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Executives

Bill Walton - Chairman and CEO

Shelley Huchel - Director of IR

Penni Roll - CFO

Mike Grisius - Vice Chairman, Investment Committee

Rob Long - Head of Asset Management

Joan Sweeney - COO

Analysts

Faye Elliott - Merrill Lynch

Greg Mason - Stifel Nicolaus

Cyril Battini - Credit Suisse

Jim Bannon - JP Morgan

Vernon Plack - BB&T Capital Markets

Sanjay Sakhrani - KBW

Tom Lamb - Weybosset Research

Corey Gelormini - John Hancock

David Friedman - UBS

John Stilmar - FBR

James Shanahan - Wachovia

Faye Elliott - Merrill Lynch

Allied Capital Corporation (ALD) Q2 2008 Earnings Call August 5, 2008 8:30 AM ET

Operator

Good morning. My name is Darlene and I will be your conference operator today. At this time I would like to welcome everyone to the second quarter 2008 Earnings Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

I will now turn the call over to Mr. Bill Walton, Chairman and CEO of Allied Capital. Sir, you may begin your conference.

Bill Walton

Thanks, Darlene, and welcome to Allied Capital's second quarter 2008 conference call. I am joined today by Joan Sweeney, our Chief Operating Officer, Penni Roll, Our Chief Financial Officer, Shelley Huchel, Director of Investor Relations. We also have with us today Rob Long, Head of Asset Management and Mike Grisius, Vice Chairman of our Investment Committee.

Shelley, would you open the discussion today with the required conference call information and a discussion about forward-looking statements?

Shelley Huchel

Absolutely. Today's call is being recorded and webcast live through our website at www.alliedcapital.com. An archive of today's webcast will also be available on our website as will an audio replay of the conference call. Replay information is included in our press release today and is posted on our website.

Please note that this call is the property of Allied Capital. Any unauthorized rebroadcast of this call in any form is strictly prohibited. I would also like to call your attention to the customary Safe Harbor disclosure in our press release today regarding forward-looking information.

Today's conference call includes forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings please visit our website or call Investor Relations toll free at 888-253-0512.

For today's conference call, we have provided a companion slide deck that complements our discussion and lays out many of the numbers we will discuss. These slides are available in the presentations and reports section of the investor resources portion of our website. We will make reference to the data included in the slides throughout today's call. Finally, as always, there will be a Q&A session after the presentation.

With that, I will turn it over to Bill.

Bill Walton

Thanks, Shelley. We are here today to report on our second quarter 2008 results and to give you an update on our business and the current market environment. As you all know, the capital markets for financial services companies remain challenged and quite volatile.

The credit crisis, which was initially spurred by the meltdown in residential mortgages, has taken a significant toll on investment banks, large commercial banks and regional banks. Now BDCs, like Allied Capital, which were not generally participants in the residential mortgage business, have been affected in largely the same way and the distinctions, I think, have been somewhat ignored.

BDCs have suffered declining stock prices. Dividend yields for BDCs are now at record highs. A market like this presents both challenges and opportunities. Our primary challenge right now is our higher current cost of public equity capital, but the primary opportunity is that the credit crisis continues to present an ample supply of potential high return investments for consideration.

Our goal is to continue to deploy capital in this attractive investment environment while dealing with the fact that raising new public equity capital at current prices is unattractive. So capital efficiency and balance sheet management are the orders of the day.

One of our primary initiatives has been to focus on our current portfolio and exit lower return assets to free up capital for higher return investment opportunities. We have been actively selling and refinancing lower yielding assets since the beginning of the year. Through June 30, we have exited $598 million in investments with an average current return of 8%. This statistic includes the effect of selling $94 million in non-yielding equity positions in our agile transaction in January with Goldman Sachs.

We have invested $594 million through June 30th, comprised of new transactions totaling $494 million and fundings under existing commitments of roughly $100 million. The new transactions were underwritten at an expected internal rate of return from interest fee and potential future gains of approximately 17%.

For the balance of the year and probably well into next year, we plan to continue recycling lower yielding assets. Obviously, reinvesting capital does not increase the size of our portfolio. It does, however, provide the opportunity to improve portfolio yields which generates more operating income per dollar investment and uses our capital more efficiently.

Another initiative we have underway is to capitalize on the current investment environment through managed funds. Paradoxically, private investment capital has become a lower-cost source of investment capital than public equity capital.

Today we have $5 billion in committed private investment capital under management, including the $3.6 billion Unitranche Fund that we co-manage with GE, our two Knightsbridge funds with aggregate capital resources of about $800 million and the senior debt fund with total capital of about $500 million.

We believe, and we have got a lot of feedback from the market that the Unitranche is an ideal capital source for today's markets. Senior capital scarce and the Unitranche investment give a private equity sponsor the convenience of working with the single lender, which improves their ability to win transactions.

We estimate that through origination fees, management fees and investment return, our investment in the Unitranche Fund has the potential to provide mid-teens to low-20% internal rates of return. Through June 30th the funds invested $530 million and our portion of that was $95 million. Mike will provide more color on this later in the call.

We are actively pursuing additional managed fund opportunities as well. These potential funds target various tranches of securities in the middle market companies' capital structure from senior debt down through equity capital. Even when our cost of capital returns to its historical levels, we intend to focus on increasing our private funds under management.

By taking this route, our growth in return opportunities are threefold. One, we are earn fees on the funds under management. Two, we plan to invest in our managed funds and we expect to earn returns from these investments. Three, we have the opportunity to co-invest with these funds, thereby expanding our investment capital base. Rob Long, Head of Asset Management, has a long to-do list, and he will provide more information on managed funds later in the call.

In addition to capital efficiency measures, we have been taking a hard look at the efficiency of our operations. One silver lining to an environment like this is it causes to you take a fresh look at how you do business. We have been analyzing every aspect of our business operations, and we believe that we can reduce costs by working more efficiently without limiting our investment capacity or our ability to manage our existing portfolio.

One of the key insights that resulting from this work was that our expansion through regional offices has added a redundant cost burden to the company. When we opened the Los Angeles and Chicago offices, we did so to source incremental deals through localized business development activities and we believe continuing to have a business development function in these markets makes sense.

However, we have concluded that we can be more efficient in managing our investment activities, if we no longer maintain execution deal teams in these offices. Regional business development is helpful to achieve incremental deal flow, but we can just as effectively probably more effectively execute on a deal from Washington or New York and by doing so more efficiently manage our investment process and our cost structure.

By centralizing our investment teams here in Washington, and in New York, we believe we will maximize our effectiveness without compromising deal flow origination, our investment capability or portfolio oversight. As we transition and consolidate our deal teams in Washington and New York, we will be reducing our headcount by about 30 employees. Much of this reduction will come from our Los Angeles and Chicago offices.

In addition to headcount reductions, we have also evaluated employee compensation and have decided to reduce our bonus pool accrual for the balance of 2008. In 2007, our bonus pool was $40 million. We have decided to reduce that pool to something less than $15 million in 2008. As part of this reduction, I anticipate that I will receive no bonus in 2008 and most of the bonus reduction will occur at the top of the house among senior management members.

