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                                   FORM 10-Q

                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                          QUARTERLY REPORT PURSUANT TO
                             SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934

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

                            FOR THE QUARTERLY PERIOD
                              ENDED JUNE 30, 2001
                            COMMISSION FILE NUMBER:
                                    0-22832

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

                                    MARYLAND
                           (State or Jurisdiction of
                         Incorporation or Organization)
                                   52-1081052
                                 (IRS Employer
                              Identification No.)

                         1919 PENNSYLVANIA AVENUE, N.W.
                              WASHINGTON, DC 20006
                    (Address of Principal Executive Offices)

         REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (202) 331-1112

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

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

     On August 9, 2001 there were 92,690,062 shares outstanding of the
Registrant's common stock, $0.0001 par value.

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   2

                           ALLIED CAPITAL CORPORATION

                                FORM 10-Q INDEX


                                                           
PART I. FINANCIAL INFORMATION
     Item 1. Financial Statements
          Consolidated Balance Sheet as of June 30, 2001
         (unaudited) and December 31, 2000..................    1
          Consolidated Statement of Operations -- For the
         Three and Six Months Ended June 30, 2001 and 2000
         (unaudited)........................................    2
          Consolidated Statement of Changes in Net
         Assets -- For the Six Months Ended June 30, 2001
         and 2000 (unaudited)...............................    3
          Consolidated Statement of Cash Flows -- For the
         Six Months Ended June 30, 2001 and 2000
         (unaudited)........................................    4
          Consolidated Statement of Investments as of June
         30, 2001 (unaudited) and December 31, 2000.........    5
          Notes to Consolidated Financial Statements........   21
     Item 2. Management's Discussion and Analysis of
      Financial Condition and Results of Operations.........   32
     Item 3. Quantitative and Qualitative Disclosures about
      Market Risk...........................................   52

PART II. OTHER INFORMATION
     Item 1. Legal Proceedings..............................   53
     Item 2. Changes in Securities and Use of Proceeds......   53
     Item 3. Defaults Upon Senior Securities................   53
     Item 4. Submission of Matters to a Vote of Security
      Holders...............................................   53
     Item 5. Other Information..............................   53
     Item 6. Exhibits and Reports on Form 8-K...............   53
     Signatures.............................................   57

   3

                         PART I: FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET



                                                               JUNE 30,     DECEMBER 31,
                                                                 2001           2000
                                                              -----------   -------------
       (IN THOUSANDS, EXCEPT NUMBER OF SHARE AMOUNTS)         (UNAUDITED)
                                                                      
                                         ASSETS
Portfolio at value:
      Private finance (cost: 2001-$1,374,096;
       2000-$1,262,529).....................................  $1,405,386     $1,282,467
      Commercial real estate finance (cost: 2001-$592,901;
       2000-$503,366).......................................     595,176        505,534
                                                              ----------     ----------
          Total portfolio at value..........................   2,000,562      1,788,001
                                                              ----------     ----------
Cash and cash equivalents...................................       3,433          2,449
Other assets................................................      79,839         63,367
                                                              ----------     ----------
          Total assets......................................  $2,083,834     $1,853,817
                                                              ==========     ==========
                          LIABILITIES AND SHAREHOLDERS' EQUITY

Liabilities:
      Notes payable and debentures..........................  $  716,314     $  704,648
      Revolving credit facilities...........................     164,750         82,000
      Accounts payable and other liabilities................      24,109         30,477
                                                              ----------     ----------
          Total liabilities.................................     905,173        817,125
                                                              ----------     ----------
Commitments and Contingencies
Preferred stock.............................................       7,000          7,000
Shareholders' equity:
      Common stock, $0.0001 par value, 200,000,000 shares
       authorized; 91,578,184 and 85,291,696 shares issued
       and outstanding at June 30, 2001 and December 31,
       2000, respectively...................................           9              9
      Additional paid-in capital............................   1,176,587      1,043,653
      Common stock held in deferred compensation trust (0
       shares and 234,977 shares at June 30, 2001 and
       December 31, 2000, respectively).....................          --             --
      Notes receivable from sale of common stock............     (26,237)       (25,083)
      Net unrealized appreciation on portfolio..............      30,676         19,378
      Distributions in excess of earnings...................      (9,374)        (8,265)
                                                              ----------     ----------
          Total shareholders' equity........................   1,171,661      1,029,692
                                                              ----------     ----------
          Total liabilities and shareholders' equity........  $2,083,834     $1,853,817
                                                              ==========     ==========


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

                                        1
   4

                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENT OF OPERATIONS



                                                        FOR THE THREE
                                                        MONTHS ENDED       FOR THE SIX MONTHS
                                                          JUNE 30,           ENDED JUNE 30,
                                                     -------------------   -------------------
                                                       2001       2000       2001       2000
     (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)        --------   --------   --------   --------
                                                         (UNAUDITED)           (UNAUDITED)
                                                                          
Interest and related portfolio income:
      Interest and dividends.......................  $58,824    $42,986    $113,699   $81,714
      Premiums from loan dispositions..............      910      4,554       1,731     7,843
      Fees and other income........................    9,005      2,425      18,380     4,305
                                                     -------    -------    --------   -------
          Total interest and related portfolio
             income................................   68,739     49,965     133,810    93,862
                                                     -------    -------    --------   -------
Expenses:
      Interest.....................................   15,951     14,280      31,881    26,591
      Employee.....................................    7,547      5,191      13,965     9,760
      Administrative...............................    3,060      4,082       6,027     6,835
                                                     -------    -------    --------   -------
          Total operating expenses.................   26,558     23,553      51,873    43,186
                                                     -------    -------    --------   -------
      Formula and cut-off awards...................       63      1,712          91     3,403
                                                     -------    -------    --------   -------
Net operating income before net realized and
  unrealized gains.................................   42,118     24,700      81,846    47,273
                                                     -------    -------    --------   -------
Net realized and unrealized gains:
      Net realized gains...........................    3,837     12,865       4,991    15,041
      Net unrealized gains.........................      151     (2,775)     11,297     2,057
                                                     -------    -------    --------   -------
          Total net realized and unrealized
             gains.................................    3,988     10,090      16,288    17,098
                                                     -------    -------    --------   -------
Net increase in net assets resulting from
  operations.......................................  $46,106    $34,790    $ 98,134   $64,371
                                                     =======    =======    ========   =======
Basic earnings per common share....................  $  0.52    $  0.50    $   1.12   $  0.94
                                                     =======    =======    ========   =======
Diluted earnings per common share..................  $  0.51    $  0.50    $   1.10   $  0.94
                                                     =======    =======    ========   =======
Weighted average common shares
  outstanding -- basic.............................   89,356     69,968      87,441    68,128
                                                     =======    =======    ========   =======
Weighted average common shares
  outstanding -- diluted...........................   90,848     70,035      88,966    68,175
                                                     =======    =======    ========   =======


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

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                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

                CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS



                                                               FOR THE SIX MONTHS
                                                                 ENDED JUNE 30,
                                                              ---------------------
                                                                 2001        2000
          (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)            ----------   --------
                                                                   (UNAUDITED)
                                                                     
Operations:
     Net operating income before realized and unrealized
      gains.................................................  $   81,846   $ 47,273
     Net realized gains.....................................       4,991     15,041
     Net unrealized gains...................................      11,297      2,057
                                                              ----------   --------
          Net increase in net assets resulting from
             operations.....................................      98,134     64,371
                                                              ----------   --------
Shareholder distributions:
     Common stock dividends.................................     (87,836)   (63,866)
     Preferred stock dividends..............................        (110)      (110)
                                                              ----------   --------
          Net decrease in net assets resulting from
             shareholder distributions......................     (87,946)   (63,976)
                                                              ----------   --------
Capital share transactions:
     Sale of common stock...................................     123,262    141,954
     Issuance of common stock for portfolio investments.....          --      1,485
     Issuance of common stock upon the exercise of stock
      options...............................................       6,258      1,431
     Issuance of common stock in lieu of cash
      distributions.........................................       3,415      2,420
     Net increase in notes receivable from sale of common
      stock.................................................      (1,154)        --
     Net decrease in common stock held in deferred
      compensation trust....................................          --      3,427
     Other..................................................          --       (572)
                                                              ----------   --------
          Net increase in net assets resulting from capital
             share transactions.............................     131,781    150,145
                                                              ----------   --------
          Total increase in net assets......................  $  141,969   $150,540
                                                              ==========   ========
Net assets at beginning of period...........................  $1,029,692   $667,513
                                                              ----------   --------
Net assets at end of period.................................  $1,171,661   $818,053
                                                              ----------   --------
Net asset value per common share............................  $    12.79   $  10.96
                                                              ----------   --------
Common shares outstanding at end of period..................      91,578     74,636
                                                              ==========   ========


  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                        3
   6

                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENT OF CASH FLOWS



                                                               FOR THE SIX MONTHS
                                                                 ENDED JUNE 30,
                                                              ---------------------
                                                                2001        2000
                       (IN THOUSANDS)                         ---------   ---------
                                                                   (UNAUDITED)
                                                                    
Cash flows from operating activities:
  Net increase in net assets resulting from operations......  $  98,134   $  64,371
  Adjustments
     Net unrealized gains...................................    (11,297)     (2,057)
     Depreciation and amortization..........................        479         423
     Amortization of loan discounts and fees................     (7,722)     (6,211)
     Changes in other assets and liabilities................    (10,455)     (9,484)
                                                              ---------   ---------
       Net cash provided by operating
          activities........................................     69,139      47,042
                                                              ---------   ---------
Cash flows from investing activities:
  Portfolio investments.....................................   (320,409)   (431,600)
  Repayments of investment principal........................     44,149      58,833
  Proceeds from loan sales..................................     74,648     117,092
  Other investing activities................................     (1,846)      3,280
                                                              ---------   ---------
       Net cash used in investing activities................   (203,458)   (252,395)
                                                              ---------   ---------
Cash flows from financing activities:
  Sale of common stock......................................    123,262     141,954
  Collections of notes receivable from sale of common
     stock..................................................      3,002       2,567
  Common dividends and distributions paid...................    (84,422)    (61,446)
  Preferred stock dividends paid............................       (110)       (110)
  Net borrowings under notes payable and debentures.........     11,666       8,000
  Net borrowings under revolving lines of credit............     82,750     125,500
  Other financing activities................................       (845)       (543)
                                                              ---------   ---------
       Net cash provided by financing activities............    135,303     215,922
                                                              ---------   ---------
Net increase in cash and cash equivalents...................  $     984   $  10,569
                                                              ---------   ---------
Cash and cash equivalents at beginning of period............  $   2,449   $  18,155
                                                              ---------   ---------
Cash and cash equivalents at end of period..................  $   3,433   $  28,724
                                                              =========   =========


  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                        4
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                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENT OF INVESTMENTS



                                                                                             JUNE 30, 2001
            PRIVATE FINANCE                                                                   (UNAUDITED)
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Ability One Corporation                  Loans                                          $   10,309   $   10,309
---------------------------------------------------------------------------------------------------------------
ACE Products, Inc.                       Loans                                              14,738       14,738
---------------------------------------------------------------------------------------------------------------
Acme Paging, L.P.                        Debt Securities                                     6,988        6,988
                                         Limited Partnership Interest                        1,456           --
---------------------------------------------------------------------------------------------------------------
Allied Office Products, Inc.             Debt Securities                                     9,395        9,395
                                         Warrants                                              629          629
---------------------------------------------------------------------------------------------------------------
American Barbecue & Grill, Inc.          Warrants                                              125           --
---------------------------------------------------------------------------------------------------------------
American Home Care Supply,               Debt Securities                                     6,878        6,878
  LLC                                    Warrants                                              579          579
---------------------------------------------------------------------------------------------------------------
Aspen Pet Products, Inc.                 Loans                                              14,135       14,135
                                         Series A Preferred Stock (1,860 shares)             1,907        1,907
                                         Series A Common Stock (1,400 shares)                  140          140
---------------------------------------------------------------------------------------------------------------
ASW Holding Corporation                  Warrants                                               25           25
---------------------------------------------------------------------------------------------------------------
Aurora Communications, LLC               Loans                                              15,266       15,266
                                         Equity Interest                                     2,461        4,308
---------------------------------------------------------------------------------------------------------------
Autania AG(1)                            Debt Securities                                     4,298        4,298
                                         Common Stock (250,000 shares)                       2,140        2,140
---------------------------------------------------------------------------------------------------------------
Avborne, Inc.                            Debt Securities                                    12,142       12,142
                                         Warrants                                            1,180        1,180
---------------------------------------------------------------------------------------------------------------
Bakery Chef, Inc.                        Loans                                              16,448       16,448
---------------------------------------------------------------------------------------------------------------
Blue Rhino Corporation(1)                Debt Securities                                    13,725       13,725
                                         Warrants                                            1,200        1,200
---------------------------------------------------------------------------------------------------------------
Border Foods, Inc.                       Debt Securities                                     9,285        9,285
                                         Series A Convertible Preferred Stock
                                         (50,919 shares)                                     2,000        2,000
                                         Warrants                                              665          665
---------------------------------------------------------------------------------------------------------------
Business Loan Express, Inc.              Debt Securities                                    68,539       68,539
                                         Preferred Stock (25,111 shares)                    25,111       25,111
                                         Common Stock (25,503,043 shares)                  104,515      120,015
                                         Guaranty ($51.7 million -- See Note 3)                 --           --
---------------------------------------------------------------------------------------------------------------
Camden Partners Strategic Fund II, L.P.  Limited Partnership Interest                          893          893
---------------------------------------------------------------------------------------------------------------
CampGroup, LLC                           Debt Securities                                     2,637        2,637
                                         Warrants                                              220          220
---------------------------------------------------------------------------------------------------------------
Candlewood Hotel Company(1)              Preferred Stock (3,250 shares)                      3,250        3,250
---------------------------------------------------------------------------------------------------------------
Celebrities, Inc.                        Loan                                                  258          258
                                         Warrants                                               12          662
---------------------------------------------------------------------------------------------------------------
Classic Vacation Group, Inc.(1)          Loan                                                6,035        6,035
---------------------------------------------------------------------------------------------------------------



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


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

                                        5
   8



                                                                                             JUNE 30, 2001
            PRIVATE FINANCE                                                                   (UNAUDITED)
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Colibri Holding Corporation              Loans                                          $    3,451   $    3,451
                                         Common Stock (3,362 shares)                         1,250        1,250
                                         Warrants                                              290          290
---------------------------------------------------------------------------------------------------------------
The Color Factory Inc.                   Loan                                                4,433        4,433
                                         Preferred Stock                                       250          250
                                         Common Stock (980 shares)                           6,535        6,535
---------------------------------------------------------------------------------------------------------------
Component Hardware Group, Inc.           Debt Securities                                    10,536       10,536
                                         Class A Preferred Stock (18,000 shares)             1,800        1,800
                                         Common Stock (2,000 shares)                           200          200
---------------------------------------------------------------------------------------------------------------
Convenience Corporation of               Debt Securities                                     8,355        2,738
  America                                Series A Preferred Stock (31,521 shares)              334           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Inc.           Debt Securities                                     3,724        3,724
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC                   Loan                                                6,964        6,964
                                         Debt Securities                                     4,960        4,960
                                         Warrants                                               --        1,250
                                         Options                                                --           --
---------------------------------------------------------------------------------------------------------------
Coverall North America, Inc.             Loan                                                9,697        9,697
                                         Debt Securities                                     5,247        5,247
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
CPM Acquisition Corp.                    Loan                                                9,453        9,453
---------------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt.               Hungarian Quotas (9.2%)                               700           --
---------------------------------------------------------------------------------------------------------------
CTT Holdings                             Loan                                                1,303        1,303
---------------------------------------------------------------------------------------------------------------
CyberRep                                 Loan                                                1,041        1,041
                                         Debt Securities                                    11,062       11,062
                                         Warrants                                              660        3,310
---------------------------------------------------------------------------------------------------------------
The Debt Exchange Inc.                   Series B Convertible Preferred Stock
                                         (921,829 shares)                                    1,250        1,250
---------------------------------------------------------------------------------------------------------------
Directory Investment Corporation         Common Stock (470 shares)                             106           26
---------------------------------------------------------------------------------------------------------------
Directory Lending Corporation            Series A Common Stock (34 shares)                      --           --
                                         Series B Common Stock (6 shares)                        8           --
                                         Series C Common Stock (10 shares)                      22           --
---------------------------------------------------------------------------------------------------------------
Drilltec Patents & Technologies          Loan                                               10,918        9,262
  Company, Inc.                          Debt Securities                                     1,500        1,500
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
eCentury Capital Partners, L.P.          Limited Partnership Interest                        1,875        1,875
---------------------------------------------------------------------------------------------------------------
EDM Consulting, LLC                      Debt Securities                                     1,801          369
                                         Common Stock (100 shares)                             250           --
---------------------------------------------------------------------------------------------------------------
El Dorado Communications, Inc.           Loans                                                 306          306
---------------------------------------------------------------------------------------------------------------
Elexis Beta GmbH                         Options                                               424          524
---------------------------------------------------------------------------------------------------------------
Eparfin S.A.                             Loan                                                   29           29
---------------------------------------------------------------------------------------------------------------
Esquire Communications Ltd.(1)           Warrants                                                6           --
---------------------------------------------------------------------------------------------------------------



