CapitalSource Management Discusses Q2 2012 Results - Earnings Call Transcript

CapitalSource (CSE)

Q2 2012 Earnings Call

July 30, 2012 5:30 pm ET

Executives

Dennis Oakes - Senior Vice President of Investor Relations

James J. Pieczynski - Chief Executive Officer, Director, Member of Asset, Liability & Credit Policy Committee and President of Capitalsource Bank

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

John A. Bogler - Chief Financial Officer, Executive Vice President - Capitalsource Bank and Chief Financial Officer - Capitalsource Bank

Analysts

Mark C. DeVries - Barclays Capital, Research Division

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

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

Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division

Moshe Orenbuch - Crédit Suisse AG, Research Division

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

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

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

Daniel Furtado - Jefferies & Company, Inc., Research Division

Presentation

Operator

Good afternoon, and welcome to the CapitalSource Second Quarter 2012 Earnings Conference Call. [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, everyone, and thank you for joining the CapitalSource Second Quarter 2012 Earnings Call. With me today are CapitalSource CEO, Jim Pieczynski; CapitalSource Bank Chairman and CEO, Tad Lowrey; and John Bogler, our Chief Financial Officer.

This call is being webcast live on the 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 have also posted a presentation on our website. It provides additional detail on certain topics, which will be covered during our prepared remarks, though we will not be making specific references to the presentation. Investors are urged to carefully read the forward-looking statements' language in our earnings release and investor presentation; but essentially, they say 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.

Jim will now begin the prepared portion of our call. Jim?

James J. Pieczynski

Thank you, Dennis, and good afternoon, everyone. For us, clearly, the earlier than expected reversal of $347 million of our deferred tax asset valuation allowance was a very positive development for us in the second quarter. It substantially increased our tangible book value and moves us one step closer to applying for bank holding company status. Additionally, our loan portfolio grew very nicely with growth of 5% since March 31 and growth of 30% based on where we were at a year ago level. As we said earlier, our expectation for this year is to have 15% to 20% loan growth and we are still on track for that. This growth is still being done at attractive rates, which is resulting in our net interest margin for the second quarter of 4.95%, which is at the high end of our projected range for the year of 4.75% to 5%.

Finally, we repurchased 12 million shares during the quarter, which pushes the total repurchases to over 102 million shares since our buyback initiative began in December of 2010. This has resulted in roughly a 30% reduction in our shares outstanding.

From an overall earnings perspective, excluding the tax benefit resulting from the valuation allowance reversal, our net income for the quarter was $0.17 per share. As Tad will describe, some of the bank metrics showed modest declines from the first quarter levels, but that is generally explained by onetime items and an unusually low net loan loss provision in the prior quarter.

For the first 6 months of the year, however, we are on plan or slightly ahead of plan on key financial performance metrics relating to growth, profitability and credit performance.

After the quarter closed, as expected, we retired the remaining $23 million of our 7 1/4% convertible debentures that were outstanding. Our recourse debt at the Parent has now been reduced by 2/3 over the past 12 months and the only remaining recourse debt we have at the Parent is our long-dated trust preferred securities, which do not begin to mature until 2034.

Recognizing that reversal of the valuation allowance happened 6 months earlier than projected, I wanted to spend a moment explaining the process which led us to conclude that doing so was appropriate this quarter. As part of our normal quarterly review of the valuation allowance with our auditors, we mutually concluded that there was sufficient positive evidence to release the majority of the valuation allowance as of June 30. That evidence included 8 quarters of sustained profitability, meaningful improvement in the reliability of earnings, a significant reduction in impaired loans, and a dramatic decline in the size of the Parent loan portfolio, which gave rise to most of the historical credit losses. The reversal resulted in a tax benefit of $1.49 per share and positively impacted the company's tangible book value, which increased to $7.15 at the end of the quarter. We have previously indicated that once this initial reversal takes place, we would not expect any material reversal of the remaining valuation allowance, which is now $166 million as of June 30. Based on detailed analysis of the valuation allowance, which was undertaken prior to the action taken this quarter, we are not forecasting any additional tax benefit from the remaining allowance.

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