e10vq

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 March 31, 2011

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.)

5404 Wisconsin Avenue, 2nd Floor
Chevy Chase, MD 20815
(Address of Principal Executive Offices, Including Zip Code)

(301) 841-2700

(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 þ 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 April 29, 2011, the number of shares of the registrant’s Common Stock, par value $0.01 per share, outstanding was 323,195,591.

CapitalSource Inc.

Consolidated Balance Sheets


	March 31,			December 31,
	2011			2010
	(Unaudited)
	($ in thousands)

ASSETS
Cash and cash equivalents	$	1,151,495		$	820,450
Restricted cash (including $24.2 million and $46.5 million, respectively, of cash that can only be used to settle obligations of consolidated VIEs)		76,577			128,586
Investment securities:
Available-for-sale, at fair value		1,370,353			1,522,911
Held-to-maturity, at amortized cost		179,077			184,473

Total investment securities		1,549,430			1,707,384
Loans:
Loans held for sale		17,997			205,334
Loans held for investment		6,067,726			6,152,876
Less deferred loan fees and discounts		(93,513	)		(106,438	)
Less allowance for loan losses		(283,274	)		(329,122	)

Loans held for investment, net (including $856.7 million and $889.7 million, respectively, of loans that can only be used to settle obligations of consolidated VIEs)		5,690,939			5,717,316

Total loans		5,708,936			5,922,650
Interest receivable		57,922			57,393
Other investments		67,906			71,889
Goodwill		173,135			173,135
Other assets		487,937			563,920

Total assets	$	9,273,338		$	9,445,407


LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits	$	4,708,349		$	4,621,273
Credit facilities		—			67,508
Term debt (including $577.3 million and $693.5 million, respectively, in obligations of consolidated VIEs for which there is no recourse to the general credit of CapitalSource Inc.)		863,799			979,254
Other borrowings		1,368,462			1,375,884
Other liabilities		261,292			347,546

Total liabilities		7,201,902			7,391,465
Shareholders’ equity:
Preferred stock (50,000,000 shares authorized; no shares outstanding)		—			—
Common stock ($0.01 par value, 1,200,000,000 shares authorized; 323,345,312 and 323,225,355 shares issued and outstanding, respectively)		3,233			3,232
Additional paid-in capital		3,914,500			3,911,341
Accumulated deficit		(1,870,663	)		(1,870,572	)
Accumulated other comprehensive income, net		24,366			9,941

Total shareholders’ equity		2,071,436			2,053,942

Total liabilities and shareholders’ equity	$	9,273,338		$	9,445,407

See accompanying notes.

CapitalSource Inc.

Consolidated Statements of Operations


	Three Months Ended
	March 31,
	2011			2010
	(Unaudited)
	($ in thousands, except per share data)

Net interest income:
Interest income:
Loans	$	123,500		$	156,250
Investment securities		18,352			14,591
Other		300			573

Total interest income		142,152			171,414
Interest expense:
Deposits		13,383			16,358
Borrowings		33,369			48,643

Total interest expense		46,752			65,001

Net interest income		95,400			106,413
Provision for loan losses		44,809			218,940

Net interest income (loss) after provision for loan losses		50,591			(112,527	)
Operating expenses:
Compensation and benefits		30,379			34,183
Professional fees		7,188			10,370
Other administrative expenses		16,694			18,652

Total operating expenses		54,261			63,205
Other income (expense):
Gain on investments, net		23,515			6,079
Loss on derivatives		(1,878	)		(4,337	)
Net expense of real estate owned and other foreclosed assets		(10,173	)		(40,492	)
Other income, net		6,527			16,475

Total other income (expense)		17,991			(22,275	)

Net income (loss) from continuing operations before income taxes		14,321			(198,007	)
Income tax expense		11,162			21,006

Net income (loss) from continuing operations		3,159			(219,013	)
Net income from discontinued operations, net of taxes		—			7,323

Net income (loss)	$	3,159		$	(211,690	)

Basic income (loss) per share:
From continuing operations	$	0.01		$	(0.68	)
From discontinued operations	$	—		$	0.02
Net income (loss) per share	$	0.01		$	(0.66	)
Diluted income (loss) per share:
From continuing operations	$	0.01		$	(0.68	)
From discontinued operations	$	—		$	0.02
Net income (loss) per share	$	0.01		$	(0.66	)
Average shares outstanding:
Basic		320,196,690			320,294,724
Diluted		326,963,738			320,294,724
Dividends declared per share	$	0.01		$	0.01

See accompanying notes.

CapitalSource Inc.

Consolidated Statements of Cash Flows


	Three Months Ended
	March 31,
	2011			2010
	(Unaudited)
	($ in thousands)

Operating activities:
Net income (loss)	$	3,159		$	(211,690	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Stock option expense		1,372			1,349
Restricted stock expense		1,563			4,050
Gain on extinguishment of debt		—			(698	)
Amortization of deferred loan fees and discounts		(19,744	)		(18,685	)
Paid-in-kind interest on loans		23,736			(945	)
Provision for loan losses		44,809			218,940
Amortization of deferred financing fees and discounts		7,818			12,633
Depreciation and amortization		(1,774	)		1,725
Provision for deferred income taxes		31,483			33,515
Non-cash (gain) loss on investments, net		(26,660	)		212
Non-cash loss on foreclosed assets and other property and equipment disposals		9,546			35,741
Unrealized loss (gain) on derivatives and foreign currencies, net		2,384			(5,173	)
Accretion of discount on commercial real estate “A” participation interest		—			(5,853	)
Increase in interest receivable		(529	)		(42,647	)
Decrease (increase) in loans held for sale, net		204,050			(67	)
Decrease (increase) in other assets		24,303			(4,258	)
Decrease in other liabilities		(84,328	)		(65,803	)

Cash provided by (used in) operating activities		221,188			(47,654	)
Investing activities:
Decrease in restricted cash		52,009			36,109
Decrease in commercial real estate “A” participation interest, net		—			208,421
(Increase) decrease in loans, net		(33,729	)		178,515
Reduction (acquisition) of marketable securities, available for sale, net		180,038			(580,027	)
Reduction of marketable securities, held to maturity, net		10,253			27,591
Reduction of other investments, net		14,641			2,942
Acquisition of property and equipment, net		(493	)		(467	)

Cash provided by (used in) investing activities		222,719			(126,916	)
Financing activities:
Payment of deferred financing fees		—			(2,215	)
Deposits accepted, net of repayments		87,076			99,067
Repayments on credit facilities, net		(68,792	)		(124,650	)
Borrowings of term debt		—			14,395
Repayments and extinguishment of term debt		(116,257	)		(290,507	)
(Repayments of) borrowings under other borrowings		(12,021	)		5,137
Proceeds from exercise of options		354			—
Payment of dividends		(3,222	)		(3,228	)

Cash used in financing activities		(112,862	)		(302,001	)

Increase (decrease) in cash and cash equivalents		331,045			(476,571	)
Cash and cash equivalents as of beginning of period		820,450			1,177,020

Cash and cash equivalents as of end of period	$	1,151,495		$	700,449

Supplemental information:
Noncash transactions from investing and financing activities:
Assets acquired through foreclosure	$	2,070		$	51,887

See accompanying notes.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Note 1.	Organization

References to we, us, the Company or CapitalSource refer to CapitalSource Inc., a Delaware corporation, together with its subsidiaries. References to CapitalSource Bank include its subsidiaries, and references to Parent Company refer to CapitalSource Inc. and its subsidiaries other than CapitalSource Bank. We are a commercial lender that, 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.

For the three months ended March 31, 2011, we operated as two reportable segments: 1) CapitalSource Bank and 2) Other Commercial Finance. For the three months ended March 31, 2010, we operated 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, and our Other Commercial Finance segment comprises our loan portfolio and other business activities in the Parent Company. Our Healthcare Net Lease segment comprised our direct real estate investment business activities, which we exited completely with the sale of all of the assets related to this segment during 2010, and consequently, we have presented the financial condition and results of operations within our Healthcare Net Lease segment as discontinued operations for all periods presented. We have reclassified all comparative period results to reflect our two current reportable segments. For additional information, see Note 19, 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 of the Securities Exchange Act of 1934. 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 audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission on February 28, 2011 (“Form 10-K”).

The accompanying financial statements reflect our consolidated accounts and those of other entities in which we have a controlling financial interest including our majority-owned subsidiaries and variable interest entities (“VIEs”) where we determined that we are the primary beneficiary. All significant intercompany accounts and transactions have been eliminated.

Reclassifications

Certain amounts in prior period consolidated financial statements have been reclassified to conform to the current period presentation, including the reclassification of fee income to interest income or other income, net and the reclassification of letter of credit fee expense from interest expense to other income, net in our audited consolidated statements of operations. Accordingly, the reclassifications have been appropriately reflected throughout our consolidated financial statements.

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, 2010, included in our Form 10-K.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

New Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) amended its guidance on fair value measurements and disclosure, which was intended to improve transparency in financial reporting by requiring enhanced disclosures related to fair value measurements. These new disclosures provided for disclosure of transfers between Level 1 and Level 2 of the fair value hierarchy, of fair value measurements for each class of assets and liabilities presented, of separate information for acquisitions, sales, issuances, and settlements in the rollforward of activity of Level 3 fair value measurements, and of valuation techniques used in recurring and nonrecurring fair value measurements for both Level 2 and Level 3 measurements. We adopted this guidance on January 1, 2010, except for the guidance related to acquisitions, sales, issuances, and settlements in the rollforward of activity of Level 3 fair value measurements, which is effective for annual reporting periods ending after December 15, 2010, and for interim periods within those annual reporting periods. We adopted the guidance related to the rollforward of activity of Level 3 fair value measurements on January 1, 2011, and it did not have a material impact on our audited consolidated financial statements.

In July 2010, the FASB amended its guidance on financing receivables to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment and class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. This guidance was effective for interim and annual periods ending on or after December 15, 2010 for disclosures as of the end of a period and for interim and annual periods beginning after December 15, 2010 for disclosures related to activity during a period. We adopted the guidance for disclosures as of the end of a period on October 1, 2010 and for disclosures related to activity during a period on January 1, 2011. For further information, see Note 5, Loans and Credit Quality.

In April 2011, the FASB amended its guidance on loans to clarify which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. This guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. We plan to adopt this guidance as of July 1, 2011. We have not completed our assessment of the impact of this amended guidance.


Note 3.	Discontinued Operations

In 2010, we completed the sale of our remaining long-term healthcare facilities to Omega Healthcare Investors, Inc., and as a result, we exited the skilled nursing home ownership business. Consequently, we have presented the results of operations for this business 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.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The condensed statements of operations for the three months ended March 31, 2011 and 2010 for our discontinued operations were as follows:


	Three Months Ended
	March 31,
	2011		2010
	($ in thousands)

Revenue:
Operating lease income	$	—	$	15,266
Expenses:
Interest		—		4,513
Depreciation		—		2,540
General and administrative		—		823
Other expense		—		67

Total expenses		—		7,943

Net income from discontinued operations	$	—	$	7,323


Note 4.	Cash and Cash Equivalents and Restricted Cash

As of March 31, 2011 and December 31, 2010, our cash and cash equivalents and restricted cash balances were as follows:


	March 31, 2011				December 31, 2010
	Unrestricted		Restricted		Unrestricted		Restricted
	($ in thousands)

Cash and cash equivalents and restricted cash:
Cash and due from banks(1)	$	397,362	$	51,605	$	576,276	$	58,814
Interest-bearing deposits in other banks(2)		176,483		361		70,383		10,213
Other short-term investments(3)		577,650		24,611		173,791		59,559

Total cash and cash equivalents and restricted cash	$	1,151,495	$	76,577	$	820,450	$	128,586


(1)		Represents principal and interest collections, including those related to loans held by securitization trusts or pledged to financing sources.

(2)		Represents principal and interest collections on loan assets pledged to financing sources. Included in these balances for CapitalSource Bank were $120.6 million and $63.6 million in deposits at the Federal Reserve Bank (“FRB”) as of March 31, 2011 and December 31, 2010, respectively.

(3)		Represents principal and interest collections, including those related to loans held by securitization trusts or pledged to financing sources and also includes short-term investments held by CapitalSource Bank. Cash is invested in 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 in a short-term money market fund which has a rating of AAAm (S&P) and Aaa (Moody’s).


Note 5.	Loans and Credit Quality

As of March 31, 2011 and December 31, 2010, our outstanding loan balance was $6.1 billion and $6.4 billion, respectively. Included in these amounts were loans held for sale and loans held for investment. As of March 31, 2011 and December 31, 2010, interest and fee receivables totaled $53.6 million and $52.7 million, respectively.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Loans Held for Sale

Loans held for sale are recorded at the lower of cost or fair value in our consolidated balance sheets.

Our analysis to determine when to sell a loan is performed on a loan-by-loan basis and considers several factors, including the credit quality of the loan, any financing secured by the loan and any requirements related to the release of liens and use of sales proceeds, the potential sale price relative to our loan valuation, our liquidity needs, and the resources necessary to ensure an adequate recovery if we continued to hold the loan. When our analysis indicates that the proper strategy is to sell a loan, we initiate the sale process and designate the loan as held for sale.

During the three months ended March 31, 2011 and 2010, we transferred impaired loans with a carrying value of $30.3 million and $29.0 million, respectively, from held for investment to held for sale. These transfers were based on our decision to sell these loans as part of overall portfolio management and workout strategies. We did not incur any losses due to valuation adjustments at the time of transfer for the three months ended March 31, 2011 and 2010, respectively. We reclassified $28.6 million and $10.5 million of loans from held for sale to held for investment during the three months ended March 31, 2011 and 2010, respectively, based upon our intent to retain these loans for investment.

During the three months ended March 31, 2011 and 2010, we recognized net pre-tax gains of $1.3 million and $0.1 million, respectively, on the sale of loans.

As of March 31, 2011 and December 31, 2010, loans held for sale with an outstanding balance of $11.5 million and $14.7 million, respectively, were classified as non-accrual loans. We did not record any fair value write-downs on non-accrual loans held for sale during the three months ended March 31, 2011 and 2010, respectively.

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 and lease 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. This methodology is used consistently to develop our allowance for loan losses for all loans in our loan portfolio, and, as such, we maintain a single portfolio segment. The loans in our portfolio are grouped into seven loan classes, based on the level that we use to assess and monitor the risk and performance of the portfolio, including the nature of the borrower, collateral and lending arrangement.

As of March 31, 2011 and December 31, 2010, CapitalSource Bank pledged loans held for investment with an unpaid principal balance of $170.8 million and $166.1 million, respectively, to the Federal Home Loan Bank of San Francisco (“FHLB SF”) as collateral for its financing facility.

Non-performing loans are loans accounted for on a non-accrual basis, accruing loans which are contractually past due 90 days or more as to principal or interest payments and other loans identified as troubled debt restructurings (“TDRs”) as defined by GAAP.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During the three months ended March 31, 2011, we purchased loans held for investment with an unpaid principal balance of $315.3 million. As of March 31, 2011 and December 31, 2010, the carrying value of each class of loans held for investment, separated by performing and non-performing categories, was as follows:


	March 31, 2011						December 31, 2010
Class	Performing		Non-Performing		Total		Performing		Non-Performing		Total
	($ in thousands)

Asset-based	$	1,446,200	$	111,769	$	1,557,969	$	1,352,039	$	194,625	$	1,546,664
Cash flow		1,376,622		266,963		1,643,585		1,558,783		264,786		1,823,569
Healthcare asset-based		240,025		2,345		242,370		269,339		2,925		272,264
Healthcare real estate		768,644		32,249		800,893		841,774		28,866		870,640
Multi-family		582,928		10,693		593,621		328,300		11,010		339,310
Real estate		650,646		356,382		1,007,028		725,972		356,087		1,082,059
Small business		118,236		10,511		128,747		101,761		10,171		111,932

Total(1)	$	5,183,301	$	790,912	$	5,974,213	$	5,177,968	$	868,470	$	6,046,438


(1)		Excludes loans held for sale. Balances are net of deferred loan fees and discounts.

Credit risk within our loan portfolio is the risk of loss arising from adverse changes in a client’s or counterparty’s ability to meet its financial obligations under agreed-upon terms. The degree of credit risk will vary based on many factors including the size of the asset or transaction, the credit characteristics of the client, the contractual terms of the agreement and the availability and quality of collateral.

We use a variety of tools to continuously monitor a client’s ability to perform under its obligations. Additionally, we syndicate loan exposure to other lenders, sell loans and use other risk mitigation techniques to manage the size and risk profile of our loan portfolio.

Credit risk management for the loan portfolio begins with an assessment of the credit risk profile of a client based on an analysis of the client’s payment performance, cash flow and financial position. As part of the overall credit risk assessment of a client, each commercial credit exposure is assigned an internal risk rating that is subject to approval based on defined credit approval standards. While rating criteria vary by product, each loan rating focuses on the same two factors: financial performance and collateral. Subsequent to loan origination, risk ratings are monitored on an ongoing basis. If necessary, risk ratings are adjusted to reflect changes in the client’s financial condition, cash flow or financial position. We use risk rating aggregations to measure and evaluate concentrations within the loan portfolio. In making decisions regarding credit, we consider risk rating, collateral and industry concentration limits.

