UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

 

Commission File No. 1-31753

CapitalSource Inc.

(Exact name of registrant as specified in its charter)

 

 

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)
Securities Registered Pursuant to Section 12(b) of the Act:

 

 

Securities Registered Pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  o Yes  þ No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  o Yes  þ No

 

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.  þ Yes  o No

 

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).  o Yes  o No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  o Yes  þ No

 

The aggregate market value of the Registrant’s Common Stock, par value $0.01 per share, held by nonaffiliates of the Registrant, as of June 30, 2009 was $1,158,905,071.

 

As of February 22, 2010, the number of shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding was 322,870,525.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of CapitalSource Inc.’s Proxy Statement for the 2010 annual meeting of shareholders, a definitive copy of which will be filed with the SEC within 120 days after the end of the year covered by this Form 10-K, are incorporated by reference herein as portions of Part III of this Form 10-K.

 

 

TABLE OF CONTENTS

 

 

This Form 10-K, including the footnotes to our audited consolidated financial statements included herein, contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which are subject to numerous assumptions, risks, and uncertainties, including certain plans, expectations, goals and projections and statements about our deposit base, loan portfolios and operations, managing our credit book, our expectations regarding future credit performance, charge offs and loan losses, particularly regarding commercial real estate loans, our liquidity, capital position, credit facilities and covenant compliance, our indebtedness, payment obligations and restrictions thereunder and use of proceeds from asset sales, CapitalSource Bank’s capitalization and accessing of financing, our intention to sell assets and monetize the value of our healthcare net lease business, our intent to remain an active lender in the healthcare industry, the expected repayment of our commercial real estate participation interest (“the “A” Participation Interest”), economic and market conditions for our business, the impact of the U.S. economy and government supervision and regulation on our business and earnings, securitization markets, the performance of our loans, loan yields, the impact of accounting pronouncements, our share repurchase plan, taxes and tax audits and examinations, our unfunded commitments, our intention to originate loans at CapitalSource Bank, our portfolio run off and growth, our delinquent, non-accrual and impaired loans, our SPEs, risk management, and our valuation allowance with respect to, and our realization and utilization of, net deferred tax assets, net operating loss carryforwards and built-in losses. All statements contained in this Form 10-K that are not clearly historical in nature are forward-looking, and the words “anticipate,” “assume,” “intend,” “believe,” “forecast,” “expect,” “estimate,” “plan,” “will,” “look forward” and similar expressions are generally intended to identify forward-looking statements. All forward-looking statements (including statements regarding future financial and operating results and future transactions and their results) involve risks, uncertainties and contingencies, many of which are beyond our control, which may cause actual results, performance, or achievements to differ materially from anticipated results, performance or achievements. Actual results could differ materially from those contained or implied by such statements for a variety of factors, including without limitation: changes in economic or market conditions or investment or lending opportunities may result in increased credit losses and delinquencies in our portfolio and impair our ability to consummate favorable loans; continued or worsening disruptions in economic and credit markets may continue to make it very difficult for us to obtain financing on attractive terms or at all, could prevent us from optimizing the amount of leverage we employ and could adversely affect our liquidity position; movements in interest rates and lending spreads may adversely affect our borrowing strategy; operating CapitalSource Bank under the California and Federal Deposit Insurance Corporation (“FDIC”) regulatory regime could be more costly and restrictive than expected; we may not be successful in maintaining or growing deposits or deploying capital in favorable lending transactions or originating or acquiring assets in accordance with our strategic plan; competitive and other market pressures could adversely affect loan pricing; the nature, extent, and timing of any governmental actions and reforms; the success and timing of other business strategies and asset sales; continued or worsening charge offs, reserves and delinquencies may adversely affect our earnings and financial results; changes in tax laws or regulations could adversely affect our business; hedging activities may result in reported losses not offset by gains reported in our audited consolidated financial statements; and other risk factors reported in our audited consolidated financial statements; and other risk factors described in this Form 10-K and documents filed by us with the SEC. All forward-looking statements included in this Form 10-K are based on information available at the time the statement is made.

 

We are under no obligation to (and expressly disclaim any such obligation to) update or alter our forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

 

The information contained in this section should be read in conjunction with our audited consolidated financial statements and related notes and the information contained elsewhere in this Form 10-K, including that set forth under Item 1A, Risk Factors.

 

Overview

 

References to we, us or CapitalSource refer to CapitalSource Inc. together with its subsidiaries.

 

We are a commercial lender which, primarily through our wholly owned subsidiary, CapitalSource Bank, provides financial products to small and middle market businesses nationwide and provides depository products and services in southern and central California. Prior to the formation of CapitalSource Bank, CapitalSource Inc. (“CapitalSource,” and together with its subsidiaries other than CapitalSource Bank, the “Parent Company”) conducted its commercial lending business through our other subsidiaries. Subsequent to CapitalSource Bank’s formation, substantially all new loans have been originated at CapitalSource Bank, and we expect this will continue to be the case for the foreseeable future. Our commercial lending activities at the Parent Company consist primarily of satisfying existing commitments made prior to CapitalSource Bank’s formation and receiving payments on our existing loan portfolio. Consequently, we expect that our loans at the Parent Company will gradually run off, while CapitalSource Bank’s loan portfolio will continue to grow. As of December 31, 2009, we had 1,078 loans outstanding, of which 58 were shared between CapitalSource Bank and the Parent Company. Our total loans had an aggregate outstanding balance of $8.3 billion.

