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EX-32 - EX-32 - CAPITALSOURCE INCw76117exv32.htm
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EX-10.3 - EX-10.3 - CAPITALSOURCE INCw76117exv10w3.htm
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2009
 
Commission File No. 1-31753
 
CapitalSource Inc.
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State of Incorporation)
  35-2206895
(I.R.S. Employer Identification No.)
 
4445 Willard Avenue, 12th Floor
Chevy Chase, MD 20815
(Address of Principal Executive Offices, Including Zip Code)
 
(800) 370-9431
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of November 2, 2009, the number of shares of the registrant’s Common Stock, par value $0.01 per share, outstanding was 323,080,476.
 


 

 
TABLE OF CONTENTS
 
             
        Page
 
PART I. FINANCIAL INFORMATION
Item 1.
  Financial Statements        
    Consolidated Balance Sheets as of September 30, 2009 (unaudited) and December 31, 2008     3  
    Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2009 and 2008     4  
    Consolidated Statement of Shareholders’ Equity (unaudited) for the nine months ended September 30, 2009     5  
    Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2009 and 2008     6  
    Notes to the Unaudited Consolidated Financial Statements     7  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     57  
  Quantitative and Qualitative Disclosures about Market Risk     95  
  Controls and Procedures     95  
 
  Risk Factors     96  
  Unregistered Sales of Equity Securities and Use of Proceeds     98  
  Exhibits     98  
    99  
    100  


2


 

CapitalSource Inc.
 
 
                 
    September 30,
    December 31,
 
    2009     2008  
    (Unaudited)        
    ($ in thousands)  
 
ASSETS
Cash and cash equivalents
  $ 1,037,818     $ 1,338,563  
Restricted cash
    227,185       419,383  
Investment securities:
               
Available-for-sale, at fair value
    710,312       679,551  
Held-to-maturity, at amortized cost
    250,222       14,389  
                 
Total investment securities
    960,534       693,940  
Mortgage-backed securities pledged, trading
          1,489,291  
Mortgage-related receivables, net
    1,529,795       1,801,535  
Commercial real estate “A” Participation Interest, net
    714,238       1,396,611  
Loans:
               
Loans held for sale
    32,743       8,543  
Loans held for investment
    8,587,607       9,396,751  
Less deferred loan fees and discounts
    (150,300 )     (174,317 )
Less allowance for loan losses
    (517,405 )     (423,844 )
                 
Loans held for investment, net
    7,919,902       8,798,590  
                 
Total loans
    7,952,645       8,807,133  
Interest receivable
    113,541       117,516  
Direct real estate investments, net
    946,459       989,716  
Other investments
    96,229       127,746  
Goodwill
    173,135       173,135  
Other assets
    488,262       1,065,063  
                 
Total assets
  $ 14,239,841     $ 18,419,632  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
               
Deposits
  $ 4,390,486     $ 5,043,695  
Repurchase agreements
          1,595,750  
Credit facilities
    826,611       1,445,062  
Term debt
    4,733,273       5,338,456  
Other borrowings
    1,547,037       1,573,813  
Other liabilities
    315,232       592,136  
                 
Total liabilities
    11,812,639       15,588,912  
Shareholders’ equity:
               
Preferred stock (50,000,000 shares authorized; no shares outstanding)
           
Common stock ($0.01 par value, 1,200,000,000 shares authorized; 323,100,000 and 282,804,211 shares issued and outstanding, respectively)
    3,231       2,828  
Additional paid-in capital
    3,899,604       3,686,765  
Accumulated deficit
    (1,501,669 )     (868,425 )
Accumulated other comprehensive income, net
    25,910       9,095  
                 
Total CapitalSource Inc. shareholders’ equity
    2,427,076       2,830,263  
Noncontrolling interests
    126       457  
                 
Total shareholders’ equity
    2,427,202       2,830,720  
                 
Total liabilities and shareholders’ equity
  $ 14,239,841     $ 18,419,632  
                 
 
See accompanying notes.


3


 

 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2009     2008     2009     2008  
          As Adjusted
          As Adjusted
 
          (Note 3)           (Note 3)  
    (Unaudited)
 
    ($ in thousands, except per share data)  
 
Net investment income:
                               
Interest income:
                               
Loans
  $ 173,980     $ 239,294     $ 556,465     $ 707,913  
Investment securities
    13,421       24,739       47,443       111,496  
Other
    1,126       9,979       3,781       17,150  
                                 
Total interest income
    188,527       274,012       607,689       836,559  
Fee income
    25,281       29,974       81,583       104,882  
                                 
Total interest and fee income
    213,808       303,986       689,272       941,441  
Operating lease income
    27,247       28,140       82,533       80,040  
                                 
Total investment income
    241,055       332,126       771,805       1,021,481  
Interest expense:
                               
Deposits
    22,674       32,178       91,020       32,178  
Borrowings
    82,672       142,672       256,226       491,259  
                                 
Total interest expense
    105,346       174,850       347,246       523,437  
                                 
Net investment income
    135,709       157,276       424,559       498,044  
Provision for loan losses
    221,385       110,261       580,499       147,594  
                                 
Net investment (loss) income after provision for loan losses
    (85,676 )     47,015       (155,940 )     350,450  
Operating expenses:
                               
Compensation and benefits
    29,339       29,473       99,184       99,070  
Depreciation of direct real estate investments
    8,713       8,898       26,515       26,804  
Professional fees
    15,263       7,839       44,543       29,762  
Other administrative expenses
    20,026       15,309       59,138       44,034  
                                 
Total operating expenses
    73,341       61,519       229,380       199,670  
Other (expense) income:
                               
Loss on investments, net
    (8,472 )     (30,010 )     (29,566 )     (34,003 )
(Loss) gain on derivatives
    (10,298 )     2,659       (12,317 )     (20,354 )
(Loss) gain on residential mortgage investment portfolio
    (3 )     (26,956 )     15,308       (73,273 )
Gain (loss) on extinguishment of debt
    11,472       70,057       (41,091 )     82,782  
Other (expense) income, net
    (9,725 )     12,413       (36,192 )     16,898  
                                 
Total other (expense) income
    (17,026 )     28,163       (103,858 )     (27,950 )
                                 
Net (loss) income before income taxes
    (176,043 )     13,659       (489,178 )     122,830  
Income tax expense
    98,193       58       135,947       40,377  
                                 
Net (loss) income
    (274,236 )     13,601       (625,125 )     82,453  
Net income (loss) attributable to noncontrolling interests
    10       (100 )     (28 )     1,480  
                                 
Net (loss) income attributable to CapitalSource Inc. 
  $ (274,246 )   $ 13,701     $ (625,097 )   $ 80,973  
                                 
Net (loss) income per share attributable to CapitalSource Inc.:
                               
Basic
  $ (0.87 )   $ 0.05     $ (2.07 )   $ 0.33  
Diluted
  $ (0.87 )   $ 0.05     $ (2.07 )   $ 0.33  
Average shares outstanding:
                               
Basic
    315,604,434       272,005,048       301,823,130       242,495,601  
Diluted
    315,604,434       272,585,479       301,823,130       243,614,848  
Dividends declared per share
  $ 0.01     $ 0.05     $ 0.03     $ 1.25  
 
See accompanying notes.


4


 

CapitalSource Inc.
 
 
                                                 
    CapitalSource Inc. Shareholders’ Equity              
                      Accumulated
             
                      Other
             
          Additional
          Comprehensive
          Total
 
    Common
    Paid-In
    Accumulated
    Income
    Noncontrolling
    Shareholders’
 
    Stock     Capital     Deficit     (Loss), Net     Interests     Equity  
    (Unaudited)
 
    ($ in thousands)  
 
Total shareholders’ equity as of December 31, 2008
  $ 2,828     $ 3,686,765     $ (868,425 )   $ 9,095     $ 457     $ 2,830,720  
Net loss
                (625,097 )           (28 )     (625,125 )
Other comprehensive loss:
                                               
Cumulative effect of adoption of investment valuation guidance
                397       (397 )            
Unrealized gain, net of tax
                      17,212             17,212  
                                                 
Total comprehensive loss
                                            (607,913 )
Divestiture of noncontrolling interests
                            (303 )     (303 )
Repurchase of common stock
    (6 )     (794 )                       (800 )
Dividends paid
          (730 )     (8,544 )                 (9,274 )
Proceeds from issuance of common stock, net
    203       76,872                         77,075  
Exchange of convertible debt
    198       118,358                         118,556  
Stock option expense
          2,985                         2,985  
Restricted stock activity
    8       16,148                         16,156  
                                                 
Total shareholders’ equity as of September 30, 2009
  $ 3,231     $ 3,899,604     $ (1,501,669 )   $ 25,910     $ 126     $ 2,427,202  
                                                 
 
See accompanying notes.


5


 

 
 
                 
    Nine Months Ended
 
    September 30,  
    2009     2008  
    Unaudited  
    ($ in thousands)  
 
Operating activities:
               
Net (loss) income
  $ (625,125 )   $ 82,453  
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
               
Stock option expense
    2,985       530  
Restricted stock expense
    17,962       26,498  
Loss (gain) on extinguishment of debt
    41,091       (82,782 )
Amortization of deferred loan fees and discounts
    (58,818 )     (71,576 )
Paid-in-kind interest on loans
    (17,434 )     13,430  
Provision for loan losses
    580,499       147,594  
Amortization of deferred financing fees and discounts
    48,146       89,086  
Depreciation and amortization
    25,309       28,608  
Provision (benefit) for deferred income taxes
    130,607       (18,807 )
Non-cash loss on investments, net
    31,495       35,119  
Non-cash loss on property and equipment disposals
    21,180       9,270  
Unrealized loss on derivatives and foreign currencies, net
    22,280       10,756  
Unrealized (gain) loss on residential mortgage investment portfolio, net
    (60,567 )     51,810  
Net decrease in mortgage-backed securities pledged, trading
    1,485,133       2,508,787  
Amortization of discount on residential mortgage investments
    11       (8,398 )
Accretion of discount on commercial real estate “A” participation interest
    (20,487 )     (12,694 )
Decrease in interest receivable
    5,893       16,077  
Decrease in loans held for sale, net
    31,055       246,376  
Decrease (increase) in other assets
    485,411       (43,402 )
Decrease in other liabilities
    (271,734 )     (96,676 )
                 
Cash provided by operating activities
    1,874,892       2,932,059  
Investing activities:
               