We believe that the likelihood of not being paid according to the contractual terms of a loan is, in large part, dependent upon the assessed level of risk associated with the loan. The internal rating that is assigned to a loan provides a view as to the relative risk of each loan. We employ an internal risk rating scale to establish a view of the credit quality of each loan. This scale is based on the credit classifications of assets as prescribed by government regulations and industry standards and is separated into the following groups:


	•	Pass — Loans with standard, acceptable levels of credit risk;

	•	Special mention — Loans that have potential weaknesses that deserve close attention, and which, if left uncorrected, may result in a loss or deterioration of our credit position;

	•	Substandard — Loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected; and

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	•	Doubtful — Loans that have all the weaknesses inherent in one classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

As of March 31, 2011 and December 31, 2010, the carrying value of each class of loans held for investment, by internal risk rating, was as follows:


	Internal Risk Rating
Class	Pass		Special Mention		Substandard		Doubtful		Total
	($ in thousands)

As of March 31, 2011:
Asset-based	$	1,187,296	$	151,677	$	146,129	$	72,867	$	1,557,969
Cash flow		950,691		190,193		378,663		124,038		1,643,585
Healthcare asset-based		193,683		31,085		15,257		2,345		242,370
Healthcare real estate		702,875		43,949		38,821		15,248		800,893
Multi-family		549,146		33,782		8,735		1,958		593,621
Real estate		367,595		111,892		453,607		73,934		1,007,028
Small business		113,146		6,248		5,227		4,126		128,747

Total(1)	$	4,064,432	$	568,826	$	1,046,439	$	294,516	$	5,974,213

As of December 31, 2010:
Asset-based	$	1,207,990	$	39,612	$	169,986	$	129,076	$	1,546,664
Cash flow		1,110,779		216,399		350,287		146,104		1,823,569
Healthcare asset-based		245,486		9,243		15,509		2,026		272,264
Healthcare real estate		773,955		37,730		47,090		11,865		870,640
Multi-family		330,017		—		8,919		374		339,310
Real estate		396,044		98,401		470,034		117,580		1,082,059
Small business		97,444		6,278		5,514		2,696		111,932

Total(1)	$	4,161,715	$	407,663	$	1,067,339	$	409,721	$	6,046,438


(1)		Excludes loans held for sale. Balances are net of deferred loan fees and discounts.

Non-Accrual and Past Due Loans

We will place a loan on non-accrual status if there is substantial doubt about the borrower’s ability to service its debt and other obligations or if the loan is 90 or more days past due and is not well-secured and in the process of collection. When a loan is placed on non-accrual status, accrued and unpaid interest is reversed and the recognition of interest and fee income on that loan will stop until factors indicating doubtful collection no longer exist and the loan has been brought current. Payments received on non-accrual loans are generally first applied to principal. A loan may be returned to accrual status when its interest or principal is current, repayment of the remaining contractual principal and interest is expected or when the loan otherwise becomes well-secured and is in the process of collection. Cash payments received from the borrower and applied to the principal balance of the loan while the loan was on non-accrual status are not reversed if a loan is returned to accrual status.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of March 31, 2011 and December 31, 2010, the carrying value of non-accrual loans was as follows:


	March 31, 2011		December 31, 2010
	($ in thousands)

Asset-based	$	71,870	$	142,847
Cash flow		180,276		183,606
Healthcare asset-based		2,345		2,925
Healthcare real estate		32,249		28,866
Multi-family		10,693		11,010
Real estate		205,044		265,615
Small business		5,086		4,980

Total(1)	$	507,563	$	639,849


(1)		Excludes loans held for sale and purchased credit impaired loans. Balances are net of deferred loan fees and discounts.

As of March 31, 2011 and December 31, 2010, the delinquency status of loans in our loan portfolio was as follows:


											Greater than 90
	30-89 Days		Greater than 90								Days Past Due and
	Past Due		Days Past Due		Total Past Due		Current		Total Loans		Accruing
	($ in thousands)

As of March 31, 2011:
Asset-based	$	38,000	$	22,792	$	60,792	$	1,488,017	$	1,548,809	$	2,264
Cash flow		3,587		64,587		68,174		1,575,411		1,643,585		—
Healthcare asset-based		—		—		—		242,370		242,370		—
Healthcare real estate		—		21,681		21,681		772,317		793,998		—
Multi-family		564		9,096		9,660		583,961		593,621		—
Real estate		10		132,783		132,793		869,400		1,002,193		44,596
Small business		3,683		4,113		7,796		115,527		123,323		—

Total(1)	$	45,844	$	255,052	$	300,896	$	5,647,003	$	5,947,899	$	46,860

As of December 31, 2010:
Asset-based	$	8,074	$	27,130	$	35,204	$	1,500,537	$	1,535,741	$	3,244
Cash flow		10,573		60,644		71,217		1,752,352		1,823,569		—
Healthcare asset-based		—		—		—		272,264		272,264		—
Healthcare real estate		—		25,887		25,887		840,527		866,414		—
Multi-family		2,324		9,293		11,617		327,692		339,309		—
Real estate		54		148,197		148,251		924,590		1,072,841		45,783
Small business		4,317		4,981		9,298		97,444		106,742		—

Total(1)	$	25,342	$	276,132	$	301,474	$	5,715,406	$	6,016,880	$	49,027


(1)		Excludes loans held for sale and purchased credit impaired loans. Balances are net of deferred loan fees and discounts.

Impaired Loans

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 a shortfall in the amount of contractual payments due to us.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Assessing the likelihood that a loan will not be paid according to its contractual terms involves the consideration of all relevant facts and circumstances and requires a significant amount of judgment. For such purposes, factors that are considered include:


	•	The current performance of the borrower;

	•	The current economic environment and financial capacity of the borrower to preclude a default;

	•	The willingness of the borrower to provide the support necessary to preclude a default (including the potential for successful resolution of a potential problem through modification of terms); and

	•	The borrower’s equity position in the underlying collateral, if applicable, based on our best estimate of the fair value of the collateral.

In assessing the adequacy of available evidence, we consider whether the receipt of payments is dependent on the fiscal health of the borrower or the sale, refinancing or foreclosure of the loan.

We continue to recognize interest income on loans that have been identified as impaired, but that have not been placed on non-accrual status. If the loan is placed on non-accrual status, accrued and unpaid interest is reversed and the recognition of interest and fee income on that loan will stop until factors indicating doubtful collection no longer exist, and the loan has been brought current.

As of and for the three months ended March 31, 2011, information pertaining to our impaired loans was as follows:


	Carrying		Legal Principal		Related			Average		Interest Income
	Value(1)		Balance(2)		Allowance			Balance		Recognized
	($ in thousands)

With no related allowance recorded:
Asset-based	$	68,180	$	119,958	$	—		$	79,808	$	770
Cash flow		129,366		192,915		—			131,014		1,220
Healthcare asset-based		1,945		2,004		—			819		—
Healthcare real estate		19,460		21,597		—			19,026		—
Multi-family		9,096		13,396		—			10,498		—
Real estate		260,634		361,886		—			308,633		1,676
Small business		10,387		17,889		—			10,338		—

Total(1)		499,068		729,645		—			560,136		3,666
With allowance recorded:
Asset-based		43,589		54,043		(5,906	)		77,586		—
Cash flow		137,597		208,356		(40,875	)		148,574		832
Healthcare asset-based		400		11,260		(964	)		1,790		—
Healthcare real estate		12,789		14,430		(2,688	)		10,663		—
Multi-family		1,597		2,288		(147	)		399		—
Real estate		34,004		46,274		(10,549	)		57,319		—
Small business		124		132		(58	)		141		—

Total(1)		230,100		336,783		(61,187	)		296,472		832

Total impaired loans	$	729,168	$	1,066,428	$	(61,187	)	$	856,608	$	4,498


(1)		Carrying value of impaired loans before applying specific reserves. Excludes loans held for sale. Balances are net of deferred loan fees and discounts.

(2)		Represents the contractual amounts owed to us by borrowers.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of and for the year ended December 31, 2010, information pertaining to our impaired loans was as follows:


	Carrying		Legal Principal		Related			Average		Interest Income
	Value(1)		Balance(2)		Allowance			Balance		Recognized
	($ in thousands)

With no related allowance recorded:
Asset-based	$	96,514	$	180,659	$	—		$	147,560	$	5,158
Cash flow		128,658		205,454		—			181,308		6,487
Healthcare asset-based		463		825		—			1,575		132
Healthcare real estate		18,881		19,892		—			20,119		11
Multi-family		11,010		15,402		—			2,655		35
Real estate		323,292		407,423		—			190,510		5,770
Small business		9,861		17,708		—			4,317		—

Total(1)		588,679		847,363		—			548,044		17,593
With allowance recorded:
Asset-based		98,762		112,732		(21,684	)		60,580		23
Cash flow		142,171		191,172		(33,069	)		109,825		1,901
Healthcare asset-based		2,462		11,614		(675	)		4,908		—
Healthcare real estate		9,984		11,278		(2,323	)		9,101		179
Multi-family		—		—		—			13,425		—
Real estate		69,128		92,833		(21,076	)		407,720		1,624
Small business		310		359		(141	)		1,096		—

Total(1)		322,817		419,988		(78,968	)		606,655		3,727

Total impaired loans	$	911,496	$	1,267,351	$	(78,968	)	$	1,154,699	$	21,320


(1)		Carrying value of impaired loans before applying specific reserves. Excludes loans held for sale. Balances are net of deferred loan fees and discounts.

(2)		Represents the contractual amounts owed to us by borrowers.

As of March 31, 2011 and December 31, 2010, the carrying value of impaired loans with no related allowance recorded was $499.1 million and $588.7 million, respectively. Of these amounts, $236.0 million and $222.4 million, respectively, related to loans that were charged off to their carrying values. These charge offs were primarily the result of collateral dependent loans for which ultimate collection depends solely on the sale of the collateral. The remaining $263.1 million and $366.3 million related to loans that had no recorded charge offs or specific reserves as of March 31, 2011 and December 31, 2010, respectively, based on our estimates that we ultimately will collect all interest and principal amounts due.

The average balances of impaired loans during the three months ended March 31, 2011 and 2010 were $856.6 million and $1.1 billion, respectively. The total amounts of interest income that were recognized on impaired loans during the three months ended March 31, 2011 and 2010 were $4.5 million and $5.1 million, respectively. The amounts of cash basis interest income that were recognized on impaired loans during the three months ended March 31, 2011 and 2010 were $0.1 million in both periods. If our non-accrual loans had performed in accordance with their original terms, interest income would have been increased by $33.0 million and $39.5 million for the three months ended March 31, 2011 and 2010, respectively.

Allowance for Loan Losses

Our allowance for loan losses represents management’s estimate of incurred loan losses inherent in our loan and lease portfolio as of the balance sheet date. The estimation of the allowance for loan losses is based on a variety

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

of factors, including past loan loss experience, the current credit profile of our borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral and general economic conditions. Provisions for loan losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.

We perform quarterly and systematic detailed reviews of our loan portfolio to identify credit risks and to assess the overall collectability of the portfolio. The allowance on certain pools of loans with similar characteristics is estimated using reserve factors that are reflective of historical loss rates.

Our portfolio is reviewed regularly, and, on a periodic basis, individual loans are reviewed and assigned a risk rating. Loans subject to individual reviews are analyzed and segregated by risk according to our internal risk rating scale. These risk ratings, in conjunction with an analysis of historical loss experience, current economic conditions, industry performance trends, and any other pertinent information, including individual valuations on impaired loans, are factored in the estimation of the allowance for loan losses. The historical loss experience is updated quarterly to incorporate the most recent data reflective of the current economic environment.

If the recorded investment in an impaired loan exceeds the present value of payments expected to be received, the fair value of the collateral or the loan’s observable market price, a specific allowance is established as a component of the allowance for loan losses.

When available information confirms that specific loans or portions thereof are uncollectible, these amounts are charged off against the allowance for loan losses. To the extent we later collect amounts previously charged off, we will recognize a recovery by increasing the allowance for loan losses for the amount received.

We also consider whether losses may have been incurred in connection with unfunded commitments to lend. In making this assessment, we exclude from consideration those commitments for which funding is subject to our approval based on the adequacy of underlying collateral that is required to be presented by a borrower or other terms and conditions. Reserves for losses related to unfunded commitments are included within other liabilities on our audited consolidated balance sheets.

Activity in the allowance for loan losses related to our loans held for investment for the three months ended March 31, 2011 and 2010, respectively, was as follows:


	Three Months Ended
	March 31,
	2011			2010
	($ in thousands)

Balance as of beginning of period	$	329,122		$	586,696
Charge offs		(96,462	)		(111,262	)
Recoveries		13,413			6

Net charge offs		(83,049	)		(111,256	)
Charge offs upon transfer to held for sale		(7,608	)		(8,187	)
Provision for loan losses		44,809			218,940

Balance as of end of period	$	283,274		$	686,193

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of March 31, 2011 and December 31, 2010, the balances of the allowance for loan losses and the carrying value of loans held for investment disaggregated by impairment methodology were as follows:


	March 31, 2011				December 31, 2010
			Allowance for				Allowance for
	Loans		Loan Losses		Loans		Loan Losses
	($ in thousands)

Individually evaluated for impairment	$	721,204	$	61,187	$	904,466	$	78,019
Collectively evaluated for impairment		5,320,203		222,087		5,217,393		249,912
Acquired loans with deteriorated credit quality		26,319		—		31,017		1,191

Total	$	6,067,726	$	283,274	$	6,152,876	$	329,122

Troubled Debt Restructurings

During the three months ended March 31, 2011 and 2010, loans with an aggregate carrying value, which includes principal, deferred fees and accrued interest, of $154.8 million and $200.8 million, respectively, as of their respective restructuring dates, were involved in TDRs. Loans involved in these TDRs are assessed as impaired, generally for a period of at least one year following the restructuring. A loan that has been involved in a TDR 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. As of March 31, 2011, one loan with an aggregate carrying value of $23.5 million that had been previously restructured in a TDR was not classified as impaired, as it performed in accordance with the restructured terms for twelve consecutive months. As of December 31, 2010, all of our loans restructured in TDRs were classified as impaired loans.

The aggregate carrying values of loans that had been restructured in TDRs as of March 31, 2011 and December 31, 2010 were as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Non-accrual	$	309,699	$	400,851
Accruing		218,767		154,262

Total	$	528,466	$	555,113

We recorded charge offs related to these restructured loans of $70.7 million and $28.2 million for the three months ended March 31, 2011 and 2010, respectively. The specific reserves related to these loans were $50.2 million and $35.5 million as of March 31, 2011 and December 31, 2010, respectively.

For a loan that accrues interest immediately after that loan is restructured in a TDR, we generally do not charge off a portion of the loan as part of the restructuring. If a portion of a loan has been charged off, we will not accrue interest on the remaining portion of the loan if the charged off portion is still contractually due from the borrower. However, if the charged off portion of the loan is legally forgiven through concessions to the borrower, then the restructured loan may be placed on accrual status if the remaining contractual amounts due on the loan are reasonably assured of collection. In addition, for certain TDRs, especially those involving a commercial real estate loan, we may split the loan into an A note and a B note, placing the performing A note on accrual and charging off the B note. For an amortizing loan with monthly payments, the borrower is required to demonstrate sustained payment performance for a minimum of six months to return a non-accrual restructured loan to accrual status.

Our evaluation of whether collection of interest and principal is reasonably assured is based on the facts and circumstances of each individual borrower and our assessment of the borrower’s ability and intent to repay in accordance with the revised loan terms. We generally consider such factors as historical operating performance and payment history of the borrower, indications of support by sponsors and other interest holders, the terms of the

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

modified loan, the value of any collateral securing the loan and projections of future performance of the borrower as part of this evaluation.

Foreclosed Assets

Real Estate Owned (“REO”)

When we foreclose on a real estate asset that collateralizes a loan, we record the asset at its estimated fair value less costs to sell at the time of foreclosure if the related REO is classified as held for sale. Upon foreclosure, 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 value less costs to sell. For REO determined to be held for sale, subsequent valuation adjustments are recorded as a valuation allowance, which is recorded as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations. REO that does not meet the criteria of held for sale is classified as held for use and initially recorded at its fair value. The real estate asset is subsequently depreciated over its estimated useful life. Fair value adjustments on REO held for use are recorded only if the carrying amount of an asset is not recoverable and exceeds its fair value.

As of March 31, 2011 and December 31, 2010, we had $70.1 million and $92.3 million, respectively, of REO classified as held for sale, which was recorded in other assets in our consolidated balance sheets. Activity related to REO held for sale for the three months ended March 31, 2011 and 2010 was as follows:


	Three Months Ended
	March 31,
	2011			2010
	($ in thousands)

Balance as of beginning of period	$	92,265		$	101,401
Transfers from loans held for investment and other assets		4,749			54,566
Fair value adjustments		(2,044	)		(16,048	)
Transfers from REO held for use		—			2,850
Real estate sold		(24,920	)		(6,492	)

Balance as of end of period	$	70,050		$	136,277

During the three months ended March 31, 2011 and 2010, we recognized a gain of $0.3 million and a loss of $0.3 million, respectively, on the sales of REO held for sale as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations.

As of both March 31, 2011 and December 31, 2010, we had $1.4 million of REO classified as held for use, which was recorded in other assets in our consolidated balance sheets. We did not recognize any impairment losses during the three months ended March 31, 2011. During the three months ended March 31, 2010, we recognized impairment losses of $4.6 million on REO held for use as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations.

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 less costs to sell at the time of foreclosure. At the time of foreclosure, we record charge offs when the carrying amount of the original loan exceeds the estimated fair value of the acquired loans. As of March 31, 2011 and December 31, 2010, we had $25.3 million and $55.8 million, respectively, of loans acquired through foreclosure, net of valuation allowances of $0.8 million and $3.2 million, respectively, which were recorded in other assets in our consolidated balance sheets. We recorded a provision for losses of $7.8 million and $15.2 million, respectively, related to loans acquired through foreclosure as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations for the three months ended March 31, 2011 and 2010. During the three months ended March 31, 2011, we recognized a gain of $1.7 million on the sales of loans acquired through foreclosure as a component of net expense of real estate owned and other

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

foreclosed assets in our consolidated statements of operations. There were no such sales during the three months ended March 31, 2010.


Note 6.	Investments

Investment Securities, Available-for-Sale

As of March 31, 2011 and December 31, 2010, our investment securities, available-for-sale were as follows:


	March 31, 2011									December 31, 2010
			Gross		Gross							Gross		Gross
	Amortized		Unrealized		Unrealized			Fair		Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
	($ in thousands)

Agency callable notes	$	164,223	$	268	$	(2,168	)	$	162,323	$	164,219	$	418	$	(1,749	)	$	162,888
Agency debt		76,843		1,060		—			77,903		102,263		1,167		—			103,430
Agency discount notes		—		—		—			—		164,917		57		—			164,974
Agency MBS		944,968		13,067		(3,497	)		954,538		860,441		15,035		(5,321	)		870,155
Asset-backed securities		21,398		1,208		—			22,606		—		—		—			—
Collateralized loan obligation		9,595		8,336		—			17,931		12,249		—		—			12,249
Corporate debt		5,013		95		(15	)		5,093		5,013		122		—			5,135
Equity securities		202		214		—			416		202		61		—			263
Municipal bond		3,235		—		—			3,235		—		—		—			—
Non-agency MBS		97,062		889		(964	)		96,987		112,917		1,640		(873	)		113,684
U.S. Treasury and agency securities		29,795		1		(475	)		29,321		90,587		24		(478	)		90,133

Total	$	1,352,334	$	25,138	$	(7,119	)	$	1,370,353	$	1,512,808	$	18,524	$	(8,421	)	$	1,522,911

Included in investment securities, available-for-sale, were 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”), discount notes issued by Fannie Mae, Freddie Mac and the FHLB (“Agency discount notes”), commercial and residential mortgage-backed securities issued and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae (“Agency MBS”), asset-backed securities, investments in a collateralized loan obligation, corporate debt, equity securities, a municipal bond, commercial and residential mortgage-backed securities issued by non-government agencies (“Non-agency MBS”), and U.S. Treasury and agency securities.