We are also looking at reducing other administrative expenses and eliminating costs that we believe do not add incremental value. It is important to emphasize, and I can not stress this enough that we are not cutting costs in areas, where we see opportunities to grow our business like in our asset management activities. In 2008, we have added to our headcount by eight individuals in the asset management area and we will continue to look to hire or acquire additional capacity for asset management and capital markets activities.

On a net basis, however, we have trimmed the organization for increased efficiency and overall we currently estimate that these efficiency measures will translate into cost savings in 2008 and 2009. Penni is going to provide more detail on run rate cost savings later in the call.

Let me shift to another area, where we believe we can create or I might say recreate value. During the second quarter, our net unrealized depreciation on the portfolio was $148 million. The depreciation of the portfolio in this quarter occurred largely in the buyout portfolio and we believe that much of this depreciation is representative of decreased enterprise values and a softening economy and is not a harbinger of future losses.

Buyout investing is a long-term proposition and valuation volatility is normal in a portfolio, if the economy cycles and assets are revalued. Recent value declines in our buyout investments or in those investments, where we have a significant equity position have been largely driven by continued devaluation of financial assets or by softness in EBITDA in a weaker consumer economy.

In a handful of cases, like Ciena, where depreciation has resulted from more difficult circumstances, we are in active workout mode. We will expect some valuation volatility and here there is probably a longer-term horizon to optimize value. We have historically realized strong returns from a buyout investing and those returns have become mainly from adding value and improving the EBITDA of our portfolio companies.

Just as we are analyzing the efficiency of our own company, we are working with our buyout portfolio companies to challenge the efficiency of their operations, so that they are positioned to weather this challenging environment and grow. We have got a white-hot focus on these companies and that are currently depreciated, and we realize, we stand to improve our equity capital position should these companies improve their operations and recover unrealized depreciation overtime.

The other part of the portfolio, looking at the debt portfolio, where we own only nominal equity positions, unrealized depreciation on these assets was approximately 6% of total net unrealized depreciation this quarter. We see this is indicative of the underlying strength of our credit underwriting discipline and the restraint we exercise over the past several years in the overheated credit markets. You can see from our portfolio delinquency, non-accrual, and grading statistics, overall portfolio credit quality remains largely stable.

Allied Capital is celebrating its 50th anniversary this year, and I think what we have shown overtime is that we can adapt quickly to changing markets. We think as we continue to execute on the strategies I have just outlined, recycling our assets, building our asset management business, operating more efficiently and continue to build or rebuild value in the buyout portfolio, we will move our business forward even in an environment, where the public equity markets remain difficult.

Now, Penni, could you discuss our second quarter results.

Penni Roll

Yes, thank you, Bill. Let's start with a discussion of our June 30, 2008 balance sheet. Now, I would like for you to turn to the slide deck, and if you turn to page 3 of your summary balance sheet. We ended the quarter with total assets of $4.9 billion, total debt of $2 billion, and total shareholders equity of $2.8 billion. Our shareholders equity included undistributed earnings of $430.3 million. Our leverage ratio at June 30, 2008 was 0.72 to 1 and net of cash and other liquid investments was 0.64 to 1.

We invested $318.9 million in the second quarter and we were repaid or exited from investments totaling $332.8 million. After including the impact of this quarters valuation changes, our portfolio value was $4.5 billion, as of June 30, 2008. The yield on our interest-bearing portfolio at June 30 increased to 12.7% as compared to 12.3% at March 31st, 2008. In addition to our core investment portfolio, we continue to maintain a portfolio of liquid assets, and at the end of the quarter we had investments in treasuries and other liquid assets of $100.1 million, and cash of $128.8 million.

Let me turn now to capital raising activities in the second quarter. Although the cost of our equity capital has increased recently, earlier in the second quarter, when the stock price was higher, we raised additional equity capital through two public offerings for net proceeds of $231.6 million. Also in June, we issued $193 million of long-term unsecured five and seven-year notes in a private placement at a weighted average coupon of 7.91%. This debt issuance effectively replaced the $153 million of private debt that we repaid in May upon its maturity.

The capital we raised in the second quarter helped strengthen our balance sheet by enabling us to repay borrowings on a revolving line of credit as well. Net borrowings underline of credit decreased during the quarter from $269 million to $81 million. At June 30, 2008, shareholders' equity or net asset value was $15.93 per share, as compared to $16.99 per share at March 31st, 2008.

Now, please turn to slide 4 for a summary of the changes in NAV for the quarter. During the second quarter, net investment income increased NAV by $0.37 per share. Net realized losses decreased NAV by $0.10 per share. Dividends paid to shareholders decreased NAV by $0.65 per share, and NAV decreased by $0.86 per share due to net changes in unrealized appreciation or depreciation. The two equity capital raises increased NAV by $0.18 per share.

As undistributed earnings resulting from spillover income billed and then its paid out NAV will fluctuate accordingly. Please keep in mind that the dividends for the first two quarters of 2008 were paid from 2007's spillover income. So NAV declined. Also as the portfolio changes in value overtime and gains and losses are realized NAV will fluctuate.

Now, let's move to a discussion of our earnings and for this please turn to slide 5. Interest income for the quarter ended June 30, 2008 was $119 million, as compared to $117.8 million in the first quarter of 2008. Dividend income for the second quarter of '08 was $0.2 million, down from $16.9 million in the first quarter. If you remember from last quarter's discussion, first quarter dividend income was unusually high due to the recapitalization of Norwesco and the sale of assets to AGILE 1.

Fees and other income were $15.4 million for the second quarter as compared to $10.3 million in the first quarter. This quarter's fees and other income included structuring fees totaling $5.4 million related to investments made by the Unitranche Fund. Structuring fees of $3 million related to new investments for our own portfolio, management and other fees from portfolio companies of $3.1 million, commitment and guarantee fees of $1.9 million, and funds management fees of $1.6 million. Fees and other income will fluctuate from quarter-to-quarter, depending on the level of investment activity, changes in the portfolio composition, and related management fee income and the level of fund assets under management.

Total operating expenses were $66.6 million in the second quarter of 2008, as compared to $73.4 million in the first quarter. The comparability of quarter-to-quarter expenses was affected by several items, so please turn to slide 6 for a more detailed analysis.

Interest expense; excluding installment sale interest expense was $34.5 million as compared to $35.7 million in the first quarter of 2008. Employee expenses decreased by $9.4 million to $13.3 million in the second quarter from $22.7 million in the first quarter of '08. The decline was primarily attributable to a $14 million reduction in the amount of the 2008 bonus accrual offset by a $4 million increase from the first quarter expense due to the mark-to-market reduction of the Individual Performance Award or IPA in the first quarter.

In the first quarter IPA expense was reduced by $4 million mark-to-market write down in the IPA deferred compensation trust. As you may recall, we distributed the assets of the deferred comp trust in March of '08, so in the second quarter the IPA expense was $2.2 million, which represented the recurring cash component of the expense.

