTION>
OPTIONS
EXERCISABLE ALLOCATED
OWNED WITHIN 60 DAYS TO ESOP
DIRECTLY OF NOV. 5, 1999 ACCOUNT
-------- --------------- ---------
<S> <C> <C> <C>
Mr. Walton.................................................. 277,400 235,564 874
Mr. Williams, Jr............................................ 284,346 97,598 --
Mr. McNeill................................................. 112,337 118,344 8,727
Ms. Roll.................................................... 49,884 24,551 3,453
Mr. Scheurer................................................ 235,267 124,043 22,151
Ms. Sweeney................................................. 196,355 124,759 9,462
Mr. Williams III............................................ 365,998 92,802 69,675
</TABLE>

In addition, the beneficial ownership of each non-officer director includes
exercisable options to purchase 10,000 shares.

(3) Includes 299,988 shares held by the ESOP, of which Messrs. Walton and
Williams III are co-trustees. Participants in the ESOP may direct the voting
of these shares; however, if a participant does not direct the voting, the
co-trustees of the ESOP will vote the shares on behalf of the participants.
Messrs. Walton and Williams III disclaim beneficial ownership of such
shares. As of November 5, 1999, substantially all shares held in the ESOP
had been allocated.

B-7
<PAGE> 120

(4) Includes 276,691 shares held by a corporation for which Mr. Steuart serves
as an executive officer.

(5) Shares are held by a trust for the benefit of Mr. Toomey and his wife.

(6) Includes a total of 917,661 shares underlying stock options exercisable
within 60 days of November 5, 1999, which are assumed to be outstanding for
the purpose of calculating the group's percentage ownership, and 299,988
shares held by the ESOP.

INVESTMENT ADVISORY SERVICES

The Company is internally managed and therefore has not entered into any
advisory agreement with, nor pays advisory fees to, an outside investment
adviser. The Company is a registered investment adviser under the Advisers Act
and provides advisory services to other entities. The Company currently has 88
investment and other portfolio management professionals, who manage the
investments of the Company as well as the investments of other managed entities,
as well as 36 other professional employees and staff. For our mezzanine and CMBS
transactions, our investment decisions are made by an investment committee,
which is composed of senior investment professionals of the Company. For Allied
Capital Express transactions, a committee comprised of small business and real
estate lenders meet to approve all loans. In addition, in certain instances
where risk/return characteristics warrant and for every transaction larger than
$10 million, the executive committee of the board of directors must also approve
the transaction. See "Management" in the prospectus.

SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR

The investments of the Company and its subsidiaries are held in safekeeping
by Riggs Bank N.A. ("Riggs") at 808 17th Street, N.W., Washington, D.C. 20006.
LaSalle National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk
Grove Village, Illinois 60007, serves as the trustee and custodian with respect
to assets of the Company held for securitization purposes. American Stock
Transfer & Trust Company, 40 Wall Street, 46th Floor, New York, New York 10005
acts as the Company's transfer, dividend paying and reinvestment plan agent and
registrar.

ACCOUNTING SERVICES

Arthur Andersen LLP ("Andersen") has served as the independent accountant
to the Company since December 31, 1997. Prior to the year ended December 31,
1997, Allied Lending's financial statements were audited by Matthews, Carter and
Boyce, P.C., or its predecessor ("Matthews"). On December 12, 1997, Matthews
resigned, effective upon the consummation of the merger, and Andersen was
engaged and continues as the independent accountants of the Company. The
decision to change accountants was recommended by the Company's Audit Committee
and was approved by the board of directors of the Company.

For the year ended December 31, 1996, and up to the date of resignation of
Matthews, there were no disagreements with Matthews on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure which, if not resolved to the satisfaction of Matthews, would have
caused it to make reference to the subject matter of the disagreement in
connection with its report. The independent accountants' report on the 1996
financial statements did not contain an adverse opinion or a disclaimer of
opinion, and was not qualified or modified as to uncertainty, audit scope or
accounting principles. Each of Andersen and Matthews has advised the Company
that neither it nor any present member or associate of the relevant firm has any
financial interest, direct or indirect, in the Company or its subsidiaries.

BROKERAGE ALLOCATION AND OTHER PRACTICES

Since the Company generally acquires and disposes of its investments in
privately negotiated transactions, it infrequently uses brokers in the normal
course of business.

B-8
<PAGE> 121

TAX STATUS

The following discussion is a general summary of the material federal
income tax considerations applicable to the Company and to an investment in the
common stock and does not purport to be a complete description of the income tax
considerations applicable to such an investment. The discussion is based upon
the Code, Treasury Regulations, and administrative and judicial interpretations,
each as of the date of this SAI and all of which are subject to change. You
should consult your own tax advisor with respect to tax considerations which
pertain to your purchase of common stock.

The Company. The Company has elected for each taxable year to be treated
as a "regulated investment company" or "RIC" under Subchapter M of the Code and
intends to continue to maintain that status. If the Company qualifies as a RIC
and distributes to stockholders in a timely manner at least 90% of its
"investment company taxable income," as defined in the Code (i.e., net
investment income, including accrued original issue discount, and net short-term
capital gains) (the "90% Distribution Requirement") each year, it will not be
subject to federal income tax on the portion of its investment company taxable
income and net capital gains (net long-term capital gain in excess of net
short-term capital loss) it distributes to stockholders. In addition, if the
Company distributes in a timely manner 98% of its capital gain net income for
each one-year period ending on December 31, and distributes 98% of its net
ordinary income for each calendar year (as well as any income not distributed in
prior years), it will not be subject to the 4% nondeductible federal excise tax
imposed with respect to certain undistributed income of RICs. The Company
generally endeavors to distribute to stockholders all of its investment company
taxable income and its net capital gain, if any, for each taxable year so that
such Company will not incur income and excise taxes on its earnings.

In order to qualify as a RIC for federal income tax purposes, the Company
must, among other things: (a) continue to qualify as a BDC under the 1940 Act,
(b) derive in each taxable year 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 (the "90% Income Test"); and (c)
diversify its holdings so that at the end of each quarter of the taxable year
(i) at least 50% of the value of the Company's assets consists of cash, cash
items, U.S. government securities, securities of other RICs, and other
securities if such other securities of any one issuer do not represent more than
5% of the Company's assets or 10% of the outstanding voting securities of the
issuer, and (ii) no more than 25% of the value of the Company's assets is
invested in the securities of one issuer (other than U.S. government securities
or securities of other RICs) or of two or more issuers that are controlled (as
determined under applicable Code rules) by the Company and are engaged in the
same or similar or related trades or businesses. The failure of one or more of
the Company's subsidiaries to continue to qualify as RICs could adversely affect
the Company's ability to satisfy the foregoing diversification requirements.

If the Company acquires or is deemed to have acquired debt obligations that
were issued originally at a discount or that otherwise are treated under
applicable tax rules as having original issue discount, it must include in
income each year a portion of the original issue discount that accrues over the
life of the obligation regardless of whether cash representing such income is
received by the relevant entity in the same taxable year and to make
distributions accordingly.

B-9
<PAGE> 122

Although it does not presently expect to do so, the Company is authorized
to borrow funds and to sell assets in order to satisfy distribution
requirements. However, under the 1940 Act, the Company is not permitted to make
distributions to stockholders while the Company's debt obligations and other
senior securities are outstanding unless certain "asset coverage" tests are met.
Moreover, the Company's ability to dispose of assets to meet its distribution
requirements may be limited by other requirements relating to its status as a
RIC, including the diversification requirements. If the Company disposes of
assets in order to meet distribution requirements, the Company may make such
dispositions at times which, from an investment standpoint, are not
advantageous.

If the Company fails to satisfy the 90% Distribution Requirement or
otherwise fails to qualify as a RIC in any taxable year, it will be subject to
tax in that year on all of its taxable income, regardless of whether it makes
any distributions to its stockholders. In that case, all of the Company's
distributions to its stockholders will be characterized as ordinary income (to
the extent of the Company's current and accumulated earnings and profits). In
contrast, as is explained below, if the Company qualifies as a RIC, a portion of
its distributions may be characterized as long-term capital gain in the hands of
stockholders.

U.S. Stockholders. Other than distributions properly designated as
"capital gain dividends" as is described below, dividends to U.S. Stockholders
(as defined below) of the investment company taxable income of the Company will
be taxable as ordinary income to stockholders to the extent of the Company's
current or accumulated earnings and profits, whether paid in cash or reinvested
in additional shares. A "U.S. Stockholder" is a stockholder who is (i) a citizen
or resident of the United States, (ii) a corporation, partnership or other
entity created in or organized under the laws of the United States or any
political subdivision thereof, (iii) an estate, the income of which is subject
to United States federal income taxation regardless of its source, or (iv) a
trust subject to the supervision of a court within the United States and the
control of a United States person. Distributions of the Company's net capital
gain properly designated by the Company as "capital gain dividends" will be
taxable to stockholders as a long-term capital gain regardless of the
stockholder's holding period for his or her shares. Distributions in excess of
the Company's earnings and profits will first reduce the adjusted tax basis of
the stockholder's shares and, after the adjusted basis is reduced to zero, will
constitute capital gains to the stockholder. For a summary of the tax rates
applicable to capital gains, including capital gains dividends, see discussion
below.

To the extent that the Company retains any net capital gain, it may
designate such retained gain as "deemed distributions" and pay a tax thereon for
the benefit of its stockholders. In that event, the stockholders will be
required to report their share of retained net capital gain on their tax returns
as if it had been distributed to them and report a credit, or claim or refund
for the tax paid thereon by the Company. The amount of the deemed distribution
net of such tax will be added to the stockholder's cost basis for his or her
shares. Since the Company expects to pay tax on net capital gain at its regular
corporate capital gain tax rate, and since that rate is in excess of the maximum
rate currently payable by individuals on net capital gain, the amount of tax
that individual stockholders will be treated as having paid will exceed the
amount of tax that such stockholders would be required to pay on net capital
gain. Stockholders who are not subject to federal income tax or tax on capital
gains should be able to file a Form 990T or an income tax return on the
appropriate form that allows them to recover the taxes paid on their behalf.

Any dividend declared by the Company in October, November, or December of
any calendar year, payable to stockholders of record on a specified date in such
a month and actually paid during January of the following year, will be treated
as if it had been received by the stockholders on December 31 of the year in
which the dividend was declared.

You should consider the tax implications of buying shares just prior to a
distribution. Even if the price of the shares includes the amount of the
forthcoming distribution, you may be taxed upon

B-10
<PAGE> 123

receipt of the distribution and will not be entitled to offset the distribution
against the tax basis in your shares.

You may recognize taxable gain or loss if you sell or exchange your shares.
Any gain arising from (or, in the case of distributions in excess of earnings
and profits, treated as arising from) the sale or exchange of shares generally
will be a capital gain or loss. This capital gain or loss normally will be
treated as a long-term capital gain or loss if you have held your shares for
more than one year; otherwise, it will be classified as short-term capital gain
or loss. However, any capital loss arising from the sale or exchange of shares
held for six months or less will be treated as a long-term capital loss to the
extent of the amount of capital gain dividends received with respect to such
shares and, for this purpose, the special rules of Section 246(c)(3) and (4) of
the Code generally apply in determining the holding period of shares. It is
unclear how any such long-term capital loss offsets capital gains taxable at
different rates. All or a portion of any loss realized upon a taxable
disposition of shares of the Company may be disallowed if other shares of the
Company are purchased (under a DRIP plan or otherwise) within 30 days before or
after the disposition.

In general, net capital gain derived from an investment in the Company (the
excess of net long-term capital gain over net short-term capital loss) of
non-corporate taxpayers currently is subject to a maximum federal income tax
rate of 20% (subject to reduction in certain situations) while other income may
be taxed at rates as high as 39.6%. Capital gains derived from the disposition
of assets held for more than one year generally are subject to federal income
tax at the rate of 20%. Corporate taxpayers currently are subject to federal
income tax on net capital gain at the maximum 35% rate also applied to ordinary
income. Tax rates imposed by states and local jurisdictions on capital gain and
ordinary income may differ.

The Company will send to each of its stockholders, as promptly as possible
after the end of each fiscal year, a notice detailing, on a per share and per
distribution basis, the amounts includible in such stockholder's taxable income
for such year as ordinary income and as long-term capital gain. In addition, the
federal tax status of each year's distributions generally will be reported to
the IRS. Distributions may also be subject to additional state, local, and
foreign taxes depending on a stockholder's particular situation. The Company's
ordinary income dividends to its corporate shareholders may, if certain
conditions are met, qualify for the dividends received deduction to the extent
that the Company has received qualifying dividend income during the taxable
year; capital gain dividends distributed by the Company are not eligible for the
dividends received deduction.

Non-U.S. Stockholders. A Stockholder that is not a U.S. Stockholder (a
"Non-U.S. Stockholder") generally is subject to withholding of United States
federal income tax at a 30% rate (or lower applicable treaty rate) on dividends
from the Company (other than capital gain dividends) that are not "effectively
connected" with a United States trade or business carried on by such
stockholder. Accordingly, investment in the Company is likely to be appropriate
for a Non-U.S. Stockholder only if such person can utilize a foreign tax credit
or corresponding tax benefit in respect of such United States withholding tax.

Non-effectively connected capital gain dividends and gains realized from
the sale of stock will not be subject to United States federal income tax in the
case of (i) a Non-U.S. Stockholder that is a corporation and (ii) a Non-U.S.
Stockholder that is not present in the United States for more than 182 days
during the taxable year (assuming that certain other conditions are met).
However, certain Non-U.S. Stockholders may nonetheless be subject to backup
withholding on capital gain dividends and gross proceeds paid to them upon the
sale of their stock. See "Backup Withholding" below.

If income from the Company or gains realized from the sale of stock are
effectively connected with a Non-U.S. Stockholder's United States trade or
business, then such amounts will be subject to United States federal income tax
at the tax rates applicable to United States persons. Non-U.S.

B-11
<PAGE> 124

Stockholders that are corporations may be also subject to an additional "branch
profits tax" with respect to income from the Company that is effectively
connected with a United States trade or business.

The United States Treasury Department recently issued Treasury regulations
generally effective for payments made after December 31, 1999 concerning the
withholding of tax and information reporting for certain amounts paid to
nonresident alien individuals and foreign corporations (the "Final Withholding
Regulations"). Among other things, the Final Withholding Regulations may require
Non-U.S. Stockholders to furnish new certification of their foreign status not
later than December 31, 1999. Prospective investors should consult their tax
advisors concerning the applicability and effect of the Final Withholding
Regulations on an investment in stock.

The tax consequences to a Non-U.S. Stockholder entitled to claim the
benefits of an applicable tax treaty may be different from those described in
this section. An applicable tax treaty may reduce the rate or the scope of U.S.
taxation imposed on the income of an eligible Non-U.S. Stockholder. Non-U.S.
Stockholders may be required to provide appropriate documentation to establish
their entitlement to the benefits of such a treaty. Foreign investors are
advised to consult their tax advisors with respect to the tax implications of
purchasing, holding and disposing of stock.

Backup Withholding. The Company may be required to withhold United States
federal income tax at a rate of 31% ("backup withholding") from dividends and
redemption proceeds paid to non-corporate stockholders. This tax may be withheld
from dividends if (i) the stockholder fails to furnish the Company with its
correct taxpayer identification number, (ii) the IRS notifies the Company that
the stockholder has failed to properly report certain interest and dividend
income to the IRS and to respond to notices to that effect or (iii) when
required to do so, the stockholder fails to certify that he or she is not
subject to backup withholding. Redemption proceeds may be subject to withholding
under the circumstances described in (i) above.

The Company may be required to report annually to the IRS and to each
Non-U.S. Stockholder the amount of dividends paid to such stockholder and the
amount, if any, of tax withheld pursuant to the backup withholding rules with
respect to such dividends. This information may also be made available to the
tax authorities in the Non-U.S. Stockholder's country of residence.

Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules from payments made to a stockholder may be refunded or
credited against such stockholder's United States federal income tax liability,
if any, provided that the required information is furnished to the IRS.

YOU SHOULD CONSULT YOUR OWN TAX ADVISOR WITH RESPECT TO THE PARTICULAR TAX
CONSEQUENCES TO THEM OF AN INVESTMENT IN THE COMPANY, INCLUDING THE POSSIBLE
EFFECT OF ANY PENDING LEGISLATION OR PROPOSED REGULATION.

B-12
<PAGE> 125

PART C

OTHER INFORMATION

ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS

1. FINANCIAL STATEMENTS.

The following financial statements of Allied Capital Corporation (the
"Company" or the "Registrant") are included in this registration statement in
"Part A: Information Required in a Prospectus":

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Balance Sheet -- September 30, 1999 (unaudited)
and December 31, 1998 and 1997.............................. F-1
Consolidated Statement of Operations -- For the Nine Months
Ended September 30, 1999 and 1998 (unaudited) and for the
Years Ended December 31, 1998, 1997 and 1996.............. F-2
Consolidated Statement of Changes in Net Assets -- For the
Nine Months Ended September 30, 1999 and 1998 (unaudited)
and For the Years Ended December 31, 1998, 1997 and
1996...................................................... F-3
Consolidated Statement of Cash Flows -- For the Nine Months
Ended September 30, 1999 and 1998 (unaudited) and for the
Years Ended December 31, 1998, 1997 and 1996.............. F-4
Consolidated Statement of Investments -- September 30, 1999
(unaudited) and December 31, 1998......................... F-5
Notes to Consolidated Financial Statements.................. F-16
Report of Independent Public Accountants.................... F-38
</TABLE>

2. EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
a.1(1) Articles of Amendment and Restatement of the Articles of
Incorporation.
a.2(2) Articles of Merger.
b.(3) Bylaws.
c. Not applicable.
d.(6) Specimen certificate of the Company's Common Stock, par
value $0.0001, the rights of holders of which are defined in
Exhibits a.1, a.2 and b.
e.(3) Dividend Reinvestment Plan.
f.1(4) Form of debenture between certain subsidiaries of ACC and
the U.S. Small Business Administration.
f.2.a(11) Credit Agreement dated as of March 9, 1999 between the
Company, as borrower, each of the financial institutions
initially a signatory thereto, as Lenders, and Nationsbank,
N.A., as administrative agent, Nationsbanc Montgomery
Securities LLC, as sole lead arranger and sole book manager,
First Union National Bank, as syndication agent, BankBoston,
N.A., as documentation agent, Riggs Bank, N.A., as managing
agent, and Chevy Chase Bank, F.S.B. and Credit Lyonnais New
York Branch, as co-agents.
f.2.b(12) First Amendment to Credit Agreement dated May 7, 1999.
f.3(7) Note Agreement dated as of April 30, 1998.
f.4(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.
f.5(12) Note Agreement dated as of May 1, 1999.
f.6* Second Amended and Restated Master Loan & Security Agreement
dated October 28, 1999 between the Company and Morgan
Stanley Mortgage Capital, Inc.
</TABLE>

C-1
<PAGE> 126

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
f.7.a(6) Sale and Servicing Agreement dated, as of January 1, 1998,
among Allied Capital CMT, Inc., Allied Capital Commercial
Mortgage Trust 1998-1 and Allied Capital Corporation and
LaSalle National Bank and ABN AMRO Bank N.V.
f.7.b(6) Indenture dated as of January 1, 1998, between the Allied
Capital Commercial Mortgage Trust 1998-1 and LaSalle
National Bank.
f.7.c(6) Amended and Restated Trust Agreement, dated January 1, 1998
between Allied Capital CMT, LaSalle National Bank Inc. and
Wilmington Trust Company.
f.7.d(6) Guaranty dated as of January 1, 1998 by the Company.
g. Not applicable.
h.1(13) Form of Underwriting Agreement, if applicable.
i.1(3) Employee Stock Ownership Plan, as amended on December 31,
1997.
i.1a(7) First Amendment to the Allied Capital Corporation Employee
Stock Ownership Plan dated April 30, 1998.
i.1b* Termination Amendment to the Allied Capital Employee Stock
Ownership Plan effective December 31, 1999.
i.2(10) Amended and Restated Deferred Compensation Plan dated
December 30, 1998.
i.3(9) Stock Option Plan.
i.4 Description of Formula Award and Cut-Off Award Arrangements.
A discussion of the Formula and Cut-off Awards is set forth
on pages 56 through 58 of the Prospectus to the Registration
Statement and pages B-4 through B-6 of the SAI.
i.5(14) Allied Capital 401(k) Plan dated September 1, 1999.
j.1(6) Form of Custody Agreement with Riggs Bank N.A. with respect
to safekeeping.
j.2(6) Form of Custody Agreement with LaSalle National Bank.
l.* Opinion of counsel and consent to its use.
m. Not applicable.
n.1* Consent of Arthur Andersen LLP, independent public
accountants.
n.2* Consent of Sutherland Asbill & Brennan LLP (included in
Exhibit l).
o. Not applicable.
p. Not applicable.
q. Not applicable.
</TABLE>

- -------------------------

<TABLE>
<C> <S>
* Filed herewith.
(1) Incorporated by reference to exhibit 3(i) filed 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 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 the exhibit f.7 filed with
Allied I's Pre-Effective Amendment No. 2 to the registration
statement on Form N-2 on January 24, 1996 (File No.
33-64629). Assignment to the Company is incorporated by
reference to Exhibit 10.3 of the Company's Annual Report on
Form 10-K for the year ended December 31, 1997.
(6) Incorporated by reference to the exhibit of the same name to
the Company's registration statement on Form N-2 filed on
the Company's behalf with the Commission on May 5, 1998
(File No. 333-51899).
(7) Incorporated by reference to the exhibit of same name filed
with the Company's Quarterly Report on Form 10-Q for the
period ended June 30, 1998.
(8) Incorporated by reference to the exhibit of the same name
filed with the Company's Quarterly Report on Form 10-Q for
the period ended September 30, 1998.
(9) Incorporated by reference to Exhibit 4 of the Allied Capital
Corporation Stock Option Plan registration statement on Form
S-8, filed on behalf of such Plan on February 3, 1998 (File
No. 333-45525).
</TABLE>

C-2
<PAGE> 127

<TABLE>
<C> <S>
(10) Incorporated by reference to the exhibit of the same name
filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1998.
(11) Incorporated by reference to Exhibit f.2.a with the
Company's registration statement on Form N-2 (File No.
333-75161) filed on March 26, 1999.
(12) Incorporated by reference to the exhibit of the same name
filed with the Company's Quarterly Report on Form 10-Q for
the period ended June 30, 1999.
(13) Incorporated by reference to Exhibit h.1 filed with this
registration statement (File No. 333-84973).
(14) Incorporated by reference to Exhibit 4.4 of the Allied
Capital 401(k) Plan registration statement on Form S-8,
filed on behalf of such Plan on October 8, 1999 (File No.
333-88681).
</TABLE>

ITEM 25. MARKETING ARRANGEMENTS

The information contained under the heading "Plan of Distribution" on page
65 of the prospectus is incorporated herein by reference, and any information
concerning any underwriters will be contained in the accompanying prospectus
supplement, if any.

ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

<TABLE>
<S> <C>
Commission registration fee*................................ $ 19,532
NASD filing fee*............................................ $ 7,526
Nasdaq National Market Additional Listing Fee*.............. $ 80,000
Accounting fees and expenses................................ $100,000
Legal fees and expenses..................................... $300,000
Printing and engraving...................................... $250,000
Miscellaneous fees and expenses............................. $ 2,942
--------
Total.................................................. $760,000
========
</TABLE>

- -------------------------
* Estimated for filing purposes.

All of the expenses set forth above shall be borne by the Company.

ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL

Direct Subsidiaries

The following list sets forth each of the Company's subsidiaries, the state
or country under whose laws the subsidiary is organized, and the percentage of
voting securities or membership interests owned by the Company in such
subsidiary:

<TABLE>
<S> <C>
Allied Investment Corporation (Maryland).................... 100%
Allied Capital SBLC Corporation (Maryland).................. 100%
Allied Capital REIT, Inc. ("Allied REIT") (Maryland)........ 100%
Allied Capital Holdings LLC (Delaware)...................... 100%
Allied Capital Beteiligungsberatung GmbH (Germany).......... 100%
</TABLE>

Each of the Company's subsidiaries are consolidated with the Company for
financial reporting purposes, except as noted below.

Indirect Subsidiaries

The Company indirectly controls the entities set forth below through Allied
REIT. Allied REIT owns either all of the membership interests (in the case of a
limited liability company, "LLC") or all of the outstanding voting stock (in the
case of a corporation) of each entity. The following list sets

C-3
<PAGE> 128

forth each of Allied REIT's subsidiaries, the state under whose laws the
subsidiary is organized, and the percentage of voting securities or membership
interests owned by Allied REIT of such subsidiary:

<TABLE>
<S> <C>
Allied Capital Property LLC (Delaware)...................... 100%
Allied Capital Equity LLC (Delaware)........................ 100%
9586 I-25 East Frontage Road, Longmont, CO 80504 LLC
(Delaware)................................................ 100%
8930 Stanford Boulevard LLC (Delaware)...................... 100%
Allied Capital CMT, Inc. (Delaware)......................... 100%
</TABLE>

Allied REIT also indirectly owns Allied Capital Commercial Mortgage Trust
1998-1, a Delaware business trust that is wholly owned by Allied Capital CMT,
Inc. ("CMT"). Each subsidiary of Allied REIT and CMT is not required to maintain
financial and other reports required under the Securities Act because each does
not have a class of securities registered under the Securities Act.