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


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

                                        6
   9



                                                                                             JUNE 30, 2001
            PRIVATE FINANCE                                                                   (UNAUDITED)
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
E-Talk Corporation                       Debt Securities                                $    8,852   $    6,509
                                         Warrants                                            1,157           --
---------------------------------------------------------------------------------------------------------------
Executive Greetings, Inc.                Debt Securities                                    15,908       15,908
                                         Warrants                                              360          360
---------------------------------------------------------------------------------------------------------------
ExTerra Credit Recovery, Inc.            Series A Preferred Stock (500 shares)                 594          344
                                         Common Stock (2,500 shares)                            --           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Fairchild Industrial Products            Debt Securities                                     5,841        5,841
  Company                                Warrants                                              280        3,628
---------------------------------------------------------------------------------------------------------------
Galaxy American                          Debt Securities                                    43,137       43,887
  Communications, Inc.                   Options                                                --           --
---------------------------------------------------------------------------------------------------------------
Garden Ridge Corporation                 Debt Securities                                    26,835       26,835
                                         Preferred Stock (1,130 shares)                      1,130        1,130
                                         Common Stock (471 shares)                             613          613
---------------------------------------------------------------------------------------------------------------
Genesis Worldwide, Inc.(1)               Loan                                                1,067           --
---------------------------------------------------------------------------------------------------------------
Gibson Guitar Corporation                Debt Securities                                    16,803       16,803
                                         Warrants                                              525        2,325
---------------------------------------------------------------------------------------------------------------
Ginsey Industries, Inc.                  Loans                                               5,000        5,000
                                         Convertible Debentures                                500          500
                                         Warrants                                               --          504
---------------------------------------------------------------------------------------------------------------
Global Communications, LLC               Debt Securities                                    12,931       12,931
                                         Equity Interest                                    11,067       11,067
                                         Options                                             1,639        1,639
---------------------------------------------------------------------------------------------------------------
Grant Broadcasting Systems II            Warrants                                               87        5,976
---------------------------------------------------------------------------------------------------------------
Grant Television, Inc.                   Equity Interest                                       660          660
---------------------------------------------------------------------------------------------------------------
Grotech Partners, VI, L.P.               Limited Partnership Interest                        1,179          878
---------------------------------------------------------------------------------------------------------------
The Hartz Mountain Corporation           Debt Securities                                    27,298       27,298
                                         Common Stock (200,000 shares)                       2,000        2,000
                                         Warrants                                            2,613        2,613
---------------------------------------------------------------------------------------------------------------
HealthASPex, Inc.                        Series A Convertible Preferred Stock
                                         (1,036,700 shares)                                  4,140        4,140
                                         Series A Preferred Stock
                                         (414,680 shares)                                      760          760
                                         Common Stock (1,451,380 shares)                         4            4
---------------------------------------------------------------------------------------------------------------
HMT, Inc.                                Debt Securities                                     9,960        9,960
                                         Common Stock (300,000 shares)                       3,000        3,000
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Hotelevision, Inc.                       Preferred Stock (315,100 shares)                      315          315
---------------------------------------------------------------------------------------------------------------
Icon International, Inc.                 Class A Common Stock (12,114 shares)                1,142        1,423
                                         Class C Common Stock (25,707 shares)                   76           95
---------------------------------------------------------------------------------------------------------------
Impact Innovations Group                 Debt Securities                                     6,477        6,477
                                         Warrants                                            1,674        1,674
---------------------------------------------------------------------------------------------------------------
Intellirisk Management Corporation       Loans                                              21,873       21,873
---------------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing
    and restricted.


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

                                        7
   10



                                                                                             JUNE 30, 2001
            PRIVATE FINANCE                                                                   (UNAUDITED)
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
International Fiber Corporation          Debt Securities                                $   21,950   $   21,950
                                         Common Stock (1,029,068 shares)                     5,483        5,483
                                         Warrants                                              550          550
---------------------------------------------------------------------------------------------------------------
iSolve Incorporated                      Series A Preferred Stock (14,853 shares)              874          588
                                         Common Stock (13,306 shares)                           14           --
---------------------------------------------------------------------------------------------------------------
Jakel, Inc.                              Loan                                               19,667       19,667
---------------------------------------------------------------------------------------------------------------
JRI Industries, Inc.                     Debt Securities                                     1,962        1,962
                                         Warrants                                               74           74
---------------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc.                    Debt Securities                                     1,682        1,682
                                         Warrants                                              259        6,500
---------------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc.                 Warrants                                              348        4,494
                                         Equity Interest                                         4           11
---------------------------------------------------------------------------------------------------------------
Kirkland's, Inc.                         Debt Securities                                     7,098        7,098
                                         Preferred Stock (917 shares)                          412          412
                                         Warrants                                               96           96
---------------------------------------------------------------------------------------------------------------
Kyrus Corporation                        Debt Securities                                     7,772        7,772
                                         Warrants                                              348          348
---------------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc.         Debt Securities                                     4,232        4,232
                                         Common Stock (64,535 shares)                          142          142
---------------------------------------------------------------------------------------------------------------
The Loewen Group, Inc.(1)                High-Yield Senior Secured Debt                     15,150       13,650
---------------------------------------------------------------------------------------------------------------
Logic Bay Corporation                    Preferred Stock (1,131,222 shares)                  5,000        5,000
---------------------------------------------------------------------------------------------------------------
Love Funding Corporation                 Series D Preferred
                                         Stock (26,000 shares)                                 359          213
---------------------------------------------------------------------------------------------------------------
Magna Card, Inc.                         Debt Securities                                       152          152
                                         Preferred Stock (1,875 shares)                         94           94
                                         Common Stock (4,687 shares)                            --           --
---------------------------------------------------------------------------------------------------------------
Master Plan, Inc.                        Loan                                                1,204        1,204
                                         Common Stock (156 shares)                              42        3,042
---------------------------------------------------------------------------------------------------------------
MedAssets.com, Inc.                      Series B Convertible
                                         Preferred Stock (227,665 shares)                    2,049        2,049
                                         Warrants                                              136          136
---------------------------------------------------------------------------------------------------------------
Mid-Atlantic Venture Fund IV, L.P.       Limited Partnership Interest                        2,475        2,402
---------------------------------------------------------------------------------------------------------------
Midview Associates, L.P.                 Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc.               Debt Securities                                     1,823          153
                                         Common Stock (33,333 shares)                           --           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
MortgageRamp.com, Inc.                   Class A Common Stock (800,000 shares)               4,000        4,000
---------------------------------------------------------------------------------------------------------------
Morton Grove                             Loan                                               15,747       15,747
  Pharmaceuticals, Inc.                  Redeemable Convertible Preferred Stock
                                           (106,947 shares)                                  5,000        9,000
---------------------------------------------------------------------------------------------------------------
MVL Group                                Debt Securities                                    14,406       14,406
                                         Warrants                                              643          643
---------------------------------------------------------------------------------------------------------------
NETtel Communications, Inc.              Debt Securities                                    13,483        8,483
---------------------------------------------------------------------------------------------------------------



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


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

                                        8
   11



                                                                                             JUNE 30, 2001
            PRIVATE FINANCE                                                                   (UNAUDITED)
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Nobel Learning Communities,              Debt Securities                                $    9,615   $    9,615
  Inc.(1)                                Series D Convertible
                                         Preferred Stock (265,957 shares)                    2,000        2,000
                                         Warrants                                              575          575
---------------------------------------------------------------------------------------------------------------
North American                           Loans                                               1,390          840
  Archery, LLC                           Convertible Debentures                              2,248        2,008
---------------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, L.P.       Debt Securities                                       332          332
---------------------------------------------------------------------------------------------------------------
Novak Biddle Venture Fund III, LP        Equity Interest                                       150          150
---------------------------------------------------------------------------------------------------------------
Nursefinders, Inc.                       Debt Securities                                    11,052       11,052
                                         Warrants                                              900          900
---------------------------------------------------------------------------------------------------------------
Onyx Television GmbH                     Preferred Units (600,000 shares)                      200          200
---------------------------------------------------------------------------------------------------------------
Opinion Research Corporation(1)          Debt Securities                                    14,107       14,107
                                         Warrants                                              996          996
---------------------------------------------------------------------------------------------------------------
Oriental Trading Company, Inc.           Loan                                                  128          128
                                         Debt Securities                                    12,580       12,580
                                         Preferred Equity Interest                           1,500        1,822
                                         Common Equity Interest                                 --           --
                                         Warrants                                               13          266
---------------------------------------------------------------------------------------------------------------
Outsource Partners, Inc.                 Debt Securities                                    23,878       23,878
                                         Warrants                                              826          826
---------------------------------------------------------------------------------------------------------------
Packaging Advantage Corporation          Debt Securities                                    11,540       11,540
                                         Common Stock (200,000 shares)                       2,000        2,000
                                         Warrants                                              963          963
---------------------------------------------------------------------------------------------------------------
Physicians Specialty Corporation         Debt Securities                                    39,405       39,405
                                         Common Stock (79,567,042 shares)                    1,000          100
---------------------------------------------------------------------------------------------------------------
Pico Products, Inc.(1)                   Loan                                                1,300        1,300
                                         Debt Securities                                     4,591        1,591
                                         Common Stock (208,000 shares)                          59           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Polaris Pool Systems, Inc.               Debt Securities                                     6,530        6,530
                                         Warrants                                            1,050        1,050
---------------------------------------------------------------------------------------------------------------
Powell Plant Farms, Inc.                 Loan                                               16,462       16,462
---------------------------------------------------------------------------------------------------------------
Proeducation GmbH                        Loan                                                   40           40
---------------------------------------------------------------------------------------------------------------
Professional Paint, Inc.                 Debt Securities                                    20,750       20,750
                                         Preferred Stock (15,000 shares)                    15,000       15,000
                                         Common Stock (110,000 shares)                          69           69
---------------------------------------------------------------------------------------------------------------
Progressive International                Debt Securities                                     3,954        3,954
  Corporation                            Preferred Stock (500 shares)                          500          500
                                         Common Stock (197 shares)                              13           13
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Raytheon Aerospace LLC                   Debt Securities                                     5,000        5,000
                                         Common LLC Interest                                    --           --
---------------------------------------------------------------------------------------------------------------
Redox Brands, Inc.                       Debt Securities                                     9,285        9,285
                                         Warrants                                              584          584
---------------------------------------------------------------------------------------------------------------



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


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

                                        9
   12



                                                                                             JUNE 30, 2001
            PRIVATE FINANCE                                                                   (UNAUDITED)
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Schwinn Holdings Corporation             Debt Securities                                $   10,556   $    4,451
                                         Warrants                                              395           --
---------------------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc.               Series A Preferred
                                         Stock (1,000 shares)                                  500           --
---------------------------------------------------------------------------------------------------------------
Soff-Cut Holdings, Inc.                  Debt Securities                                     8,603        8,603
                                         Preferred Stock (300 shares)                          300          300
                                         Common Stock (2,000 shares)                           200          200
                                         Warrants                                              446          446
---------------------------------------------------------------------------------------------------------------
Southern Communications, LLC             Equity Interest                                     9,779        9,779
---------------------------------------------------------------------------------------------------------------
Southwest PCS, LLC                       Loan                                                7,938        7,938
---------------------------------------------------------------------------------------------------------------
Spa Lending Corporation                  Preferred Stock (28,625 shares)                       505          406
                                         Common Stock (6,208 shares)                            25           18
---------------------------------------------------------------------------------------------------------------
Staffing Partners Holding                Debt Securities                                     4,991        4,991
  Company, Inc.                          Series A Redeemable Preferred Stock
                                         (414,600 shares)                                    2,073        2,073
                                         Class A1 Common Stock (1,000 shares)                    1            1
                                         Class A2 Common Stock (40,000 shares)                  40           40
                                         Class B Common Stock (9,200 shares)                     9            9
                                         Warrants                                               10           10
---------------------------------------------------------------------------------------------------------------
Startec Global Communications,           Debt Securities                                    20,732       20,732
  Corporation(1)                         Loan                                               15,000       15,000
                                         Common Stock (258,064 shares)                       3,000           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Sunsource Inc.(1)                        Debt Securities                                    29,667       29,667
                                         Loan                                                8,500        8,500
                                         Warrants                                              450        2,954
---------------------------------------------------------------------------------------------------------------
SunStates Refrigerated Services,         Loans                                               6,062        4,573
  Inc.                                   Debt Securities                                     2,445        1,384
---------------------------------------------------------------------------------------------------------------
Sure-Tel, Inc.                           Loan                                                  207          207
                                         Preferred Stock (1,116,902 shares)                  4,602        4,602
                                         Warrants                                              662          662
                                         Options                                                --          900
---------------------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P.            Debt Securities                                    12,973       12,973
---------------------------------------------------------------------------------------------------------------
Total Foam, Inc.                         Debt Securities                                       266          127
                                         Common Stock (910 shares)                              10           --
---------------------------------------------------------------------------------------------------------------
Tubbs Snowshoe Company, LLC              Debt Securities                                     3,906        3,906
                                         Warrants                                               54           54
                                         Equity Interests                                      500          500
---------------------------------------------------------------------------------------------------------------
United Pet Group, Inc.                   Debt Securities                                     4,962        4,962
                                         Warrants                                               15           15
---------------------------------------------------------------------------------------------------------------
Updata Venture Partners, II, L.P.        Limited Partnership Interest                        1,900        1,900
---------------------------------------------------------------------------------------------------------------
Velocita, Inc.                           Debt Securities                                    11,601       11,601
                                         Warrants                                            3,540        3,540
---------------------------------------------------------------------------------------------------------------
Venturehouse Group, LLC                  Common Equity Interest                                667          564
---------------------------------------------------------------------------------------------------------------
Walker Investment Fund II, LLLP          Limited Partnership Interest                        1,000          882
---------------------------------------------------------------------------------------------------------------



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


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

                                        10
   13



                                                                                             JUNE 30, 2001
            PRIVATE FINANCE                                                                   (UNAUDITED)
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Warn Industries, Inc.                    Debt Securities                                $   18,632   $   18,632
                                         Warrants                                            1,429        3,129
---------------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Company         Warrants                                               24          322
---------------------------------------------------------------------------------------------------------------
Wilmar Industries, Inc.                  Debt Securities                                    32,300       32,300
                                         Warrants                                            3,169        3,169
---------------------------------------------------------------------------------------------------------------
Wilshire Restaurant Group, Inc.          Debt Securities                                    15,348       15,348
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Wilton Industries, Inc.                  Loan                                               12,836       12,836
---------------------------------------------------------------------------------------------------------------
Woodstream Corporation                   Debt Securities                                     7,610        7,610
                                         Equity Interests                                    1,700        2,372
                                         Warrants                                              450          627
---------------------------------------------------------------------------------------------------------------
Wyo-Tech Acquisition Corporation         Debt Securities                                    12,570       12,570
                                         Preferred Stock (100 shares)                        3,700        3,700
                                         Common Stock (99 shares)                              100       15,850
---------------------------------------------------------------------------------------------------------------
     Total private finance (128 investments)                                            $1,374,096   $1,405,386
---------------------------------------------------------------------------------------------------------------



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


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

                                        11
   14



                                                                                JUNE 30, 2001
                                                                                 (UNAUDITED)
                                                   INTEREST       NUMBER OF   -----------------
   (IN THOUSANDS, EXCEPT NUMBER OF LOANS)        RATE RANGES        LOANS      COST      VALUE
---------------------------------------------  ----------------   ---------   -------   -------
                                                                            
COMMERCIAL REAL ESTATE FINANCE

Commercial Mortgage Loans                          Up to  6.99%        3      $   894   $ 2,593
                                                   7.00%- 8.99%       15       32,171    34,271
                                                   9.00%-10.99%       28       23,859    23,816
                                                  11.00%-12.99%       18       14,121    13,884
                                                  13.00%-14.99%        9       13,204    13,178
                                               15.00% and above        2           92        68
-----------------------------------------------------------------------------------------------
     Total commercial mortgage loans                                  75      $84,341   $87,810
-----------------------------------------------------------------------------------------------




                                                      STATED
                                                     INTEREST     FACE
                                                     --------     ----
                                                                            
Purchased CMBS
  Mortgage Capital Funding, Series 1998-MC3            5.5%     $ 54,491   $   26,427   $   26,427
  Morgan Stanley Capital I, Series 1999-RM1            6.4%       51,046       21,574       21,574
  COMM 1999-1                                          5.6%       74,879       34,889       34,889
  Morgan Stanley Capital I, Series 1999-FNV1           6.1%       45,536       22,201       22,201
  DLJ Commercial Mortgage Trust 1999-CG2               6.1%       96,432       44,776       44,776
  Commercial Mortgage Acceptance Corp., Series
     1999-C1                                           6.8%       34,856       16,444       16,444
  LB Commercial Mortgage Trust, Series 1999-C2         6.7%       29,005       11,161       11,161
  Chase Commercial Mortgage Securities Corp.,
     Series 1999-2                                     6.5%       43,046       20,702       20,702
  FUNB CMT, Series 1999-C4                             6.5%       49,287       22,472       22,628
  Heller Financial, HFCMC Series 2000 PH-1             6.6%       45,456       18,853       18,853
  SBMS VII, Inc., Series 2000-NL1                      7.2%       24,230       13,290       13,290
  DLJ Commercial Mortgage Trust, Series 2000-CF1       7.0%       40,502       19,393       19,393
  Deutsche Bank Alex. Brown, Series Comm 2000-C1       6.9%       41,084       19,376       19,376
  LB-UBS Commercial Mortgage Trust, Series 2000-C4     6.9%       31,471       11,562       11,562
  Credit Suisse First Boston Mortgage Securities
     Corp., Series 2001-CK1                            5.9%       58,786       28,936       28,936
  Crest 2001-1, Ltd. (collateralized debt
     obligation)                                       0.0%       24,625       24,914       24,914
  JP Morgan-CIBC-Deutsche 2001                         5.8%       60,889       29,487       29,487
  Lehman Brothers-UBS Warburg 2001-C4                  6.4%       80,434       43,834       43,810
--------------------------------------------------------------------------------------------------
     Total purchased CMBS                                       $886,055   $  430,291   $  430,423
--------------------------------------------------------------------------------------------------
Residual CMBS                                                              $   72,850   $   72,850
Residual Interest Spread                                                        2,324        2,024
Real Estate Owned                                                               3,095        2,069
--------------------------------------------------------------------------------------------------
     Total commercial real estate finance                                  $  592,901   $  595,176
--------------------------------------------------------------------------------------------------
Total portfolio                                                            $1,966,997   $2,000,562
--------------------------------------------------------------------------------------------------