As Bill mentioned earlier, we have also reduced headcount, which after the payment of approximately $3.4 million in severance costs will further reduce compensation expense overtime. To provide some context for these expense reductions, in 2007 employee compensation expense, excluding stock option expense, was $89.2 million. This 2007 expense was reduced by non-cash IPA mark-to-market expense reductions of $14 million. So, 2007 cash compensation expense was approximately $103.2 million, or an average of about $25.8 million per quarter.

Our headcount reductions, combined with reductions in the 2008 bonus pool, are estimated to result in a 2008 third and fourth quarter compensation expense, excluding stock option expense and severance costs, of approximately $17 million to $18 million in the third quarter and $16 million to $17 million in the fourth quarter.

For 2009 budgeting purposes, we are estimating compensation expense, excluding stock option expense, to be in the range of $67 million to $72 million for the entire year, which we believe represents a significant cost reduction. Of course, our current estimates for the third and fourth quarter of 2008 and for the full year of 2009 are subject to change as we see opportunities to add to our asset management staffing or should other circumstances warrant additional hiring or compensation adjustments. As such, our actual costs may differ materially from these estimates.

Employee stock option expense was $3.9 million for the second quarter of '08 as compared to $4.2 million expense in the prior quarter. Our core administrative expenses for the second quarter were $12.3 million as compared to $9.5 million in the first quarter. We typically experience lower admin expenses in the first quarter of the year and higher administrative expenses in the second quarter, partially driven by the proxy season and related annual report costs and stock record expense. Excise taxes were $1.9 million in the second quarter, and we had an income tax expense of $2.2 million for the quarter.

Now, turning back to slide 5, this brings us to net investment income of $63.9 million, $0.37 per share in the second quarter, as compared to $69.5 million or $0.43 per share in the first quarter of 2008, and $25.2 million or $0.16 per share in the second quarter of 2007. Net realized losses for the second quarter were $17.9 million, or $0.10 per share. Gross gains totaled $5 million for the quarter while gross losses were $22.9 million.

Net investment income and net realized losses totaled $46 million for the second quarter of 2008 or $0.27 per share. Net investment income and net realized gains or losses are the primary components of the taxable income that supports the dividend. Dividends paid in the second quarter of '08 were $116.1 million or $0.65 per share, and were paid from taxable spillover income from 2007.

Net unrealized depreciation for the second quarter totaled $148.2 million, or $0.86 per share. Net investment income and net realized losses reduced by net unrealized depreciation resulted in a net loss for the quarter of $102.2 million, or $0.59 per share.

Now, I would like to turn our discussion back to the net change in unrealized appreciation or depreciation. Please turn to slide 8 in the slide deck. For the quarter ended June 30, 2008, the total net change in unrealized appreciation or depreciation was a decrease of $148.2 million. This change resulted from $162.9 million in net unrealized depreciation from changes in portfolio value, a $2.2 million reversal of previously recorded unrealized appreciation associated with the realization of gains, and $16.9 million reversal of previously recorded unrealized depreciation associated with the realization of losses.

For the second quarter, 50 of our private finance portfolio investments appreciated in value while 82 depreciated in value. We continue to receive third party valuation assistance for our private finance portfolio and as you can see from slide 9 we received third party assistance for 94.9% of the private finance portfolio for the second quarter of 2008.

Of the remaining 5.1% of the private finance portfolio, 2.4% represented deals closed during the second quarter. You will be able to review the changes in portfolio valuation in more detail in our Form 10-Q that we will file shortly.

Now let me turn to a discussion of our portfolio quality metrics, grade 4 and 5 assets or workout assets, loans and debts securities not accruing interest, and loans and debts securities over 90 days delinquent.

Generally our credit statistics are relatively stable for the quarter as most of the improvement in the credit statistics results from further depreciation of nonperforming assets.

Please turn to slide 11. Here you see a summary of our grade 4 and 5 assets or workout assets for the last ten years and for the past ten quarters. Grade 4 and 5 assets were 77.9 million or 1.7% of the portfolio value at June 30, 2008, compared to 113 million or 2.4% of the portfolio of value at March 31/08.

On slide 12, we have a similar analysis for loans and debt securities not accruing interest. Loans and debt securities not accruing interest at June 30, '08, were 109.6 million, or 2.4% of the portfolio value, as compared to 150.7 million or 3.3% of the total portfolio value is on March 31/08.

On slide 13, we have a separate analysis for loans and debt securities over 90 days delinquent. Loans and debt securities over 90 days delinquent at June 30, '08 were 23.8 million or 0.5% of the portfolio value.

At March 31, 2008, loans and debt securities over 90 days delinquent were 69.4 million or 1.5% of the portfolio at value.

Now, I would like to move to a discussion about our taxable earnings and spillover income. At December 31, 2007, the company had estimated excess taxable income of $403 million available for distribution to shareholders in 2008. The company's regular quarterly dividend payout for the first two quarters of '08 at $0.65 per share each was 108 million and 116 million respectively.

In July, our Board of Directors declared the third and fourth quarter dividends for 2008, maintaining them at $0.65 per share per quarter. Based on these paid and declared dividends, we expect that a substantial portion of our 2008 dividend payments will be made from excess 2007 taxable earnings.

As a result, we expect that a substantial portion of the taxable income generated in 2008 will be available for distribution in 2009. In addition to spillover taxable income, the company also has approximately $235 million in deferred taxable income resulting from installment sale gains.

These gains may be deferred for tax purposes until the installment notes are sold or are collected in cash. As always, I would like to add a caveat to this discussion with the comment that our 2007 taxable earnings and installment sale gains are estimates and will not be finalized until we file our 2007 tax return in September of this year.

I also want to point out that we experienced numerous temporary and permanent differences in the recognition of book and taxable income, and as a result our estimate of tax undistributed earnings exceeds our book undistributed earnings by over $100 million. I encourage you to read our tax disclosure in our 2007 Form 10-K and our second quarter Form 10-Q for a more detailed discussion of our taxable earnings.

With that Bill, I will turn it back to you.

Bill Walton

Thanks, Penni. Mike and Rob, can you give us an update on our business and today's markets.

Mike Grisius

Sure. Thanks, Bill.

Please turn to slide 16. We invested a total of $319 million this quarter. We funded Unitranche's debt for a portfolio of $10.3 million with an average yield of 10.7%, subordinated debt of 110.9 million with an average yield of 13.2%, including $39.1 million of subordinated notes in the Knightsbridge 2008 CLO, and invested $24 million in junior CLO securities with an average yield of 16.6%.

We made new equity investments totaling $22.6 million. We also originated senior loans of $86 million with an average yield of 6.8%. Note that we generally seek to sell or refinance most of the senior loan capital that we invest in within several minutes after origination. These senior loans can be attractive investments for our managed funds that are seeking senior loan investments.

One of our key activities for debt investing is originating loans for the Unitranche Funds. During the second quarter we invested $63.1 million into the Unitranche Fund so that it could fund four new Unitranche investments. Since its launch in December 2007 through June 30, 2008, the Unitranche Fund has closed six Unitranche investments totaling $530 million of invested capital.

