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CapitalSource (CSE)

Q4 2010 Earnings Call

February 24, 2011 8:30 am ET

Executives

Donald Cole - Chief Financial Officer

Douglas Lowrey - Chief Executive Officer of CapitalSource Bank, President of CapitalSource Bank and Director of CapitalSource Bank

James Pieczynski - Co-Chief Executive Officer and Director

Steven Museles - Co-Chief Executive Officer and Director

John Delaney - Co-Founder, Executive Chairman and Member of Asset, Liability & Credit Policy Committee

Dennis Oakes - Senior Vice President of Investor Relations

Analysts

Douglas Harter - Crédit Suisse AG

Michael Taiano - Sandler O’Neill & Partners

Robert Napoli - Piper Jaffray Companies

Sameer Gokhale - Keefe, Bruyette, & Woods, Inc.

Bruce Harting - Barclays Capital

Donald Fandetti - Citigroup Inc

John Stilmar - SunTrust Robinson Humphrey, Inc.

Henry Coffey - Sterne Agee & Leach Inc.

Steven Alexopoulos - JP Morgan Chase & Co

John Hecht - JMP Securities LLC

Presentation

Operator

Good morning, and welcome to the CapitalSource, Inc. Fourth quarter and Full Year 2010 Earnings Conference Call and Webcast. [Operator Instructions] I would now like to turn the conference over to Dennis Oakes. Please go ahead, sir.

Dennis Oakes

Good morning, and thank you for joining the CapitalSource earnings call for the fourth quarter and the full year of 2010.

Joining me this morning are John Delaney, Executive Chairman; Co-Chief Executive Officers, Jim Pieczynski and Steve Museles; CapitalSource Bank CEO Tad Lowrey; and Chief Financial Officer, Don Cole.

This call is being webcast live on our website, and a recording will be available later this morning. Our earnings press release and website provide details on accessing that archived call. We have posted a presentation on our website this morning that provides additional detail on certain topics, 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 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. More detailed information about risk factors can be found in our reports with the SEC.

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

John Delaney

Thank you, Dennis. 2010 was a pivotal year in the company's transformation to a business model, which pairs an independent regional bank and a national lending platform. First evidence of this progress is the fact that 65% of total company assets were in CapitalSource Bank at December 31, 2010, compared to 46% one year earlier. The Bank Loan portfolio grew 25% during the year, while most of its peers struggle to add assets. We also acquired three new lending platforms, improved net interest margin and significantly lowered cost of funds at the bank. We achieved every important aspect of our 2010 plan, including the elimination of over $2.5 billion or 55% of Parent Company debt, reducing it from $4.5 billion at 12/31/2009 to $2 billion at the end of this past year. And we finished the year with $467 million of unrestricted cash at the Parent. Amending the Senior Secured Notes in December provided meaningful financial flexibility expanding our capacity to effectively utilize this cash, including for the redemption of the convertible debentures in July of 2011, which currently have an outstanding balance of $281 million. Our credit improved throughout the year. The quarterly loan loss provisions average less than $30 million for the final three quarters of 2010. In addition, our nonaccrual loan declined from $1.1 billion at the end of 2009 to $700 million at the end of 2010, a 35% drop. I also want to point out that January marked the one year anniversary of our new management structure, which includes Steve and Jim as co-CEOs, Tad as CEO of CapitalSource Bank and my role as Executive Chairman. This arrangement has worked extremely well. Jim is based on the West Coast, where he focuses on loan origination and coordination with the bank's executive management team. Steve, who is based here in Chevy Chase, has focused its attention on our regulatory relationships and shrinking the Parent Company's portfolio. They also are working together to reduce operating expenses and obviously work closely with Tad who has skillfully guided the bank through a highly successful year from a financial and regulatory perspective. Their collective focus on day-to-day operations allowed me to concentrate my efforts this past year on certain important strategic and financial initiatives, which is where my experience and personal context had the greatest impact and which we successfully completed. I want to touch briefly on the company's primary goals and objectives for the year ahead before turning the call over to Jim. Our first priority is to convert CapitalSource Bank to a commercial charter, and Steve will provide an update on our progress as it relates to that. Continuing to turn excess equity at the Parent into cash through normal loan payoffs and asset sales is a second priority. Doing so will permit us to reinvest excess cash in the bank or return it to shareholders. Our third objective is sustained net loan growth at CapitalSource Bank, of course. Achieving these priorities will substantially complete the transformation I spoke about earlier. Finally, our overriding goal is to grow our consolidated profitability, which is dependent upon loan growth, stable credit and reducing operating expenses. CapitalSource is well positioned to achieve these goals. It has a deep bench of talent, a super strong balance sheet and a valuable deposit in asset platform. The wind is now in the company's sails. In a fashion, we have not had the luxury of enjoying for several years, and I'm extremely proud of the work we have done through this important transition and want to personally thank everyone for their hard work and support across these last several years. Jim is up next and will focus his remarks on what an outstanding performance our loan origination teams had this year. Jim?