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


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

                                        12
   15

                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENT OF INVESTMENTS



            PRIVATE FINANCE                                                                DECEMBER 31, 2000
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Ability One Corporation                  Loans                                          $    9,974   $    9,974
---------------------------------------------------------------------------------------------------------------
ACE Products, Inc.                       Loans                                              14,276       14,276
---------------------------------------------------------------------------------------------------------------
Acme Paging, L.P.                        Debt Securities                                     6,984        6,984
                                         Limited Partnership Interest                        1,456           --
---------------------------------------------------------------------------------------------------------------
Allied Office Products, Inc.             Debt Securities                                     9,360        9,360
                                         Warrants                                              629          629
---------------------------------------------------------------------------------------------------------------
American Barbecue & Grill, Inc.          Warrants                                              125           --
---------------------------------------------------------------------------------------------------------------
American Home Care Supply,               Debt Securities                                     6,853        6,853
  LLC                                    Warrants                                              579          579
---------------------------------------------------------------------------------------------------------------
Aspen Pet Products, Inc.                 Loans                                              13,862       13,862
                                         Series A Preferred Stock (1,860 shares)             1,860        1,860
                                         Series A Common Stock (1,400 shares)                  140          140
---------------------------------------------------------------------------------------------------------------
ASW Holding Corporation                  Warrants                                               25           25
---------------------------------------------------------------------------------------------------------------
Aurora Communications, LLC               Loans                                              14,410       14,410
                                         Equity Interest                                     1,500        3,347
---------------------------------------------------------------------------------------------------------------
Avborne, Inc.                            Debt Securities                                    12,255       12,255
                                         Warrants                                            1,180        1,180
---------------------------------------------------------------------------------------------------------------
Bakery Chef, Inc.                        Loans                                              15,899       15,899
---------------------------------------------------------------------------------------------------------------
Border Foods, Inc.                       Debt Securities                                     9,904        9,904
                                         Series A Convertible Preferred Stock
                                         (50,919 shares)                                     2,000        2,000
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Business Loan Express, Inc.              Debt Securities                                    74,465       74,465
                                         Preferred Stock (25,111 shares)                    25,111       25,111
                                         Common Stock (25,503,043 shares)                  104,504      104,504
---------------------------------------------------------------------------------------------------------------
Camden Partners Strategic Fund II, L.P.  Limited Partnership Interest                          613          613
---------------------------------------------------------------------------------------------------------------
CampGroup, LLC                           Debt Securities                                     2,579        2,579
                                         Warrants                                              220          220
---------------------------------------------------------------------------------------------------------------
Candlewood Hotel Company(1)              Preferred Stock (3,250 shares)                      3,250        3,250
---------------------------------------------------------------------------------------------------------------
Celebrities, Inc.                        Loan                                                  277          277
                                         Warrants                                               12          312
---------------------------------------------------------------------------------------------------------------
Classic Vacation Group, Inc.(1)          Debt Securities                                     5,688        5,688
---------------------------------------------------------------------------------------------------------------
Colibri Holding Corporation              Loans                                               3,438        3,438
                                         Common Stock (3,362 shares)                         1,250        1,250
                                         Warrants                                              290          290
---------------------------------------------------------------------------------------------------------------
Component Hardware Group                 Debt Securities                                    10,302       10,302
                                         Class A Preferred Stock (18,000 shares)             1,800        1,800
                                         Common Stock (2,000 shares)                           200          200
---------------------------------------------------------------------------------------------------------------



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


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

                                        13
   16



            PRIVATE FINANCE                                                                DECEMBER 31, 2000
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Convenience Corporation of               Debt Securities                                $    8,355   $    2,738
  America                                Series A Preferred Stock (31,521 shares)              334           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Inc.           Debt Securities                                     3,424        3,424
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
CorrFlex Graphics, LLC                   Loan                                                6,952        6,952
                                         Debt Securities                                     4,954        4,954
                                         Warrants                                               --          500
                                         Options                                                --           --
---------------------------------------------------------------------------------------------------------------
Cosmetic Manufacturing                   Loan                                                  120          120
  Resources, LLC                         Debt Securities                                     5,848        5,848
                                         Options                                                87           87
---------------------------------------------------------------------------------------------------------------
Coverall North America, Inc.             Loan                                                9,692        9,692
                                         Debt Securities                                     4,965        4,965
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt.               Hungarian Quotas (9.2%)                               700           --
---------------------------------------------------------------------------------------------------------------
CTT Holdings                             Loan                                                1,224        1,224
---------------------------------------------------------------------------------------------------------------
CyberRep                                 Loan                                                  949          949
                                         Debt Securities                                    10,295       10,295
                                         Warrants                                              660        1,310
---------------------------------------------------------------------------------------------------------------
Directory Investment Corporation         Common Stock (470 shares)                             100           20
---------------------------------------------------------------------------------------------------------------
Directory Lending Corporation            Series A Common Stock (34 shares)                      --           --
                                         Series B Common Stock (6 shares)                        8           --
                                         Series C Common Stock (10 shares)                      22           --
---------------------------------------------------------------------------------------------------------------
Drilltec Patents & Technologies          Loan                                               10,918        8,762
  Company, Inc.                          Debt Securities                                     1,500        1,500
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
eCentury Capital Partners, L.P.          Limited Partnership Interest                        1,875        1,875
---------------------------------------------------------------------------------------------------------------
EDM Consulting, LLC                      Debt Securities                                     1,875          343
                                         Common Stock (100 shares)                             250           --
---------------------------------------------------------------------------------------------------------------
El Dorado Communications, Inc.           Loans                                                 306          306
---------------------------------------------------------------------------------------------------------------
Elexis Beta GmbH                         Options                                               424          424
---------------------------------------------------------------------------------------------------------------
Eparfin S.A.                             Loan                                                   29           29
---------------------------------------------------------------------------------------------------------------
Esquire Communications Ltd.(1)           Warrants                                                6           --
---------------------------------------------------------------------------------------------------------------
E-Talk Corporation                       Debt Securities                                     8,804        8,804
                                         Warrants                                            1,157        1,157
---------------------------------------------------------------------------------------------------------------
Ex Terra Credit Recovery, Inc.           Series A Preferred Stock (500 shares)                 594          344
                                         Common Stock (2,500 shares)                            --           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Executive Greetings, Inc.                Debt Securities                                    15,880       15,880
                                         Warrants                                              360          360
---------------------------------------------------------------------------------------------------------------
Fairchild Industrial Products            Debt Securities                                     5,810        5,810
  Company                                Warrants                                              280        3,628
---------------------------------------------------------------------------------------------------------------



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


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

                                        14
   17



            PRIVATE FINANCE                                                                DECEMBER 31, 2000
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
FTI Consulting, Inc.(1)                  Warrants                                       $      970   $    2,554
---------------------------------------------------------------------------------------------------------------
Galaxy American                          Debt Securities                                    33,399       33,399
  Communications, Inc.                   Warrants                                              500        1,250
---------------------------------------------------------------------------------------------------------------
Garden Ridge Corporation                 Debt Securities                                    26,537       26,537
                                         Preferred Stock (1,130 shares)                      1,130        1,130
                                         Common Stock (471 shares)                             613          613
---------------------------------------------------------------------------------------------------------------
Genesis Worldwide, Inc.(1)               Loan                                                1,067        1,067
---------------------------------------------------------------------------------------------------------------
Gibson Guitar Corporation                Debt Securities                                    16,441       16,441
                                         Warrants                                              525        1,525
---------------------------------------------------------------------------------------------------------------
Ginsey Industries, Inc.                  Loans                                               5,000        5,000
                                         Convertible Debentures                                500          500
                                         Warrants                                               --          154
---------------------------------------------------------------------------------------------------------------
Global Communications, LLC               Debt Securities                                    12,732       12,732
                                         Equity Interest                                    10,467       10,467
                                         Options                                             1,639        1,639
---------------------------------------------------------------------------------------------------------------
Grant Broadcasting Systems II            Warrants                                               87        5,976
---------------------------------------------------------------------------------------------------------------
Grant Television, Inc.                   Equity Interest                                       660          660
---------------------------------------------------------------------------------------------------------------
Grotech Partners, VI, L.P.               Limited Partnership Interest                          869          869
---------------------------------------------------------------------------------------------------------------
The Hartz Mountain Corporation           Debt Securities                                    27,162       27,162
                                         Common Stock (200,000 shares)                       2,000        2,000
                                         Warrants                                            2,613        2,613
---------------------------------------------------------------------------------------------------------------
HealthASPex, Inc.                        Series A Convertible Preferred Stock
                                         (396,908 shares)                                    1,340        1,340
                                         Series A Preferred Stock
                                         (225,112 shares)                                      760          760
                                         Common Stock (1,036,700 shares)                        --           --
---------------------------------------------------------------------------------------------------------------
HMT, Inc.                                Debt Securities                                     9,956        9,956
                                         Common Stock (300,000 shares)                       3,000        3,000
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Hotelevision, Inc.                       Preferred Stock (315,100 shares)                      315          315
---------------------------------------------------------------------------------------------------------------
Icon International, Inc.                 Class A Common Stock (12,114 shares)                1,142        1,423
                                         Class C Common Stock (25,707 shares)                   76           95
---------------------------------------------------------------------------------------------------------------
Impact Innovations Group                 Debt Securities                                     6,367        6,367
                                         Warrants                                            1,674        1,674
---------------------------------------------------------------------------------------------------------------
Intellirisk Management Corporation       Loans                                              21,449       21,449
---------------------------------------------------------------------------------------------------------------
International Fiber Corporation          Debt Securities                                    21,626       21,626
                                         Common Stock (1,029,068 shares)                     5,483        5,483
                                         Warrants                                              550          550
---------------------------------------------------------------------------------------------------------------
iSolve Incorporated                      Series A Preferred Stock (14,853 shares)              874          874
                                         Common Stock (13,306 shares)                           14           14
---------------------------------------------------------------------------------------------------------------
Jakel, Inc.                              Loan                                               19,236       19,236
---------------------------------------------------------------------------------------------------------------



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


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

                                        15
   18



            PRIVATE FINANCE                                                                DECEMBER 31, 2000
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
JRI Industries, Inc.                     Debt Securities                                $    1,953   $    1,953
                                         Warrants                                               74           74
---------------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc.                    Debt Securities                                     2,294        2,294
                                         Warrants                                              259        6,500
---------------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc.                 Warrants                                              348        4,493
                                         Equity Interest                                         4           11
---------------------------------------------------------------------------------------------------------------
Kirkland's, Inc.                         Debt Securities                                     6,347        6,347
                                         Preferred Stock (917 shares)                          412          412
                                         Warrants                                               96           96
---------------------------------------------------------------------------------------------------------------
Kyrus Corporation                        Debt Securities                                     7,734        7,734
                                         Warrants                                              348          348
---------------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Inc.         Debt Securities                                     3,475        3,475
                                         Common Stock (64,535 shares)                          142          142
---------------------------------------------------------------------------------------------------------------
The Loewen Group, Inc.(1)                High-Yield Senior Secured Debt                     15,150       14,150
---------------------------------------------------------------------------------------------------------------
Logic Bay Corporation                    Preferred Stock (1,131,222 shares)                  5,000        5,000
---------------------------------------------------------------------------------------------------------------
Love Funding Corporation                 Series D Preferred
                                         Stock (26,000 shares)                                 359          213
---------------------------------------------------------------------------------------------------------------
Master Plan, Inc.                        Loan                                                2,000        2,000
                                         Common Stock (156 shares)                              42        3,042
---------------------------------------------------------------------------------------------------------------
MedAssets.com, Inc.                      Series B Convertible
                                         Preferred Stock (227,665 shares)                    2,049        2,049
                                         Warrants                                              136          136
---------------------------------------------------------------------------------------------------------------
Mid-Atlantic Venture Fund IV, L.P.       Limited Partnership Interest                        2,475        2,475
---------------------------------------------------------------------------------------------------------------
Midview Associates, L.P.                 Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc.               Debt Securities                                     1,823          243
                                         Common Stock (33,333 shares)                           --           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
MortgageRamp.com, Inc.                   Class A Common Stock (800,000 shares)               4,000        4,000
---------------------------------------------------------------------------------------------------------------
Morton Grove                             Loan                                               15,356       15,356
  Pharmaceuticals, Inc.                  Redeemable Convertible Preferred Stock
                                           (106,947 shares)                                  5,000        8,500
---------------------------------------------------------------------------------------------------------------
MVL Group                                Debt Securities                                    14,124       14,124
                                         Warrants                                              643        1,912
---------------------------------------------------------------------------------------------------------------
NETtel Communications, Inc.              Debt Securities                                    13,472       13,472
---------------------------------------------------------------------------------------------------------------
Nobel Learning Communities,              Debt Securities                                     9,571        9,571
  Inc.(1)                                Series D Convertible
                                         Preferred Stock (265,957 shares)                    2,000        2,000
                                         Warrants                                              575          500
---------------------------------------------------------------------------------------------------------------
North American                           Loans                                               1,390          811
  Archery, LLC                           Convertible Debentures                              2,248        1,996
---------------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, L.P.       Debt Securities                                       349          349
---------------------------------------------------------------------------------------------------------------



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


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

                                        16
   19



            PRIVATE FINANCE                                                                DECEMBER 31, 2000
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Nursefinders, Inc.                       Debt Securities                                $   11,006   $   11,006
                                         Warrants                                              900          900
---------------------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc.                  Debt Securities                                       140           --
---------------------------------------------------------------------------------------------------------------
Onyx Television GmbH                     Common Stock (600,000 shares)                         200          200
---------------------------------------------------------------------------------------------------------------
Opinion Research Corporation(1)          Debt Securities                                    14,033       14,033
                                         Warrants                                              996          996
---------------------------------------------------------------------------------------------------------------
Oriental Trading Company, Inc.           Debt Securities                                    12,456       12,456
                                         Loan                                                  128          128
                                         Preferred Equity Interest                           1,483        1,483
                                         Common Equity Interest                                 17           17
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Outsource Partners, Inc.                 Debt Securities                                    23,853       23,853
                                         Warrants                                              826          826
---------------------------------------------------------------------------------------------------------------
Packaging Advantage Corporation          Debt Securities                                    11,497       11,497
                                         Common Stock (200,000 shares)                       2,000        2,000
                                         Warrants                                              963          963
---------------------------------------------------------------------------------------------------------------
Physicians Specialty Corporation         Debt Securities                                    14,809       14,809
                                         Redeemable Preferred
                                         Stock (850 shares)                                    850           --
                                         Convertible Preferred
                                         Stock (97,411 shares)                                 150           --
                                         Warrants                                              476           --
---------------------------------------------------------------------------------------------------------------
Pico Products, Inc.(1)                   Loan                                                1,300        1,300
                                         Debt Securities                                     4,591        1,591
                                         Common Stock (208,000 shares)                          59           --
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Polaris Pool Systems, Inc.               Debt Securities                                     6,483        6,483
                                         Warrants                                            1,050        1,050
---------------------------------------------------------------------------------------------------------------
Powell Plant Farms, Inc.                 Loan                                               15,707       15,707
---------------------------------------------------------------------------------------------------------------
Proeducation GmbH                        Loan                                                   40           40
---------------------------------------------------------------------------------------------------------------
Professional Paint, Inc.                 Debt Securities                                    20,000       20,000
                                         Preferred Stock (15,000 shares)                    15,000       15,000
                                         Common Stock (110,000 shares)                          69           69
---------------------------------------------------------------------------------------------------------------
Progressive International                Debt Securities                                     3,949        3,949
  Corporation                            Preferred Stock (500 shares)                          500          500
                                         Common Stock (197 shares)                              13           13
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Schwinn Holdings Corporation             Debt Securities                                    10,367       10,367
                                         Warrants                                              395          395
---------------------------------------------------------------------------------------------------------------
Seasonal Expressions, Inc.               Series A Preferred
                                         Stock (1,000 shares)                                  500           --
---------------------------------------------------------------------------------------------------------------
Soff-Cut Holdings, Inc.                  Debt Securities                                     8,454        8,454
                                         Preferred Stock (300 shares)                          300          300
                                         Common Stock (2,000 shares)                           200          200
                                         Warrants                                              446          446
---------------------------------------------------------------------------------------------------------------



