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Capital Source (CSE)

Q3 2010 Earnings Call

October 29, 2010 8:30 a.m. ET

Executives

Dennis Oakes - IR

John Delaney - Founder, Executive Chairman and Chairman of the Board

Jim Pieczynski - Co-CEO and Board Member

Steve Museles - Co-CEO and Board Member

Don Cole - CFO

Analysts

Scott Valentin - FBR Capital Markets

John Hecht - JMP Securities

Michael Taiano - Sandler O'Neill

Sameer Gokhale - Keefe, Bruyette & Woods

Henry Coffey - Sterne Agee

Moshe Orenbuch - Credit Suisse

Bob Napoli - Piper Jaffray

Presentation

Operator

Good morning and welcome to the CapitalSource Third Quarter 2010 earnings conference call. [Operator Instructions.] I would now like to turn the conference over to Dennis Oakes. Please go ahead.

Dennis Oakes

Good morning and thank you for joining the CapitalSource earnings call for the third quarter of 2010. Joining me this morning are John Delaney, our Executive Chairman; Co-Chief Executive Officers, Jim Pieczynski and Steve Museles; and Don Cole, our Chief Financial Officer.

This call is being webcast live on our website and a recording will be available beginning at approximately 12:00 noon, Eastern Time today. Our earnings release and website provide details on accessing the archived call. We have posted a presentation on our website this morning that provides additional detail on certain topics and which will be referred to during our prepared remarks.

Investors are urged to carefully read the forward-looking statements language in our earnings release, but essentially it says that 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.

And 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. More detailed information about risk factors can be found in our reports with the SEC.

John will lead of out the prepared portion of our call, after which we will take your questions. John?

John Delaney

Thank you Dennis. Jim, Steve, and Donald will discuss the details of the quarter, but I wanted to focus my remarks this morning on the company's strategic direction, which is where I spend the majority of my time.

We continue to take the steps necessary to complete our transformation to a pure bank model. We have been at it for over two years, and while we are not quite there yet, each passing quarter brings us closer to completion to what has been a very successful transition.

Returning to sustained profitability was dependent upon finishing the significant reserve build required for our pre-crisis legacy portfolio, particularly in our commercial real estate book. As we have stated previously, the credit performance in this portfolio has stabilized and we expect the current level of loan loss reserves will be adequate to cover anticipated future charge-offs.

The sub-$40 million provision in both the last two quarters, after proceeding seven quarters each averaged $220 million is evidence of the stability we have worked so hard to achieve.

With the deconsolidation of the 2006-A Securitization Trust, we have accelerated de-leveraging of the parent. For the first time this quarter, CapitalSource Bank has a loan balance greater than the parent, which we view as an important prerequisite for our bank holding company application. Achieving bank holding company status and converting to a commercial bank are key strategic objectives for 2011.

Paying down parent company debt, simplifying our capital structure, and turning the parent legacy portfolio into cash over the next 24 to 36 months is another major strategic focus. Doing so will unlock substantial capital, which can then be invested in the bank or returned to shareholders once certain debt obligations are met.

We can envision scenarios where opportunities for good risk-adjusted lending are abundant, in which case we will invest the parent capital in our bank. Alternatively, the bank may have more than adequate capital to pursue its opportunity set, in which case the excess capital will be returned to shareholders.

In my judgment, the biggest variable in this analysis is the massive maturity wall from 2012 to 2014 in both corporate and real estate credit. If the depth of the markets and the conditions of banks and insurance companies have not improved, our bank could have extraordinary opportunities for smart, profitable loan growth.

If, on the other hand, the world is in a good place and liquidity is abundant, we will likely be returning substantial capital to shareholders. It is not clear, as we sit here today, that the corporate credit markets, which I would describe currently as normal, or the real estate credit markets, which I would characterize as just waking up, will be able to handle this maturity wall.

Utilizing our well-proven national direct origination platform to grow assets at CapitalSource Bank is at the heart of our going forward strategy. New loans funded in the past two quarters totaled nearly $850 million and exceeded the total for the previous four quarters combined, which is indicative of the success we are having as economic conditions slowly improve.

Finally, we are mindful of the need to achieve efficiencies, both financial and operating, as we shrink the parent and consolidate our operations within CapitalSource Bank.

I will now turn the call over to Jim, who will discuss our new loan originations in greater detail. Jim?

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