 

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 in the Parent Company; and our Healthcare Net Lease segment comprises our direct real estate investment business activities. For additional information, see Note 25, Segment Data, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Through our CapitalSource Bank segment activities, we provide a wide range of financial products primarily to small and middle market businesses across the United States and also offer depository products and services in southern and central California, which are insured by the FDIC to the maximum amounts permitted by regulation. As of December 31, 2009, CapitalSource Bank had 443 loans outstanding, of which, 58 loans were shared with the Parent Company and also held a $530.6 million senior participation interest in a pool of commercial real estate loans and related assets (the “A” Participation Interest). Loans held by CapitalSource Bank had an aggregate principal balance of $3.1 billion.

 

Through our Other Commercial Finance segment activities, the Parent Company provided financial products primarily to small and middle market businesses. As of December 31, 2009, our Other Commercial Finance segment had 693 loans outstanding, of which, 58 loans were shared with CapitalSource Bank. Loans held by the Parent Company had an aggregate balance of $5.2 billion.

 

Through our Healthcare Net Lease segment activities, we invested in income-producing healthcare facilities — principally long-term healthcare facilities in the United States. We provided lease financing to skilled nursing facilities and, to a lesser extent, assisted living facilities, and long-term acute care facilities. As of December 31, 2009, this segment held $336.0 million in direct real estate investments comprising 103 healthcare facilities leased to 25 tenants through long-term, triple-net operating leases. During the year ended December 31, 2009, we sold 82 healthcare facilities and anticipate selling the remaining facilities in 2010 and 2011. Upon the completion of these asset sales, we will exit the skilled nursing facility ownership business, but continue to actively provide financing for owners and operators in the long-term healthcare industry. As a result, much of the Healthcare Net Lease segment activity and assets are classified as discontinued operations in our audited consolidated financial statements. For additional information, see Note 3, Discontinued Operations, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Although we have made loans as large as $325.0 million, as of December 31, 2009, our average loan size was $7.7 million, and our average loan exposure by client was $11.3 million. Our loans generally have a remaining life to maturity of 1 to 5 years with a weighted average life to maturity of 2.5 years as of December 31, 2009. Substantially all of our loans require monthly interest payments at variable rates and, in many cases, our loans provide for interest rate floors that help us maintain our yields when interest rates are low or declining. We price our loans based upon the risk profile of our clients. As of December 31, 2009, our geographically diverse client base consisted of 739 clients with headquarters in 43 states, the District of Columbia, Puerto Rico and select international locations, primarily in Canada and Europe.

In our CapitalSource Bank and Other Commercial Finance segments, we specialize in the following lending areas:

 

 

Change in Reportable Segments

 

For the years ended December 31, 2008 and 2007, 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 new three reportable segments. For additional information, see Note 25, Segment Data, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Developments During Fiscal Year 2009

 

During 2009, we simplified our business by:

 

 

We continued to follow our business plan to fund substantially all our new loans through CapitalSource Bank and to manage liquidity and credit outcomes of the Parent Company as its portfolio runs off.

 

Sale of Healthcare Net Lease Assets

 

During the year ended December 31, 2009, we sold 82 long-term healthcare facilities with a total net book value of $400.3 million, realizing a pre-tax loss of $9.4 million. Two transactions comprised 77 of the facilities sold. In November 2009, we sold 37 long-term healthcare facilities (the “November Sale Assets”) for approximately $100.0 million in cash. In December 2009, in the first step of a multi-step transaction, we sold 40 long-term healthcare facilities (the “Step 1 Assets”) to Omega Healthcare Investors, Inc. (“Omega”) for approximately $184.2 million in cash and approximately 1.4 million shares of Omega common stock valued at $25.6 million. In addition, by acquiring our facilities in the December 2009 closing, Omega became obligated to pay us $59.4 million of indebtedness associated with the Step 1 Assets. Step two of the transaction with Omega will include the sale of an additional 40 long-term healthcare facilities (the “Step 2 Assets”), which we expect to complete in 2010.

 

In December 2009, we also received approximately 1.3 million shares of Omega common stock valued at $25.0 million in consideration for a non-refundable option that can be exercised by Omega to acquire an additional 63 of our long-term healthcare facilities (the “Step 3 Assets”) at any time through December 31, 2011. Upon the completion of the sale of Step 2 Assets and Step 3 Assets, we will exit the skilled nursing home ownership business, but continue to actively provide financing for owners and operators in the long-term healthcare industry.

 

We have presented the financial condition and results of operations of all assets within our Healthcare Net Lease segment, with the exception of the Step 3 Assets, as discontinued operations for all periods presented.

Additionally, the results of the discontinued operations include the activities of other healthcare facilities that have been sold since the inception of the business. The Step 3 Assets have been included in our continuing operations as they do not meet the criteria to be held for sale as of December 31, 2009. For additional information, see Note 3, Discontinued Operations, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Improvement in Parent Company Liquidity

 

In 2009, despite the challenging economic environment, we were able to close several transactions that strengthened our balance sheet and improved our liquidity at the Parent Company. As of December 31, 2008, we had six secured credit facilities with aggregate commitments of $2.6 billion and an aggregate outstanding principal balance of $1.4 billion, each with maturity dates in 2009 or 2010. In addition, as of December 31, 2008, our Parent Company unrestricted cash and immediately available committed borrowing capacity was $204.9 million. As of December 31, 2009, we had four secured credit facilities with aggregate commitments of $691.3 million and an aggregate outstanding principal balance of $542.8 million. The maturities of our existing facilities occur in 2010 through 2012. As of December 31, 2009, our Parent Company unrestricted cash and immediately available committed borrowing capacity was $445.0 million.

 

We terminated two credit facilities and fully repaid the outstanding principal balances, extended the maturities of our other four credit facilities and reduced the principal balance of these credit facilities by $902.3 million. In addition, we increased our Parent Company unrestricted cash and immediately available borrowing capacity by $240.1 million through the issuance of 20,125,000 shares of our common stock, new debt issuances, the sale of certain of our Healthcare Net Lease properties, proceeds from loan and asset sales and cash from operations.