The amortized cost and fair value of investment securities, available-for-sale that CapitalSource Bank pledged as collateral as of March 31, 2011 and December 31, 2010 were as follows:


	March 31, 2011				December 31, 2010
Source	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	($ in thousands)

FHLB	$	810,977	$	821,684	$	877,766	$	889,888
FRB		29,661		28,923		35,056		34,256
Non-government Correspondent Bank(1)		39,991		39,992		37,979		37,989
Government Agency(2)		29,044		29,511		29,069		29,305

	$	909,673	$	920,110	$	979,870	$	991,438


(1)		Represents the amounts CapitalSource Bank pledged as collateral for letters of credit and foreign exchange contracts.

(2)		Represents the amounts CapitalSource Bank pledged as collateral to secure funds deposited by a local government agency.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Realized gains or losses resulting from the sale of investments are calculated using the specific identification method and are included in gain on investments, net in our consolidated statements of operations. During the three months ended March 31, 2011 and 2010, we sold investment securities, available-for-sale for $70.2 million and $20.0 million, respectively, recognizing net pre-tax gains of $14.5 million and $0.7 million, respectively.

During the three months ended March 31, 2011 and 2010, we recognized $4.8 million and $0.8 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.

During the three months ended March 31, 2011, we recorded other-than-temporary impairments (“OTTI”) of $1.5 million, included as a component of gain on investments, net, in our consolidated statements of operations, related to a decline in the fair value of our municipal bond. We recorded no such OTTI during the three months ended March 31, 2010. Additionally, during the three months ended March 31, 2010, we recorded OTTI of $0.3 million on equity securities, included as a component of gain on investments, net in our consolidated statements of operations. We recorded no such OTTI during the three months ended March 31, 2011.

Investment Securities, Held-to-Maturity

As of March 31, 2011 and December 31, 2010, the amortized cost of investment securities, held-to-maturity was $179.1 million and $184.5 million, respectively, and consisted of commercial mortgage-backed securities rated AAA held by CapitalSource Bank. The amortized costs and estimated fair values of the investment securities, held-to-maturity, that CapitalSource Bank pledged as collateral as of March 31, 2011 and December 31, 2010 were as follows:


	March 31, 2011				December 31, 2010
Source:	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	($ in thousands)

FHLB	$	15,381	$	16,430	$	21,260	$	22,431
FRB		146,359		152,987		143,927		153,756

	$	161,740	$	169,417	$	165,187	$	176,187

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Unrealized Losses on Investment Securities

As of March 31, 2011 and December 31, 2010, the gross unrealized losses and fair values of investment securities that were in unrealized loss positions were as follows:


	Less Than 12 Months					12 Months or More					Total
	Gross					Gross					Gross
	Unrealized			Fair		Unrealized			Fair		Unrealized			Fair
	Losses			Value		Losses			Value		Losses			Value
	($ in thousands)

As of March 31, 2011
Investment securities, available-for-sale:
Agency callable notes	$	(2,168	)	$	132,054	$	—		$	—	$	(2,168	)	$	132,054
Agency MBS		(3,497	)		365,637		—			—		(3,497	)		365,637
Corporate debt		(15	)		—		—			—		(15	)		—
Non-agency MBS		(831	)		29,733		(133	)		6,982		(964	)		36,715
U.S. Treasury and agency securities		(475	)		19,321		—			—		(475	)		19,321

Total investment securities, available-for-sale	$	(6,986	)	$	546,745	$	(133	)	$	6,982	$	(7,119	)	$	553,727

Total investment securities, held-to-maturity	$	—		$	—	$	—		$	—	$	—		$	—

As of December 31, 2010
Investment securities, available-for-sale:
Agency callable notes	$	(1,749	)	$	92,471	$	—		$	—	$	(1,749	)	$	92,471
Agency MBS		(5,321	)		252,844		—			—		(5,321	)		252,844
Non-agency MBS		(835	)		20,905		(38	)		8,384		(873	)		29,289
U.S. Treasury and agency securities		(478	)		20,151		—			—		(478	)		20,151

Total investment securities, available-for-sale	$	(8,383	)	$	386,371	$	(38	)	$	8,384	$	(8,421	)	$	394,755

Total investment securities, held-to-maturity(1)	$	(97	)	$	13,524	$	—		$	—	$	(97	)	$	13,524


(1)		Consists of commercial mortgage-backed securities rated AAA held by CapitalSource Bank.

Securities in unrealized loss positions are analyzed individually as part of our ongoing assessment of OTTI, and we do not believe that any unrealized losses in our portfolio as of March 31, 2011 and December 31, 2010 represent an OTTI. The losses are primarily related to four agency callable notes, five Agency MBS, and one Small Business Administration asset-backed security (“SBA ABS”). The unrealized losses are attributable to fluctuations in their market prices due to current market conditions and interest rate levels. Agency securities have the highest debt rating and are backed by government-sponsored entities. The SBA ABS also has the highest debt rating and is backed by the U.S. Government. As such, we expect to recover the entire amortized cost basis of the impaired securities. We have the ability and the intention to hold these securities until their fair values recover to cost or maturity.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Contractual Maturities

As of March 31, 2011, the contractual maturities of our available-for-sale and held-to-maturity investment securities 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	$	55,037	$	55,252	$	—	$	—
Due after one year through five years		189,281		188,995		26,191		30,403
Due after five years through ten years(1)		93,845		97,017		—		—
Due after ten years(2)(3)		1,014,171		1,029,089		152,886		156,541

Total	$	1,352,334	$	1,370,353	$	179,077	$	186,944


(1)		Includes Agency and Non-agency MBS, with fair values of $33.7 million and $40.7 million, respectively, and weighted-average expected maturities of 2.27 years and 2.98 years, respectively, based on interest rates and expected prepayment speeds as of March 31, 2011.

(2)		Includes Agency and Non-agency MBS, including CMBS, with fair values of $920.8 million and $212.8 million, respectively, and weighted-average expected maturities of 4.40 years and 1.36 years, respectively, based on interest rates and expected prepayment speeds as of March 31, 2011.

(3)		Includes securities with no stated maturity.

Other Investments

As of March 31, 2011 and December 31, 2010, our other investments were as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Investments carried at cost	$	33,310	$	33,062
Investments carried at fair value		218		222
Investments accounted for under the equity method		34,378		38,605

Total	$	67,906	$	71,889

During the three months ended March 31, 2011 and 2010, we sold other investments for $10.1 million and $9.4 million, respectively, recognizing net pre-tax gains of $9.8 million and $6.4 million, respectively. During the three months ended March 31, 2011 and 2010, we recorded OTTI of $0.2 million and $2.0 million, respectively, relating to our investments carried at cost.


Note 7.	Guarantor Information

The following represents the supplemental consolidating condensed financial information as of March 31, 2011 and December 31, 2010 and for the three months ended March 31, 2011 and 2010 of (i) CapitalSource Inc., which as discussed in Note 10, Borrowings, is the issuer of our 2014 Senior Secured Notes, as well as our Senior Debentures and Subordinated Debentures (together, the “Debentures”), (ii) CapitalSource Finance LLC (“CapitalSource Finance”), which is a guarantor of our 2014 Senior Secured Notes and the Debentures, and (iii) our subsidiaries that are not guarantors of the 2014 Senior Secured Notes or the Debentures. CapitalSource Finance, a wholly owned indirect subsidiary of CapitalSource Inc., has guaranteed our 2014 Senior Secured Notes and the Senior Debentures, fully and unconditionally, on a senior basis and 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.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidating Balance Sheet
March 31, 2011
(Unaudited)


				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	$	89,085		$	429,841		$	520,616		$	111,953		$	—		$	1,151,495
Restricted cash		—			15,050			61,385			142			—			76,577
Investment securities:
Available-for-sale, at fair value		—			1,348,771			—			21,582			—			1,370,353
Held-to-maturity, at amortized cost		—			179,077			—			—			—			179,077

Total investment securities		—			1,527,848			—			21,582			—			1,549,430
Loans:
Loans held for sale		—			6,021			522			11,454			—			17,997
Loans held for investment		—			5,051,593			199,347			816,786			—			6,067,726
Less deferred loan fees and discounts		—			(71,826	)		(9,706	)		(19,115	)		7,134			(93,513	)
Less allowance for loan losses		—			(195,106	)		(23,265	)		(64,903	)		—			(283,274	)

Loans held for investment, net		—			4,784,661			166,376			732,768			7,134			5,690,939

Total loans		—			4,790,682			166,898			744,222			7,134			5,708,936
Interest receivable		—			14,158			53,076			(9,312	)		—			57,922
Investment in subsidiaries		2,380,786			1,908			1,466,372			1,589,581			(5,438,647	)		—
Intercompany receivable		375,000			9			111,327			380,948			(867,284	)		—
Other investments		—			47,474			13,918			6,514			—			67,906
Goodwill		—			173,135			—			—			—			173,135
Other assets		54,313			240,554			103,496			187,501			(97,927	)		487,937

Total assets	$	2,899,184		$	7,240,659		$	2,497,088		$	3,033,131		$	(6,396,724	)	$	9,273,338

Liabilities and shareholders’ equity
Liabilities:
Deposits	$	—		$	4,708,349		$	—		$	—		$	—		$	4,708,349
Term debt		286,500			577,299			—			—			—			863,799
Other borrowings		526,254			400,000			442,208			—			—			1,368,462
Other liabilities		14,964			122,580			93,503			153,226			(122,981	)		261,292
Intercompany payable		—			46,850			380,948			416,420			(844,218	)		—

Total liabilities		827,718			5,855,078			916,659			569,646			(967,199	)		7,201,902
Shareholders’ equity:
Common stock		3,233			921,000			—			—			(921,000	)		3,233
Additional paid-in capital		3,914,502			(80,768	)		623,182			2,532,198			(3,074,614	)		3,914,500
(Accumulated deficit) retained earnings		(1,870,635	)		530,346			938,039			(87,226	)		(1,381,187	)		(1,870,663	)
Accumulated other comprehensive income, net		24,366			15,003			19,208			18,513			(52,724	)		24,366

Total shareholders’ equity		2,071,466			1,385,581			1,580,429			2,463,485			(5,429,525	)		2,071,436

Total liabilities and shareholders’ equity	$	2,899,184		$	7,240,659		$	2,497,088		$	3,033,131		$	(6,396,724	)	$	9,273,338

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidating Balance Sheet
December 31, 2010


				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	$	94,614		$	353,666		$	252,012		$	120,158		$	—		$	820,450
Restricted cash		—			39,335			85,142			4,109			—			128,586
Investment securities:
Available-for-sale, at fair value		—			1,510,384			—			12,527			—			1,522,911
Held-to-maturity, at amortized cost		—			184,473			—			—			—			184,473

Total investment securities		—			1,694,857			—			12,527			—			1,707,384
Loans:
Loans held for sale		—			171,887			16,202			17,245			—			205,334
Loans held for investment		—			5,008,287			284,445			860,144			—			6,152,876
Less deferred loan fees and discounts		—			(79,877	)		(10,362	)		(18,429	)		2,230			(106,438	)
Less allowance for loan losses		—			(223,553	)		(29,626	)		(75,943	)		—			(329,122	)

Loans held for investment, net		—			4,704,857			244,457			765,772			2,230			5,717,316

Total loans		—			4,876,744			260,659			783,017			2,230			5,922,650
Interest receivable		—			25,780			18,174			13,439			—			57,393
Investment in subsidiaries		2,339,200			3,594			1,561,468			1,623,244			(5,527,506	)		—
Intercompany receivable		375,000			9			134,079			301,241			(810,329	)		—
Other investments		—			52,066			13,887			5,936			—			71,889
Goodwill		—			173,135			—			—			—			173,135
Other assets		89,198			249,119			156,557			234,034			(164,988	)		563,920

Total assets	$	2,898,012		$	7,468,305		$	2,481,978		$	3,097,705		$	(6,500,593	)	$	9,445,407

Liabilities and shareholders’ equity
Liabilities:
Deposits	$	—		$	4,621,273		$	—		$	—		$	—		$	4,621,273
Credit facilities		—			65,606			—			1,902			—			67,508
Term debt		285,731			693,523			—			—			—			979,254
Other borrowings		523,650			412,000			440,234			—			—			1,375,884
Other liabilities		34,658			170,408			121,227			208,816			(187,563	)		347,546
Intercompany payable		—			46,850			301,241			441,372			(789,463	)		—

Total liabilities		844,039			6,009,660			862,702			652,090			(977,026	)		7,391,465
Shareholders’ equity:
Common stock		3,232			921,000			—			—			(921,000	)		3,232
Additional paid-in capital		3,911,344			74,588			679,241			2,556,428			(3,310,260	)		3,911,341
(Accumulated deficit) retained earnings		(1,870,544	)		457,302			930,076			(114,898	)		(1,272,508	)		(1,870,572	)
Accumulated other comprehensive income, net		9,941			5,755			9,959			4,087			(19,801	)		9,941

Total CapitalSource Inc. shareholders’ equity		2,053,973			1,458,645			1,619,276			2,445,617			(5,523,569	)		2,053,942
Noncontrolling interests		—			—			—			(2	)		2			—

Total shareholders’ equity		2,053,973			1,458,645			1,619,276			2,445,615			(5,523,567	)		2,053,942

Total liabilities and shareholders’ equity	$	2,898,012		$	7,468,305		$	2,481,978		$	3,097,705		$	(6,500,593	)	$	9,445,407

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidating Statement of Operations
Three Months Ended March 31, 2011
(Unaudited)


				CapitalSource Finance LLC
				Combined			Combined			Other						Consolidated
	CapitalSource			Non-Guarantor			Guarantor			Non-Guarantor						CapitalSource
	Inc.			Subsidiaries			Subsidiaries			Subsidiaries			Eliminations			Inc.
	($ in thousands)

Net interest income:
Interest income:
Loans	$	10,194		$	105,054		$	(1,891	)	$	20,538		$	(10,395	)	$	123,500
Investment securities		—			14,723			7			3,622			—			18,352
Other		—			238			55			7			—			300

Total interest income		10,194			120,015			(1,829	)		24,167			(10,395	)		142,152
Interest expense:
Deposits		—			13,383			—			—			—			13,383
Borrowings		24,425			5,710			4,917			11,253			(12,936	)		33,369

Total interest expense		24,425			19,093			4,917			11,253			(12,936	)		46,752

Net interest (loss) income		(14,231	)		100,922			(6,746	)		12,914			2,541			95,400
Provision for loan losses		—			(797	)		40,203			5,403			—			44,809

Net interest (loss) income after provision for loan losses		(14,231	)		101,719			(46,949	)		7,511			2,541			50,591
Operating expenses:
Compensation and benefits		235			12,028			18,947			—			(831	)		30,379
Professional fees		964			459			4,834			931			—			7,188
Other administrative expenses		1,156			21,819			11,039			4,379			(21,699	)		16,694

Total operating expenses		2,355			34,306			34,820			5,310			(22,530	)		54,261
Other income:
Gain on investments, net		—			11,649			22			11,844			—			23,515
(Loss) gain on derivatives		—			(777	)		(1,122	)		21			—			(1,878	)
Net expense of real estate owned and other foreclosed assets		—			(2,343	)		(189	)		(7,641	)		—			(10,173	)
Other (expense) income, net		(317	)		4,979			18,726			3,023			(19,884	)		6,527
Earnings (loss) in subsidiaries		27,245			(1,120	)		72,263			13,128			(111,516	)		—

Total other income		26,928			12,388			89,700			20,375			(131,400	)		17,991

Net income before income taxes		10,342			79,801			7,931			22,576			(106,329	)		14,321
Income tax expense (benefit)		7,183			6,780			(10	)		(2,791	)		—			11,162

Net income	$	3,159		$	73,021		$	7,941		$	25,367		$	(106,329	)	$	3,159

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidating Statement of Operations
Three Months Ended March 31, 2010
(Unaudited)


				CapitalSource Finance LLC
				Combined			Combined			Other						Consolidated
	CapitalSource			Non-Guarantor			Guarantor			Non-Guarantor						CapitalSource
	Inc.			Subsidiaries			Subsidiaries			Subsidiaries			Eliminations			Inc.
	($ in thousands)

Net interest income:
Interest income:
Loans	$	9,850		$	110,361		$	10,817		$	40,000		$	(14,778	)	$	156,250
Investment securities		—			14,305			47			239			—			14,591
Other		—			570			1			2			—			573

Total interest income		9,850			125,236			10,865			40,241			(14,778	)		171,414
Interest expense:
Deposits		—			16,358			—			—			—			16,358
Borrowings		29,353			8,189			7,723			15,777			(12,399	)		48,643

Total interest expense		29,353			24,547			7,723			15,777			(12,399	)		65,001

Net interest (loss) income		(19,503	)		100,689			3,142			24,464			(2,379	)		106,413
Provision for loan losses		—			85,548			792			132,600			—			218,940

Net interest (loss) income after provision for loan losses		(19,503	)		15,141			2,350			(108,136	)		(2,379	)		(112,527	)
Operating expenses:
Compensation and benefits		222			13,270			20,691			—			—			34,183
Professional fees		681			602			7,371			1,716			—			10,370
Other administrative expenses		1,137			12,892			13,471			13,604			(22,452	)		18,652

Total operating expenses		2,040			26,764			41,533			15,320			(22,452	)		63,205
Other (expense) income:
Gain (loss) on investments, net		—			5,219			(104	)		964			—			6,079
(Loss) gain on derivatives		—			(1,542	)		5,231			(8,026	)		—			(4,337	)
Net expense of real estate owned and other foreclosed assets		—			(4,439	)		(824	)		(35,229	)					(40,492	)
Other (expense) income, net		(172	)		13,477			23,455			1,986			(22,271	)		16,475
Loss in subsidiaries		(189,975	)		(514	)		(8,137	)		(21,760	)		220,386			—