Decrease (increase) in restricted cash
    192,198       (1,282,422 )
Decrease in mortgage-related receivables, net
    215,090       175,556  
Decrease in commercial real estate “A” participation interest, net
    702,860       206,730  
Acquisition of CS Advisors CLO II
          (18,619 )
Decrease in loans, net
    344,641       292,458  
Cash received (paid) for real estate
    15,710       (10,154 )
Acquisition of marketable securities, available for sale, net
    (36,991 )     (845,813 )
Acquisition of marketable securities, held to maturity, net
    (227,591 )      
Reduction of other investments, net
    5,401       5,917  
Net cash acquired in FIL transaction
          3,187,037  
Acquisition of property and equipment, net
    (17,456 )     (3,564 )
                 
Cash provided by investing activities
    1,193,862       1,707,126  
Financing activities:
               
Payment of deferred financing fees
    (39,161 )     (59,477 )
Deposits accepted, net of repayments
    (653,552 )     (122,115 )
Repayments under repurchase agreements, net
    (1,595,750 )     (1,039,954 )
Repayments on credit facilities, net
    (628,489 )     (860,855 )
Borrowings of term debt
    311,874        
Repayments of term debt
    (907,634 )     (1,682,698 )
Borrowings (repayments) under other borrowings
    76,174       (68,505 )
Proceeds from issuance of common stock, net of offering costs
    77,075       601,881  
Repurchase of common stock
    (800 )      
Proceeds from exercise of options
          361  
Tax expense on share-based payments
          (6,548 )
Payment of dividends
    (9,236 )     (290,614 )
                 
Cash used in financing activities
    (3,369,499 )     (3,528,524 )
                 
(Decrease) increase in cash and cash equivalents
    (300,745 )     1,110,661  
Cash and cash equivalents as of beginning of period
    1,338,563       178,699  
                 
Cash and cash equivalents as of end of period
  $ 1,037,818     $ 1,289,360  
                 
Supplemental information:
               
Noncash transactions from investing and financing activities:
               
Assumption of FIL assets and liabilities
  $     $ 3,292,185  
Beneficial conversion option on convertible debt
          52,946  
Exchange of common stock for convertible debentures
    61,618        
Assets acquired through foreclosure
    48,660       94,030  
Assumption of note payable
          25,647  
Acquisition of real estate
          2,120  
Conversion of noncontrolling interests into common stock
          34,819  
Intangible lease liability adjustments
          2,397  
 
See accompanying notes.


6


 

 
CapitalSource Inc.
 
 
Note 1.   Organization
 
CapitalSource Inc. (“CapitalSource,” and together with its subsidiaries other than CapitalSource Bank, the “Parent Company”), a Delaware corporation, is a commercial lender that, through its wholly owned subsidiary, CapitalSource Bank, provides financial products to middle market businesses and provides depository products and services in southern and central California. Prior to the formation of CapitalSource Bank, CapitalSource conducted its commercial lending business through its other subsidiaries, whereas subsequent to CapitalSource Bank’s formation, substantially all new loans have been originated at CapitalSource Bank. The Parent Company’s commercial lending activities consist primarily of satisfying existing commitments made prior to CapitalSource Bank’s formation.
 
We currently operate as three reportable segments: 1) CapitalSource Bank, 2) Other Commercial Finance, and 3) Healthcare Net Lease. Our CapitalSource Bank segment comprises our commercial lending and banking business activities; our Other Commercial Finance segment comprises our loan portfolio and residential mortgage business activities in the Parent Company; and our Healthcare Net Lease segment comprises our direct real estate investment business activities.
 
For the three and nine months ended September 30, 2008, we presented financial results through three reportable segments: 1) Commercial Banking, 2) Healthcare Net Lease, and 3) Residential Mortgage Investment. Beginning in the first quarter of 2009, changes were made in the way management organizes financial information to make operating decisions, resulting in the activities previously reported in the Commercial Banking segment being disaggregated into the CapitalSource Bank and Other Commercial Finance segments and the results of our Residential Mortgage Investment segment being combined into the Other Commercial Finance segment. We have reclassified all comparative prior period segment information to reflect our current segments. For financial information about our segments, see Note 20, Segment Data.
 
Note 2.   Summary of Significant Accounting Policies
 
Interim Consolidated Financial Statements Basis of Presentation
 
Our interim consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments and eliminations, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The current period’s results of operations are not necessarily indicative of the results that ultimately may be achieved for the year. The interim consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in our Form 8-K filed on July 2, 2009, which recasted the financial statements and footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2008, due to the retrospective adoption of new accounting pronouncements, as filed with the Securities and Exchange Commission on March 2, 2009 (“Form 10-K”).
 
The financial statements reflect our consolidated accounts, including all of our consolidated subsidiaries and the related consolidated results of operations with all intercompany balances and transactions eliminated in consolidation.
 
We have conducted our subsequent events review through November 4, 2009.
 
Reclassifications
 
Certain amounts in prior period consolidated financial statements have been reclassified to conform to the current period presentation, including the reclassification of noncontrolling interests.


7


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Except as discussed below, our accounting policies are described in Note 2, Summary of Significant Accounting Policies, of our audited consolidated financial statements as of December 31, 2008, included in our Form 10-K.
 
New Accounting Pronouncements
 
The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC” 105), Generally Accepted Accounting Principles (“GAAP”), which established the FASB Accounting Standards Codification (the “Codification” or “ASC”) as the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification became non-authoritative. The Codification was made effective by the FASB for periods ending on or after September 15, 2009. This quarterly report reflects the guidance in the Codification.
 
In December 2007, the FASB issued guidance establishing principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. It also provided a framework for recognizing and measuring the goodwill acquired in the business combination and determined what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The effective date of adoption is for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We adopted this guidance, and it did not have a material impact on our consolidated financial statements.
 
In February 2008, the FASB issued guidance delaying the effective date of fair value measurement disclosures for all non financial assets and liabilities, except those items recognized or disclosed at fair value on an annual or more frequently recurring basis, until years beginning after November 15, 2008. We adopted this guidance, and it did not have a material impact on our consolidated financial statements.
 
In April 2009, the FASB issued further guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly when compared with normal market activity for the asset or liability (or similar assets or liabilities) and, further, identifying circumstances that indicate a transaction is not orderly. It applies to all assets and liabilities within the scope of accounting guidance that require or permit fair value measurements, except items cited as scope exceptions in the Codification. The guidance is effective prospectively for interim and annual reporting periods ending after June 15, 2009. We adopted this guidance, and it did not have a material impact on our consolidated financial statements.
 
In March 2008, the FASB issued guidance related to disclosures about derivative instruments and hedging activities, which was intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity’s derivative instruments and hedging activities and their effects on the entity’s financial position, financial performance, and cash flows. The guidance applies to all derivative instruments within the scope of the Derivatives and Hedging Activities Topic of the Codification. It also applies to non-derivative hedging instruments and all hedged items designated and qualifying as hedges under this topic. The effective date of adoption is the beginning of the first fiscal year beginning after November 15, 2008. We adopted this guidance, and it did not have a material impact on our consolidated financial statements.
 
In April 2009, the FASB issued guidance to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. It applies to all assets acquired and liabilities assumed in a business combination that arise from contingencies that would be within the scope of existing guidance on accounting for contingencies, if not


8


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
acquired or assumed in a business combination, except for assets or liabilities arising from contingencies that are outside this scope of this new guidance. This guidance is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We adopted this guidance, and it did not have a material impact on our consolidated financial statements.
 
In April 2009, the FASB amended its guidance on other-than-temporary impairment for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The additional guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. It is effective for interim and annual reporting periods ending after June 15, 2009. We adopted this guidance, and it did not have a material impact on our consolidated financial statements.
 
In April 2009, the FASB amended its guidance on the fair value of financial instruments to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This also amended existing guidance on interim financial reporting to require those disclosures in summarized financial information at interim reporting periods. This guidance is effective for interim reporting periods ending after June 15, 2009. We adopted this guidance, and it did not have a material impact on our consolidated financial statements. For additional information about fair value of our financial instruments, see Note 19, Fair Value Measurements.
 
In May 2009, the FASB issued guidance establishing principles and requirements for subsequent events accounting and disclosure, setting forth general principles of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide specific guidance on the accounting treatment for subsequent events or transactions. This is effective prospectively for interim or annual financial periods ending after June 15, 2009. We adopted this guidance, and it did not have a material impact on our consolidated financial statements.
 
In June 2009, the FASB amended its guidance on the accounting for transfers and servicing of financial assets and extinguishments of liabilities and established additional disclosures about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It applies to all entities and eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets. This guidance is effective as of the beginning of our first annual reporting period that begins after November 15, 2009 for all transfers occurring subsequent to the adoption date. We will adopt this guidance on January 1, 2010, and have not completed our assessment of the impact of its adoption on our consolidated financial statements.
 
In June 2009, the FASB issued new guidance changing how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. This requires enhanced disclosures about variable interest entities that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. This guidance also requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. It does not change the existing scope for accounting and assessment of variable interest entities, however it adds entities previously considered qualifying special-purpose entities, as the concept of these entities was eliminated. This guidance is effective for our first annual reporting period that begins after November 15, 2009. We will adopt this guidance on January 1, 2010, and have not completed our assessment of the impact of its adoption on our consolidated financial statements.


9


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
Note 3.   Retrospective Application of Accounting Pronouncements
 
In May 2008, the FASB issued guidance clarifying the requirements for accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) and specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The guidance applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement, unless the embedded conversion option is required to be separately accounted for as a derivative under the Derivatives and Hedge Accounting Topic of the Codification. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and requires retroactive application for all periods presented in the consolidated financial statements.
 
In December 2007, the FASB issued guidance, which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary and clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The guidance also amends certain consolidation procedures for consistency with the requirements of the Consolidation Topic of the Codification. The effective date for application of this guidance is the beginning of the first fiscal year beginning after December 15, 2008.
 