 

Management Change Announced

 

In December 2009, we announced the appointment of Steven A. Museles and James J. Pieczynski as Co-CEOs and members of the Company’s Board of Directors, and the formation of an Office of the Chairman, effective January 1, 2010. Founder and former CEO, John K. Delaney, assumed the new role of Executive Chairman and continues to chair the CapitalSource Board of Directors. Dean Graham stepped down as President. The changes were designed to further enhance operational efficiency and ensure effective execution of key initiatives. Both Museles, former Executive Vice President and Chief Legal Officer, and Pieczynski, former President of the Health Care Real Estate business, are longtime members of the CapitalSource senior executive management team.

 

Loan Products, Service Offerings and Investments

 

CapitalSource Bank Segment and Other Commercial Finance Segment

 

Our primary commercial lending and depository products and services include:

 

 

Healthcare Net Lease Segment

 

 

As of December 31, 2009, our portfolio of assets by type was as follows (percentages by gross carrying values):

 

Loan Products and Investments by Type

 

 

As of December 31, 2009, our commercial loan portfolio by geographic region was as follows:

 

Commercial Loan Portfolio by Geographic Region

 

 

 

 

CapitalSource Bank Segment Overview

 

Portfolio Composition

 

As of December 31, 2009 and 2008, the composition of the CapitalSource Bank segment portfolio was as follows:

 

 

 

 

Cash and Cash Equivalents

 

As of December 31, 2009 and 2008, CapitalSource Bank had $822.0 million and $1.2 billion, respectively, in cash and cash equivalents, including restricted cash of $65.9 million and $17.4 million, respectively. Cash and cash equivalents consists of collections from our borrowers, amounts due from banks, U.S. Treasury securities, short-term investments and commercial paper with an initial maturity of three months or less. For additional information, see Note 4, Cash and Cash Equivalents and Restricted Cash, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Investment Securities, Available-for-Sale

 

As of December 31, 2009 and 2008, CapitalSource Bank owned $901.8 million and $642.7 million, respectively, in investment securities, available-for-sale. Included in these investment securities, available-for-sale, were discount notes issued by Fannie Mae, Freddie Mac and the Federal Home Loan Bank (“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”), residential mortgage-backed securities issued and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae (“Agency MBS”), residential mortgage-backed securities rated AAA issued by non-government-agencies (“Non-agency MBS”) and corporate debt securities. CapitalSource Bank pledged substantially all of the investment securities, available-for-sale, to the Federal Home Loan Bank of San Francisco (“FHLB SF”) and the Federal Reserve Bank (“FRB”) as a source of borrowing capacity as of December 31, 2009. For additional information, see Note 7, Investments, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

Investment Securities, Held-to-Maturity

 

As of December 31, 2009 and 2008, CapitalSource Bank owned $242.1 million and $14.4 million, respectively, in investment securities, held-to-maturity, consisting of AAA-rated commercial mortgage-backed securities. For additional information, see Note 7, Investments, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Commercial Real Estate “A” Participation Interest

 

As of December 31, 2009 and 2008, the “A” Participation Interest had an outstanding balance of $530.6 million and $1.4 billion, respectively, net of discount. We expect the “A” Participation Interest to be fully repaid during 2010. For additional information, see Note 6, Commercial Lending Assets and Credit Quality, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

CapitalSource Bank Segment Loan Portfolio Composition

 

As of December 31, 2009 and 2008, the CapitalSource Bank loan portfolio had a gross outstanding balance of $3.1 billion and $2.7 billion, respectively. In 2008, we utilized the North American Industry Classification (“NAICS”) to determine the industry classification of our loans. In 2009, we determined our industry classifications using the industry classification categories outlined for the FDIC quarterly regulatory filings, which are consistent with how management categorizes these loans for management reporting. We have recast all periods presented to reflect the industry classification categories used in the FDIC quarterly regulatory filings to ensure comparability of all periods at both the consolidated and segment levels. Total CapitalSource Bank loan portfolio reflected in the portfolio statistics below includes gross loans held for investment.

 

As of December 31, 2009 and 2008, the composition of the CapitalSource Bank loan portfolio by loan type was as follows:

 

 

Our loans have stated maturities at origination that generally range from three to eight years. As of December 31, 2009, the weighted average maturity and weighted average remaining life of our CapitalSource Bank loan portfolio were approximately 5.2 years and 3.0 years, respectively. As of December 31, 2009, the weighted average remaining lives of the CapitalSource Bank loan portfolio by loan type were as follows:

 

 

Substantially all of the CapitalSource Bank loan portfolio bears interest at adjustable rates pegged to an interest rate index plus a specified margin. Approximately 71% of the portfolio is subject to an interest rate floor. Due to low market interest rates as of December 31, 2009, substantially all loans with interest rate floors were bearing interest at such floors. The weighted average spread between the floor rate and the fully indexed rate on the loans was 2.67% as of December 31, 2009. To the extent the underlying indices subsequently increase, CapitalSource Bank’s interest yield on this portfolio will not rise as quickly due to the effect of the interest rate floors.

As of December 31, 2009, the composition of CapitalSource Bank loan balances by index and by loan type was as follows:

 

 

As of December 31, 2009, our CapitalSource Bank loan portfolio by industry was as follows (percentages by gross carrying values as of December 31, 2009):

 

CapitalSource Bank Loan Portfolio by Industry⁽¹⁾

 

 

 

 

 

As of December 31, 2009, CapitalSource Bank’s largest loan had an outstanding balance of $129.2 million. As of December 31, 2009, our CapitalSource Bank commercial loan portfolio by loan balance was as follows:

 

CapitalSource Bank Loan Portfolio by Loan Balance

 

 

As of December 31, 2009, the number of loans, average loan size, number of clients and average loan size per client by loan type were as follows:

 

 

 

 

FHLB SF Stock

 

As of December 31, 2009 and 2008, CapitalSource Bank owned FHLB SF stock with a carrying value of $20.2 million. Investments in FHLB SF stock are recorded at historical cost. FHLB SF stock does not have a readily determinable fair value, but may generally be sold back to the FHLB SF at par value upon stated notice; however, the FHLB SF has currently ceased repurchases of excess stock. The investment in FHLB SF stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. No impairment losses have been recorded through December 31, 2009.