Total other (expense) income		(190,147	)		12,201			19,621			(62,065	)		198,115			(22,275	)

Net (loss) income from continuing operations before income taxes		(211,690	)		578			(19,562	)		(185,521	)		218,188			(198,007	)
Income tax expense		—			2,169			—			18,837			—			21,006

Net loss from continuing operations		(211,690	)		(1,591	)		(19,562	)		(204,358	)		218,188			(219,013	)
Net income from discontinued operations, net of taxes		—			—			—			7,323			—			7,323

Net loss attributable to CapitalSource Inc.	$	(211,690	)	$	(1,591	)	$	(19,562	)	$	(197,035	)	$	218,188		$	(211,690	)

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidating Statement of Cash Flows
Three Months Ended March 31, 2011
(Unaudited)


				CapitalSource Finance LLC
				Combined			Combined			Other						Consolidated
	CapitalSource			Non-Guarantor			Guarantor			Non-Guarantor						CapitalSource
	Inc.			Subsidiaries			Subsidiaries			Subsidiaries			Eliminations			Inc.
	($ in thousands)

Operating activities:
Net income	$	3,159		$	73,021		$	7,941		$	25,367		$	(106,329	)	$	3,159
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Stock option expense		—			368			1,004			—			—			1,372
Restricted stock expense		—			790			773			—			—			1,563
Amortization of deferred loan fees and discounts		—			(17,406	)		(806	)		(1,532	)		—			(19,744	)
Paid-in-kind interest on loans		—			24,774			(492	)		(546	)		—			23,736
Provision for loan losses		—			(797	)		40,203			5,403			—			44,809
Amortization of deferred financing fees and discounts		7,257			1,627			88			(1,154	)		—			7,818
Depreciation and amortization		—			(2,473	)		699			—			—			(1,774	)
Provision (benefit) for deferred income taxes		19,931			(14,448	)		—			26,000			—			31,483
Non-cash gain on investments, net		—			(23,530	)		(142	)		(2,988	)		—			(26,660	)
Non-cash loss on foreclosed assets and other property and equipment disposals		—			1,662			100			7,784			—			9,546
Unrealized loss (gain) on derivatives and foreign currencies, net		—			1,077			1,321			(14	)		—			2,384
Decrease (increase) in interest receivable		—			11,622			(34,902	)		22,751			—			(529	)
Decrease in loans held for sale, net		—			171,798			15,815			16,437			—			204,050
Decrease (increase) in intercompany receivable		—			—			22,752			(79,707	)		56,955			—
Decrease in other assets		11,070			16,972			50,571			12,751			(67,061	)		24,303
Decrease in other liabilities		(19,851	)		(47,702	)		(26,942	)		(54,415	)		64,582			(84,328	)
Net transfers with subsidiaries		(24,227	)		(160,992	)		46,197			27,510			111,512			—

Cash (used in) provided by operating activities		(2,661	)		36,363			124,180			3,647			59,659			221,188
Investing activities:
Decrease in restricted cash		—			24,285			23,757			3,967			—			52,009
(Increase) decrease in loans, net		—			(81,564	)		41,328			11,411			(4,904	)		(33,729	)
Reduction of marketable securities, available for sale, net		—			180,038			—			—			—			180,038
Reduction of marketable securities, held to maturity, net		—			10,253			—			—			—			10,253
Reduction (acquisition) of other investments, net		—			14,846			171			(376	)		—			14,641
Disposal (acquisition) of property and equipment, net		—			25			(518	)		—			—			(493	)

Cash provided by investing activities		—			147,883			64,738			15,002			(4,904	)		222,719
Financing activities:
Deposits accepted, net of repayments		—			87,076			—			—			—			87,076
Increase (decrease) in intercompany payable		—			—			79,707			(24,952	)		(54,755	)		—
Repayments on credit facilities, net		—			(66,890	)		—			(1,902	)		—			(68,792	)
Repayments and extinguishment of term debt		—			(116,257	)		—			—			—			(116,257	)
Repayments of other borrowings		—			(12,000	)		(21	)		—			—			(12,021	)
Proceeds from exercise of options		354			—			—			—			—			354
Payment of dividends		(3,222	)		—			—			—			—			(3,222	)

Cash (used in) provided by financing activities		(2,868	)		(108,071	)		79,686			(26,854	)		(54,755	)		(112,862	)

(Decrease) increase in cash and cash equivalents		(5,529	)		76,175			268,604			(8,205	)		—			331,045
Cash and cash equivalents as of beginning of period		94,614			353,666			252,012			120,158			—			820,450

Cash and cash equivalents as of end of period	$	89,085		$	429,841		$	520,616		$	111,953		$	—		$	1,151,495

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidating Statement of Cash Flows
Three Months Ended March 31, 2010
(Unaudited)


				CapitalSource Finance LLC
				Combined
				Non-			Combined			Other						Consolidated
	CapitalSource			Guarantor			Guarantor			Non-Guarantor						CapitalSource
	Inc.			Subsidiaries			Subsidiaries			Subsidiaries			Eliminations			Inc.
	($ in thousands)

Operating activities:
Net loss	$	(211,690	)	$	(1,591	)	$	(19,562	)	$	(197,035	)	$	218,188		$	(211,690	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Stock option expense		—			323			1,026			—			—			1,349
Restricted stock expense		—			466			3,584			—			—			4,050
Gain on extinguishment of debt		(698	)		—			—			—			—			(698	)
Amortization of deferred loan fees and discounts		—			(9,840	)		(5,837	)		(3,008	)		—			(18,685	)
Paid-in-kind interest on loans		—			(1,683	)		(1,052	)		1,790			—			(945	)
Provision for loan losses		—			85,548			792			132,600			—			218,940
Amortization of deferred financing fees and discounts		9,651			1,992			105			885			—			12,633
Depreciation and amortization		—			(1,865	)		908			2,682			—			1,725
Provision (benefit) for deferred income taxes		—			11,596			(182	)		22,101			—			33,515
Non-cash loss (gain) on investments, net		—			431			56			(275	)		—			212
Non-cash loss on foreclosed assets and other property and equipment disposals		—			3,127			293			32,321			—			35,741
Unrealized (gain) loss on derivatives and foreign currencies, net		—			(2,522	)		(10,446	)		7,795			—			(5,173	)
Accretion of discount on commercial real estate “A” participation interest		—			(5,853	)		—			—			—			(5,853	)
Decrease (increase) in interest receivable		—			5,958			(77,113	)		28,508			—			(42,647	)
Increase in loans held for sale, net		—			(67	)		—			—			—			(67	)
Increase in intercompany receivable		—			—			(14,084	)		(4,804	)		18,888			—
Decrease (increase) in other assets		10,248			25,272			4,287			(12,406	)		(31,659	)		(4,258	)
(Decrease) increase in other liabilities		(16,330	)		(65,631	)		(23,900	)		9,991			30,067			(65,803	)
Net transfers with subsidiaries		254,767			(24,037	)		43,044			(53,388	)		(220,386	)		—

Cash provided by (used in) operating activities		45,948			21,624			(98,081	)		(32,243	)		15,098			(47,654	)
Investing activities:
Decrease (increase) in restricted cash		—			42,125			8,154			(14,170	)		—			36,109
Decrease in commercial real estate “A” participation interest		—			208,421			—			—			—			208,421
Decrease in loans, net		—			40,266			10,663			125,206			2,380			178,515
Acquisition of marketable securities, available for sale, net		—			(580,027	)		—			—			—			(580,027	)
Reduction of marketable securities, held to maturity, net		—			27,591			—			—			—			27,591
(Acquisition) reduction of other investments, net		—			(17,950	)		(208	)		21,100			—			2,942
(Acquisition) disposal of property and equipment, net		—			(7,254	)		(383	)		7,170			—			(467	)

Cash (used in) provided by investing activities		—			(286,828	)		18,226			139,306			2,380			(126,916	)
Financing activities:
Payment of deferred financing fees		(833	)		(171	)		—			(1,211	)		—			(2,215	)
Deposits accepted, net of repayments		—			99,067			—			—			—			99,067
Increase in intercompany payable		—			—			4,804			12,674			(17,478	)		—
Repayments on credit facilities, net		(90,055	)		(12,875	)		(6,861	)		(14,859	)		—			(124,650	)
Borrowings of term debt		—			—			—			14,395			—			14,395
Repayments and extinguishment of term debt		—			(188,125	)		—			(102,382	)		—			(290,507	)
(Repayments of) borrowings under other borrowings		(17,994	)		25,000			(20	)		(1,849	)		—			5,137
Payment of dividends		(3,228	)		—			—			—			—			(3,228	)

Cash used in financing activities		(112,110	)		(77,104	)		(2,077	)		(93,232	)		(17,478	)		(302,001	)

(Decrease) increase in cash and cash equivalents		(66,162	)		(342,308	)		(81,932	)		13,831			—			(476,571	)
Cash and cash equivalents as of beginning of period		99,103			760,343			265,977			51,597						1,177,020

Cash and cash equivalents as of end of period	$	32,941		$	418,035		$	184,045		$	65,428		$	—		$	700,449

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 8.	Deposits

As of March 31, 2011 and December 31, 2010, CapitalSource Bank had $4.7 billion and $4.6 billion, respectively, in deposits insured up to the maximum limit by the Federal Deposit Insurance Corporation (“FDIC”). As of March 31, 2011 and December 31, 2010, CapitalSource Bank had $1.8 billion and $1.7 billion, respectively, of certificates of deposit in the amount of $100,000 or more. As of March 31, 2011 and December 31, 2010, CapitalSource Bank had $283.7 million and $266.7 million, respectively, of certificates of deposit in the amount of $250,000 or more.

As of March 31, 2011 and December 31, 2010, the weighted-average interest rates for savings and money market deposit accounts were 0.84% and 0.83%, respectively, and for certificates of deposit were 1.23% and 1.27%, respectively. The weighted-average interest rates for all deposits as of March 31, 2011 and December 31, 2010 were 1.15% and 1.18%, respectively.

As of March 31, 2011 and December 31, 2010, interest-bearing deposits at CapitalSource Bank were as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Interest-bearing deposits:
Money market	$	236,649	$	236,811
Savings		726,481		694,157
Certificates of deposit		3,745,219		3,690,305

Total interest-bearing deposits	$	4,708,349	$	4,621,273

As of March 31, 2011, certificates of deposit at CapitalSource Bank detailed by maturity were as follows ($ in thousands):


Maturing by:
March 31, 2012	$	3,079,769
March 31, 2013		564,969
March 31, 2014		27,683
March 31, 2015		42,445
March 31, 2016		30,353

Total	$	3,745,219

For the three months ended March 31, 2011 and 2010, interest expense on deposits was as follows:


	Three Months Ended
	March 31,
	2011			2010
	($ in thousands)

Savings and money market	$	1,944		$	2,265
Certificates of deposit		11,495			14,146
Fees for early withdrawal		(56	)		(53	)

Total interest expense on deposits	$	13,383		$	16,358

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 9.	Variable Interest Entities

Troubled Debt Restructurings

Certain of our loan modifications qualify as events that require reconsideration of our borrowers as variable interest entities. Through reconsideration, we determined that certain of our borrowers involved in TDRs did not hold sufficient equity at risk to finance their activities without subordinated financial support. As a result, we concluded that these borrowers were variable interest entities.

We also determined that we should not consolidate these borrowers because we do not have a controlling financial interest. The equity investors of these borrowers have the power to direct the activities that will have the most significant impact on the economics of these borrowers. These equity investors’ interests also provide them with rights to receive benefits in the borrowers that could potentially be significant. As a result, we have determined that the equity investors continue to have a controlling financial interest in the borrowers subsequent to the restructuring.

Our interests in borrowers qualifying as variable interest entities were $407.4 million and $493.7 million as of March 31, 2011 and December 31, 2010, respectively, and are included in loans held for investment in our consolidated balance sheets. For certain of these borrowers, we may have obligations to fund additional amounts through either unfunded commitments or letters of credit issued to or on behalf of these borrowers. Consequently, our maximum exposure to loss as a result of our involvement with these entities was $506.1 million and $610.6 million as of March 31, 2011 and December 31, 2010, respectively.

Term Debt Securitizations

In conjunction with our commercial term debt securitizations, we established and contributed loans to separate single purpose entities (collectively, referred to as the “Issuers”). The Issuers are structured to be legally isolated, bankruptcy remote entities. The Issuers issued notes and certificates that are collateralized by their underlying assets, which primarily comprise loans contributed to the securitizations. We service the underlying loans contributed to the Issuers and earn periodic servicing fees paid from the cash flows of the underlying loans. The Issuers have all legal obligations to repay the outstanding notes and certificates and we have no legal obligation to contribute additional assets to the Issuers. As of March 31, 2011 and December 31, 2010, the total outstanding balances of these commercial term debt securitizations were $905.6 million and $1.0 billion, respectively. These amounts include $328.2 million of notes and certificates that we held as of both March 31, 2011 and December 31, 2010.

We have determined that the Issuers are variable interest entities, subject to applicable consolidation guidance and have concluded that the entities were designed to pass along risks related to the credit performance of the underlying loan portfolio. Except as set forth below, as a result of our power to direct the activities that most significantly impact the credit performance of the underlying loan portfolio and our economic interests in the Issuers, we have concluded that we are the primary beneficiary of each of the Issuers. Consequently, except as set forth below, we report the assets and liabilities of the Issuers in our consolidated financial statements, including the underlying loans and the issued notes and certificates held by third parties. As of March 31, 2011 and December 31, 2010, the carrying amounts of the consolidated liabilities related to the Issuers were $581.2 million and $697.5 million, respectively. These amounts include term debt recorded in our consolidated balance sheets and represent obligations for which there is only legal recourse to the Issuers. As of March 31, 2011 and December 31, 2010, the carrying amounts of the consolidated assets related to the Issuers were $853.5 million and $901.9 million, respectively. These amounts include loans held for investment, net recorded in our consolidated balance sheets and relate to assets that can only be used to settle obligations of the Issuers.

During the third quarter of 2010, we delegated certain of our collateral management and special servicing rights in the 2006-A term debt securitization trust (the “2006-A” Trust) and sold our equity interest and certain notes issued by the 2006-A trust for $7.0 million. As a result of the transaction, we determined that we no longer had the power to direct the activities that most significantly impact the economic performance of the 2006-A Trust. In

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

making this determination, we assessed the character and significance of the servicing and collateral management fees paid to the delegate and concluded that such fees represented an implicit variable interest in the 2006-A Trust. This assessment involved significant judgment surrounding the credit performance and timing of cash flows of the underlying assets of the 2006-A Trust, including the performance of additional assets to be purchased by the 2006-A Trust, pursuant to the terms of the indenture. In October 2010, we assigned our special servicing rights so that we are no longer the named special servicer of the 2006-A Trust.

As a result of the determination above, we concluded that we were no longer the primary beneficiary and deconsolidated the 2006-A Trust. We also concluded that the deconsolidation of the 2006-A Trust qualified as a financial asset transfer and that the transaction resulted in our surrendering control over the financial assets held by the 2006-A Trust. This resulted in the removal of carrying amounts of $801.9 million of loans, $55.7 million of restricted cash and $891.3 million of term debt from our consolidated balance sheet and the recognition of a gain of $16.7 million, recorded in other income, net in our consolidated statement of income for the three months ended September 30, 2010. As of March 31, 2011, the fair value of interests in the 2006-A Trust that we had repurchased in the market subsequent to the initial securitization and held as of March 31, 2011 was $17.9 million and were classified as investment securities, available-for-sale in our consolidated balance sheets. We have no additional funding commitments or other obligations related to these interests. Except for a guarantee provided to a swap counterparty of the 2006-A Trust, we have not provided any additional financial support to the 2006-A Trust during the three months ended March 31, 2011. This swap had a fair value to the counterparty of $13.2 million as of March 31, 2011. The interests in the Trust and the swap guarantee comprise our maximum exposure to loss related to the 2006-A Trust. During the three months ended March 31, 2011, we recognized a gain of $13.3 million, included in gain on investments in our consolidated statement of income, on the sale of certain of our interests in the 2006-A Trust. In addition, we recorded an unrealized gain of $8.3 million, included as a component of other comprehensive income, on the securities that we still hold in the 2006-A Trust as of March 31, 2011 as a result of valuation adjustments.


Note 10.	Borrowings

For additional information on our borrowings, see Note 11, Borrowings, in our audited consolidated financial statements for the year ended December 31, 2010, included in our Form 10-K.

As of March 31, 2011 and December 31, 2010, the composition of our outstanding borrowings was as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Credit facilities	$	—	$	67,508
Term debt(1)		863,799		979,254
Other borrowings:
Convertible debt, net(2)		526,254		523,650
Subordinated debt		439,281		437,286
FHLB SF borrowings		400,000		412,000
Notes payable		2,927		2,948

Total other borrowings		1,368,462		1,375,884

Total borrowings	$	2,232,261	$	2,422,646


(1)		Amounts presented are net of debt discounts of $13.6 million and $14.4 million as of March 31, 2011 and December 31, 2010, respectively.

(2)		Amounts presented are net of debt discounts of $4.3 million and $6.9 million as of March 31, 2011 and December 31, 2010, respectively.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Credit Facilities

As of March 31, 2011 and December 31, 2010, we had access to a secured credit facility to finance our commercial loans and for general corporate purposes. We terminated this credit facility on April 12, 2011. Information pertaining to this secured credit facility was as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Committed capacity	$	40,000	$	167,508
Outstanding borrowings		—		67,508

Undrawn capacity(1)	$	40,000	$	100,000


(1)		Undrawn capacity on the secured credit facility was limited by issued and outstanding letters of credit totaling $10.7 million and $21.0 million, as of March 31, 2011 and December 31, 2010, respectively.

Term Debt

As of March 31, 2011 and December 31, 2010, the carrying amounts of our term debt related to securitizations were $577.3 million and $693.5 million, respectively. As of March 31, 2011 and December 31, 2010, our 2014 Senior Secured Notes had balances of $286.5 million and $285.7 million, respectively, net of discounts of $13.5 million and $14.3 million, respectively.