On January 1, 2009, we applied this guidance to our convertible debt and non-controlling interests retrospectively. The adoption of this guidance affected financial statement line items for the periods presented below as follows:
 
Consolidated Balance Sheets
 
                         
    September 30, 2009  
    As Computed Prior to
    As Reported after
       
    Adoption     Adoption     Effect of Change  
    ($ in thousands)  
 
Other assets
  $ 483,298     $ 488,262     $ 4,964  
Other borrowings
    1,557,390       1,547,037       (10,353 )
Additional paid-in capital
    3,883,572       3,899,604       16,032  
Accumulated deficit
    (1,500,954 )     (1,501,669 )     (715 )
 
                         
    December 31, 2008  
    As Computed Prior to
    As Reported after
       
    Adoption     Adoption     Effect of Change  
    ($ in thousands)  
 
Other assets
  $ 1,060,332     $ 1,065,063     $ 4,731  
Other borrowings
    1,560,224       1,573,813       13,589  
Additional paid-in capital
    3,683,065       3,686,765       3,700  
Accumulated deficit
    (855,867 )     (868,425 )     (12,558 )


10


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidated Statements of Income
 
                         
    Three Months Ended September 30, 2009  
    As Computed Prior to
    As Reported after
       
    Adoption     Adoption     Effect of Change  
    ($ in thousands, except per share amounts)  
 
Interest expense: borrowings
  $ 84,595     $ 82,672     $ (1,923 )
Net loss
    (276,149 )     (274,236 )     1,913  
Net income attributable to noncontrolling interests(1)
    10       10        
Net loss attributable to CapitalSource Inc. 
          (274,246 )     (274,246 )
Net loss per share attributable to CapitalSource Inc.(2)
                       
Basic
    (0.87 )     (0.87 )      
Diluted
    (0.87 )     (0.87 )      
 
                         
    Three Months Ended September 30, 2008  
    As Originally Reported     As Adjusted     Effect of Change  
    ($ in thousands, except per share amounts)  
 
Interest expense: borrowings
  $ 148,318     $ 142,672     $ (5,646 )
Net income
    8,055       13,601       5,546  
Net loss attributable to noncontrolling interests(1)
    (100 )     (100 )      
Net income attributable to CapitalSource Inc. 
          13,701       13,701  
Net income per share attributable to CapitalSource Inc.(2)
                       
Basic
    0.03       0.05       0.02  
Diluted
    0.03       0.05       0.02  
 
                         
    Nine Months Ended September 30, 2009  
    As Computed Prior to
    As Reported after
       
    Adoption     Adoption     Effect of Change  
    ($ in thousands, except per share amounts)  
 
Interest expense: borrowings
  $ 268,069     $ 256,226     $ (11,843 )
Net loss
    (636,996 )     (625,125 )     11,871  
Net loss attributable to noncontrolling interests(1)
    (28 )     (28 )      
Net loss attributable to CapitalSource Inc. 
          (625,097 )     (625,097 )
Net loss per share attributable to CapitalSource Inc.(2)
                       
Basic
    (2.11 )     (2.07 )     0.04  
Diluted
    (2.11 )     (2.07 )     0.04  
 


11


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
                         
    Nine Months Ended September 30, 2008  
    As Originally Reported     As Adjusted     Effect of Change  
    ($ in thousands, except per share amounts)  
 
Interest expense: borrowings
  $ 497,346     $ 491,259     $ (6,087 )
Net income
    74,886       82,453       7,567  
Net income attributable to noncontrolling interests(1)
    1,480       1,480        
Net income attributable to CapitalSource Inc. 
          80,973       80,973  
Net income per share attributable to CapitalSource Inc.(2)
                       
Basic
    0.31       0.33       0.02  
Diluted
    0.31       0.33       0.02  
 
 
(1) The caption “Noncontrolling interests expense” was changed to “Net (loss) income attributable to noncontrolling interests” to conform to the presentation requirements of the Consolidation Topic of the Codification.
 
(2) The caption “Net (loss) income per share” was changed to “Net (loss) income per share attributable to CapitalSource Inc.” to conform to the presentation requirements of the Consolidation Topic of the Codification.
 
Consolidated Statements of Cash Flows
 
                         
    Nine Months Ended September 30, 2009  
    As Computed Prior to
    As Reported after
       
    Adoption     Adoption     Effect of Change  
    ($ in thousands)  
 
Net loss
  $ (636,996 )   $ (625,125 )   $ 11,871  
Operating activities:
                       
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
                       
Amortization of deferred financing fees and discounts
    59,989       48,146       (11,843 )
Financing activities:
                       
Payment of dividends
    (9,208 )     (9,236 )     (28 )
 
                         
    Nine Months Ended September 30, 2008  
    As Originally Reported     As Adjusted     Effect of Change  
    ($ in thousands)  
 
Net income
  $ 74,886     $ 82,453     $ 7,567  
Operating activities:
                       
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Amortization of deferred financing fees and discounts
    95,173       89,086       (6,087 )
Financing activities:
                       
Payment of dividends
    (289,134 )     (290,614 )     (1,480 )

12


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
Note 4.   Cash and Cash Equivalents and Restricted Cash
 
As of September 30, 2009 and December 31, 2008, our cash and cash equivalents and restricted cash balances were as follows:
 
                 
    September 30,
    December 31,
 
    2009     2008  
    ($ in thousands)  
 
Cash and due from banks(1)
  $ 194,051     $ 249,610  
Interest-bearing deposits in other banks(2)
    30,915       19,963  
Other short-term investments(3)
    795,932       984,237  
Investment securities(4)
    244,105       504,136  
                 
Total cash and cash equivalents and restricted cash
  $ 1,265,003     $ 1,757,946  
                 
 
 
(1) Represents principal and interest collections on loan assets held by securitization trusts or pledged to credit facilities and escrows for future expenses related to our direct real estate investments. A portion of these collections are invested in money market funds that invest primarily in U.S. Treasury securities, and in 2008, repurchase agreements secured by U.S. Treasury securities. The restricted portion of the balance was $37.4 million and $60.9 million as of September 30, 2009 and December 31, 2008, respectively. Cash and due from bank accounts for CapitalSource Bank were $141.9 million and $132.3 million as of September 30, 2009 and December 31, 2008, respectively. Included in this balance for CapitalSource Bank were $100.7 million and $52.1 million in deposits at the Federal Reserve Bank (“FRB”) as of September 30, 2009 and December 31, 2008, respectively. The cash and due from bank accounts for CapitalSource Bank were not restricted.
 
(2) Represents principal and interest collections on loan assets pledged to credit facilities. The restricted portion was $11.0 million and $8.4 million as of September 30, 2009 and December 31, 2008, respectively.
 
(3) Represents principal and interest collections on loan assets held by securitization trusts or pledged to credit facilities and also includes short-term investments held by CapitalSource Bank. Principal and interest collections are invested in money market funds that invest primarily in U.S. Treasury securities, and in 2008, repurchase agreements secured by U.S. Treasury securities. The restricted portion was $178.8 million and $150.0 million as of September 30, 2009 and December 31, 2008, respectively. The CapitalSource Bank cash is invested in (i) short term investment grade commercial paper which is rated by at least two of the three major rating agencies (S&P, Moody’s or Fitch) and has a rating of A1 (S&P), P1 (Moody’s) or F1 (Fitch), and (ii) in money market funds that invest primarily in U.S. Treasury and Agency securities and repurchase agreements secured by the same.
 
(4) Includes discount notes with AAA ratings totaling $244.1 million and $303.0 million as of September 30, 2009 and December 31, 2008, respectively, issued by the Federal Home Loan Bank System (“FHLB”), Fannie Mae or Freddie Mac. These investments have a remaining weighted average maturity of 40 days and 61 days as of September 30, 2009 and December 31, 2008, respectively. CapitalSource Bank pledged these notes to the FHLB of San Francisco (“FHLB SF”) as a source of borrowing capacity as of September 30, 2009. There was no restricted portion as of September 30, 2009, and $200.0 million was restricted as of December 31, 2008.
 
Note 5.   Mortgage-Related Receivables and Related Owner Trust Securitizations
 
In February 2006, we purchased beneficial interests in special purpose entities (“SPEs”) that acquired and securitized pools of adjustable rate, prime residential mortgage loans. These beneficial interests are subordinate to other interests issued by the SPEs that are held by third parties. We determined that the SPEs were variable interest entities designed to create and pass along risks related to the credit performance of the underlying residential mortgage loan portfolio.


13


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
We concluded that we were the primary beneficiary of the SPEs as we expected that our subordinated interests would absorb a majority of the expected losses related to these risks. As a result, we consolidated the assets and liabilities of such entities for financial statement purposes. In so doing, we also determined that the SPEs’ interest in the underlying mortgage loans constituted, for accounting purposes, receivables secured by underlying mortgage loans. Since initial consolidation, there has been no change to our assessment of the nature of the risks associated with the SPEs, and no events have occurred that would give rise to reconsidering our conclusion that we are the primary beneficiary of the SPEs or that the SPEs are variable interest entities.
 
We recorded mortgage-related receivables, as well as the principal amount of related debt obligations incurred by the SPEs to fund these receivables, in our consolidated balance sheets as of September 30, 2009 and December 31, 2008. The carrying amounts of the assets and liabilities of the SPEs reported in our consolidated balance sheet as of September 30, 2009, were $1.5 billion for both assets and liabilities. We are restricted from pledging or exchanging the assets held by the SPEs. Cash flows from these underlying residential mortgage loans are designated to pay off the related liabilities. Recourse is limited to the assets held in the SPE and does not extend to the general credit of CapitalSource. As a result, our economic exposure is limited to the beneficial interests we purchased in the respective securitization trusts. Our initial economic exposure related to these beneficial interests was approximately $109.1 million at the time of their purchase. This exposure has since decreased to approximately $3.5 million as of September 30, 2009, primarily as a result of recorded charge offs and reserves.
 
Recognized mortgage-related receivables are, in economic substance, mortgage loans. Such mortgage loans are all prime, hybrid adjustable-rate loans. At acquisition, the mortgage loans that back our mortgage-related receivables had a weighted average loan-to-value ratio of 73% and a weighted average Fair Isaac & Co. (“FICO”) score of 737.
 
As of September 30, 2009 and December 31, 2008, the carrying amount of our residential mortgage-related receivables, net, including accrued interest, the allowance for loan losses, and the balance of unamortized purchase discounts, was $1.5 billion and $1.8 billion, respectively. As of September 30, 2009 and December 31, 2008, approximately 97% and 95%, respectively, of mortgage-related receivables were financed with permanent term debt in the amounts of $1.5 billion and $1.7 billion, respectively, and were recognized by us through the consolidation of SPEs. This term debt was recorded as a component of term debt in our consolidated balance sheets.
 