The Company indirectly controls Allied Capital SBLC Holdings LLC (Delaware)
through Allied Capital SBLC Corporation, which owns 100% of the membership
interests. The Company indirectly controls Allied Investment Holdings LLC
(Delaware) through Allied Investment Corporation, which owns 100% of the
membership interests.

Other Entities Deemed to be Controlled by the Company

The Company provides investment advisory services to the certain entities
and therefore may be deemed to control such entities and their respective
subsidiaries. The following list sets forth each such entity and its respective
subsidiaries and the state under whose laws the entity or subsidiary is
organized:

Allied Capital Germany Fund LLC (Delaware)(1, 2)

Allied Capital Syndication LLC (Delaware)(2)

Business Mortgage Investors, Inc. (Maryland)(1)
Wholly owned subsidiaries of Business Mortgage Investors, Inc.:
BMI Holdings, Inc. (Maryland)
BMI Funding, Inc. (Delaware)
Indirect subsidiary of Business Mortgage Investors, Inc.
BMI Funding LLC (Delaware), of which BMI Funding, Inc. owns substantially
all membership interests

The Company has also established certain limited purpose entities in order to
facilitate certain portfolio transactions.
- -------------------------
(1) By so including these entities herein, the Registrant does not concede that
it controls such entities.

(2) Subsidiary does not consolidate for financial reporting purposes.

ITEM 28. NUMBER OF HOLDERS OF SECURITIES

The following table sets forth the approximate number of record holders of
the Company's Common Stock at November 5, 1999.

<TABLE>
<CAPTION>
NUMBER OF
TITLE OF CLASS RECORD HOLDERS
-------------- --------------
<S> <C>
Common Stock, $0.0001 par value........................... 4,500
</TABLE>

C-4
<PAGE> 129

ITEM 29. INDEMNIFICATION

The Annotated Code of Maryland, Corporations and Associations (the
"Maryland Law"), Section 2-418 provides that a Maryland corporation may
indemnify any director of the corporation and any person who, while a director
of the corporation, is or was serving at the request of the corporation as a
director, officer, partner, trustee, employee, or agent of another foreign or
domestic corporation, partnership, joint venture, trust, other enterprise or
employee benefit plan, made a party to any proceeding by reason of service in
that capacity unless it is established that the act or omission of the director
was material to the matter giving rise to the proceeding and was committed in
bad faith or was the result of active and deliberate dishonesty; or the director
actually received an improper personal benefit in money, property or services;
or, in the case of any criminal proceeding, the director had reasonable cause to
believe that the act or omission was unlawful. Indemnification may be made
against judgments, penalties, fines, settlements, and reasonable expenses
actually incurred by the director in connection with the proceeding, but if the
proceeding was one by or in the right of the corporation, indemnification may
not be made in respect of any proceeding in which the director shall have been
adjudged to be liable to the corporation. Such indemnification may not be made
unless authorized for a specific proceeding after a determination has been made,
in the manner prescribed by the law, that indemnification is permissible in the
circumstances because the director has met the applicable standard of conduct.
On the other hand, the director must be indemnified for expenses if he or she
has been successful in the defense of the proceeding or as otherwise ordered by
a court. The law also prescribes the circumstances under which the corporation
may advance expenses to, or obtain insurance or similar cover for, directors.

The law also provides for comparable indemnification for corporate officers
and agents.

The Articles of Incorporation of the Company provide that its directors and
officers shall, and its agents in the discretion of the board of directors may,
be indemnified to the fullest extent permitted from time to time by the laws of
Maryland (with such power to indemnify officers and directors limited to the
scope provided for in Section 2-418 as currently in force), provided, however,
that such indemnification is limited by the Investment Company Act of 1940 or by
any valid rule, regulation or order of the Securities and Exchange Commission
thereunder. The Company's Bylaws, however, provide that the Company may not
indemnify any director or officer against liability to the Company or its
security holders to which he or she might otherwise be subject by reason of such
person's willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his or her office unless a
determination is made by final decision of a court, by vote of a majority of a
quorum of directors who are disinterested, non-party directors or by independent
legal counsel that the liability for which indemnification is sought did not
arise out of such disabling conduct.

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Company pursuant to the provisions described above, or otherwise, the Company
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Company of expenses incurred or
paid by a director, officer or controlling person in the successful defense of
an action, suit or proceeding) is asserted by a director, officer or controlling
person in connection with the securities being registered, the Company will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of the court of the issue.

The Company carries liability insurance for the benefit of its directors
and officers on a claims-made basis of up to $10,000,000, subject to a $250,000
retention and the other terms thereof.

C-5
<PAGE> 130

The Agreement and Plan of Merger (the "Merger Agreement") by and among
Advisers, Allied I, Allied II, Allied Lending and Allied Commercial provides
that, from and after consummation of the Merger the Company shall indemnify any
person who at the date of the Merger Agreement, or had been at any time prior to
such date or who becomes prior to the effective time of the merger, an officer
or director of Allied I, Allied II, Allied Commercial or Advisers, or any of
their respective subsidiaries, from any and all liabilities resulting from their
acts and omissions prior to the effective time of the merger to the full extent
permitted by Maryland Law and the 1940 Act, including but not limited to acts
and omissions arising out of or pertaining to the merger, and shall maintain in
effect for at least 72 months directors' and officers' liability insurance
policies with respect to matters occurring prior to the effective time of the
merger.

ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER

Not applicable.

ITEM 31. LOCATION OF ACCOUNTS AND RECORDS

The Company maintains at its principal office physical possession of each
account, book or other document required to be maintained by Section 31(a) of
the 1940 Act and the rules thereunder.

ITEM 32. MANAGEMENT SERVICES

Not applicable.

ITEM 33. UNDERTAKINGS

The Registrant hereby undertakes:

(1) to suspend the offering of shares until the prospectus is amended
if subsequent to the effective date of this Registration Statement, its net
asset value declines more than ten percent from its net asset value as of
the effective date of this Registration Statement;

(2) to file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:

(i) to include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;

(ii) to reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or
the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high
end of the estimated maximum offering range may be reflected
in the form of prospectus filed with the Commission pursuant
to Rule 424(b) under the Securities Act of 1933 if, in the
aggregate, the changes in volume and price represent no more
than a 20% change in the maximum aggregate offering price
set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and

(iii) to include any material information with respect to the plan
of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement.

C-6
<PAGE> 131

(3) that, for the purpose of determining any liability under the
Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this Registration Statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant under Rule 497(h)
under the Securities Act of 1933 shall be deemed to be part of this
Registration Statement as of the time it was declared effective;

(4) to remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering;

(5) that, for the purpose of determining any liability under the
Securities Act of 1933, each post effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of the securities at
that time shall be deemed to be the initial bona fide offering thereof; and

(6) to send by first class mail or other means designed to ensure
equally prompt delivery, within two business days of receipt of a written
or oral request, any Statement of Additional Information.

Subject to the terms and conditions of Section 15(d) of the Securities
Exchange Act of 1934, the registrant hereby undertakes to file with the
Securities and Exchange Commission such supplementary and periodic information,
documents and reports as may be prescribed by any rule or regulation of the
Commission heretofore or hereafter duly adopted pursuant to authority conferred
in that section.

Insofar as indemnification for liability arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions of its charter and bylaws permitting
indemnification, or otherwise, the registrant has been advised that in the
opinion of the Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.

C-7
<PAGE> 132

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Washington, in the
District of Columbia, on the 10th day of November, 1999.

ALLIED CAPITAL CORPORATION

By: /s/ William L. Walton
----------------------------------------
William L. Walton
Chief Executive Officer and
President

Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities indicated on November 10, 1999.

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ WILLIAM L. WALTON Chairman of the Board, Chief Executive Officer, and
- --------------------------------------------- President
William L. Walton

* Director
- ---------------------------------------------
Brooks H. Browne

* Director
- ---------------------------------------------
John D. Firestone

* Director
- ---------------------------------------------
Anthony T. Garcia

* Director
- ---------------------------------------------
Lawrence I. Hebert

* Director
- ---------------------------------------------
John I. Leahy

* Director
- ---------------------------------------------
Robert E. Long

* Director
- ---------------------------------------------
Warren K. Montouri

* Director
- ---------------------------------------------
Guy T. Steuart II

* Director
- ---------------------------------------------
T. Murray Toomey

* Director
- ---------------------------------------------
Laura W. van Roijen
</TABLE>
<PAGE> 133

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
* Director
- ---------------------------------------------
George C. Williams

/s/ PENNI F. ROLL Executive Vice President and Chief Financial
- --------------------------------------------- Officer (Principal Financial and Accounting
Penni F. Roll Officer)
</TABLE>

* Signed by William L. Walton pursuant to a power of attorney signed by the
individual and filed with this registration statement on August 11, 1999.

<PAGE> 134

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------------- -----------
<S> <C>
Ex - 99.2f.6 Second Amended and Restated Master Loan & Security Agreement
Ex - 99.2i.1b Termination Amendment to ESOP
Ex - 99.2n.1 Consent of Arthur Andersen LLP, independent public
accountants
Ex - 99.21 Opinion of counsel and consent to its use
</TABLE>

<PAGE> 1
EXHIBIT 99.2f.6

EXECUTION COPY

SECOND AMENDED AND RESTATED MASTER LOAN AND SECURITY AGREEMENT

_____________________________

DATED AS OF OCTOBER 28, 1999

______________________________

ALLIED CAPITAL CORPORATION,
AS BORROWER

AND

MORGAN STANLEY MORTGAGE CAPITAL INC.
AS LENDER

<PAGE> 2

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----

<S> <C>
SECTION 1. DEFINITIONS AND ACCOUNTING MATTERS.
-----------------------------------
1.01 Certain Defined Terms. ......................................................................... 1
----------------------------
1.02 Accounting Terms and Determinations. ........................................................... 10
------------------------------------------

SECTION 2. LOANS, NOTE AND PREPAYMENTS.
----------------------------
2.01 Loans. ......................................................................................... 11
------------
2.02 Notes. ......................................................................................... 11
------------
2.03 Procedure for Borrowing. ....................................................................... 11
------------------------------
2.04 Limitation on Types of Loans; Illegality. ...................................................... 12
-----------------------------------------------
2.05 Repayment of Loans; Interest. .................................................................. 13
-----------------------------------
2.06 Mandatory Prepayments or Pledge. ............................................................... 13
--------------------------------------
2.07 Indemnity. ..................................................................................... 13
----------------
2.08 Extension of Termination Date. ................................................................. 14
------------------------------------

SECTION 3. PAYMENTS; COMPUTATIONS; ETC.
----------------------------
3.01 Payments. ...................................................................................... 14
---------------
3.02 Computations. .................................................................................. 14
-------------------
3.03 Requirements of Law. ........................................................................... 14
--------------------------
3.04 Facility Fee; Exit Fee. ........................................................................ 15
-----------------------------

SECTION 4. COLLATERAL SECURITY.
--------------------
4.01 Collateral; Security Interest. ................................................................. 16
------------------------------------
4.02 Further Documentation.. ........................................................................ 17
----------------------------
4.03 Changes in Locations, Name, etc.. .............................................................. 17
--------------------------------------
4.04 Lender's Appointment as Attorney-in-Fact. ...................................................... 18
-----------------------------------------------
4.05 Performance by Lender of Borrower's Obligations. ............................................... 19
------------------------------------------------------
4.06 Proceeds.. ..................................................................................... 19
---------------
4.07 Remedies. ...................................................................................... 19
---------------
4.08 Limitation on Duties Regarding Preservation of Collateral. ..................................... 20
----------------------------------------------------------------
4.09 Powers Coupled with an Interest. ............................................................... 21
--------------------------------------
4.10 Release of Security Interest.. ................................................................. 21
-----------------------------------

SECTION 5. CONDITIONS PRECEDENT.
---------------------
5.01 Initial Loan. .................................................................................. 21
-------------------
5.02 Initial and Subsequent Loans. .................................................................. 22
-----------------------------------

SECTION 6. REPRESENTATIONS AND WARRANTIES.
-------------------------------
6.01 Existence. ..................................................................................... 23
----------------
6.02 Financial Condition. ........................................................................... 24
--------------------------
6.03 Litigation. .................................................................................... 24
-----------------
6.04 No Breach.. .................................................................................... 24
----------------
6.05 Action. ........................................................................................ 25
-------------
</TABLE>

-i-
<PAGE> 3

<TABLE>
<S> <C>
6.06 Approvals. ..................................................................................... 25
----------------
6.07 Margin Regulations. ............................................................................ 25
-------------------------
6.08 Taxes. ......................................................................................... 25
------------
6.09 Investment Company Act.. ....................................................................... 25
-----------------------------
6.10 Collateral; Collateral Security. ............................................................... 25
--------------------------------------
6.11 Chief Executive Office. ........................................................................ 26
-----------------------------
6.12 Location of Books and Records.. ................................................................ 26
------------------------------------
6.13 Hedging. ....................................................................................... 26
--------------
6.14 True and Complete Disclosure. .................................................................. 26
-----------------------------------
6.15 Consolidated Shareholders' Equity. ............................................................. 27
----------------------------------------
6.16 ERISA. ......................................................................................... 27
------------
6.17 Material Subsidiaries. ......................................................................... 27
----------------------------

SECTION 7. COVENANTS OF THE BORROWER.
--------------------------
7.01 Financial Statements. .......................................................................... 27
---------------------------
7.02 Litigation. .................................................................................... 28
-----------------
7.03 Existence, etc. ................................................................................ 28
---------------------
7.04 Prohibition of Fundamental Changes. ............................................................ 29
-----------------------------------------
7.05 Borrowing Base Deficiency. ..................................................................... 29
--------------------------------
7.06 Notices. ....................................................................................... 29
--------------
7.07 Hedging. ....................................................................................... 29
--------------
7.08 Reports. ....................................................................................... 30
--------------
7.09 Underwriting Guidelines. ....................................................................... 30
------------------------------
7.10 Transactions with Affiliates. .................................................................. 30
-----------------------------------
7.11 Limitation on Liens. ........................................................................... 30
--------------------------
7.12 Limitation on Distributions. ................................................................... 30
----------------------------------
7.13 Consolidated Shareholders' Equity. ............................................................. 31
----------------------------------------
7.14 Maintenance of Ratio of Total Indebtedness to Consolidated Shareholders' Equity. ............... 31
--------------------------------------------------------------------------------------
7.15 Maintenance of Profitability. .................................................................. 31
-----------------------------------
7.16 Servicing Tape.. ............................................................................... 31
---------------------
7.17 Interest Rate Protection Agreements. ........................................................... 31
------------------------------------------
7.18 Required Filings. .............................................................................. 31
-----------------------
7.19 No Adverse Selection. .......................................................................... 31
---------------------------
7.20 Computer Systems. .............................................................................. 31
-----------------------
7.21 ERISA.. ........................................................................................ 31
------------
7.22 Remittance of Prepayments. ..................................................................... 31
--------------------------------
7.23 Lender's Right to Purchase. .................................................................... 31
---------------------------------
7.24 Securitizations. ............................................................................... 32
----------------------
7.25 Material Subsidiaries. ......................................................................... 32
----------------------------
</TABLE>

-ii-
<PAGE> 4

<TABLE>
<S> <C>
SECTION 8. EVENTS OF DEFAULT.
------------------

SECTION 9. REMEDIES UPON DEFAULT.
----------------------

SECTION 10. NO DUTY OF LENDER.
------------------

SECTION 11. MISCELLANEOUS.
--------------
11.01 Waiver. ........................................................................................ 35
-----------
11.02 Notices. ....................................................................................... 35
------------
11.03 Indemnification and Expenses. .................................................................. 35
---------------------------------
11.04 Amendments. .................................................................................... 36
---------------
11.05 Successors and Assigns. ........................................................................ 36
---------------------------
11.06 Survival.. ..................................................................................... 36
-------------
11.07 Captions. ...................................................................................... 37
-------------
11.08 Counterparts. .................................................................................. 37
-----------------
11.09 Loan Agreement Constitutes Security Agreement; Governing Law. .................................. 37
-----------------------------------------------------------------
11.10 SUBMISSION TO JURISDICTION; WAIVERS. ........................................................... 37
----------------------------------------
11.11 WAIVER OF JURY TRIAL. .......................................................................... 37
-------------------------
11.12 Acknowledgments. ............................................................................... 38
--------------------
11.13 Hypothecation or Pledge of Loans. .............................................................. 38
-------------------------------------
11.14 Servicing. ..................................................................................... 38
--------------
11.15 Periodic Due Diligence Review. ................................................................. 39
----------------------------------
11.16 Set-Off. ....................................................................................... 40
------------
11.17 Intent. ........................................................................................ 40
-----------
</TABLE>

SCHEDULES

SCHEDULE 1 Representations and Warranties re: Mortgage Loans
SCHEDULE 2 Filing Jurisdictions and Offices
SCHEDULE 3 List of Material Subsidiaries

EXHIBITS

EXHIBIT A Form of Second Amended and Restated Promissory Note
EXHIBIT B Second Amended and Restated Custodial Agreement
EXHIBIT C Opinion of Counsel to Borrower
EXHIBIT D Form of Request for Borrowing
EXHIBIT E-1 Form of Borrower's Release Letter
EXHIBIT E-2 Form of Warehouse Lender's Release Letter
EXHIBIT F Underwriting Guidelines
EXHIBIT G Form of Servicer Notice

-iii-
<PAGE> 5

SECOND AMENDED AND RESTATED MASTER LOAN AND SECURITY
AGREEMENT

SECOND AMENDED AND RESTATED MASTER LOAN AND SECURITY
AGREEMENT, dated as of October 28, 1999, among ALLIED CAPITAL CORPORATION, a
Maryland corporation successor by merger to Allied Capital Commercial
Corporation (the "Borrower") and MORGAN STANLEY MORTGAGE CAPITAL INC., a New
York corporation (the "Lender").

RECITALS

WHEREAS, the Borrower and the Lender entered into an Amended
and Restated Master Loan and Security Agreement, dated October 7, 1998 (the
"Existing Agreement");

WHEREAS, the Borrower has requested that the Lender from time
to time make revolving credit loans to them on a committed basis to finance
certain multifamily and commercial mortgage loans owned by the Borrower, and
the Lender is prepared to make such loans upon the terms and conditions hereof;

WHEREAS, the Lender and the Borrower desire to amend and
restate the Existing Agreement to provide terms and conditions under which the
Lender is prepared to make further revolving credit loans to the Borrower from
and after the date hereof.

NOW, THEREFORE, for good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the parties hereby
agree that the Existing Agreement is amended and restated in its entirety as
follows:

Section 1. Definitions and Accounting Matters.

1.01 Certain Defined Terms. As used herein, the following
terms shall have the following meanings (all terms defined in this Section 1.01
or in other provisions of this Loan Agreement in the singular to have the same
meanings when used in the plural and vice versa):

"Affiliate" shall mean with respect to any Person, any
"affiliate" of such Person as such term is defined in the United States
Bankruptcy Code.

"Applicable Collateral Percentage" shall mean (a) with respect
to all Eligible Mortgage Loans that can be readily deposited in a Standard
Securitization Transaction, 85% to 88%, as determined by the Lender, and (b)
with respect to Other Eligible Mortgage Loans, such percentage as is acceptable
to the Lender in its sole discretion.

"Applicable Margin" shall mean (a) with respect to Eligible
Mortgage Loans other than Other Eligible Mortgage Loans, 100 basis points (1%),
and (b) with respect to Other Eligible Mortgage Loans, such margin as is
acceptable to the Lender in its sole discretion.

<PAGE> 6

"Bailee Agreement" shall mean a Bailee Agreement, among the
Borrower, the Lender and a Settlement Agent, in form and substance acceptable
to the Lender.

"Bankruptcy Code" shall mean the United States Bankruptcy Code
of 1978, as amended from time to time.

"Borrower" shall have the meaning provided in the heading
hereof.

"Borrowing Base" shall mean the aggregate Collateral Value of
all Eligible Mortgage Loans.

"Borrowing Base Deficiency" shall have the meaning provided in
Section 2.06 hereof.

"Business Day" shall mean any day other than (i) a Saturday or
Sunday or (ii) a day on which the New York Stock Exchange, the Federal Reserve
Bank of New York or the Custodian is authorized or obligated by law or
executive order to be closed.

"Business Development Company" shall mean an investment
company that has elected to be regulated as a 'business development company'
under the 1940 Act.

"Capital Lease Obligations" shall mean, for any Person, all
obligations of such Person to pay rent or other amounts under a lease of (or
other agreement conveying the right to use) Property to the extent such
obligations are required to be classified and accounted for as a capital lease
on a balance sheet of such Person under GAAP, and, for purposes of this Loan
Agreement, the amount of such obligations shall be the capitalized amount
thereof, determined in accordance with GAAP.

"Code" shall mean the Internal Revenue Code of 1986, as
amended from time to time.

"Collateral" shall have the meaning provided in Section
4.01(b) hereof.

"Collateral Value" shall mean, with respect to each Eligible
Mortgage Loan, the lesser of (a) the Applicable Collateral Percentage of the
Market Value of such Mortgage Loan, and (b) the outstanding principal balance
of such Mortgage Loan; provided, that:

(i) the Collateral Value shall be deemed to be zero with
respect to each Eligible Mortgage Loan (1) in respect of which there is a
breach of a representation and warranty set forth on Schedule 1 (assuming each
representation and warranty is made as of the date Collateral Value is
determined), (2) in respect of which there is a delinquency in the payment of
principal and/or interest which continues for a period 30 days or more (without
regard to any applicable grace periods), (3) which is an Eligible Mortgage Loan
which remains pledged to the Lender hereunder later than 270 days after the
date on which it is first included in the Collateral (other than Outstanding
Mortgage Loans) or (4) which has been released from the possession of the
Custodian under the Custodial Agreement to the Borrower for a period in excess
of 14 days; or (5) a Table-Funded Mortgage Loan for which the Custodian has
failed to receive the original

-2-
<PAGE> 7

Mortgage Loan Documents by 10:00 a.m., New York time on the fourth Business Day
following the applicable Funding Date; and

(ii) the aggregate Collateral Value of Eligible Mortgage
Loans which are Table-Funded Mortgage Loans may not exceed $30,000,000, unless
otherwise approved by the Lender in its sole discretion.

"Consolidated Shareholders' Equity" shall mean, as of the date
of determination thereof, the total shareholders' equity of the Borrower and
its Consolidated Subsidiaries as the same would be required to appear on a
consolidated balance sheet of the Borrower and its Consolidated Subsidiaries
prepared as of such date in accordance with GAAP, including, in any case,
common stock of the Borrower (valued at cost) held in the Allied Capital
Corporation Deferred Compensation Trust and Permitted Preferred Stock of the
Borrower and its Consolidated Subsidiaries but excluding any stock, common or
preferred, not both issued and outstanding.

"Consolidated Subsidiaries" shall mean any Subsidiary which is
required to be consolidated on financial statements of the Borrower prepared
accordance with GAAP.

"Custodial Agreement" shall mean the Second Amended and
Restated Custodial Agreement, dated as of the date hereof, among the Borrower,
the Custodian and the Lender, substantially in the form of Exhibit B hereto, as
the same shall be modified and supplemented and in effect from time to time.

"Custodian" shall mean LaSalle National Bank, as custodian
under the Custodial Agreement, and its successors and permitted assigns
thereunder.

"Default" shall mean an Event of Default or an event that with
notice or lapse of time or both would become an Event of Default.

"Dollars" and "$" shall mean lawful money of the United States
of America.

"Due Diligence Review" shall mean the performance by the
Lender of any or all of the reviews permitted under Section 11.15 hereof with
respect to any or all of the Mortgage Loans, as desired by the Lender from time
to time.

"Effective Date" shall mean the date upon which the conditions
precedent set forth in Section 5.01 shall have been satisfied.

"Eligible Mortgage Loans" shall mean (a) any Mortgage Loan
secured by a first mortgage lien on a retail, office, hotel or other commercial
property or (b) any Mortgage Loan secured by a first mortgage lien on a
five-or-more family residential property; provided, however, that, in each
case, with respect to each Mortgage Loan either (A)(i) the representations and
warranties in Section 6.10 and Part I of Schedule 1 hereof are correct in all
material respects (ii) each Mortgage Loan is underwritten in accordance with
the Borrower's Underwriting Guidelines and (iii) each Mortgage Loan is eligible
for inclusion in a Standard Securitization Transaction or (B) such Mortgage
Loan is an Other Eligible Mortgage Loan; provided that, in no event shall any
Mortgage Loan the pledge of which under this Loan Agreement constitutes a

-3-
<PAGE> 8

pledge of a security under the 1934 Act or the foreclosure upon which would
constitute the acquisition of a security under the 1934 Act or the sale of
which would constitute the sale of a security under the 1934 Act (without in
any way affecting the characterization of such Mortgage Loan under the 1940
Act) be considered an Eligible Mortgage Loan for purposes hereof.

