Summary of PROSPECT CAPITAL CORP

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
(All figures in this item are in thousands except share, per share and other data)

References herein to "we," "us" or "our" refer to Prospect Capital Corporation and its subsidiary unless the context specifically requires otherwise.

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this quarterly report on Form 10-Q. Historical results set forth are not necessarily indicative of our future financial position and results of operations.

Note on Forward Looking Statements

Some of the statements in this report constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained herein involve risks and uncertainties, including statements as to:

º our future operating results;

º our business prospects and the prospects of our portfolio companies;

º the impact of investments that we expect to make;

º our contractual arrangements and relationships with third parties;

º the dependence of our future success on the general economy and its impact on the industries in which we invest;

º the ability of our portfolio companies to achieve their objectives;

º our expected financings and investments;

º the adequacy of our cash resources and working capital; and

º the timing of cash flows, if any, from the operations of our portfolio companies.

We generally use words such as "anticipates," "believes," "expects," "intends" and similar expressions to identify forward-looking statements. Our actual results could differ materially from those projected in the forward-looking statements for any reason, including the factors set forth in "Risk Factors" and elsewhere in this report.

We have based the forward-looking statements included in this report on information available to us on the date of this report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including any annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ materially. In addition to the discussion below, our critical accounting policies are further described in the notes to the financial statements.

Basis of Consolidation

Under the 1940 Act rules, the regulations pursuant to Article 6 of Regulation S-X, and the American Institute of Certified Public Accountants' Audit and Accounting Guide for Investment Companies, we are precluded from consolidating any entity other than another investment company or an operating company which provides substantially all of its services and benefits to us. Our September 30, 2008, June 30, 2008, and September 30, 2007

financial statements include our accounts and the accounts of Prospect Capital Funding, LLC, our only wholly-owned, closely-managed subsidiary that is also an investment company. All intercompany balances and transactions have been eliminated in consolidation.

Investment Classification

We are a non-diversified company within the meaning of the 1940 Act. We classify our investments by level of control. As defined in the 1940 Act, control investments are those where there is the ability or power to exercise a controlling influence over the management or policies of a company. Control is generally deemed to exist when a company or individual possesses or has the right to acquire within 60 days or less, a beneficial ownership of 25% or more of the voting securities of an investee company. Affiliated investments and affiliated companies are defined by a lesser degree of influence and are deemed to exist through the possession outright or via the right to acquire within 60 days or less, beneficial ownership of 5% or more of the outstanding voting securities of another person.

Investments are recognized when we assume an obligation to acquire a financial instrument and assume the risks for gains or losses related to that instrument. Investments are derecognized when we assume an obligation to sell a financial instrument and forego the risks for gains or losses related to that instrument. Specifically, we record all security transactions on a trade date basis. Investments in other, non-security financial instruments are recorded on the basis of subscription date or redemption date, as applicable. Amounts for investments recognized or derecognized but not yet settled are reported as Receivables for investments sold and Payables for investments purchased, respectively, in the Consolidated Statements of Assets and Liabilities.

Investment Valuation

Our Board of Directors has established procedures for the valuation of our investment portfolio. These procedures are detailed below.

Investments for which market quotations are readily available are valued at such market quotations.

Short-term investments that mature in 60 days or less, such as United States Treasury Bills, are valued at amortized cost, which approximates fair value. The amortized cost method involves recording a security at its cost (i.e., principal amount plus any premium and less any discount) on the date of purchase and thereafter amortizing/ accreting that difference between the principal amount due at maturity and cost assuming a constant yield to maturity as determined at the time of purchase. Short-term securities that mature in more than 60 days are valued at current market quotations by an independent pricing service or at the mean between the bid and ask prices obtained from at least two brokers or dealers (if available, or otherwise by a principal market maker or a primary market dealer). Investments in money market mutual funds are valued at their net asset value as of the close of business on the day of valuation.

For most of our investments, market quotations are not available. With respect to investments for which market quotations are not readily available or when such market quotations are deemed not to represent fair value, our Board of Directors has approved a multi-step valuation process each quarter, as described below:

1) our quarterly valuation process begins with each portfolio company or investment being reviewed by our investment professionals with the independent valuation firm;

2) the independent valuation firm engaged by our Board of Directors conducts independent appraisals and makes their own independent assessment;

3) the audit committee of our Board of Directors reviews and discusses the preliminary valuation of our Investment Adviser and that of the independent valuation firm; and

4) the Board of Directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith based on the input of our investment adviser, the independent valuation firm and the audit committee.

Investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company's ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors.

In September, 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements", or FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. We have adopted this statement on a prospective basis beginning in the quarter ended September 30, 2008. Adoption of this statement did not have a material effect on our financial statements for the quarter ended September 30, 2008.

FAS No. 157 classifies the inputs used to measure these fair values into the following hierarchy:

Level 1: Quoted prices in active markets for identical assets or liabilities, accessible by the Company at the measurement date.

Level 2: Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.

Level 3: Unobservable inputs for the asset or liability.

In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to each investment.

The changes to generally accepted accounting principles from the application of FAS 157 relate to the definition of fair value, framework for measuring fair value, and the expanded disclosures about fair value measurements. FAS 157 applies to fair value measurements already required or permitted by other standards. In accordance with FAS 157, the fair value of our investments is defined as the price that we would receive upon selling an investment in an orderly transaction to an independent buyer in the principal or most advantageous market in which that investment is transacted.

Revenue Recognition

Realized gains or losses on the sale of investments are calculated using the specific identification method.

Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing and/or commitment fees associated with investments in portfolio companies are accreted into interest income over the respective terms of the applicable loans. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as interest income.

Dividend income is recorded on the ex-dividend date.

Structuring fees and similar fees are recognized as income as earned, usually when paid. Structuring fees, excess deal deposits, net profits interests and overriding royalty interest are included in other income.

Loans are placed on non-accrual status when principal or interest payments are past due 90 days or more or when there is reasonable doubt that principal or interest will be collected. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management's judgment. Non-accrual loans are restored to accrual status when past due principal and interest is paid and in management's judgment, are likely to remain current. At September 30, 2008 two loans extended to Integrated and one loan extended to WEPI were on non-accrual status. The loan principal of these loans amounted to $54,420 at September 30, 2008.

Introduction

We are a financial services company that primarily lends and invests in middle market, privately-held companies. We are a closed-end investment company that has filed an election to be treated as a business development company under the 1940 Act. We invest primarily in senior and subordinated debt and equity of companies in need of capital for acquisitions, divestitures, growth, development, project financing and recapitalization. We work with the management teams or financial sponsors to seek investments with historical cash flows, asset collateral or contracted pro-forma cash flows.

We seek to be a long-term investor with our portfolio companies. To date we have invested primarily in industries related to the industrial/energy economy. However, we continue to widen our strategy focus in other sectors of the economy to diversify our portfolio holdings.

Statement of Assets and Liabilities Overview

During the three months ended September 30, 2008, net assets have increased by $2,116 from $429,623 to $431,739. This net increase in assets resulted from a $13,998 increase from operations, offset by $11,882 in dividends declared to our stockholders. We recognized net investment income of $23,502 during the quarter and net realized gains on investments of $1,645 that was offset by a decrease in net assets due to changes in unrealized appreciation/ depreciation of investments of $11,149. The result was the $13,998 increase in net assets resulting from operations.

The aggregate value of our portfolio investments was $549,303 and $497,530 as of September 30, 2008 and June 30, 2008, respectively. During the three months ended September 30, 2008, our net cost of investments increased by $62,922, or 12.7%, as we invested in 3 new investments and follow-on investments while we sold one investment, received repayment on another investment, and settled the net profit interests on a third investment. This increased level of investment was financed by increased borrowings on our credit facility and from funds generated from operations. At September 30, 2008, we are invested in 31 long-term portfolio investments (including a net profits interest remaining in Charlevoix).

Investment Activity

During the three months ended September 30, 2008, we completed 3 new investments and several follow-on investments in existing portfolio companies, totaling approximately $70,036. The more significant of these investments are described briefly in the following:

On August 1, 2008, we provided $7,400 in debt financing to Castro Cheese Company, Inc., or Castro, based in Houston, Texas. Castro is a leading manufacturer, marketer, and distributor of Hispanic cheeses and creams.

On August 4, 2008, we provided $15,000 in debt financing to support the take-private acquisition of the TriZetto Group, or TriZetto. TriZetto is a leading healthcare information technology company.

On August 21, 2008, we provided a $26,000 senior secured debt financing and co-invested $2,300 in equity alongside Great Point Partners, LLC ("Great Point") in its growth recapitalization of BNN Holdings Corp. d/b/a Biotronic NeuroNetwork ("Biotronic"), based in Ann Arbor, Michigan. Biotronic is the largest independent national provider of intra-operative neurophysiological monitoring services.

