CapitalSource (CSE)

Q2 2011 Earnings Call

July 29, 2011 8:30 am ET


Donald Cole - Chief Financial Officer

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

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

Dennis Oakes - Senior Vice President of Investor Relations


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

Moshe Orenbuch - Crédit Suisse AG

Donald Fandetti - Citigroup Inc

John Stilmar - SunTrust Robinson Humphrey, Inc.

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

Scott Valentin - FBR Capital Markets & Co.

Steven Alexopoulos - JP Morgan Chase & Co

Jeff Davis - Guggenheim Securities, LLC

Mark DeVries - Barclays Capital

John Hecht - JMP Securities LLC



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Good morning, and welcome to the CapitalSource Inc. Second 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, Andrew, and good morning, everyone. And thanks for joining the CapitalSource Second Quarter 2011 Earnings Call. On the call this morning are Executive Chairman, John Delaney; Co-Chief Executive Officers, Jim Pieczynski and Steven Museles; CapitalSource Bank President and CEO, Tad Lowrey; and Chief Financial Officer, Don Cole.

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 also have posted a presentation on our website earlier this morning, which provide 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 press 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.

Tad will begin our call this morning, and following Don's remarks, we will take your questions. John?

John Delaney

Thank you, Dennis, and good morning, everyone. We're happy to be here this morning, particularly since this week marks the third anniversary of the launch of CapitalSource Bank, which is something that we're all celebrating around here this week and very pleased about.

When we announced our first quarter earnings in April, we indicated that we had 2 strategic priorities. The first was preserving and returning capital to shareholders, and the second was to convert the charter of CapitalSource Bank to a more traditional California-chartered commercial bank. We also said those objectives needed to be balanced or sequenced in a fashion that would create the greatest value for our shareholders. Over the past 3 months, our management team and Board were engaged in an extensive and thorough evaluation process designed to determine how to best achieve those goals. Specifically, we examined 3 options, each with the aid of an outside financial adviser to make the process as rigorous as possible.

First, selling Parent's assets in bulk. Second, potentially splitting the Parent and bank into 2 separate public companies, a bank and a business development corporation that would focus on non-bank lending activities. And third, essentially staying the course from a structural and asset perspective but letting Parent assets run off naturally while paying down debt and aggressively returning capital to shareholders. While finding a way to pursue our 2 primary strategic priorities simultaneously would have been ideal, the options that allowed us to do so involve significant complexity, uncertainty and delay. The Board concluded that the course of action in the best interest of the shareholders is returning all of the Parent's capital to shareholders in a form of either stock buybacks, which are arguably really an investment in the company, and/or dividends and that we should begin pursuing this path immediately. The decision to return Parent capital to shareholders was the preferred path because it creates, in our judgment, the most shareholder value and involves the least risk, even though it will extend the timeframe for conversion to a commercial bank charter.

Parent Company capital represents over half of our total capital, as about 45% of our capital is in CapitalSource Bank. We are committed to returning all of the Parent capital to shareholders, though that course could -- though, of course, we could adjust that decision if attractive and high-returning opportunities creating more value for our shareholders were to present themselves. Considering the high level of bank capital, which we put to work as our first priority, we do not foresee opportunities at this point that would utilize the Parent capital.

Since we are planning for the Parent Company to ultimately become a regulated bank holding company, we are sensitive to the need to maintain appropriate levels of capital and liquidity. As a result, we conducted a capital adequacy analysis including stress tests focused on our capital and funding needs before the Board authorized the first step in our capital deployment plan. Based on that analysis, the Board has increased our share repurchase authority to $185 million, $10 million of which was utilized last December. We chose this level because $175 million is the restricted payment capacity we currently have as of June 30 under the terms of the senior secured notes. It will take us time to achieve the first phase of share repurchases so we intend to immediately begin actively buying back our shares consistent with market conditions and subject to applicable legal, contractual and regulatory constraints.

The Parent Company has been shrinking rapidly over the past 2 years. Our debt has declined by approximately 75%, and total loans at the Parent have declined by close to $5 billion to approximately $1.4 billion at June 30, which includes $611 million loans held in our non-recourse securitizations. Our Parent Company liquidity improved substantially during the same period, growing to nearly $1.2 billion at the end of the second quarter, which is roughly equal to our total recourse debt, which includes $440 million of trust preferred securities, which do not mature for nearly 25 years.

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