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


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

                                        17
   20



            PRIVATE FINANCE                                                                DECEMBER 31, 2000
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Southern Communications, LLC             Equity Interest                                $    9,779   $    9,779
---------------------------------------------------------------------------------------------------------------
Southwest PCS, LLC                       Loan                                                7,500        7,500
---------------------------------------------------------------------------------------------------------------
Southwest PCS, L.P.                      Debt Securities                                     6,518        7,435
---------------------------------------------------------------------------------------------------------------
Spa Lending Corporation                  Preferred Stock (28,625 shares)                       547          437
                                         Common Stock (6,208 shares)                            25           18
---------------------------------------------------------------------------------------------------------------
Staffing Partners Holding                Debt Securities                                     4,990        4,990
  Company, Inc.                          Series A Redeemable Preferred Stock (414,600
                                         shares)                                             2,073        2,073
                                         Class A1 Common Stock (1,000 shares)                    1            1
                                         Class A2 Common Stock (40,000 shares)                  40           40
                                         Class B Common Stock (9,200 shares)                     9            9
                                         Warrants                                               10           10
---------------------------------------------------------------------------------------------------------------
Startec Global Communications,           Debt Securities                                    20,200       20,200
  Corporation(1)                         Common Stock (258,064 shares)                       3,000        3,000
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
Sunsource Inc.(1)                        Debt Securities                                    29,850       29,850
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------
SunStates Refrigerated Services,         Loans                                               6,062        4,573
  Inc.                                   Debt Securities                                     2,445        1,384
---------------------------------------------------------------------------------------------------------------
Sure-Tel, Inc.                           Loan                                                  207          207
                                         Preferred Stock (1,116,902 shares)                  4,558        4,558
                                         Warrants                                              662          662
                                         Options                                                --          900
---------------------------------------------------------------------------------------------------------------
Sydran Food Services II, L.P.            Debt Securities                                    12,973       12,973
---------------------------------------------------------------------------------------------------------------
Total Foam, Inc.                         Debt Securities                                       268          127
                                         Common Stock (910 shares)                              10           --
---------------------------------------------------------------------------------------------------------------
Tubbs Snowshoe Company, LLC              Debt Securities                                     3,899        3,899
                                         Warrants                                               54           54
                                         Equity Interests                                      500          500
---------------------------------------------------------------------------------------------------------------
United Pet Group                         Debt Securities                                     4,959        4,959
                                         Warrants                                               15           15
---------------------------------------------------------------------------------------------------------------
Velocita, Inc.                           Debt Securities                                    11,532       11,532
                                         Warrants                                            3,540        3,540
---------------------------------------------------------------------------------------------------------------
Venturehouse Group, LLC                  Common Equity Interest                                333          333
---------------------------------------------------------------------------------------------------------------
Walker Investment Fund II, LLLP          Limited Partnership Interest                          800          800
---------------------------------------------------------------------------------------------------------------
Warn Industries, Inc.                    Debt Securities                                    19,330       19,330
                                         Warrants                                            1,429        1,929
---------------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Company         Warrants                                               24          322
---------------------------------------------------------------------------------------------------------------
Wilmar Industries, Inc.                  Debt Securities                                    31,720       31,720
                                         Warrants                                            3,169        3,169
---------------------------------------------------------------------------------------------------------------
Wilshire Restaurant Group, Inc.          Debt Securities                                    15,191       15,191
                                         Warrants                                               --           --
---------------------------------------------------------------------------------------------------------------



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


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

                                        18
   21



            PRIVATE FINANCE                                                                DECEMBER 31, 2000
           PORTFOLIO COMPANY                                                            -----------------------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)                  INVESTMENT(2)                     COST        VALUE
---------------------------------------  ---------------------------------------------  ----------   ----------
                                                                                            
Wilton Industries, Inc.                  Loan                                           $   12,836   $   12,836
---------------------------------------------------------------------------------------------------------------
Woodstream Corporation                   Debt Securities                                     7,590        7,590
                                         Equity Interests                                    1,700        1,700
                                         Warrants                                              450          450
---------------------------------------------------------------------------------------------------------------
Wyo-Tech Acquisition Corporation         Debt Securities                                    15,677       15,677
                                         Preferred Stock (100 shares)                        3,700        3,700
                                         Common Stock (99 shares)                              100        7,100
---------------------------------------------------------------------------------------------------------------
     Total private finance (122 investments)                                            $1,262,529   $1,282,467
---------------------------------------------------------------------------------------------------------------



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


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

                                        19
   22



                                                                             DECEMBER 31, 2000
                                                 INTEREST       NUMBER OF   -------------------
  (IN THOUSANDS, EXCEPT NUMBER OF LOANS)       RATE RANGES        LOANS       COST      VALUE
-------------------------------------------  ----------------   ---------   --------   --------
                                                                           
COMMERCIAL REAL ESTATE FINANCE

Commercial Mortgage Loans                        Up to  6.99%        3      $    882   $  2,582
                                                 7.00%- 8.99%       13        30,032     32,132
                                                 9.00%-10.99%       17        22,302     22,190
                                                11.00%-12.99%       38        35,250     35,042
                                                13.00%-14.99%       12        14,391     14,391
                                             15.00% and above        2           100         76
-----------------------------------------------------------------------------------------------
     Total commercial mortgage loans                                85      $102,957   $106,413
-----------------------------------------------------------------------------------------------




                                                      STATED
                                                     INTEREST     FACE
                                                     --------     ----
                                                                            
Purchased CMBS
  Mortgage Capital Funding, Series 1998-MC3            5.5%     $ 54,491   $   25,681   $   25,681
  Morgan Stanley Capital I, Series 1999-RM1            6.4%       59,640       27,429       27,429
  COMM 1999-1                                          5.6%       74,879       34,352       34,352
  Morgan Stanley Capital I, Series 1999-FNV1           6.1%       45,536       21,972       21,972
  DLJ Commercial Mortgage Trust 1999-CG2               6.1%       96,432       44,332       44,332
  Commercial Mortgage Acceptance Corp., Series
     1999-C1                                           6.8%       34,856       16,397       16,397
  LB Commercial Mortgage Trust, Series 1999-C2         6.7%       29,005       10,910       10,910
  Chase Commercial Mortgage Securities Corp.,
     Series 1999-2                                     6.5%       43,046       20,552       20,552
  FUNB CMT, Series 1999-C4                             6.5%       49,287       22,515       22,761
  Heller Financial, HFCMC Series 2000 PH-1             6.6%       45,456       19,039       19,039
  SBMS VII, Inc., Series 2000-NL1                      7.2%       30,079       17,820       18,007
  DLJ Commercial Mortgage Trust, Series 2000-CF1       7.0%       40,502       19,166       19,166
  Deutsche Bank Alex. Brown, Series Comm 2000-C1       6.9%       41,084       19,170       19,170
  LB-UBS Commercial Mortgage Trust, Series 2000-C4     6.9%       31,471       11,552       11,552
--------------------------------------------------------------------------------------------------
     Total purchased CMBS                                       $675,764   $  310,887   $  311,320
--------------------------------------------------------------------------------------------------
Residual CMBS                                                              $   78,723   $   78,723
Residual Interest Spread                                                        3,297        2,997
Real Estate Owned                                                               7,502        6,081
--------------------------------------------------------------------------------------------------
     Total commercial real estate finance                                  $  503,366   $  505,534
--------------------------------------------------------------------------------------------------
Total portfolio                                                            $1,765,895   $1,788,001
--------------------------------------------------------------------------------------------------



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


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

                                        20
   23

                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. ORGANIZATION

     Allied Capital Corporation, a Maryland corporation, is a closed-end
management investment company that has elected to be regulated as a business
development company ("BDC") under the Investment Company Act of 1940 ("1940
Act"). Allied Capital Corporation ("ACC") has a wholly owned subsidiary that has
also elected to be regulated as a BDC. Allied Investment Corporation ("Allied
Investment") is licensed under the Small Business Investment Act of 1958 as a
Small Business Investment Company ("SBIC"). In April 2001, ACC established a
consolidated wholly owned subsidiary, A.C. Corporation ("AC Corp."), which
provides consulting, structuring and diligence services on private finance and
commercial real estate transactions, as well as consulting, structuring and
management services to existing portfolio companies. In addition, the Company
has a real estate investment trust subsidiary, Allied Capital REIT, Inc.
("Allied REIT") and 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."

     The investment objective of the Company is to achieve current income and
capital gains. In order to achieve this objective, the Company invests in
private and undervalued public companies in a variety of different industries
and in diverse geographic locations.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  BASIS OF PRESENTATION

     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries that make investments or are operating
companies that provide services to the Company. All intercompany accounts and
transactions have been eliminated in consolidation. Certain reclassifications
have been made to the 2000 balances to conform with the 2001 financial statement
presentation.

     The accompanying unaudited consolidated financial statements of the Company
have been prepared in accordance with generally accepted accounting principles
("GAAP") for interim financial information. Accordingly, they do not include all
of the information and footnotes required by GAAP for complete consolidated
financial statements. In the opinion of management, the unaudited consolidated
financial results of the Company included herein contain all adjustments
(consisting of only normal recurring accruals) necessary to present fairly the
financial position of the Company as of and for the six months ended June 30,
2001 and 2000 and the results of operations, changes in net assets, and cash
flows for these periods. The results of operations for the six months ended June
30, 2001 are not necessarily indicative of the operating results to be expected
for the full year.

                                        21
   24
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO

  PRIVATE FINANCE

     At June 30, 2001 and December 31, 2000, the private finance portfolio
consisted of the following:



                                           2001                              2000
                              -------------------------------   -------------------------------
                                 COST        VALUE      YIELD      COST        VALUE      YIELD
            ($ IN THOUSANDS)  ----------   ----------   -----   ----------   ----------   -----
                                                                        
Loans and debt securities...  $1,076,659   $1,044,541   14.6%   $  983,887   $  966,257   14.6%
Equity interests............     297,437      360,845              278,642      316,210
                              ----------   ----------           ----------   ----------
          Total.............  $1,374,096   $1,405,386           $1,262,529   $1,282,467
                              ==========   ==========           ==========   ==========


     Private finance investments are generally structured as loans and debt
securities that carry a relatively high fixed rate of interest, which may be
combined with equity features, such as conversion privileges, or warrants or
options to purchase a portion of the portfolio company's equity at a nominal
price.

     Debt securities 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 debt maturities and principal amortization
schedules vary.

     Equity interests consist primarily of securities issued by privately owned
companies and may be subject to restrictions on their resale or may be otherwise
illiquid. Equity securities generally do not produce a current return, but are
held for investment appreciation and ultimate gain on sale.

     At June 30, 2001 and December 31, 2000, equity interests include the
Company's common stock and preferred stock investment in Business Loan Express,
Inc. ("BLX") of $120,015,000 and $25,111,000 and $104,504,000 and $25,111,000 at
value, respectively. During the first quarter of 2001, BLX secured a 3-year
$117.5 million unsecured revolving credit facility. As the controlling
shareholder of BLX, the Company has provided an unconditional guaranty to the
BLX credit facility lenders in an amount up to 50% of the total obligations
(consisting of principal, accrued interest and other fees) of BLX on the line of
credit. The amount guaranteed by the Company at June 30, 2001 was $51.7 million.
This guaranty can be called by the lenders only in the event of a default by
BLX. BLX was in compliance with the terms of its credit facility at June 30,
2001. In consideration for providing this guaranty, BLX will pay the Company an
annual guaranty fee of $2.9 million.

     At June 30, 2001 and December 31, 2000, approximately 98% of the Company's
private finance loan portfolio was composed of fixed interest rate loans. At
June 30, 2001 and December 31, 2000, loans and debt securities with a value of
$81,330,000 and $72,966,000, respectively, were not accruing interest. Loans
greater than 120 days delinquent generally do not accrue interest.

                                        22
   25
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

     The geographic and industry compositions of the private finance portfolio
at value at June 30, 2001 and December 31, 2000 were as follows:



                                                              2001   2000
                                                              ----   ----
                                                               
GEOGRAPHIC REGION
Mid-Atlantic................................................   41%    43%
Midwest.....................................................   21     18
West........................................................   16     17
Southeast...................................................   15     12
Northeast...................................................    6      8
International...............................................    1      2
                                                              ---    ---
          Total.............................................  100%   100%
                                                              ===    ===
INDUSTRY
Consumer Products...........................................   27%    26%
Business Services...........................................   23     24
Financial Services..........................................   15     16
Industrial Products.........................................    9      9
Retail......................................................    5      5
Broadcasting & Cable........................................    5      5
Telecommunications..........................................    5      6
Education...................................................    3      3
Other.......................................................    8      6
                                                              ---    ---
          Total.............................................  100%   100%
                                                              ===    ===


  COMMERCIAL REAL ESTATE FINANCE

     At June 30, 2001 and December 31, 2000, the commercial real estate finance
portfolio consisted of the following:



                                               2001                          2000
                                    ---------------------------   ---------------------------
                                      COST      VALUE     YIELD     COST      VALUE     YIELD
         ($ IN THOUSANDS)           --------   --------   -----   --------   --------   -----
                                                                      
Loans.............................  $ 84,341   $ 87,810    8.2%   $102,957   $106,413    9.1%
CMBS..............................   505,465    505,297   14.6%    392,907    393,040   14.2%
REO...............................     3,095      2,069              7,502      6,081
                                    --------   --------           --------   --------
          Total...................  $592,901   $595,176           $503,366   $505,534
                                    ========   ========           ========   ========


  LOANS

     The commercial mortgage loan portfolio contains loans that were originated
by the Company or were purchased from third-party sellers.

     At June 30, 2001 and December 31, 2000, approximately 78% and 22% and 69%
and 31% of the Company's commercial mortgage loan portfolio was composed of
fixed and adjustable interest rate

                                        23
   26
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

loans, respectively. As of June 30, 2001 and December 31, 2000, loans with a
value of $11,350,000 and $14,433,000, respectively, were not accruing interest.
Loans greater than 120 days delinquent generally do not accrue interest.

     In December 2000, the Company purchased commercial mortgage loans with a
face amount of $6.5 million for $5.5 million from Business Mortgage Investors,
Inc., a company managed by ACC.

     The geographic composition and the property types securing the commercial
mortgage loan portfolio at value at June 30, 2001 and December 31, 2000 were as
follows:



                                                              2001   2000
                                                              ----   ----
                                                               
GEOGRAPHIC REGION
Southeast...................................................   37%    39%
Northeast...................................................   21      5
Midwest.....................................................   20     14
Mid-Atlantic................................................   12     22
West........................................................   10     20
                                                              ---    ---
          Total.............................................  100%   100%
                                                              ===    ===
PROPERTY TYPE
Hospitality.................................................   34%    28%
Retail......................................................   25     19
Office......................................................   22     30
Recreation..................................................    4      9
Other.......................................................   15     14
                                                              ---    ---
          Total.............................................  100%   100%
                                                              ===    ===


  CMBS

     At June 30, 2001 and December 31, 2000, the CMBS portfolio consisted of the
following:



                                                 2001                  2000
                                          -------------------   -------------------
                                            COST      VALUE       COST      VALUE
             (IN THOUSANDS)               --------   --------   --------   --------
                                                               
Purchased CMBS..........................  $430,291   $430,423   $310,887   $311,320
Residual CMBS...........................    72,850     72,850     78,723     78,723
Residual interest spread................     2,324      2,024      3,297      2,997
                                          --------   --------   --------   --------
          Total.........................  $505,465   $505,297   $392,907   $393,040
                                          ========   ========   ========   ========


     PURCHASED CMBS  The Company has Purchased CMBS bonds with a face amount of
$886,055,000 and a cost of $430,291,000, with the difference representing
original issue discount. As of June 30, 2001 and December 31, 2000, the
estimated yield to maturity on the Purchased CMBS was approximately 15.4%. The
Company's yield on its Purchased CMBS is 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

                                        24
   27
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

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. At June 30, 2001 and December 31,
2000, the yield on the Purchased CMBS portfolio was computed assuming a 1% loss
estimate for its entire underlying collateral mortgage pool. 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.

     The non-investment grade and unrated tranches of the Purchased CMBS bonds
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.

     The Company entered into one short sale contract with a financial
institution as part of a strategy to manage interest rate risk with respect to
certain CMBS bonds. The Company used the short sale for hedging and risk
management only and not for speculative purposes. At June 30, 2001, the fair
value of the contract was a loss of $95,000. The fair value of this contract has
been reflected in net unrealized gains. The Company held no derivative financial
instruments at December 31, 2000.

     The underlying rating classes of the Purchased CMBS are as follows:



                                                     JUNE 30, 2001         DECEMBER 31, 2000
                                                 ---------------------   ---------------------
                                                            PERCENTAGE              PERCENTAGE
                    ($ IN THOUSANDS)              VALUE      OF TOTAL     VALUE      OF TOTAL
                                                 --------   ----------   --------   ----------
                                                                        
BB+............................................  $  6,074       1.4%     $     --        --%
BB.............................................    30,624       7.1         8,472       2.7
BB-............................................    49,006      11.4        37,061      11.9
B+.............................................    77,968      18.1        59,827      19.3
B..............................................   108,344      25.2        89,999      28.9
B-.............................................    63,704      14.8        56,665      18.2
CCC............................................     8,846       2.1         7,857       2.5
Unrated........................................    85,857      19.9        51,439      16.5
                                                 --------     -----      --------     -----
          Total................................  $430,423     100.0%     $311,320     100.0%
                                                 ========     =====      ========     =====


     RESIDUAL CMBS AND RESIDUAL INTEREST SPREAD.  The Residual CMBS primarily
consists of a retained interest from a post-Merger asset securitization whereby
bonds were sold in three classes rated "AAA," "AA" and "A."

     The Company sold $295 million of loans, and received cash proceeds, net of
costs, of approximately $223 million. The Company retained a trust certificate
for its residual interest in the loan pool sold, and will receive interest
income from this Residual CMBS as well as the Residual Interest Spread from the
interest earned on the loans sold less the interest paid on the bonds over the
life of the bonds.

                                        25
   28
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

     As a result of this securitization, the Company recorded a gain of $14.8
million, which represents the difference between the cost basis of the assets
sold and the fair value of the assets received, net of the costs of the
securitization and the cost of settlement of interest rate swaps. As of June 30,
2001 and December 31, 2000, the mortgage loan pool had an approximate weighted
average stated interest rate of 9.3%. The three bond classes sold had an
aggregate weighted average interest rate of 6.6% as of June 30, 2001, and 6.5%
as of December 31, 2000.

     The Company uses a discounted cash flow methodology for determining the
value of its retained Residual CMBS and Residual Interest Spread ("Residual").
In determining the cash flow of the Residual, the Company assumes a prepayment
speed of 15% after the applicable prepayment lockout period and credit losses of
1% of the total principal balance of the underlying collateral throughout the
life of the collateral. The value of the resulting Residual cash flows is then
determined by applying a discount rate of 9% which, in the Company's view, is
commensurate with the market's perception of risk of comparable assets.