On July 23, 2008 and September 8, 2008 we made follow-on secured debt investments of $400 and $2,700, respectively in Iron Horse Coiled Tubing in support of the build out of additional equipment.

During the three months ended September 30, 2008, we closed-out 2 positions which are briefly described below.

On July 3, 2008, we exercised our warrant for 4,960,585 shares of common stock in Deep Down, Inc. As permitted by the terms of the warrant, we elected to make this exercise on a cashless basis entitling us to 2,618,129 common shares. On August 1, 2008, we sold all the shares acquired receiving $1,649 of net proceeds.

On August 27, 2008, R-V Industries repaid the $7,526 debt outstanding to us.

On September 30, 2008, we settled our net profits interests ("NPIs") in IEC Systems LP ("IEC") and Advanced Rig Services LLC ("ARS") with the companies for a combined $12,576. IEC and ARS originally issued the NPIs to us when we loaned a combined $25,600 to IEC and ARS on November 20, 2007. In conjunction with the NPI realization, we simultaneously reinvested the $12,576 as incremental senior secured debt in IEC and ARS. The incremental debt will amortize over the period ending November 20, 2010.

The following is a quarter-by-quarter summary of our investment activity:

               Quarter-End         Acquisitions (1)       Dispositions (2)
           September 30, 2008    $            70,456    $            10,949
           June 30, 2008                     118,913                 61,148
           March 31, 2008                     31,794                 28,891
           December 31, 2007                 120,846                 19,223
           September 30, 2007                 40,394                 17,949
           June 30, 2007                     130,345                  9,857
           March 31, 2007                     19,701                  7,731
           December 31, 2006                  62,679                 17,796
           September 30, 2006                 24,677                  2,781
           June 30, 2006                      42,783                  5,752
           March 31, 2006                     15,732                    901
           December 31, 2005                       -                  3,523
           September 30, 2005                 25,342                      -
           June 30, 2005                      17,544                      -
           March 31, 2005                      7,332                      -
           December 31, 2004                  23,771                 32,083
           September 30, 2004                 30,371                      -
              Since inception    $           782,680    $           218,584


____________________

(1) Includes new deals, additional fundings, refinancings and PIK interest

(2) Includes scheduled principal payments, prepayments and refinancings

Investment Holdings

As of September 30, 2008, we continue to pursue our investment strategy. Despite our name change to "Prospect Capital Corporation" and the termination of our policy to invest at least 80% of our net assets in energy companies, we currently have a concentration of investments in companies in the energy and energy related industries. Some of the companies in which we invest have relatively short or no operating histories. These companies are and will

be subject to all of the business risk and uncertainties associated with any new business enterprise, including the risk that these companies may not reach their investment objective or the value of our investment in them may decline substantially or fall to zero.

Our portfolio had an annualized current yield of 15.5% and 15.5% across all our long-term debt and certain equity investments as of September 30, 2008 and September 30, 2007, respectively. This yield includes interest from all of our long-term investments as well as dividends from GSHI, NRG and Ajax. We expect the current yield to decline over time as we increase the size of the portfolio. Monetization of other equity positions that we hold is not included in this yield calculation. In each of our portfolio companies, we hold equity positions, ranging from minority interests to majority stakes, which we expect over time to contribute to our investment returns. Some of these equity positions include features such as contractual minimum internal rates of returns, preferred distributions, flip structures and other features expected to generate additional investment returns, as well as contractual protections and preferences over junior equity, in addition to the yield and security offered by our cash flow and collateral debt protections.

As of September 30, 2008, we own controlling interests in Ajax Rolled Ring & Machine, or Ajax, C&J Cladding, LLC, or C&J, Gas Solutions Holdings, Inc., or GSHI, Integrated Contract Services, Inc., or Integrated, Iron Horse Coiled Tubing, Inc., or Iron Horse, NRG Manufacturing, Inc., or NRG, R-V Industries, Inc., or R-V, Worcester Energy Partners, Inc., or WEPI, and Yatesville Coal Holdings, Inc., or Yatesville. We also own affiliated interests in Appalachian Energy Holdings, LLC, or AEH, and Biotronic NeuroNetwork, or Biotronic.