As of September 30, 2009 and December 31, 2008, mortgage-related receivables, whose underlying mortgage loans are 90 or more days past due or were in the process of foreclosure were as follows:
 
                 
    September 30,
  December 31,
    2009   2008
    ($ in thousands)
 
Mortgage-related receivables whose underlying mortgage loans are 90 or more days past due or are in the process of foreclosure(1)
  $ 127,723     $ 51,348  
Percentage of mortgage-related receivables
    8.17 %     2.82 %
 
 
(1) Mortgage loans 90 or more days past due are also placed on non-accrual status.
 
During the three and nine months ended September 30, 2009, the carrying value of foreclosed assets increased by $1.5 million and $0.3 million, respectively. As of September 30, 2009 and December 31, 2008, the carrying values of the foreclosed assets were $7.6 million and $7.3 million, respectively.


14


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The activity in the allowance for loan losses on mortgage-related receivables for the nine months ended September 30, 2009 and 2008, was as follows:
 
                 
    Nine Months Ended
 
    September 30,  
    2009     2008  
 
Balance as of beginning of period
  $ 9,266     $ 796  
Provision for loan losses
    66,000       11,876  
Charge offs, net of recoveries
    (40,858 )     (4,888 )
                 
Balance as of end of period
  $ 34,408     $ 7,784  
                 
 
During the three and nine months ended September 30, 2009, we recognized interest income on our mortgage-related receivables of $18.3 million and $59.4 million, respectively, as a component of interest income on loans in the consolidated statements of income. For the three and nine months ended September 30, 2008, we recognized interest income on our mortgage-related receivables of $23.1 million and $72.1 million, respectively, as a component of interest income on loans in the consolidated statements of income.
 
Note 6.   Commercial Lending Assets and Credit Quality
 
As of September 30, 2009 and December 31, 2008, our total commercial loan portfolio had an outstanding balance of $9.4 billion and $10.9 billion, respectively. Included in these amounts were loans held for investment, loans held for sale, a commercial real estate participation interest (“the “A” Participation Interest”), and related interest and fee receivables (collectively, “Commercial Lending Assets”). As of September 30, 2009 and December 31, 2008, interest and fee receivables totaled $102.8 million and $93.3 million, respectively.
 
Commercial Real Estate “A” Participation Interest
 
As of September 30, 2009, the carrying value of the “A” Participation Interest was $714.2 million, representing our share of a $3.6 billion pool of commercial real estate loans and related assets, net of a remaining purchase discount of $18.8 million.
 
The activity with respect to the “A” Participation Interest for the period from December 31, 2008 to September 30, 2009 was as follows ($ in thousands):
 
         
“A” Participation Interest as of December 31, 2008
  $ 1,396,611  
Principal payments
    (702,860 )
Discount accretion
    20,487  
         
“A” Participation Interest as of September 30, 2009
  $ 714,238  
         
 
During the three and nine months ended September 30, 2009, we recognized $10.7 million and $35.3 million, respectively, in interest income on the “A” Participation Interest.
 
The “A” Participation Interest is reported at the outstanding principal balance less the associated discount. Interest income on the “A” Participation Interest is accrued as earned and recorded as a component of interest income on loans in our consolidated statements of income. The discount is accreted into interest income over the estimated life of the instrument using the interest method.
 
The “A” Participation Interest is governed by a participation agreement that is structured to minimize our exposure to credit risk. We have pari passu rights in the underlying loans pursuant to which we receive 70% of all borrower principal repayments from the underlying loans and properties. In addition, under the participation agreement, iStar FM Loans, LLC, the holder of the “B” Participation Interest, assumed all future funding obligations with respect to the loans underlying the participation agreement. Accordingly, although the holder


15


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
of the “B” Participation Interest continues to increase its percentage of the overall funding of the underlying loans, we continue to receive 70% of all borrower repayments. Thus, the structure of the “A” Participation Interest accelerates the paydown of the “A” Participation Interest, relative to the paydown of the overall underlying portfolio of assets. This accelerated paydown serves to reduce our exposure to credit risk. Additionally, the “A” Participation Interest is structured so that we do not have loan and property-level risk. We receive payments based on the cash flows of the entire underlying pool of assets and not any one asset in particular. Therefore, we will incur a loss only if the portfolio, as a whole, fails to repay at least to the extent of the “A” Participation Interest balance.
 
As of September 30, 2009, no allowance for loan losses was deemed necessary with respect to the “A” Participation Interest.
 
Loans Held for Sale
 
Loans held for sale are recorded at the lower of cost or fair value in our consolidated balance sheets. During the three and nine months ended September 30, 2009, we recognized a net pre-tax loss of $7.7 million and $10.7 million, respectively, on the sale of loans. During the three and nine months ended September 30, 2008, we recognized net pre-tax losses of $27,000 and net pre-tax gains of $2.6 million, respectively, on the sale of loans.
 
During the three and nine months ended September 30, 2009, loans held for investment with a carrying amount of $55.8 million and $130.8 million, respectively, were transferred to loans held for sale based on management’s intent with respect to the loans, resulting in no losses in the three month period and $11.4 million in losses for the nine months due to valuation adjustments.
 
Loans Held for Investment
 
Loans held for investment are recorded at the principal amount outstanding, net of deferred loan costs or fees and any discounts received or premiums paid on purchased loans. We maintain an allowance for loan losses for loans held for investment, which is calculated based on management’s estimate of incurred loan losses inherent in our loan portfolio as of the balance sheet date. Activity in the allowance for loan losses related to our loans held for investment for the nine months ended September 30, 2009 and 2008, respectively, was as follows:
 
                 
    Nine Months Ended
 
    September 30,  
    2009     2008  
    ($ in thousands)  
 
Balance as of beginning of period
  $ 423,844     $ 138,930  
Provision for loan losses
    514,499       135,718  
Charge offs, net of recoveries
    (420,938 )     (110,793 )
                 
Balance as of end of period
  $ 517,405     $ 163,855  
                 
 
As of September 30, 2009 and December 31, 2008, the principal balances of contractually delinquent loans, non-accrual loans and impaired loans were as follows:
 
                 
    September 30,
    December 31,
 
    2009     2008  
    ($ in thousands)  
 
Loans 30-89 days contractually delinquent
  $ 131,567     $ 299,322  
Loans 90 or more days contractually delinquent
    395,537       141,104  
Non-accrual loans(1)
    993,543       439,547  
Impaired loans(2)
    1,306,719       692,278  
 
 
(1) Includes loans with aggregate principal balances of $359.6 million and $110.3 million as of September 30, 2009 and December 31, 2008, respectively, which were also classified as loans 90 or more days contractually


16


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
delinquent and loans with aggregate principal balances of $104.0 million and $49.4 million as of September 30, 2009 and December 31, 2008, respectively, which were classified as 30-89 days contractually delinquent. Includes non-performing loans classified as held for sale that had an aggregate principal balance of $25.1 million and $14.5 million as of September 30, 2009 and December 31, 2008, respectively.
 
(2) Includes loans with aggregate principal balances of $366.1 million and $128.9 million as of September 30, 2009 and December 31, 2008, respectively, which were also classified as loans 90 or more days contractually delinquent, loans with aggregate principal balances of $131.6 million and $133.2 million as of September 30, 2009 and December 31, 2008, respectively, which were classified as 30-89 days contractually delinquent, and loans with aggregate principal balances of $968.5 million and $423.4 million as of September 30, 2009 and December 31, 2008, respectively, which were also classified as loans on non-accrual status. The net carrying value of impaired loans was $1.3 billion and $683.1 million as of September 30, 2009 and December 31, 2008, respectively, prior to the application of allocated reserves.
 
We consider a loan to be impaired when, based on current information, we determine that it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the original loan agreement. In this regard, impaired loans include loans where we expect to encounter a significant delay in the collection of, and/or shortfall in the amount of contractual payments due to us. As of September 30, 2009 and December 31, 2008, we had $727.7 million and $359.3 million of impaired loans, respectively, with allocated reserves of $91.4 million and $87.4 million, respectively. As of September 30, 2009 and December 31, 2008, we had $579.0 million and $333.0 million, respectively, of loans that we assessed as impaired and for which we did not record any allocated reserves based upon our belief that it is probable that we ultimately will collect all principal amounts due.
 
The average balances of impaired loans during the three and nine months ended September 30, 2009 were $1.2 billion and $1.0 billion, respectively, and were $581.2 million and $457.3 million, respectively, during the three and nine months ended September 30, 2008. The total amounts of interest income that were recognized on impaired loans during the three and nine months ended September 30, 2009 were $10.8 million and $25.4 million, respectively and were $9.4 million and $22.9 million, respectively, during the three and nine months ended September 30, 2008. The amounts of cash basis interest income that were recognized on impaired loans during the three and nine months ended September 30, 2009 were $3.7 million and $9.7 million, respectively, and were $7.8 million and $15.9 million, respectively, during the three and nine months ended September 30, 2008. If the non-accrual loans had performed in accordance with their original terms, interest income would have been increased by $33.7 million and $85.6 million, respectively, for the three and nine months ended September 30, 2009, and $12.8 million and $31.8 million, respectively, for the three and nine months ended September 30, 2008.
 
During the three and nine months ended September 30, 2009, loans with an aggregate carrying value of $427.7 million and $795.1 million, respectively, as of their respective restructuring dates, were involved in troubled debt restructurings. As of September 30, 2009 and December 31, 2008, the balance of loans that had been restructured in troubled debt restructurings were $650.7 million and $381.4 million, respectively. Additionally, loans involved in these troubled debt restructurings are assessed as impaired, generally for a period of at least one year following the restructuring. A loan that has been involved in a troubled debt restructuring might no longer be assessed as impaired one year subsequent to the restructuring, assuming the loan performs under the restructured terms and the restructured terms were at market. The allocated reserves for loans that were involved in troubled debt restructurings were $25.8 million and $48.0 million, as of September 30, 2009 and December 31, 2008, respectively.
 
Foreclosed Assets
 
Real Estate Owned
 
When we foreclose on real estate assets that collateralized a loan, we record the assets at their estimated fair value at the time of foreclosure. Upon foreclosure and through liquidation, we evaluate the asset’s fair value as compared to the loan’s carrying amount and record a charge off when the carrying amount of the loan exceeds fair


17


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
value. Subsequent valuation adjustments are recorded as a valuation allowance which are recorded as a component of other (expense) income, net in our consolidated statements of income. We estimate fair value at the asset’s liquidation value, based on market conditions, less estimated costs to sell such asset.
 