"Equity Issuance" shall mean any issuance or sale by a Person
of its capital stock or other similar equity security, or any warrants, options
or similar rights to acquire, or securities convertible into or exchangeable
for, such capital stock or other similar equity security.

"ERISA" shall mean the Employee Retirement Income Security Act
of 1974, as amended from time to time.

"ERISA Affiliate" shall mean any corporation or trade or
business that is a member of any group of organizations (i) described in
Section 414(b) or (c) of the Code of which the Borrower is a member and (ii)
solely for purposes of potential liability under Section 302(c)(11) of ERISA
and Section 412(c)(11) of the Code and the lien created under Section 302(f) of
ERISA and Section 412(n) of the Code, described in Section 414(m) or (o) of the
Code of which the Borrower is a member.

"Eurodollar Rate" shall mean with respect to each day during
each Interest Period pertaining to such Loan, the rate per annum equal to the
rate appearing at page 5 of the Telerate Screen, on the first day of such
Interest Period, for the one-month term corresponding to such Interest Period,
and if such rate shall not be so quoted, the rate per annum at which the Lender
is offered Dollar deposits at or about 10:00 A.M., New York City time, on the
first day of such Interest Period, by prime banks in the interbank eurodollar
market where the eurodollar and foreign currency and exchange operations in
respect of its Loans are then being conducted for delivery on the first day of
such Interest Period for the number of days comprised therein and in an amount
comparable to the amount of the Loans to be outstanding during such Interest
Period.

"Event of Default" shall have the meaning set forth in Section
8 hereof.

"Exit Fee" shall have the meaning set forth in Section
3.04(b).

"Federal Funds Rate" shall mean, for any day, the weighted
average of the rates on overnight federal funds transactions with members of
the Federal Reserve System arranged by federal funds brokers, as published on
the next succeeding Business Day by the Federal Reserve Bank of New York, or,
if such rate is not so published for any day which is a Business Day, the
average of the quotations for the day of such transactions received by the
Lender from three federal funds brokers of recognized standing selected by it.

"Funding Date" shall mean the date on which a Loan is made
hereunder.

"GAAP" shall mean generally accepted accounting principles as
in effect from time to time in the United States.

"Governmental Authority" shall mean any nation or government,
any state or other political subdivision thereof, any entity exercising
executive, legislative, judicial,

-4-
<PAGE> 9

regulatory or administrative functions of or pertaining to government and any
court or arbitrator having jurisdiction over the Borrower, any of its
Subsidiaries, or any of its properties.

"Guarantee" shall mean, as to any Person, any obligation of
such Person directly or indirectly guaranteeing any Indebtedness of any other
Person or in any manner providing for the payment of any Indebtedness of any
other Person or otherwise protecting the holder of such Indebtedness against
loss (whether by virtue of partnership arrangements, by agreement to keep-well,
to purchase assets, goods, securities or services, or to take-or-pay or
otherwise); provided that the term "Guarantee" shall not include (i)
endorsements for collection or deposit in the ordinary course of business, or
(ii) obligations to make servicing advances for delinquent taxes and insurance
or other obligations in respect of a Mortgaged Property, to the extent required
by the Lender. The amount of any Guarantee of a Person shall be deemed to be
an amount equal to the stated or determinable amount of the primary obligation
in respect of which such Guarantee is made or, if not stated or determinable,
the maximum reasonably anticipated liability in respect thereof as determined
by such Person in good faith. The terms "Guarantee" and "Guaranteed" used as
verbs shall have correlative meanings.

"Indebtedness" shall mean, for any Person: (a) obligations
created, issued or incurred by such Person for borrowed money (whether by loan,
the issuance and sale of debt securities or the sale of Property to another
Person subject to an understanding or agreement, contingent or otherwise, to
repurchase such Property from such Person); (b) obligations of such Person to
pay the deferred purchase or acquisition price of Property or services, other
than trade accounts payable (other than for borrowed money) arising, and
accrued expenses incurred, in the ordinary course of business so long as such
trade accounts payable are payable within 90 days of the date the respective
goods are delivered or the respective services are rendered; (c) Indebtedness
of others secured by a Lien on the Property of such Person, other than the
respective Indebtedness so secured that has not been assumed by such Person;
(d) obligations (contingent or otherwise) of such Person in respect of letters
of credit or similar instruments issued or accepted by banks and other
financial institutions for account of such Person; (e) Capital Lease
Obligations of such Person; (f) obligations of such Person under repurchase
agreements, sale/buy-back agreements or like arrangements; (g) Indebtedness of
others Guaranteed by such Person; (h) all obligations of such Person incurred
in connection with the acquisition or carrying of fixed assets by such Person;
and (i) Indebtedness of general partnerships of which such Person is a general
partner.

"Interest Period" shall mean, with respect to any Loan, (a)
initially, the period commencing on the applicable Funding Date to but
excluding the first Payment Date; and (b) thereafter, each period commencing on
a Payment Date to but excluding the next Payment Date; provided that,
notwithstanding the foregoing, (i) an Interest Period may be for a term of
fewer days as mutually agreed upon between the Borrower and the Lender and (ii)
no Interest Period may end after the Termination Date.

"Interest Rate Protection Agreement" shall mean, any interest
rate swap, cap or collar agreement or similar arrangements providing for
protection against fluctuations in interest rates or the exchange of nominal
interest obligations, either generally or under specific contingencies, entered
into by the Borrower and reasonably acceptable to the Lender.

-5-
<PAGE> 10

"Lender" shall have the meaning provided in the heading
hereto.

"Lien" shall mean any mortgage, lien, pledge, charge, security
interest or similar encumbrance.

"Loan" shall have the meaning provided in Section 2.01(a)
hereof.

"Loan Agreement" shall mean this Second Amended and Restated
Master Loan and Security Agreement, as the same may be amended, supplemented or
otherwise modified from time to time.

"Loan Documents" shall mean, collectively, this Loan
Agreement, the Note and the Custodial Agreement.

"Market Value" shall mean, as of any date in respect of an
Eligible Mortgage Loan, the price at which such Eligible Mortgage Loan could
readily be sold as determined in good faith by the Lender, which price may be
determined to be zero. The Lender's determination of Market Value shall be
conclusive upon the parties absent manifest error on the part of the Lender.

"Material Adverse Effect" shall mean a material adverse effect
on (a) the Property, business, operations, financial condition or prospects of
the Borrower, (b) the status of the Borrower as a Business Development Company
or the Borrower's compliance with the 1940 Act, (c) the ability of the Borrower
to perform its obligations under any of the Loan Documents to which it is a
party, (d) the validity or enforceability of any of the Loan Documents, (e) the
rights and remedies of the Lender under any of the Loan Documents, (f) the
timely payment of the principal of or interest on the Loans or other amounts
payable in connection therewith or (g) the Collateral.

"Maximum Credit" shall mean $100,000,000.

"Material Subsidiary" shall mean, as of the date of any
determination thereof, any Subsidiary which has total assets having a value
(determined in accordance with the market valuation method pursuant to GAAP)
greater than or equal to $20,000,000.

"Mortgage" shall mean the mortgage, deed of trust or other
instrument securing a Mortgage Note, which creates a first lien on the fee in
real property securing the Mortgage Note and the assignment of rents and leases
related thereto.

"Mortgage File" shall have the meaning assigned thereto in the
Custodial Agreement.

"Mortgage Loan" shall mean a mortgage loan which the Custodian
has been instructed to hold for the Lender pursuant to the Custodial Agreement,
and which Mortgage Loan includes, without limitation, (i) a Mortgage Note and
related Mortgage and (ii) all right, title and interest of the Borrower in and
to the Mortgaged Property covered by such Mortgage.

-6-
<PAGE> 11

"Mortgage Loan Documents" shall mean, with respect to a
Mortgage Loan, the documents comprising the Mortgage File for such Mortgage
Loan.

"Mortgage Loan Schedule" shall have the meaning assigned
thereto in the Custodial Agreement.

"Mortgage Loan Schedule and Exception Report" shall mean the
mortgage loan Schedule and exception report prepared by the Custodian pursuant
to the Custodial Agreement.

"Mortgage Loan Tape" shall mean a computer-readable magnetic
tape with respect to each Mortgage Loan, to be delivered by the Borrower to the
Lender pursuant to Section 2.03(a) hereof, containing tape fields set forth in
Annex 1 to the Custodial Agreement.

"Mortgage Note" shall mean the original executed promissory
note or other evidence of the indebtedness of a mortgagor/borrower with respect
to a Mortgage Loan.

"Mortgaged Property" shall mean the real property (including
all improvements, buildings, fixtures, building equipment and personal property
thereon and all additions, alterations and replacements made at any time with
respect to the foregoing) and all other collateral securing repayment of the
debt evidenced by a Mortgage Note.

"Mortgagor" shall mean the obligor on a Mortgage Note.

"MS & Co." shall mean Morgan Stanley & Co. Incorporated, a
registered broker-dealer.

"Multiemployer Plan" shall mean a multiemployer plan defined
as such in Section 3(37) of ERISA to which contributions have been or are
required to be made by the Borrower or any ERISA Affiliate and that is covered
by Title IV of ERISA.

"Net Income" shall mean, for any period, the net income of the
Borrower for such period as determined in accordance with GAAP.

"Net Proceeds" shall mean, with respect to an Equity Issuance
by a Person, the aggregate amount of all cash received by such Person in
respect of such Equity Issuance net of investment banking fees, legal fees,
accountants fees, underwriting discounts and commissions and other customary
fees and expenses actually incurred by such Person in connection with such
Equity Issuance.

"1940 Act" shall mean the Investment Company Act of 1940, as
amended.

"1934 Act" shall mean the Securities and Exchange Act of 1934,
as amended.

"Note" shall have the meaning provided in Section 2.02(a)
hereof.

"Other Eligible Mortgage Loans" shall mean each Mortgage Loan
that does not satisfy the requirements of clause (b)(A) in the definition of
Eligible Mortgage Loans but that is

-7-
<PAGE> 12

otherwise expressly approved as an Eligible Mortgage Loan by the Lender in
writing in its sole discretion.

"Other Relevant Subsidiary" shall mean any Subsidiary,
individually or together with other Subsidiaries, the occurrence of any of the
events described in Section 8 hereof, with respect to which could reasonably be
expected to have a Material Adverse Effect.

"Outstanding Mortgage Loan" shall mean a Mortgage Loan pledged
to the Lender prior to the date hereof which remains pledged to the Lender on
the date hereof.

"Payment Date" shall mean (a) the first Business day of each
calendar month, commencing with the first Business Day of the month following
the month in which the first Funding Date occurs, and (b) the Termination Date.

"PBGC" shall mean the Pension Benefit Guaranty Corporation or
any entity succeeding to any or all of its functions under ERISA.

"Person" shall mean any individual, corporation, company,
voluntary association, partnership, joint venture, limited liability company,
trust, unincorporated association or government (or any agency, instrumentality
or political subdivision thereof).

"Permitted Preferred Stock" shall mean (i) preferred stock
that is issued from time to time by a Subsidiary to the United States Small
Business Administration having an aggregate stated value not exceeding
$7,000,000 at any one time outstanding, or (ii) preferred stock that is issued
from time to time by a Subsidiary for the purpose of qualifying such Subsidiary
as a real estate investment trust under Section 856 through 860 of the Internal
Revenue Code and having an aggregate stated value not exceeding $500,000 at any
one time outstanding, provided that in any event Permitted Preferred Stock
shall not include any Voting Stock.

"Plan" shall mean an employee benefit or other plan
established or maintained by the Borrower or any ERISA Affiliate and covered by
Title IV of ERISA, other than a Multiemployer Plan.

"Prepayment" shall mean for any Mortgage Loan, any unScheduled
payment of principal due thereunder.

"Post-Default Rate" shall mean, in respect of any principal of
any Loan or any other amount under this Loan Agreement, the Note or any other
Loan Document that is not paid when due to the Lender (whether at stated
maturity, by acceleration, by optional or mandatory prepayment or otherwise), a
rate per annum during the period from and including the due date to but
excluding the date on which such amount is paid in full equal to 2% per annum
plus the Prime Rate.

"Prime Rate" shall mean the prime rate announced to be in
effect from time to time, as published as the average rate in The Wall Street
Journal.

"Property" shall mean any right or interest in or to property
of any kind whatsoever, whether real, personal or mixed and whether tangible or
intangible.

-8-
<PAGE> 13

"Regulations T, U and X" shall mean Regulations T, U and X of
the Board of Governors of the Federal Reserve System (or any successor), as the
same may be modified and supplemented and in effect from time to time.

"Requirement of Law" shall mean as to any Person, the
certificate of incorporation and by- laws or other organizational or governing
documents of such Person, and any law, treaty, rule or regulation or
determination of an arbitrator or a court or other Governmental Authority, in
each case applicable to or binding upon such Person or any of its property or
to which such Person or any of its property is subject.

"Responsible Officer" shall mean, as to any Person, the chief
executive officer, managing director or treasurer, or with respect to financial
matters, the chief financial officer of such Person.

"Secured Obligations" shall have the meaning provided in
Section 4.01(c) hereof.

"Servicer" shall have the meaning provided in Section 11.14(c)
hereof.

"Servicing Agreement" shall have the meaning provided in
Section 11.14(c) hereof.

"Servicing Records" shall have the meaning provided in Section
11.14(b) hereof.

"Settlement Agent" shall mean, with respect to any Loan, the
entity approved by the Lender, in its sole good-faith discretion (which may be
a title company, escrow company or attorney in accordance with local law and
practice in the jurisdiction where the related Table-Funded Mortgage Loan is
being originated) to which the proceeds of such Loan are to be wired pursuant
to the instructions of the Lender.

"Standard Securitization Transaction" shall mean a
securitization transaction backed by Mortgage Loans underwritten or placed on
behalf of the Borrower which transaction has received an investment grade
rating from any nationally-recognized rating agency and otherwise conforms to
the current standards of institutional securitization applicable to mortgage
loans substantially similar in nature to the Mortgage Loans.

"Subsidiary" shall mean, with respect to any Person, any
corporation, partnership or other entity of which at least a majority of the
securities or other ownership interests having by the terms thereof ordinary
voting power to elect a majority of the board of directors or other persons
performing similar functions of such corporation, partnership or other entity
(irrespective of whether or not at the time securities or other ownership
interests of any other class or classes of such corporation, partnership or
other entity shall have or might have voting power by reason of the happening
of any contingency) is at the time directly or indirectly owned or controlled
by such Person or one or more Subsidiaries of such Person or by such Person and
one or more Subsidiaries of such Person Notwithstanding the foregoing, the term
"Subsidiary," when used with respect to the Borrower, shall not include any
Person if the securities or other ownership interests of such Person held by
the Borrower (directly or through one or more Subsidiaries of the Borrower)
would be required under GAAP to be accounted for on a consolidated balance
sheet of the Borrower as portfolio investments.

-9-
<PAGE> 14

"System" shall mean all hardware or software, or any system
consisting of one or more thereof, including, without limitation, any and all
enhancements, upgrades, customizations, modifications, maintenance and the like
utilized by any Person for the benefit of such Person to perform its
obligations and to administer and track, store, process, provide, and where
appropriate, insert, true and accurate dates and calculations for dates and
spans with respect to the Mortgage Loans.

"Table-Funded Mortgage Loan" shall mean a Mortgage Loan which
is pledged to the Lender simultaneously with the origination thereof by the
Borrower, which origination is financed in part or in whole with proceeds of
Loans advanced directly to a Settlement Agent and which Table-Funded Mortgage
Loan is held by the Settlement Agent pursuant to a Bailee Agreement.

"Termination Date" shall mean October 27, 2000 or such earlier
date on which this Loan Agreement shall terminate in accordance with the
provisions hereof or by operation of law provided that such Termination Date
may be extended from time to time pursuant to Section 2.08 hereof.

"Test Period" shall have the meaning provided in Section 7.15
hereof.

"Total Indebtedness" shall mean, for any period, the aggregate
Indebtedness of the Borrower and its Consolidated Subsidiaries during such
period, determined on a consolidated basis in accordance with GAAP less the
amount of any nonspecific balance sheet reserves also maintained in accordance
with GAAP.

"Underwriting Guidelines" shall mean the underwriting
guidelines attached as Exhibit F hereto.

"Uniform Commercial Code" shall mean the Uniform Commercial
Code as in effect on the date hereof in the State of New York; provided that if
by reason of mandatory provisions of law, the perfection or the effect of
perfection or non-perfection of the security interest in any Collateral is
governed by the Uniform Commercial Code as in effect in a jurisdiction other
than New York, "Uniform Commercial Code" shall mean the Uniform Commercial Code
as in effect in such other jurisdiction for purposes of the provisions hereof
relating to such perfection or effect of perfection or non-perfection.

"Voting Stock" shall mean securities of any class or classes,
the holders of which are ordinarily, in the absence of contingencies, entitled
to elect a majority of the corporate directors (or persons performing similar
functions).

"Year 2000 Compliant" shall mean the ability of a System to
continue its normal functions including and following January 1, 2000 and the
ability of such System to support its continued normal usage such that neither
the performance nor the correct functioning of such System will be affected by
the approach, and passing into, the year 2000.

1.02 Accounting Terms and Determinations. Except as
otherwise expressly provided herein, all accounting terms used herein shall be
interpreted, and all financial

-10-
<PAGE> 15

statements and certificates and reports as to financial matters required to be
delivered to the Lender hereunder shall be prepared, in accordance with GAAP.

Section 2. Loans, Note and Prepayments.

2.01 Loans.

(a) Subject to the fulfillment of the conditions
precedent set forth in Sections 5.01 and 5.02 hereof, and provided that no
Default shall have occurred and be continuing hereunder, the Lender agrees,
from time to time, on the terms and conditions of this Loan Agreement, to make
loans (individually, a "Loan" and, collectively, the "Loans") to the Borrower
in Dollars, from and including the Effective Date to and including the
Termination Date in an aggregate principal amount at any one time outstanding
up to but not exceeding the Maximum Credit as in effect from time to time.

(b) Subject to the terms and conditions of this Loan
Agreement, during such period the Borrower may borrow, repay and reborrow
hereunder; provided that, notwithstanding the foregoing, the Lender shall have
no obligation to make Loans to the Borrower in excess of the then current
Maximum Credit and, in the event the obligation of the Lender to make Loans to
the Borrower is terminated as permitted hereunder, the Lender shall have no
further obligation to make additional Loans hereunder.

2.02 Notes.

(a) The Loans made by the Lender shall be evidenced by a
single second amended and restated promissory note of the Borrower
substantially in the form of Exhibit A hereto (the "Note"), dated August 21,
1997, as amended and restated as of the date hereof, payable to the Lender in a
principal amount equal to the amount of the Maximum Credit as originally in
effect and otherwise duly completed. The Lender shall have the right to have
its Note subdivided, by exchange for promissory notes of lesser denominations
or otherwise.

(b) The date, amount and interest rate of each Loan made
by the Lender to the Borrower, and each payment made on account of the
principal thereof, shall be recorded by the Lender on its books and, prior to
any transfer of the Note, endorsed by the Lender on the Schedule attached to
the Note or any continuation thereof; provided that the failure of the Lender
to make any such recordation or endorsement shall not affect the obligations of
the Borrower to make a payment when due of any amount owing hereunder or under
the Note in respect of the Loans.

2.03 Procedure for Borrowing.

(a) The Borrower may request a borrowing hereunder, on
any Business Day during the period from and including the Effective Date to and
including the Termination Date, by delivering to the Lender, with a copy to the
Custodian, a written request for borrowing, substantially in the form of
Exhibit D attached hereto, which request must be received by the

-11-
<PAGE> 16

Lender prior to 11:00 a.m., New York City time, one (l) Business Day prior to
the requested Funding Date. Such request for borrowing shall (i) attach a
Schedule identifying the Eligible Mortgage Loans that the Borrower proposes to
pledge to the Lender and to be included in the Borrowing Base in connection
with such borrowing, (ii) specify the requested Funding Date and the requested
Loan amount, (iii) include a Mortgage Loan Tape containing information with
respect to the Eligible Mortgage Loans that the Borrower proposes to pledge to
the Lender and to be included in the Borrowing Base in connection with such
borrowing, which Mortgage Loan Tape shall specify any deviations from the
Underwriting Guidelines and Schedule 1 of this Loan Agreement, and (iv) attach
an officer's certificate signed by a Responsible Officer of the Borrower as
required by Section 5.02(b) hereof.

(b) Upon the Borrower's request for a borrowing pursuant
to Section 2.03(a), the Lender shall, assuming all conditions precedent set
forth in Section 5.01 and 5.02 have been met and provided no Default shall have
occurred and be continuing, make a Loan to the Borrower on the requested
Funding Date, in the amount so requested.

(c) The requesting Borrower shall release to the
Custodian no later than 12:00 p.m., New York City time, one (1) Business Day
prior to the requested Funding Date, the Mortgage File pertaining to each
Eligible Mortgage Loan to be pledged to the Lender and included in the
Borrowing Base on such requested Funding Date, in accordance with the terms and
conditions of the Custodial Agreement.

(d) Pursuant to the Custodial Agreement, the Custodian
shall deliver to the Lender and the Borrower, no later than 11:00 a.m. on a
Funding Date, a Trust Receipt (as defined in the Custodial Agreement) in
respect of all Eligible Mortgage Loans (other than a Table-Funded Mortgage
Loan) pledged to the Lender on such Funding Date, and a Mortgage Loan Schedule
and Exception Report. Subject to Section 5 hereof, such borrowing will then be
made available to the Borrower by the Lender transferring, via wire transfer,
with respect to Loans secured by Mortgage Loans other than Table-Funded
Mortgage Loans, to the following account of the Borrower: Bank of America ABA
052-001633 Acct # 391-897-3064, and, with respect to Loans secured by
Table-Funded Mortgage Loans, to the Settlement Agent in accordance with the
Borrower's instructions.

2.04 Limitation on Types of Loans; Illegality. Anything
herein to the contrary notwithstanding, if, on or prior to the determination of
any Eurodollar Rate:

(a) the Lender determines, which determination shall be
conclusive, that quotations of interest rates for the relevant deposits
referred to in the definition of "Eurodollar Rate" in Section 1.01 hereof are
not being provided in the relevant amounts or for the relevant maturities for
purposes of determining rates of interest for Loans as provided herein; or

(b) the Lender determines, which determination shall be
conclusive, that the relevant rate of interest referred to in the definition of
"Eurodollar Rate" in Section 1.01 hereof upon the basis of which the rate of
interest for Loans is to be determined is not likely adequately to cover the
cost to the Lender of making or maintaining Loans; or

-12-
<PAGE> 17

(c) it becomes unlawful for the Lender to honor its
obligation to make or maintain Loans hereunder using a Eurodollar Rate;

then the Lender shall give the Borrower prompt notice thereof
and, so long as such condition remains in effect, the Lender shall be under no
obligation to make additional Loans (provided that the Borrower and the Lender
will use their best efforts to mutually agree upon an interest rate for future
Loans, and upon such agreement, the Lender shall be obligated to make such
additional Loans hereunder bearing such interest rate), and the Borrower shall
at Borrower's option, either prepay all such Loans as may be outstanding,
without penalty or premium, or pay interest on such Loans at a rate per annum
equal to the Federal Funds Rate plus 1.5%.

2.05 Repayment of Loans; Interest.

(a) The Borrower hereby promises to repay in full on the
Termination Date the then aggregate outstanding principal amount of the Loans.
Prepayments on one or more of the Mortgage Loans may occur at any time and from
time to time without penalty or premium.

(b) The Borrower hereby promises to pay to the Lender
interest on the unpaid principal amount of each Loan for the period from and
including the date of such Loan to but excluding the date such Loan shall be
paid in full, at a rate per annum equal to the Eurodollar Rate plus the
Applicable Margin. Notwithstanding the foregoing, the Borrower hereby promises
to pay to the Lender interest at the applicable Post-Default Rate on any
principal of any Loan and on any other amount payable by the Borrower hereunder
or under the Note that shall not be paid in full when due (whether at stated
maturity, by acceleration or by mandatory prepayment or otherwise) for the
period from and including the due date thereof to but excluding the date the
same is paid in full. Accrued interest on each Loan shall be payable on each
Payment Date, except that interest payable at the Post-Default Rate shall
accrue daily and shall be payable upon such accrual. Promptly after the
determination of any interest rate provided for herein or any change therein,
the Lender shall give notice thereof to the Borrower.

(c) It is understood and agreed that, unless and until a
Default shall have occurred and be continuing, the Borrower shall be entitled
to the proceeds of the Mortgage Loans, including interest and principal
payments thereunder and proceeds from the sale thereof, pledged to the Lender
hereunder.

