CapitalSource Inc. (CSE)

Q2 2010 Earnings Call

July 30, 2010 08:30 am ET


Dennis Oakes - IR

John Delaney - Founder, Executive Chairman and Chairman of the Board

Jim Pieczynski - Co-CEO and Board Member

Steve Museles - Co-CEO and Board Member

Don Cole - CFO


Bob Napoli - Piper Jaffray

John Hecht - JMP Securities

Sameer Gokhale - Keefe, Bruyette & Woods

Don Fandetti - Citigroup

Michael Taiano - Sandler O'Neill

Bruce Harting - Barclays Capital

Scott Valentin - FBR Capital Markets

Henry Coffey - Sterne Agee

Moshe Orenbuch - Credit Suisse



Good morning and welcome to the CapitalSource Second Quarter 2010 Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions). After today’s presentation there will be an opportunity to ask questions. (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

Good morning and thank you everyone for joining the CapitalSource earnings call for the second quarter of 2010. Joining me this morning are John Delaney, our Executive Chairman; Co-Chief Executive Officers, Jim Pieczynski and Steve Museles; and Don Cole, our Chief Financial Officer.

This call is being webcast live on our website and a recording will be available beginning at approximately 12:00 noon, Eastern Time today. Our earnings press release and website provide details on accessing the archived call. We have posted a presentation on our website this morning that provides additional detail on certain topics and which will be referred to during our prepared remarks.

Investors are urged to read the forward-looking statements language in our earnings release, but essentially it says that 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.

And 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 filed with the SEC.

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

John Delaney

Thank you, Dennis and good morning everyone. The overall performance of our business this quarter, particularly our return to profitability and the significant increase in new loans [written] at CapitalSource Bank, represent a clear turning point for the company as we continue to successfully put the effects of the financial crisis behind us.

The progress we made this quarter is a reflection of the work we have done strategically and operationally over the last several years. Recognizing the negative effects of both the economic recession and the more severe balance sheet recession, we built substantial reserves over the past six quarters.

The dramatic decline in provisions this quarter to just $25 million is an indication that we have reached the point of relative stability in our portfolio and reflects that provisioning. It also provides further evidence for the view we articulated on our first quarter call that we have reached the point with a level of reserves held against the legacy loan portfolio with sufficient cover or cumulative losses.

In addition to meaningful net loan growth at CapitalSource Bank, credit stabilization and a return to profitability in the second quarter, we also completed the sale of our net leased assets securing highly qualified and experienced team to launch our small business lending effort and reduced the parent company debt by nearly a $1 billion.

Subsequent to the quarter close, we took the step necessary to deconsolidate our 2006-A commercial real estate securitization. Don will provide more detail about the accounting implications of that transaction but the move has three key benefits.

First, by derecognizing the loans in which we have no economic interest, our financial statements will be simplified and more accurately reflect economic reality. Second, the removal of approximately $930 million of loans with a carrying value of $801 million from the parent company balance sheet will accelerate the shift in the relative percentage of the company’s total asset held at CapitalSource Bank which we view as an important step on our path to bank holding company status and continued positioning of the business as a bank. And third, the removal of nearly $900 million of debt from our balance sheet will contribute to the continued deleveraging of the parent which is another goal of ours.

Before turning the call over to Jim, I want to touch briefly on our status of our plan for redeeming the convertible debentures which are puttable one year from now. After repurchase of $17 million at a modest discount took part in the second quarter, the outstanding balance on those converts is just under $300 million given our liquidity and cash flow expectations for the next 12 to 18 months.

We are highly confident that we will have sufficient cash to redeem the converts while maintaining the liquidity needed to run our business. Jim will provide some color on what a very strong quarter for all of our origination teams around the country. Jim?

Jim Pieczynski

Thanks John and good morning to all of you who are listening on the call. Our origination level for this quarter was very strong with new funded loans of $440 million which is the highest level we’ve had in nine quarters and well above our targeted level of $250 to $350 million for the quarter.

As a further testament to our diversified lending platform, the originations were spread among all of our business groups thus adding the benefit of the diversification to the impressive volume. As with the first quarter, the healthcare team underwrote the largest portion of new loans with asset-based cash flow and real estate originations that accounted for nearly 30% of the total funded loans in the quarter. We also funded loans in the security, technology, corporate asset finance, rediscount, commercial real estate and multifamily groups which provided further diversification. In addition to our internally generated loans, we also completed the acquisition of MainStreet Lender which included the purchase of a $100 million portfolio of small business loans, bringing our new loan level for the quarter to well over $0.5 billion. In addition to this, we hired MainStreet’s experienced small business lending team and we have integrated them into our origination platform.

The group also closed down its first loans during the quarter and we are excited about the growth of our prospects in that lending space. We believe that the value of our strong National Direct Origination franchise is quite evident at a time when many of our regional bank peers are reporting intensive loan growth, shrinking balance sheets and rising but under deployed deposits.

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