James Pieczynski

Thank you, John, and good morning, everyone. Our loan origination accelerated as 2010 closed. We funded a total of $536 million in new loans in the fourth quarter, which was a 32% increase over the prior quarter. New funded loans for the year topped $1.6 billion, and we's are expecting 10% to 15% growth in new originations during 2011, which we expect will take our yearly total to the $1.8 billion level. Quarterly production is likely to be uneven, but we expect it to be in the range of $400 million to $500 million per quarter. Based on the loans that have already closed in January and February combined with others that are in our pipeline, we are confident that the first quarter will meet our expectations. New loans in the fourth quarter were spread among most of our loan products with the largest concentration being in equipment finance from our corporate asset finance group. Technology cash flow, healthcare cash flow, multi-family and general commercial real estate were also substantial contributors. Throughout the year, it's important to point out that a different one of our 12 business groups had the highest loan production each quarter, which demonstrates the strength of our diverse national origination platform. Our Healthcare Asset-based Lending business led the first quarter, while our commercial real estate and healthcare real estate groups led the second and third quarters, respectively. As I just mentioned, our corporate asset finance team led the charge in the fourth quarter. Our productivity level in 2010 was a clear demonstration of the strong national lending franchise, which CapitalSource has built over the last decade. Total production was significantly strengthened more over by the addition of three new business segments during the year. The corporate asset finance, small business and professional practice lending groups together accounted for nearly 21% of our new funded loans. Our Multi-family business, which completed its first full year of operation, contributed an additional 14%. Our perennial strength in healthcare lending, including asset base, cash flow and healthcare real estate, were also evidence, contributing another 28% of the total. Result of this is that the bank experienced net loan growth of $143 million in the fourth quarter despite having $232 million of loan payoffs and an additional $89 million of principal payments. That growth was evenly balanced with 32% being asset-based loans, 37% being cash flow and 31% being real estate, which includes multi-family small business and healthcare real estate. We expect average contractual yields to tighten a bit during the course of 2011 due to a combination of increasing middle-market competition and the ongoing shift of our total portfolio to a higher overall percentage of relatively lower-yielding and small business, multi-family and equipment finance loans. Though in many cases those areas tend to produce lower all-in contractual yields, the capital requirements are lower for the multi-family loan and the guaranteed portion of the SDA loans. Because we have a depository platform with a relatively low cost of funds, we will still be able to maintain a very attractive net interest margin despite any decline in overall yields. Our entire originations, underwriting and closing teams did a spectacular job in 2010, and we anticipate an excellent 2011, as well. As we look forward to the year ahead, one of our key strategic goals for the company is to achieve meaningful net loan growth at CapitalSource Bank, while redeploying and reducing excess liquidity, while still maintaining our absolute underwriting discipline. We have the personnel in place to continue to grow our annual production, with an origination engine as strong as we have ever had. As the economy continues to improve, we expect our quarterly asset generation will continue to grow, as well. Steve will now provide details of some of the other key performance metrics for the bank last quarter and give an update on Parent loan sales and our efforts to obtain a Commercial Bank Charter. Steve?

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