The following is a summary of our investment portfolio by level of control:

                                  September 30, 2008              September 30, 2007
                                Fair           Percent          Fair           Percent
    Level of Control            Value       of Portfolio        Value       of Portfolio
Control                      $   202,324          35.0 %     $   145,645          40.1 %
Affiliate                         33,392           5.8 %          14,631           4.0 %
Non-Control/Non-Affiliate        313,587          54.2 %         191,981          52.8 %
Money Market Funds                28,658           5.0 %          11,348           3.1 %
   Total Portfolio           $   577,961         100.0 %     $   363,605         100.0 %

The following is our investment portfolio presented by type of investment at September 30, 2008 and September 30, 2007, respectively:

                                  September 30, 2008              September 30, 2007
                                Fair           Percent          Fair           Percent
   Type of Investment          Value        of Portfolio        Value       of Portfolio
Money Market Funds           $   28,658            5.0 %     $    11,348           3.1 %
Senior Secured Debt             265,582           46.0 %         218,282          60.0 %
Subordinated Secured Debt       201,769           34.9 %          79,001          21.7 %
Preferred Stock                   8,732            1.5 %             120           0.1 %
Common Stock                     62,136           10.7 %          51,301          14.1 %
Membership Interests              3,447            0.6 %               -           0.0 %
Warrants                          7,637            1.3 %           3,553           1.0 %
   Total Portfolio           $  577,961          100.0 %     $   363,605         100.0 %

The following is our investment portfolio presented by geographic location of the investment at September 30, 2008 and September 30, 2007, respectively:

                             September 30, 2008               September 30, 2007
                           Fair           Percent           Fair           Percent
Geographic Exposure       Value        of Portfolio        Value        of Portfolio
Canada                 $     12,800           2.2 %     $     19,847           5.5 %
Midwest US                   75,890          13.1 %           36,965          10.2 %
Northeast US                 57,522          10.0 %           43,940          12.1 %
Southeast US                128,463          22.2 %           69,055          19.0 %
Southwest US                229,575          39.7 %          167,450          46.0 %
Western US                   45,053           7.8 %           15,000           4.1 %
Money Market Funds           28,658           5.0 %           11,348           3.1 %
   Total Portfolio     $    577,961         100.0 %     $    363,605         100.0 %

The following is our investment portfolio presented by industry sector of the investment at September 30, 2008 and September 30, 2007, respectively:

                                      September 30, 2008               September 30, 2007
                                    Fair           Percent           Fair           Percent
      Industry Sector              Value        of Portfolio        Value        of Portfolio
Biofuels/Ethanol                $          -           0.0 %     $      8,000           2.2 %
Biomass Power                         12,202           2.1 %           24,413           6.7 %
Construction Services                  5,189           0.9 %           16,000           4.4 %
Contracting                            5,000           0.9 %            5,000           1.4 %
Financial Services                    22,987           4.0 %           25,000           6.9 %
Food Products                         27,281           4.7 %                -           0.0 %
Gas Gathering and Processing          63,454          11.0 %           45,000          12.4 %
Healthcare                            56,717           9.8 %                -           0.0 %
Manufacturing                        102,735          17.8 %           48,664          13.4 %
Metal Services                         7,821           1.3 %            5,837           1.6 %
Mining and Coal Production            27,891           4.8 %           16,970           4.6 %
Oilfield Fabrication                  37,109           6.4 %                -           0.0 %
Oil and Gas Production               110,449          19.1 %          134,494          37.0 %
Pharmaceuticals                       11,332           2.0 %                -           0.0 %
Production Services                   12,800           2.2 %           16,253           4.5 %
Retail                                12,407           2.1 %                -           0.0 %
Shipping Vessels                       6,675           1.1 %            6,626           1.8 %
Specialty Minerals                    15,911           2.8 %                -           0.0 %
Technical Services                    11,343           2.0 %                -           0.0 %
Money Market Funds                    28,658           5.0 %           11,348           3.1 %
   Total Portfolio              $    577,961         100.0 %     $    363,605         100.0 %

Investment Valuation

In determining the fair value of our portfolio investments at September 30, 2008, the Audit Committee considered valuations from the independent valuation firm and from management having an aggregate range of $519,641 to $570,010, excluding money market investments.

During the fiscal year ended September 30, 2008, several general economic factors have occurred which have affected the valuation of our investment portfolio.

Generally, interest rates offered on loans similar to those that we have . . .