The economics of our investment in the Unitranche Fund are attractive to Allied Capital. In addition to earning current interest on our subordinated notes on the fund we earn management and sourcing fees of 37.5 basis points per annum on the funded assets. We also earn upfront fees on each new transaction close and have the potential to earn excess cash flow from the portfolio on our junior debt investment in the fund as we build a critical mass of income producing assets.

Overall, if you add fees, stated return, and excess spread we believe that our investment in the Unitranche Fund will generate an IRR in a range between the mid-teens to low 20%. Unitranche Fund closed on four investments in the second quarter totaling $388.5 million. The funds investments for the quarter were as follows.

An $88 million investment to support the acquisition of Central Power Products by Norco Inc., and for the recapitalization of Norco, a leading designer and provider of new and rebuilt parts and services for the North American railroads.

A $71.5 million facility for Royal and Company, a company that provides undergraduates student recruitment services to colleges and universities in the U.S. A $64 million financing to support the recapitalization of Industrial Air Tools, a leading distributor of tools, consumable supplies and equipment to offshore oil and gas drillers and refiners.

The recapitalization transaction was led by Allied Capital, the ZF Fund and management of Industrial Air Tools and $165 million financing for York Insurance Services Group, a leading third party insurance claims administrator.

The transaction financed an acquisition, refinanced the company's senior syndicated credit facilities and repaid $46 million of mezzanine debt held by Allied Capital.

Also during the quarter we made some attractive direct investments for our portfolio as well. We invested in the following, a $52 million senior secured note in Abraxas Corporation, a leading government contractor. $41 million of senior secured notes to support the recapitalization of the leading advertising information services company and $13.5 million of debt and equity capital to support the recapitalization of industrial air tools by Allied Capital, ZS fund in management. This investment was done in conjunction with the Unitranche Fund's financing that I just mentioned.

Now I would like to turn the discussion over to Rob to give you a current picture of the private marketplace and an update on recent developments in our asset management activities.

Rob Long

Thanks Mike. The contraction of the senior credit market continues to affect the LBO market, loan pricing and loan structures. After a brief recovery in April and May from the first quarter lows, the senior loan market weakened again in June. Regional commercial banks had been picking up market share in the absence of new CLO activity, but in recent months, demand from these banks seems to be weaker.

As a result, senior debt is more scarce and pricing and structures are improving further from a lenders perspective. The weak senior loan market is having a negative impact on the M&A market. Please turn to slide 17, where you can see that LBO volume continued to decline, falling from an average of approximately $100 billion per quarter in 2007 to $41 billion in the second quarter of 2008.

Total first half 2008 LBO volume was $88.8 billion as compared to $240 billion in the comparable first half of 2007. On slide 18, we see the leveraged loan debt multiples have fallen significantly in 2008. For the second quarter of 2008 industry average total debt multiples for leveraged financings were 5.1 times EBITDA.

In the middle market, structures are more conservative with average total debt multiples at 4.1 times EBITDA. Middle market average senior debt leverage was at a comfortable 3.2 times EBITDA, down significantly from the four to five times multiples we saw over the past few years.

In the middle market and the larger market, mezzanine or subordinated debt has grown to be a larger component of the LBO capital structure. As mezzanine capital has filled the gap in capital structures left by the scarcity of senior lenders.

Turning to slide 19, purchase price multiples have not yet declined in a meaningful way and stood steady at 8.4 times EBITDA through the first half 2008. Even though debt finance hag been greatly reduced, private equity sponsors have continued to buy companies at fairly high prices, choosing to put more equity into deals to get them done.

You can see from slide 20 that equity contributions have remained over 40% of capital structures in the second quarter. In this environment, senior debt markets appear to be the most constrained, and as a result, represent a good relative value in the marketplace. Fortunately, we have been successful in building a base of senior debt managed funds to take advantage of this opportunity in the capital markets.

Now let's turn to a discussion of our managed fund strategy. As Bill mentioned earlier, today we have approximately $5 billion of committed capital in four key managed funds, the Unitranche Fund LLC, the Allied Capital senior debt fund and two Knightsbridge funds.

In addition, our portfolio company Callidus Capital has assets under management dedicated to the senior loan product of approximately $3.6 billion. The total Allied Capital investment platform consists of our own balance sheet assets of approximately $5 billion, managed funds with committed capital of $5 billion and our investments in portfolio companies that manage additional investment assets.

From these resources, we can provide financing to the middle market from senior debt capital through equity capital. Because we believe the senior debt market is particularly attractive today, we have been focusing on growing our fund management activities in the senior loan product.

A year ago, we announced the launch of the Allied Capital senior debt fund, which we have been deploying over the last 12 months and is now about 500 million in size. More recently, we have added the two Knightsbridge middle market CLO vehicles to our managed funds.

Last year, our search for attractive asset pools where we could invest junior capital led us to invest in the $500 million Knightsbridge 2007 CLO. In March, we assumed management of the fund from Deutsche bank. We were able to assume the management contract with no additional investment. Through this relationship, we were able to structure a second $280 million Knightsbridge 2008 CLO which we closed as manager in June of 2008.

Both CLOs are focused on middle market senior loan assets. Because of Allied Capital's proprietary origination capability, our managed funds have access to proprietary source of investment opportunities. We can originate senior loans for middle market companies and subsequently sell those loans to our managed funds. In fact, during the second quarter, we sold 12 senior loan credits totaling $108 million to our managed funds. These assets had a weighted average yield of 8.8%.

Now, we believe the current weak state of the structured finance market may lead to more opportunities like Knightsbridge. We are beginning to see a consolidation trend among similar asset managers and the structured finance market is not likely to reopen for smaller asset managers with only a few funds.

Allied Capital has the benefit of a long history of proven credit performance, and the ability to analyze and invest in funds, where we can assume the role of manager. Our capital is being redeployed at significantly higher rates in this process and we are adding new sources of fee and asset management revenues from these activities.

As Bill discussed earlier, asset management benefits our company in three distinct ways. First, we generate fees from asset management activities, both management and as Mike mentioned asset origination fees. Second, we have the opportunity to invest into our managed funds. Finally, we have the opportunity to co-invest with the managed fund so that we can finance larger transactions and extend the reach of our capital.

We are actively pursuing new managed fund concepts that may provide capital in varying ways to middle market companies. We are also experienced real estate lenders and we are exploring opportunities in this area as well. A third initiative underway is to explore new relationships with other senior lenders or other lenders similar to what we have developed with the Unitranche fund, because we believe that growth through strategic relationships for managed funds provides additional benefits in increasing our origination platform.

I want to emphasize, however, that our focus from an investment and credit stand will remain in areas we know, middle market and commercial real estate finance. This is what we know and we do not plan to stray from our core knowledge base, as we grow our asset management platform.

With that I will turn the discussion back to Bill.