2.06 Mandatory Prepayments or Pledge.

If at any time the aggregate outstanding principal amount of
Loans exceeds the Borrowing Base (a "Borrowing Base Deficiency"), as determined
by the Lender and notified to the Borrower on any Business Day, the Borrower
shall no later than one (1) Business Day after receipt of such notice, either
prepay the Loans in part or in whole or pledge additional Eligible Mortgage
Loans (which Collateral shall be in all respects acceptable to the Lender) to
the Lender, such that after giving effect to such prepayment or pledge the
aggregate outstanding principal amount of the Loans does not exceed the
Borrowing Base.

2.07 Indemnity. If the Borrower makes a prepayment of the
Loans on any day which is not a Payment Date, the Borrower shall indemnify the
Lender and hold the Lender

-13-
<PAGE> 18

harmless from any actual loss or expense which the Lender may sustain or incur
arising from the reemployment of funds obtained by the Lender to maintain the
Loans hereunder or from fees payable to terminate the deposits from which such
funds were obtained. This Section 2.07 shall survive termination of this
Agreement and payment of the Note.

2.08 Extension of Termination Date. At the request of the
Borrower made at least thirty (30) days, but in no event earlier than ninety
(90) days, prior to the then current Termination Date, the Lender may in its
sole discretion extend the Termination Date for a period to be determined by
Lender in its sole discretion by giving written notice of such extension to the
Borrower no later than twenty (20) days, but in no event earlier than thirty
(30) days, prior to the then current Termination Date. Any failure by the
Lender to deliver such notice of extension shall be deemed to be the Lender's
determination not to extend the then current Termination Date.

Section 3. Payments; Computations; Etc.

3.01 Payments.

(a) Except to the extent otherwise provided herein, all
payments of principal, interest and other amounts to be made by the Borrower
under this Loan Agreement and the Note, shall be made in Dollars, in
immediately available funds, without deduction, set-off or counterclaim, to the
Lender at the following account maintained by the Lender: Account No. 40615114,
for the account of MSMCI, Citibank, N.A., ABA No. 021000089, Attn: Whole Loan
Operations not later than 1:00 p.m., New York City time, on the date on which
such payment shall become due (and each such payment made after such time on
such due date shall be deemed to have been made on the next succeeding Business
Day). The Borrower acknowledges that it has no rights of withdrawal from the
foregoing account.

(b) Except to the extent otherwise expressly provided
herein, if the due date of any payment under this Loan Agreement or the Note
would otherwise fall on a day that is not a Business Day, such date shall be
extended to the next succeeding Business Day, and interest shall be payable for
any principal so extended for the period of such extension.

3.02 Computations. Interest on the Loans shall be
computed on the basis of a 360-day year for the actual days elapsed (including
the first day but excluding the last day) occurring in the period for which
payable.

3.03 Requirements of Law.

(a) If any Requirement of Law enacted and in effect after
the date of this Agreement (other than with respect to any amendment made to
the Lender's certificate of incorporation and by-laws or other organizational
or governing documents) or any change in the interpretation or application
thereof or compliance by the Lender with any request or directive (whether or
not having the force of law) from any central bank or other Governmental
Authority made subsequent to the date hereof:

-14-
<PAGE> 19

(i) shall subject the Lender to any tax of any kind
whatsoever with respect to this Loan Agreement, the Note or any Loan
made by it (excluding net income taxes) or change the basis of
taxation of payments to the Lender in respect thereof;

(ii) shall impose, modify or hold applicable any reserve,
special deposit, compulsory Loan or similar requirement against assets
held by, deposits or other liabilities in or for the account of,
advances, Loans or other extensions of credit by, or any other
acquisition of funds by, any office of the Lender which is not
otherwise included in the determination of the Eurodollar Rate
hereunder;

(iii) shall impose on the Lender any other condition;

and the result of any of the foregoing is to increase the cost to the Lender,
by an amount which the Lender deems to be material, of making, continuing or
maintaining any Loan or to reduce any amount due or owing hereunder in respect
thereof, then, in any such case, the Borrower shall promptly pay the Lender
such additional amount or amounts as will compensate the Lender for such
increased cost or reduced amount receivable.

(b) If the Lender shall have determined that the adoption
of or any change in any Requirement of Law (other than with respect to any
amendment made to the Lender's certificate of incorporation and by-laws or
other organizational or governing documents) regarding capital adequacy or in
the interpretation or application thereof or compliance by the Lender or any
corporation controlling the Lender with any request or directive regarding
capital adequacy (whether or not having the force of law) from any Governmental
Authority made subsequent to the date hereof shall have the effect of reducing
the rate of return on the Lender's or such corporation's capital as a
consequence of its obligations hereunder to a level below that which the Lender
or such corporation could have achieved but for such adoption, change or
compliance (taking into consideration the Lender's or such corporation's
policies with respect to capital adequacy) by an amount deemed by the Lender to
be material, then from time to time, the Borrower shall promptly pay to the
Lender such additional amount or amounts as will compensate the Lender for such
reduction.

(c) If the Lender becomes entitled to claim any
additional amounts pursuant to this Section, it shall promptly notify the
Borrower of the event by reason of which it has become so entitled. A
certificate as to any additional amounts payable pursuant to this Section
submitted by the Lender to the Borrower shall be conclusive in the absence of
manifest error.

3.04 Facility Fee; Exit Fee.

(a) The Borrower agrees to pay to the Lender on or prior
to the Effective Date a facility fee equal to 12.5 basis points (0.125%) per
annum of the Maximum Credit, such payment to be made in Dollars, in immediately
available funds, without deduction, set-off or counterclaim, to the Lender at
the account set forth in Section 3.01(a) hereof. In the event that the Lender
fails to make a Loan to the Borrower due solely to any of the circumstances set
forth in Section 5.02(i)(i), (ii) or (iii) or 5.02(j) hereof, then, upon
request of the Borrower, the Lender shall refund to the Borrower that portion
of the facility fee paid pursuant to this Section 3.04(a), pro-rated over the
number of days (notwithstanding any extension of the Termination Date

-15-
<PAGE> 20

pursuant to Section 2.08 hereof such amount shall be calculated based upon the
original term of this Loan Agreement) during which the Lender fails to make
Loans requested by the Borrower solely because of the circumstances set forth
in Section 5.02(i)(i), (ii) or (iii) or 5.02(j) hereof.

(b) The Borrower agrees to pay to the Lender an exit fee
equal to 0.5% of the Disposition Amount upon Disposition of such Mortgage
Loans, as of the date on which any such pledged Mortgage Loans are no longer
pledged to the Lender hereunder (the "Exit Fee"), each such payment to be made
in Dollars, in immediately available funds, without deduction, set-off or
counterclaim, to the Lender at the account set forth in Section 3.01(a) hereof.
Without limiting the generality of the foregoing, any Exit Fee for any
Disposition shall accrue and be payable as a condition to release by the Lender
of its Lien on the applicable Mortgage Loans that are subject to such
Disposition. For purposes of this Section, a "Disposition" shall mean any of
the following: (i) the sale or securitization of Mortgage Loans pledged to the
Lender hereunder; (ii) termination of this Loan Agreement for any reason
whatsoever (provided that, in the event the Lender shall fail to extend the
Termination Date pursuant to a request by the Borrower pursuant to Section 2.08
hereof, or in the event the Borrower shall terminate this Loan Agreement
because of the Lender's failure to make a loan pursuant to Section 5.02(i)(i),
(ii) or (iii) or Section 5.02(j), any Exit Fee which would otherwise be due
solely as a result of the occurrence of the Termination Date hereunder (and
absent any Event of Default hereunder) shall be deemed waived by the Lender);
or (iii) the release of any or all of the Mortgage Loans from the Lien of the
Lender hereunder. For purposes of this Section, the "Disposition Amount" shall
equal: (y) with respect to a Disposition pursuant to clauses (i) and (ii)
above, the outstanding principal balance of the Loan secured by Mortgage Loans
pledged to the Lender hereunder, and (z) with respect to a Disposition pursuant
to clause (iii) above, the Collateral Value attributable to the Mortgage Loans
so released.

Section 4. Collateral Security.

4.01 Collateral; Security Interest.

(a) Pursuant to the Custodial Agreement, the Custodian
shall hold the Mortgage Loan Documents as exclusive bailee and agent for the
Lender pursuant to terms of the Custodial Agreement and shall deliver to the
Lender Trust Receipts (as defined in the Custodial Agreement) each to the
effect that it has reviewed such Mortgage Loan Documents in the manner and to
the extent required by the Custodial Agreement and identifying any deficiencies
in such Mortgage Loan Documents as so reviewed.

(b) All of the Borrower's right, title and interest in,
to and under each of the following items of property, whether now owned or
hereafter acquired, now existing or hereafter created and wherever located, is
hereinafter referred to as the "Collateral":

(i) all Mortgage Loans;

(ii) all Mortgage Loan Documents, including without
limitation all promissory notes, and all Servicing Records (as defined
in Section 11.14(b) below), servicing agreements and any other
collateral pledged or otherwise relating to such Mortgage Loans,
together with all files, documents, instruments, surveys,
certificates,

-16-
<PAGE> 21

correspondence, appraisals, accounting records and other books and
records relating thereto;

(iii) all mortgage guaranties and insurance (issued by
governmental agencies or otherwise) and any mortgage insurance
certificate or other document evidencing such mortgage guaranties or
insurance relating to any Mortgage Loan and all claims and payments
thereunder;

(iv) all other insurance policies and insurance proceeds
relating to any Mortgage Loan or the related Mortgaged Property;

(v) all Interest Rate Protection Agreements between the
Borrower and the Lender or any Affiliate of the Lender, relating to or
constituting any and all of the foregoing;

(vi) all collateral, however defined, under any other
agreement between the Borrower or any of its Affiliates on the one
hand and the Lender or any of its Affiliates on the other hand;

(vii) all "general intangibles" as defined in the Uniform
Commercial Code relating to or constituting any and all of the
foregoing; and

(viii) any and all replacements, substitutions,
distributions on or proceeds of any and all of the foregoing.

(c) The Borrower hereby assigns, pledges and grants a
security interest in all of its right, title and interest in, to and under the
Collateral to the Lender to secure the repayment of principal of and interest
on all Loans and all other amounts owing to the Lender hereunder, under the
Note and under the other Loan Documents (collectively, the "Secured
Obligations"). The Borrower agrees to mark its computer records and tapes to
evidence the interests granted to the Lender hereunder.

4.02 Further Documentation. At any time and from time to
time, upon the written request of the Lender, and at the sole expense of the
Borrower, the Borrower will promptly and duly execute and deliver, or will
promptly cause to be executed and delivered, such further instruments and
documents and take such further action as the Lender may reasonably request for
the purpose of obtaining or preserving the full benefits of this Loan Agreement
and of the rights and powers herein granted, including, without limitation, the
filing of any financing or continuation statements under the Uniform Commercial
Code in effect in any jurisdiction with respect to the Liens created hereby.
The Borrower also hereby authorizes the Lender to file any such financing or
continuation statement without the signature of the Borrower to the extent
permitted by applicable law. A carbon, photographic or other reproduction of
this Loan Agreement shall be sufficient as a financing statement for filing in
any jurisdiction.

4.03 Changes in Locations, Name, etc. The Borrower shall
not (a) change the location of its chief executive office/chief place of
business from that specified in Section 6 hereof or (b) change its name,
identity or corporate structure (or the equivalent) or change the location
where it maintains its records with respect to the Collateral unless it shall
have given the

-17-
<PAGE> 22

Lender at least 30 days prior written notice thereof and shall have delivered
to the Lender all Uniform Commercial Code financing statements and amendments
thereto as the Lender shall request and taken all other actions deemed
necessary by the Lender to continue its perfected status in the Collateral with
the same or better priority.

4.04 Lender's Appointment as Attorney-in-Fact.

(a) The Borrower hereby irrevocably constitutes and
appoints the Lender and any officer or agent thereof, with full power of
substitution, as its true and lawful attorney-in-fact with full irrevocable
power and authority in the place and stead of the Borrower and in the name of
the Borrower or in its own name, from time to time during the continuance of a
Default in the Lender's discretion, for the purpose of carrying out the terms
of this Loan Agreement, to take any and all appropriate action and to execute
any and all documents and instruments which may be necessary or desirable to
accomplish the purposes of this Loan Agreement, and, without limiting the
generality of the foregoing, the Borrower hereby gives the Lender the power and
right, on behalf of the Borrower, without assent by, but with notice to, the
Borrower, if an Event of Default shall have occurred and be continuing, to do
the following:

(i) in the name of the Borrower or its own name, or
otherwise, to take possession of and endorse and collect any checks,
drafts, notes, acceptances or other instruments for the payment of
moneys due under any mortgage insurance or with respect to any other
Collateral and to file any claim or to take any other action or
proceeding in any court of law or equity or otherwise deemed
appropriate by the Lender for the purpose of collecting any and all
such moneys due under any such mortgage insurance or with respect to
any other Collateral whenever payable;

(ii) to pay or discharge taxes and Liens levied or placed
on or threatened against the Collateral; and

(iii) (A) to direct any party liable for any payment under
any Collateral to make payment of any and all moneys due or to become
due thereunder directly to the Lender or as the Lender shall direct;
(B) to ask or demand for, collect, receive payment of and receipt for,
any and all moneys, claims and other amounts due or to become due at
any time in respect of or arising out of any Collateral; (C) to sign
and endorse any invoices, assignments, verifications, notices and
other documents in connection with any of the Collateral; (D) to
commence and prosecute any suits, actions or proceedings at law or in
equity in any court of competent jurisdiction to collect the
Collateral or any portion thereof and to enforce any other right in
respect of any Collateral; (E) to defend any suit, action or
proceeding brought against the Borrower with respect to any
Collateral; (F) to settle, compromise or adjust any suit, action or
proceeding described in clause (E) above and, in connection therewith,
to give such discharges or releases as the Lender may deem
appropriate; and (G) generally, to sell, transfer, pledge and make any
agreement with respect to or otherwise deal with any of the Collateral
as fully and completely as though the Lender were the absolute owner
thereof for all purposes, and to do, at the Lender's option and the
Borrower's expense, at any time, and from time to time, all acts and
things which the Lender deems necessary to protect, preserve or
realize upon the Collateral and

-18-
<PAGE> 23

the Lender's Liens thereon and to effect the intent of this Loan
Agreement, all as fully and effectively as the Borrower might do.

The Borrower hereby ratifies all that said attorneys shall lawfully do or cause
to be done by virtue hereof. This power of attorney is a power coupled with an
interest and shall be irrevocable.

(b) The Borrower also authorizes the Lender, at any time
and from time to time, to execute, in connection with any sale provided for in
Section 4.07 hereof, any endorsements, assignments or other instruments of
conveyance or transfer with respect to the Collateral.

(c) The powers conferred on the Lender are solely to
protect the Lender's interests in the Collateral and shall not impose any duty
upon the Lender to exercise any such powers. The Lender shall be accountable
only for amounts that it actually receives as a result of the exercise of such
powers, and neither the Lender nor any of its officers, directors, or employees
shall be responsible to the Borrower for any act or failure to act hereunder,
except for its own gross negligence or willful misconduct.

4.05 Performance by Lender of Borrower's Obligations. If
the Borrower fails to perform or comply with any of its agreements contained in
the Loan Documents, concurrently with providing notice to the Borrower, the
Lender may itself perform or comply, or otherwise cause performance or
compliance, with such agreement, the expenses of the Lender incurred in
connection with such performance or compliance, together with interest thereon
at a rate per annum equal to the Post-Default Rate, shall be payable, subject to
Section 11.18 hereof, by the Borrower to the Lender on demand and shall
constitute Secured Obligations.

4.06 Proceeds. If an Event of Default shall occur and be
continuing, (a) all proceeds of Collateral received by the Borrower consisting
of cash, checks and other near-cash items shall be held by the Borrower in
trust for the Lender, segregated from other funds of the Borrower, and shall
forthwith upon receipt by the Borrower be turned over to the Lender in the
exact form received by the Borrower (duly endorsed by the Borrower to the
Lender, if required) and (b) any and all such proceeds received by the Lender
(whether from the Borrower or otherwise) may, in the sole discretion of the
Lender, be held by the Lender as collateral security for, and/or then or at any
time thereafter may be applied by the Lender against, the Secured Obligations
(whether matured or unmatured), such application to be in such order as the
Lender shall elect. Any balance of such proceeds remaining after the Secured
Obligations shall have been paid in full and this Loan Agreement shall have
been terminated shall be paid over to the Borrower or to whomsoever may be
lawfully entitled to receive the same. For purposes hereof, proceeds shall
include, but not be limited to, all principal and interest payments, all
prepayments and payoffs, insurance claims, condemnation awards, sale proceeds,
real estate owned rents and any other income and all other amounts received
with respect to the Collateral.

4.07 Remedies. If an Event of Default shall occur and be
continuing, the Lender may, at its option, enter into one or more Interest Rate
Protection Agreements covering all or a portion of the Mortgage Loans pledged
to the Lender hereunder, and the Borrower shall be responsible for all damages,
judgments, costs and expenses of any kind which may be

-19-
<PAGE> 24

imposed on, incurred by or asserted against the Lender relating to or arising
out of such Interest Rate Protection Agreements including without limitation
any losses resulting from such Interest Rate Protection Agreements. If an
Event of Default shall occur and be continuing, the Lender may exercise, in
addition to all other rights and remedies granted to it in this Loan Agreement
and in any other instrument or agreement securing, evidencing or relating to
the Secured Obligations, all rights and remedies of a secured party under the
Uniform Commercial Code. Without limiting the generality of the foregoing, the
Lender without demand of performance or other demand, presentment, protest,
advertisement or notice of any kind (except any notice required by law referred
to below) to or upon the Borrower or any other Person (each and all of which
demands, presentments, protests, advertisements and notices are hereby waived),
may in such circumstances forthwith collect, receive, appropriate and realize
upon the Collateral, or any part thereof, and/or may forthwith sell, lease,
assign, give option or options to purchase, or otherwise dispose of and deliver
the Collateral or any part thereof (or contract to do any of the foregoing), in
one or more parcels or as an entirety at public or private sale or sales, at
any exchange, broker's board or office of the Lender or elsewhere upon such
terms and conditions as it may deem advisable and at such prices as it may deem
best, for cash or on credit or for future delivery without assumption of any
credit risk. The Lender shall have the right upon any such public sale or
sales, and, to the extent permitted by law, upon any such private sale or
sales, to purchase the whole or any part of the Collateral so sold, free of any
right or equity of redemption in the Borrower, which right or equity is hereby
waived or released. The Borrower further agrees, at the Lender's request, to
assemble the Collateral and make it available to the Lender at places which the
Lender shall reasonably select, whether at the Borrower's premises or
elsewhere. The Lender shall apply the net proceeds of any such collection,
recovery, receipt, appropriation, realization or sale, after deducting all
reasonable costs and expenses incurred therein or incidental to the care or
safekeeping of any of the Collateral or in any way relating to the Collateral
or the rights of the Lender hereunder, including without limitation reasonable
attorneys' fees and disbursements, to the payment in whole or in part of the
Secured Obligations, in such order as the Lender may elect, and only after such
application and after the payment by the Lender of any other amount required or
permitted by any provision of law, including without limitation Section
9-504(1)(c) of the Uniform Commercial Code, need the Lender account for the
surplus, if any, to the Borrower. To the extent permitted by applicable law,
the Borrower waives all claims, damages and demands it may acquire against the
Lender arising out of the exercise by the Lender of any of its rights
hereunder, other than those claims, damages and demands arising from the gross
negligence or willful misconduct of the Lender. If any notice of a proposed
sale or other disposition of Collateral shall be required by law, such notice
shall be deemed reasonable and proper if given at least 10 days before such
sale or other disposition. The Borrower shall remain liable for any deficiency
(plus accrued interest thereon as contemplated pursuant to Section 2.05(b)
hereof) if the proceeds of any sale or other disposition of the Collateral are
insufficient to pay the Secured Obligations and the fees and disbursements of
any attorneys employed by the Lender to collect such deficiency.

4.08 Limitation on Duties Regarding Preservation of
Collateral. The Lender's duty with respect to the custody, safekeeping and
physical preservation of the Collateral in its possession, under Section 9-207
of the Uniform Commercial Code or otherwise, shall be to deal with it in the
same manner as the Lender deals with similar property for its own account.
Neither the Lender nor any of its directors, officers or employees shall be
liable for failure to demand, collect or realize upon all or any part of the
Collateral or for any delay in doing so or shall be

-20-
<PAGE> 25

under any obligation to sell or otherwise dispose of any Collateral upon the
request of the Borrower or otherwise.

4.09 Powers Coupled with an Interest. All authorizations
and agencies herein contained with respect to the Collateral are irrevocable
and powers coupled with an interest.

4.10 Release of Security Interest. Upon termination of
this Loan Agreement and repayment to the Lender of all Secured Obligations and
the performance of all obligations under the Loan Documents the Lender shall
release its security interest in any remaining Collateral.

Section 5. Conditions Precedent.

5.01 Initial Loan. The obligation of the Lender to make
its initial Loan hereunder is subject to the satisfaction, immediately prior to
or concurrently with the making of such Loan, of the condition precedent that
the Lender shall have received all of the following, each of which shall be
reasonably satisfactory to the Lender and its counsel in form and substance:

(a) Loan Documents.

(i) Note. The Note, duly completed and executed; and

(ii) Custodial Agreement. The Custodial Agreement, duly
executed and delivered by the Borrower and the Custodian. In
addition, the Borrower shall have taken such other action as the
Lender shall have requested in order to perfect the security interests
created pursuant to the Loan Agreement;

(b) Organizational Documents. A good standing
certificate and certified copies of the charter and by-laws (or equivalent
documents) of the Borrower and of all corporate or other authority for the
Borrower with respect to the execution, delivery and performance of the Loan
Documents and each other document to be delivered by the Borrower from time to
time in connection herewith (and the Lender may conclusively rely on such
certificate until it receives notice in writing from the Borrower to the
contrary);

(c) Legal Opinion. A legal opinion of outside counsel to
the Borrower, substantially in the form attached hereto as Exhibit C;

(d) Trust Receipt and Mortgage Loan Schedule and
Exception Report. A Trust Receipt, substantially in the form of Annex 2 of the
Custodial Agreement and Mortgage Loan Schedule and Exception Report, dated the
Effective Date, from the Custodian, duly completed, with a Mortgage Loan
Schedule and Exception Report attached thereto;

(e) Servicing Agreement(s). Any Servicing Agreement,
certified as a true, correct and complete copy of the original, with the letter
of the applicable Servicer consenting to termination of such Servicing
Agreement upon the occurrence of an Event of Default attached; and

-21-
<PAGE> 26

(f) Other Documents. Such other documents as the Lender
may reasonably request.

5.02 Initial and Subsequent Loans. The making of each
Loan to the Borrower (including the initial Loan) on any Business Day is
subject to the satisfaction of the following further conditions precedent, both
immediately prior to the making of such Loan and also after giving effect
thereto and to the intended use thereof:

(a) no Default or Event of Default shall have occurred
and be continuing;

(b) both immediately prior to the making of such Loan and
also after giving effect thereto and to the intended use thereof, the
representations and warranties made by the Borrower in Section 6 hereof, and
elsewhere in each of the Loan Documents, shall be true, correct and complete on
and as of the date of the making of such Loan in all material respects (in the
case of the representations and warranties in Section 6.10 and Schedule 1,
solely with respect to Mortgage Loans included in the Borrowing Base) with the
same force and effect as if made on and as of such date (or, if any such
representation or warranty is expressly stated to have been made as of a
specific date, as of such specific date). The Lender shall have received an
officer's certificate signed by a Responsible Officer of the Borrower
certifying as to the truth, accuracy and completeness of the above, which
certificate shall specifically include a statement that the Borrower is in
compliance with all governmental licenses and authorizations and is qualified
to do business and in good standing in all required jurisdictions and that such
borrowing does not violate restrictions imposed upon the Borrower as a Business
Development Company or otherwise.