As of September 30, 2009 and December 31, 2008, we had $67.1 million and $84.4 million, respectively, of real estate owned (“REO”), which was recorded in other assets in our consolidated balance sheets. Activity in REO for the three and nine months ended September 30, 2009 and 2008 was as follows:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    ($ in thousands)  
 
REO as of beginning of period
  $ 95,149     $ 67,609     $ 84,437     $ 19,741  
Transfers from loans held for investment
    11,150             47,873       54,843  
Fair value adjustments
    (2,298 )     (7,575 )     (18,923 )     (8,651 )
Transfers to property held for investment
    (11,260 )           (11,260 )      
Real estate sold
    (25,687 )     (1,057 )     (35,073 )     (6,956 )
                                 
REO as of end of period
  $ 67,054     $ 58,977     $ 67,054     $ 58,977  
                                 
 
During the three and nine months ended September 30, 2009, we recognized a gain of $1.5 million and a loss of $0.3 million, respectively, on the sales of REO as a component of other income (expense) in the consolidated statements of income. For the three and nine months ended September 30, 2008, we recognized gains of $45,000 and $0.4 million, respectively, on the sale of REO as a component of other income (expense) in the consolidated statements of income.
 
Other Foreclosed Assets
 
When we foreclose on a borrower whose underlying collateral consists of loans, we record the acquired loans at the estimated fair value at the time of foreclosure. As of September 30, 2009, we had $109.7 million of loans acquired through foreclosure, which were recorded in loans held for investment in our consolidated balance sheets. As of December 31, 2008, there were no loans acquired as a result of foreclosure.


18


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
Note 7.   Investments
 
Investment Securities, Available-for-Sale
 
As of September 30, 2009 and December 31, 2008, our investment securities, available-for-sale were as follows:
 
                                                                 
    September 30, 2009     December 31, 2008  
          Gross
    Gross
                Gross
    Gross
       
          Unrealized
    Unrealized
    Fair
          Unrealized
    Unrealized
    Fair
 
    Cost     Gains     Losses     Value     Cost     Gains     Losses     Value  
    ($ in thousands)  
 
Agency discount notes
  $ 9,999     $ 1     $     $ 10,000     $ 149,383     $ 562     $     $ 149,945  
Agency callable notes
    193,300       403       (446 )     193,257       312,829       2,249             315,078  
Agency debt
    25,560       275       (158 )     25,677       30,697             (383 )     30,314  
Agency MBS
    325,735       7,845       (129 )     333,451       141,213       1,023             142,236  
Non-agency MBS
    133,743       373       (635 )     133,481       325       52             377  
Equity security
    514             (321 )     193       514             (301 )     213  
Corporate debt
    12,287       776             13,063       39,100       147       (219 )     39,028  
Collateralized loan obligation
    1,169       21             1,190       2,360                   2,360  
                                                                 
Total
  $ 702,307     $ 9,694     $ (1,689 )   $ 710,312     $ 676,421     $ 4,033     $ (903 )   $ 679,551  
                                                                 
 
Included in investment securities, available-for-sale, were discount notes issued by Fannie Mae, Freddie Mac and the FHLB (“Agency discount notes”), callable notes issued by Fannie Mae, Freddie Mac, the FHLB and Federal Farm Credit Bank (“Agency callable notes”), bonds issued by the FHLB (“Agency debt”), commercial and residential mortgage-backed securities issued and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae (“Agency MBS”), commercial and residential mortgage-backed securities issued by non-government agencies (“Non-agency MBS”), corporate debt, an investment in a subordinated note of a collateralized loan obligation and an equity security. CapitalSource Bank pledged to the FHLB of San Francisco (“FHLB SF”) and FRB investment securities, available-for-sale with an estimated fair value of $656.7 million and $19.3 million, respectively, as sources of borrowing capacity as of September 30, 2009.
 
During the three and nine months ended September 30, 2009, we sold investment securities, available-for-sale for $28.4 million and $46.5 million, respectively, recognizing net pre-tax gains of $63,000 and $0.5 million, respectively. We did not sell any of these investments during the three and nine months ended September 30, 2008.
 
During the three and nine months ended September 30, 2008, we recorded other-than-temporary impairments in the fair value of our Non-agency MBS of $1.4 million and $4.1 million, respectively, as a component of gain (loss) on residential mortgage investment portfolio in the consolidated statements of income. We did not incur any such other-than-temporary impairments in the fair value of our Non-agency MBS during the three and nine months ended September 30, 2009. Additionally, we recorded no other-than- temporary impairment during the three months ended September 30, 2009, and $11.7 million during the nine months ended September 30, 2009, related to corporate debt, as a component of loss on investments, net in the consolidated statements of income. During the three and nine months ended September 30, 2008, we did not record any other-than-temporary impairment related to corporate debt. During the three and nine months ended September 30, 2009, we recorded other-than-temporary impairments in the fair value of the collateralized loan obligation of $0.4 million and $1.8 million, respectively, as a component of loss on investments, net in the consolidated statements of income. During the three and nine months ended September 30, 2008, we recorded other-than-temporary impairments in the fair value of the collateralized loan obligation of $0.8 million for both periods, as a component of loss on investments, net in the consolidated statements of income.


19


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
During the three and nine months ended September 30, 2009, we recognized $6.9 million and $0.5 million, respectively, of net unrealized after-tax gains, related to our available-for-sale investment securities, as a component of accumulated other comprehensive income, net in our consolidated balance sheets.
 
As of September 30, 2009 and December 31, 2008, the gross unrealized losses and fair value of investment securities, available-for-sale, that were in an unrealized loss position, were as follows:
 
                                                 
    Less Than 12 Months     12 Months or More     Total  
    Gross
          Gross
          Gross
       
    Unrealized
          Unrealized
          Unrealized
       
    Losses     Fair Value     Losses     Fair Value     Losses     Fair Value  
    ($ in thousands)  
 
As of September 30, 2009
                                               
Agency callable notes
  $ (446 )   $ 84,854     $     $     $ (446 )   $ 84,854  
Agency debt
    (158 )     16,040                   (158 )     16,040  
Agency MBS
    (129 )     22,780                   (129 )     22,780  
Non-agency MBS
    (635 )     72,398                   (635 )     72,398  
Equity security
                (321 )     193       (321 )     193  
                                                 
Total
  $ (1,368 )   $ 196,072     $ (321 )   $ 193     $ (1,689 )   $ 196,265  
                                                 
As of December 31, 2008
                                               
Agency debt
  $ (383 )   $ 30,314     $     $     $ (383 )   $ 30,314  
Equity security
                (301 )     213       (301 )     213  
Corporate debt
    (219 )     2,781                   (219 )     2,781  
                                                 
Total
  $ (602 )   $ 33,095     $ (301 )   $ 213     $ (903 )   $ 33,308  
                                                 
 
We do not believe that any unrealized losses greater than 12 months in our available-for-sale portfolio as of September 30, 2009 and December 31, 2008 represent an other-than-temporary impairment. These losses are related to an equity security and are attributable to fluctuations in its market price due to current market conditions.
 
Investment Securities, Held-to-Maturity
 
As of September 30, 2009 and December 31, 2008, the amortized cost of investment securities, held-to-maturity, was $250.2 million and $14.4 million, respectively and consisted of AAA-rated commercial mortgage-backed securities. In addition, CapitalSource Bank pledged to the FHLB SF and FRB investment securities, held-to-maturity, with an amortized cost of $74.5 million and $170.2 million, respectively, and estimated fair value of $76.6 million and $182.2 million, respectively, as sources of borrowing capacity as of September 30, 2009.


20


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Contractual Maturities
 
As of September 30, 2009, the contractual maturities of our investment securities, available-for-sale, and investment securities, held-to-maturity, were as follows:
 
                                 
    Investment Securities,
    Investment Securities,
 
    Available-for-Sale     Held-to-Maturity  
          Estimated
          Estimated
 
    Amortized Cost     Fair Value     Amortized Cost     Fair Value  
    ($ in thousands)  
 
Due in one year or less
  $ 29,816     $ 29,763     $ 35,202     $ 34,901  
Due after one year through five years
    159,042       159,495       205,681       218,893  
Due after five years through ten years
    106,952       108,562       9,339       10,342  
Due after ten years(1)(2)
    406,497       412,492              
                                 
Total
  $ 702,307     $ 710,312     $ 250,222     $ 264,136  
                                 
 
 
(1) Included in this category are Agency and Non-agency MBS with weighted-average expected maturities of approximately 3.5 years and 2.2 years, respectively, based on interest rates and expected prepayment speeds as of September 30, 2009.
 
(2) Includes securities with no stated maturity.
 
Other Investments
 
As of September 30, 2009 and December 31, 2008, our other investments were as follows:
 
                 
    September 30,
    December 31,
 
    2009     2008  
    ($ in thousands)  
 
Investments carried at cost
  $ 53,896     $ 61,279  
Investments carried at fair value
    1,498       4,661  
Investments accounted for under the equity method
    40,835       61,806  
                 
Total
  $ 96,229     $ 127,746  
                 
 
During the three and nine months ended September 30, 2009, we sold other investments for $10.6 million and $23.2 million, respectively, recognizing a net pre-tax gain of $0.7 million and a net pre-tax loss of $2.4 million, respectively. For the three and nine months ended September 30, 2008, we sold other investments for $12.1 million and $22.2 million, respectively, recognizing a net pre-tax loss of $0.3 million and a net pre-tax gain of $4.6 million, respectively. During the three and nine months ended September 30, 2009, we recorded other-than-temporary impairments of $6.8 million and $11.4 million, respectively, relating to our investments carried at cost. During the three and nine months ended September 30, 2008, we recorded other-than-temporary impairments of $30.8 million and $40.0 million, respectively, relating to our investments carried at cost.
 
Residential Mortgage-Backed Securities
 
Prior to the second quarter of 2009, we invested in residential mortgage-backed securities that were issued and guaranteed by Fannie Mae or Freddie Mac (“Agency RMBS”), which were included in the line item “mortgage-backed securities pledged, trading” in the audited consolidated balance sheets as of December 31, 2008. All our Agency RMBS were collateralized by adjustable rate residential mortgage loans, including hybrid adjustable rate mortgage loans.