Bill Walton

Thanks, Rob. Before we open the line for questions let me review the dividend. Our Board has recently declared the third and fourth quarter regular quarterly dividends for 2008 of $0.65 per share each. As Penni mentioned, most of our 2008 dividend will be paid from 2007 taxable earnings. Given the substantial capital gains realized in 2007, we estimate today that our 2008 dividends may have a substantial capital gain component of about 75%. As you know, the capital gain component of the dividend is typically taxed at lower 15% tax rate for individuals.

Now, let me summarize a few takeaways from today's call. We are obviously in a difficult public equity capital market, but we believe we are strategically adapting our business in order to move forward successfully. First, as we talked about, we are recycling lower return assets in the portfolio to higher return assets.

Second, we are pushing ahead on several asset management fronts. Fee income from our funds currently under management, both management fee and origination fee was about $7 million this quarter and as assets under management increase, we should see further benefits from fee income investment return on our capital investment managed funds and we should benefit from expanding our origination capabilities through co-investment with managed funds.

Third, we are increasing our operating efficiencies. Finally, we are focusing on building or in some cases rebuilding value in our buyout investments. As you know, buyouts have the potential to significantly move our needle with respect to investment returns and we have ample resource dedicated to increasing the value of our buyout portfolio.

Darlene, can we now open the lines for question.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Faye Elliott with Merrill Lynch.

Faye Elliott - Merrill Lynch

Hi, good morning. I just have a question regarding your unrealized depreciation levels and what we might see for those assets going forward. Do you consider those marks to be likely future losses? Could those come back in the future? Can you just talk a little bit about that?

Bill Walton

The short answer is no. We expect the vast majority of the marks this quarter to be valuation adjustments based on lower levels of EBITDA and in some cases, some valuation changes because of lower multiples for financial assets. We have got some companies in the portfolio, that are in the food business and their margins have been hurt and I think the printing business has been hurt a little bit. The companies are being cutback on some things. So, we are seeing some softness in that business.

We are not seeing business model problems by and large. We have got a couple of them that we have worked to rebuild. Ciena is well-known. I think, they were working to reduce our exposure through paying down the line of credit, which is the project we have underway, but in large part we do not see that there is going to be a permanent loss here.

Faye Elliott - Merrill Lynch

So, these are more growing pain marks as opposed to marks that would permanently impair the shareholders' equity, basically?

Bill Walton

Well, I think it just reflect the decline in current profitability in some of the companies portfolio. As you know, with enterprise value, even if the multiples stay the same, if EBITDA drops, you have got a mark to your equity.

Faye Elliott - Merrill Lynch

Right

Bill Walton

I think that is the period we are in now. We would expect that the economy recovers and as these business, as we mentioned reposition our cost structure to adapt to the new environment we would hope they would return to historical levels of profitability. We would push them back into the win column.

Faye Elliott - Merrill Lynch

Great. If I can ask one more question, do you have any goal for assets under management over, say, the next year, year and a half? Can you give a level where you might like to see your assets under management?

Bill Walton

I can not throw out a number, but I can say that we have got 10 to 12 different initiatives underway, and it is hard to predict with probability, which one of the 10 to 12 or so will fall into the win column or what those dollar amounts would be, but we would hope there would be a material increase in our current amount of assets under management. As Rob probably gave a sense of, we have got a lot of resources and a lot of conversations going on focused on doing just that, which is increasing assets under management.

Faye Elliott - Merrill Lynch

Okay, great. Thank you very much.

Bill Walton

I might add to that we have got a tremendous franchise in our credit culture and our investment culture and our returns and skill sets in commercial real estate in the middle market equity investing and debt investing. I think there is notwithstanding the lack of capital in public markets, there is an awful lot of capital on the sidelines to invest in alternative assets and co-invest with companies with our record.

Rob Long

I would also just add that we have been quite successful in creating our senior platform, and I expect that there will be some additional growth just from the momentum that we have created in this new platform for us. We are also looking at other asset categories to finance other parts of the balance sheet going forward. So I think the short answer to your question is that we have a goal of having more assets under management that will help drive our fees and our income and our net return.

Operator

Your next question comes from the line of Greg Mason with Stifel Nicolaus.

Greg Mason - Stifel Nicolaus

My first question is for Penni. Penni, on slide 12, on your non-accruing interest, those loans fell from $151 million down to $110 million. Can you walk us through how much of that was depreciation of assets versus loans moving in and out?

Penni Roll

It is primarily related to just depreciation in those assets.

Greg Mason - Stifel Nicolaus

So were there any new loans in or any existing loans that came out?

Penni Roll

Yes, we had just a couple of smaller loans that came in, and I think maybe one that came out, but the bulk of the change really relates to depreciation, and existing assets in that category.

Greg Mason - Stifel Nicolaus

Okay. Then also, Penni, typically the third quarter we see a spike in excise taxes and income taxes. Should we expect to see the same thing next quarter, and do you have any type of magnitude we should look at?

Penni Roll

I do not have a magnitude at this point. As you know, we accrue the excise tax as we go throughout the year based on our estimate of excess taxable income for the current year that we will spillover into the next year. That is prorated based upon the taxable income earnings that we earn in a given quarter, and obviously we have six months of the year to go still. So that will be adjusted accordingly as we have our net investment income and net realized or gains or losses occurring in the back half of the year, but realized gains and losses do play a component of that so it is hard to pin down a number.

Greg Mason - Stifel Nicolaus

Would it be appropriate to say because we have not had the big realized gains like we had last year, we might not have the same spike that we have had in the last couple of years?

Penni Roll

No, it is hard to say. Again, we have six months of the year still to go, so we will accrue it as we earn the income.

Greg Mason - Stifel Nicolaus

Okay, great. Then, looking at your four and five category rated ex Ciena is the same number this quarter, does that imply that the $30 million of Ciena is gone, and if so, can you talk about the obligations guaranteed by the line of credit and how you are doing on reducing that exposure and what do you think about that exposure?

Penni Roll

To answer your first question, the value of Ciena this quarter is roughly the value of the senior debt that is outstanding on the company. So you will see in our statement of investments the value of our Class A equity interest is about $9,000. If you look at the guarantees by Allied right now the outstanding on Ciena's revolving line of credit at the end of June was $332 million, and we also had $104 million of standby letters of credit that we posted on our line of credit. So, our total guarantees (inaudible) $440 million. We considered those as part of our valuation for the quarter. So as Bill said, we are really focused right now with regard to Ciena of managing the company in the pool of assets that they have there to gain value from those assets to then repay the line of credit.

Greg Mason - Stifel Nicolaus

Okay. So you feel that the assets there are fine to pay the $440 million.

Penni Roll

Well, as of the June 30 valuation, we believe that the net realizable value of the assets is sufficient to cover the guaranteed amounts.

Greg Mason - Stifel Nicolaus

Okay. One last question here. On the potential optimizing of your portfolio from a yield perspective, what opportunities do you have to sell some of your own on balance sheet assets into the Unitranche Fund, and what do the economics look like in terms of increased interest rates, if you are able to do that?