(d) subject to the Lender's right to perform one or more
Due Diligence Reviews pursuant to Section 11.15 hereof, the Lender shall have
completed its Due Diligence Review of the Mortgage Loan Documents for each Loan
and such other documents, records, agreements, instruments, mortgaged
properties or information relating to such Loans as the Lender in its sole
discretion deems appropriate to review and such review shall be satisfactory to
the Lender in its sole discretion;

(e) the Lender shall have received from the Custodian a
Mortgage Loan Schedule with exceptions as are acceptable to the Lender in its
sole discretion in respect of Eligible Mortgage Loans to be pledged hereunder
on such Business Day;

(f) Bailee Agreement. A Bailee Agreement in respect of
Table-Funded Mortgage Loans to be pledged to hereunder on such Business Day,
duly executed by the parties thereto;

(g) the Lender shall have received from the Borrower a
Warehouse Lender's Release Letter substantially in the form of Exhibit E-2
hereto (or such other form acceptable to the Lender) or a Seller's Release
Letter substantially in the form of Exhibit E-1 hereto (or such other form
acceptable to the Lender) covering each Mortgage Loan to be pledged to the
Lender;

-22-
<PAGE> 27

(h) the Consolidated Shareholders' Equity is not equal to
or less than $475,000,000;

(i) none of the following shall have occurred and/or be
continuing:

(i) an event or events shall have occurred resulting in
the effective absence of a "repo market" or comparable "lending
market" for financing debt obligations secured by mortgage loans or
securities (or reasonably expected to be) or an event or events shall
have occurred resulting in the Lender not being able to finance any
Mortgage Loans through the "repo market" or "lending market" with
traditional counterparties at rates which would have been reasonable
prior to the occurrence of such event or events;

(ii) an event or events shall have occurred resulting in
the effective absence of a "securities market" for securities backed
by mortgage loans (or reasonably expected to be) or an event or events
shall have occurred resulting in the Lender not being able to sell
securities backed by mortgage loans at prices which would have been
reasonable prior to such event or events; or

(iii) there shall have occurred a material adverse change
in the financial condition of the Lender which effects (or can
reasonably be expected to effect) materially and adversely the ability
of the Lender to fund its obligations under this Loan Agreement;

(iv) there shall have occurred any action, suit,
arbitration, investigation (including, without limitation, any of the
foregoing which are pending or threatened) or other legal or
arbitrable proceeding affecting the Borrower or affecting any of the
Property of any of them before any Governmental Authority (i) as to
which individually or in the aggregate there is a reasonable
likelihood of an adverse decision which would be reasonably likely to
have a material adverse effect on its Property, business or financial
condition or prospects or, (ii) makes a claim or claims in an
aggregate amount greater than $5,000,000.00, (ii) which, individually
or in the aggregate, if adversely determined, could be reasonably
likely to have a Material Adverse Effect, or (iii) which requires
filing with the Securities and Exchange Commission in accordance with
the 1934 Act or any rules thereunder.

(j) Morgan Stanley Dean Witter & Co.'s corporate bond
rating as calculated by S&P or Moody's has not been lowered or downgraded to a
rating below A- as indicated by S&P or below A3 as indicated by Moody's.

Each request for a borrowing by the Borrower hereunder shall constitute a
certification by the Borrower that all the conditions set forth in this Section
5 (other than Sections 5.02(d), 5.02(i)(i), (ii) and (iii) and 5.02(j)) have
been satisfied (both as of the date of such notice, request or confirmation and
as of the date of such borrowing).

Section 6. Representations and Warranties. The Borrower
represents and warrants to the Lender that throughout the term of this Loan
Agreement:

6.01 Existence. The Borrower (a) is a corporation duly
organized, validly existing and in good standing under the laws of the
jurisdiction of its organization, (b) has all

-23-
<PAGE> 28

requisite corporate or other power, and has all governmental licenses,
authorizations, consents and approvals necessary to own its assets and carry on
its business as now being or as proposed to be conducted, except where the lack
of such licenses, authorizations, consents and approvals would not be
reasonably likely to have a material adverse effect on its Property, business
or financial condition or prospects; and (c) is qualified to do business and is
in good standing in all other jurisdictions in which the nature of the business
conducted by it makes such qualification necessary, except where failure so to
qualify would not be reasonably likely (either individually or in the
aggregate) to have a Material Adverse Effect.

6.02 Financial Condition. The Borrower has heretofore
furnished to the Lender a copy of (a) the consolidated balance sheets of the
Borrower and its consolidated Subsidiaries for the first two quarterly fiscal
periods of the fiscal year of the Borrower ended December 31, 1999 and the
related consolidated statements of operations and changes in net assets and of
cash flows for the Borrower and its consolidated Subsidiaries for such
quarterly fiscal periods, setting forth in each case in comparative form the
figures for the previous year, (b) the consolidated balance sheets of the
Borrower and its consolidated Subsidiaries for the 1998 fiscal year and the
related consolidated statements of operations and changes in net assets and of
cash flows for the Borrower and its consolidated Subsidiaries for such fiscal
year, setting forth in each case in comparative form the figures for the
previous year, with the opinion thereon of Arthur Andersen LLP. All such
financial statements are complete and correct and fairly present, in all
material respects, the consolidated financial condition of the Borrower and its
consolidated Subsidiaries and the consolidated results of its operations as at
such dates and for such fiscal periods, all in accordance with GAAP applied on
a consistent basis. Since June 30, 1999, there has been no material adverse
change in the consolidated business, operations or financial condition of the
Borrower from that set forth in said financial statements.

6.03 Litigation. There are no actions, suits,
arbitrations, investigations (including, without limitation, any of the
foregoing which are pending or threatened) or other legal or arbitrable
proceedings affecting the Borrower or any of its Subsidiaries or affecting any
of the Property of any of them before any Governmental Authority that (i)
questions or challenges the validity or enforceability of any of the Loan
Documents or performance by the Borrower of its obligations thereunder, (ii) as
to which individually or in the aggregate there is a reasonable likelihood of
an adverse decision which would be reasonably likely to have a material adverse
effect on its Property, business or financial condition or prospects, (iii)
makes a claim or claims in an aggregate amount greater than $5,000,000.00, (iv)
which, individually or in the aggregate, if adversely determined, could be
reasonably likely to have a Material Adverse Effect, or (v) which requires
filing with the Securities and Exchange Commission in accordance with the 1934
Act or any rules thereunder.

6.04 No Breach. Neither (a) the execution and delivery of
the Loan Documents nor (b) the consummation of the transactions therein
contemplated in compliance with the terms and provisions thereof will conflict
with or result in a breach of the charter or by-laws of the Borrower, or any
applicable law, rule or regulation, or any order, writ, injunction or decree of
any Governmental Authority, including the Investment Company Act of 1940, or
any Servicing Agreement or other material agreement or instrument to which the
Borrower is a party or by which the Borrower or any of its Property is bound or
to which it is subject, or constitute a default under any such material
agreement or instrument or result in the creation or imposition of

-24-
<PAGE> 29

any Lien (except for the Liens created pursuant to this Loan Agreement) upon
any Property of the Borrower pursuant to the terms of any such agreement or
instrument.

6.05 Action. The Borrower has all necessary corporate or
other power, authority and legal right to execute, deliver and perform its
obligations under each of the Loan Documents; the execution, delivery and
performance by the Borrower of each of the Loan Documents have been duly
authorized by all necessary corporate or other action on its part; and each
Loan Document has been duly and validly executed and delivered by the Borrower
and constitutes a legal, valid and binding obligation of the Borrower,
enforceable against the Borrower in accordance with its terms subject to
bankruptcy laws and other similar laws of general application affecting rights
of creditors and subject to the rules of equity including those respecting the
availability of specific performance.

6.06 Approvals. No authorizations, approvals or consents
of, and no filings or registrations with, any Governmental Authority or any
securities exchange are necessary for the execution, delivery or performance by
the Borrower of the Loan Documents or for the legality, validity or
enforceability thereof, except for filings and recordings in respect of the
Liens created pursuant to this Loan Agreement.

6.07 Margin Regulations. Neither the making of any Loan
hereunder, nor the use of the proceeds thereof, will violate or be inconsistent
with the provisions of Regulations T, U or X.

6.08 Taxes. The Borrower and each of its Subsidiaries has
filed all Federal income tax returns and all other material tax returns or
necessary extensions that are required to be filed by any of them and have paid
all taxes due pursuant to such returns or pursuant to any assessment received
by any of them, except for any such taxes as are being appropriately contested
in good faith by appropriate proceedings diligently conducted and with respect
to which adequate reserves have been provided. The charges, accruals and
reserves on the books of the Borrower and its Subsidiaries in respect of taxes
and other governmental charges are, in the opinion of the Borrower, adequate.

6.09 Investment Company Act. The Borrower has elected to
be regulated as a Business Development Company under the 1940 Act. The
execution, delivery and performance by the Borrower of this Agreement and the
other Loan Documents and each borrowing by the Borrower hereunder do not and
will not violate or conflict with, or require any consent of any Governmental
Authority under, the 1940 Act.

6.10 Collateral; Collateral Security.

(a) The Borrower has not assigned, pledged, nor otherwise
conveyed or encumbered any Mortgage Loan or other Collateral to any other
Person, and immediately prior to the pledge of such Mortgage Loan or any other
Collateral to the Lender, the Borrower was the sole owner of such Mortgage Loan
or such other Collateral and had good and marketable title thereto, free and
clear of all Liens, in each case except for Liens to be released simultaneously
with the Liens granted in favor of the Lender hereunder. No Mortgage Loan
pledged to the Lender hereunder was acquired (by purchase or otherwise) by the
Borrower from an Affiliate of

-25-
<PAGE> 30

the Borrower, or such other acquisition approved in writing by the Lender at
the Lender's sole discretion.

(b) The provisions of this Loan Agreement are effective
to create in favor of the Lender a valid security interest in all right, title
and interest of the Borrower in, to and under the Collateral.

(c) Upon receipt by the Custodian of each Mortgage Note,
endorsed in blank by a duly authorized officer of the Borrower, the Lender
shall have a fully perfected first priority security interest therein, in the
Mortgage Loan evidenced thereby and in the Borrower's interest in the related
Mortgaged Property.

(d) Upon the filing of financing statements on Form UCC-1
naming the Lender as "Secured Party" and the Borrower as "Debtor", and
describing the Collateral, in the jurisdictions and recording offices listed on
Schedule 2 attached hereto, the security interests granted hereunder in the
Collateral will constitute fully perfected first priority security interests
under the Uniform Commercial Code in all right, title and interest of the
Borrower in, to and under such Collateral which can be perfected by filing
under the Uniform Commercial Code.

6.11 Chief Executive Office. The Borrower's chief
executive office on the Effective Date, and during the four months immediately
preceding the Effective Date, the Borrower's chief executive office, is, and
has been, located at 1919 Pennsylvania Avenue, N.W., Washington, D.C. 20006.
On the Effective Date, the Borrower's jurisdiction of organization is the State
of Maryland.

6.12 Location of Books and Records. The location where
the Borrower keeps its books and records, including all computer tapes and
records relating to the Collateral is its chief executive office.

6.13 Hedging. The Borrower shall enter into Interest Rate
Protection Agreements pursuant to the Borrower's variable rate debt having terms
with respect to protection against fluctuations in interest rates pursuant to
the Borrower's policies and procedures reasonably acceptable to the Lender.

6.14 True and Complete Disclosure. The information,
reports, financial statements, exhibits and Schedules furnished in writing by or
on behalf of the Borrower to the Lender in connection with the negotiation,
preparation or delivery of this Loan Agreement and the other Loan Documents or
included herein or therein or delivered pursuant hereto or thereto, when taken
as a whole, do not contain any untrue statement of material fact or omit to
state any material fact necessary to make the statements herein or therein, in
light of the circumstances under which they were made, not misleading. All
written information furnished after the date hereof by or on behalf of the
Borrower to the Lender in connection with this Loan Agreement and the other Loan
Documents and the transactions contemplated hereby and thereby will be true,
complete and accurate in every material respect, or (in the case of projections)
based on reasonable estimates, on the date as of which such information is
stated or certified. There is no fact known to a Responsible Officer of the
Borrower, after due inquiry, that could reasonably be expected to have a
Material Adverse Effect that has not been disclosed herein, in the other Loan

-26-
<PAGE> 31

Documents or in a report, financial statement, exhibit, Schedule, disclosure
letter or other writing furnished to the Lender for use in connection with the
transactions contemplated hereby or thereby.

6.15 Consolidated Shareholders' Equity. On the Effective
Date, the Consolidated Shareholders' Equity is not less than $542,000,000.

6.16 ERISA. The Borrower has not established nor
contributed to a Plan or Multiemployer Plan.

6.17 Material Subsidiaries. As of the Effective Date, the
Material Subsidiaries of the Borrower are listed on Schedule 3 hereto.

Section 7. Covenants of the Borrower. The Borrower covenants
and agrees with the Lender that, so long as any Loan is outstanding and until
payment in full of all Secured Obligations:

7.01 Financial Statements. The Borrower shall deliver to
the Lender:

(a) as soon as available and in any event within 45 days
after the end of each of the first three quarterly fiscal periods of each
fiscal year of the Borrower, the unaudited consolidated balance sheets of the
Borrower and its consolidated Subsidiaries as at the end of such period and the
related unaudited consolidated statements of operations and changes in net
assets and of cash flows for the Borrower and its consolidated Subsidiaries for
such period and the portion of the fiscal year through the end of such period,
setting forth in each case in comparative form the figures for the previous
year, accompanied by a certificate of a Responsible Officer of the Borrower,
which certificate shall state that said consolidated financial statements
fairly present the consolidated financial condition and results of operations
of the Borrower and its consolidated Subsidiaries in accordance with GAAP,
consistently applied, as at the end of, and for, such period (subject to normal
year-end audit adjustments);

(b) as soon as available and in any event within 120 days
after the end of each fiscal year of the Borrower, the consolidated balance
sheets of the Borrower as at the end of such fiscal year and the related
consolidated statements of operations and changes in net assets and of cash
flows for the Borrower for such year, setting forth in each case in comparative
form the figures for the previous year, accompanied by an opinion thereon of
independent certified public accountants of recognized national standing, which
opinion shall not be qualified as to scope of audit or going concern and shall
state that said consolidated financial statements fairly present the
consolidated financial condition and results of operations of the Borrower and
its consolidated Subsidiaries as at the end of, and for, such fiscal year in
accordance with GAAP;

(c) from time to time such other information regarding
the financial condition, operations, or business of the Borrower as the Lender
may reasonably request; and

The Borrower will furnish to the Lender, at the time it furnishes each set of
financial statements pursuant to paragraphs (a) and (b) above, a certificate of
a Responsible Officer of the Borrower to the effect that, to the best of such
Responsible Officer's knowledge, the Borrower during such fiscal period or year
has observed or performed all of its covenants and other agreements, and

-27-
<PAGE> 32

satisfied every condition, contained in this Loan Agreement and the other Loan
Documents to be observed, performed or satisfied by it, and that such
Responsible Officer has obtained no knowledge of any Default or Event of
Default except as specified in such certificate (and, if any Default or Event
of Default has occurred and is continuing, describing the same in reasonable
detail and describing the action the Borrower has taken or proposes to take
with respect thereto).

7.02 Litigation. The Borrower will, promptly, and in any
event within 10 days after service of process on any of the following, give to
the Lender notice of all litigation, actions, suits, arbitrations,
investigations (including, without limitation, any of the foregoing which are
pending or threatened) or other legal or arbitrable proceedings affecting the
Borrower or any of its Subsidiaries or affecting any of the Property of any of
them before any Governmental Authority that (i) questions or challenges the
validity or enforceability of any of the Loan Documents or performance by the
Borrower of its obligations thereunder, (ii) as to which individually or in the
aggregate there is a reasonable likelihood of an adverse decision which would
be reasonably likely to have a material adverse effect on its Property,
business or financial condition or prospects, (iii) which makes a claim or
claims in an aggregate amount greater than $5,000,000.00, (iv) which,
individually or in the aggregate, if adversely determined, could be reasonably
likely to have a Material Adverse Effect, or (v) which requires filing with the
Securities and Exchange Commission in accordance with the 1934 Act and any
rules thereunder.

7.03 Existence, etc. The Borrower will:

(a) preserve and maintain its legal existence and all of
its material rights, privileges, licenses and franchises including the
Borrower's election to be regulated as a Business Development Company,
(provided that nothing in this Section 7.03(a) shall prohibit any transaction
expressly permitted under Section 7.04 hereof);

(b) comply with the requirements of all applicable laws,
rules, regulations and orders of Governmental Authorities (including, without
limitation, all environmental laws) if failure to comply with such requirements
would be reasonably likely (either individually or in the aggregate) to have a
material adverse effect on its Property, business or financial condition, or
prospects;

(c) keep adequate records and books of account, in which
complete entries will be made in accordance with GAAP consistently applied;

(d) not move its chief executive office from the address
referred to in Section 6.11 or change its jurisdiction of organization from the
jurisdiction referred to in Section 6.11 unless it shall have provided the
Lender 30 days' prior written notice of such change;

(e) pay and discharge all taxes, assessments and
governmental charges or levies imposed on it or on its income or profits or on
any of its Property prior to the date on which penalties attach thereto, except
for any such tax, assessment, charge or levy the payment of which is being
contested in good faith and by proper proceedings and against which adequate
reserves are being maintained; and

-28-
<PAGE> 33

(f) permit representatives of the Lender, during normal
business hours and upon reasonable advance notice, to examine, copy and make
extracts from its books and records, to inspect any of its Properties, and to
discuss its business and affairs with its officers, all to the extent
reasonably requested by the Lender.

7.04 Prohibition of Fundamental Changes. The Borrower
shall not enter into any transaction of merger or consolidation or
amalgamation, or liquidate, wind up or dissolve itself (or suffer any
liquidation, winding up or dissolution) or sell all or substantially all of its
assets; provided, that the Borrower may merge or consolidate with (a) any
wholly owned subsidiary of the Borrower, or (b) any other Person if the
Borrower is the surviving corporation; and provided further, that if after
giving effect thereto, no Default would exist hereunder.

7.05 Borrowing Base Deficiency. If at any time there
exists a Borrowing Base Deficiency the Borrower shall cure same in accordance
with Section 2.06 hereof.

7.06 Notices. The Borrower shall give notice to the Lender:

(a) promptly upon receipt of notice or knowledge of the
occurrence of any Default or Event of Default;

(b) with respect to any Mortgage Loan pledged to the
Lender hereunder, within one Business Day of receipt of any principal
prepayment other than Scheduled payments (in full or partial) of such pledged
Mortgage Loan;

(c) with respect to any Mortgage Loan pledged to the
Lender hereunder, immediately upon receipt of notice or knowledge that the
underlying Mortgaged Property has been damaged by waste, fire, earthquake or
earth movement, windstorm, flood, tornado or other casualty, or otherwise
damaged so as to affect adversely the Collateral Value of such pledged Mortgage
Loan; and

(d) promptly upon receipt of notice or knowledge of (i)
any default related to any Collateral, (ii) any Lien or security interest
(other than security interests created hereby or by the other Loan Documents)
on, or claim asserted against, any of the Collateral or (iii) any event or
change in circumstances which could reasonably be expected to have a material
adverse effect on the Property, business or financial condition or prospects of
the Borrower.

(e) promptly upon receipt of notice or knowledge that The
Borrower may not be in compliance with the requirements of the 1940 Act for a
Business Development Company.

Each notice pursuant to this Section shall be accompanied by a statement of a
Responsible Officer of the Borrower setting forth details of the occurrence
referred to therein and stating what action the Borrower has taken or proposes
to take with respect thereto.

7.07 Hedging. The Borrower shall at all times maintain
Interest Rate Protection Agreements, pursuant to the Borrower's variable rate
debt having terms with respect to protection against fluctuations in interest
rates pursuant to the Borrower's policies and procedures reasonably acceptable
to the Lender. The Borrower shall deliver to the Lender

-29-
<PAGE> 34

quarterly (unless requested more frequently by the Lender) a written summary of
the notional amount of all outstanding Interest Rate Protection Agreements.

7.08 Reports. The Borrower shall provide the Lender with
a quarterly report, which report shall include, among other items, a summary of
the Borrower's delinquency and loss experience with respect to mortgage loans
held by the Borrower, plus any such additional reports as the Lender may
reasonably request with respect to the Borrower's or any Servicer's servicing
portfolio or pending originations of mortgage loans. The Borrower shall
provide the Lender with information, promptly upon the Borrower's receipt, with
respect to each Mortgaged Property related to each Mortgage Loan pledged to the
Lender hereunder, including without limitation, the operating statements, rent
roll (if applicable and which may be provided on a quarterly basis if not
available on a monthly basis) and occupancy status of such Mortgaged Property
and property level information.

7.09 Underwriting Guidelines. Without the prior written
consent of the Lender, the Borrower shall not amend materially nor otherwise
modify materially the Underwriting Guidelines. Notwithstanding the preceding
sentence, in the event that the Borrower makes any amendment or modification to
its Underwriting Guidelines, the Borrower shall promptly deliver to the Lender
a complete copy of the amended or modified Underwriting Guidelines.

7.10 Transactions with Affiliates. The Borrower will not
enter into any transaction, including without limitation any purchase, sale,
lease or exchange of property or the rendering of any service, with any
Affiliate unless such transaction is (a) otherwise permitted under this Loan
Agreement, (b) in the ordinary course of the Borrower's business and (c) upon
fair and reasonable terms no less favorable to the Borrower than it would
obtain in a comparable arm's length transaction with a Person which is not an
Affiliate, or make a payment that is not otherwise permitted by this Section
7.10 to any Affiliate. In no event shall the Borrower pledge to the Lender
hereunder any Mortgage Loan acquired by the Borrower from an Affiliate of the
Borrower other than an acquisition approved in writing by the Lender at the
Lender's sole discretion.

7.11 Limitation on Liens. The Borrower will defend the
Collateral against, and will take such other action as is necessary to remove,
any Lien, security interest or claim on or to the Collateral, other than the
security interests created under this Loan Agreement, and the Borrower will
defend the right, title and interest of the Lender in and to any of the
Collateral against the claims and demands of all persons whomsoever.

7.12 Limitation on Distributions. After the occurrence
and during the continuation of any Event of Default under Section 8(a), (b),
(f), (g) or (h), or clause (i) or (ii) of (k) hereof, the Borrower shall not
make any payment on account of, or set apart assets for, a sinking or other
analogous fund for the purchase, redemption, defeasance, retirement or other
acquisition of any equity or partnership interest of the Borrower, whether now
or hereafter outstanding, or make any other distribution in respect of any of
the foregoing or to any shareholder or equity owner of the Borrower in its
capacity as such, either directly or indirectly, whether in cash or property or
in obligations of the Borrower or any of its consolidated Subsidiaries.

-30-
<PAGE> 35

7.13 Consolidated Shareholders' Equity. The Borrower
shall not permit the Consolidated Shareholders' Equity to be less than (i)
$425,000,000 plus (ii) 75% of the Net Proceeds of all Equity Issuances effected
by the Borrower or any of its Subsidiaries at any time subsequent to the date
hereof (excluding the Net Proceeds of any Equity Issuance by a Subsidiary to
Subsidiaries or to the Borrower).

7.14 Maintenance of Ratio of Total Indebtedness to
Consolidated Shareholders' Equity. The Borrower shall not permit the ratio of
Total Indebtedness with respect to recourse obligations to Consolidated
Shareholders' Equity at any time to be greater than 3:1.

7.15 Maintenance of Profitability. The Borrower shall
not permit, for any period of two consecutive fiscal quarters (each such
period, a "Test Period"), Net Income for such Test Period, before income taxes
for such Test Period and distributions made during such Test Period, to be less
than $1.00.

7.16 Servicing Tape. The Borrower shall provide to the
Lender on the twelfth (12th) Business Day of each month a computer readable
file containing servicing information, including without limitation those
fields specified by the Lender from time to time, on a loan-by-loan basis and
in the aggregate, with respect to the Mortgage Loans serviced hereunder by the
Borrower or any Servicer.

7.17 Interest Rate Protection Agreements. The Borrower
shall not pledge, hypothecate, encumber or permit any Lien to exist on any
Interest Rate Protection Agreement, except with respect to those Interest Rate
Protection Agreements between the Borrower and the Lender or any Affiliate of
the Lender.

7.18 Required Filings. The Borrower shall promptly
provide the Lender with copies of all documents which the Borrower or any
Subsidiary of the Borrower is required to file with the Securities and Exchange
Commission in accordance with the 1934 Act or any rules thereunder.

7.19 No Adverse Selection. The Borrower has not selected
the Collateral in a manner so as to adversely affect the Lender's interests.

7.20 Computer Systems. The Borrower shall take all action
necessary to assure that its System shall reasonably be expected to be Year
2000 Compliant.

7.21 ERISA. The Borrower shall not establish nor
contribute to a Plan or Multiemployer Plan.

7.22 Remittance of Prepayments. The Borrower shall
remit, with sufficient detail to enable the Lender to appropriately identify
the Mortgage Loan to which any amount remitted applies, to the Lender on each
Thursday (or the next Business Day if such Thursday is not a Business Day) all
Prepayments that the Borrower has received during the previous week.

7.23 Lender's Right to Purchase. Prior to any whole loan
sale of any Mortgage Loan to a bona-fide third party purchaser, the Borrower
shall first provide the Lender with the opportunity to submit a bid on said
Mortgage Loans.

-31-
<PAGE> 36

7.24 Securitizations. The Borrower agrees that MS&Co.
shall retain the exclusive option to act as sole lead underwriter or sole lead
placement agent in connection with the consummation of the next securitization
of any Mortgage Loans by the Borrower or any of the Borrower's Subsidiaries
following the Effective Date.

7.25 Material Subsidiaries. The Borrower shall
immediately notify the Lender upon any present of future Subsidiary of the
Borrower becoming a Material Subsidiary by delivering a revised Schedule 3
hereto.