Convertible Debt

As of March 31, 2011 and December 31, 2010, the carrying amounts of the liability and equity components of our convertible debt were as follows:


	March 31,			December 31,
	2011			2010
	($ in thousands)

Convertible debt principal	$	530,523		$	530,523
Less: debt discount		(4,269	)		(6,873	)

Net carrying value	$	526,254		$	523,650

Equity components recorded in additional paid-in capital	$	101,220		$	101,220

As of March 31, 2011, the unamortized discounts on our 3.5%, 4.0% and 7.25% Convertible Debentures will be amortized through the first put dates of July 15, 2011, July 15, 2011, and July 15, 2012, respectively. As of March 31, 2011, the conversion prices and the numbers of shares used to determine the aggregate consideration that would be delivered upon conversion of our convertible debentures were as follows:


	Conversion Price		Number of Shares

3.5% Senior Convertible Debentures due 2034	$	20.77		406,566
4.0% Senior Subordinated Convertible Debentures due 2034		20.77		13,096,998
7.25% Senior Subordinated Convertible Debentures due 2037		27.09		9,226,975

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

For the three months ended March 31, 2011 and 2010, the interest expense recognized on our Convertible Debentures and the effective interest rates on the liability components were as follows:


	Three Months Ended
	March 31,
	2011			2010
	($ in thousands)

Interest expense recognized on:
Contractual interest coupon	$	7,377		$	7,668
Amortization of deferred financing fees		300			373
Amortization of debt discount		2,604			2,631

Total interest expense recognized	$	10,281		$	10,672

Effective interest rate on the liability component:
3.5% Senior Convertible Debentures due 2034		7.16	%		7.16	%
4.0% Senior Subordinated Convertible Debentures due 2034		7.85	%		7.78	%
7.25% Senior Subordinated Convertible Debentures due 2037		7.79	%		7.79	%

For information on the contingent interest feature of the 3.5% Debentures, see Note 11, Borrowings, in our audited consolidated financial statements for the year ended December 31, 2010, included in our Form 10-K.

FHLB SF Borrowings and FRB Credit Program

CapitalSource Bank is a member of the FHLB SF. As of March 31, 2011 and December 31, 2010, CapitalSource Bank had borrowing capacity with the FHLB SF based on pledged collateral as follows:


	March 31,			December 31,
	2011			2010
	($ in thousands)

Borrowing capacity	$	879,846		$	885,842
Less: outstanding principal		(400,000	)		(412,000	)
Less: outstanding letters of credit		(600	)		(600	)

Unused borrowing capacity	$	479,246		$	473,242

CapitalSource Bank is an approved depository institution under the primary credit program of the FRB of San Francisco’s discount window eligible to borrow from the FRB for short periods, generally overnight. As of March 31, 2011 and December 31, 2010, collateral with amortized costs of $176.0 million and $179.0 million, respectively, and fair values of $181.9 million and $188.0 million, respectively, had been pledged under this program. As of March 31, 2011 and December 31, 2010, there were no borrowings outstanding.


Note 11.	Shareholders’ Equity

Common Stock Shares Outstanding

Common stock share activity for the three months ended March 31, 2011 was as follows:


Outstanding as of December 31, 2010			323,225,355
Exercise of options			101,434
Restricted stock and other stock activities			18,523

Outstanding as of March 31, 2011			323,345,312

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 12.	Income Taxes

We provide for income taxes as a “C” corporation on income earned from operations. For the tax year ended December 31, 2010, our subsidiaries were not able to participate in the filing of a consolidated federal tax return. We intend to reconsolidate our subsidiaries in 2011 for federal tax purposes. We are subject to federal, foreign, state and local taxation in various jurisdictions.

In 2009, we established a valuation allowance against a substantial portion of our net deferred tax assets for subsidiaries where we determined that there was significant negative evidence with respect to our ability to realize such assets. Negative evidence we considered in making this determination included the incurrence of operating losses at several of our subsidiaries, and uncertainty regarding the realization of a portion of the deferred tax assets at future points in time. As of March 31, 2011 and December 31, 2010, the total valuation allowance was $456.5 million and $413.8 million, respectively. Although realization is not assured, we believe it is more likely than not that the net deferred tax assets of $63.0 million as of March 31, 2011 will be realized. We intend to maintain a valuation allowance with respect to our deferred tax assets until sufficient positive evidence exists to support its reduction or reversal.

During the three months ended March 31, 2011, we recorded income tax expense of $11.2 million. The expense for the three months ended March 31, 2011 was primarily the result of the re-establishment of a valuation allowance at the consolidated group level with respect to CapitalSource Bank’s net deferred tax assets. The valuation allowance was recorded in connection with our plan to reconsolidate our corporate entities for federal tax purposes in 2011. For the three months ended March 31, 2010, we recorded income tax expense of $21.0 million. The effective income tax rate on our consolidated net income and loss from continuing operations was 77.9% and (10.6)% for the three months ended March 31, 2011 and 2010, respectively.

We file income tax returns with the United States and various state, local and foreign jurisdictions and generally remain subject to examinations by these tax jurisdictions for tax years 2006 through 2010. We are currently under examination by the Internal Revenue Service and certain states for the tax years 2006 to 2008.


Note 13.	Comprehensive Income (Loss)

Comprehensive income (loss) for the three months ended March 31, 2011 and 2010 was as follows:


	Three Months Ended
	March 31,
	2011		2010
	($ in thousands)

Net income (loss) from continuing operations	$	3,159	$	(219,013	)
Net income from discontinued operations, net of taxes		—		7,323

Net income (loss)		3,159		(211,690	)
Unrealized gain on available-for-sale securities, net of taxes		4,843		760
Unrealized gain (loss) on foreign currency translation, net of taxes		9,582		(9,972	)
Unrealized loss on cash flow hedges, net of taxes		—		(22	)

Comprehensive income (loss)	$	17,584	$	(220,924	)

Accumulated other comprehensive income, net, as of March 31, 2011 and December 31, 2010 was as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Unrealized gain on available-for-sale securities, net of taxes	$	10,606	$	5,763
Unrealized gain on foreign currency translation, net of taxes		13,760		4,178

Accumulated other comprehensive income, net	$	24,366	$	9,941

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 14.	Net Income (Loss) Per Share

The computations of basic and diluted net income (loss) per share for the three months ended March 31, 2011 and 2010, respectively, were as follows:


	Three Months Ended
	March 31,
	2011		2010
	($ in thousands, except per share data)

Net income (loss):
From continuing operations	$	3,159	$	(219,013	)
From discontinued operations, net of taxes		—		7,323

Net income (loss)	$	3,159	$	(211,690	)
Average shares — basic		320,196,690		320,294,724
Effect of dilutive securities:
Option shares		2,519,314		—
Unvested restricted stock		1,153,497		—
Stock units		3,094,237		—

Average shares — diluted		326,963,738		320,294,724

Basic net income (loss) per share
From continuing operations	$	0.01	$	(0.68	)
From discontinued operations, net of taxes	$	—	$	0.02
Net income (loss) per share	$	0.01	$	(0.66	)
Diluted net income (loss) per share
From continuing operations	$	0.01	$	(0.68	)
From discontinued operations, net of taxes	$	—	$	0.02
Net income (loss) per share	$	0.01	$	(0.66	)

The weighted average shares that have an antidilutive effect in the calculation of diluted net income (loss) per share attributable to CapitalSource Inc. and have been excluded from the computations above were as follows:


	Three Months Ended
	March 31,
	2011		2010

Stock units		—		3,616,480
Stock options		1,820,596		2,563,621
Shares issuable upon conversion of convertible debt		13,488,710		15,013,163
Unvested restricted stock		251,358		1,080,046


Note 15.	Bank Regulatory Capital

CapitalSource Bank is subject to various regulatory capital requirements established by federal and state regulatory agencies. Failure to meet minimum capital requirements can result in regulatory agencies initiating certain mandatory and possibly additional discretionary actions that, if undertaken, could have a direct material effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, CapitalSource Bank must meet specific capital guidelines that involve quantitative measures of its assets and liabilities as calculated under regulatory accounting practices. CapitalSource Bank’s capital amounts and other requirements are also subject to qualitative judgments by its regulators about risk weightings and other factors. See Item 1, Business — Supervision and Regulation, in our Form 10-K and

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Supervision and Regulation within Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-Q for a further description of CapitalSource Bank’s regulatory requirements.

Under prompt corrective action regulations, a “well-capitalized” bank must have a total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a Tier 1 leverage ratio of 5%. Under its approval order from the FDIC, CapitalSource Bank must be “well-capitalized” and at all times have a minimum total risk-based capital ratio of 15%, a minimum Tier-1 risk-based capital ratio of 6% and a minimum Tier 1 leverage ratio of 5%. CapitalSource Bank’s ratios and the minimum requirements as of March 31, 2011 and December 31, 2010 were as follows:


	March 31, 2011										December 31, 2010
	Actual					Minimum Required					Actual					Minimum Required
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
	($ in thousands)

Tier-1 Leverage	$	791,341		13.47	%	$	293,779		5.00	%	$	756,821		13.15	%	$	287,830		5.00	%
Tier-1 Risk-Based Capital		791,341		17.52			270,941		6.00			756,821		16.86			269,335		6.00
Total Risk-Based Capital		848,773		18.80			677,351		15.00			813,822		18.13			673,336		15.00

The California Department of Financial Institutions (the “DFI”) approval order requires that CapitalSource Bank, until July 2011, maintain a minimum ratio of tangible shareholder’s equity to total tangible assets of at least 10.00%. As of March 31, 2011 and December 31, 2010, CapitalSource Bank satisfied the DFI capital ratio requirement with ratios of 13.06% and 12.61%, respectively.


Note 16.	Commitments and Contingencies

We provide standby letters of credit in conjunction with several of our lending arrangements and property lease obligations. As of March 31, 2011 and December 31, 2010, we had issued $134.9 million and $143.4 million, respectively, in stand-by letters of credit which expire at various dates over the next nine years. If a borrower defaults on its commitment(s) subject to any letter of credit issued under these arrangements, we would be required to meet the borrower’s financial obligation and would seek repayment of that financial obligation from the borrower. These arrangements had carrying amounts totaling $3.1 million and $3.8 million, as reported in other liabilities in our consolidated balance sheets as of March 31, 2011 and December 31, 2010, respectively.

As of March 31, 2011 and December 31, 2010, we had unfunded commitments to extend credit to our clients of $1.7 billion and $1.9 billion, respectively, including unfunded commitments to extend credit by CapitalSource Bank of $936.3 million and $958.7 million, respectively, and by the Parent Company of $810.7 million and $977.7 million, respectively. Additional information on these contingencies is included in Note 19, Commitments and Contingencies, in our audited consolidated financial statements for the year ended December 31, 2010, included in our Form 10-K.

During the years ended December 31, 2010 and 2009, we sold all of our direct real estate investment properties. We are responsible for indemnifying the current owners for any remediation, including costs of removal and disposal of asbestos that existed prior to the sales, through the third anniversary date of the sale. We will recognize any remediation costs if notified by the current owners of their intention to exercise their indemnification rights, however, no such notification has been received to date. As of March 31, 2011, sufficient information was not available to estimate our potential liability for conditional asset retirement obligations as the obligations to remove the asbestos from these properties continue to have indeterminable settlement dates.

From time to time we are party to legal proceedings. We do not believe that any currently pending or threatened proceeding, if determined adversely to us, would have a material adverse effect on our business, financial condition or results of operations, including our cash flows.


Note 17.	Derivative Instruments

We are exposed to certain risks related to our ongoing business operations. The primary risks managed through the use of derivative instruments are interest rate risk and foreign exchange risk. We do not enter into derivative

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

instruments for speculative purposes. As of March 31, 2011, none of our derivatives were designated as hedging instruments pursuant to GAAP.

We enter into various derivative instruments to manage our exposure to interest rate risk. The objective is to manage interest rate sensitivity by modifying the characteristics of certain assets and liabilities to reduce the adverse effect of changes in interest rates. We primarily use interest rate swaps and basis swaps to manage our interest rate risks.

Interest rate swaps are contracts in which a series of interest rate cash flows, based on a specific notional amount as well as fixed and variable interest rates, are exchanged over a prescribed period. To minimize the economic effect of interest rate fluctuations specific to our fixed rate debt and certain fixed rate loans, we enter into interest rate swap agreements whereby either we pay a fixed interest rate and receive a variable interest rate or we pay a variable interest rate and receive a fixed interest rate over a prescribed period.

We also enter into basis swaps to eliminate risk between our LIBOR-based term debt securitizations and the prime-based loans pledged as collateral for that debt. These basis swaps modify our exposure to interest rate risk typically by converting our prime rate loans to a one-month LIBOR rate. The objective of this swap activity is to protect us from risk that interest collected under the prime rate loans will not be sufficient to service the interest due under the one-month LIBOR-based term debt.

We enter into forward exchange contracts to hedge foreign currency denominated loans we originate against foreign currency fluctuations. The objective is to manage the uncertainty of future foreign exchange rate fluctuations. These forward exchange contracts provide for a fixed exchange rate which has the effect of reducing or eliminating changes to anticipated cash flows to be received from foreign currency-denominated loan transactions as the result of changes to exchange rates.

In March 2011, we entered into a trade agreement to transfer a $49.6 million loan commitment to a third party. As the trade agreement had not settled as of March 31, 2011, it qualified as a forward contract. We did not recognize any gains or losses on this derivative during the three months ended March 31, 2011.

Derivative instruments expose us to credit risk in the event of nonperformance by counterparties to such agreements. This risk exposure consists primarily of the termination value of agreements where we are in a favorable position. We manage the credit risk associated with various derivative agreements through counterparty credit review and monitoring procedures. We obtain collateral from certain counterparties and monitor all exposure and collateral requirements daily. We continually monitor the fair value of collateral received from counterparties and may request additional collateral from counterparties or return collateral pledged as deemed appropriate. We also posted collateral of $10.0 million related to counterparty requirements for foreign exchange contracts at CapitalSource Bank. Our agreements generally include master netting agreements whereby we are entitled to settle our individual derivative positions with the same counterparty on a net basis upon the occurrence of certain events. As of March 31, 2011, our derivative counterparty exposure was as follows ($ in thousands):


Gross derivative counterparty exposure	$	33,442
Master netting agreements		(22,061	)

Net derivative counterparty exposure	$	11,381

We report our derivatives in our consolidated balance sheets at fair value on a gross basis irrespective of our master netting arrangements. We held $11.5 million of collateral against our derivative instruments that were in an asset position as of March 31, 2011. For derivatives that were in a liability position, we had posted collateral of $48.8 million as of March 31, 2011.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of March 31, 2011, the notional amounts and fair values of our various derivative instruments as well as their locations in our consolidated balance sheets were as follows:


	March 31, 2011						December 31, 2010
			Fair Value						Fair Value
	Notional Amount		Other Assets		Other Liabilities		Notional Amount		Other Assets		Other Liabilities
	($ in thousands)

Interest rate contracts	$	1,270,468	$	33,442	$	69,536	$	1,287,399	$	41,309	$	77,410
Foreign exchange contracts		35,428		—		1,229		35,557		—		877
Forward contracts		49,596		—		—		—		—		—

Total	$	1,355,492	$	33,442	$	70,765	$	1,322,956	$	41,309	$	78,287

The gains and losses on our derivative instruments recognized during the three months ended March 31, 2011 and 2010 as well as the locations of such gains and losses in our consolidated statements of operations were as follows:


		Loss Recognized in Income
		Three Months Ended
		March 31,
	Location	2011			2010
		($ in thousands)

Interest rate contracts	Loss on derivatives	$	(802	)	$	(2,703	)
Foreign exchange contracts	Loss on derivatives		(1,076	)		(1,634	)

Total		$	(1,878	)	$	(4,337	)


Note 18.	Fair Value Measurements

We use fair value measurements to record fair value adjustments to certain of our assets and liabilities and to determine fair value disclosures. Investment securities, available-for-sale, warrants and derivatives are recorded at fair value on a recurring basis. In addition, we may be required, in specific circumstances, to measure certain of our assets at fair value on a nonrecurring basis, including investment securities, held-to-maturity, loans held for sale, loans held for investment, REO and certain other investments.

Fair Value Determination

Fair value is based on quoted market prices or by using market based inputs where available. Given the nature of some of our assets and liabilities, clearly determinable market based valuation inputs are often not available; therefore, these assets and liabilities are valued using internal estimates. As subjectivity exists with respect to many of our valuation estimates used, the fair values we have disclosed may not equal prices that we may ultimately realize if the assets are sold or the liabilities settled with third parties.

Below is a description of the valuation methods for our assets and liabilities recorded at fair value on either a recurring or nonrecurring basis. While we believe the valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain assets and liabilities could result in a different estimate of fair value at the measurement date.

Assets and Liabilities

Cash

Cash and cash equivalents and restricted cash are recorded at historical cost. The carrying amount is a reasonable estimate of fair value as these instruments have short-term maturities and interest rates that approximate market.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Investment Securities, Available-for-Sale

Investment securities, available-for-sale, consist of U.S. Treasury bills, Agency discount notes, Agency callable notes, Agency debt, Agency MBS, Non-agency MBS, and corporate debt securities that are carried at fair value on a recurring basis and classified as available-for-sale securities. Fair value adjustments on these investments are generally recorded through other comprehensive income. However, if impairment on an investment, available-for-sale is deemed to be other-than-temporary, all or a portion of the fair value adjustment may be reported in earnings. The securities are valued using quoted prices from external market participants, including pricing services. If quoted prices are not available, the fair value is determined using quoted prices of securities with similar characteristics or independent pricing models, which utilize observable market data such as benchmark yields, reported trades and issuer spreads. These securities are primarily classified within Level 2 of the fair value hierarchy.

Investment securities, available-for-sale, also consist of a collateralized loan obligation, which include the interests we hold in the deconsolidated 2006-A Trust, and a municipal bond, whose values are determined using internally developed valuation models. These models may utilize discounted cash flow techniques for which key inputs include the timing and amount of future cash flows and market yields. Market yields are based on comparisons to other instruments for which market data is available. These models may also utilize industry valuation benchmarks, such as multiples of EBITDA, to determine a value for the underlying enterprise. Given the lack of active and observable trading in the market, our collateralized loan obligation and municipal bond are classified in Level 3.