21


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
During the first quarter of 2009, we sold all of our Agency RMBS and unwound all of the related derivatives remaining in our residential mortgage investment portfolio, realizing a gain of $15.3 million as a component of (loss) gain on residential mortgage investment portfolio in the consolidated statements of income.
 
Note 8.   Guarantor Information
 
The following represents the supplemental consolidating condensed financial information of CapitalSource Inc. As discussed in Note 13, Borrowings, in our audited consolidated financial statements for the year ended December 31, 2008 included in our Form 10-K and Note 11, Borrowings, in these financial statements, CapitalSource Inc. is the issuer of our “2014 Senior Secured Notes,” as defined in Note 11, Borrowings, as well as our Senior Debentures and Subordinated Debentures (together, the “Debentures”). CapitalSource Finance LLC (“CapitalSource Finance”) is a guarantor of our 2014 Senior Secured Notes and the Debentures, and our subsidiaries that are not guarantors of the 2014 Senior Secured Notes or the Debentures, as of September 30, 2009 and December 31, 2008 and for the three and nine months ended September 30, 2009 and 2008. CapitalSource Finance, a 100% owned indirect subsidiary of CapitalSource Inc., has guaranteed our 2014 Senior Secured Notes and the Senior Debentures, fully and unconditionally, on a senior basis. CapitalSource Finance also has guaranteed the Subordinated Debentures, fully and unconditionally, on a senior subordinate basis. Separate consolidated financial statements of the guarantor are not presented, as we have determined that they would not be material to investors.


22


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Balance Sheet
September 30, 2009
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    (Unaudited)  
    ($ in thousands)  
 
Assets
                                               
Cash and cash equivalents
  $ 3,997     $ 733,618     $ 284,797     $ 15,406     $     $ 1,037,818  
Restricted cash
          75,229       92,515       59,441             227,185  
Investment securities:
                                               
Available-for-sale, at fair value
          701,566       595       8,151             710,312  
Held-to-maturity, at amortized cost
          250,222                         250,222  
                                                 
Total investment securities
          951,788       595       8,151             960,534  
Mortgage-related receivables, net
                      1,529,795             1,529,795  
Commercial real estate “A” participation interest, net
          714,238                         714,238  
Loans:
                                               
Loans held for sale
          26,537             6,206             32,743  
Loans held for investment
          5,385,353       288,627       2,913,633       (6 )     8,587,607  
Less deferred loan fees and discounts
          (76,392 )     (19,040 )     (37,724 )     (17,144 )     (150,300 )
Less allowance for loan losses
          (237,868 )     (66,375 )     (213,162 )           (517,405 )
                                                 
Loans held for investment, net
          5,071,093       203,212       2,662,747       (17,150 )     7,919,902  
                                                 
Total loans
          5,097,630       203,212       2,668,953       (17,150 )     7,952,645  
Interest receivable
          47,945       1,524       64,047       25       113,541  
Direct real estate investments, net
                      946,459             946,459  
Investment in subsidiaries
    3,270,484       4,542       1,511,337       1,485,258       (6,271,621 )      
Intercompany note receivable
    375,000       10       131,029       412,180       (918,219 )      
Other investments
          66,082       14,480       15,667             96,229  
Goodwill
          173,135                         173,135  
Other assets
    53,971       164,011       123,523       257,643       (110,886 )     488,262  
                                                 
Total assets
  $ 3,703,452     $ 8,028,228     $ 2,363,012     $ 7,463,000     $ (7,317,851 )   $ 14,239,841  
                                                 
Liabilities and shareholders’ equity
                                               
Liabilities:
                                               
Deposits
  $     $ 4,390,486     $     $     $     $ 4,390,486  
Credit facilities
    419,488       200,953       57,505       148,665             826,611  
Term debt
    282,536       1,713,281             2,737,456             4,733,273  
Other borrowings
    558,701       200,000       443,569       344,767             1,547,037  
Other liabilities
    15,651       90,936       91,505       231,042       (113,902 )     315,232  
Intercompany note payable
          46,850       271,097       600,272       (918,219 )      
                                                 
Total liabilities
    1,276,376       6,642,506       863,676       4,062,202       (1,032,121 )     11,812,639  
Shareholders’ equity:
                                               
Common stock
    3,231       921,000                   (921,000 )     3,231  
Additional paid-in capital
    3,899,573       (234,258 )     746,449       3,314,931       (3,827,091 )     3,899,604  
(Accumulated deficit) retained earnings
    (1,501,638 )     677,671       726,913       65,488       (1,470,103 )     (1,501,669 )
Accumulated other comprehensive income, net
    25,910       21,309       25,974       20,231       (67,514 )     25,910  
                                                 
Total CapitalSource Inc. shareholders’ equity
    2,427,076       1,385,722       1,499,336       3,400,650       (6,285,708 )     2,427,076  
Noncontrolling interests
                      148       (22 )     126  
                                                 
Total shareholders’ equity
    2,427,076       1,385,722       1,499,336       3,400,798       (6,285,730 )     2,427,202  
                                                 
Total liabilities and shareholders’ equity
  $ 3,703,452     $ 8,028,228     $ 2,363,012     $ 7,463,000     $ (7,317,851 )   $ 14,239,841  
                                                 


23


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Balance Sheet
December 31, 2008
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    ($ in thousands)  
 
Assets
                                               
Cash and cash equivalents
  $ 11     $ 1,230,254     $ 38,866     $ 69,432     $     $ 1,338,563  
Restricted cash
          35,695       81,337       302,351             419,383  
Investment securities:
                                               
Available-for-sale, at fair value
          646,675       1,236       31,640             679,551  
Held-to-maturity, at amortized cost
          14,389                         14,389  
                                                 
Total investment securities
          661,064       1,236       31,640             693,940  
Mortgage-backed securities pledged, trading
                      1,489,291             1,489,291  
Mortgage-related receivables, net
                      1,801,535             1,801,535  
Commercial real estate “A” participation interest, net
          1,396,611                         1,396,611  
Loans:
                                               
Loans held for sale
          1,561             6,982             8,543  
Loans held for investment
          6,040,079       398,509       2,958,169       (6 )     9,396,751  
Less deferred loan fees and discounts
          (85,245 )     (32,950 )     (45,052 )     (11,070 )     (174,317 )
Less allowance for loan losses
          (55,600 )     (295,002 )     (73,242 )           (423,844 )
                                                 
Loans held for investment, net
          5,899,234       70,557       2,839,875       (11,076 )     8,798,590  
                                                 
Total loans
          5,900,795       70,557       2,846,857       (11,076 )     8,807,133  
Interest receivable
          55,689       2,178       59,649             117,516  
Direct real estate investments, net
                      989,716             989,716  
Investment in subsidiaries
    4,397,772             1,657,532       1,602,354       (7,657,658 )      
Intercompany note receivable
    75,000       9       185,765       264,000       (524,774 )      
Other investments
          86,239       21,098       20,409             127,746  
Goodwill
          173,135                         173,135  
Other assets
    39,169       102,213       253,270       853,546       (183,135 )     1,065,063  
                                                 
Total assets
  $ 4,511,952     $ 9,641,704     $ 2,311,839     $ 10,330,780     $ (8,376,643 )   $ 18,419,632  
                                                 
Liabilities and shareholders’ equity
                                               
Liabilities:
                                               
Deposits
  $     $ 5,043,695     $     $     $     $ 5,043,695  
Repurchase agreements
                      1,595,750             1,595,750  
Credit facilities
    890,000       456,999       82,462       15,601             1,445,062  
Term debt
          2,238,382             3,100,074             5,338,456  
Other borrowings
    729,474             441,899       402,440             1,573,813  
Other liabilities
    62,181       198,272       52,552       463,656       (184,525 )     592,136  
Intercompany note payable
          46,850       122,917       355,007       (524,774 )      
                                                 
Total liabilities
    1,681,655       7,984,198       699,830       5,932,528       (709,299 )     15,588,912  
Shareholders’ equity:
                                               
Common stock
    2,828       921,000                   (921,000 )     2,828  
Additional paid-in capital
    3,686,965       146,019       699,806       3,926,123       (4,772,148 )     3,686,765  
(Accumulated deficit) retained earnings
    (868,394 )     587,837       908,731       468,063       (1,964,662 )     (868,425 )
Accumulated other comprehensive income, net
    8,898       2,650       3,472       3,586       (9,511 )     9,095  
                                                 
Total CapitalSource Inc. shareholders’ equity
    2,830,297       1,657,506       1,612,009       4,397,772       (7,667,321 )     2,830,263  
Noncontrolling interests
                      480       (23 )     457  
                                                 
Total shareholders’ equity
    2,830,297       1,657,506       1,612,009       4,398,252       (7,667,344 )     2,830,720  
                                                 
Total liabilities and shareholders’ equity
  $ 4,511,952     $ 9,641,704     $ 2,311,839     $ 10,330,780     $ (8,376,643 )   $ 18,419,632  
                                                 


24


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Income
Three Months Ended September 30, 2009
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    (Unaudited)  
    ($ in thousands)  
 
Net investment income:
                                               
Interest income:
                                               
Loans
  $ 7,638     $ 110,589     $ 1,229     $ 63,412     $ (8,888 )   $ 173,980  
Investment securities
          12,839       56       526             13,421  
Other
          1,086       25       15             1,126  
                                                 
Total interest income
    7,638       124,514       1,310       63,953       (8,888 )     188,527  
Fee income
          9,486       11,601       6,217       (2,023 )     25,281  
                                                 
Total interest and fee income
    7,638       134,000       12,911       70,170       (10,911 )     213,808  
Operating lease income
                      27,247             27,247  
                                                 
Total investment income
    7,638       134,000       12,911       97,417       (10,911 )     241,055  
Interest expense:
                                               
Deposits
          22,674                         22,674  
Borrowings
    32,442       11,617       7,815       39,686       (8,888 )     82,672  
                                                 
Total interest expense
    32,442       34,291       7,815       39,686       (8,888 )     105,346  
                                                 
Net investment (loss) income
    (24,804 )     99,709       5,096       57,731       (2,023 )     135,709  
Provision for loan losses
          42,940       5,628       172,817             221,385  
                                                 
Net investment (loss) income after provision for loan losses
    (24,804 )     56,769       (532 )     (115,086 )     (2,023 )     (85,676 )
Operating expenses:
                                               