Section 8. Events of Default. Each of the following events
shall constitute an event of default (an "Event of Default") hereunder:

(a) the Borrower shall default in the payment of any
principal of or interest on any Loan when due (whether at stated maturity, upon
acceleration or at mandatory or optional prepayment); or

(b) the Borrower shall default in the payment of any
other amount payable by it hereunder or under any other Loan Document after
notification by the Lender of such default, and such default shall have
continued unremedied for five Business Days; or

(c) any representation, warranty or certification made or
deemed made herein or in any other Loan Document by the Borrower or any
certificate furnished to the Lender pursuant to the provisions hereof or
thereof shall prove to have been false or misleading in any material respect as
of the time made or furnished other than the representations and warranties set
forth in Schedule 1, which shall be considered solely for the purpose of
determining the Collateral Value of the Mortgage Loans; unless (i) the Borrower
shall have made any such representations and warranties with knowledge that
they were materially false or misleading at the time made, or (ii) any such
representations and warranties have been determined by the Lender in its sole
discretion to be materially false or misleading on a regular basis); or

(d) the Borrower shall fail to comply with the
requirements of Section 7.03(a), Section 7.04, Section 7.05, Section 7.06, or
any of Sections 7.09 through 7.22 or Section 7.25 hereof; or the Borrower shall
otherwise fail to comply with the requirements of Section 7.03 hereof and such
default shall continue unremedied for a period of five Business Days; or the
Borrower shall fail to observe or perform any other covenant or agreement
contained in this Loan Agreement or any other Loan Document and such failure to
observe or perform shall continue unremedied for a period of seven Business
Days; or

(e) a final judgment or judgments for the payment of
money in excess of $20,000,000 in the aggregate shall be rendered against the
Borrower or any of its Subsidiaries by one or more courts, administrative
tribunals or other bodies having jurisdiction and the same shall not be
satisfied, discharged (or provision shall not be made for such discharge) or
bonded, or a stay of execution thereof shall not be procured, within 60 days
from the date of entry thereof, and the Borrower or any such Subsidiary shall
not, within said period of 60 days, or such longer period during which
execution of the same shall have been stayed or bonded, appeal therefrom and
cause the execution thereof to be stayed during such appeal; or

-32-
<PAGE> 37

(f) the Borrower shall admit in writing its inability to
pay its debts as such debts become due; or

(g) the Borrower or any of its Material Subsidiaries or
any of its Other Relevant Subsidiaries shall (i) apply for or consent to the
appointment of, or the taking of possession by, a receiver, custodian, trustee,
examiner or liquidator or the like of itself or of all or a substantial part of
its property, (ii) make a general assignment for the benefit of its creditors,
(iii) commence a voluntary case under the Bankruptcy Code, (iv) file a petition
seeking to take advantage of any other law relating to bankruptcy, insolvency,
reorganization, liquidation, dissolution, arrangement or winding-up, or
composition or readjustment of debts, (v) fail to controvert in a timely and
appropriate manner, or acquiesce in writing to, any petition filed against it
in an involuntary case under the Bankruptcy Code or (vi) take any corporate or
other action for the purpose of effecting any of the foregoing; or

(h) a proceeding or case shall be commenced, without the
application or consent of the Borrower or any of its Material Subsidiaries or
any of its Other Relevant Subsidiaries, in any court of competent jurisdiction,
seeking (i) its reorganization, liquidation, dissolution, arrangement or
winding-up, or the composition or readjustment of its debts, (ii) the
appointment of, or the taking of possession by, a receiver, custodian, trustee,
examiner, liquidator or the like of the Borrower or any such Material
Subsidiary or Other Relevant Subsidiary or of all or any substantial part of
its property, or (iii) similar relief in respect of the Borrower or any such
Material Subsidiary or Other Relevant Subsidiary under any law relating to
bankruptcy, insolvency, reorganization, liquidation, dissolution, arrangement
or winding-up, or composition or adjustment of debts, and such proceeding or
case shall continue undismissed, or an order, judgment or decree approving or
ordering any of the foregoing shall be entered and continue unstayed and in
effect, for a period of 60 or more days; or an order for relief against the
Borrower or any such Material Subsidiary or Other Relevant Subsidiary shall be
entered in an involuntary case under the Bankruptcy Code; or

(i) the Custodial Agreement or any Loan Document shall
for whatever reason be terminated or cease to be in full force and effect, or
the enforceability thereof shall be contested by the Borrower;

(j) the Borrower shall grant, or suffer to exist, any
Lien on any Collateral except the Liens contemplated hereby; or the Liens
contemplated hereby shall cease to be first priority perfected Liens on the
Collateral in favor of the Lender or shall be Liens in favor of any Person
other than the Lender;

(k) (i) the Borrower or any of the Borrower's
Subsidiaries shall fail to pay when due and payable the principal of, or
interest on, any Indebtedness (other than the Loans) having an aggregate
outstanding principal amount of $5,000,000 or more, (ii) the maturity of any
Indebtedness (other than the Loans) of the Borrower or any of the Borrower's
Subsidiaries having an aggregate outstanding principal amount of $5,000,000 or
more shall have (x) been accelerated in accordance with the provisions of any
indenture, contract or instrument evidencing, providing for the creation of or
otherwise concerning such Indebtedness or (y) been required to be prepaid prior
to the stated maturity thereof; or (iii) any other event shall have occurred
and be continuing with respect to any Indebtedness (other than the Loans) of
the

-33-
<PAGE> 38

Borrower or any of the Borrower's Subsidiaries having an aggregate outstanding
principal amount of $5,000,000 or more which, with or without the passage of
time, the giving of notice, or otherwise, would permit any holder or holders of
such Indebtedness, any trustee or agent acting on behalf of such holder or
holders or any other Person, to accelerate the maturity of any such
Indebtedness or require any such Indebtedness to be prepaid prior to its stated
maturity; or

(l) any materially adverse change in the Property,
business, financial condition or prospects of the Borrower or any of the
Borrower's Material Subsidiaries or Other Related Subsidiaries shall occur, in
each case as determined by the Lender in its sole discretion, or any other
condition shall exist which, in the Lender's sole discretion, constitutes a
material impairment of the Borrower's ability to perform its obligations under
this Loan Agreement, the Note or any other Loan Document; or

(m) the discovery by the Lender of a condition or event
which existed at or prior to the execution hereof and which the Lender, in its
sole discretion, determines materially and adversely affects; (i) the condition
(financial or otherwise) of the Borrower, any of its Affiliates; or (ii) the
ability of either the Borrower or the Lender to fulfill its respective
obligations under this Loan Agreement.

Section 9. Remedies Upon Default.

(a) An Event of Default shall be deemed to be continuing
unless expressly waived by the Lender in writing. Upon the occurrence of one
or more Events of Default hereunder, the Lender's obligation to make additional
Loans to the Borrower shall automatically terminate without further action by
any Person. Upon the occurrence of one or more Events of Default other than
those referred to in Section 8(g) or (h), the Lender may immediately declare
the principal amount of the Loans then outstanding under the Note to be
immediately due and payable, together with all interest thereon and fees and
expenses accruing under this Loan Agreement. Upon the occurrence of an Event
of Default referred to in Sections 8(g) or (h), such amounts shall immediately
and automatically become due and payable without any further action by any
Person. Upon such declaration or such automatic acceleration, the balance then
outstanding on the Note shall become immediately due and payable, without
presentment, demand, protest or other formalities of any kind, all of which are
hereby expressly waived by the Borrower.

(b) Upon the occurrence of one or more Events of Default,
the Lender shall have the right to obtain physical possession of the Servicing
Records and all other files of the Borrower relating to the Collateral and all
documents relating to the Collateral which are then or may thereafter come in
to the possession of the Borrower or any third party acting for the Borrower
and the Borrower shall deliver to the Lender such assignments as the Lender
shall request. The Lender shall be entitled to specific performance of all
agreements of the Borrower contained in this Loan Agreement.

-34-
<PAGE> 39

Section 10. No Duty of Lender. The powers conferred on the
Lender hereunder are solely to protect the Lender's interests in the Collateral
and shall not impose any duty upon it to exercise any such powers. The Lender
shall be accountable only for amounts that it actually receives as a result of
the exercise of such powers, and neither it nor any of its officers, directors,
employees or agents shall be responsible to the Borrower for any act or failure
to act hereunder, except for its or its own gross negligence or willful
misconduct.

Section 11. Miscellaneous.

11.01 Waiver. No failure on the part of the Lender to
exercise and no delay in exercising, and no course of dealing with respect to,
any right, power or privilege under any Loan Document shall operate as a waiver
thereof, nor shall any single or partial exercise of any right, power or
privilege under any Loan Document preclude any other or further exercise
thereof or the exercise of any other right, power or privilege. The remedies
provided herein are cumulative and not exclusive of any remedies provided by
law.

11.02 Notices. Except as otherwise expressly permitted by
this Loan Agreement, all notices, requests and other communications provided
for herein and under the Custodial Agreement (including without limitation any
modifications of, or waivers, requests or consents under, this Loan Agreement)
shall be given or made in writing (including without limitation by telex or
telecopy) delivered to the intended recipient at the "Address for Notices"
specified below its name on the signature pages hereof or thereof); or, as to
any party, at such other address as shall be designated by such party in a
written notice to each other party provided, that a copy of all notices given
under Section 7.01 shall simultaneously be delivered to Credit Department,
Morgan Stanley Dean Witter, 1221 Avenue of the Americas, 35th Floor, New York,
New York 10036; Attention: Patrick Romaine. Except as otherwise provided in
this Loan Agreement and except for notices given under Section 2 (which shall
be effective only on receipt), all such communications shall be deemed to have
been duly given when transmitted by telex or telecopy or personally delivered
or, in the case of a mailed notice, upon receipt, in each case given or
addressed as aforesaid.

11.03 Indemnification and Expenses.

(a) The Borrower agrees to hold the Lender, and its
Affiliates and their officers, directors, employees, agents and advisors (each
an "Indemnified Party") harmless from and indemnify any Indemnified Party
against all liabilities, losses, damages, judgments, costs and expenses of any
kind which may be imposed on, incurred by or asserted against such Indemnified
Party (collectively, the "Costs") relating to or arising out of this Loan
Agreement, the Note, any other Loan Document or any transaction contemplated
hereby or thereby, or any amendment, supplement or modification of, or any
waiver or consent under or in respect of, this Loan Agreement, the Note, any
other Loan Document or any transaction contemplated hereby or thereby, that, in
each case, results from anything other than any Indemnified Party's gross
negligence or willful misconduct. Without limiting the generality of the
foregoing, the Borrower agrees to hold any Indemnified Party harmless from and
indemnify such Indemnified Party against all Costs with respect to (i)
Table-Funded Mortgage Loans relating to or arising out of any breach, violation
or alleged breach or violation of any consumer credit laws, including without
limitation the Truth in Lending Act and/or the Real Estate Settlement
Procedures Act

-35-
<PAGE> 40

and (ii) all Mortgage Loans relating to or arising out of any violation or
alleged violation of any environmental law, rule or regulation that, in each
case, results from anything other than such Indemnified Party's gross
negligence or willful misconduct. In any suit, proceeding or action brought by
an Indemnified Party in connection with any Mortgage Loan for any sum owing
thereunder, or to enforce any provisions of any Mortgage Loan, the Borrower
will save, indemnify and hold such Indemnified Party harmless from and against
all expense, loss or damage suffered by reason of any defense, set-off,
counterclaim, recoupment or reduction or liability whatsoever of the account
debtor or obligor thereunder, arising out of a breach by the Borrower of any
obligation thereunder or arising out of any other agreement, indebtedness or
liability at any time owing to or in favor of such account debtor or obligor or
its successors from the Borrower. The Borrower also agrees to reimburse an
Indemnified Party as and when billed by such Indemnified Party for all such
Indemnified Party's costs and expenses incurred in connection with the
enforcement or the preservation of such Indemnified Party's rights under this
Loan Agreement, the Note, any other Loan Document or any transaction
contemplated hereby or thereby, including without limitation the reasonable
fees and disbursements of its counsel. The Borrower hereby acknowledges that,
notwithstanding the fact that the Note is secured by the Collateral, the
obligation of the Borrower under the Note is a recourse obligation of the
Borrower.

(b) The Borrower agrees to pay as and when billed by the
Lender all of the out-of-pocket costs and expenses incurred by the Lender in
connection with the development, preparation and execution of, and any
amendment, supplement or modification to, this Loan Agreement, the Note, any
other Loan Document or any other documents prepared in connection herewith or
therewith. The Borrower agrees to pay as and when billed by the Lender all of
the out-of-pocket costs and expenses incurred in connection with the
consummation and administration of the transactions contemplated hereby and
thereby including without limitation all the reasonable fees, disbursements and
expenses of counsel to the Lender, not to exceed $25,000, which amount shall be
deducted from the first Loan disbursement.

11.04 Amendments. Except as otherwise expressly provided
in this Loan Agreement, any provision of this Loan Agreement may be modified or
supplemented only by an instrument in writing signed by the Borrower and the
Lender and any provision of this Loan Agreement may be waived by the Lender.

11.05 Successors and Assigns. This Loan Agreement shall be
binding upon and inure to the benefit of the parties hereto and their
respective successors and permitted assigns.

11.06 Survival. The obligations of the Borrower under
Sections 3.03, 3.04 and 11.03 hereof shall survive the repayment of the Loans
and the termination of this Loan Agreement. In addition, each representation
and warranty made or deemed to be made by a request for a borrowing, herein or
pursuant hereto shall survive the making of such representation and warranty,
and the Lender shall not be deemed to have waived, by reason of making any
Loan, any Default that may arise because any such representation or warranty
shall have proved to be false or misleading, notwithstanding that the Lender
may have had notice or knowledge or reason to believe that such representation
or warranty was false or misleading at the time such Loan was made.

-36-
<PAGE> 41

11.07 Captions. The table of contents and captions and
section headings appearing herein are included solely for convenience of
reference and are not intended to affect the interpretation of any provision of
this Loan Agreement.

11.08 Counterparts. This Loan Agreement may be executed in
any number of counterparts, all of which taken together shall constitute one
and the same instrument, and any of the parties hereto may execute this Loan
Agreement by signing any such counterpart.

11.09 Loan Agreement Constitutes Security Agreement;
Governing Law. This Loan Agreement shall be governed by New York law without
reference to choice of law doctrine, and shall constitute a security agreement
within the meaning of the Uniform Commercial Code.

11.10 SUBMISSION TO JURISDICTION; WAIVERS. LENDER AND THE
BORROWER HEREBY IRREVOCABLY AND UNCONDITIONALLY:

(a) SUBMITS FOR ITSELF AND ITS PROPERTY IN ANY LEGAL
ACTION OR PROCEEDING RELATING TO THIS LOAN AGREEMENT, THE NOTE AND THE OTHER
LOAN DOCUMENTS, OR FOR RECOGNITION AND ENFORCEMENT OF ANY JUDGMENT IN RESPECT
THEREOF, TO THE NON-EXCLUSIVE GENERAL JURISDICTION OF THE COURTS OF THE STATE
OF NEW YORK, THE FEDERAL COURTS OF THE UNITED STATES OF AMERICA FOR THE
SOUTHERN DISTRICT OF NEW YORK, AND APPELLATE COURTS FROM ANY THEREOF;

(b) CONSENTS THAT ANY SUCH ACTION OR PROCEEDING MAY BE
BROUGHT IN SUCH COURTS AND, TO THE EXTENT PERMITTED BY LAW, WAIVES ANY
OBJECTION THAT IT MAY NOW OR HEREAFTER HAVE TO THE VENUE OF ANY SUCH ACTION OR
PROCEEDING IN ANY SUCH COURT OR THAT SUCH ACTION OR PROCEEDING WAS BROUGHT IN
AN INCONVENIENT COURT AND AGREES NOT TO PLEAD OR CLAIM THE SAME;

(c) AGREES THAT SERVICE OF PROCESS IN ANY SUCH ACTION OR
PROCEEDING MAY BE EFFECTED BY MAILING A COPY THEREOF BY REGISTERED OR CERTIFIED
MAIL (OR ANY SUBSTANTIALLY SIMILAR FORM OF MAIL), POSTAGE PREPAID, TO ITS
ADDRESS SET FORTH UNDER ITS SIGNATURE BELOW OR AT SUCH OTHER ADDRESS OF WHICH
THE LENDER SHALL HAVE BEEN NOTIFIED; AND

(d) AGREES THAT NOTHING HEREIN SHALL AFFECT THE RIGHT TO
EFFECT SERVICE OF PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR SHALL LIMIT
THE RIGHT TO SUE IN ANY OTHER JURISDICTION.

11.11 WAIVER OF JURY TRIAL. EACH OF THE BORROWER AND THE
LENDER HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE
LAW, ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF
OR RELATING TO THIS LOAN

-37-
<PAGE> 42

AGREEMENT, ANY OTHER LOAN DOCUMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY OR
THEREBY.

11.12 Acknowledgments. The Borrower hereby acknowledges
that:

(a) it has been advised by counsel in the negotiation,
execution and delivery of this Loan Agreement, the Note and the other Loan
Documents;

(b) the Lender has no fiduciary relationship to the
Borrower, and the relationship between the Borrower and the Lender is solely
that of debtor and creditor; and

11.13 Hypothecation or Pledge of Loans. The Lender shall
have free and unrestricted use of all Collateral and nothing in this Loan
Agreement shall preclude the Lender from engaging in repurchase transactions
with the Collateral or otherwise pledging, repledging, transferring,
hypothecating, or rehypothecating the Collateral. Nothing contained in this
Loan Agreement shall obligate the Lender to segregate any Collateral delivered
to the Lender by the Borrower, however the Lender shall be obligated to deliver
the Collateral back to the Borrower in accordance with, and subject to, the
provisions of this Loan Agreement.

11.14 Servicing.

(a) The Borrower covenants to maintain or cause the
servicing of the Mortgage Loans to be maintained in conformity with accepted
and prudent servicing practices in the industry for the same type of mortgage
loans as the Mortgage Loans and in a manner at least equal in quality to the
servicing the Borrower provides for mortgage loans which it owns. In the event
that the preceding language is interpreted as constituting one or more
servicing contracts, each such servicing contract shall terminate automatically
upon the earliest of (i) an Event of Default, (ii) the date on which all the
Secured Obligations have been paid in full or (iii) the transfer of servicing
approved by the Borrower.

(b) If the Mortgage Loans are serviced by the Borrower,
(i) the Borrower agrees that the Lender is the collateral assignee of all
servicing records, including but not limited to any and all servicing
agreements, files, documents, records, data bases, computer tapes, copies of
computer tapes, proof of insurance coverage, insurance policies, appraisals,
other closing documentation, payment history records, and any other records
relating to or evidencing the servicing of Mortgage Loans (the "Servicing
Records"), and (ii) the Borrower grants the Lender a security interest in all
servicing fees and rights relating to the Mortgage Loans and all Servicing
Records to secure the obligation of the Borrower or its designee to service in
conformity with this Section and any other obligation of the Borrower to the
Lender. The Borrower covenants to safeguard such Servicing Records and to
deliver them promptly to the Lender or its designee (including the Custodian)
at the Lender's request.

(c) If the Mortgage Loans are serviced by a third party
servicer (the "Servicer"), the Borrower (i) shall provide a copy of the
servicing agreement to the Lender, which shall be in form and substance
acceptable to the Lender (the "Servicing Agreement"); (ii) shall provide a
Servicer Notice to the Servicer substantially in the form of Exhibit G hereto,
and

-38-
<PAGE> 43

(ii) hereby irrevocably assigns to the Lender and the Lender's successors and
assigns all right, title, interest of the Borrower in, to and under, and the
benefits of, any Servicing Agreement with respect to the Mortgage Loans. Any
successor to the Servicer shall be approved in writing by the Lender prior to
such successor's assumption of servicing obligations with respect to the
Mortgage Loans.

(d) If the servicer of the Mortgage Loans is the Borrower
or the Servicer is an Affiliate of the Borrower, the Borrower shall provide to
the Lender a letter from the Borrower or the Servicer, as the case may be, to
the effect that upon the occurrence of an Event of Default the Lender may
terminate any Servicing Agreement and transfer servicing to its designee, at no
cost or expense to the Lender, it being agreed that the Borrower will pay any
and all fees required to terminate the Servicing Agreement and to effectuate
the transfer of servicing to the designee of the Lender.

(e) After the Funding Date, until the pledge of any
Mortgage Loan is relinquished by the Custodian, the Borrower will have no right
to modify or alter the terms of such Mortgage Loan and the Borrower will have
no obligation or right to repossess such Mortgage Loan or substitute another
Mortgage Loan, except as provided in the Custodial Agreement.

(f) In the event the Borrower or its Affiliate is
servicing the Mortgage Loans, the Borrower shall permit the Lender to inspect
the Borrower's or its Affiliate's servicing facilities, as the case may be, for
the purpose of satisfying the Lender that the Borrower or its Affiliate, as the
case may be, has the ability to service the Mortgage Loans as provided in this
Loan Agreement.

(g) The Borrower shall ensure that the Servicer shall
take all action necessary to assure that the Servicer's System shall reasonably
be expected to be Year 2000 Compliant.

11.15 Periodic Due Diligence Review. The Borrower
acknowledges that the Lender has the right to perform continuing due diligence
reviews with respect to the Mortgage Loans, for purposes of verifying
compliance with the representations, warranties and specifications made
hereunder, or otherwise, and the Borrower agrees that upon reasonable (but no
less than five Business Days prior notice, unless a Default shall have
occurred, in which case no notice shall be required) to the Borrower, the
Lender or its authorized representatives will be permitted during normal
business hours to examine, inspect, and make copies and extracts of, the
Mortgage Files and any and all documents, records, agreements, instruments or
information relating to such Mortgage Loans in the possession or under the
control of the Borrower and/or the Custodian. The Borrower also shall make
available to the Lender, on a reasonable basis, a knowledgeable financial or
accounting officer for the purpose of answering questions respecting the
Mortgage Files and the Mortgage Loans. Without limiting the generality of the
foregoing, the Borrower acknowledges that the Lender may make Loans to the
Borrower based solely upon the information provided by the Borrower to the
Lender in the Mortgage Loan Tape and the representations, warranties and
covenants contained herein, and that the Lender, at its option, has the right
at any time to conduct a partial or complete due diligence review on some or
all of the Mortgage Loans securing such Loan, including without limitation
ordering new credit reports and new appraisals on the related Mortgaged
Properties and otherwise re-generating the

-39-
<PAGE> 44

information used to originate such Mortgage Loan. The Lender may underwrite
such Mortgage Loans itself or engage a mutually agreed upon third party
underwriter to perform such underwriting. The Borrower agrees to cooperate
with the Lender and any third party underwriter in connection with such
underwriting, including, but not limited to, providing the Lender and any third
party underwriter with access to any and all documents, records, agreements,
instruments or information relating to such Mortgage Loans in the possession,
or under the control, of the Borrower. The Borrower further agrees that if a
Default shall have occurred, the Borrower shall reimburse the Lender for any
and all out-of-pocket costs and expenses incurred by the Lender in connection
with the Lender's activities pursuant to this Section 11.15 performed following
such Default.

11.16 Set-Off. In addition to any rights and remedies of
the Lender provided by this Loan Agreement and by law, the Lender shall have
the right, without prior notice to the Borrower, any such notice being
expressly waived by the Borrower to the extent permitted by applicable law,
upon any amount becoming due and payable by the Borrower hereunder (whether at
the stated maturity, by acceleration or otherwise) to set-off and appropriate
and apply against such amount any and all deposits (general or special, time or
demand, provisional or final), in any currency, and any other credits,
indebtedness or claims, in any currency, in each case whether direct or
indirect, absolute or contingent, matured or unmatured, at any time held or
owing by the Lender or any Affiliate thereof to or for the credit or the
account of the Borrower. The Lender agrees promptly to notify the Borrower
after any such set-off and application made by the Lender; provided that the
failure to give such notice shall not affect the validity of such set-off and
application.

11.17 Intent. The parties recognize that each Loan is a
"securities contract" as that term is defined in Section 741 of Title 11 of the
United States Code, as amended.

[SIGNATURE PAGE FOLLOWS]

-40-
<PAGE> 45

IN WITNESS WHEREOF, the parties hereto have caused this Loan
Agreement to be duly executed and delivered as of the day and year first above
written.

BORROWER

ALLIED CAPITAL CORPORATION

By /s/ KELLY A. ANDERSON
-----------------------
Name: Kelly A. Anderson
Title: Executive Vice President,
Treasurer

Address for Notices:

1919 Pennsylvania Avenue, N.W.
Washington, D.C. 20006
Attention: Ms. Kelly A. Anderson
Telecopier No.: (202) 659-2053
Telephone No: (202) 973-6328

LENDER

MORGAN STANLEY MORTGAGE CAPITAL INC.

