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CapitalSource (CSE)

Q3 2011 Earnings Call

October 27, 2011 5:30 pm ET

Executives

James J. Pieczynski - Co-Chief Executive Officer and Director

John K. Delaney - Chairman and Member of Asset, Liability & Credit Policy Committee

Donald F. Cole - Chief Financial Officer

Dennis Oakes - Senior Vice President of Investor Relations

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

Analysts

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

Donald Fandetti - Citigroup Inc, Research Division

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

Scott Valentin - FBR Capital Markets & Co., Research Division

John Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

Mark C. DeVries - Barclays Capital, Research Division

Michael P. Taiano - Sandler O'Neill + Partners, L.P., Research Division

Presentation

Operator

Good afternoon, and welcome to the CapitalSource Inc. Third Quarter 2011 Earnings 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, Amy. Good afternoon and welcome to the CapitalSource Third Quarter 2011 Earnings Call. With me today are John Delaney, Executive Co-Chairman; Co-Chief Executive Officer, Jim Pieczynski; CapitalSource Bank President and CEO, Tad Lowrey; and Chief Financial Officer, Don Cole.

This call is being webcast live on our 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 also have 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 finally, more detailed information about risk factors can be found in our reports filed with the SEC.

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

John K. Delaney

Thank you, Dennis, and good afternoon, everyone. During the third quarter we made substantial progress on our share repurchase program, cut our recourse debt in half, had the largest quarterly loan growth in more than 4 years, and produced another quarter of very solid financial performance at CapitalSource Bank.

My remarks today will address our return of capital activity and examine how well we are positioned after celebrating the third anniversary of CapitalSource Bank this past July. Jim will then provide more detail on new loan production and our continued efforts to reduce operating expenses. Tad will elaborate on the bank performance, and Don will focus on the significant balance sheet deleveraging in the quarter and our sources off parent liquidity.

As investors know firsthand, the third quarter was a turbulent one for financial services and the financial markets in general. Increased volatility and the downward pressure on financial stocks from June through September, did, however, work to our benefit from the perspective of our share repurchase activities.

During quarter, we acquired just shy of 50 million of our shares, which was well beyond our expectations and reduced total outstanding shares by 15%, which is obviously very significant. We purchased those shares at an average price of $6.19. After utilizing approximately $309 million of available repurchase authority during the third quarter, with had approximately $66 million remaining at quarter end. Given that progress and consistent with the intentions we've announced in the past, our board this week increased our share repurchase authority by another $200 million.

We expect to pay some of our share repurchases through the end of next year to be more measured than this past quarter, however, as you would expect our rate of buybacks will be dependent upon certain liquidity factors including the pace of loan repayments and satisfaction of cash obligations, particularly the $175 million of convertible debentures puttable next July, which is the only remaining near-term recourse debt we have.

Based on our liquidity projections and taking into account our normal operating cash, needs, we are extremely confident in our ability to redeem the converts next July, while maintaining a steady pace of share repurchases.

As I mentioned it earlier, we celebrated the third anniversary of the formation of CapitalSource Bank during the quarter. Since the bank was established in July 2008, we have nearly doubled its loan portfolio while building a healthy net interest margin, producing a solid return on asset and carrying very high capital and liquidity levels. In fact, our bank's performance compares favorably with nearly any comparable back in the country on each of those measures.

Since inception, we have operated under a California industrial bank charter, which is consistent with our extremely efficient and stable deposit the other histology in the current very low interest rate environment. But we've also made clear our longer-term intention to convert to a traditional commercial charter.

Well, the bank has grown, the parent company's loan portfolio and debt have declined dramatically. In just the last 2 years, we have gone from $5.7 billion of loans and $5 billion of recourse and non-recourse debt at the parent on September 30, 2009, to only $1.3 billion of loans and total debt of less than $1 billion at the end of the third quarter. Importantly, $346 million of the remaining debt is non-recourse securitizations and another $437 million are Trust Preferred Securities, which do not mature for more than 20 years. The relative split of consolidated assets has flipped from 61% at the parent and 39% at the bank 2 years ago to 22% and 78% respectively as of today.

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