Deposits

 

As of December 31, 2009 and 2008, a summary of CapitalSource Bank’s deposit portfolio by product type and the maturity of the certificates of deposit portfolio were as follows:

 

 

 

FHLB SF Borrowings

 

FHLB SF borrowings were $200.0 million as of December 31, 2009. CapitalSource Bank did not have FHLB SF borrowings as of December 31, 2008. These borrowings were used primarily for interest rate risk management purposes. The weighted-average remaining maturity of the borrowings was approximately 1.9 years as of December 31, 2009.

 

As of December 31, 2009, the remaining maturity and the weighted average interest rate of FHLB SF borrowings were as follows:

 

Other Commercial Finance Segment Overview

 

Portfolio Composition

 

Total Other Commercial Finance loan portfolio reflected in the portfolio statistics below includes gross loans held for investment and loans held for sale, including lower of cost or fair value adjustments. As of December 31, 2009 and 2008, the composition of the Other Commercial Finance segment portfolio was as follows:

 

 

 

 

Other Commercial Finance Segment Loan Portfolio Composition

 

As of December 31, 2009 and 2008, our total Other Commercial Finance loan portfolio had a gross outstanding balance of $5.2 billion and $6.8 billion, respectively. Included in these amounts were loans held for sale of $0.7 million and $8.5 million as of December 31, 2009 and 2008, respectively.

 

As of December 31, 2009 and 2008, the composition of the Other Commercial Finance loan portfolio by loan type was as follows:

 

 

Our commercial loans have stated maturities at origination that generally range from 3 to 8 years. As of December 31, 2009, the weighted average maturity and weighted average remaining life of our Other Commercial Finance commercial loan portfolio were approximately 5.8 years and 2.4 years, respectively. As of December 31, 2009, the weighted average remaining lives of the Other Commercial Finance loan portfolio by loan type were as follows:

 

As of December 31, 2009, the composition of Other Commercial Finance loan balances by index and by loan type was as follows:

 

 

Approximately 55% of the adjustable rate loan portfolio is subject to an interest rate floor. Due to low market interest rates as of December 31, 2009, substantially all loans with interest rate floors were bearing interest at such floors. The weighted average spread between the floor rate and the fully indexed rate on the loans was 2.88% as of December 31, 2009. To the extent the underlying indices subsequently increase, the interest yield on these adjustable rate loans will not rise as quickly due to the effect of the interest rate floors.

As of December 31, 2009, our Other Commercial Finance loan portfolio by industry was as follows (percentages by gross carrying values as of December 31, 2009):

 

Other Commercial Finance Loan Portfolio by Industry⁽¹⁾

 

 

 

 

As of December 31, 2009, the largest commercial loan in our Other Commercial Finance segment had an outstanding balance of $325.0 million and is a mezzanine loan to a borrower that owns, operates, leases or manages

201 skilled nursing facilities, 22 assisted living facilities and four transition care units in 12 states. As of December 31, 2009, our Other Commercial Finance loan portfolio by loan balance was as follows:

 

Other Commercial Finance Loan Portfolio by Loan Balance

 

 

As of December 31, 2009, our Other Commercial Finance loan portfolio by geographic region was as follows:

 

Commercial Loan Portfolio by Geographic Region

 

 

 

As of December 31, 2009, the number of loans, average loan size, number of clients and average loan size per client by loan type were as follows:

 

 

 

 

Mortgage-related Receivables

 

As of December 31, 2008, we had $1.8 billion in mortgage-related receivables secured by prime residential mortgage loans. In December 2009, we sold our beneficial interest in these receivables, and as such, there was no outstanding balance of these receivables as of December 31, 2009. For additional information, see Note 5, Mortgage-Related Receivables and Related Owner Trust Securitizations, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Other Investments

 

We have made investments in some of our borrowers in connection with the loans provided to them. These investments usually comprised equity interests such as common stock, preferred stock, limited liability company interests, limited partnership interests and warrants.

 

As of December 31, 2009 and 2008, the carrying values of our other investments in the Other Commercial Finance segment were $96.5 million and $127.7 million, respectively. Included in these balances were investments carried at fair value totaling $1.4 million and $4.7 million, respectively.

 

Healthcare Net Lease Segment Overview

 

During the year ended December 31, 2009, we sold 82 long-term healthcare facilities and anticipate selling our remaining Healthcare Net Lease real estate investments in 2010 and 2011. Upon the completion of these asset sales, we will exit the skilled nursing home ownership business, but continue to actively provide financing for owners and operators in the long-term healthcare industry. As a result, much of the Healthcare Net Lease segment activity and assets are classified as discontinued operations in our audited consolidated financial statements. For additional information, see Note 3, Discontinued Operations, in our accompanying audited consolidated financial statements for the year ended December 31, 2009 and Item 2, Properties.

 

Portfolio Composition

 

We own real estate for long-term investment purposes. These real estate investments are generally long-term healthcare facilities leased through long-term, triple-net operating leases. We had $554.2 million in direct real estate investments as of December 31, 2009, which consisted primarily of land and buildings.

