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CapitalSource (CSE)

Q1 2011 Earnings Call

April 29, 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

Robert Napoli - Piper Jaffray Companies

Michael Taiano - Sandler O’Neill & Partners

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

Donald Fandetti - Citigroup Inc

Moshe Orenbuch - Crédit Suisse AG

John Stilmar - SunTrust Robinson Humphrey, Inc.

Scott Valentin - FBR Capital Markets & Co.

Henry Coffey - Sterne Agee & Leach Inc.

Unknown Analyst -

Steven Alexopoulos - JP Morgan Chase & Co

John Hecht - JMP Securities LLC

Presentation

Operator

Good morning, and welcome to the CapitalSource Incorporated First Quarter 2011 Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Dennis Oakes. Please go ahead.

Dennis Oakes

Thank you, Maureen. Good morning, and thank you for joining the CapitalSource First Quarter 2011 Earnings Call. With me this morning are John Delaney, Executive Chairman; Co-Chief Executive Officers, Jim Pieczynski and Steve Museles; Chief Financial Officer, Don Cole; and CapitalSource Bank President and CEO, Tad Lowrey.

This call is being webcast live on the company website and a recording will be available later this morning. 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 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 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 furthermore, detailed information about risk factors can be found in our reports filed with the SEC.

John will begin the prepared portion of the call. After Don concludes his remarks, we will take questions. John?

John Delaney

Thanks, Dennis. 2011 is off to a very solid start. In the first quarter at CapitalSource Bank, we funded over $625 million of new loans, increased profitability, improved credit performance and maintained robust capital levels which had been in place since the bank's formation.

At the Parent, we presently have over $1 billion of unrestricted cash. With the exception of higher-than-expected provisioning and other cleanup items for a few loans in the legacy portfolio, our financial performance this quarter was consistent with our expectations and in line with the full year guidance we provided on our fourth quarter call.

Over the last 4 quarters, we have shown a strengthening balance sheet, rapidly paying down debt and accumulating significant cash, significantly improved credit performance which has stabilized but continues to require modest quarterly provisioning for the legacy portfolio, steadily increasing margins and capital levels of CapitalSource Bank and consistent profitability.

All of these developments have allowed us to re-orient our short-term strategic focus from a defensive stance to an intensive, proactive and forward-looking effort to both fund new loans at the bank and improve its profitability.

We have 2 strategic priorities at the company which are to execute on a strategy to utilize in a manner that enhances shareholder value the significant excess capital and liquidity we have accumulated at the Parent and to convert the bank to a commercial charter.

Regarding the latter, we began our pursuit of bank holding company status earlier this year, which is a path to converting the charter. Though we are required to keep the details of our interactions with the Federal Reserve staff confidential, we can report that our dialogue has resulted in a very clear understanding of the actions required for us to be considered for a bank holding company.

In that regard, we are now working to determine the most effective and timely steps for converting CapitalSource Bank to a commercial charter, which we believe, we will ultimately accomplish. We also remain fully committed to making prudent use of excess capital in a manner that is in the best interest of our shareholders and do not intend to simply hold excess capital indefinitely, hoping for a big opportunity to come our way.

There are several possible strategies for deployment of excess capital that we are currently assessing which we could pursue separately or in combination with one another.

In the short-term, we will remain focused on growing assets and enhancing profitability at CapitalSource Bank with our existing platform and charter, both of which happened nicely this quarter. As we assess and implement our strategic initiatives, we are mindful that we need to balance our top 2 strategic priorities. In doing so, it is possible that we may pursue a course that takes longer than we originally planned to convert to a commercial charter and/or to utilize this excess capital.

Jim is up next and he will review the very strong loan originations in the quarter.

James Pieczynski

Thank you, John, and good morning, everybody. New loans funded in the first quarter were $627.5 million, with production coming from several of our business groups. The total for the quarter includes $278 million of multifamily loans, which is a higher production level than we had originally anticipated for the full-year plan of our business. So with this, we see a very reasonable chance to exceed our original initial origination target of $1.8 billion to $1.9 billion.

The new funded loan total for the quarter was 17% higher than it was in the fourth quarter, which is in contrast to our usual experience where typically there are a significant amount of closings in the fourth quarter and a slowdown in the first quarter. Based on the loans that we've also closed in April and others that we have in the pipeline or our credit review process, we are confident that the second quarter will meet our run rate expectations of $400 million to $500 million, which we communicated earlier.

Though the largest concentration of new loans in the first quarter was multifamily, our timeshare receivables and equipment finance businesses were also significant contributors. The value of our diverse group of origination teams was evidenced once again, which as a different group has had the highest level of originations in each of the last 5 quarters.

Also, as discussed on our earnings call last quarter, we continue to expect average contractual yield to tighten a bit during the course of this year due to a combination of increasing competition and the ongoing shift of our total portfolio to a higher overall percentage of relatively lower yielding, small business, multifamily and equipment finance loans.

Multifamily and SBA [Small Business Act] loans in this quarter, for example, accounted for 47% of the total loan production and had an average all-in yield of 5.42%. The 6.96% blended yield on the remainder of the loans originated in the first quarter was consistent with our expectations. It's also important to remember that both the multifamily loans and the guaranteed portion of the SBA loans provide solid returns on equity due to the lower capital requirements required by the banking regulators.

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