     The geographic composition and the property types of the underlying
mortgage loan pools securing the CMBS calculated using the underwritten
principal balance at June 30, 2001 and December 31, 2000 were as follows:



                                                              2001   2000
                                                              ----   ----
                                                               
GEOGRAPHIC REGION
West........................................................   31%    31%
Mid-Atlantic................................................   24     23
Midwest.....................................................   21     22
Southeast...................................................   18     19
Northeast...................................................    6      5
                                                              ---    ---
          Total.............................................  100%   100%
                                                              ===    ===
PROPERTY TYPE
Retail......................................................   32%    32%
Housing.....................................................   28     30
Office......................................................   24     21
Hospitality.................................................    8      8
Other.......................................................    8      9
                                                              ---    ---
          Total.............................................  100%   100%
                                                              ===    ===


     SMALL BUSINESS FINANCE

     The Company, through its wholly owned subsidiary, Allied SBLC, participated
in the SBA's Section 7(a) Guaranteed Loan Program ("7(a) loans"). As discussed
in Note 1, Allied SBLC is no longer a consolidated subsidiary of the Company at
December 31, 2000. As a result, the Company's small business portfolio had no
balance at and after December 31, 2000.

                                        26
   29
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. DEBT

     At June 30, 2001 and December 31, 2000, the Company had the following debt:



                                                        2001                    2000
                                                ---------------------   ---------------------
                                                 FACILITY     AMOUNT     FACILITY     AMOUNT
                                                  AMOUNT      DRAWN       AMOUNT      DRAWN
                      (IN THOUSANDS)            ----------   --------   ----------   --------
                                                                         
Notes payable and debentures:
  Unsecured long-term notes payable...........  $  544,000   $544,000   $  544,000   $544,000
  SBA debentures..............................     101,800     87,000       87,350     78,350
  Auction rate reset note.....................      79,614     79,614       76,598     76,598
  OPIC loan...................................       5,700      5,700        5,700      5,700
                                                ----------   --------   ----------   --------
          Total notes payable and
             debentures.......................     731,114    716,314      713,648    704,648
                                                ----------   --------   ----------   --------
Revolving credit facilities:
  Revolving line of credit....................     417,500    164,750      417,500     82,000
  Master loan and security agreement..........          --         --           --         --
                                                ----------   --------   ----------   --------
          Total revolving credit facilities...     417,500    164,750      417,500     82,000
                                                ----------   --------   ----------   --------
  Total.......................................  $1,148,614   $881,064   $1,131,148   $786,648
                                                ==========   ========   ==========   ========


  NOTES PAYABLE AND DEBENTURES

     UNSECURED LONG-TERM NOTES PAYABLE.  In June 1998, May 1999, November 1999
and October 2000, the Company issued unsecured long-term notes to private
institutional investors. The notes require semi-annual interest payments until
maturity and have terms of five or seven years. The weighted average interest
rate on the notes was 7.8% at June 30, 2001 and December 31, 2000. The notes may
be prepaid in whole or in part together with an interest premium, as stipulated
in the note agreement.

     SBA DEBENTURES.  At June 30, 2001 and December 31, 2000, the Company had
debentures payable to the SBA with terms of ten years and at fixed interest
rates ranging from 4.3% to 9.1%. The weighted average interest rate was 6.9% and
7.6% at June 30, 2001 and December 31, 2000, respectively. 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.

     AUCTION RATE RESET NOTE.  The Company has a $79,614,000 Auction Rate Reset
Senior Note Series A that matures on December 2, 2002 and bears interest at the
three-month London Interbank Offer Rate ("LIBOR") plus 1.75%, which adjusts
quarterly. Interest is due quarterly and the Company, at its option, may pay or
defer and capitalize such interest payments. The amount outstanding on the note
will increase as interest due is deferred and capitalized.

     As a means to repay the note, the Company has entered into an agreement to
issue $79,614,000 of debt, equity or other securities in one or more public or
private transactions, or prepay the Auction Rate Reset Note, on or before August
31, 2002. If the note is prepaid, the Company will pay a fee equal to 0.5% of
the aggregate amount of the note outstanding.

                                        27
   30
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. DEBT, CONTINUED

     Scheduled future maturities of notes payable and debentures at June 30,
2001 are as follows:



                            YEAR                              AMOUNT MATURING
                            ----                              ---------------
                                                              (IN THOUSANDS)
                                                           
2001........................................................     $     --
2002........................................................       79,614
2003........................................................      140,000
2004........................................................      221,000
2005........................................................      179,000
Thereafter..................................................       96,700
                                                                 --------
          Total.............................................     $716,314
                                                                 ========


  REVOLVING CREDIT FACILITIES

     REVOLVING LINE OF CREDIT.  At June 30, 2001, the Company has an unsecured
revolving line of credit for $417,500,000. The facility may be expanded up to
$500,000,000. At the Company's option, the facility bears interest at a rate
equal to (i) the one-month LIBOR plus 1.25% or (ii) the higher of (a) the Bank
of America, N.A. prime rate or (b) the Federal Funds rate plus 0.50%. The
interest rate adjusts at the beginning of each new interest period, usually
every thirty days. The interest rates were 5.2% and 7.9% at June 30, 2001 and
December 31, 2000, respectively, and the facility requires an annual commitment
fee equal to 0.25% of the committed amount. The line expires in March 2002. The
line of credit requires monthly interest payments and all principal is due upon
its expiration.

     On August 3, 2001, the Company increased the capacity on the revolving line
of credit to $467,500,000, which may be expanded up to $600,000,000, and
extended the maturity to August 2003, with the right to extend the maturity for
one additional year at the Company's sole option, under substantially similar
terms.

     MASTER LOAN AND SECURITY AGREEMENT.   The Company had a facility to borrow
up to $100,000,000, using certain commercial mortgage loans as collateral. The
agreement charged interest at the one-month LIBOR plus 1.0%, adjusted daily. The
agreement matured on October 27, 2000 and was not renewed.

     The average debt outstanding on the revolving credit facilities was
$89,043,000 and $154,853,000 for the six months ended June 30, 2001 and for the
year ended December 31, 2000, respectively. The maximum amount borrowed under
these facilities and the weighted average interest rate for the six months ended
June 30, 2001 and for the year ended December 31, 2000, were $181,500,000 and
$257,000,000, and 6.4% and 7.6%, respectively.

NOTE 5. PREFERRED STOCK

     Allied Investment has outstanding a total of 60,000 shares of $100 par
value, 3% cumulative preferred stock and 10,000 shares of $100 par value, 4%
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%
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

                                        28
   31
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5. PREFERRED STOCK, CONTINUED

securities and any dividends accumulated and unpaid to the date of redemption.
The 4% redeemable cumulative preferred stock has a required redemption date in
June 2005.

NOTE 6. SHAREHOLDERS' EQUITY

     Sales of common stock for the six months ended June 30, 2001, and the year
ended December 31, 2000 were as follows:



                                                                2001       2000
                       (IN THOUSANDS)                         --------   --------
                                                                   
Number of common shares.....................................     5,824     14,812
Gross proceeds..............................................  $130,139   $263,460
Less costs including underwriting fees......................    (6,877)   (12,548)
                                                              --------   --------
  Net proceeds..............................................  $123,262   $250,912
                                                              ========   ========


     In addition, the Company issued 4,123,407 shares of common stock to acquire
BLC Financial Services, Inc. in a stock-for-stock exchange on December 31, 2000
for proceeds of $86,076,000.

     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 sale prices reported for the
Company's common stock for the five consecutive days immediately prior to the
dividend payment date.

     Dividend reinvestment plan activity for the six months ended June 30, 2001
and for the year ended December 31, 2000 was as follows:



                                                               2001     2000
              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)        ------   ------
                                                                 
Shares issued...............................................     148      254
Average price per share.....................................  $23.08   $18.79


                                        29
   32
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 7. EARNINGS PER COMMON SHARE

     Earnings per common share for the six months ended June 30, 2001 and 2000
were as follows:



                                                              FOR THE SIX MONTHS
                                                                ENDED JUNE 30,
                                                              -------------------
                                                                2001       2000
          (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)             --------   --------
                                                                   
Net increase in net assets resulting from operations........  $98,134    $64,371
Less preferred stock dividends..............................     (110)      (110)
                                                              -------    -------
Income available to common shareholders.....................  $98,024    $64,261
                                                              =======    =======
Basic shares outstanding....................................   87,441     68,128
Dilutive options outstanding to officers....................    1,525         47
                                                              -------    -------
Diluted shares outstanding..................................   88,966     68,175
                                                              =======    =======
BASIC EARNINGS PER COMMON SHARE.............................  $  1.12    $  0.94
                                                              =======    =======
DILUTED EARNINGS PER COMMON SHARE...........................  $  1.10    $  0.94
                                                              =======    =======


NOTE 8. CUT-OFF AWARD AND FORMULA AWARD

     The Predecessor Companies' existing stock option plans were canceled and
the Company established a cut-off dollar amount for all existing, but unvested
options as of the date of the Merger (the "Cut-off Award"). The Cut-off Award
was computed for each unvested option as of the Merger date. The Cut-off Award
was 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 was 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 approximated $2.9 million in the aggregate and has
been expensed as the Cut-off Award vests. For the six months ended June 30, 2001
and for the year ended December 31, 2000, $91,000 and $535,000, respectively, of
the Cut-off Award vested.

     The Formula Award was established to compensate employees from the point
when their unvested options would cease to appreciate in value (the Merger
announcement date), up until the time at which they would be able to receive
option awards in ACC post-merger. In the aggregate, the Formula Award equaled 6%
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 and was used to purchase shares of the Company's
stock (included in common stock held in deferred compensation trust). The
Formula Award vested equally in three installments on December 31, 1998, 1999
and 2000. The Formula Award has been expensed in each year in which it vested.
For the year ended December 31, 2000, $5,648,000, was expensed as a result of
the

                                        30
   33
                  ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 8. CUT-OFF AWARD AND FORMULA AWARD, CONTINUED

Formula Award. At December 31, 2000, the liability related to the Formula Award
was $5,648,000, and has been included in common stock held in deferred
compensation trust. Vested Formula Awards have been distributed to recipients by
the Company, however, sale of the Company's stock by the recipients is
restricted. Unvested Formula Awards were forfeited upon a recipient's separation
from service and the related Company stock was retired. During 2000, $563,000,
of the Formula Award was forfeited.

NOTE 9. DIVIDENDS AND DISTRIBUTIONS

     The Company's Board of Directors declared and the Company paid a $0.99 per
common share dividend or $87,836,000 for the six months ended June 30, 2001.

                                        31
   34

ITEM 2.

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto included herein and in the Company's
annual report on Form 10-K. This Management's Discussion and Analysis contains
certain forward-looking statements. These statements include the plans and
objectives of management for future operations and financial objectives, loan
portfolio growth and availability of funds. These forward-looking statements are
subject to the inherent uncertainties in predicting future results and
conditions. Certain factors that could cause actual results and conditions to
differ materially from those projected in these forward-looking statements are
set forth below in the Investment Considerations section. Other factors that
could cause actual results to differ materially include the uncertainties of
economic, competitive and market conditions, and future business decisions, all
of which are difficult or impossible to predict accurately and many of which are
beyond the control of the Company. Although the Company believes that the
assumptions underlying the forward-looking statements included herein are
reasonable, any of the assumptions could be inaccurate and, therefore, there can
be no assurance that the forward-looking statements included herein will prove
to be accurate. Therefore, the inclusion of such information should not be
regarded as a representation by the Company or any other person that the
objectives and plans of the Company will be achieved.

OVERVIEW

     The Company provides private investment capital to private and undervalued
public companies in a variety of different industries and in diverse geographic
locations. Our lending and investment activity is focused in private finance and
commercial real estate finance, primarily the purchase of commercial
mortgage-backed securities.

     The Company's portfolio composition at June 30, 2001, and December 31, 2000
was as follows:



                                                                AT           AT
                                                             JUNE 30,   DECEMBER 31,
                                                               2001         2000
                                                             --------   ------------
                                                                  
Private Finance............................................     70%          72%
Commercial Real Estate Finance.............................     30%          28%
Small Business Finance.....................................     --%          --%


     The Company's earnings depend primarily on the level of interest and
related portfolio income and net realized and unrealized gains 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 and the amortization of loan origination points and discounts.
The level of interest income is directly related to the balance of the
interest-bearing investment portfolio multiplied by the weighted average yield
on the interest-bearing 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.

                                        32
   35

PORTFOLIO AND INVESTMENT ACTIVITY

     Total portfolio investment activity and yields as of and for the three and
six months ended June 30, 2001 and 2000 and as of and for the year ended
December 31, 2000 were as follows:



                            AT AND FOR THE THREE    AT AND FOR THE SIX
                                MONTHS ENDED           MONTHS ENDED
                                  JUNE 30,               JUNE 30,          AT AND FOR THE
                            ---------------------   -------------------      YEAR ENDED
                              2001        2000        2001       2000     DECEMBER 31, 2000
     ($ IN MILLIONS)        ---------   ---------   --------   --------   -----------------
                                                           
Portfolio at Value........  $2,000.6    $1,488.3    $2,000.6   $1,488.3       $1,788.0
Investments Funded........  $  149.3    $  184.0    $  300.1   $  402.3       $  901.5
Repayments................  $   14.4    $    5.3    $   44.1   $   58.8       $  154.1
Sales.....................  $   39.5    $   77.5    $   74.6   $  117.1       $  280.2
Yield.....................      14.2%       13.6%       14.2%      13.6%          14.1%


PRIVATE FINANCE

     Private finance investment activity and yields as of and for the three and
six months ended June 30, 2001 and 2000 and as of and for the year ended
December 31, 2000 were as follows:



                                AT AND FOR THE      AT AND FOR THE
                                 THREE MONTHS         SIX MONTHS
                                ENDED JUNE 30,      ENDED JUNE 30,      AT AND FOR THE
                               -----------------   -----------------      YEAR ENDED
                                 2001      2000      2001      2000    DECEMBER 31, 2000
       ($ IN MILLIONS)         --------   ------   --------   ------   -----------------
                                                        
Portfolio at Value...........  $1,405.4   $871.6   $1,405.4   $871.6       $1,282.5
Investments Funded...........  $   93.5   $126.4   $  114.1   $239.0       $  600.9
Repayments...................  $    6.9   $  2.4   $   24.0   $ 39.2       $  117.7
Yield........................      14.6%    14.5%      14.6%    14.5%          14.6%


     The private finance portfolio increased 10% from December 31, 2000 to June
30, 2001, and increased 98% during the year ended December 31, 2000. Buyout and
private finance activity across the industry slowed during the first half of
2001 largely due to credit tightening among senior lenders. Equity-focused
buyout firms generally need both senior and subordinated debt to leverage
private equity investments, and during the first half of 2001, activity in the
senior bank market, and in particular the senior syndicated loan market, has
been slow. As a result, the Company's investment activity for the six months
ended June 30, 2001 has been at a slower pace than the comparable period for the
prior year.

     During the second quarter, the Company announced that it intends to acquire
SunSource Inc. to create a privately owned portfolio company controlled by the
Company. The two companies have signed a definitive merger agreement, which
provides that the Company will pay approximately $72 million, or $10.375 per
SunSource common share, in cash for all of the outstanding common equity of
SunSource. Management of SunSource will participate with the Company in the
buyout transaction and will retain an approximate 6% ownership position on a
fully diluted basis in the newly created portfolio company. It is anticipated
that this transaction will close by September 30, 2001. SunSource is an existing
portfolio company, and during the second quarter of 2001 the Company increased
its investment in SunSource by purchasing a subordinated note for $8.5 million
from a third party.

                                        33
   36

     The Company's increasing capital base has enabled it to make larger private
finance investments, supporting the increase in originations in 2000. Key
investment characteristics for new private finance mezzanine investments were as
follows:



                                                                FOR THE YEAR
                                                                    ENDED
                                                              DECEMBER 31, 2000
                                                              -----------------
                                                           
New investment characteristics:
  Number of investments.....................................           34
  Average investment size (millions)........................       $ 14.0
  Average current yield.....................................         14.7%
  Average portfolio company revenue (millions)..............       $153.5
  Average portfolio company years in business...............           36


The average investment characteristics above are computed using simple averages
based upon underwriting data for investment activity for that year. As a result,
any one investment may have had individual investment characteristics that may
vary significantly from the stated simple average. In addition, average
investment characteristics may vary from year to year.

     The current yield on the private finance portfolio will fluctuate over time
depending on the equity "kicker" or warrants received with each debt financing.
Private finance investments are generally structured such that equity kickers
may provide an additional future investment return of up to 10%.

     During 2000, the Company acquired BLC Financial Services, Inc. in a going
private transaction, and the Company's investment in BLX is included in the
private finance portfolio. See "Small Business Finance" discussion for more
details below.

     During the second quarter of 2000, the Company began an initiative to
invest in and strategically partner with select private equity funds focused on
venture capital investments. The strategy for these fund investments is to
provide solid investment returns and build strategic relationships with the fund
managers and their portfolio companies. The Company believes that it will have
opportunities to co-invest with the funds as well as finance their portfolio
companies as they mature.

     The Company believes that the fund investment strategy is an effective
means of participating in private equity investing through a diverse pooled
investment portfolio. The fund concept allows the Company to participate in a
pooled investment return without exposure to the risk of any single investment.
Since the beginning of 2000, the Company has committed a total of $44.5 million
to eight private equity funds. The committed amount is expected to be invested
over the next three years. The Company funded $1.5 million, $3.1 million and
$7.0 million of this commitment for the three and six months ended June 30, 2001
and for the year ended December 31, 2000, respectively.