Compensation and benefits
    230       12,999       16,110                   29,339  
Depreciation of direct real estate investments
                      8,713             8,713  
Professional fees
    2,886       696       8,791       2,890             15,263  
Other administrative expenses
    1,049       13,625       14,675       7,992       (17,315 )     20,026  
                                                 
Total operating expenses
    4,165       27,320       39,576       19,595       (17,315 )     73,341  
Other (expense) income:
                                               
Loss on investments, net
          (4,813 )     (221 )     (3,438 )           (8,472 )
Loss on derivatives
          (3,259 )     (81 )     (6,958 )           (10,298 )
Loss on residential mortgage investment portfolio
                      (3 )           (3 )
Gain on debt extinguishment
                      11,472             11,472  
Other income (expense), net
    10       3,896       11,511       (8,159 )     (16,983 )     (9,725 )
Earnings in subsidiaries
    (254,378 )     (889 )     16,731       (14,359 )     252,895        
                                                 
Total other (expense) income
    (254,368 )     (5,065 )     27,940       (21,445 )     235,912       (17,026 )
                                                 
Net (loss) income before income taxes
    (283,337 )     24,384       (12,168 )     (156,126 )     251,204       (176,043 )
Income tax (benefit) expense
    (9,091 )     2,363       500       104,421             98,193  
                                                 
Net (loss) income
    (274,246 )     22,021       (12,668 )     (260,547 )     251,204       (274,236 )
Net income attributable to noncontrolling interests
                      10             10  
                                                 
Net (loss) income attributable to CapitalSource Inc. 
  $ (274,246 )   $ 22,021     $ (12,668 )   $ (260,557 )   $ 251,204     $ (274,246 )
                                                 


25


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Income
Three Months Ended September 30, 2008
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    (Unaudited)
 
    ($ in thousands)  
 
Net investment income:
                                               
Interest income:
                                               
Loans
  $ 1,081     $ 139,953     $ 6,346     $ 93,001     $ (1,087 )   $ 239,294  
Investment securities
          2,021       172       22,546             24,739  
Other
          7,025       551       2,403             9,979  
                                                 
Total interest income
    1,081       148,999       7,069       117,950       (1,087 )     274,012  
Fee income
          5,305       15,383       8,919       367       29,974  
                                                 
Total interest and fee income
    1,081       154,304       22,452       126,869       (720 )     303,986  
Operating lease income
                      28,140             28,140  
                                                 
Total investment income
    1,081       154,304       22,452       155,009       (720 )     332,126  
Interest expense:
                                               
Deposits
          32,178                         32,178  
Borrowings
    24,509       35,966       12,195       71,089       (1,087 )     142,672  
                                                 
Total interest expense
    24,509       68,144       12,195       71,089       (1,087 )     174,850  
                                                 
Net investment (loss) income
    (23,428 )     86,160       10,257       83,920       367       157,276  
Provision for loan losses
          3,535       107,166       (440 )           110,261  
                                                 
Net investment (loss) income after provision for loan losses
    (23,428 )     82,625       (96,909 )     84,360       367       47,015  
Operating expenses:
                                               
Compensation and benefits
    194       9,455       19,820       4             29,473  
Depreciation of direct real estate investments
                      8,898             8,898  
Professional fees
    234       1,593       4,732       1,280             7,839  
Other administrative expenses
    8,688       11,832       12,966       9       (18,186 )     15,309  
                                                 
Total operating expenses
    9,116       22,880       37,518       10,191       (18,186 )     61,519  
Other income (expense):
                                               
Loss on investments, net
          (2,284 )     (4,009 )     (23,717 )           (30,010 )
Gain (loss) on derivatives
          3,677       1,725       (2,743 )           2,659  
Loss on residential mortgage investment portfolio
                      (26,956 )           (26,956 )
Gain on debt extinguishment
                14,259       55,798             70,057  
Other income, net
          14,712       23,295       1,545       (27,139 )     12,413  
Earnings in subsidiaries
    46,245             61,527       (33,191 )     (74,581 )      
Intercompany
          (7,109 )     13,025       (5,916 )            
                                                 
Total other income (expense)
    46,245       8,996       109,822       (35,180 )     (101,720 )     28,163  
                                                 
Net income (loss) before income taxes
    13,701       68,741       (24,605 )     38,989       (83,167 )     13,659  
Income tax expense (benefit)
          7,285             (7,227 )           58  
                                                 
Net income (loss)
    13,701       61,456       (24,605 )     46,216       (83,167 )     13,601  
Net loss attributable to noncontrolling interests
          (71 )           (29 )           (100 )
                                                 
Net income (loss) attributable to CapitalSource Inc. 
  $ 13,701     $ 61,527     $ (24,605 )   $ 46,245     $ (83,167 )   $ 13,701  
                                                 


26


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Income
Nine Months Ended September 30, 2009
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    (Unaudited)
 
    ($ in thousands)  
 
Net investment income:
                                               
Interest income:
                                               
Loans
  $ 8,930     $ 352,111     $ 4,306     $ 204,018     $ (12,900 )   $ 556,465  
Investment securities
          33,790       290       13,363             47,443  
Other
          3,551       79       151             3,781  
                                                 
Total interest income
    8,930       389,452       4,675       217,532       (12,900 )     607,689  
Fee income
          23,531       39,110       23,265       (4,323 )     81,583  
                                                 
Total interest and fee income
    8,930       412,983       43,785       240,797       (17,223 )     689,272  
Operating lease income
                      82,533             82,533  
                                                 
Total investment income
    8,930       412,983       43,785       323,330       (17,223 )     771,805  
Interest expense:
                                               
Deposits
          91,020                         91,020  
Borrowings
    86,059       39,831       24,867       118,369       (12,900 )     256,226  
                                                 
Total interest expense
    86,059       130,851       24,867       118,369       (12,900 )     347,246  
                                                 
Net investment (loss) income
    (77,129 )     282,132       18,918       204,961       (4,323 )     424,559  
Provision for loan losses
          179,746       85,516       315,237             580,499  
                                                 
Net investment (loss) income after provision for loan losses
    (77,129 )     102,386       (66,598 )     (110,276 )     (4,323 )     (155,940 )
Operating expenses:
                                               
Compensation and benefits
    1,044       39,195       58,945                   99,184  
Depreciation of direct real estate investments
                      26,515             26,515  
Professional fees
    6,664       2,534       27,997       7,348             44,543  
Other administrative expenses
    3,452       41,022       43,884       32,872       (62,092 )     59,138  
                                                 
Total operating expenses
    11,160       82,751       130,826       66,735       (62,092 )     229,380  
Other (expense) income:
                                               
Loss on investments, net
          (10,357 )     (2,723 )     (16,486 )           (29,566 )
(Loss) gain on derivatives
          (7,876 )     279       (3,368 )     (1,352 )     (12,317 )
Gain on residential mortgage investment portfolio
                      15,308             15,308  
(Loss) gain on debt extinguishment
    (57,128 )                 16,037             (41,091 )
Other income (expense), net
    10       18,666       25,145       (19,408 )     (60,605 )     (36,192 )
Earnings in subsidiaries
    (488,760 )     (889 )     2,076       (173,777 )     661,350        
Intercompany
                3,558       (3,558 )            
                                                 
Total other (expense) income
    (545,878 )     (456 )     28,335       (185,252 )     599,393       (103,858 )
                                                 
Net (loss) income before income taxes
    (634,167 )     19,179       (169,089 )     (362,263 )     657,162       (489,178 )
Income tax (benefit) expense
    (9,070 )     7,682       500       136,835             135,947  
                                                 
Net (loss) income
    (625,097 )     11,497       (169,589 )     (499,098 )     657,162       (625,125 )
Net loss attributable to noncontrolling interests
                      (28 )           (28 )
                                                 
Net (loss) income attributable to CapitalSource Inc. 
  $ (625,097 )   $ 11,497     $ (169,589 )   $ (499,070 )   $ 657,162     $ (625,097 )
                                                 


27


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Income
Nine months Ended September 30, 2008
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    (Unaudited)
 
    ($ in thousands)  
 
                                                 
Net investment income:
                                               
                                                 
Interest income:
                                               
                                                 
Loans
  $ 3,335     $ 336,004     $ 30,075     $ 341,843     $ (3,344 )   $ 707,913  
                                                 
Investment securities
          2,522       633       108,341             111,496  
                                                 
Other
          8,190       2,646       6,314             17,150  
                                                 
                                                 
Total interest income
    3,335       346,716       33,354       456,498       (3,344 )     836,559  
                                                 
Fee income
          27,292       39,320       37,941       329       104,882  
                                                 
                                                 
Total interest and fee income
    3,335       374,008       72,674       494,439       (3,015 )     941,441  
                                                 
Operating lease income
                      80,040             80,040  
                                                 
                                                 
Total investment income
    3,335       374,008       72,674       574,479       (3,015 )     1,021,481  
                                                 
Interest expense:
                                               
                                                 
Deposits
          32,178                         32,178  
                                                 
Borrowings
    66,094       114,507       36,773       277,229       (3,344 )     491,259  
                                                 
                                                 
Total interest expense
    66,094       146,685       36,773       277,229       (3,344 )     523,437  
                                                 
                                                 
Net investment (loss) income
    (62,759 )     227,323       35,901       297,250       329       498,044  
                                                 
Provision for loan losses
          3,535       135,635       8,424             147,594  
                                                 
                                                 
Net investment (loss) income after provision for loan losses
    (62,759 )     223,788       (99,734 )     288,826       329       350,450  
                                                 
Operating expenses:
                                               
                                                 
Compensation and benefits
    875       15,766       82,425       4             99,070  
                                                 
Depreciation of direct real estate investments
                      26,804             26,804  
                                                 
Professional fees
    2,459       2,963       20,421       3,919             29,762  
                                                 
Other administrative expenses
    31,001       13,989       33,060       2,615       (36,631 )     44,034  
                                                 
                                                 
Total operating expenses
    34,335       32,718       135,906       33,342       (36,631 )     199,670  
                                                 
Other income (expense):
                                               
                                                 
Loss on investments, net
          (2,986 )     (6,229 )     (24,574 )     (214 )     (34,003 )
                                                 
(Loss) gain on derivatives
          (1,389 )     23,812       (42,777 )           (20,354 )
                                                 
Loss on residential mortgage investment portfolio
                      (73,273 )           (73,273 )
                                                 
Gain on debt extinguishment
                28,504       54,278             82,782  
                                                 
Other income, net
          13,260       48,840       382       (45,584 )     16,898  
                                                 