By /s/ MARC FLAMINO
-----------------
Name: Marc Flamino
Title: Vice President

Address for Notices:

1585 Broadway
New York, New York 10036
Attention: Mr. Andy Neuberger
Telecopier No.: 212-761-0093
Telephone No.: 212-761-2408

-41-
<PAGE> 46

SCHEDULE 1

REPRESENTATIONS AND WARRANTIES RE: MORTGAGE LOANS

Part I. Eligible Mortgage Loans

As to each Eligible Mortgage Loan included in the Borrowing
Base on a Funding Date (and the related Mortgage, Mortgage Note, Assignment of
Mortgage and Mortgaged Property), the Borrower shall be deemed to make the
following representations and warranties to the Lender as of such date and as
of each date Collateral Value is determined (certain defined terms used herein
and not otherwise defined in the Loan Agreement appearing in Part III to this
Schedule 1, except as otherwise set forth on an Officer's Certificate (as
defined in the Custodial Agreement) delivered on or prior to Funding Date or
otherwise disclosed in writing to the Lender.

(a) Mortgage Loans as Described. The information set
forth in the Mortgage Loan Schedule with respect to the Mortgage Loan is
complete, true and correct in all material respects.

(b) No Outstanding Charges. There are no material
defaults in complying with the terms of the Mortgage securing the Mortgage Loan,
and to the best of the Borrower's knowledge, all taxes, governmental
assessments, required insurance premiums, water, sewer and municipal charges,
leasehold payments or ground rents which previously became due and owing have
been paid. Neither the Borrower nor to the best of the Borrower's knowledge, the
Qualified Originator from which the Borrower acquired the Mortgage Loan has
advanced funds, or induced, solicited or knowingly received any advance of funds
by a party other than the Mortgagor, directly or indirectly, for the payment of
any amount required under the Mortgage Loan, except for interest accruing from
the date of the Mortgage Note or date of disbursement of the proceeds of the
Mortgage Loan, whichever is earlier, to the day which precedes by one month the
Due Date of the first installment of principal and interest thereunder.

(c) Original Terms Unmodified. The terms of the Mortgage
Note and Mortgage have not been impaired, waived, altered or modified in any
respect, from the date of origination except by a written instrument which has
been recorded, if necessary to protect the interests of the Lender, and which
has been delivered to the Custodian and the terms of which are reflected in the
Mortgage Loan Schedule. The substance of any such waiver, alteration or
modification has been approved by the title insurer, to the extent required, and
its terms are reflected on the Mortgage Loan Schedule. No Mortgagor in respect
of the Mortgage Loan has been released, in whole or in part, except in
connection with an assumption agreement approved by the title insurer, to the
extent required, and which assumption agreement is part of the Mortgage File
delivered to the Custodian and the terms of which are reflected in the Mortgage
Loan Schedule (to the extent such terms affect the information on the Mortgage
Loan Schedule).

(d) No Defenses. To the best of the Borrower's knowledge,
the Mortgage Loan is not subject to any right of rescission, set-off,
counterclaim or defense, including without limitation the defense of usury, nor
will the operation of any of the terms of the Mortgage Note or the

Schedule 1, Page 1
<PAGE> 47

Mortgage, or the exercise of any right thereunder, render either the Mortgage
Note or the Mortgage unenforceable, in whole or in part and no such right of
rescission, set-off, counterclaim or defense has been asserted with respect
thereto. The Borrower has no knowledge nor has it received any notice that any
Mortgagor in respect of the Mortgage Loan is a debtor in any state or federal
bankruptcy or insolvency proceeding.

(e) Hazard Insurance. The Mortgaged Property is insured
by a fire and extended perils insurance policy, issued by a Qualified Insurer,
and such other hazards as are customary in the area where the Mortgaged Property
is located, and to the extent required by the Borrower as of the date of
origination consistent with the Underwriting Guidelines, against earthquake and
other risks insured against by Persons operating like properties in the locality
of the Mortgaged Property, in an amount not less than the greatest of (i) 100%
of the replacement cost of all improvements to the Mortgaged Property, (ii) the
outstanding principal balance of the Mortgage Loan, or (iii) the amount
necessary to avoid the operation of any co- insurance provisions with respect to
the Mortgaged Property, and consistent with the amount that would have been
required as of the date of origination in accordance with the Underwriting
Guidelines. If any portion of the Mortgaged Property is in an area identified by
any federal Governmental Authority as having special flood hazards, and flood
insurance is available, a flood insurance policy meeting the current guidelines
of the Federal Insurance Administration is in effect with a generally acceptable
insurance carrier, in an amount representing coverage not less than the lesser
of (1) the full insurable value of the Mortgaged Property, and (2) the maximum
amount of insurance available under the Flood Disaster Protection Act of 1973,
as amended. All such insurance policies (collectively, the "hazard insurance
policy") contain a standard mortgagee clause naming the Borrower, its successors
and assigns (including without limitation, subsequent owners of the Mortgage
Loan), as mortgagee, and may not be reduced, terminated or canceled without 30
days' prior written notice to the mortgagee. No such notice has been received by
the Borrower. All premiums on such insurance policy have been paid. The related
Mortgage obligates the Mortgagor to maintain all such insurance and, at such
Mortgagor's failure to do so, authorizes the mortgagee to maintain such
insurance at the Mortgagor's cost and expense and to seek reimbursement therefor
from such Mortgagor. Where required by state law or regulation, the Mortgagor
has been given an opportunity to choose the carrier of the required hazard
insurance, provided the policy is not a "master" or "blanket" hazard insurance
policy covering a condominium, or any hazard insurance policy covering the
common facilities of a planned unit development. To the best of the Borrower's
knowledge, the hazard insurance policy is the valid and binding obligation of
the insurer and is in full force and effect. The Borrower has not engaged in,
and to the best of the Borrower's knowledge, the Mortgagor has not engaged in,
any act or omission which would impair the coverage of any such policy, the
benefits of the endorsement provided for herein, or the validity and binding
effect of either including, without limitation, no unlawful fee, commission,
kickback or other unlawful compensation or value of any kind has been or will be
received, retained or realized by any attorney, firm or other Person, and no
such unlawful items have been received, retained or realized by the Borrower.
The Mortgagor maintains (A) rental continuation coverage sufficient to protect
against loss for a period of up to 12 months, under a policy issued by a
Qualified Insurer and (B) ordinance or law coverage if applicable under the
terms and conditions of the Underwriting Guidelines.

(f) Compliance with Applicable Laws. With respect to
Mortgage Loans originated by the Borrower, and to the best of the Borrower's
knowledge with respect to Mortgage Loans acquired by the Borrower, (i) any and
all requirements of any federal, state or

Schedule 1, Page 2
<PAGE> 48

local law including, without limitation, usury, or disclosure laws applicable
to the Mortgage Loan have been complied with, and (ii) the consummation of the
transactions contemplated hereby will not involve the violation of any such
laws or regulations, and the Borrower shall maintain or shall cause its agent
to maintain in its possession, available for the inspection of the Lender, and
shall deliver to the Lender, upon demand, evidence of compliance with all such
requirements.

(g) No Satisfaction of Mortgage. The Mortgage has not been
satisfied, canceled, subordinated or rescinded, in whole or in part, and the
Mortgaged Property has not been released from the lien of the Mortgage, in whole
or in part, nor has any instrument been executed that would effect any such
release, cancellation, subordination or rescission.

(h) Location and Type of Mortgaged Property. The Mortgaged
Property is located in an Acceptable State as identified in the Mortgage Loan
Schedule and consists of real property upon which is located one or more
commercial or multifamily structures; provided, however, that any commercial or
multifamily property shall conform with the Underwriting Guidelines. The
Mortgaged Property is being used for the purpose set forth in the Mortgagor's
loan application, unless otherwise notified by the Mortgagor.

(i) Valid First Lien. The Mortgage is a valid, subsisting,
enforceable and perfected first lien on the real property included in the
Mortgaged Property, including all buildings on the Mortgaged Property and all
installations and mechanical, electrical, plumbing, heating and air conditioning
systems located in or annexed to such buildings, and all additions, alterations
and replacements made at any time with respect to the foregoing. The lien of the
Mortgage is subject only to: (1) the lien of current real property taxes and
assessments not yet due and payable; (2) covenants, conditions and restrictions,
rights of way, easements and other matters of the public record as of the date
of recording acceptable to prudent mortgage lending institutions generally and
specifically referred to in the lender's title insurance policy delivered to the
originator of the Mortgage Loan and (a) referred to or otherwise considered in
the appraisal made for the originator of the Mortgage Loan or (b) which do not
materially and adversely affect the Appraised Value of the Mortgaged Property
set forth in such appraisal; and (3) other matters to which like properties are
commonly subject which do not materially interfere with the benefits of the
security intended to be provided by the Mortgage or the use, enjoyment, value or
marketability of the related Mortgaged Property. Any security agreement, chattel
mortgage or equivalent document related to and delivered in connection with the
Mortgage Loan establishes and creates a valid, subsisting and enforceable first
lien and first priority security interest on the property described therein and
the Borrower has full right to pledge and assign the same to the Lender. The
Mortgaged Property was not, as of the date of origination of the Mortgage Loan,
subject to a mortgage, deed of trust, deed to secure debt or other security
instrument creating a lien subordinate to the lien of the Mortgage.

(j) Validity of Mortgage Documents. The Mortgage Note and
the Mortgage and any other agreement executed and delivered by a Mortgagor or
guarantor, if applicable, in connection with a Mortgage Loan are genuine, and
each is the legal, valid and binding obligation of the maker thereof enforceable
in accordance with its terms subject to bankruptcy laws and other similar laws
of general application affecting rights of creditors and subject to the

Schedule 1, Page 3
<PAGE> 49

application of the rules of equity, including those respecting the availability
of specific performance.

(k) Full Disbursement of Proceeds. The Mortgage Loan has
been closed and the proceeds of the Mortgage Loan have been fully disbursed and
there is no further requirement for future advances thereunder, and either (i)
any and all requirements as to completion of any on-site or off-site improvement
and as to disbursements of any escrow funds therefor have been complied with or
(ii) an escrow of funds for the completion of any on-site or off-site
improvements has been established in an amount sufficient to make all repairs
required by the Qualified Originator to the Mortgaged Property. All costs, fees
and expenses incurred in making or closing the Mortgage Loan and the recording
of the Mortgage were paid, and the Mortgagor is not entitled to any refund of
any amounts paid or due under the Mortgage Note or Mortgage. To the best of the
Borrower's knowledge, all costs, fees and expenses incurred in making or closing
the Mortgage Loan and the recording of the Mortgage were paid, and the Mortgagor
is not entitled to any refund of any amounts paid or due under the Mortgage Note
or Mortgage.

(l) Ownership. The Borrower is the sole owner and holder
of the Mortgage Loan. The Mortgage Loan is not assigned or pledged, and the
Borrower has good, indefeasible and marketable title thereto, and has full right
to transfer, pledge and assign the Mortgage Loan to the Lender free and clear of
any encumbrance, equity, participation interest, lien, pledge, charge, claim or
security interest, and has full right and authority subject to no interest or
participation of, or agreement with, any other party, to assign, transfer and
pledge each Mortgage Loan pursuant to this Loan Agreement and following the
pledge of each Mortgage Loan, the Lender will hold such Mortgage Loan free and
clear of any encumbrance, equity, participation interest, lien, pledge, charge,
claim or security interest except any such security interest created pursuant to
the terms of this Loan Agreement.

(m) Doing Business. To the best of the Borrower's
knowledge, all parties which have had any interest in the Mortgage Loan, whether
as mortgagee, assignee, pledgee or otherwise, are (or, during the period in
which they held and disposed of such interest, were) (i) in compliance with any
and all applicable licensing requirements of the laws of the state wherein the
Mortgaged Property is located, and (ii) either (A) organized under the laws of
such state, (B) qualified to do business in such state, (C) a federal savings
and loan association, a savings bank or a national bank having a principal
office in such state, or (D) not doing business in such state.

(n) Loan-to-Value Ratio and Debt Service Ratio. The
Loan-to-Value Ratio for the Mortgage Loan is not greater than that set forth in
the Underwriting Guidelines. The Debt Service Ratio for the Mortgage Loan is not
less than that set forth in the Underwriting Guidelines.

(o) Title Insurance. The Mortgage Loan is covered by
either (i) an attorney's opinion of title and abstract of title, the form and
substance of which is acceptable to prudent mortgage lending institutions making
mortgage loans in the area wherein the Mortgaged Property is located or (ii) an
ALTA lender's title insurance policy or other generally acceptable form of
policy or insurance and each such title insurance policy is issued by a title
insurer qualified to do business in the jurisdiction where the Mortgaged
Property is located, insuring the

Schedule 1, Page 4
<PAGE> 50

Borrower, its successors and assigns, as to the first priority lien of the
Mortgage in the original principal amount of the Mortgage Loan, subject only to
the exceptions contained in clauses (1), (2) and (3) of paragraph (i) of this
Schedule 1. Where required by state law or regulation, the Mortgagor has been
given the opportunity to choose the carrier of the required mortgage title
insurance. Additionally, such lender's title insurance policy affirmatively
insures ingress and egress and against encroachments by or upon the Mortgaged
Property or any interest therein. The title policy does not contain any
special exceptions (other than the standard exclusions) for zoning and uses and
has been marked to delete the standard survey exception or to replace the
standard survey exception with a specific survey reading. The Borrower, its
successors and assigns, are the sole insureds of such lender's title insurance
policy, and such lender's title insurance policy is valid and remains in full
force and effect and will be in force and effect upon the consummation of the
transactions contemplated by this Loan Agreement. No claims have been made
under such lender's title insurance policy. The title policy has been marked
to delete the intervening lien exception and all premiums for such policy,
including any premiums for endorsements and special endorsements, have been
paid.

(p) No Defaults. To the best of the Borrower's knowledge,
there is no default, breach, violation or event of acceleration existing under
the Mortgage or the Mortgage Note and no event has occurred which, with the
passage of time or with notice and the expiration of any grace or cure period,
to the best of the Borrower's knowledge, would constitute a default, breach,
violation or event of acceleration, and neither the Borrower nor its
predecessors have waived any default, breach, violation or event of
acceleration.

(q) No Mechanics' Liens. To the best of the Borrower's
knowledge, there are no mechanics' or similar liens or claims which have been
filed for work, labor or material (and no rights are outstanding that under the
law could give rise to such liens) affecting the Mortgaged Property which are or
may be liens prior to, or equal or coordinate with, the lien of the Mortgage.

(r) Location of Improvements; No Encroachments. To the
best of the Borrower's knowledge, all improvements which were considered in
determining the Appraised Value of the Mortgaged Property lie wholly within the
boundaries and building restriction lines of the Mortgaged Property, and no
improvements on adjoining properties encroach upon the Mortgaged Property or the
Lender's title insurance policy referenced in (o) above affirmatively insures
such encroachments. To the best of the Borrower's knowledge, no improvement
located on or being part of the Mortgaged Property is in violation of any
applicable zoning and building law, ordinance or regulation.

(s) Origination; Payment Terms. Principal payments on the
Mortgage Loan commenced no more than 60 days after funds were disbursed in
connection with the Mortgage Loan. The Mortgage Note is payable monthly with
interest calculated and payable in arrears, sufficient to amortize the Mortgage
Loan fully by the stated maturity date, or otherwise providing for a balloon
payment in accordance with the Underwriting Guidelines over an original term of
not more than 30 years from commencement of amortization.

(t) Customary Provisions. The Mortgage Note has a stated
maturity. The Mortgage contains customary and enforceable provisions such as to
render the rights and remedies of the holder thereof adequate for the
realization against the Mortgaged Property of the

Schedule 1, Page 5
<PAGE> 51

benefits of the security provided thereby, including, (i) in the case of a
Mortgage designated as a deed of trust, by trustee's sale, and (ii) otherwise
by power of sale or judicial foreclosure. The Mortgage or the laws of the
applicable state in which the Mortgaged Property is located provides for the
appointment of a receiver for rents in the event of an institution of
foreclosure proceedings, or allows the Mortgagee to enter into possession to
collect rents to the extent permitted by applicable law.

(u) Conformance with Underwriting Guidelines. The Mortgage
Loan was underwritten in accordance with the Underwriting Guidelines.

(v) Occupancy of the Mortgaged Property. To the best of
the Borrower's knowledge, as of the Funding Date the Mortgaged Property is
lawfully occupied under applicable law. To the best of the Borrower's knowledge,
all inspections, licenses and certificates required to be made or issued with
respect to all occupied portions of the Mortgaged Property and, with respect to
the use and occupancy of the same, including but not limited to, certificates of
occupancy and fire underwriting certificates, have been made or obtained from
the appropriate authorities. To the best of the Borrower's knowledge, the
Borrower has not received notification from any governmental authority that the
Mortgaged Property is in material non-compliance with such laws or regulations,
is being used, operated or occupied unlawfully or has failed to have or obtain
such inspection, licenses or certificates, as the case may be. The Borrower has
not received notice of any violation or failure to conform with any such law,
ordinance, regulation, standard, license or certificate.

(w) Deeds of Trust. In the event the Mortgage constitutes
a deed of trust, a trustee, authorized and duly qualified under applicable law
to serve as such has been properly designated and currently so serves and is
named in the Mortgage, and no fees or expenses are or will become payable by the
Custodian or the Lender to the trustee under the deed of trust, except in
connection with a trustee's sale after default by the Mortgagor.

(x) Delivery of Mortgage Documents. The Mortgage Note, the
Mortgage, the Assignment of Mortgage and any other documents required to be
delivered under the Custodial Agreement for each Mortgage Loan have been
delivered to the Custodian. The Borrower or its agent is in possession of a
complete, true and accurate Mortgage File in compliance with the Custodial
Agreement, except for such documents the originals of which have been delivered
to the Custodian.

(y) Transfer of Mortgage Loans. The Assignment of Mortgage
is in recordable form and is acceptable for recording under the laws of the
jurisdiction in which the Mortgaged Property is located.

(z) No Buydown Provisions; No Graduated Payments or
Contingent Interests. The Mortgage Loan does not contain provisions pursuant to
which Monthly Payments are paid or partially paid with funds deposited in any
separate account established by the Borrower, the Mortgagor, or anyone on behalf
of the Mortgagor, or paid by any source other than the Mortgagor nor does it
contain any other similar provisions which may constitute a "buydown" provision.
The Mortgage Loan is not a graduated payment mortgage loan and the Mortgage Loan
does not have a shared appreciation or other contingent interest feature.

Schedule 1, Page 6
<PAGE> 52

(aa) Mortgaged Property Undamaged. To the best of the
Borrower's knowledge, the Mortgaged Property is undamaged by waste, fire,
earthquake or earth movement, windstorm, flood, tornado or other casualty so as
to affect materially and adversely the value of the Mortgaged Property as
security for the Mortgage Loan or the use for which the premises were intended
and each Mortgaged Property is in good repair. To the best of the Borrower's
knowledge, there have not been any condemnation proceedings commenced with
respect to the Mortgaged Property and the Borrower has no knowledge of any such
proceedings.

(bb) Collection Practices; Escrow Deposits. The
origination and collection practices used by the originator, each servicer of
the Mortgage Loan and the Borrower with respect to the Mortgage Loan have been
in all material respects in compliance with Accepted Servicing Practices,
applicable laws and regulations, and have been in all material respects legal.
With respect to escrow deposits and Escrow Payments, all such payments are in
the possession of, or under the control of, the Borrower and there exist no
deficiencies in connection therewith for which customary arrangements for
repayment thereof have not been made. All Escrow Payments have been collected in
full compliance with state and federal law.

(cc) Other Insurance Policies. To the best of the
Borrower's knowledge, no action, inaction or event has occurred and no state of
facts exists or has existed that has resulted or will result in the exclusion
from, denial of, or defense to coverage under any applicable special hazard
insurance policy or bankruptcy bond, irrespective of the cause of such failure
of coverage. In connection with the placement of any such insurance, no
commission, fee, or other compensation has been or will be received by the
Borrower or by any officer, director, or employee of the Borrower or any
designee of the Borrower or any corporation in which the Borrower or any
officer, director, or employee had a financial interest at the time of placement
of such insurance.

(dd) Appraisal. The Mortgage File contains an appraisal of
the related Mortgaged Property signed (to the best of the Borrower's knowledge,
prior to the date a commitment to fund such Mortgage Loan becomes binding) by a
qualified appraiser, duly appointed by the Borrower, who had no interest, direct
or indirect in the Mortgaged Property or in any loan made on the security
thereof, and whose compensation is not affected by the approval or disapproval
of the Mortgage Loan.

(ee) Capitalization of Interest. The Mortgage Note does
not by its terms provide for the capitalization or forbearance of interest;
provided that the Mortgage Note may have been restructured, and at the time of
such restructuring, outstanding interest may have been capitalized.

(ff) No Equity Participation. No document relating to the
Mortgage Loan provides for any contingent or additional interest in the form of
participation in the cash flow of the Mortgaged Property or a sharing in the
appreciation of the value of the Mortgaged Property. The indebtedness evidenced
by the Mortgage Note is not convertible to an ownership interest in the
Mortgaged Property or the Mortgagor and the Borrower has not financed nor does
it own directly or indirectly, any equity of any form in the Mortgaged Property
or the Mortgagor.

Schedule 1, Page 7
<PAGE> 53

(gg) Proceeds of Mortgage Loan. Except as expressly
previously disclosed to the Lender, the proceeds of the Mortgage Loan have not
been and shall not be used to satisfy, in whole or in part, any debt owed or
owing by the Mortgagor to the Borrower or any Affiliate or correspondent of the
Borrower except in each case, fees and expenses incurred in the origination of
the Mortgage Loan.

(hh) Withdrawn Mortgage Loans. If the Mortgage Loan has
been released to the Borrower pursuant to a Request for Release and Receipt as
permitted under Section 5 of the Custodial Agreement, then, the promissory note
relating to the Mortgage Loan was returned to the Custodian within 10 days of
release (or if such tenth day is not a Business Day, the next succeeding
Business Day).

(ii) No Exception. The Custodian has not noted any material
exceptions on an Exception Report (as defined in the Custodial Agreement) with
respect to the Mortgage Loan which would materially adversely affect the
Mortgage Loan or the Lender's security interest, granted by the Borrower, in the
Mortgage Loan.

(jj) Qualified Originator. The Mortgage Loan has been
originated by, and, if applicable, purchased by the Borrower from, a Qualified
Originator.

(kk) Title Survey; Improvements. To the best of the
Borrower's knowledge, the Mortgage File includes a title survey, certified to
the Borrower or the Qualified Originator, its successors and assigns, and the
title insurance company, in accordance with most recent minimum standards for
title surveys as determined by the American Land Title Association, with the
signature and seal of a licensed engineer or surveyor affixed thereto.

(ll) Inspection. The Borrower or the Qualified Originator
or its agents, has inspected or has caused to be inspected each related
Mortgaged Property in connection with the origination thereof no earlier than
six months prior to the related Funding Date.

(mm) Access Routes. To the best of the Borrower's
knowledge, at the time of origination, the Mortgaged Property was (i) contiguous
to a physically open, dedicated all-weather public street, (ii) had all
necessary permits and approvals for ingress and egress, (iii) was adequately
serviced by public or private water, public or private sewer systems and
utilities, and (iv) was on a separate tax parcel, separate and apart from any
other property owned by the Mortgagor or any other Person.

(nn) Mortgagor is Landlord under Leases. Each Mortgagor is
the owner and holder of the landlord's interest under any lease for use and
occupancy of all or any portion of the related Mortgaged Property. Neither the
Borrower nor, to the best of the Borrower's knowledge, the Mortgagor, has made
any assignments of the landlord's interest in any such lease or any portion of
the rents, additional rents, charges, issues or profits due and payable or to
become due and payable under any such lease (other than an assignment in favor
of the Borrower or in favor of the Lender) which assignments are presently
outstanding. The assignment of leases and/or rents and any security agreement,
chattel mortgage or equivalent document related to and delivered in connection
with the Mortgage Loan establishes and creates a valid and enforceable first
lien or first priority security interest on the leases affecting the Mortgaged

Schedule 1, Page 8
<PAGE> 54

Property except as enforceability may be limited by bankruptcy or other laws
affecting creditor's rights generally or by the application of the rules of
equity.