                                        34
   37

COMMERCIAL REAL ESTATE FINANCE

     Commercial real estate finance investment activity and yields as of and for
the three and six months ended June 30, 2001 and 2000 and as of and for the year
ended December 31, 2000 were as follows:



                                           AT AND FOR THE             AT AND FOR THE          AT AND FOR THE
                                         THREE MONTHS ENDED          SIX MONTHS ENDED           YEAR ENDED
                                              JUNE 30,                   JUNE 30,              DECEMBER 31,
                                        ---------------------       -------------------       --------------
                                         2001           2000         2001         2000             2000
        ($ IN MILLIONS)                 ------         ------       ------       ------       --------------
                                                                               
Portfolio at Value.............         $595.2         $548.8       $595.2       $548.8           $505.5
Investments Funded.............         $ 55.8         $ 27.2       $186.0       $ 91.1           $149.0
Repayments.....................         $  7.5         $  1.3       $ 20.1       $ 14.3           $ 24.8
Sales..........................         $ 39.4         $ 38.0       $ 74.6       $ 51.5           $151.7
Yield..........................           13.6%          13.0%        13.6%        13.0%            13.1%


     The commercial real estate finance portfolio increased 18% from December
31, 2000 to June 30, 2001, and decreased 3% for the year ended December 31,
2000. During 1998, the Company reduced its commercial mortgage loan origination
activity for its own portfolio due to declining interest rates and began to sell
its loans to other lenders. Then, beginning in the fourth quarter of 1998, the
Company began to take advantage of a unique market opportunity to acquire
non-investment grade commercial mortgage-backed securities ("CMBS") at
significant discounts from the face amount of the bonds. Turmoil in the capital
markets at that time created a lack of liquidity for the traditional buyers of
non-investment grade bonds. As a result, yields on these collateralized bonds
increased, thus providing an attractive investment opportunity. The Company
believes that CMBS is an attractive asset class because of the yields that can
be earned on a security that is fully secured by commercial mortgage loans. The
Company has opportunistically purchased CMBS since the fourth quarter of 1998.
The Company plans to continue its CMBS investment activity, however, in order to
maintain a balanced portfolio the Company expects that purchased CMBS will
continue to represent approximately 20% to 25% of total assets during 2001. The
Company's CMBS investment activity level will be dependent upon its ability to
purchase CMBS at attractive yields.

     The Company purchases CMBS at an approximate discount of 50% from the face
amount of the bonds. During the second quarter of 2001, the Company purchased
$54.9 million in CMBS with a face value of $95.6 million and a weighted average
yield to maturity of 14.9% after assuming a 1% loss rate on the underlying
collateral mortgage pool. During the six months ended June 30, 2001 the Company
purchased $159.3 million in CMBS with a face value of $277.9 million. In
addition, the Company purchased $24.6 million in non-investment grade securities
related to a collateralized debt issuance secured by CMBS and investment grade
real estate investment trust bonds. The weighted average yield to maturity on
purchases made during the first six months of 2001 is 15.6% after assuming a 1%
loss rate on the underlying collateral mortgage pool. During 2000, the Company
purchased $124.3 million in CMBS with a face amount of $244.6 million and a
weighted average yield to maturity of 14.7% after assuming a 1% loss rate on the
underlying collateral mortgage pool.

     As a part of the Company's strategy to maximize its return on equity
capital, the Company sold CMBS bonds rated BB+, BB and BB- during the second
quarter of 2001, the first six months of 2001 and the fourth quarter of 2000
totaling $33.7 million, $68.9 million and $98.7 million, respectively. These
bonds had an effective yield of 10.0%, 10.2% and 11.5%, and were sold for $34.0
million, $70.1 million and $102.5 million, respectively, resulting in a realized
gain on the sale. The sale of these lower-yielding bonds increased the Company's
overall liquidity. The effective yield on the Company's remaining purchased CMBS
portfolio at June 30, 2001 was 15.4%, after assuming a 1% loss on the entire
underlying mortgage loan pool. At June 30, 2001 and December 31, 2000, the

                                        35
   38

value of the purchased CMBS portfolio was $430.4 million and $311.3 million and
the unamortized discount was $455.8 million and $364.9 million, respectively.

     The original principal balance of the underlying pool of the approximately
3,000 loans that are collateral for the Company's CMBS had underwritten loan to
value ("LTV") and underwritten debt service coverage ratios ("DSCR") as follows:



                    LOAN TO VALUE RANGES                          $        %
                    --------------------                      ---------   ---
                                                                ($ IN
                                                              MILLIONS)
                                                                    
Less than 60%...............................................  $ 1,847.1    12%
60-65%......................................................    1,330.3     8%
65-70%......................................................    2,645.4    17%
70-75%......................................................    5,262.3    33%
75-80%......................................................    4,695.5    29%
Greater than 80%............................................      208.1     1%
                                                              ---------   ---
                                                              $15,988.7   100%
                                                              =========   ===
Weighted average LTV........................................       69.6%




                   DEBT SERVICE COVERAGE
                        RATIO RANGES                              $        %
                   ---------------------                      ---------   ---
                                                                ($ IN
                                                              MILLIONS)
                                                                    
Greater than 2.00...........................................  $   510.1     3%
1.76-2.00...................................................      487.1     3%
1.51-1.75...................................................    1,848.6    12%
1.26-1.50...................................................    9,090.1    57%
1.00-1.25...................................................    4,052.8    25%
                                                              ---------   ---
                                                              $15,988.7   100%
                                                              =========   ===
Weighted average DSCR.......................................       1.41


     The Company has been liquidating much of its whole commercial mortgage loan
portfolio so that it can redeploy the proceeds into higher yielding assets and
for the three and six months ended June 30, 2001, the Company sold $5.8 million
of commercial mortgage loans. For the year ended December 31, 2000, the Company
sold $53.1 million of commercial mortgage loans. At June 30, 2001, the Company's
whole commercial real estate loan portfolio had been reduced to $87.8 million
from $106.4 million at December 31, 2000.

SMALL BUSINESS FINANCE

     On December 31, 2000, the Company acquired 95% of BLC Financial Services,
Inc. in a "going private" buyout transaction for $95.2 million. The Company
issued approximately 4.1 million shares, or $86.1 million of new equity, and
paid $9.1 million in cash to acquire BLC. The new portfolio company has changed
its name to Business Loan Express, Inc. ("BLX").

     As part of the transaction, the Company recapitalized its Allied Capital
Express operations as an independently managed private portfolio company and
merged it into BLX. As part of the recapitalization, the Company contributed
certain assets, including the online rules-based underwriting technology and
fixed assets, and transferred 37 employees into the private portfolio company.
Upon completion of the transaction, the Company's investment in BLX totaled
$204.1 million and consisted of $74.5 million of 25% subordinated debt, $25.1
million of preferred stock, and $104.5 million of common stock. BLX is included
in the private finance portfolio.

                                        36
   39

     During the first quarter of 2001, BLX secured a 3-year $117.5 million
revolving credit facility ("BLX Credit Facility"). As the controlling
shareholder of BLX, the Company has provided an unconditional guaranty to the
BLX Credit Facility lenders in an amount of up to 50% of the total obligations
(consisting of principal, accrued interest and other fees) of BLX on the line of
credit. The amount guaranteed by the Company at June 30, 2001 was $51.7 million.
This guaranty can be called by the lenders only in the event of a default by
BLX. BLX was in compliance with the terms of the BLX Credit Facility at June 30,
2001.

     Prior to its contribution to BLX, Allied Capital Express loan activity and
yields as of and for the year ended December 31, 2000 were as follows:



                      ($ IN MILLIONS)                          2000
                      ---------------                         ------
                                                           
Portfolio at Value..........................................  $   --
New Investments.............................................  $151.6
Repayments..................................................  $ 11.6
Sales.......................................................  $128.5
Yield.......................................................      --


     Allied Capital Express loan origination activity for 2000 increased due to
the opening of new regional office locations and from opportunities created by
the Company's Internet site launched in the fall of 1999. Loans in the Allied
Capital Express program were originated for sale; therefore, the increase in
loan sales was the result of the increase in originations. In addition,
beginning in 1999, the Company began to sell 90% of the unguaranteed portion of
SBA 7(a) loans through a structured finance agreement with a commercial paper
conduit. Allied Capital Express targeted small commercial real estate loans that
were, in many cases, originated in conjunction with SBA 7(a) loans. SBA 7(a)
loans were originated with variable interest rates priced at spreads ranging
from 1.75% to 2.75% over the prime lending rate.

                                        37
   40

RESULTS OF OPERATIONS

COMPARISON OF SIX MONTHS ENDED JUNE 30, 2001 AND 2000

     The following table summarizes Allied Capital's operating results for the
six months ended June 30, 2001 and 2000.



                                                        FOR THE SIX
                                                        MONTHS ENDED
                                                          JUNE 30,
                                                     ------------------              PERCENT
                                                       2001      2000      CHANGE    CHANGE
    ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)       --------   -------   --------   -------
                                                                         
INTEREST AND RELATED PORTFOLIO INCOME
     Interest and dividends........................  $113,699   $81,714   $ 31,985      39%
     Premiums from loan dispositions...............     1,731     7,843     (6,112)    (78)%
     Fees and other income.........................    18,380     4,305     14,075     327%
                                                     --------   -------   --------     ---
          Total interest and related portfolio
             income................................   133,810    93,862     39,948      43%
                                                     --------   -------   --------     ---
EXPENSES
     Interest......................................    31,881    26,591      5,290      20%
     Employee......................................    13,965     9,760      4,205      43%
     Administrative................................     6,027     6,835       (808)    (12)%
                                                     --------   -------   --------     ---
          Total operating expenses.................    51,873    43,186      8,687      20%
                                                     --------   -------   --------     ---
     Formula and cut-off awards....................        91     3,403     (3,312)    (97)%
                                                     --------   -------   --------     ---
          Net operating income before net realized
             and unrealized gains..................    81,846    47,273     34,573      73%
                                                     --------   -------   --------     ---
NET REALIZED AND UNREALIZED GAINS
     Net realized gains............................     4,991    15,041    (10,050)    (67)%
     Net unrealized gains..........................    11,297     2,057      9,240     449%
                                                     --------   -------   --------     ---
          Total net realized and unrealized
             gains.................................    16,288    17,098       (810)     (5)%
                                                     --------   -------   --------     ---
Net increase in net assets resulting from
  operations.......................................  $ 98,134   $64,371   $ 33,763      52%
                                                     ========   =======   ========     ===
Diluted net operating income per share.............  $   0.92   $  0.69   $   0.23      33%
                                                     ========   =======   ========     ===
Diluted earnings per share.........................  $   1.10   $  0.94   $   0.16      17%
                                                     ========   =======   ========     ===
Weighted average shares outstanding -- diluted.....    88,966    68,175     20,791      30%


     Net increase in net assets resulting from operations (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.

     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

                                        38
   41

includes dividend income, premiums from loan dispositions, prepayment premiums,
and fees and other income.



                                                               FOR THE SIX
                                                               MONTHS ENDED
                                                                 JUNE 30,
                                                              --------------
                                                               2001    2000
         ($ IN MILLIONS, EXCEPT PER SHARE AMOUNTS)            ------   -----
                                                                 
Total Interest and Related Portfolio Income.................  $133.8   $93.9
Per share...................................................  $ 1.50   $1.38


     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 20% to $1,639.7 million at June 30, 2001 from $1,361.1 million at
June 30, 2000. The weighted average yield on the interest bearing investments in
the portfolio at June 30, 2001 and 2000 was as follows:



                                                                JUNE 30,
                                                              -------------
                                                              2001    2000
                                                              -----   -----
                                                                
Private Finance.............................................  14.6%   14.5%
Commercial Real Estate Finance..............................  13.6%   13.0%
Small Business Finance......................................    --%   12.3%
Total Portfolio.............................................  14.2%   13.6%


     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 $0.7 million and $5.8 million for the six months ended June 30, 2001
and 2000, respectively. Premium income results from the premium paid by
purchasers on loans sold less the origination commissions associated with the
loans sold. For the six months ended June 30, 2000, premiums from loan sales
resulted primarily from the sale of loans originated through Allied Capital
Express. Upon the merger of the Allied Capital Express operations into BLX, the
premium from loan sales earned historically is intended to be replaced with
interest income earned by the Company from its subordinated debt investment in
BLX as well as fees earned from its guaranty of the BLX Credit Facility and its
management contract with BLX.

     Prepayment premiums were $1.0 million and $2.0 million for the six months
ended June 30, 2001 and 2000, respectively. While the scheduled maturities of
private finance and commercial real estate loans range 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.

     Fees and other income include diligence, financial structuring, management
and guaranty fees of $15.8 million for the six months ended June 30, 2001. The
Company continues to emphasize new financial structuring, diligence and
portfolio management activity that generates additional fee income. Because
individual fees for any one activity can vary in size, fee income may vary from
quarter to quarter.

                                        39
   42

     Operating expenses include interest, employee and administrative expenses.
The Company's single largest expense is interest on indebtedness. The
fluctuations in interest expense during the six months ended June 30, 2001 and
2000 are attributable to changes in the level of borrowings by the Company and
its subsidiaries under various notes payable and debentures and revolving credit
facilities. The Company's borrowing activity and weighted average interest cost,
including fees and closing costs, were as follows:



                                                              AT AND FOR THE
                                                                SIX MONTHS
                                                                   ENDED
                                                                 JUNE 30,
                                                              ---------------
                                                               2001     2000
                      ($ IN MILLIONS)                         ------   ------
                                                                 
Total Outstanding Debt......................................  $881.1   $726.4
Average Outstanding Debt....................................  $801.3   $659.0
Weighted Average Cost.......................................     7.4%     8.1%
BDC Asset Coverage*.........................................     247%     225%


-------------------------
* As a BDC, the Company is generally required to maintain a ratio of 200% of
  total assets to total borrowings.

     Employee expenses include salaries and employee benefits. The increase in
salaries and employee benefits for the periods presented reflects wage increases
and the experience level of employees hired. Total employees were 101 and 129 at
June 30, 2001 and 2000, respectively. As part of the recapitalization of Allied
Capital Express discussed above, employees of the Company were transferred to
the portfolio company at the end of 2000. Expenses related to employees
dedicated to Allied Capital Express are reflected in employee expense for the
six months ended June 30, 2000.

     Administrative expenses include the leases for the Company's headquarters
in Washington, DC, and its regional offices, travel costs, stock record
expenses, directors' fees, legal and accounting fees and various other expenses.
Administrative expenses for the six months ended June 30, 2000 included expenses
related to Allied Capital Express regional offices. The cost of these regional
offices was transferred to BLX at the beginning of 2001. For the six months
ended June 30, 2001 and 2000, employee and administrative costs as a percentage
of total interest and related portfolio income less interest expense plus net
realized and unrealized gains was 17% and 20%, respectively.

     The formula and cut-off awards totaled $3.4 million, or $0.05 per share,
for the six months ended June 30, 2000. The formula award vested over a
three-year period which ended on December 31, 2000.

     Net realized gains resulted from the sale of equity securities associated
with certain private finance investments and the realization of unamortized
discount resulting from the sale and early

                                        40
   43

repayment of private finance loans, commercial mortgage loans and Purchased CMBS
bonds, offset by losses on investments. Realized gains and losses were as
follows:



                                                               FOR THE SIX
                                                              MONTHS ENDED
                                                                JUNE 30,
                                                              -------------
                                                              2001    2000
                      ($ IN MILLIONS)                         -----   -----
                                                                
Realized Gains..............................................  $ 6.6   $15.9
Realized Losses.............................................   (1.6)   (0.9)
                                                              -----   -----
Net Realized Gains..........................................  $ 5.0   $15.0
                                                              =====   =====
Net Unrealized Gains........................................  $11.3   $ 2.1
                                                              =====   =====


     Realized gains for the six months ended June 30, 2001 primarily resulted
from transactions involving two portfolio companies, Southwest PCS, LLC ($0.8
million) and FTI Consulting, Inc. ($4.6 million), and the sale of Purchased CMBS
BB bonds ($0.9 million). Realized gains for the six months ended June 30, 2000
resulted primarily from transactions involving five portfolio companies. The
Company reversed previously recorded unrealized appreciation totaling $4.0
million and $3.7 million when these gains were realized for the six months ended
June 30, 2001 and 2000, respectively.

     Realized losses for the six months ended June 30, 2001 and 2000 resulted
from the continued liquidation of the Company's whole loan commercial real
estate portfolio, as well as other small losses in the private finance
portfolio. The Company reversed previously recorded unrealized depreciation
totaling $2.2 million and $0.7 million when the related losses were realized in
the six months ended June 30, 2001 and 2000, respectively.

     Net unrealized gains for the three months ended June 30, 2001 and 2000
consisted of valuation changes resulting from the Board of Directors' valuation
of the Company's assets and the effect of reversals of unrealized appreciation
or depreciation resulting from realized gains or losses.

     The Company increased the value of its equity investment in BLX by $15.5
million at March 31, 2001. During the first quarter, BLX secured a 3-year $117.5
million revolving credit facility and completed a $65 million securitization of
unguaranteed SBA 7(a) loans. As a result of the elimination of the refinancing
risk that existed at the time of the merger, and BLX's progress in merger
integration, the Company increased the value of its equity investment. The
Company also increased the value of its investment in Wyo-Tech Acquisition
Corporation by $8.8 million at March 31, 2001, due to its continued growth and
positive performance. In addition to BLX and Wyo-Tech, the Company increased the
value of other portfolio companies by $9.9 million in total for the six months
ended June 30, 2001. These companies increased in value because of continued
positive performance, and valuation data that would indicate that a valuation
increase was necessary.

     The Company decreased the value of its common equity investment in Startec
Global Communications Corporation by $3.0 million and the value of its debt
investment in NETtel Communications, Inc. by $5.0 million at March 31, 2001. In
addition, the Company decreased the value of other portfolio companies by a
total of $13.1 million for the six months ended June 30, 2001.

     At June 30, 2001, net unrealized appreciation in the portfolio totaled
$30.7 million and was composed of unrealized appreciation of $78.6 million,
resulting primarily from appreciated equity interests in portfolio companies,
and unrealized depreciation of $47.9 million, resulting primarily from
underperforming loan and equity interests in the portfolio. Net realized and
unrealized gains can vary substantially on a quarterly basis.

                                        41
   44

     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.