Investment securities, available-for-sale, also consist of equity securities which are valued using the stock price of the underlying company in which we hold our investment. Our equity securities are classified in Level 1 or 2 depending on the level of activity within the market.

Investment Securities, Held-to-Maturity

Investment securities, held-to-maturity consist of commercial mortgage-backed-securities. These securities are generally recorded at amortized cost, but are recorded at fair value on a non-recurring basis to the extent we record an OTTI on the securities. Fair value measurements are determined using quoted prices from external market participants, including pricing services. If quoted prices are not available, the fair value is determined using quoted prices of securities with similar characteristics or independent pricing models, which utilize observable market data such as benchmark yields, reported trades and issuer spreads.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value, with fair value adjustments recorded on a nonrecurring basis. The fair value is determined using actual market transactions when available. In situations when market transactions are not available, we use the income approach through internally developed valuation models to estimate the fair value. This requires the use of significant judgment surrounding discount rates and the timing and amounts of future cash flows. Key inputs to these valuations also include costs of completion and unit settlement prices for the underlying collateral of the loans. Fair values determined through actual market transactions are classified within Level 2 of the fair value hierarchy, while fair values determined through internally developed valuation models are classified within Level 3 of the fair value hierarchy.

Loans Held for Investment

Loans held for investment are recorded at outstanding principal, net of any deferred fees and unamortized purchase discounts or premiums and net of an allowance for loan losses. We may record fair value adjustments on a nonrecurring basis when we have determined that it is necessary to record a specific reserve against a loan and we measure such specific reserve using the fair value of the loan’s collateral. To determine the fair value of the collateral, we may employ different approaches depending on the type of collateral.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In cases where our collateral is a fixed or other tangible asset, including commercial real estate, our determination of the appropriate method to use to measure fair value depends on several factors including the type of collateral that we are evaluating, the age of the most recent appraisal performed on the collateral, and the time required to obtain an updated appraisal. Typically, we obtain an updated third-party appraisal to estimate fair value using external valuation specialists.

For impaired collateral dependent commercial real estate loans, we typically obtain an updated appraisal as of the date the loan is deemed impaired to measure the amount of impairment. In situations where we are unable to obtain a timely updated appraisal, we perform internal valuations which utilize assumptions and calculations similar to those customarily utilized by third party appraisers and consider relevant property specific facts and circumstances. In certain instances, our internal assessment of value may be based on adjustments to outdated appraisals by analyzing the changes in local market conditions and asset performance since the appraisals were performed. The outdated appraisal values may be discounted by percentages that are determined by analyzing changes in local market conditions since the dates of the appraisals as well as by consulting databases, comparable market sale prices, brokers’ opinions of value and other relevant data. We do not make adjustments that increase the values indicated by outdated appraisals by using higher recent sale comparisons.

Impaired collateral dependent commercial real estate loans for which ultimate collection depends solely on the sale of the collateral are charged off to the estimated fair value of the collateral less estimated costs to sell. For certain of these loans, we charged off to an amount different than the value indicated by the most recent appraisal. This was primarily the result of both factors causing the appraisal to be outdated as outlined above and other factors surrounding the loans not considered by appraisals, such as pending loan sales and other transaction specific factors. As of March 31, 2011 and December 31, 2010, we charged off an additional $59.0 million, net, and $58.2 million, net, respectively, in loan balances compared with amounts that would have been charged off based on the appraised values of the collateral. In addition, we have impaired collateral dependent commercial real estate loans with a carrying amount at March 31, 2011 of $6.9 million for which we do not have appraisals. Valuations for the real estate collateral securing these loans are based on observable transactions and industry metrics.

Our policy on updating appraisals related to these originated impaired collateral dependent commercial real estate loans generally is to obtain current appraisals subsequent to the impairment date if there are significant changes to the underlying assumptions from the most recent appraisal. Some factors that could cause significant changes include the passage of more than twelve months since the time of the last appraisal; the volatility of the local market; the availability of financing; the inventory of competing properties; new improvements to, or lack of maintenance of, the subject property or competing surrounding properties; a change in zoning; environmental contamination; or failure of the project to meet material assumptions of the original appraisal. This policy for updating appraisals does not vary by commercial real estate loan type.

We continue to monitor collateral values on partially charged-off impaired collateral dependent commercial real estate loans and may record additional charge offs upon receiving updated appraisals. We do not return such partially charged-off loans to performing status, except in limited circumstances when such loans have been formally restructured and have met key performance criteria including compliance with restructured payment terms. We do not return such partially charged-off loans to performing status based solely on the results of appraisals.

In cases where our collateral is not a fixed or tangible asset, we typically use industry valuation benchmarks to determine the value of the asset or the underlying enterprise.

When fair value adjustments are recorded on loans held for investment, we typically classify them in Level 3 of the fair value hierarchy.

We determine the fair value estimates of loans held for investment for fair value disclosures primarily using external valuation specialists. These valuation specialists group loans based on credit rating and collateral type, and the fair value is estimated utilizing discounted cash flow techniques. The valuations take into account current market rates of return, contractual interest rates, maturities and assumptions regarding expected future cash flows.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Within each respective loan grouping, current market rates of return are determined based on quoted prices for similar instruments that are actively traded, adjusted as necessary to reflect the illiquidity of the instrument. This approach requires the use of significant judgment surrounding current market rates of return, liquidity adjustments and the timing and amounts of future cash flows.

Other Investments

Other investments accounted for under the cost or equity methods of accounting are carried at fair value on a nonrecurring basis to the extent that they are determined to be other-than-temporarily impaired during the period. As there is rarely an observable price or market for such investments, we determine fair value using internally developed models. Our models utilize industry valuation benchmarks, such as multiples of EBITDA, to determine a value for the underlying enterprise. We reduce this value by the value of debt outstanding to arrive at an estimated equity value of the enterprise. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the pricing indicated by the external event will be used to corroborate our private equity valuation. Fair value measurements related to these investments are typically classified within Level 3 of the fair value hierarchy.

Warrants

Warrants are carried at fair value on a recurring basis and generally relate to privately held companies. Warrants for privately held companies are valued based on the estimated value of the underlying enterprise. This fair value is derived principally using a multiple determined either from comparable public company data or from the transaction where we acquired the warrant and a financial performance indicator based on EBITDA or another revenue measure. Given the nature of the inputs used to value privately held company warrants, they are classified in Level 3 of the fair value hierarchy.

FHLB SF Stock

Our investment in FHLB stock is recorded at historical cost. FHLB stock does not have a readily determinable fair value, but may be sold back to the FHLB at its par value with stated notice. 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 on our investment in FHLB stock have been recorded through March 31, 2011.

Derivative Assets and Liabilities

Derivatives are carried at fair value on a recurring basis and primarily relate to interest rate swaps, caps, floors, basis swaps and forward exchange contracts which we enter into to manage interest rate risk and foreign exchange risk. Our derivatives are principally traded in over-the-counter markets where quoted market prices are not readily available. Instead, derivatives are measured using market observable inputs such as interest rate yield curves, volatilities and basis spreads. We also consider counterparty credit risk in valuing our derivatives. We typically classify our derivatives in Level 2 of the fair value hierarchy.

Real Estate Owned

REO is initially recorded at its estimated fair value less costs to sell at the time of foreclosure if the related REO is classified as held for sale. REO held for sale is carried at the lower of its carrying amount or fair value subsequent to the date of foreclosure, with fair value adjustments recorded on a nonrecurring basis. REO held for use is recorded at its carrying amount, net of accumulated depreciation, with fair value adjustments recorded on a nonrecurring basis if the carrying amount of the real estate is not recoverable and exceeds its fair value. When available, the fair value of REO is determined using actual market transactions. When market transactions are not available, the fair value of REO is typically determined based upon recent appraisals by third parties. We may or may not adjust these third party appraisal values based on our own internally developed judgments and estimates. To

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the extent that market transactions or third party appraisals are not available, we use the income approach through internally developed valuation models to estimate the fair value. This requires the use of significant judgment surrounding discount rates and the timing and amounts of future cash flows. Fair values determined through actual market transactions are classified within Level 2 of the fair value hierarchy while fair values determined through third party appraisals and through internally developed valuation models are classified within Level 3 of the fair value hierarchy.

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. Valuation of that collateral, which often is a pool of many small balance loans, is typically performed utilizing internally-developed estimates. These estimates rely upon default and recovery rates, market discount rates and the underlying value of collateral supporting the loans. Underlying collateral values may be supported by appraisals or broker price opinions. When fair value adjustments are recorded on these loans, we typically classify them in Level 3 of the fair value hierarchy.

Deposits

Deposits are carried at historical cost. The carrying amounts of deposits for savings and money market accounts and brokered certificates of deposit are deemed to approximate fair value as they either have no stated maturities or short-term maturities. Certificates of deposit are grouped by maturity date, and the fair value is estimated utilizing discounted cash flow techniques. The interest rates applied are rates currently being offered for similar certificates of deposit within the respective maturity groupings.

Credit Facilities

The fair value of credit facilities is estimated based on current market interest rates for similar debt instruments adjusted for the remaining time to maturity.

Term Debt

Term debt comprises term debt securitizations and our 2014 Senior Secured Notes. For disclosure purposes, the fair values of our term debt securitizations and 2014 Senior Secured Notes are determined based on actual prices from recent third party purchases of our debt when available and based on indicative price quotes received from various market participants when recent transactions have not occurred.

Other Borrowings

Our other borrowings comprise convertible debt and subordinated debt. For disclosure purposes, the fair value of our convertible debt is determined from quoted market prices in active markets or, when the market is not active, from quoted market prices for debt with similar maturities. The fair value of our subordinated debt is determined based on recent third party purchases of our debt when available and based on indicative price quotes received from market participants when recent transactions have not occurred.

Off-Balance Sheet Financial Instruments

Loan Commitments and Letters of Credit

Loan commitments and letters of credit generate ongoing fees at our current pricing levels, which are recognized over the term of the commitment period. For disclosure purposes, the fair value is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the current creditworthiness of the counterparties and current market conditions. In addition, for loan commitments, the market rates of return utilized in the valuation of the loans held for investment as described above are applied to this analysis to reflect current market conditions.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Assets and Liabilities Carried at Fair Value on a Recurring Basis

Assets and liabilities have been grouped in their entirety within the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. Assets and liabilities carried at fair value on a recurring basis on the balance sheet as of March 31, 2011 were as follows:


					Significant
	Fair Value		Quoted Prices in		Other		Significant
	Measurement as of		Active Markets for		Observable		Unobservable
	March 31, 2011		Identical Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)
	($ in thousands)

Assets
Investment securities, available-for-sale:
Agency callable notes	$	162,323	$	—	$	162,323	$	—
Agency debt		77,903		—		77,903		—
Agency MBS		954,538		—		954,538		—
Assets-backed securities		22,606		—		22,606		—
Collateralized loan obligation		17,931		—		—		17,931
Corporate debt		5,093		—		5,093		—
Equity securities		416		416		—		—
Municipal bond		3,235		—		—		3,235
Non-agency MBS		96,987		—		96,987		—
U.S. Treasury and agency securities		29,321		—		29,321		—

Total investment securities, available-for-sale		1,370,353		416		1,348,771		21,166
Investments carried at fair value:
Warrants		218		—		—		218
Other assets held at fair value:
Derivative assets		33,442		—		33,442		—

Total assets	$	1,404,013	$	416	$	1,382,213	$	21,384

Liabilities
Other liabilities held at fair value:
Derivative liabilities	$	70,765	$	—	$	70,765	$	—

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Assets and liabilities carried at fair value on a recurring basis on the balance sheet as of December 31, 2010 were as follows:


					Significant
	Fair Value		Quoted Prices in		Other		Significant
	Measurement as of		Active Markets for		Observable		Unobservable
	December 31, 2010		Identical Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)
	($ in thousands)

Assets
Investment securities, available-for-sale:
Agency discount notes	$	164,974	$	—	$	164,974	$	—
Agency callable notes		162,888		—		162,888		—
Agency debt		103,430		—		103,430		—
Agency MBS		870,155		—		870,155		—
Non-agency MBS		113,684		—		113,684		—
Equity securities		263		263		—		—
Corporate debt		5,135		—		5,120		15
Collateralized loan obligation		12,249		—		—		12,249
U.S. Treasury and agency securities		90,133		—		90,133		—

Total investment securities, available-for-sale		1,522,911		263		1,510,384		12,264
Investments carried at fair value:
Warrants		222		—		—		222
Other assets held at fair value:
Derivative assets		41,309		—		41,309		—

Total assets	$	1,564,442	$	263	$	1,551,693	$	12,486

Liabilities
Other liabilities held at fair value:
Derivative liabilities	$	78,287	$	—	$	78,287	$	—

A summary of the changes in the fair values of assets and liabilities carried at fair value for the three months ended March 31, 2011 that have been classified in Level 3 of the fair value hierarchy was as follows:


			Realized and Unrealized
			Gains (Losses)
									Total																			Unrealized
									Realized																			Gains
						Included in			and										Total									(Losses)
	Balance as of					Other			Unrealized										Acquisitions,			Transfers In (Out)				Balance as of		As of
	January 1,		Included in			Comprehensive			Gains										Sales, and			of Level 3				March 31,		March 31,
	2011		Income			Income, Net			(Losses)			Acquisitions		Sales			Settlements		Settlements			In		(Out)		2011		2011
	($ in thousands)

Assets
Investment securities, available-for-sale:
Corporate debt	$	15	$	—		$	(15	)	$	(15	)	$	—	$	—		$	—	$	—		$	—	$	—	$	—	$	—
Collateralized loan obligation		12,249		16,346			8,336			24,682			—		(19,000	)		—		(19,000	)		—		—		17,931		1,662
Municipal bonds		—		(1,496	)		—			(1,496	)		4,731		—			—		4,731			—		—		3,235		(1,496	)

Total		12,264		14,850			8,321			23,171			4,731		(19,000	)		—		(14,269	)		—		—		21,166		166
Warrants		222		9			—			9			—		(14	)		—		(14	)		—		—		218		(5	)

Total assets	$	12,486	$	14,859		$	8,321		$	23,180		$	4,731	$	(19,014	)	$	—	$	(14,283	)	$	—	$	—	$	21,384	$	161

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A summary of the changes in the fair values of assets and liabilities carried at fair value for the three months ended March 31, 2010 that have been classified in Level 3 of the fair value hierarchy was as follows:


			Realized and Unrealized
			Gains (Losses)
									Total																			Unrealized
									Realized										Total									Gains
						Included in			and										Acquisitions,									(Losses)
	Balance as of					Other			Unrealized										Sales,			Transfers In (Out)				Balance as of		As of
	January 1,		Included in			Comprehensive			Gains										and			Level 3				March 31,		March 31,
	2010		Income			Income, Net			(Losses)			Acquisitions		Sales			Settlements		Settlements			In		(Out)		2010		2010
	($ in thousands)

Assets
Investment securities, available-for-sale:
Non-agency MBS	$	61	$	—		$	—		$	—		$	—	$	(33	)	$	—	$	(33	)	$	—	$	—	$	28	$	—
Corporate debt		4,457		57			(149	)		(92	)		—		—			—		—			—		—		4,365		57
Collateralized loan obligation		1,326		636			(308	)		328			—		(1,654	)		—		(1,654	)		—		—		—		—

Total		5,844		693			(457	)		236			—		(1,687	)		—		(1,687	)		—		—		4,393		57
Warrants		1,392		(148	)		—			(148	)		—		—			—		—			—		—		1,244		(148	)

Total assets	$	7,236	$	545		$	(457	)	$	88		$	—	$	(1,687	)	$	—	$	(1,687	)	$	—	$	—	$	5,637	$	(91	)

Realized and unrealized gains and losses on assets and liabilities classified in Level 3 of the fair value hierarchy included in income for the three months ended March 31, 2011 and 2010, reported in interest income and gain on investments, net were as follows:


	Interest Income				Gain on Investments, Net
	Three Months Ended March 31,
	2011		2010		2011			2010
	($ in thousands)

Total gains included in earnings for the period	$	3,056	$	91	$	11,803		$	454
Unrealized gains (losses) relating to assets still held at reporting date		1,657		57		(1,496	)		(148	)

Assets Carried at Fair Value on a Nonrecurring Basis

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. As described above, these adjustments to fair value usually result from the application of lower of cost or fair value accounting or write downs of individual assets. The table below provides the fair values of those assets for which nonrecurring fair value adjustments were recorded during the three months ended March 31, 2011, classified by their position in the fair value hierarchy. The table also provides the gains (losses) related to those assets recorded during the three months ended March 31, 2011.


									Total
									Net
			Quoted						Losses
			Prices in						for the
			Active		Significant				Three
	Fair Value		Markets		Other		Significant		Months
	Measurement		for Identical		Observable		Unobservable		Ended
	as of		Assets		Inputs		Inputs		March 31,
	March 31, 2011		(Level 1)		(Level 2)		(Level 3)		2011
	($ in thousands)

Assets
Loans held for sale	$	10,822	$	—	$	10,822	$	—	$	—
Loans held for investment(1)		269,130		—		—		269,130		(28,023	)
Investments carried at cost		1,274		—		—		1,274		(173	)
Investments accounted for REO(2)		38,835		—		—		38,835		(2,036	)
Loans acquired through foreclosure, net		20,168		—		—		20,168		(7,803	)

Total assets	$	340,229	$	—	$	10,822	$	329,407	$	(38,035	)


(1)		Represents impaired loans held for investment measured at fair value of the collateral less transaction costs. Transaction costs were not significant during the period.

(2)		Represents REO measured at fair value of the collateral less transaction costs. Transaction costs were not significant during the period.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The table below provides the fair values of those assets for which nonrecurring fair value adjustments were recorded during the three months ended March 31, 2010, classified by their position in the fair value hierarchy. The table also provides the gains (losses) related to those assets recorded during the three months ended March 31, 2010.


									Total
									Net
			Quoted						Losses
			Prices in						for the
			Active		Significant				Three
	Fair Value		Markets		Other		Significant		Months
	Measurement		for Identical		Observable		Unobservable		Ended
	as of		Assets		Inputs		Inputs		March 31,
	March 31, 2010		(Level 1)		(Level 2)		(Level 3)		2010
	($ in thousands)

Assets
Loans held for sale	$	15,005	$	—	$	15,005	$	—	$	—
Loans held for investment(1)		412,718		—		—		412,718		(141,696	)
Investments carried at cost		910		—		—		910		(2,014	)
REO(2)		79,055		—		—		79,055		(20,689	)
Loans acquired through foreclosure, net		108,804		—		—		108,804		(15,170	)

Total assets	$	616,492	$	—	$	15,005	$	601,487	$	(179,569	)


(1)		Represents impaired loans held for investment measured at fair value of the loan’s collateral less transaction costs. Transaction costs were not significant during the period.