As of December 31, 2009, our Healthcare Net Lease direct real estate investment portfolio by geographic region was as follows:

 

Healthcare Net Lease Portfolio by Geographic Region

 

 

 

 

No client in our Healthcare Net Lease segment accounted for more than 10% of our total revenues in 2009. We use the term “client” with respect to our leased real estate investments to mean the legal entity that is the lessee pursuant to the lease agreement. As of December 31, 2009, the largest geographical concentration was Florida, which made up approximately 45% of our direct real estate investment portfolio. As of December 31, 2009, the single largest industry concentration in our direct real estate investment portfolio was skilled nursing, which made up approximately 99% of the investments.

As of December 31, 2009, our direct real estate investment portfolio by asset balance was as follows:

 

Healthcare Net Lease Portfolio by Asset Balance

 

 

Financing

 

We depend on depository and external financing sources to fund our operations. We employ a variety of financing arrangements, including deposits, secured credit facilities, term debt, convertible debt, subordinated debt and equity. As a member of the FHLB SF, one of 12 regional banks in the FHLB system, CapitalSource Bank had financing availability with the FHLB SF as of December 31, 2009 equal to 20% of CapitalSource Bank’s total assets, increased from 15% as of December 31, 2008. We expect that we will continue to seek and use external financing sources in the future. We cannot assure you, however, that we will have access to any of these funding sources. Our existing financing arrangements are described in further detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.

 

Competition

 

Our markets are competitive and characterized by varying competitive factors. We compete with a large number of financial services companies, including:

 

 

Some of our competitors have substantial market positions. Many of our competitors are large companies that have substantial capital, technological and marketing resources. Some of our competitors also have access to lower cost of capital. We believe we compete based on:

 

 

 

Supervision and Regulation

 

Our bank operations are subject to regulation by federal and state regulatory agencies. This regulation is intended primarily for the protection of depositors and the deposit insurance fund, and secondarily for the stability of the U.S. banking system. It is not intended for the benefit of stockholders of financial institutions. CapitalSource Bank is a California industrial bank and is subject to supervision and regular examination by the FDIC and the California Department of Financial Institutions (“DFI”). In addition, CapitalSource Bank’s deposits are insured up to applicable limits by the FDIC.

 

Although the Parent Company is not directly regulated or supervised by the DFI, the FDIC, the Federal Reserve Board or any other federal or state bank regulatory authority either as a bank holding company or otherwise, the FDIC has authority pursuant to arrangements with the Parent Company and CapitalSource Bank to examine the relationship and transactions between the Parent Company and CapitalSource Bank and the effect of such relationships and transactions on CapitalSource Bank. The Parent Company also is subject to regulation by other applicable federal and state agencies, such as the SEC. We are required to file periodic reports with these regulators and provide any additional information that they may require.

 

The following summary describes some of the more significant laws, regulations, and policies that affect our operations; it is not intended to be a complete listing of all laws that apply to us. From time to time, federal, state and foreign legislation is enacted and regulations are adopted which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. We cannot predict whether or when potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations, would have on our financial condition or results of operations.

 

General

 

CapitalSource Bank must file reports with the DFI and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to changing its approved business plan or entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. The FDIC recently issued revised guidance concerning banks currently designated as de novo pursuant to which the FDIC will increase the time period for de novo supervisory procedures from three to seven years, and enhance its supervision for compliance examinations and Community Reinvestment Act evaluations, and CapitalSource Bank will be required to submit updated financial statements and business plans for years four through seven. There are periodic examinations by the DFI and FDIC to evaluate CapitalSource Bank’s safety and soundness and compliance with various regulatory requirements. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the regulators or Congress, could have a material adverse impact on our operations.

 

The FDIC and DFI have enforcement authority over our operations, which includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inaction may provide the basis for enforcement action, including misleading or untimely reports filed with the FDIC or DFI. Except under certain circumstances, public disclosure of final enforcement actions by the FDIC or DFI is required.

 

In addition, the investment, lending and branching authority of CapitalSource Bank is prescribed by state and federal laws and CapitalSource Bank is prohibited from engaging in any activities not permitted by these laws.

California law provides that industrial banks are generally subject to a limit on loans to one borrower. A bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily marketable collateral. As of December 31, 2009, CapitalSource Bank’s limit on loans to one borrower was $138.5 million if unsecured and $230.9 million if secured by collateral.

 

The FDIC and DFI, as well as the other federal banking agencies, have adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.

 

The Parent Company has entered into a supervisory agreement with the FDIC (the “Parent Agreement”) consenting to examination of the Parent Company by the FDIC to monitor compliance with the laws and regulations applicable to CapitalSource Bank and its affiliates. The Parent Company and CapitalSource Bank are parties to a Capital Maintenance and Liquidity Agreement (“CMLA”) with the FDIC providing that, to the extent CapitalSource Bank independently is unable to do so, the Parent Company must maintain CapitalSource Bank’s total risk-based capital ratio at not less than 15% and must maintain CapitalSource Bank’s total risk-based capital ratio at all times to meet the levels required for a bank to be considered “well-capitalized” under the relevant banking regulations. Additionally, pursuant to requirements of the FDIC, the Parent Company has provided a $150 million unsecured revolving credit facility that CapitalSource Bank may draw on at any time it or the FDIC deems necessary. The Parent Agreement also requires the Parent Company to maintain the capital levels of CapitalSource Bank at the levels required in the CMLA.

 

It is important to meet minimum capital requirements to avoid mandatory or additional discretionary actions initiated by these regulatory agencies. These potential actions could have a direct material effect on our audited consolidated financial statements. Based upon the regulatory framework, we must meet specific capital guidelines that involve quantitative measures of the banking assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts, the ability to pay dividends and other requirements and classifications are also subject to qualitative judgments by the regulators about risk weightings and other factors.