(oo) Mortgaged Property Leased to Tenants. To the best of
the Borrower's knowledge as to each Mortgage Loan secured by Mortgaged Property
which is leased to tenants: (i) the Mortgaged Property is not subject to any
leases other than the leases described in the rent roll contained in the
Servicing File (hereinafter referred to as the "Leases"), and such rent roll is
accurate and complete in all material respects, including description of the
rent and term. (ii) no Person has any possessory interest in the Mortgaged
Property or right to occupy the same except under and pursuant to the provisions
of the Leases and except those possessory interests set forth in clauses (2) and
(3) of paragraph (i) of this Schedule 1, Part I, (iii) each Lease of all or any
portion of the Mortgaged Property is subordinate to the Mortgage, unless
otherwise approved by the Borrower; (iv) with respect to any Lease having the
benefit of a non-disturbance or similar recognition agreement, there are no
circumstances or conditions with respect to the Mortgage, the Mortgaged
Property, and Mortgagor, any tenant (alone or considered with other tenants) of
the Mortgaged Property, or the Mortgagor's or any tenant's credit standing that
would cause prudent mortgage lenders making loans similar to the Mortgage Loan
in the area in which the Mortgaged Property is located to refuse to grant such
non-disturbance or similar recognition agreement; are no recorded assignments of
the Leases or of any portion of the rents, additional rents, charges, issues or
profits due and payable or to become due and payable thereunder (hereinafter
collectively referred to as the "Rents") to anyone other than the Mortgagor or a
mortgagee which are now outstanding; (v) no Leases contain any option to
purchase, any right of first refusal to lease or purchase, any express right to
terminate the Lease or vacate the premises prior to expiration of the lease
term, or any express right to abate or defer rent or any other similar
provisions which materially adversely affect the Mortgaged Property or which
might materially, adversely affect the rights of any holder of the Mortgage
Loan; (vi) of the Leases are in full force and effect and have not been modified
or amended other than by documents contained in the Servicing File, and the
Servicing File contains true and complete copies of the Leases; (vii) The
Mortgagor has certified that all rents due and payable under the Leases have
been paid in full and no such rents have been paid more than one month in
advance of the Due Date; and (viii) the Mortgagor has certified that neither the
Mortgagor (landlord) nor any tenant under the Leases is in default under any of
the terms, covenants or provisions of the Leases and the Borrower knows of no
event which, but for the passage of time or the giving of notice or both, would
constitute an event of default under any of the Leases.

(pp) Organization. If not an individual, to the best of
the Borrower's knowledge, the Mortgagor has been duly organized and is validly
existing and in good standing under the laws of the jurisdiction of its
formation. To the best of the Borrower's knowledge based on the Mortgagor's
representations and warranties, the Mortgagor has requisite power and authority
to (i) own its properties, (ii) transact the business in which it is now
engaged, (iii) execute and deliver the Mortgage Note, the Mortgage and the other
Mortgage and the other Mortgage Loan Documents and (iv) consummate the
transactions contemplated hereby and thereby. To the best of the Borrower's
knowledge based on the Mortgagor's representations and warranties, the Mortgagor
is duly qualified to do business and is in good standing in the jurisdiction
where it is required to be so qualified in connection with the ownership,
maintenance, management and operation of the Mortgaged Property. The Mortgagor
has represented, warranted and covenanted that it shall (1) own no assets, and
will not engage in any

Schedule 1, Page 9
<PAGE> 55

business, other than ownership, operation and management of its respective
Mortgaged Property except as Scheduled and identified to the Lender (2) not
enter into any contract or agreement with any affiliate except upon terms and
conditions that are intrinsically fair and substantially similar to those that
would be available on an arms-length basis with persons other than such
affiliate; (3) not incur any indebtedness or obligation, secured or unsecured,
direct or indirect, absolute or contingent (including guaranteeing any
obligation), other than pursuant to the Mortgage Loan Document and other known
liens or other trade payables; (4) not make any loans or advances to any third
party, and shall not acquire obligations or securities of its affiliates; (5)
pay its debts and liabilities (including, as applicable, shared personnel and
overhead expenses) only from its own assets; (6) comply with the provisions of
its organizational documents; (7) do all things necessary to observe
organizational formalities and to preserve its existence, and will not amend,
modify or otherwise change its organizational documents, or suffer same to be
amended, modified or otherwise changed, without the prior written consent of
the Lender; (8) maintain all of its books, records, financial statements and
bank accounts separate from those of its Affiliates; (9) be, and at all times
will hold itself out to the public as, a legal entity separate and distinct
from any other entity (including any affiliate), shall correct any known
misunderstanding regarding its status as a separate entity, shall conduct
business in its own name, shall not identify itself or any of its affiliates as
a division or part of the other and shall maintain and utilize separate
stationery, invoices and checks; (10) maintain adequate capital for the normal
obligations reasonably foreseeable in a business of its size and character and
in light of its contemplated business operations; (11) not engage in or suffer
any change of ownership, dissolution, winding up, liquidation, consolidation or
merger in whole or in part; (12) not commingle its funds or other assets with
those of any affiliate or any other Person; (13) maintain its assets in such a
manner that it will not be costly or difficult to segregate, ascertain or
identify its individual assets from those of any affiliate or any other person;
and (14) not and will not hold itself out to be responsible for the debts or
obligations of any other Person.

(qq) Mortgagor Properly Licensed and in Compliance With
Terms of Mortgage Loan Documents. To the best of the Borrower's knowledge based
on the Mortgagor's representations and warranties, (i) the Mortgagor was at the
time of origination in possession of all licenses, permits and other
authorizations necessary and required by applicable law for the conduct of its
business; (ii) all such licenses, permits and authorizations are valid and in
full force and effect and (iii) all material conditions on the Mortgagor's part
to be fulfilled under the terms of any lease of the Mortgaged Property have been
satisfied.

(rr) No Conflicts. To the best of the Borrower's knowledge
based on the Mortgagor's representations and warranties, (i) the execution,
delivery and performance of the Mortgage Note, the Mortgage, and the other
Mortgage Loan Documents by the Mortgagor do not conflict with or constitute a
default under, or result in the creation or imposition of any lien (other than
pursuant to the Mortgage Loan Documents) mortgage, deed of trust, loan
agreement, partnership agreement, or other agreement or instrument to which the
Mortgagor is a party or to which the Mortgaged Property is subject, nor will
such action result in any violation of the provisions of any statute or any
jurisdiction over the Mortgagor or the Mortgaged Property, and (ii) any
qualification of or with any Governmental Authority required for the execution,
deliver, and performance by the Mortgagor of the Mortgage Note, the Mortgage, or
the other Mortgage Loan Documents has been obtained as is in full force and
effect.

Schedule 1, Page 10
<PAGE> 56

(ss) Litigation. To the best of the Borrower's knowledge
based on the Mortgagor's representations and warranties, there are no actions,
suits, or proceedings at law or in equity by or before any Governmental
Authority now pending or threatened against or affecting the Mortgagor or the
Mortgaged Property, which actions, suits or proceedings, if determined against
the Mortgagor or the Mortgaged Property, might materially adversely affect the
condition (financial or otherwise) or business of the Mortgagor or the condition
or ownership of the Mortgaged Property.

(tt) No Violation of Environmental Laws. To the best of the
Borrower's knowledge, there is no pending action or proceeding directly
involving the Mortgaged Property in which compliance with any environmental law,
rule or regulation is an issue; and to the best of the Borrower's knowledge,
nothing further remains to be done to satisfy in full all requirements of each
such law, rule or regulation constituting a prerequisite to use and enjoyment of
said property.

(uu) Agreements. To the best of the Borrower's knowledge
based on the Mortgagor's representations and warranties, the Mortgagor is not a
party to any agreement or instrument or subject to any restriction which might
adversely affect the Mortgagor. To the best of the Borrower's knowledge based on
the Mortgagor's representations and warranties, the Mortgagor is not in default
in any material respect in the performance, observance, or fulfillment of any of
the obligations, covenants or conditions contained in any agreement or
instrument to which it is a party or by which the Mortgagor or the Mortgaged
Property is bound.

(vv) No Bankruptcy Filing. To the best of the Borrower's
knowledge based on the Mortgagor's representations and warranties, the Mortgagor
is not contemplating either the filing of a petition by it under any state or
federal bankruptcy or insolvency laws or the liquidation of all or a major
portion of the Mortgagor's assets or the Mortgaged Property.

(ww) Full and Accurate Disclosure. To the best of the
Borrower's knowledge based on the Mortgagor's representations and warranties, no
statement of fact made by the Mortgagor in the Mortgage Loan Documents contains
any untrue statement of a material fact or omits to state any material fact
necessary to make statements contained herein or therein not misleading.

(xx) No Plan Assets. To the best of the Borrower's
knowledge based on the Mortgagor's representations and warranties, the Mortgagor
is not an "employee benefit plan," as defined in Sections 3 (3) of ERISA,
subject to Title I of ERISA, and none of the assets of the Mortgagor constitutes
or will constitute "plan assets" of one or more such plans within the meaning of
29 C.F.R. Section 2510.3-101.

(yy) Compliance. To the best of the Borrower's knowledge,
the Mortgagor and the Mortgaged Property and the use thereof comply in all
material respects with all applicable legal requirements, including, without
limitation, parking requirements. To the best of the Borrower's knowledge based
on the Mortgagor's representations and warranties, the Mortgagor is not in
default or violation of any order, writ, injunction, decree or demand of any
Governmental Authority, the violation of which might materially adversely affect
the condition (financial or otherwise) or business of the Mortgagor.

Schedule 1, Page 11
<PAGE> 57

(zz) Contracts. To the best of the Borrower's knowledge
based on the Mortgagor's representations and warranties, there are no material
contracts (other than management contracts) affecting the Mortgaged Property
that are not terminable on one month's notice or less without cause and without
penalty or premium.

(aaa) Financial Information. To the best of the Borrower's
knowledge, based upon the Mortgagor's representations and warranties, all
financial data, including, without limitation the statements of cash flow and
income and operating expense, that have been delivered to the Qualified
Originator (i) are true, complete, and correct in all material respects, and
(ii) accurately represent the financial condition of the Mortgaged Property and
the persons covered thereby as of the date of such reports.

(bbb) Not a Foreign Person. To the best of the Borrower's
knowledge based upon the Mortgagor's representations and warranties, the
Mortgagor is not a "foreign person" within the meaning of Section 1445(f)(3) of
the Code.

(ccc) Separate Lots. To the best of the Borrower's knowledge
based on the Mortgagor's representations and warranties, the Mortgaged Property
is not assessed jointly with any other real property constituting a separate tax
lot or with any other real property constituting a separate tax lot or with any
personal property not constituting part of such Mortgaged Property such that the
lien of any taxes which may be levied against such personal property shall be
assessed or levied or charged as a lien on the Mortgaged Property.

(ddd) Assessments. To the best of the Borrower's knowledge
based upon the Mortgagor's representations and warranties, there are no pending
or proposed special or other assessments for public improvements or otherwise
affecting the Mortgaged Property, nor to the best of the Borrower's knowledge
based upon the Mortgagor's representations and warranties are there any
contemplated improvements to the Mortgaged Property that may result in such
special or other assessments.

(eee) Mortgage Submitted for Recordation. The Mortgage
either has been or will promptly be submitted for recordation in the appropriate
governmental recording office of the jurisdiction where the Mortgaged Property
is located.

(fff) The Ground Lease. To the best of the Borrower's
knowledge based upon the Mortgagor's representations and warranties with respect
to each ground lease to which the Mortgaged Property is subject (a "Ground
Lease"): (i) the Mortgagor is the owner of a valid and subsisting interest as
tenant under the Ground Lease; (ii) the Ground Lease is unmodified and not
supplemented by any writing or otherwise (other than as disclosed in the
Servicing File) and is in full force and effect; (iii) all rent, additional rent
and other charges reserved therein have been paid to the extent they are payable
to the date hereof; (iv) the Mortgagor enjoys the quiet and peaceful possession
of the estate demised thereby, subject to any sublease; (v) the Mortgagor is not
in default under any of the terms thereof and there are no circumstances which,
with the passage of time or the giving of notice or both, would constitute an
event of default thereunder; (vii) the lessor under the Ground Lease is not in
default under any of the terms or provisions thereof on the part of the lessor
to be observed or performed; (vii) the lessor under the Ground Lease has
satisfied all of its repair or construction obligations, if any, to date
pursuant to the

Schedule 1, Page 12
<PAGE> 58

terms of the Ground Lease; and (ix) the execution, delivery and performance of
the Mortgage do not require the consent (other than those consents which have
been obtained and are in full force and effect) under, and will not contravene
any provision of or cause a default under, the Ground Lease.

(ggg) Table-Funded Mortgage Loans. With respect to each
Mortgage Loan that is a Table-Funded Mortgage Loan, the Settlement Agent has
entered into a Bailee Agreement agreeing to hold the related Mortgage Loan
Documents as agent and bailee for the Lender and to promptly forward such
Mortgage Loan Documents to the Custodian for receipt by the fourth (4th)
Business Day following the applicable Funding Date.

Schedule 1, Page 13
<PAGE> 59

Part II. Eligible Commercial Mortgage Loans that are Secured by Hotels

As to each Eligible Commercial Mortgage Loan secured by a
Hotel included in the Borrowing Base on a Funding Date (and the related
Mortgage, Mortgage Note, Assignment of Mortgage and Mortgaged Property), the
Borrower shall be deemed to make the following representations and warranties
to the Lender as of such date (certain defined terms used herein and not
otherwise defined in the Agreement appearing in Part III to this Schedule 1,
except as otherwise set forth on an Officer's Certificate (as defined in the
Custodial Agreement) delivered on or prior to Funding Date or otherwise
disclosed in writing to the Lender.

(a) To the best of the Borrower's knowledge, the
Franchise Agreement, if any, is in full force and effect and there is no
default, breach or violation existing thereunder by any party thereto and no
event (other than payments due but not yet delinquent) which, with the passage
of time or with notice and the expiration of any grace or cure period would
constitute a default, breach or violation by any party thereunder;

(b) To the best of the Borrower's knowledge, the
Management Agreement, if any, is in full force and effect and there is no
default, breach or violation existing thereunder by any party thereto and no
event (other than payments due but not yet delinquent) which, with the passage
of time or with notice and the expiration of any grace or cure period would
constitute a default, breach or violation by any party thereunder;

(c) To the best of the Borrower's knowledge, the
Mortgagor owns/and or possesses, and holds free from burdensome restrictions or
known conflicts with the rights of others, all material licenses,
registrations, permits, certificates, authorizations and approvals necessary
for the operation of the Mortgaged Property as a Hotel; and

(d) Neither the execution and delivery of the Mortgage
Loan Documents, the Mortgagor's performance thereunder, the recordation of the
Mortgage, will materially and adversely affect (x) the Mortgagor's rights under
either the Franchise Agreement, if any, or the Management Agreement, if any, or
(y) the licenses, registration, permits, certificates, authorizations and
approvals necessary for the operation of the Hotel; provided, however, in the
case of clause (y) the Borrower's knowledge is limited to the Borrower's actual
knowledge based on (1) a review of such items and (2) reliance on an opinion of
counsel from the Mortgagor's counsel.

Schedule 1, Page 14
<PAGE> 60

Part III. Defined Terms

In addition to terms defined elsewhere in the Loan Agreement,
the following terms shall have the following meanings when used in this
Schedule 1:

"Acceptable State" shall mean any state for which approval has
not been revoked by the Lender in its sole discretion, any such notice of
revocation to be given no later than 10 Business Days prior to its intended
effective date.

"Accepted Servicing Practices" shall mean, with respect to any
Mortgage Loan, those mortgage servicing practices of prudent mortgage lending
institutions which service mortgage loans of the same type as such Mortgage
Loans in the jurisdiction where the related Mortgaged Property is located.

"ALTA" means the American Land Title Association.

"Appraised Value" shall mean the value set forth in an
appraisal made in connection with the origination of the related Mortgage Loan
as the value of the Mortgaged Property.

"Assignment of Mortgage" shall mean an assignment of the
Mortgage, notice of transfer or equivalent instrument in recordable form,
sufficient under the laws of the jurisdiction wherein the related Mortgaged
Property is located to reflect the transfer of the Mortgage.

"Best's" means Best's Key Rating Guide, as the same shall be
amended from time to time.

"Cut-off Date" means the first day of the month in which the
related Funding Date occurs.

"Debt Service Ratio" means as of any date of determination and
for any period, the applicable "Debt Service Coverage" ratio determined in
accordance with, and defined in, the Underwriting Guidelines.

"Due Date" means the day of the month on which the Monthly
Payment is due on a Mortgage Loan, exclusive of any days of grace.

"Escrow Payments" means with respect to any Mortgage Loan, the
amounts constituting ground rents, taxes, assessments, water rates, sewer
rents, municipal charges, mortgage insurance premiums, fire and hazard
insurance premiums, condominium charges, and any other payments required to be
escrowed by the Mortgagor with the mortgagee pursuant to the Mortgage or any
other document.

"Freddie Mac" means Freddie Mac, or any successor thereto.

"Fannie Mae" means Fannie Mae, or any successor thereto.

Schedule 1, Page 15
<PAGE> 61

"Gross Margin" means with respect to each adjustable rate
Mortgage Loan, the fixed percentage amount set forth in the related Mortgage
Note.

"Ground Lease" means a lease for all or any portion of the
real property comprising the Mortgaged Property, the lessee's interest in which
is held by the Mortgagor of the related Mortgage Loan.

"Ground Lessee" shall mean the ground lessee under a Ground
Lease.

"Hotel" shall mean a real estate development owned by the
Mortgagor or for which the Mortgagor is a Ground Lessee, which constitutes a
full operational hotel or motel, including all land, amenities and
improvements, with individual rooms principally for short-term rental to
tenants occupying same, as more particularly described in the Underwriting
Guidelines.

"Index" means with respect to each adjustable rate Mortgage
Loan, the index set forth in the related Mortgage Note for the purpose of
calculating the interest rate thereon.

"Insurance Proceeds" means with respect to each Mortgage Loan,
proceeds of insurance policies insuring the Mortgage Loan or the related
Mortgaged Property.

"Interest Rate Adjustment Date" means with respect to each
adjustable rate Mortgage Loan, the date, specified in the related Mortgage Note
and the Mortgage Loan Schedule, on which the Mortgage Interest Rate is
adjusted.

"Loan-to-Value Ratio" or "LTV" means with respect to any
Mortgage Loan, the ratio of the original outstanding principal amount of the
Mortgage Loan to the lesser of (a) the Appraised Value of the Mortgaged
Property at origination or (b) if the Mortgaged Property was purchased within
12 months of the origination of the Mortgage Loan, the purchase price of the
Mortgaged Property.

"Monthly Payment" means the Scheduled monthly payment of
principal and interest on a Mortgage Loan as adjusted in accordance with
changes in the Mortgage Interest Rate pursuant to the provisions of the
Mortgage Note for an adjustable rate Mortgage Loan.

"Mortgage Interest Rate" means the annual rate of interest
borne on a Mortgage Note, which shall be adjusted from time to time with
respect to adjustable rate Mortgage Loans.

"Mortgage Interest Rate Cap" means with respect to an
adjustable rate Mortgage Loan, the limit on each Mortgage Interest Rate
adjustment as set forth in the related Mortgage Note.

"Mortgagee" means the Borrower or any subsequent holder of a
Mortgage Loan.

"Origination Date" shall mean, with respect to each Mortgage
Loan, the date of the Mortgage Note relating to such Mortgage Loan, unless such
information is not provided by the Borrower with respect to such Mortgage Loan,
in which case the Origination Date shall be deemed to be the date that is 40
days prior to the date of the first payment under the Mortgage Note relating to
such Mortgage Loan.

Schedule 1, Page 16
<PAGE> 62

"PMI Policy" or "Primary Insurance Policy" means a policy of
primary mortgage guaranty insurance issued by a Qualified Insurer.

"Qualified Insurer" means an insurance company duly qualified
as such under the laws of the states in which the Mortgaged Property is
located, duly authorized and licensed in such states to transact the applicable
insurance business and to write the insurance provided, and approved as an
insurer by Fannie Mae and Freddie Mac and whose claims paying ability is rated
in the two highest rating categories by any of the rating agencies with respect
to primary mortgage insurance and in the two highest rating categories by
Best's with respect to hazard and flood insurance.

"Qualified Originator" means an originator of Mortgage Loans
reasonably acceptable to the Lender.

"Servicing File" means with respect to each Mortgage Loan, the
file retained by the Borrower consisting of originals of all documents in the
Mortgage File which are not delivered to a Custodian and copies of the Mortgage
Loan Documents set forth in Section 2 of the Custodial Agreement.

Schedule 1, Page 17

<PAGE> 1
EXHIBIT 99.2i.1b

TERMINATION AMENDMENT TO THE
ALLIED EMPLOYEE STOCK OWNERSHIP
PLAN AND TRUST AGREEMENT

Allied Capital Corporation, having adopted the Allied Employee Stock Ownership
Plan and Trust Agreement (the "Plan"), effective as of January 1, 1998, having
reserved to itself in Section 9.2 of the Plan the right to terminate the Plan at
any time, hereby terminates the Plan effective as of December 31, 1999 (the
"Termination Date") and provides for the distribution of each Participant's
account balance upon the terms and conditions set forth in this Termination
Amendment:

1. The Plan is hereby terminated effective as of the Termination Date.

2. The Trustee is hereby authorized and instructed by the Plan
Administrator to distribute, in accordance with Plan Article VII, to
each Participant his account balance as soon as administratively
feasible.

3. Upon the distribution of all Participants' account balances, all
liabilities of the Plan to Participants shall cease and the Trust Fund
maintained pursuant to the Plan shall thereupon terminate and
dissolve.

4. Allied Capital Corporation hereby reserves the right to further amend
the Plan and to amend the provisions of this Termination Amendment.

IN WITNESS WHEREOF, this instrument is duly executed this 21st day of October,
1999.

By: /s/ KELLY A. ANDERSON
--------------------------------------------
Kelly A. Anderson, Executive Vice President
and Treasurer

Attest:

/s/ SUZANNE V. SPARROW
- -----------------------------
Suzanne V. Sparrow, Secretary

<PAGE> 1
EXHIBIT EX-99.2n.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the use of our report
dated February 18, 1999, and to all references to our Firm included in or made
part of this registration statement.

/s/ Arthur Andersen LLP

Vienna, Virginia
November 10, 1999

<PAGE> 1
EXHIBIT EX-99.2L

Sutherland Asbill & Brennan LLP
1275 Pennsylvania Avenue, N.W.
Washington, D.C. 20004

November 10, 1999

STEVEN B. BOEHM
DIRECT LINE: (202) 383-0176
Internet: [email protected]

Allied Capital Corporation
1919 Pennsylvania Avenue, N.W.
3rd Floor
Washington, D.C. 20006

Ladies and Gentlemen:

We have acted as counsel to Allied Capital Corporation, a Maryland
corporation (the "Company") in connection with the offering from time to time by
the Company of up to 6,000,000 shares of the Company's common stock, par value
$0.0001 per share (the "Shares"). Such offering is the subject of a registration
statement on Form N-2, under the Securities Act of 1933, as amended (the "Act")
filed by the Company on August 11, 1999, as amended by post-effective amendment
number one to the registration statement (the "registration statement") being
filed by the Company with the Commission. The Registration Statement provides
that the Shares may be offered in amounts, at prices, and on terms to be set
forth in one or more supplements (each a "Prospectus Supplement") to the final
prospectus (the "Prospectus").

We have participated in the preparation of the Registration Statement
and have examined originals or copies, certified or otherwise identified to our
satisfaction by public officials or officers of the Company as authentic copies
of originals, of (i) the Company's charter (the "Charter") and its bylaws ("the
Bylaws"), (ii) resolutions of the board of directors of the Company relating to
the authorization of the preparation and filing of the Registration Statement
and approving the offer and the issuance of the Shares, and (iii) such other
documents as in our judgment were necessary to enable us to render the opinions
expressed below. In our review and examination of all such documents, we have
assumed the legal capacity of all natural persons, the genuineness of all
signatures, the authenticity of all documents and records submitted to us as
originals, and the conformity with authentic originals of all documents and
records submitted to us as copies. To the extent we have deemed appropriate, we
have relied upon certificates of public officials and certificates and
statements of corporate officers of the Company as to certain factual matters.

We assume that prior to the issuance of any Shares there will exist,
under the Charter of the Company, the requisite number of authorized but
unissued shares of common stock of the Company. In addition, we assume that
underwriting agreements for the offerings of the Shares (an "Underwriting
Agreement") will be valid and legally binding agreements that conform to the
description thereof set forth in the applicable Prospectus Supplement.
<PAGE> 2
Allied Capital Corporation
November 10, 1999
Page 2

We assume that the issuance, sale and amount of the Shares to be
offered from time to time will be authorized and determined by proper action of
the Board of Directors of the Company in accordance with the parameters
described in the Registration Statement (each, a "Board Action") and in
accordance with the Company's Charter and Bylaws and with applicable Maryland
law.

This opinion is limited to the laws of the State of Maryland, and we
express no opinion with respect to the laws of any other jurisdiction. The
opinions expressed in this letter are based on our review of the General
Corporation Law of Maryland.

Based upon and subject to the foregoing and our investigation of such
matters of law as we have considered advisable, we are of the opinion that:

1. The Company is a corporation duly incorporated and existing under
the laws of the State of Maryland.

2. Upon due authorization by Board Action of the issuance of the
Shares, and upon the consummation of the sale of Shares and the
payment of the consideration therefor in accordance with the
terms and provisions of such Board Action, the Registration
Statement (as declared effective under the Act), the Prospectus or
the applicable Prospectus Supplement and, if applicable, an
Underwriting Agreement, the Shares will be duly authorized,
validly issued, fully paid and nonassessable.

We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to our firm in the "Legal Matters"
section of the prospectus included in the Registration Statement. We do not
admit by giving this consent that we are in the category of persons whose
consent is required under Section 7 of the Securities Act of 1933, as amended.

Very truly yours,
Sutherland Asbill & Brennan LLP

By: /s/ Steven B. Boehm
---------------------
Steven B. Boehm

SSB/gth