     At June 30, 2001, the Company's portfolio was graded as follows:



                                                          PORTFOLIO      PERCENTAGE OF
                        GRADE                             AT VALUE      TOTAL PORTFOLIO
                        -----                           -------------   ---------------
                                                        (IN MILLIONS)
                                                                  
1.....................................................    $  449.7            22.5%
2.....................................................     1,430.0            71.5%
3.....................................................        43.1             2.2%
4.....................................................        45.1             2.2%
5.....................................................        32.7             1.6%
                                                          --------           -----
                                                          $2,000.6           100.0%
                                                          ========           =====


     Grade 5 private finance investments at June 30, 2001, totaled $31.7
million, at value, or 1.6%, of the Company's total portfolio. Total Grade 4 and
5 assets as a percentage of the total portfolio at value at June 30, 2001 and
December 31, 2000 and 1999 were 3.8%, 5.7% and 3.8%, respectively. The Company
expects that a certain number of portfolio companies will be in the Grade 4 or 5
category from time to time. Part of the business of private finance is working
with troubled portfolio companies to improve their businesses and protect the
Company's investment. The number of portfolio companies and related investment
amount included in Grade 4 and 5 may fluctuate significantly from quarter to
quarter as the Company helps these companies work through their problems. 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.

     At June 30, 2001, delinquencies in the underlying collateral pool for the
Company's CMBS portfolio were 0.35%. The yield used to accrue interest on this
portfolio assumes a 1% loss rate on the entire underlying collateral mortgage
pool, and as of June 30, 2001, no losses have been realized.

     For the total investment portfolio, loans greater than 120 days delinquent
were $63.5 million at value at June 30, 2001, or 3.2% of the total portfolio.
Included in this category are loans valued at $10.9 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, 2000
were $56.4 million at value, or 3.2% of the total portfolio, which included
$13.3 million that were fully secured by real estate. As a provider of long-term
privately negotiated investment capital, it is not atypical to defer payment of
principal or interest from time to time. As a result, the amount of the
portfolio that is greater than 120 days delinquent may vary from quarter to
quarter. The terms of the private finance agreements frequently provide an
opportunity for portfolio companies to restructure their debt and equity
capital. During such restructuring, the Company may not receive or accrue
interest or dividend payments. The investment portfolio is priced to provide
current returns for our shareholders assuming that a portion of the portfolio at
any time may not be accruing interest currently. The Company also prices its
investments for a total return including current interest or dividends plus
capital gains from the sale of equity securities. Therefore, the amount of loans
greater

                                        42
   45

than 120 days delinquent is not necessarily an indication of future principal
loss or loss of anticipated investment return. The Company's portfolio grading
system is used as a means to assess loss of investment return (Grade 4 assets)
or loss of investment principal (Grade 5 assets).

     The Company has elected to be taxed as a regulated investment company
("RIC") under Subchapter M of the Internal Revenue Code of 1986, as amended
("Code"). As long as the Company qualifies as a RIC, the Company is not taxed on
its investment company taxable income or realized capital gains, to the extent
that such income or gains are distributed, or deemed to be distributed, to
shareholders on a timely basis. 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.

     In order to maintain its RIC status, the Company must, in general, (1)
continue to qualify as a BDC; (2) derive at least 90% of its gross income from
dividends, interest, gains from the sale of securities and other specified types
of income; (3) meet investment diversification requirements as defined in the
Code; and (4) distribute annually to shareholders at least 90% of its investment
company taxable income as defined in the Code. 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 qualify for such treatment in
future years.

     The weighted average common shares outstanding used to compute basic
earnings per share were 87.4 million and 68.1 million for the six months ended
June 30, 2001 and 2000, 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 89.0 million and 68.2 million for the six months ended
June 30, 2001 and 2000, respectively.

                                        43
   46

COMPARISON OF THREE MONTHS ENDED JUNE 30, 2001 AND 2000

     The following table summarizes Allied Capital's operating results for the
three months ended June 30, 2001 and 2000.



                                                         FOR THE THREE
                                                         MONTHS ENDED
                                                           JUNE 30,
                                                       -----------------             PERCENT
                                                        2001      2000     CHANGE    CHANGE
     ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)        -------   -------   -------   -------
                                                                         
INTEREST AND RELATED PORTFOLIO INCOME
     Interest and dividends..........................  $58,824   $42,986   $15,838      37%
     Premiums from loan dispositions.................      910     4,554    (3,644)    (80)%
     Fees and other income...........................    9,005     2,425     6,580     271%
                                                       -------   -------   -------     ---
          Total interest and related portfolio
             income..................................   68,739    49,965    18,774      38%
                                                       -------   -------   -------     ---
EXPENSES
     Interest........................................   15,951    14,280     1,671      12%
     Employee........................................    7,547     5,191     2,356      45%
     Administrative..................................    3,060     4,082    (1,022)    (25)%
                                                       -------   -------   -------     ---
          Total operating expenses...................   26,558    23,553     3,005      13%
                                                       -------   -------   -------     ---
     Formula and cut-off awards......................       63     1,712    (1,649)    (96)%
                                                       -------   -------   -------     ---
          Net operating income before net realized
             and unrealized gains....................   42,118    24,700    17,418      71%
                                                       -------   -------   -------     ---
NET REALIZED AND UNREALIZED GAINS
     Net realized gains..............................    3,837    12,865    (9,028)    (70)%
     Net unrealized gains............................      151    (2,775)    2,926     105%
                                                       -------   -------   -------     ---
          Total net realized and unrealized gains....    3,988    10,090    (6,102)    (60)%
                                                       -------   -------   -------     ---
Net increase in net assets resulting from
  operations.........................................  $46,106   $34,790   $11,316      33%
                                                       =======   =======   =======     ===
Diluted net operating income per share...............  $  0.46   $  0.35   $  0.11      24%
                                                       =======   =======   =======     ===
Diluted earnings per share...........................  $  0.51   $  0.50   $  0.01       2%
                                                       =======   =======   =======     ===
Weighted average shares outstanding -- diluted.......   90,848    70,035    20,813      30%


     Net increase in net assets resulting from operations (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. In addition to the discussion of the comparison of the three months
ended June 30, 2001 to the three months ended June 30, 2000 that follows, refer
to the "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Comparison of Six Months Ended June 30, 2001 and 2000" above
for additional discussion regarding the nature of and reasons for fluctuation in
income and expense items in the company's operating results.

     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

                                        44
   47

includes dividend income, premiums from loan dispositions, prepayment premiums,
and fees and other income.



                                                                FOR THE THREE
                                                                MONTHS ENDED
                                                                  JUNE 30,
                                                              -----------------
                                                              2001        2000
         ($ IN MILLIONS, EXCEPT PER SHARE AMOUNTS)            -----       -----
                                                                    
Total Interest and Related Portfolio Income.................  $68.7       $50.0
Per share...................................................  $0.76       $0.71


     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 20% to $1,639.7 million at June 30, 2001 from $1,361.1 million at
June 30, 2000.

     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 $0.7 million and $3.6 million for the three months ended June 30,
2001 and 2000, respectively. Premium income results from the premium paid by
purchasers on loans sold less the origination commissions associated with the
loans sold. For the three months ended June 30, 2000, premiums from loan sales
resulted primarily from the sale of loans originated through Allied Capital
Express. Upon the merger of the Allied Capital Express operations into BLX, the
premium from loan sales earned historically is intended to be replaced with
interest income earned by the Company from its subordinated debt investment in
BLX as well as fees earned from its guaranty of the BLX Credit Facility and its
management contract with BLX. Prepayment premiums were $0.2 million and $0.9
million for the three months ended June 30, 2001 and 2000, respectively.

     Fees and other income include diligence and financial structuring fees and
management and guaranty fees of $7.3 million for the three months ended June 30,
2001.

     Operating expenses include interest, employee and administrative expenses.
The Company's single largest expense is interest on indebtedness. The
fluctuations in interest expense during the three months ended June 30, 2001 and
2000 are attributable to changes in the level of borrowings by the Company and
its subsidiaries under various notes payable and debentures and revolving credit
facilities. The Company's borrowing activity and weighted average interest cost,
including fees and closing costs, were as follows:



                                                                AT AND FOR THE
                                                              THREE MONTHS ENDED
                                                                   JUNE 30,
                                                             ---------------------
                                                              2001           2000
                      ($ IN MILLIONS)                        ------         ------
                                                                      
Total Outstanding Debt.....................................  $881.1         $726.4
Average Outstanding Debt...................................  $812.5         $690.6
Weighted Average Cost......................................     7.4%           8.1%
BDC Asset Coverage*........................................     247%           225%


-------------------------
* As a BDC, the Company is generally required to maintain a ratio of 200% of
  total assets to total borrowings.

     Employee expenses include salaries and employee benefits. The increase in
salaries and employee benefits for the periods presented reflects wage increases
and the experience level of employees hired. Total employees were 101 and 129 at
June 30, 2001 and 2000, respectively. As part of the

                                        45
   48

recapitalization of Allied Capital Express discussed above, employees of the
Company were transferred to the portfolio company at the end of 2000. Expenses
related to employees dedicated to Allied Capital Express are reflected in
employee expense for the three months ended June 30, 2000.

     Administrative expenses include the leases for the Company's headquarters
in Washington, DC, and its regional offices, travel costs, stock record
expenses, directors' fees, legal and accounting fees and various other expenses.
Administrative expenses for the three months ended June 30, 2000 included
expenses related to Allied Capital Express regional offices. The cost of these
regional offices was transferred to BLX at the beginning of 2001. For the three
months ended June 30, 2001 and 2000, employee and administrative costs as a
percentage of total interest and related portfolio income less interest expense
plus net realized and unrealized gains was 19% and 20%, respectively.

     Net realized gains resulted from the sale of equity securities associated
with certain private finance investments and the realization of unamortized
discount resulting from the sale and early repayment of private finance loans,
commercial mortgage loans and Purchased CMBS bonds, offset by losses on
investments. Realized gains and losses were as follows:



                                                                FOR THE THREE
                                                                MONTHS ENDED
                                                                  JUNE 30,
                                                              -----------------
                                                              2001        2000
                      ($ IN MILLIONS)                         -----       -----
                                                                    
Realized Gains..............................................  $ 4.7       $13.2
Realized Losses.............................................   (0.9)       (0.3)
                                                              -----       -----
Net Realized Gains..........................................  $ 3.8       $12.9
                                                              =====       =====
Net Unrealized Gains........................................  $ 0.2       $(2.8)
                                                              =====       =====


     For further discussion of net realized and unrealized gains and losses,
refer to "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Comparison of Six Months Ended June 30, 2001 and 2000"
above.

     The weighted average common shares outstanding used to compute basic
earnings per share were 89.4 million and 70.0 million for the three months ended
June 30, 2001 and 2000, 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 90.8 million and 70.0 million for the three months ended
June 30, 2001 and 2000, respectively.

                                        46
   49

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

CASH AND CASH EQUIVALENTS

     At June 30, 2001, the Company had $3.4 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 credit
facilities.

DEBT

     The Company had outstanding debt at June 30, 2001 as follows:



                                                                                           ANNUAL
                                                             FACILITY       AMOUNT        INTEREST
                                                              AMOUNT      OUTSTANDING     COST(1)
                      ($ IN MILLIONS)                        --------   ---------------   --------
                                                                                 
Notes payable and debentures:
  Unsecured long-term notes payable........................  $  544.0       $544.0          7.9%
  SBA debentures...........................................     101.8         87.0          7.9%
  Auction rate reset note..................................      79.6         79.6          5.9%
  OPIC loan................................................       5.7          5.7          6.6%
                                                             --------       ------          ----
         Total notes payable and debentures................  $  731.1       $716.3          7.7%
                                                             --------       ------          ----
Revolving credit facilities:
    Revolving line of credit...............................     417.5        164.8          6.1%
                                                             --------       ------          ----
         Total debt........................................  $1,148.6       $881.1          7.4%
                                                             ========       ======          ====


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

     UNSECURED LONG-TERM NOTES PAYABLE.  The Company has issued long-term debt
to institutional lenders, primarily insurance companies. The notes have five- or
seven-year maturities, with maturity dates beginning in 2003. The notes require
payment of interest only semi-annually, and all principal is due upon maturity.

     SBA DEBENTURES.  The Company, through its SBIC subsidiary, has debentures
payable to the SBA with terms of ten years. The notes require payment of
interest only semi-annually, and all principal is due upon maturity. The Company
may currently borrow up to $101.8 million from the SBA under the SBIC program.
At June 30, 2001, the Company has a commitment to borrow up to an additional
$14.8 million above the amount outstanding from the SBA. The commitment expires
on September 30, 2005.

     AUCTION RATE RESET NOTE.  The Company has a $79.6 million Auction Rate
Reset Senior Note Series A that matures on December 2, 2002 and bears interest
at the three-month London Inter-Bank Offer Rate ("LIBOR") plus 1.75% which
adjusts quarterly. Interest is due quarterly and the Company, at its option, may
pay or defer and capitalize such interest payments. The amount outstanding on
the note will increase as interest due is deferred and capitalized. As a means
to repay the note, the Company has entered into an agreement to issue $79.6
million of debt, equity or other securities in one or more public or private
transactions, or prepay the Auction Rate Reset Note, on or before August 31,
2002. If the note is prepaid, the Company will pay a fee equal to 0.5% of the
aggregate amount of the note outstanding.

                                        47
   50

     REVOLVING LINE OF CREDIT.  As of June 30, 2001, the Company has a two-year,
$417.5 million unsecured revolving line of credit that expires in May 2002. This
facility may be expanded up to $500 million. At the Company's option, the credit
facility bears interest at a rate equal to (i) the one-month LIBOR plus 1.25% or
(ii) the higher of (a) the Bank of America, N.A. prime rate or (b) the Federal
Funds rate plus 0.50%. The credit facility requires monthly payments of
interest, and all principal is due upon maturity. On August 3, 2001, the Company
amended this credit facility to have borrowing capacity of $467.5 million, which
can be expanded up to $600 million, and extended the maturity to August 2003,
with the right to extend the maturity for an additional one year at the
Company's sole option, under substantially the same terms.

EQUITY CAPITAL AND DIVIDENDS

     The Company raises debt and equity capital for continued investment in its
portfolio. Because the Company is a RIC, it distributes its income and requires
external capital for growth. Because the Company is a BDC, 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, or
approximately 1 to 1 debt to equity capital ratio.

     To support its growth during the six months ended June 30, 2001, the
Company raised $123.3 million in new equity capital primarily through the sale
of shares from its shelf registration statement. The Company issues equity from
time to time when it has a clear use of proceeds for attractive investment
opportunities. Historically, this process has enabled the Company to raise
equity on an accretive basis for existing shareholders. At June 30, 2001, total
shareholders' equity had increased to $1.17 billion.

     The Company's Board reviews the dividend rate quarterly, and adjusts the
quarterly dividend rate throughout the year as the Company's earnings momentum
builds. For the first and second quarter of 2001, the Board declared a $0.49 and
$0.50 per common share dividend, respectively. For the third quarter of 2001,
the Board has declared a dividend of $0.51 per common share. Dividends are paid
from the Company's taxable income.

     As a result of growth in ordinary taxable income combined with the
increased size and diversity of the Company's portfolio and its projected future
capital gains, the Company's Board of Directors will continue to evaluate
whether to retain or distribute capital gains as they occur. The Company's
dividend policy allows the Company to continue to distribute some capital gains,
but will also allow the Company to retain gains that exceed a normal capital
gains distribution level, and therefore avoid any unusual spike in dividends in
any one year. The dividend policy also enables the Board to selectively retain
gains to support future growth.

     The Company plans to maintain a strategy of financing its operations,
dividend requirements and future investments with cash from operations, through
borrowings under short- or long-term credit facilities or other debt securities,
through asset sales, or through the sale or issuance of new equity capital. The
Company maintains a matched-funding philosophy that focuses on matching the
estimated maturities of its loan and investment portfolio to the estimated
maturities of its borrowings. The Company will utilize its short-term credit
facilities only as a means to bridge to long-term financing, which may result in
temporary differences in the matching of estimated maturities. The Company
evaluates its interest rate exposure on an ongoing basis. To the extent deemed
necessary, the Company may hedge variable and short-term interest rate exposure
through interest rate swaps or other techniques. At June 30, 2001, the Company's
debt to equity ratio was 0.75 to 1 and weighted average cost of funds was 7.4%.
There are no significant maturities of long-term debt until 2003. The Company
believes that it has access to capital sufficient to fund its ongoing investment
and operating activities, and from which to pay dividends.

                                        48
   51

                           INVESTMENT CONSIDERATIONS

     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.

     INVESTING IN PRIVATE COMPANIES INVOLVES A HIGH DEGREE OF RISK.  Our
portfolio consists primarily of long-term loans to and investments in private
companies. Investments in private businesses involve a high degree of business
and financial risk, which can result in substantial losses and accordingly
should be considered speculative. There is generally no publicly available
information about the companies in which we invest, and we rely significantly on
the diligence of our employees and agents to obtain information in connection
with the Company's investment decisions. In addition, some smaller businesses
have narrower product lines and market shares than their competition, and may be
more vulnerable to customer preferences, market conditions or economic
downturns, which may adversely affect the return on, or the recovery of, our
investment in such businesses.

     OUR FINANCIAL RESULTS COULD BE NEGATIVELY AFFECTED IF BLX FAILS TO PERFORM
AS EXPECTED. Business Loan Express, Inc. ("BLX") is our largest portfolio
investment. Our financial results could be negatively affected if BLX, as a
portfolio company, fails to perform as expected. At June 30, 2001, the
investment totaled $213.7 million, or 10% of total assets. In addition, as
controlling shareholder of BLX, the Company has provided an unconditional
guaranty to BLX's credit facility lenders in an amount equal to 50% of BLX's
total obligations on its $117.5 million unsecured revolving credit facility. The
amount guaranteed by the Company at June 30, 2001 was $51.7 million. This
guaranty can only be called in the event of a default by BLX.

     OUR BORROWERS MAY DEFAULT ON THEIR PAYMENTS.  We make unsecured,
subordinated loans and invest in equity securities, which may involve a higher
degree of repayment risk. We primarily invest in and lend to companies that may
have limited financial resources and that may be unable to obtain financing from
traditional sources. Numerous factors may affect a borrower's ability to repay
its loan, including the failure to meet its business plan, a downturn in its
industry or negative economic conditions. Deterioration in a borrower's
financial condition and prospects may be accompanied by deterioration in any
collateral for the loan.