 

Federal Home Loan Bank System

 

CapitalSource Bank is a member of the FHLB SF, which is one of twelve regional FHLBs that provide its members with a source of funding for mortgages and asset-liability management, liquidity for a member’s short-term needs and additional funds for housing finance and community development. Each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. Each FHLB makes advances to members in accordance with policies and procedures established by the Board of Directors of that FHLB, which are subject to the oversight of the Federal Housing Finance Agency. All borrowings from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. As of December 31, 2009, CapitalSource Bank’s unused FHLB SF borrowing capacity was $764.4 million, reflecting $200.0 million of principal outstanding and a letter of credit in the amount of $0.8 million. There were no outstanding FHLB SF borrowings as of December 31, 2008, but a letter of credit in the amount of $0.8 million was outstanding. The financing is subject to various terms and conditions including a pledge of acceptable collateral, satisfaction of the FHLB stock ownership requirement and certain limits regarding the maximum term of debt.

 

As a member, CapitalSource Bank is required to purchase and maintain stock in the FHLB SF. As of December 31, 2009, CapitalSource Bank had $20.2 million in FHLB SF stock, which was in compliance with this requirement. The FHLB SF declared a cash dividend for the fourth quarter of 2009 at an annual rate of 0.27%, payable in March 2010.

 

Under federal law, the FHLB is required to pay 20% of net earnings to fund a portion of the interest on the Resolution Funding Corporation debt and to contribute to low and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low and moderate income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions also could have an adverse effect on the value of FHLB stock in the future.

A reduction in value of CapitalSource Bank’s FHLB stock may result in a corresponding reduction in CapitalSource Bank’s capital.

 

Insurance of Accounts and Regulation by the FDIC

 

CapitalSource Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against insured institutions.

 

The Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), requires the FDIC to establish and implement a Restoration Plan if the DIF ratio falls below 1.15%. In 2008, the DIF ratio fell below 1.15% and the FDIC established the Restoration Plan, effective for the first quarter of 2009. Under the Restoration Plan system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and other factors. An institution’s assessment rate depends upon the category to which it is assigned. Assessment rates are determined by the FDIC. Beginning April 1, 2009, initial base assessment rates ranged from 12 to 16 basis points for the healthiest institutions to 45 basis points of assessable deposits for those that pose the highest risk. An institution’s total base assessment rate can vary from the initial base rate as the result of possible adjustments for unsecured debt, secured liabilities and brokered deposits. After applying all possible adjustments, total base assessment rates ranged from seven to 24 basis points for the healthiest institutions to 40 to 77.5 basis points for those that pose the highest risk. The FDIC may adopt rates that are higher or lower than total base assessment rates without the necessity of further notice and comment rulemaking, provided that no single adjustment from one quarter to the next can exceed three basis points. No institution may pay a dividend if in default of the FDIC assessment.

 

In the second quarter of 2009, the FDIC imposed a special assessment of five basis points on each deposit institution’s assets minus Tier 1 capital as of June 30, 2009. It also provided for additional assessments in 2009 if the FDIC estimates the reserve ratio of the DIF will fall to a level that would adversely affect the public confidence. In the third quarter of 2009, the FDIC also increased the annual assessment rate for 2011 and 2012 by three basis points.

 

Instead of additional special assessments, in the fourth quarter of 2009, the FDIC further amended the Restoration Plan to require all insured institutions prepay assessments through 2012. The amount of prepayment is based on an assumption of five percent annual growth in deposits and the assessment rate in effect on September 30, 2009, with the assessment rate increasing by three basis points in 2011. The prepaid assessment qualifies for a zero percent risk weighting under risk-based capital rules. The prepaid assessment does not preclude the FDIC from changing the assessment rate or further modifying the risk-based assessment system. The FDIC could institute further assessments in an effort to return the DIF to the statutory minimum ratio, and such assessments could be as much as 10 basis points per quarter. In addition, the FDIC can impose special assessments on an as needed basis if the reserve ratio of the Deposit Insurance Fund is estimated to fall to a level that would adversely affect public confidence.

 

A significant increase in insurance premiums would have an adverse effect on the operating expenses and results of operations of CapitalSource Bank. There can be no prediction as to what insurance assessment rates will be in the future. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the DFI.

 

In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. The assessment rates, which are determined quarterly, averaged 1.06 basis points of assessable deposits in 2009.

Prompt Corrective Action

 

The FDIC and DFI are required to take certain supervisory actions against undercapitalized banks, the severity of which depends upon the institution’s degree of undercapitalization. Generally, an institution is considered to be “undercapitalized” if it has a core capital ratio of less than 4.0% (3.0% or less for institutions with the highest examination rating), a ratio of total capital to risk-weighted assets of less than 8.0%, or a ratio of Tier 1 capital to risk-weighted assets of less than 4.0%. An institution that has a core capital ratio that is less than 3.0%, a total risk-based capital ratio less than 6.0%, and a Tier 1 risk-based capital ratio of less than 3.0% is considered to be “significantly undercapitalized” and an institution that has a tangible capital ratio equal to or less than 2.0% is deemed to be “critically undercapitalized.” Subject to a narrow exception, the FDIC or DFI is required to appoint a receiver or conservator for a bank that is “critically undercapitalized.” Regulations also require that a capital restoration plan be filed with the FDIC and DFI within 45 days of the date an institution receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. “Significantly undercapitalized” and “critically undercapitalized” institutions are subject to more extensive mandatory regulatory actions. The FDIC or DFI also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

 

The risk-based capital standard requires banks to maintain Tier 1 and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively, to be considered “adequately capitalized.” In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, and assigned by regulation based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

 

To remain in compliance with the conditions imposed by the FDIC, Capital Source Bank is required to maintain a total risk-based capital ratio of not less than 15% and must at all times be “well-capitalized,” which requires CapitalSource Bank to have minimum total risk-based capital ratio of 10%, Tier 1 risk-based capital ratio of 6% and Tier 1 leverage ratio of 5%. Further, the DFI approval order requires that CapitalSource Bank, during the first three years of operations, maintain a minimum ratio of tangible shareholder’s equity to total tangible assets of 10.0%. As of December 31, 2009, CapitalSource Bank had Tier-1 leverage, Tier-1 risked-based capital and total risk based capital ratios of 12.80%, 16.19% and 17.47%, respectively, each in excess of the minimum percentage requirements for “well-capitalized” institutions. As of December 31, 2009, CapitalSource Bank satisfied the DFI capital ratio requirement with a ratio of 12.32%. For additional information, see Note 19, Bank Regulatory Capital, in our accompanying audited consolidated financial statements for the year ended December 31, 2009.