Mike Grisius

Well, this is Mike Grisius. Let me try to tackle that question. We mentioned in the call that we think there are tremendous opportunities to increase the overall yields in our portfolio, just recognizing where the marketplace is now relative to where it is been in the last couple years. We will not sell directly into the Unitranche vehicle assets that we have on portfolio. However, we are actively considering in a number of cases refinancing some of those individual assets through the Unitranche vehicle, and the Unitranche vehicle itself, as I mentioned earlier, offers much higher return opportunities. Depending on the ultimate portfolio of the performance of the portfolio, anywhere from the mid-teens to mid 20% IRRs is really what the opportunity set is through the Unitranche vehicle.

Rob Long

This is Rob Long. As I mentioned, we did sell 12 loans to the senior debt vehicles, about 108 million, and those funds continue to grow and continue to have the capacity to do this with a similar economic effect in that we have invested in the junior capital of some of the senior funds that generate returns in line with what Mike mentioned for the Unitranche fund. So there is a very powerful effect of redeploying the senior assets.

You may recall that from 2005 to 2007, as a way of managing credit risk we increased our senior debt exposure on the Allied Capital balance sheet to almost or about 25% of the portfolio. We are now seeing a natural repaying of those assets, and then a redeploying of those assets into significantly higher yielding investments.

Greg Mason - Stifel Nicolaus

Great. Thank you.

Operator

Your next question comes from the line of Cyril Battini with Credit Suisse.

Cyril Battini – Credit Suisse

Thank you but all my questions have been asked already.

Operator

Your next question comes from the line of Jim Bannon with JP Morgan.

Jim Bannon - JP Morgan

Thanks a lot. How much, my first question is why do you transfer assets, senior debt assets to the scene debt fund but not Unitranche to the Unitranche Fund, and then beyond that, how much of the repayments in sales this quarter was related either to the transfer of funds or the recapitalization of funds within the BDC that went into one of those outside funds?

Bill Walton

I think the first question is, with respect to the Unitranche Fund with our partner, we look at loans on a case-by-case basis, and there are always things going on in underlying companies that lead to occasions to consider a refinancing. Perhaps there is an acquisition. So together with our partner we have approached it, as Mike outlined, and I think there are significant opportunities out of that portfolio that Allied had previously created of Unitranche Fund to refinance them as they have their natural growth opportunities into the Unitranche Fund. Mike? Do you have anything to add?

Mike Grisius

Well, we look at those deals on a case-by-case basis, and I think as Rob mentioned, we have a co-investor in the fund, so as we look at each of those transactions, needs to stand on its own, and it needs to be really a new financing versus a secondary financing where we are going to sell the asset into the fund. That is just generally not way we have approached it.

Jim Bannon - JP Morgan

Okay.

Mike Grisius

We are active, I think the important point, though is that we are actively assessing our existing Unitranche portfolio and recognize that in many cases those, while they are very solid assets, they represent sub optimal return opportunities. So, in some cases we are look at refinancing those transactions through the Unitranche Fund. In other cases we are expecting them to pay off naturally as the portfolio rolls off, and so the best thing to do is just to wait for that payoff to occur and redeploy those assets into those dollars into higher returning opportunities as well.

Bill Walton

You might keep in mind that we have a fairly conservative approach to the leverage in our firm and in the Unitranche in particular. So Unitranches that were initiated in 2006 that may have had a cash flow sweep of 50% or 75% are paying down their total leverage as the companies perform, and they may be able to refinance in the senior debt market alone. So not every Unitranche stays a Unitranche, and I think that goes to the underlying credit strength of our portfolio as well. Your question with respect to the total amount, I do not have that number offhand.

Penni Roll

The sales to the managed fund.

Bill Walton

The sales to the managed fund.

Penni Roll

About 108 million that we sold to the managed fund this quarter.

Bill Walton

Go ahead.

Jim Bannon - JP Morgan

And...

Bill Walton

Go ahead.

Jim Bannon - JP Morgan

I am sorry; do you anticipate that being sort a steady number or that number increasing over the next few quarters?

Penni Roll

No, I do not think we anticipate that that is a run rate number of any sort. I mean, it really comes down to the senior loans are essentially more of a commodity, if you will, and easier to do a secondary transaction. The Unitranche deals obviously are far more complicated and deeper into the capital structure and are a completely different type of instrument.

Bill Walton

I think we will see some moving into our funds, some moving to refinancing by other parties, so there will still be a fair amount of liquidity as the loans in the portfolio mature.

Jim Bannon - JP Morgan

Sure. Terrific. Thanks a lot.

Operator

Your next question comes from the line of Vernon Plack with BB&T Capital Markets.

Vernon Plack - BB&T Capital Markets

Bill, this question really relates to liquidity and balance sheet management. As you look at the balance sheet with about $2 billion in debt and given the guarantee that you have with Ciena, given some reduction in NAV, with a dividend payout being higher than earnings, and in this current environment where the equity capital markets are closed and assuming they remain closed, is it likely that we will actually see the portfolio shrink a little bit here over the next several quarters, or what is the likelihood that that, in fact, will occur?

Bill Walton

I think the base case is probably stays about the same size, shrinks slightly.

Vernon Plack - BB&T Capital Markets

Okay.

Bill Walton

I think we see enough liquidity in the existing portfolio to recycle the higher yielding assets, that is, I think the main approach to how we want to deploy capital, and so the goal is to keep the portfolio close to the same size at a materially higher yield.

If you look at what we did in the first half of the year, replaced 8% yielding assets with what we hope to be 17% yielding assets, and so we can do that with a bigger chunk of the existing portfolio, we think we will be repositioning it during the tough time in the equity markets, something approaching our historical portfolio yields which is good and also produces a lot of operating income.

Joan Sweeney

Vernon, this is Joan. If you look at slide 3 on the slide deck, I think it is illustrative that the portfolio a year ago, Q2 '07 was $4.4 million. The portfolio yield on the debt portfolio has moved from 11.6% to 12.7%. You can see that directly on the interest income line.

Vernon Plack - BB&T Capital Markets

Right.

Joan Sweeney

The move upward movement there, so this recycling assets, although does not really change the portfolio in size very much, and as Bill said, might even shrink it a little bit, if you can redeploy the yield, it does keep things moving forward.

Vernon Plack - BB&T Capital Markets

All right, right. Okay. I want to make sure that I understand if I look at the guarantee to Ciena of roughly $400 million, can I just assume that at some point that will become an obligation of Allied, I do not completely know whether or not Ciena actually has the capability of paying off that line of credit.

Joan Sweeney

Well, if you look at the guarantee amount on the line of credit at June 30th was $332 million.

Vernon Plack - BB&T Capital Markets

Right.

Joan Sweeney

If you look at that guarantee, Ciena has assets on its balance sheet in the process of liquidating assets to pay down the line of credit. It also will work with its lender to recapitalize its balance sheet over the next several months, so it can move forward. The letters of credit are there supporting securitized assets.

Vernon Plack - BB&T Capital Markets

Okay.

Joan Sweeney

So to the extent that the securitization pool move forward they will be called, if there is not sufficient cash flow in the securitization pools over time. Again, there are also assets supporting that letter of credit as well.

Vernon Plack - BB&T Capital Markets

Okay, and I assume one more if I could, the thought is to essentially restructure Ciena and work on Ciena with John running Ciena to try and fix it.

Joan Sweeney

Right.

Vernon Plack - BB&T Capital Markets

Okay.

Joan Sweeney

As I said, at June 30, the valuation of Ciena covers the $332 million of outstanding on the line of credit today based on current assumption of net realizable value of those banks.

Vernon Plack - BB&T Capital Markets

Okay. All right, thank you.

Operator

Your next question comes from the line of Sanjay Sakhrani with KBW.

Sanjay Sakhrani - KBW

I have been answered. I am trying to reconcile. On slide 16, you show the yields on new investments made in the second quarter. I just would have thought there would be a more meaningful increase relative to what we have seen in the past. It does not seem like the yields have moved that much across each product set. Would you just talk about that a little bit? Thanks.

Bill Walton

Let me try to tackle some of that. I think one of the things that you need to pay attention to, as it relates to the Unitranche Fund in particular, that yield only reflects the contractual yield on the junior securities that are within the fund.

It does not reflect the total IRR opportunity. As we put assets into that fund, we earn income off of the origination of the assets. We also earn a management fee off of the total assets that is deployed in the fund. Of course our investment through the fund is only a percentage of that.

So that has a pretty strong yield enhancement that is not reflected there. In addition to that, overtime, the way that fund is set up, we have an opportunity to earn excess cash flow that is created through the fund waterfall as well. So that in that respect, it is not a complete reflection of what the return opportunity is.

The subordinated debt market is noticeably in this market, there is a certainly a much better opportunity to deploy capital and subordinated debt at higher returns than we have experienced in quite sometime, and it feels like, we can not say this definitively, because the market changes all the time, but it certainly feels like there is solid momentum in the direction of the lenders in the subordinated markets, such that there should be an increasing yield opportunity in that side of our business as well overtime. I think you will see that in the higher yields in the subordinated debt deals that we have done as well.

Rob Long

This is Rob Long. I need to add a few other points. As you see in the quarter, there was a fair amount of senior investments being made. Some of these will be recycled. It is important to know that when we do senior loans they often get syndicated subsequently, so, that is one thing. Second thing, there are some investment grade notes that were component of the CLO investment that we did in the second quarter, so BBB and A notes have lower yields. Some of these may also be recycled. I think that is covering up some of the higher yields in the sub debt category that Mike was talking about, because as we have said it before, the sub debt market is more or like 14% or 15% market today, not a 13% market.

So, I am trying to explain the difference between the numbers that you are looking at for the second quarter addition. There were some other things going on here. Finally, as you look at the CLO math, we show a yield o our equity much as Mike mentioned the yields in the Unitranche fund, this is an effective yield method based on assumptions and early in the time of the CLO you have a ramp-up period. So, the yields that we show our CLO equity are not necessarily what we actually receive to the extent that a CLO is fully ramped and its performance is good it maybe above the levels shown in our assumptions on this page.

Sanjay Sakhrani - KBW

Okay. So it is fair to assume that the yield on the stuff that you will keep on balance sheet is probably higher than what is reflected on the sheet?

Rob Long

I think that is the message that I am saying. They are complicated set of equations.

Sanjay Sakhrani - KBW

Okay. Then in that CLO equity piece, I mean, if you disclosed anything on the assumptions you make to come up with that gain?

Bill Walton

No. We do talk about the assumptions we use for valuation purposes in our 10-K and 10-Qs and we can have a further discussion later if you like. I think I will tell you that across the Callidus vehicles and the Allied vehicles, we have been pretty happy with the performance relative to the assumptions used at the time of the underwriting of the various vehicles, which is to say our strong credit culture has led us to be quite happy with the performance of these vehicles.

Sanjay Sakhrani - KBW

Okay, great. Thank you very much.

Operator

Your next question comes from the line of [Tom Lamb], Weybosset Research.

Tom Lamb - Weybosset Research

Good morning, ladies and gentlemen. One moment, please.

Fla Lewis - Weybosset Research

Hello, it is Fla Lewis. My question was has any consideration been given to buying back stock Allied stock speaking of higher yields?

Bill Walton

Rob, yes.

Rob Long

Yes, it has. We have thought about it. If the price gets to the point where we think it is accretive that is something we would definitely look at very seriously. The short answer is yes. I think it all depends on what is accreting and what is not. There is some level that the stock price is at where we think buying the stock back is the best use of our capital.

Fla Lewis - Weybosset Research

How big a discount to net asset value would you want?

Rob Long

As a shareholder, I do not want a very big one. As somebody buying it back, I do not know, we will have to come back with some math. We will stay tuned. We will let you know.

Fla Lewis - Weybosset Research

I am staying tuned. Thank you.

Operator

Your next question comes from Corey Gelormini with John Hancock.

Corey Gelormini - John Hancock

Yes, thank you. In terms of the unrealized depreciation for the quarter, can you give us a sense of how much was in the various one to five buckets and also your equity holdings and basically was there a big component for any particular holding? I mean, looking at your 4s and 5s and non-accruals, it seems to be minor in those buckets. So, I am assuming it is throughout the portfolio. [I am going] to just and try a get a sense though is it more in the three bucket versus the one and two bucket or is it more in equities?

Joan Sweeney

Hey, Corey, This is Joan. I think if you look at the, first of all, you need to lock at the Q when it comes out because you will have all various disclosures there. As we said, the bulk of the depreciation really came from the buyout portfolio and it was because of enterprise value depreciation.

Corey Gelormini - John Hancock

Yes.

Joan Sweeney

So, you will see that across all grading categories as a result, because we do not think that it is necessarily representative of future loss in certain instances. So, it is only going to be in four or five, five if we think it is indicative of future loss, four it is indicative of investment returns. So, it'll be in various categories. As Bill mentioned, it really was a function of enterprise value.

In the debt portfolio, as Penni mentioned, unrealized depreciation and you could say non-buyout or situations, where we did not have significant equity position that was only about 6% of the depreciation total. So, this really is not a situation a credit situation in the portfolio. It really is just decreasing values of companies in this environment.

Corey Gelormini - John Hancock

In the equity portfolio?

Joan Sweeney

Yes, in equity. Then there is, if you look at it, it is not just equity, its debt, but is more related to buyout investments where we are valuing those based on enterprise value.

Corey Gelormini - John Hancock

Exactly, with the bottom of the structure.

Joan Sweeney

Right, exactly.

Corey Gelormini - John Hancock

Okay, very good. Thank you.

Operator

Your next question comes from the line of David Friedman with UBS.

David Friedman - UBS

You answered on the previous question. Thank you.

Operator

Your next question comes from the line of John Stilmar with FBR.

John Stilmar - FBR

Hello. Thank you very much for taking my question. Most of mine have been answered. Specificity around the senior debt fund, are there any maturities in the senior debt fund that are coming up in the next 12 months to 24 months?

Bill Walton

When you say maturities, of the loans in it or the capital?

John Stilmar - FBR

I am sorry, the capital structure, please.

Bill Walton

We have a structure that is beyond the ultimate maturity of the structure is the later than the longest lived asset in the fund. Having said that, we do expect to do a financing to create a term structure, and overtime, there will be other term financings that happen as the portfolio grows, hopefully, but there is no immediate event of a maturity that would cause us to have to sell any loan.

John Stilmar - FBR

Okay. So there is no maturity in the next 12 months to 18 months, or there is …?

Bill Walton

We have one leverage facility in the fund, and it has a final maturity that is beyond the life of all of the loans in the fund.

John Stilmar - FBR

Okay.

Bill Walton

You probably will look to do a term securitization before the end of the year to create a specific term financing from the structure we have in place today.

John Stilmar - FBR

Okay. That is very helpful. Thank you very much.

Operator

Your next question comes from the line of James Shanahan with Wachovia.

James Shanahan - Wachovia

What was the size and coupon of the privately issued notes that matured in May?

Penni Roll

It was $153 million that matured that had a 5.5% coupon.

James Shanahan - Wachovia

Thank you, Penni. I have been able to piece together some data here, and by my estimates I do not see that you have any meaningful maturities of privately issued debt until, it looks like, November of 2009. Is that accurate?

Penni Roll

That is right. We have next year about $15 million of debt maturing in March which is a very small number, and that is those European notes that we issued years ago. Then we have $252 million that matures in November. So on a relative basis to the size of the balance sheet; we have a small amount of debt maturing in 2009.

James Shanahan - Wachovia

I agree that is small. Based upon, Bill's comments that the portfolio growth would be limited near term, I am wondering if this also has anything to do with the cost of not only equity capital but debt capital, too. Do you have any idea where the company within maybe a range of potential outcomes might be able to issue unsecured senior debt in the marketplace today?

Penni Roll

We just did a private placement or placed note issuance in June where we issued $193 of five and seven-year notes with the weighted average coupon of 7.9%. So, I think that is a pretty good report of where we think we would issue right now.

James Shanahan - Wachovia

Perfect. Thank you.

Operator

Your next question comes from the line of (inaudible) with Aviation Advisory.

Unidentified Analyst

Good morning. Couple questions, please. First of all, the unrealized depreciation. Does that count towards taxable income, and therefore it is not going to have any effect on the spillover income into 2009, the level of dividends you might be able to pay in 2009?

Penni Roll

No, unrealized appreciation and depreciation do not impact taxable income. The primary drivers of our taxable income are realized earnings which are the net investment income, which is the income coming from fees and interest offset with operating and interest expense, plus our net realized gains and losses. So, those unrealized effects do not come into the taxable income equation.

Bill Walton

As you will see when we issue the Q, as you look at where the depreciation is coming from, it is what you would expect when you think about what is going on in the economy. There is some softness in margins and companies where food costs are a major part of their cost structure. There is some softness in some consumer spending items. Apparel that being affected. Anything that is related to gasoline prices and consumers' ability to pay for things some are little bit in the aftermarket automotive things.

If we are in a consumer recession, that is reflected in some of the valuations. Having said that, the companies that we are invested in are market share leaders with substantial presences in the market and there are companies that have gone through a lot of different cycles. So we would expect a lot of this is part of the normal cyclical to and falling of the company, and that is reflected when you have got a buyout portfolio the size of ours.

Mike Grisius

The thing to note there is that unlike our debt portfolio where you have an equity cushion underneath the debt that you put in the company, our buyout portfolio is directly impacted by a bit of softness in the underlying cash flow of the business. That will materialize in the valuation that you see, and you may have a period of time where you end up depreciating the value of that asset as you go through a cycle like this, as Bill said. Fundamentally, what we have done culturally and, I think important to take note of this that when we invest in businesses, we look for businesses that have sound fundamentals.

So there are businesses that have very good business models with differentiated product or service offerings. They are industry leaders, they have got strong capital cat, tries stirks and they are backed by exceptional management teams, and we have stuck to that over the years, year after year, and I will tell you that if you do that as we have, when you come back out of the economy, you see the appreciation effect of that.

In fact many times, when you go through a soft time in the economy and a buyout portfolio, it actually represents and creates very interesting opportunities to grow the long-term value of some of the portfolio of companies as well. So we have a lot of confidence that we will do that with our buyout portfolio. Right now we have laser focus on making sure that we are maximizing the enterprise value of those investments and we have really dedicated extra resources and attention on, in particular, the handful of deals that have been written down for this period of time.

Unidentified Analyst

Thank you. With regard to Ciena, did I understand correctly there is been a further write-down so you have written down all but 900,000 of the equity at this point?

Penni Roll

Yes, there has been a further write-down in the value of our Class A equity interest in Ciena is $9,000.

Unidentified Analyst

Does that mean, as a practical matter, if there would need to be a further write-down or further deterioration of the situation of Ciena that some of those guarantees you provided are likely to be triggered, or you are going to have to provide some other support?

Penni Roll

Well, the guarantee under the current line of credit with the Ciena lenders is callable only in certain events but there would be potential exposure to Allied Capital to the extent that the assets there of Ciena are insufficient to cover the outstanding liabilities to the senior debt holders. So at this point right now at June 30 we believe the net realizable value of the asset covers the outstanding senior debt.

Unidentified Analyst

Okay. Can you elaborate further on why you chose to make a further write-down because there have been repeated write-downs at Ciena. I know it has been a problematic situation. What change in the second quarter that necessitated further write-downs?

Penni Roll

With every asset in the portfolio we go through a revaluation process every quarter and we have to value the investment based on the information we have available to us at the time of the valuation. With regard to Ciena what we are just seeing from the first quarter to the second quarter is just further decline in the value of their assets, including their assets and loan assets on their balance sheet and the value of their residual interest for securitized assets that they have. That is reflective of the current market.

Unidentified Analyst

Okay. Is this part its been an increase in nonperforming assets at Ciena?

Penni Roll

I think it probably you would expect that they would have increasing nonperforming assets in their portfolio because again they are in a small business loan portfolio so as the economy softens, you would expect to see increases in nonperforming assets but I think it is more a function of just playing declining market values for financial assets. I think as they go out and try to test the market to sell assets they are getting real-time marks of what the market is willing to bear for the assets, and as they get that data that is being factored into the valuation.

Unidentified Analyst

Thank you all very much.

Rob Long

Okay, Darlene. We have got time for one more question.

Operator

Your final question comes from the line of Faye Elliott with Merrill Lynch.

Faye Elliott - Merrill Lynch

Hi. Thank you. All of my questions have been answered at this point.

Bill Walton

Okay. Well, thanks, everyone, for listening in on the Q2 call. As I said the conditions are not ideal right now but we think that we have got the weapons to deal with certain initiatives in place, and we will see a recovery of a lot of the value that we may have seen lost this quarter, and we will talk with you about it in Q3.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Allied Capital Corporation Q2 2008 Earnings Call Transcript
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