     OUR PORTFOLIO OF INVESTMENTS IS ILLIQUID.  We acquire most of our
investments directly from private companies. The majority of the investments in
our portfolio will be subject to restrictions on resale or otherwise have no
established trading market. The illiquidity of most of our portfolio may
adversely affect our ability to dispose of loans and securities at times when it
may be advantageous for us to liquidate such investments.

     INVESTMENTS IN NON-INVESTMENT GRADE COMMERCIAL MORTGAGE-BACKED SECURITIES
MAY BE ILLIQUID AND MAY HAVE A HIGHER RISK OF DEFAULT.  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 (i.e., "AAA" through
"BBB"), and are sometimes referred to as "junk bonds." The non-investment grade
CMBS tend to be less liquid, may have a higher risk of default and may be more
difficult to value. 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.

                                        49
   52

     OUR PORTFOLIO INVESTMENTS ARE RECORDED AT FAIR VALUE AS DETERMINED BY THE
BOARD OF DIRECTORS IN ABSENCE OF READILY ASCERTAINABLE PUBLIC MARKET
VALUES.  Pursuant to the requirements of the Investment Company Act of 1940
("1940 Act"), the Board of Directors is required to value each asset quarterly,
and we are required to carry our portfolio at fair value as determined by the
Board of Directors. Since there is typically no public market for the loans and
equity securities of the companies in which we make investments, our Board of
Directors estimates the fair value of these loans and equity securities pursuant
to a written valuation policy and a consistently applied valuation process.
Unlike banks, we are not permitted to provide a general reserve for anticipated
loan losses; we are instead required by the 1940 Act to specifically value each
individual investment and record an unrealized loss for an asset that we believe
has become impaired. 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. We adjust quarterly the valuation of
our portfolio to reflect the Board of Directors' estimate of the current fair
value of each investment in our portfolio. Any changes in estimated value are
recorded in the Company's statement of operations as "Net unrealized gains
(losses)."

     WE BORROW MONEY WHICH MAGNIFIES THE POTENTIAL FOR GAIN OR LOSS ON AMOUNTS
INVESTED AND MAY INCREASE THE RISK OF INVESTING IN OUR COMPANY.  We borrow from,
and issue senior debt securities to, banks, insurance companies and other
lenders. Lenders of these senior securities have fixed dollar claims on our
consolidated assets that are superior to the claims of our common shareholders.
Borrowings, also known as leverage, magnify the potential for gain or loss on
amounts invested and, therefore, increase the risks associated with investing in
our securities. If the value of our consolidated assets increases, then
leveraging would cause the net asset value attributable to the Company's common
stock to increase more sharply than it would have had we not leveraged.
Conversely, if the value of our consolidated assets decreases, leveraging would
cause net asset value to decline more sharply than it otherwise would have had
we not leveraged. Similarly, any increase in our consolidated income in excess
of consolidated interest payable on the borrowed funds would cause our net
income to increase more than it would without the leverage, while any decrease
in our consolidated income would cause net income to decline more sharply than
it would have had we not borrowed. Such a decline could negatively affect our
ability to make common stock dividend payments. Leverage is generally considered
a speculative investment technique.

     At June 30, 2001, the Company had $881.1 million of outstanding
indebtedness, bearing a weighted annual interest cost of 7.4%. In order for us
to cover these annual interest payments on indebtedness, we must achieve annual
returns on our portfolio of at least 3.1%.

     WE MAY NOT BORROW MONEY UNLESS WE MAINTAIN ASSET COVERAGE FOR INDEBTEDNESS
OF AT LEAST 200% WHICH MAY AFFECT RETURNS TO SHAREHOLDERS.  We must maintain
asset coverage for a class of senior security representing indebtedness of at
least 200%. Our ability to achieve our investment objective may depend in part
on our continued ability to maintain a leveraged capital structure by borrowing
from banks or other lenders on favorable terms. There can be no assurance that
we will be able to maintain such leverage. If asset coverage declines to less
than 200%, we may be required to sell a portion of our investments when it is
disadvantageous to do so. As of June 30, 2001, our asset coverage for senior
indebtedness was 247%.

                                        50
   53

     CHANGES IN INTEREST RATES MAY AFFECT OUR COST OF CAPITAL AND NET OPERATING
INCOME. Because we borrow money to make investments, our net operating income is
dependent upon the difference between the rate at which we borrow funds and the
rate at which we invest these funds. As a result, there can be no assurance that
a significant change in market interest rates will not have a material adverse
effect on our portfolio income. In periods of sharply rising interest rates, our
cost of funds would increase, which would reduce our net operating income before
net realized and unrealized gains. However, there would be no effect on the
return, if any, that could be generated from our equity interests. We use a
combination of long-term and short-term borrowings and equity capital to finance
our investing activities. The Company utilizes its short-term credit facilities
only as a means to bridge to long-term financing. Our long-term fixed-rate
investments are financed primarily with long-term fixed-rate debt and equity. We
may use interest rate risk management techniques in an effort to limit our
exposure to interest rate fluctuations. Such techniques may include various
interest rate hedging activities to the extent permitted by the 1940 Act.

     BECAUSE WE MUST DISTRIBUTE INCOME, WE WILL CONTINUE TO NEED ADDITIONAL
CAPITAL TO GROW. We will continue to need capital to fund incremental growth in
our investments. Historically, we have borrowed from financial institutions and
have issued equity securities. A reduction in the availability of new capital
could limit our ability to grow. We must distribute at least 90% of our taxable
net operating income excluding net realized long-term capital gains to our
stockholders to maintain our regulated investment company ("RIC") status. As a
result such earnings will not be available to fund investment originations. We
expect to continue to borrow from financial institutions and sell additional
equity securities. If we fail to obtain funds from such sources or from other
sources to fund our investments, it could limit our ability to grow, which could
have a material adverse effect on the value of the Company's common stock. In
addition, as a business development company ("BDC"), we are generally required
to maintain a ratio of at least 200% of total assets to total borrowings, which
may restrict our ability to borrow in certain circumstances.

     OUR PRIVATE FINANCE INVESTMENTS MAY NOT PRODUCE CAPITAL GAINS.  Private
finance investments are typically structured as debt securities with a
relatively high fixed rate of interest and with an equity feature such as
conversion rights, warrants or options. As a result, private finance investments
generate interest income from the time they are made, and may also produce a
realized gain from an accompanying equity feature. We cannot be sure that our
portfolio will generate a current return or capital gains.

     LOSS OF PASS-THROUGH TAX TREATMENT WOULD SUBSTANTIALLY REDUCE NET ASSETS
AND INCOME AVAILABLE FOR DIVIDENDS.  We have operated the Company so as to
qualify to be taxed as a RIC under Subchapter M of the Internal Revenue Code of
1986, as amended ("Code"). If we meet source of income, diversification and
distribution requirements, the Company qualifies for effective pass-through tax
treatment. The Company would cease to qualify for such 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/or corporate level income tax if we fail to make required distributions
as a RIC. If the Company ceased 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.

                                        51
   54

     WE OPERATE IN A COMPETITIVE MARKET FOR INVESTMENT OPPORTUNITIES.  We
compete for investments with many other companies and individuals, some of whom
have greater resources than we do. Increased competition would make it more
difficult for us to purchase or originate investments at attractive prices. As a
result of this competition, sometimes we may be precluded from making otherwise
attractive investments.

     CHANGES IN THE LAW OR REGULATIONS THAT GOVERN THE COMPANY COULD HAVE A
MATERIAL IMPACT ON THE COMPANY OR OUR OPERATIONS.  We are regulated by the
Securities and Exchange Commission and the SBA. In addition, changes in the laws
or regulations that govern BDCs, RICs, real estate investment trusts ("REITs")
and SBICs may significantly affect our business. Any change in the law or
regulations that govern our business could have a material impact on the Company
or its operations. Laws and regulations may be changed from time to time, and
the interpretations of the relevant laws and regulations also are subject to
change.

     QUARTERLY RESULTS MAY FLUCTUATE AND MAY NOT BE INDICATIVE OF FUTURE
QUARTERLY PERFORMANCE. The Company's quarterly operating results could fluctuate
and therefore, you should not rely on quarterly results to be indicative of the
Company's performance in future quarters. Factors that could cause quarterly
operating results to fluctuate include, among others, variations in the
investment origination volume and fee income earned, variation in timing of
prepayments, variations in and the timing of the recognition of realized and
unrealized gains or losses, the degree to which we encounter competition in our
markets and general economic conditions.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     There has been no material change in the quantitative or qualitative
disclosures about market risk since December 31, 2000.

                                        52
   55

                           PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     The Company is party to certain lawsuits in the normal course of business.
While the outcome of these legal proceedings cannot at this time be predicted
with certainty, the Company does not expect that these proceedings will have a
material effect upon the Company's financial condition or results of operations.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

     During the three months ended June 30, 2001 ACC issued a total of 69,381
shares pursuant to a dividend reinvestment plan. This plan is not registered and
relies on an exemption from registration in the Securities Act of 1933.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     On May 8, 2001, the Company held its Annual Meeting of Shareholders in
Washington, DC. Shareholders voted on two matters; the substance of these
matters and the results of the voting of each such matter are described below.
There were no broker non-votes for these matters.

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



                                                           FOR       WITHHELD
                                                        ----------   ---------
                                                               
William L. Walton.....................................  70,274,662   6,881,794
George C. Williams, Jr................................  76,122,498   1,033,956
Brooks H. Browne......................................  75,878,768   1,277,686
Robert E. Long........................................  76,089,506   1,066,949


          The following directors are continuing as directors of the Company for
     their respective terms -- John D. Firestone, Anthony T. Garcia, Lawrence I.
     Hebert, Laura W. van Roijen, John I. Leahy, Warren K. Montouri, Guy T.
     Steuart II, and T. Murray Toomey, Esq.

     2. Ratification of the selection of Arthur Andersen LLP to serve as
        independent public accountants for the year ending December 31, 2001.
        Votes were cast as follows:



   FOR      AGAINST   ABSTAIN
----------  -------   -------
                
76,436,597  479,444   240,405


ITEM 5.  OTHER INFORMATION

     Not applicable.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

     (a) List of Exhibits



  EXHIBIT
   NUMBER                             DESCRIPTION
  -------                             -----------
           
 3(i)(a)(21)  Articles of Amendment and Restatement of the Articles of
              Incorporation.
 3(i)(b)(16)  Articles of Merger.


                                        53
   56



  EXHIBIT
   NUMBER                             DESCRIPTION
  -------                             -----------
           
 3(i)(c)(17)  Amendment to the Amended and Restated Articles of
              Incorporation.
 3(ii)10      Bylaws.
 4.1(4)       Specimen certificate of the Company's Common stock, par
              value $0.0001 per share. See exhibits 3(i), 3(ii) and 3(iii)
              for other instruments defining the rights of security
              holders.
 4.2(2)       Form of debenture between certain subsidiaries of the
              Company and the U.S. Small Business Administration.
 5            Not applicable.
 9            Not applicable.
10.1(15)      Second Amended and Restated Credit Agreement, dated August
              3, 2001.
10.2(5)       Note Agreement dated as of April 30, 1998.
10.3(3)       Loan Agreement between Allied I and Overseas Private
              Investment Corporation, dated April 10, 1995. Letter dated
              December 11, 1997 evidencing assignment of Loan Agreement
              from Allied I to the Company.
10.4(8)       Note Agreement dated as of May 1, 1999.
10.4a(10)     Note Agreement dated as of November 15, 1999.
10.4b(13)     Note Agreement dated as of October 15, 2000.
10.4c(18)     Auction Rate Reset Note Agreement, dated as of August 31,
              2000 between the Company and Intrepid Funding Master Trust,
              a Delaware business trust administered by Banc of America
              Securities LLC; Forward Issuance Agreement, dated as of
              August 31, 2000, between the Company and Banc of America
              Securities LLC; Remarketing and Contingency Purchase
              Agreement, dated as of August 31, 2000 between the Company
              and Banc of America Securities LLC.
10.5(17)      Amendment and Consent Agreement to the Amended and Restated
              Credit Agreement dated December 11, 2000.
10.6(4)       Sale and Servicing Agreement dated as of January 1, 1998
              among Allied Capital CMT, Inc., Allied Capital Commercial
              Mortgage Trust 1998-1 and the Company and LaSalle National
              Bank Inc. and ABN AMRO Bank N.V.
10.7(4)       Indenture dated as of January 1, 1998 between Allied Capital
              Commercial Mortgage Trust 1998-1 and LaSalle National Bank.
10.8(4)       Amended and Restated Trust Agreement dated January 1, 1998
              between Allied Capital CMT, Inc., LaSalle National Bank Inc.
              and Wilmington Trust Company.
10.9(4)       Guaranty dated as of January 1, 1998 by the Company.
10.10a(14)    Employment agreement dated June 15, 2000 between the Company
              and William L. Walton.
10.10b(14)    Employment agreement dated June 15, 2000 between the Company
              and Joan M. Sweeney.
10.10c(17)    Employment agreement dated June 15, 2000 between the Company
              and John M. Scheurer.
10.11(7)      Amended and Restated Deferred Compensation Plan dated
              December 30, 1998.
10.11a(19)    Amendment to Deferred Compensation Plan dated October 18,
              2000.
10.12(6)      Amended Stock Option Plan.
10.12a(9)     Allied Capital 401(k) Plan dated September 1, 1999.
10.12b(19)    Amendment to 401(k) Plan dated December 31, 2000.
10.13a(4)     Form of Custody Agreement with Riggs Bank N.A. with respect
              to safekeeping.
10.13b(4)     Form of Custody Agreement with LaSalle National Bank.


                                        54
   57



  EXHIBIT
   NUMBER                             DESCRIPTION
  -------                             -----------
           
10.13(15)     Custodian agreement with LaSalle Bank National Association,
              dated July 9, 2001.
10.14a(15)    Agreement and Plan of Merger dated June 18, 2001 by and
              among the Company, Allied Capital Lock Acquisition
              Corporation, and SunSource Inc.
10.15(20)     Control Investor Guaranty Agreement, dated as of March 28,
              2001, between the Company and Fleet National Bank, in its
              capacity as Administrative Agent for the Lenders and
              Business Loan Express, Inc.
10.18(1)      Dividend Reinvestment Plan.
11            Statement regarding computation of per share earnings is
              incorporated by reference to Note 8 to the Company's Notes
              to the Consolidated Financial Statements contained in the
              Company's 2000 Annual Report on Form 10-K for the year ended
              December 31, 2000.
21            Subsidiaries of the Company and jurisdiction of
              incorporation/organization:
                   Allied Investment Corporation             Maryland
                   Allied Capital REIT, Inc.                 Maryland
                   Allied Capital Holdings LLC               Delaware
                   Allied Capital Beteiligungsberatung GmbH   Germany
                   A.C. Corporation                          Delaware


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

      (1) 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.

      (2) 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.

      (3) Incorporated by reference to Exhibit f.7 of Allied I's Pre-Effective
          Amendment No. 2 filed with the registration statement on Form N-2 on
          January 24, 1996 (File No. 33-64629). Assignment to Company is
          incorporated by reference to Exhibit 10.3 of the Company's Annual
          Report on Form 10-K for the year ended December 31, 1997.

      (4) 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).

      (5) 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.

      (6) Incorporated by reference to Exhibit A of the Company's definitive
          proxy materials for the Company's 2000 Annual Meeting of Stockholders
          filed with the Commission on March 29, 2000.

      (7) 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.

      (8) Incorporated by reference to the exhibit of the same name filed with
          the Company's Quarterly Report on Form 10-Q for the period ended June
          30, 1999.

      (9) 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).

     (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, 1999.

     (11) Incorporated by reference to Appendix A to the Company's registration
          statement on Form N-14 filed on the Company's behalf with the
          Commission on November 6, 2000.

     (12) Incorporated by reference to the exhibit of the same name to the
          Company's registration statement on Form N-14 filed on the Company's
          behalf with the Commission on November 6, 2000.

                                        55
   58

     (13) Incorporated by reference to the exhibit of the same name to the
          Company's Quarterly Report on Form 10-Q for the period ended September
          30, 2000.

     (14) Incorporated by reference to the exhibit of the same name to the
          Company's registration statement on Form N-2 (File No. 333-43534)
          filed on August 11, 2000.

     (15) Incorporated by reference to the exhibit of the same name to the
          Company's registration statement on Form N-2 filed on August 10, 2001.

     (16) 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).

     (17) Incorporated by reference to the exhibit of the same name filed with
          the Company's Post-Effective Amendment No. 2 to the registration
          statement on Form N-2 filed on March 21, 2001 (File No. 333-43534).

     (18) Incorporated by reference to the exhibit of the same name filed with
          the Company's Pre-Effective Amendment No. 1 to the registration
          statement on Form N-2 filed on September 12, 2000 (File No.
          333-43534).

     (19) Incorporated by reference to the exhibit of the same name filed with
          the Company's Post-Effective Amendment No. 1 to the registration
          statement on Form N-2 filed on January 19, 2001 (File No. 333-43534).

     (20) Incorporated by reference to the exhibit of the same name filed with
          the Company's Post-Effective Amendment No. 3 to the registration
          statement on Form N-2 filed on May 15, 2001 (File No. 333-43534).

     (21) 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.

     (b) Reports on Form 8-K.

         The Company filed no reports on Form 8-K during the quarter ended June
30, 2001.

                                        56
   59

                                   SIGNATURES

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

                                          ALLIED CAPITAL CORPORATION
                                                         (Registrant)


                                                      
Dated: August 9, 2001                                    /s/ PENNI F. ROLL
                                                         ----------------------------------------------
                                                         Executive Vice President and Chief Financial
                                                         Officer


                                        57