 

Limitations on Capital Distributions

 

FDIC and DFI regulations impose various restrictions on banks with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, banks may make capital distributions during any calendar year up to 100% of net income for the year-to-date plus retained net income for the two preceding years if they are well-capitalized both before and after the proposed distribution. However, an institution deemed to be in need of more than normal supervision by the FDIC and DFI may have its dividend authority restricted by the regulating bodies. In accordance with the approval order, as a de novo bank, CapitalSource Bank is prohibited from paying dividends during its first three years of operations without consent from our regulators.

Transactions with Affiliates

 

CapitalSource Bank’s authority to engage in transactions with “affiliates” is limited by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve Board’s Regulation W. The term “affiliates” for these purposes generally means any company that controls or is under common control with an institution, and includes the Parent Company as it relates to CapitalSource Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, specified types of transactions are restricted to an aggregate percentage of the institution’s capital. Collateral in specified amounts must be provided by affiliates to receive extensions of credit from an institution. Federally insured banks are subject, with certain exceptions, to restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, these institutions are prohibited from engaging in specified tying arrangements in connection with any extension of credit or the providing of any property or service.

 

Community Reinvestment Act

 

Under the Community Reinvestment Act, every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the FDIC, in connection with the examination of CapitalSource Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by CapitalSource Bank. The FDIC may use an unsatisfactory rating as the basis for the denial of an application. Due to the heightened attention being given to the Community Reinvestment Act in the past few years, CapitalSource Bank may be required to devote additional funds for investment and lending in its local community.

 

Regulatory and Criminal Enforcement Provisions

 

The FDIC and DFI have primary enforcement responsibility over CapitalSource Bank and have the authority to bring action against all “institution-affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or $1.1 million per day in especially egregious cases. The FDIC has the authority to take such action under certain circumstances. Federal law also establishes criminal penalties for specific violations.

 

Environmental Issues Associated with Real Estate Lending

 

The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), a federal statute, generally imposes strict liability on all prior and current “owners and operators” of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for clean-up costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including the Parent Company and CapitalSource Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property.

Privacy Standards

 

The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (“GLBA”) modernized the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. CapitalSource Bank is subject to regulations implementing the privacy protection provisions of the GLBA. These regulations require CapitalSource Bank to disclose its privacy policy, including identifying with whom it shares “non-public personal information” to customers at the time of establishing the customer relationship and annually thereafter. The State of California’s Financial Information Privacy Act provides greater protection for consumer’s rights under California Law to restrict affiliate data sharing.

 

Anti-Money Laundering and Customer Identification

 

As part of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”), Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). IMLAFATA amended the Bank Secrecy Act (“BSA”) and adopted additional measures that established or increased existing obligations of financial institutions, including CapitalSource Bank, to identify their customers, monitor and report suspicious transactions, respond to requests for information by federal banking regulatory authorities and law enforcement agencies, and, at the option of CapitalSource Bank, share information with other financial institutions. The U.S. Secretary of the Treasury has adopted several regulations to implement these provisions. Pursuant to these regulations, CapitalSource Bank is required to implement appropriate policies and procedures relating to anti-money laundering matters, including compliance with applicable regulations, suspicious activities, currency transaction reporting and customer due diligence. Our BSA compliance program is subject to federal regulatory review.

 

Other Laws and Regulations

 

CapitalSource Bank is subject to many other federal statutes and regulations, such as the Equal Credit Opportunity Act, the Truth in Savings Act, the Fair Credit Reporting Act, the Fair Housing Act, the National Flood Insurance Act and various federal and state privacy protection laws. These laws, rules and regulations, among other things, impose licensing obligations, limit the interest rates and fees that can be charged, mandate disclosures and notices to customers mandate the collection and reporting of certain data regarding customers, regulate marketing practices and require the safeguarding of non-public information of customers. Penalties for violating these laws could subject CapitalSource Bank to lawsuits and could also result in administrative penalties, including, fines and reimbursements. CapitalSource Bank and the Parent Company are also subject to federal and state laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition.

 

In recent years, examination and enforcement by the state and federal banking agencies for non-compliance with the above-referenced laws and their implementing regulations have become more intense. Due to these heightened regulatory concerns, CapitalSource Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.

 

The Federal government, in response to the current economic environment, continues to evaluate possible new laws and regulations, which if enacted, could have a material impact on CapitalSource Bank and the Parent Company, including among other things increased reporting obligations, restrictions on current lending activities, Federal and state supervision and increased expenses to operate as a bank.

 

Regulation of Other Activities

 

Some other aspects of our operations are subject to supervision and regulation by governmental authorities and may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions, which, among other things:

 

 

 

In addition, many of our healthcare clients receive significant funding from governmental sources and are subject to licensure, certification and other regulation and oversight under the applicable Medicare and Medicaid programs. These regulations and governmental oversight, both on federal and state levels, indirectly affect our business in several ways as discussed below and in Item 1A, Risk Factors.

