Scrappy Lender Proves Survivor: Best in Class

CHEVY CHASE, Md., ( TheStreet) -- CapitalSource ( CSE) has every excuse to be out of business by now. Instead, it is snapping up lending business left behind by weakened competitors like CIT Group ( CIT) and General Electric ( GE).

Like CIT and GE, CapitalSource was a lender that relied on the capital markets to fund its business -- a strategy that proved unsustainable during the financial crisis.

And like CIT, it has not had the benefit of government backing for its debt via the Temporary Liquidity Guarantee Program (TLGP), a program that propped up larger lenders like GE, Bank of America ( BAC) or Wells Fargo ( WFC).

In fact, CapitalSource has received no government support of any kind.

Also, like so many troubled lenders, it extended a lot of credit to the commercial real estate sector between 2005 and 2007.

What CapitalSource had was enough vision to buy Fremont General's retail banking operations last year, giving it access to deposit-based funding before the credit crisis entered its scariest phase with Lehman's collapse in September 2008.

CEO John Delaney says he got worried because packaging loans and selling them into the market, which had initially been a struggle, eventually became disturbingly simple for his company.

"Towards the end, it got so incredibly easy. It was basically one phone call," Delaney says. "We started to become very concerned with those markets, and we started to focus of diversifying the funding."

The move to buy Fremont looks absolutely brilliant today, but Delaney gives himself only partial credit.

"We thought these markets would get tough and we needed to diversify; we didn't think they would close," he says, noting that if he had known how bad things would get he would have taken far more drastic measures.

Indeed, despite its access to bank deposits, CapitalSource saw its share price fall below a dollar in March on concerns it wouldn't be able to extend its loans. The stock was unchanged at $4.04 in early action on Tuesday, a healthy bounce off its recent low, of course, but still well beneath the 52-week peak of $11.63 it reached right around this time last year. The stock's 50-day moving average, according to Yahoo Finance, is $4.29.

But the company did manage to extend its loans where CIT couldn't because the loans represented a much smaller percentage of its total balance sheet. Also, CapitalSource essentially had to negotiate with just two banks to get its extension, rather than hundreds of bondholders.

The company is now shifting all of its new business into its bank, out of which it has written $700 million in new loans this year. Margins on those loans are quite good as CIT is not in a position to lend, and GE has pulled back dramatically.

Having been burned on real estate, CapitalSource is now looking to beef up its health care lending business, as well as trying to qualify as a Small Business Administration lender.

The analyst community doesn't appear convinced yet, with seven of 11 surveyed by Thomson Reuters rating CapitalSource a "hold".

Michael Taiano, an analyst at Sandler O'Neill behind one of those "hold" ratings, believes CapitalSource has something of a credibility issue.

"We believe investors will be skeptical of the guided range of losses given the company's recent track record of exceeding credit loss guidance," he wrote in a recent report.

Delaney acknowledges the criticism.

"We underestimated how bad certain markets would be, commercial real estate in particular," he says.

But Piper Jaffray analyst Bob Napoli believes the market is discounting CapitalSource too heavily. He says the management team is talented, and he believes their estimates of future loan performance are solid.

"They have made a more reasonable case than most that own commercial real estate are willing to admit to," Napoli says. He believes CapitalSource is an above average lender, but argues that even if it proves to be an average one, its stock should trade slightly above book value, which he puts at just under $9 per share.

Above average seems like faint praise for CapitalSource and Delaney. Surely much more exciting adjectives were attached to companies like Lehman Brothers and Bear Stearns not too long ago. They did not survive this crisis, however.

-- Written by Dan Freed in New York.

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