Earnings in subsidiaries
    178,281             181,733       55,225       (415,239 )      
                                                 
Intercompany
          (10,915 )     22,829       (11,914 )            
                                                 
                                                 
Total other income (expense)
    178,281       (2,030 )     299,489       (42,653 )     (461,037 )     (27,950 )
                                                 
                                                 
Net income before income taxes
    81,187       189,040       63,849       212,831       (424,077 )     122,830  
                                                 
Income tax expense
          7,285             33,092             40,377  
                                                 
                                                 
Net income
    81,187       181,755       63,849       179,739       (424,077 )     82,453  
                                                 
Net income attributable to noncontrolling interests
          28             1,458       (6 )     1,480  
                                                 
                                                 
Net income attributable to CapitalSource Inc. 
  $ 81,187     $ 181,727     $ 63,849     $ 178,281     $ (424,071 )   $ 80,973  
                                                 


28


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2009
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    (Unaudited)
 
    ($ in thousands)  
 
Operating activities:
                                               
Net (loss)
  $ (625,097 )   $ 11,497     $ (169,589 )   $ (499,098 )   $ 657,162     $ (625,125 )
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
                                               
Stock option expense
          792       2,193                   2,985  
Restricted stock expense
          2,841       15,121                   17,962  
Loss (gain) loss on extinguishment of debt
    57,128                   (16,037 )           41,091  
Amortization of deferred loan fees and discounts
          (20,983 )     (26,767 )     (11,068 )           (58,818 )
Paid-in-kind interest on loans
          (11,194 )     606       (6,846 )           (17,434 )
Provision for loan losses
          179,746       85,516       315,237             580,499  
Amortization of deferred financing fees and discounts
    22,131       11,894       314       13,807             48,146  
Depreciation and amortization
          (280 )     2,829       22,760             25,309  
Provision (benefit) for deferred income taxes
    8,224       (3,508 )     (36 )     125,927             130,607  
Non-cash loss on investments, net
          15,085       2,998       13,412             31,495  
Non-cash loss on property and equipment and writedowns of real estate owned
          1,993       5,737       13,450             21,180  
Unrealized loss on derivatives and foreign currencies, net
          8,891       1,307       12,082             22,280  
Unrealized gain on residential mortgage investment portfolio, net
                      (60,567 )           (60,567 )
Net decrease in mortgage-backed securities pledged, trading
                      1,485,133             1,485,133  
Amortization of discount on residential mortgage investments
                      11             11  
Accretion of discount on commercial real estate “A” participation interest
          (20,487 )                       (20,487 )
Decrease (increase) in interest receivable
          7,815       8,778       (10,675 )     (25 )     5,893  
Decrease in loans held for sale, net
          11,887       19,168                   31,055  
(Increase) decrease in intercompany note receivable
    (300,000 )           54,735       (148,180 )     393,445        
(Increase) decrease in other assets
    (5,172 )     (69,776 )     169,308       463,300       (72,249 )     485,411  
(Decrease) increase in other liabilities
    (47,528 )     (107,818 )     39,533       (226,544 )     70,623       (271,734 )
Net transfers with subsidiaries
    1,164,901       (338,186 )     213,752       (378,882 )     (661,585 )      
                                                 
Cash provided by (used in) operating activities, net of impact of acquisitions
    274,587       (319,791 )     425,503       1,107,222       387,371       1,874,892  
Investing activities:
                                               
(Increase) decrease in restricted cash
          (39,534 )     (11,178 )     242,910             192,198  
Decrease in mortgage-related receivables, net
                      215,090             215,090  
Decrease in commercial real estate “A” participation interest
          702,860                         702,860  
Decrease (increase) in loans, net
          665,671       (272,358 )     (54,746 )     6,074       344,641  
Cash received for real estate
                      15,710             15,710  
Acquisition of marketable securities, available-for-sale, net
          (36,991 )                       (36,991 )
Acquisition of marketable securities, held-to-maturity, net
          (227,591 )                       (227,591 )
Disposal (acquisition) of other investments, net
          13,794       2,573       (10,966 )           5,401  
(Acquisition) disposal of property and equipment, net
          (14,134 )     (17,051 )     13,729             (17,456 )
                                                 
Cash provided by (used in) investing activities
          1,064,075       (298,014 )     421,727       6,074       1,193,862  
Financing activities:
                                               
Payment of deferred financing fees
    (30,523 )     (738 )           (7,900 )           (39,161 )
Deposits accepted, net of repayments
          (653,552 )                       (653,552 )
Increase in intercompany note payable
                148,180       245,265       (393,445 )      
Repayments under repurchase agreements, net
                      (1,595,750 )           (1,595,750 )
(Repayments of) borrowings on credit facilities, net
    (470,512 )     (261,358 )     (29,683 )     133,064             (628,489 )
Borrowings of term debt
    281,898       6,000             23,976             311,874  
Repayments of term debt
          (531,272 )           (376,362 )           (907,634 )
(Repayments of) borrowings under other borrowings
    (118,503 )     200,000       (55 )     (5,268 )           76,174  
Proceeds from issuance of common stock, net of offering costs
    77,075                               77,075  
Repurchase of common stock
    (800 )                             (800 )
Payment of dividends
    (9,236 )                             (9,236 )
                                                 
Cash (used in) provided by financing activities
    (270,601 )     (1,240,920 )     118,442       (1,582,975 )     (393,445 )     (3,369,499 )
                                                 
Increase (decrease) in cash and cash equivalents
    3,986       (496,636 )     245,931       (54,026 )           (300,745 )
Cash and cash equivalents as of beginning of period
    11       1,230,254       38,866       69,432             1,338,563  
                                                 
Cash and cash equivalents as of end of period
  $ 3,997     $ 733,618     $ 284,797     $ 15,406     $     $ 1,037,818  
                                                 


29


 

 
CapitalSource Inc.
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2008
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
          Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    CapitalSource Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    (Unaudited)
 
    ($ in thousands)  
 
Operating activities:
                                               
Net income
  $ 81,187     $ 181,755     $ 63,849     $ 179,739     $ (424,077 )   $ 82,453  
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
                                               
Stock option expense
          (50 )     580                   530  
Restricted stock expense
          2,313       24,185                   26,498  
Gain on extinguishment of debt
                (28,504 )     (54,278 )           (82,782 )
Amortization of deferred loan fees and discounts
          (26,660 )     (25,789 )     (19,127 )           (71,576 )
Paid-in-kind interest on loans
          9,585       2,945       900             13,430  
Provision for loan losses
          3,535       135,635       8,424             147,594  
Amortization of deferred financing fees and discounts
    36,338       25,946       2,486       24,316             89,086  
Depreciation and amortization
          1,184       2,786       24,638             28,608  
Benefit for deferred income taxes
                      (18,807 )           (18,807 )
Non-cash loss (gain) on investments, net
          28,442       6,757       (80 )           35,119  
Non-cash loss on property and equipment and writedowns of real estate owned
                9,270                   9,270  
Unrealized (gain) loss on derivatives and foreign currencies, net
          (4,869 )     9,312       6,313             10,756  
Unrealized loss on residential mortgage investment portfolio, net
                      51,810             51,810  
Net decrease in mortgage-backed securities pledged, trading
                      2,508,787             2,508,787  
Amortization of discount on residential mortgage investments
                      (8,398 )           (8,398 )
Accretion of discount on commercial real estate “A” participation interest
          (12,694 )                       (12,694 )
(Increase) decrease in interest receivable
          (51,107 )     45,370       21,814             16,077  
Decrease in loans held for sale, net
          42,545       4,547       199,284             246,376  
Decrease in intercompany note receivable
                90,225       (15,153 )     (75,072 )      
Increase in other assets
    (4,343 )     (33,652 )     (90,808 )     (37,385 )     122,786       (43,402 )
(Decrease) increase in other liabilities
    (27,154 )     93,846       (23,285 )     (25,929 )     (114,154 )     (96,676 )
Net transfers with subsidiaries
    (798,809 )     570,731       (195,434 )     8,059       415,453        
                                                 
Cash (used in) provided by operating activities
    (712,781 )     830,850       34,127       2,854,927       (75,064 )     2,932,059  
Investing activities:
                                               
Decrease (increase) in restricted cash
          19,608       85,840       (1,387,870 )           (1,282,422 )
Decrease in mortgage-related receivables, net
                      175,556             175,556  
Decrease in commercial real estate “A” participation interest
          206,730                         206,730  
Acquisition of CS Advisors CLO II
                      (18,619 )           (18,619 )
(Increase) decrease in loans, net
          (1,569,218 )     (173,529 )     2,035,259       (54 )     292,458  
Cash paid for real estate
                      (10,154 )           (10,154 )
Acquisition of marketable securities, available-for-sale, net
          (845,813 )                       (845,813 )
Disposal (acquisition) of other investments, net
          15,028       (4,168 )     (4,943 )           5,917  
Net cash acquired in FIL transaction
          3,187,037                         3,187,037  
Acquisition of property and equipment, net
          (804 )     (2,430 )     (330 )           (3,564 )
                                                 
Cash provided by (used in) investing activities
          1,012,568       (94,287 )     788,899       (54 )     1,707,126  
Financing activities:
                                               
Payment of deferred financing fees
    (25,178 )     (20,353 )     120       (14,066 )           (59,477 )
Deposits accepted, net of repayments
          (122,115 )                       (122,115 )
Decrease in intercompany note payable
                15,153       (90,225 )     75,072        
Repayments under repurchase agreements, net
          (12,673 )           (1,027,281 )           (1,039,954 )
Borrowings on (repayments of) credit facilities, net
    424,763       (440,949 )     111,091       (955,760 )           (860,855 )
Borrowings of term debt
          (46 )                 46        
Repayments of term debt
          (298,528 )           (1,384,170 )           (1,682,698 )
Repayments of other borrowings
                (59,163 )     (9,342 )           (68,505 )
Proceeds from issuance of common stock, net of offering costs
    601,881                               601,881  
Proceeds from exercise of options
    361                               361  
Tax expense on share based payments
                      (6,548 )           (6,548 )
Payment of dividends
    (289,035 )                 (1,579 )           (290,614 )
                                                 
Cash provided by (used in) financing activities
    712,792       (894,664 )     67,201       (3,488,971 )     75,118       (3,528,524 )
                                                 
Increase in cash and cash equivalents
    11       948,754       7,041       154,855             1,110,661  
Cash and