 

 

Employees

 

As of December 31, 2009, we employed 665 people, 366 of whom were employed by CapitalSource Bank. We believe that our relations with our employees are good.

Executive Officers

 

Our executive officers and their ages and positions are as follows:

 

 

 

Biographies for our executive officers are as follows:

 

John K. Delaney, 46, a co-founder of the company, has served as our Executive Chairman since January 2010, as a director and Chairman of our Board since our inception in 2000, and as our Chief Executive Officer from our inception in 2000 until January 2010. Mr. Delaney received his undergraduate degree from Columbia University and his juris doctor degree from Georgetown University Law Center.

 

Steven A. Museles, 46, has served as a director and Co-Chief Executive Officer since January 2010. Mr. Museles previously served as our Executive Vice President, Chief Legal Officer and Secretary from our inception in 2000 until January 2010, and in similar capacities for CapitalSource Bank from July 2008 through December 2009. Mr. Museles received his undergraduate degree from the University of Virginia and his juris doctor degree from Georgetown University Law Center.

 

James J. Pieczynski, 47, has served as a director and Co-Chief Executive Officer since January 2010. Mr. Pieczynski previously served as our President — Healthcare Real Estate Business from November 2008 until January 2010, our Co-President — Healthcare and Specialty Finance from January 2006 until November 2008, Managing Director — Healthcare Real Estate Group from February 2005 through December 2005, and Director — Long Term Care from November 2001 through January 2005. Mr. Pieczynski served on the board of directors and audit committee of Florida East Coast Industries Inc. from June 2004 until June 2006. Mr. Pieczynski received his undergraduate degree from the University of Illinois, Urbana-Champaign.

 

Douglas H. (Tad) Lowrey, 57, has served as the Chief Executive Officer and President of CapitalSource Bank since its formation on July 25, 2008. Prior to his appointment, Mr. Lowrey served as Executive Vice President of Wedbush, Inc., a private investment firm and holding company, from January 2006 until June 2008. Mr. Lowrey served as Chairman, President and Chief Executive Officer of Jackson Federal Bank from 1999 until February 2005 following its sale to Union Bank of California. Mr. Lowrey is an elected director of the Federal Home Loan Bank of San Francisco. He received his undergraduate degree from Arkansas Tech University and was licensed in 1977 in the state of Arkansas as a certified public accountant.

 

Donald F. Cole, 39, has served as our Chief Financial Officer since May 2009. Mr. Cole previously served as our Chief Administrative Officer from September 2008 until May 2009, our interim Chief Accounting Officer from March 2008 until September 2008, our Chief Administrative Officer from January 2007 until March 2008, our Chief Operations Officer from February 2005 until January 2007, and our Chief Information Officer from July 2003 until February 2005. Mr. Cole received his undergraduate degree and masters of business administration from the State University of New York at Buffalo and a juris doctor degree from the University of Virginia School of Law. He was licensed in 1996 in the state of New York as a certified public accountant.

 

Bryan D. Smith, 39, has served as our Chief Accounting Officer since September 2008. Previously, Mr. Smith worked as a consultant to us from June 2008 until his appointment as our Chief Accounting Officer in September 2008, and served as our Controller — Strategy Execution from January 2007 until May 2008, and our Controller from October 2003 until January 2007. Mr. Smith received his undergraduate degree from Virginia Tech in 1993 and was licensed in 1994 in the State of Maryland as a certified public accountant.

Statistical Disclosures

 

The financial data for the year ended December 31, 2009 comprises information from CapitalSource Inc., including CapitalSource Bank, for the entire year. Financial data for the year ended December 31, 2008 comprises information from CapitalSource Inc. for the entire year and CapitalSource Bank for the period from the commencement of CapitalSource Bank’s operations on July 25, 2008 through December 31, 2008. Financial data as of and for the years ended December 31, 2007, 2006, and 2005 does not include any information from CapitalSource Bank.

 

For purposes of the following statistical disclosures, we determined separate disclosure of foreign data was unnecessary because they are not material in relation to the domestic activities of our operations for all years presented in our audited consolidated financial statements. In addition, certain amounts as of and for the years ended December 31, 2009, 2008, 2007, 2006, and 2005 have been reclassified from previous years’ presentations to conform to the current year presentation.

Table 1. Distribution of Assets, Liabilities, and Shareholders’ Equity

 

For the years ended December 31, 2009, 2008 and 2007, our consolidated average balances and the resulting average interest yields and rates were as follows:

 

 

 

 

Table 2. Interest Income/Expense Variance Analysis

 

For the years ended December 31, 2009 and 2008, changes in interest income, interest expense and net interest income as a result of changes in volume, changes in interest rates or both were as follows:

 

 

Volume and interest rate variances have been calculated based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. Changes due to a combination of volume and interest rates were allocated proportionally to the absolute change in volume and interest rates.

 

Certain selected ratios associated with our financial information are included in Item 6, Selected Financial Data.

Table 3. Investment Portfolio

 

As of December 31, 2009, 2008 and 2007, the outstanding book values of our trading and investment securities were as follows:

 

 

 

 

Table 4. Investments by Maturity Dates

 

As of December 31, 2009, the carrying amounts, contractual maturities and weighted average yields of our investment securities were as follows:

 

 

 

 

Actual maturities of these securities may differ from contractual maturity dates because issuers may have the right to call or prepay obligations.

 

Table 5. Loan Balances by Product Type

 

The outstanding unpaid principal balance of loans in our commercial loan portfolio (including loans held for sale) by category as of December 31 2009, 2008, 2007, 2006 and 2005 was as follows:

 

 

 

 

Although our loan portfolio included borrowers from more than 18 industries as of December 31, 2009, we had a high concentration of our loan balances in three industries in particular. These industries and their respective percentage to total loans were follows: