By Alistair Barr

SAN FRANCISCO (Dow Jones) -- Allied Capital shares slumped 40% during morning trading on Wednesday after the small-business lender warned that it may default on its debt.

Allied (ALD) estimated that its asset coverage ratio at the end of 2008 will be less than the 200% required under its revolving credit facility and four outstanding private notes.

"Failure of the Company to satisfy the minimum 200% asset coverage ratio would constitute an event of default," it warned in a statement. That "could have a material adverse impact on the Company's liquidity, financial condition or results of operations."

The company said plans to seek relief from its lenders. Allied is trying to give the lenders and noteholders a first-priority lien, or claim, on its assets, but warned that it probably won't be able to do that by Jan. 30. Without an extension from the lenders and noteholders beyond that date, Allied said it will default.

Allied also said it won't be able to declare dividends or make other distributions to shareholders without a minimum 200% asset coverage ratio. The company also wouldn't be able to borrow more.

Allied shares dropped 40% to $2.16 during morning action on Wednesday.

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