(2)		Represents REO measured at fair value of the collateral less transaction costs. Transaction costs were not significant during the period.

Fair Value of Financial Instruments

A financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that creates a contractual obligation or right to deliver or receive cash or another financial instrument from a second entity on potentially favorable terms. The methods and assumptions used in estimating the fair values of our financial instruments are described above.

The table below provides fair value estimates for our financial instruments as of March 31, 2011 and December 31, 2010, excluding financial assets and liabilities for which carrying value is a reasonable estimate of fair value and those which are recorded at fair value on a recurring basis.


	March 31, 2011				December 31, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
	($ in thousands)

Assets:
Loans held for investment, net	$	5,690,939	$	5,789,051	$	5,717,316	$	5,767,160
Investments carried at cost		33,310		68,537		33,062		64,735
Investment securities, held-to-maturity		179,077		186,944		184,473		195,438
Liabilities:
Deposits		4,708,349		4,715,749		4,621,273		4,628,903
Credit facilities		—		—		67,508		66,464
Term debt		863,799		841,507		979,254		921,169
Convertible debt, net		526,254		541,167		523,650		539,297
Subordinated debt		439,281		254,783		437,286		253,626
Loan commitments and letters of credit		—		26,008		—		32,972

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 19.	Segment Data

For the three months ended March 31, 2011, we operated as two reportable segments: 1) CapitalSource Bank and 2) Other Commercial Finance. For the three months ended March 31, 2010, we operated 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, and our Other Commercial Finance segment comprises our loan portfolio and other business activities in the Parent Company. Our Healthcare Net Lease segment comprised our direct real estate investment business activities, which we exited completely with the sale of all of the assets related to this segment during 2010. We have reclassified all comparative period results to reflect our two current reportable segments. In addition, for comparative purposes, overhead and other intercompany allocations have been reclassified from the Healthcare Net Lease segment into the Other Commercial Finance segment for the three months ended March 31, 2010.

The financial results of our operating segments as of and for the three months ended March 31, 2011 were as follows:


	Three Months Ended March 31, 2011
			Other
	CapitalSource		Commercial			Intercompany			Consolidated
	Bank		Finance			Eliminations			Total
	($ in thousands)

Total interest income	$	91,804	$	47,614		$	2,734		$	142,152
Interest expense		15,210		31,542			—			46,752
Provision for loan losses		11,242		33,567			—			44,809
Operating expenses		32,941		41,326			(20,006	)		54,261
Total other income		2,965		32,354			(17,328	)		17,991

Net income (loss) before income taxes		35,376		(26,467	)		5,412			14,321
Income tax expense		3,095		8,067			—			11,162

Net income (loss)	$	32,281	$	(34,534	)	$	5,412		$	3,159

Total assets as of March 31, 2011	$	6,180,081	$	3,132,967		$	(39,710	)	$	9,273,338
Total assets as of December 31, 2010		6,117,368		3,418,897			(90,858	)		9,445,407

The financial results of our operating segments for the three months ended March 31, 2010 were as follows:


	Three Months Ended March 31, 2010
	CapitalSource			Other Commercial			Intercompany			Consolidated
	Bank			Finance			Eliminations			Total
	($ in thousands)

Total interest income	$	81,454		$	92,333		$	(2,373	)	$	171,414
Interest expense		17,301			47,700			—			65,001
Provision for loan losses		87,704			131,236			—			218,940
Operating expenses		24,335			50,507			(11,637	)		63,205
Other income (expense), net		8,159			(18,978	)		(11,456	)		(22,275	)

Net loss from continuing operations before income taxes		(39,727	)		(156,088	)		(2,192	)		(198,007	)
Income tax (benefit) expense		(56	)		21,062			—			21,006

Net loss from continuing operations	$	(39,671	)	$	(177,150	)	$	(2,192	)	$	(219,013	)

The accounting policies of each of the individual operating segments are the same as those described in Note 2, Summary of Significant Accounting Policies, in our audited consolidated financial statements for the year ended December 31, 2010, included in our Form 10-K.


ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-Q, including the footnotes to our unaudited 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, our intention to originate loans at CapitalSource Bank, our portfolio runoff and growth, adequacy of reserves, our liquidity and capital position, our plans regarding our 3.5% and 4.0% Convertible Debentures, CapitalSource Bank’s ability to maintain sufficient liquidity and ratios under various projected scenarios, deployment of excess capital at the Parent Company, expectations regarding our application to become a bank holding company and converting CapitalSource Bank’s charter to a commercial charter, the performance of our loans, in particular our high balance loans, loan yields, the impact of accounting pronouncements, taxes and tax audits and examinations, our unfunded commitments and deposit demands, our delinquent, non-accrual and impaired loans, our SPEs, and our valuation allowance with respect to, and our realization and utilization of, net deferred tax assets. All statements contained in this Form 10-Q that are not clearly historical in nature are forward-looking, and the words “anticipate,” “assume,” “intend,” “believe,” “forecast,” “expect,” “estimate,” “plan,” “continue,” “will,” “should,” “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 transactions on favorable terms; disruptions in economic and credit markets could prevent us from optimizing the amount of leverage we employ and could adversely affect our liquidity position, our strategy regarding the 3.5% and 4.0% Convertible Debentures could be restricted by our other indebtedness; movements in interest rates and lending spreads may adversely affect our borrowing strategy; 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 our business strategies; restrictions imposed on us by our regulators or indebtedness, assumptions we made in connection with the various projected scenarios for CapitalSource Bank liquidity could be erroneous, 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; and other risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2010 as filed with the SEC on February 28, 2011 (“Form 10 -K”), and other documents filed by us with the SEC. All forward-looking statements included in this Form 10-Q 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 consolidated financial statements and related notes and the information contained elsewhere in this Form 10-Q and in our Form 10-K.

Overview

References to we, us, the Company or CapitalSource refer to CapitalSource Inc., a Delaware corporation, together with its subsidiaries. References to CapitalSource Bank include its subsidiaries, and references to Parent Company refer to CapitalSource Inc. and its subsidiaries other than CapitalSource Bank. 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. As of March 31, 2011, we had an outstanding loan principal balance of $6.1 billion.

For the three months ended March 31, 2011, we operated as two reportable segments: 1) CapitalSource Bank and 2) Other Commercial Finance. For the three months ended March 31, 2010, we operated 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 other business activities in the Parent Company; and our Healthcare Net Lease segment comprised our direct real estate investment business activities. Our Healthcare Net Lease segment comprised our direct real estate investment business activities, which we exited completely with the sale of all of the assets related to this segment to Omega Healthcare Investors, Inc. during 2010, and consequently, we have presented the financial condition and results of operations within our Healthcare Net Lease segment as discontinued operations for all periods presented. We have reclassified all comparative period results to reflect our two current reportable segments. For additional information, see Note 19, Segment Data.

Through our CapitalSource Bank segment activities, we provide financial products primarily to small and middle market businesses throughout the United States and also offer depository products and services in southern and central California, which are insured by the Federal Deposit Insurance Corporation (“FDIC”) to the maximum amounts permitted by law. As of March 31, 2011, CapitalSource Bank had an outstanding loan principal balance of $4.0 billion and deposits of $4.7 billion.

Through our Other Commercial Finance segment activities, the Parent Company provides financial products primarily to small and middle market businesses. Our activities in the Parent Company consist primarily of satisfying existing loan commitments made prior to CapitalSource Bank’s formation and receiving payments on our existing loan portfolio. As of March 31, 2011, the Parent Company had an outstanding loan principal balance of $2.1 billion.

Current Developments

In 2011, we have continued to simplify our business and progress in our transformation to a banking model. We increased CapitalSource Bank’s profitability, continued to originate new loans in CapitalSource Bank through our broad lending platform, and improved Parent Company liquidity by repaying and terminating a significant portion of Parent Company indebtedness. As of April 30, 2011, the Parent Company’s unrestricted cash was approximately $1.1 billion, representing an increase of approximately $600 million from December 31, 2010.

In addition to growing assets and profitability, we also intend to pursue a strategy to prudently utilize excess capital at the Parent Company and to convert CapitalSource Bank’s charter from an industrial bank charter to a commercial bank charter. Our current strategy for converting CapitalSource Bank to a commercial bank is to pursue becoming a bank holding company under the Bank Holding Company Act of 1956, and based on our recent discussions with the Federal Reserve we believe we understand the actions required for the Parent Company to be considered for bank holding company status. We intend to assess and weigh the alternatives for prudently utilizing excess capital in a manner that is in the best interest of our shareholders — which may include, among other things, repayment of debt, capital contributions to CapitalSource Bank, stock repurchases, increased or special dividends or distributions — and the alternatives for converting CapitalSource Bank to a commercial bank — which may include asset sales, spin-offs or other actions. We could pursue any of these alternatives either separately or in combination with one another, or we may not pursue any of them. Accordingly, it may take longer than we originally estimated to convert CapitalSource Bank to a commercial bank and/or to utilize such excess capital. There is no assurance as to the approach we will employ to achieve these objectives or whether we will be successful.

Explanation of Reporting Metrics

Interest Income. Interest income represents interest earned on loans, investment securities, other investments, cash and cash equivalents, and collateral management fees as well as amortization of loan origination fees, net of the direct costs of origination and the amortization of purchase discounts and premiums, which are amortized into income using the interest method. Although the majority of our loans charge interest at variable rates that adjust periodically, we also have loans charging interest at fixed rates.

Interest Expense. Interest expense is the amount paid on deposits and borrowings, including the amortization of deferred financing fees and debt discounts. Interest expense includes borrowing costs associated with credit facilities, term debt, convertible debt, subordinated debt, FHLB SF borrowings and interest paid to depositors. Our

2014 Senior Secured Notes, convertible debt and certain series of our subordinated debt bear a fixed rate of interest. Deferred financing fees, debt discounts and the costs of issuing debt, such as commitment fees and legal fees, are amortized over the estimated life of the borrowing. Loan prepayments that trigger mandatory or optional debt repayments and repurchases may materially affect interest expense on our term debt since in the period of prepayment the amortization of deferred financing fees and debt acquisition costs is accelerated.

Provision for Loan Losses. The provision for loan losses is the periodic cost of maintaining an appropriate allowance for loan and lease losses inherent in our portfolio. As the size and mix of loans within these portfolios change, or if the credit quality of the portfolios change, we record a provision to appropriately adjust the allowance for loan losses.

Operating Expenses. Operating expenses include compensation and benefits, professional fees, travel, rent, insurance, depreciation and amortization, marketing and other general and administrative expenses, including deposit insurance premiums.

Other Income/Expense. Other income (expense) consists of gains (losses) on the sale of loans, gains (losses) on the sale of debt and equity investments, dividends, unrealized appreciation (depreciation) on certain investments, other-than-temporary impairment on investment securities, available for sale, gains (losses) on derivatives, due diligence deposits forfeited, unrealized appreciation (depreciation) of our equity interests in certain non-consolidated entities, servicing income, income from our management of various loans held by third parties, gains (losses) on debt extinguishment at the Parent Company, net expense of real estate owned and other foreclosed assets, and other miscellaneous fees and expenses.

Income Taxes. We provide for income taxes as a “C” corporation on income earned from operations. For the tax year ended December 31, 2010, our subsidiaries were not able to participate in the filing of a consolidated federal tax return. We intend to reconsolidate our subsidiaries beginning in 2011 for federal tax purposes. We are subject to federal, foreign, state and local taxation in various jurisdictions.

We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates for the periods in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the change.

Periodic reviews of the carrying amount of deferred tax assets are made to determine if the establishment of a valuation allowance is necessary. A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. All evidence, both positive and negative, is evaluated when making this determination. Items considered in this analysis include the ability to carry back losses to recoup taxes previously paid, the reversal of temporary differences, tax planning strategies, historical financial performance, expectations of future earnings and the length of statutory carryforward periods. Significant judgment is required in assessing future earning trends and the timing of reversals of temporary differences.

Operating Results for the Three Months Ended March 31, 2011

As further described below, the most significant factors influencing our consolidated results of operations for the three months ended March 31, 2011, compared to the three months ended March 31, 2010 were:


	•	Decreased provision for loan losses;

	•	Deconsolidation of the 2006-A term debt securitization (the “2006-A Trust”);


	•	Decreased balance of Parent Company indebtedness;

	•	Decreased balance of our loan portfolio;

	•	Gains on our investments;

	•	Decreased operating expenses;

	•	Decreased net expense of real estate owned and other foreclosed assets;

	•	Changes in lending and borrowing spreads;

	•	Divestiture of our Healthcare Net Lease segment in 2010; and

	•	Decreased income tax expense.

Our consolidated operating results for the three months ended March 31, 2011 compared to the three months ended March 31, 2010, were as follows:


	Three Months Ended
	March 31,
	2011		2010			% Change
	($ in thousands)

Interest income	$	142,152	$	171,414			(17	)
Interest expense		46,752		65,001			28
Provision for loan losses		44,809		218,940			80
Operating expenses		54,261		63,205			14
Other income (expense)		17,991		(22,275	)		181
Net income (loss) from continuing operations before income taxes		14,321		(198,007	)		107
Income tax expense		11,162		21,006			47
Net income (loss) from continuing operations		3,159		(219,013	)		101
Net income from discontinued operations, net of taxes		—		7,323			(100	)
Net income (loss)		3,159		(211,690	)		101

Our consolidated yields on interest-earning assets and the costs of interest-bearing liabilities for the three months ended March 31, 2011 and 2010 were as follows:


	Three Months Ended March 31,
	2011							2010
	Weighted		Net		Average			Weighted		Net		Average
	Average		Interest		Yield/			Average		Interest		Yield/
	Balance		Income		Cost			Balance		Income		Cost
	($ in thousands)

Total interest-earning assets(1)	$	8,290,663	$	142,152		6.95	%	$	10,876,004	$	171,414		6.39	%
Total interest-bearing liabilities(2)		6,948,800		46,752		2.73			9,067,149		65,001		2.91

Net interest spread			$	95,400		4.22	%			$	106,413		3.48	%

Net interest margin						4.67	%						3.97	%


(1)		Interest-earning assets include cash and cash equivalents, restricted cash, marketable securities, mortgage-related receivables, loans, the “A” Participation Interest and investments in debt securities.

(2)		Interest-bearing liabilities include deposits, credit facilities, term debt, convertible debt and subordinated debt.

Operating Expenses

During three months ended March 31, 2011, consolidated operating expenses decreased by $8.9 million from the three months ended March 31, 2010. The decrease was primarily due to a $3.8 million decrease in compensation

and benefits, a $3.2 million decrease in professional fees, and a $2.0 million decrease in other administrative expenses.

Income Taxes

Consolidated income tax expense for the three months ended March 31, 2011 was $11.2 million, compared to an income tax expense of $21.0 million for the three months ended March 31, 2010. The change in income tax expense was primarily the result of a reduction in the amount of valuation allowance recorded in the respective quarters. The valuation allowance recorded for the three months ended March 31, 2011 was in connection with our plan to reconsolidate our corporate entities for federal tax purposes in 2011.

Comparison of the Three Months Ended March 31, 2011 and 2010

CapitalSource Bank Segment

Our CapitalSource Bank segment operating results for the three months ended March 31, 2011, compared to the three months ended March 31, 2010, were as follows:


	Three Months Ended
	March 31,
	2011		2010			% Change
	($ in thousands)

Interest income	$	91,804	$	81,454			13
Interest expense		15,210		17,301			12
Provision for loan losses		11,242		87,704			87
Operating expenses		32,941		24,335			(35	)
Other income		2,965		8,159			(64	)
Income tax expense (benefit)		3,095		(56	)		5,627
Net income (loss)		32,281		(39,671	)		181

Interest Income

Three months ended March 31, 2011 and 2010

Total interest income increased to $91.8 million for the three months ended March 31, 2011 from $81.5 million for the three months ended March 31, 2010, with an average yield on interest-earning assets of 6.51% for the three months ended March 31, 2011 compared to 5.98% for the three months ended March 31, 2010. During the three months ended March 31, 2011 and 2010, interest income on loans was $76.8 million and $58.8 million, respectively, yielding 8.22% and 7.84% on average loan balances of $3.8 billion and $3.0 billion, respectively. During the three months ended March 31, 2011 and 2010, $5.1 million and $6.3 million, respectively, of interest income was not recognized for loans on non-accrual status, which negatively impacted the yield on loans by 0.54% and 0.84%, respectively.

The “A” Participation Interest, representing our share of a pool of commercial real estate loans and related assets, was paid off during the fourth quarter of 2010. Interest income on the “A” Participation Interest was $7.8 million during the three months ended March 31, 2010, yielding 7.15% on an average balance of $442.8 million. The “A” Participation Interest was purchased at a discount and had a stated coupon equal to one-month LIBOR plus 1.50%. The unamortized discount was accreted into income using the interest method. During the three months ended March 31, 2010, we accreted $5.9 million of discount into interest income on loans in our consolidated statements of operations.

During the three months ended March 31, 2011 and 2010, interest income from our investments, including available-for-sale and held-to-maturity securities, was $14.7 million and $14.3 million, respectively, yielding 3.74% and 4.41% on an average balance of $1.6 billion and $1.3 billion, respectively. During the three months ended March 31, 2011, we purchased $226.3 million of investment securities, available-for-sale, while $336.1 million and $10.3 million of principal repayments were received from our investment securities, available-for-sale and held-to-maturity, respectively. For the three months ended March 31, 2010, we purchased $814.2 million of

investment securities, available-for-sale while $213.9 million and $27.6 million of principal repayments were received from our investment securities, available-for-sale and held-to-maturity, respectively.

During the three months ended March 31, 2011 and 2010, interest income on cash and cash equivalents was $0.2 million and $0.5 million, respectively, yielding 0.29% and 0.31% on average balances of $314.9 million and $705.3 million, respectively.

