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CapitalSource (CSE)

Q4 2012 Earnings Call

January 29, 2013 5:30 pm ET

Executives

Dennis Oakes - Senior Vice President of Investor Relations & Corporate Communications

James J. Pieczynski - Chief Executive Officer, Director, Member of Asset, Liability & Credit Policy Committee and President of Capitalsource Bank

Douglas H. Lowrey - Chairman of Capitalsource Bank, Chief Executive Officer of Capitalsource Bank and President of Capitalsource Bank

John A. Bogler - Chief Financial Officer, Chief Financial Officer - Capitalsource Bank and Executive Vice President - Capitalsource Bank

Analysts

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division

Mark C. DeVries - Barclays Capital, Research Division

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Moshe Orenbuch - Crédit Suisse AG, Research Division

Donald Fandetti - Citigroup Inc, Research Division

Henry J. Coffey - Sterne Agee & Leach Inc., Research Division

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

Presentation

Operator

Good afternoon and welcome to the CapitalSource Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Dennis Oakes.

Dennis Oakes

Thank you, Amy. Good afternoon and welcome to the CapitalSource Fourth Quarter and Full Year 2012 Earnings Call. With me today are CapitalSource CEO, Jim Pieczynski; CapitalSource Bank Chairman and CEO, Tad Lowrey; and Chief Financial Officer, John Bogler. This call is being webcast live on the company website and a recording will be available later this evening. Our earnings press release and website provide details on accessing the archived call. We have also posted a presentation on our website, which provides additional detail on certain topics which will be covered during our prepared remarks that we will not be making specific reference to the presentation.

Investors are urged to carefully read the forward-looking statements' language in our earnings release and investor presentation. But essentially, they say the following: Statements made on this call, which are not historical facts, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All forward-looking statements, including statements regarding future financial operating results, involve risks, uncertainties and contingencies, many of which are beyond the control of CapitalSource and which may cause actual results to differ materially from anticipated results. CapitalSource is under no obligation to update or alter our forward-looking statements whether as a result of new information, future events or otherwise, and we expressly disclaim any obligation to do so. And finally, more detailed information about risk factors can be found in our reports filed with the SEC. Jim is up first. And following our prepared remarks, we will take questions. Jim?

James J. Pieczynski

Thank you, Dennis, and good afternoon, everyone. 2012 was a terrific year for CapitalSource and CapitalSource Bank. The solid fourth quarter concluded a full year of substantial achievement on a number of key financial metrics, including overall profitability, loan growth, reduced operating expenses and a consistently solid return on assets.

We also made important progress on 4 of our principal key strategic objectives for this year; number one was growing CapitalSource Bank, number two was stabilizing the credit profile of our consolidated portfolio, number 3 was reducing asset and debt at the Parent, and finally number 4 was returning over $460 million of capital to our shareholders.

In addition to this, we reversed over a $350 million valuation allowance on our deferred tax asset this year, which recognizes the value of that asset. The valuation allowance reversal free up an asset that will offset our federal tax liability for at least the next 3 to 4 years, which will create additional liquidity for the Parent. We also redeemed the last of our convertible debt in July, which leads low-cost, trust-preferred securities, which should not be getting mature until 2035, as the only remaining recourse debt at the Parent.

We ended the year strongly with consolidated net income in the fourth quarter of $47 million or $0.22 per diluted share, although that did include $0.06 per share of nonrecurring tax benefit.

Looking ahead to 2013, we remain confident in our ability to leverage our national specialty lending platform with our highly efficient deposit-gathering bank franchise in Southern and Central California in order to produce another year of significant loan growth and increased profitability at CapitalSource Bank, as we simultaneously continue the liquidation of our Parent asset and return of capital to our shareholders.

We also believe we are well positioned to achieve an important strategic objective during 2013, which is to become a bank holding company at the Parent and to obtain a commercial bank charter at CapitalSource Bank. Tad is up next. Tad?

Douglas H. Lowrey

We are extremely pleased with the financial performance of CapitalSource Bank during 2012. Focusing first on the income statement, our pretax income increased 21% over the prior year, which is reflected in 3 key metrics. First, we have experienced loan growth of almost 19%, which was at the high end of our growth expectations. Second, our net interest margin, or NIM, averaged 4.97% for the full year, and in the fourth quarter, our NIM was 4.84%, close to the midpoint of our expected range of 4.75% to 5%. And finally, our return on assets of 1.7%, 170 basis points, was above our long-term expectation of approximately 1.5%.

In the quarter, loan prepayment slowed, which reduced the favorable impact of the accelerated amortization of discounts and fees and contributed to a 13-basis point decline in our net interest margin, as we compare it to the third quarter. However, that's a good trade for us because we value the long-term benefit of loan growth and loan balances far in excess of the short-term benefit of this accelerated accretion that occurs. A lower contractual yield on new loans was another factor in the lower fourth quarter NIM.

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