Interest Expense

Three months ended March 31, 2011 and 2010

Total interest expense decreased to $15.2 million for the three months ended March 31, 2011 from $17.3 million for the three months ended March 31, 2010. The decrease was primarily due to a decline in the average cost of interest-bearing liabilities which was 1.22% and 1.47% during the three months ended March 31, 2011 and 2010, respectively. Our average balances of interest-bearing liabilities, consisting of deposits and borrowings, were $5.0 billion and $4.8 billion during the three months ended March 31, 2011 and 2010, respectively. Our interest expense on deposits for the three months ended March 31, 2011 and 2010 was $13.4 million and $16.4 million, respectively, with an average cost of deposits of 1.16% and 1.45%, respectively, on average balances of $4.7 billion and $4.6 billion, respectively. During the three months ended March 31, 2011, $1.0 billion of our time deposits matured with a weighted average interest rate of 1.09% and $1.2 million of new and renewed time deposits were issued at a weighted average interest rate of 0.97%. During the three months ended March 31, 2010, $1.4 billion of our time deposits matured with a weighted average interest rate of 1.69% and $1.3 billion of new and renewed time deposits were issued at a weighted average interest rate of 1.28%. Additionally, during the three months ended March 31, 2011, our weighted average interest rate of our liquid account deposits, savings and money market accounts, increased from 0.83% at the beginning of the quarter to 0.84% at the end of the quarter. During the three months ended March 31, 2011, our interest expense on borrowings, consisting of FHLB SF borrowings, was $1.8 million with an average cost of 1.98% on an average balance of $373.3 million. During the three months ended March 31, 2011, there were $59.0 million in advances taken and $71.0 million of maturities, including $62.0 million of short-term advances. During the three months ended March 31, 2010, our interest expense on borrowings was $0.9 million with an average cost of 1.84% on an average balance of $208.3 million. During the three months ended March 31, 2010, there were $35.0 million of advances taken and $10.0 million of maturities.

Net Interest Margin

Three months ended March 31, 2011 and 2010

The yields of income earning assets and the costs of interest-bearing liabilities in this segment for the three months ended March 31, 2011 and 2010 were as follows:


	Three Months Ended March 31,
	2011							2010
	Weighted		Net		Average			Weighted		Net		Average
	Average		Interest		Yield/			Average		Interest		Yield/
	Balance		Income		Cost			Balance		Income		Cost
	($ in thousands)

Total interest-earning assets(1)	$	5,723,305	$	91,804		6.51	%	$	5,524,348	$	81,454		5.98	%
Total interest-bearing liabilities(2)		5,047,030		15,210		1.22			4,772,299		17,301		1.47

Net interest spread			$	76,594		5.29	%			$	64,153		4.51	%

Net interest margin						5.43	%						4.71	%


(1)		Interest-earning assets include cash and cash equivalents, investments, the commercial real estate “A” Participation Interest and loans.

(2)		Interest-bearing liabilities include deposits and borrowings.

Provision for Loan Losses

Our provision for loan losses is based on our evaluation of the adequacy of the existing allowance for loan losses in relation to total loan portfolio and our periodic assessment of the inherent risks relating to the loan portfolio resulting from our review of selected individual loans. For details of activity in our provision for loan losses, see the Credit Quality and Allowance for Loan Losses section.

Operating Expenses

Three months ended March 31, 2011 and 2010

Operating expenses increased to $32.9 million for the three months ended March 31, 2011 from $24.3 million for the three months ended March 31, 2010. The increase was primarily due to an increase in loan referral fees driven by an increase in new loans funded by CapitalSource Bank.

CapitalSource Bank relies on the Parent Company to refer loans, provide loan origination due diligence services and perform certain underwriting services. For these services, CapitalSource Bank pays the Parent Company fees based upon the commitment amount of each new loan funded by CapitalSource Bank during the period. These fees are eliminated in consolidation. The fees are included in other operating expenses and were $13.5 million and $4.9 million for the three months ended March 31, 2011 and 2010, respectively.

CapitalSource Bank subleases from the Parent Company office space in several locations and also leases space to the Parent Company in other facilities in which CapitalSource Bank is the primary lessee.

Other Income

CapitalSource Bank services loans and other assets which are owned by the Parent Company and third parties, for which it receives fees based on the number of loans or other assets serviced. Loans being serviced by CapitalSource Bank for the benefit of others were $4.2 billion and $4.7 billion as of March 31, 2011 and December 31, 2010, respectively, of which $2.1 billion and $2.5 billion were owned by the Parent Company.

Three months ended March 31, 2011 and 2010

Other income decreased to $3.0 million for the three months ended March 31, 2011 from $8.2 million for the three months ended March 31, 2010 primarily due to a $4.5 million loss on the sale of unfunded commitments during the three months ended March 31, 2011 compared to no such loss recorded in the three months ended March 31, 2010. In addition, we recorded $2.9 million in net expense of real estate owned and other foreclosed assets during the three months ended March 31, 2011 compared to no such expenses recorded during the three months ended March 31, 2010. Loan servicing fees paid by the Parent Company to CapitalSource Bank decreased by $1.1 million as a result of the sale of our direct real estate investments during 2010 and a decrease in the Parent Company’s loan portfolio. These factors were partially offset by realized gains on sales of investments of $1.2 million and an increase in borrower loan fees of $1.1 million.

Other Commercial Finance Segment

Our Other Commercial Finance segment operating results for the three months ended March 31, 2011, compared to the three months ended March 31, 2010, were as follows:


	Three Months Ended
	March 31,
	2011			2010			% Change
	($ in thousands)

Interest income	$	47,614		$	92,333			(48	)%
Interest expense		31,542			47,700			34
Provision for loan losses		33,567			131,236			74
Operating expenses		41,326			50,507			18
Other income (expense)		32,354			(18,978	)		270
Income tax expense		8,067			21,062			62
Net loss from continuing operations		(34,534	)		(177,150	)		81

Interest Income

Three months ended March 31, 2011 and 2010

Interest income decreased to $47.6 million for the three months ended March 31, 2011 from $92.3 million for the three months ended March 31, 2010, primarily due to a decrease in average total interest-earning assets. During the three months ended March 31, 2011, our average balance of interest-earning assets decreased by $2.8 billion, or 52.3%, compared to the three months ended March 31, 2010, due to the deconsolidation of the 2006-A Trust in 2010 and the runoff of Parent Company loans. During the three months ended March 31, 2011, yield on average interest-earning assets increased to 7.53% from 6.97% for the three months ended March 31, 2010. During the three months ended March 31, 2011, our lending spread to average one-month LIBOR was 7.38% compared to 7.14% for the three months ended March 31, 2010. Fluctuations in yields are driven by a number of factors, including changes in short-term interest rates such as changes in the prime rate or one-month LIBOR, the coupon on loans that pay down or pay off, non-accrual loans and modifications of interest rates on existing loans.

Interest Expense

Three months ended March 31, 2011 and 2010

Interest expense decreased to $31.5 million for the three months ended March 31, 2011 from $47.7 million for the three months ended March 31, 2010 primarily due to a decrease in average interest-bearing liabilities of $2.4 billion, or 55.9%, primarily due to the impact of the deconsolidation of the 2006-A Trust in July 2010 and the reduction of the outstanding balances on our credit facilities and other term debt. Our cost of borrowings increased to 6.73% for the three months ended March 31, 2011 from 4.48% for the three months ended March 31, 2010, as a result of the reduction and termination of certain of our credit facilities, the deconsolidation of the 2006-A Trust and decreases in our remaining securitization balances, all of which generally had lower borrowing costs than the remainder of our borrowings.

Net Interest Margin

Three months ended March 31, 2011 and 2010

Net interest margin was 2.54% for the three months ended March 31, 2011, a decrease of 0.83% from 3.37% for the three months ended March 31, 2010. Net interest spread was 0.80% for the three months ended March 31, 2011, a decrease of 1.69% from 2.49% for the three months ended March 31, 2010. The decreases in net interest margin and net interest spread were primarily due to the increase in our cost of borrowings.

The yields of income earning assets and the costs of interest-bearing liabilities in this segment for the three months ended March 31, 2011 and 2010 were as follows:


	Three Months Ended March 31,
	2011							2010
	Weighted		Net		Average			Weighted		Net		Average
	Average		Interest		Yield/			Average		Interest		Yield/
	Balance		Income		Cost			Balance		Income		Cost
	($ in thousands)

Total interest-earning assets(1)	$	2,565,261	$	47,614		7.53	%	$	5,372,395	$	92,333		6.97	%
Total interest-bearing liabilities(2)		1,901,770		31,542		6.73			4,315,838		47,700		4.48

Net interest spread			$	16,072		0.80	%			$	44,633		2.49	%

Net interest margin						2.54	%						3.37	%


(1)		Interest-earning assets include cash and cash equivalents, restricted cash, mortgage-related receivables, loans and investments in debt securities.

(2)		Interest-bearing liabilities include secured and unsecured credit facilities, term debt, convertible debt and subordinated debt.

Provision for Loan Losses

Our provision for loan losses is based on our evaluation of the adequacy of the existing allowance for loan losses in relation to total loan portfolio and our periodic assessment of the inherent risks relating to the loan portfolio resulting from our review of selected individual loans. For details of activity in our provision for loan losses, see Credit Quality and Allowance for Loan Losses section.

Operating Expenses

Three months ended March 31, 2011 and 2010

Operating expenses decreased to $41.3 million for the three months ended March 31, 2011 from $50.5 million for the three months ended March 31, 2010, primarily due to a $3.6 million decrease in compensation and benefits, a $3.0 million decrease in professional fees and a $1.7 million decrease in administrative expenses. Operating expenses as a percentage of average total assets increased to 5.04% for the three months ended March 31, 2011 from 3.54% for the three months ended March 31, 2010 due to the decrease in total assets as a result of the deconsolidation of the 2006-A Trust and the runoff of Parent Company loans.

Other Income (Expense)

Three months ended March 31, 2011 and 2010

Other income was $32.4 million for the three months ended March 31, 2011 compared to $19.0 million of other expense for the three months ended March 31, 2010. This change was primarily due to gains on investments, decreases in losses on derivatives, and a decrease in net expense of real estate owned and other foreclosed assets, partially offset by increases in foreign currency exchange losses. Further explanation of the increase is described below.

Gains on investments, net increased to $22.3 million for the three months ended March 31, 2011 from $6.1 million for the three months ended March 31, 2010. The increase was primarily due to a $16.9 million increase in realized gains on the sales of available-for-sale securities and cost basis investments and a $1.8 million decrease in unrealized losses on equity investments, partially offset by a $1.3 million decrease in dividends received and a $1.2 million increase in impairments of available-for-sale securities.

Loss on derivatives decreased to $1.4 million for the three months ended March 31, 2011 from $3.6 million for the three months ended March 31, 2010 primarily due to a decrease in interest expense on interest rate swaps.

Net expense of real estate owned and other foreclosed assets decreased to $7.3 million for the three months ended March 31, 2011 from $40.5 million for the three months ended March 31, 2010. The decrease was primarily due to a $15.5 million decrease in unrealized losses on real estate owned, a $7.4 million decrease in the provision for loans acquired through foreclosure, a $3.6 million decrease in operating expenses related to real estate owned, and $2.9 million in realized gains on the sales of real estate owned. In addition, we did not recognize any impairment losses on real estate owned during the three months ended March 31, 2011 compared to $4.6 million of such impairment losses recognized during the three months ended March 31, 2010.

Other income, net decreased to $18.7 million for the three months ended March 31, 2011 from $19.0 million for the three months ended March 31, 2010. The decrease was primarily due to $1.8 million in foreign currency exchange losses for the three months ended March 31, 2011, compared to $7.6 million in foreign currency exchange gains for the three months ended March 31, 2010, and a $1.2 million decrease in earnings in equity of subsidiaries. These factors were partially offset by an increase of $9.4 million in servicing and referral fees.

Financial Condition

CapitalSource Bank Segment

As of March 31, 2011 and December 31, 2010, the CapitalSource Bank segment included:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Assets:
Cash and cash equivalents(1)	$	440,928	$	377,054
Investment securities, available-for-sale		1,348,771		1,510,384
Investment securities, held-to-maturity		179,077		184,473
Loans(2)		4,012,819		3,848,511
FHLB SF stock		19,370		19,370

Total	$	6,000,965	$	5,939,792

Liabilities:
Deposits	$	4,708,349	$	4,621,273
FHLB SF borrowings		400,000		412,000

Total	$	5,108,349	$	5,033,273


(1)		As of March 31, 2011 and December 31, 2010, the amounts include restricted cash of $12.8 million and $23.5 million, respectively.

(2)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

Cash and Cash Equivalents

Cash and cash equivalents consist of 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 consolidated financial statements for the three months ended March 31, 2011.

Investment Securities, Available-for-Sale

Investment securities, available-for-sale, consists of 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”), residential mortgage-backed securities issued and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae (“Agency MBS”), asset-backed

securities, residential mortgage-backed securities rated AAA issued by non-government-agencies (“Non-agency MBS”), corporate debt securities and U.S. Treasury and agency securities. CapitalSource Bank pledged a significant portion of its 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 March 31, 2011. For additional information, see Note 6, Investments, in our consolidated financial statements for the three months ended March 31, 2011.

Investment Securities, Held-to-Maturity

Investment securities, held-to-maturity, consists of AAA-rated commercial mortgage-backed securities. For additional information on our investment securities, held-to-maturity, see Note 6, Investments, in our accompanying consolidated financial statements for the three months ended March 31, 2011.

Loan Portfolio Composition

The CapitalSource Bank loan balances reflected in the portfolio statistics below include loans held for sale of $14.2 million as of December 31, 2010. There were no loans held for sale by CapitalSource Bank as of March 31, 2011.

As of March 31, 2011 and December 31, 2010, the composition of the CapitalSource Bank loan portfolio by loan type was as follows:


	March 31, 2011				December 31, 2010
	($ in thousands)

Commercial	$	2,041,356	51	%	$	2,029,407	53	%
Real estate		1,807,997	45			1,634,062	42
Real estate — construction		163,466	4			185,042	5

Total(1)	$	4,012,819	100	%	$	3,848,511	100	%


(1)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

As of March 31, 2011, the scheduled maturities of the CapitalSource Bank loan portfolio by loan type were as follows:


	Due in		Due in
	One Year		One to		Due After
	or Less		Five Years		Five Years		Total
	($ in thousands)

Commercial	$	168,951	$	1,618,701	$	253,704	$	2,041,356
Real estate		224,222		843,045		740,730		1,807,997
Real estate — construction		131,348		26,127		5,991		163,466

Total loans(1)	$	524,521	$	2,487,873	$	1,000,425	$	4,012,819


(1)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

As of March 31, 2011, approximately 75% of the CapitalSource Bank adjustable rate portfolio is subject to an interest rate floor and is accruing interest. Due to low market interest rates as of March 31, 2011, 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 1.87% as of March 31, 2011. 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 March 31, 2011, the composition of CapitalSource Bank loan balances by adjustable rate index and by loan type was as follows:


	Loan Type
					Real Estate —
	Commercial		Real Estate		Construction		Total		Percentage
	($ in thousands)

1-Month LIBOR	$	577,715	$	900,613	$	46,151	$	1,524,479		38	%
2-Month LIBOR		21,971		—		—		21,971		1
3-Month LIBOR		484,827		27,654		470		512,951		13
6-Month LIBOR		46,091		87,616		—		133,707		3
Prime		497,542		94,597		5,991		598,130		15
Other		67,096		54,935		—		122,031		3

Total adjustable rate loans		1,695,242		1,165,415		52,612		2,913,269		73
Fixed rate loans		325,911		599,045		—		924,956		23
Loans on non-accrual status		20,203		43,537		110,854		174,594		4

Total loans(1)	$	2,041,356	$	1,807,997	$	163,466	$	4,012,819		100	%


(1)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

FHLB SF Stock

Investments in FHLB SF stock are recorded at historical cost. FHLB SF stock does not have a readily determinable fair value, but can generally be sold back to the FHLB SF at par value upon stated notice. 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 March 31, 2011.

Deposits

As of March 31, 2011 and December 31, 2010, a summary of CapitalSource Bank’s deposits by product type and the maturities of the certificates of deposit were as follows:


	March 31, 2011					December 31, 2010
			Weighted					Weighted
			Average					Average
	Balance		Rate			Balance		Rate
	($ in thousands)

Interest-bearing deposits:
Money market	$	236,649		0.79	%	$	236,811		0.78	%
Savings		726,481		0.85			694,157		0.84
Certificates of deposit		3,745,219		1.23			3,690,305		1.27

Total interest-bearing deposits	$	4,708,349		1.15		$	4,621,273		1.18


	March 31, 2011
			Weighted
			Average
	Balance		Rate
	($ in thousands)

Remaining maturity of certificates of deposit:
0 to 3 months	$	1,004,477		1.05	%
4 to 6 months		737,448		1.05
7 to 9 months		632,683		1.23
10 to 12 months		705,161		1.35
Greater than 12 months		665,450		1.59

Total certificates of deposit	$	3,745,219		1.23

FHLB SF Borrowings

FHLB SF borrowings decreased to $400.0 million as of March 31, 2011 from $412.0 million as of December 31, 2010. These borrowings were used primarily for interest rate risk management and short-term funding purposes. The weighted-average remaining maturities of the borrowings were approximately 2.9 years and 2.3 years as of March 31, 2011 and December 31, 2010, respectively.

As of March 31, 2011, the remaining maturity and the weighted average interest rate of FHLB SF borrowings were as follows:


			Weighted
			Average
	Balance		Rate
	($ in thousands)

Less than 1 year	$	88,000		1.63	%
After 1 year through 2 years		63,000		1.98
After 2 years through 3 years		45,000		1.77
After 3 years through 4 years		45,000		2.31
After 4 years through 5 years		144,000		2.14
After 5 years		15,000		2.88

Total	$	400,000		2.01	%

Other Commercial Finance Segment

As of March 31, 2011 and December 31, 2010, the Other Commercial Finance segment included:


	March 31, 2011		December 31, 2010
	($ in thousands)

Assets:
Investment securities, available-for-sale	$	21,582	$	12,527
Loans(1)		2,072,904		2,509,699
Other investments(2)		67,906		71,877

Total	$	2,162,392	$	2,594,103


(1)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

(2)		Includes investments carried at cost, investments carried at fair value and investments accounted for under the equity method.

Investment Securities, Available-for-Sale

Investment securities, available-for-sale consist of corporate debt, equity securities, a municipal bond and our interests in the 2006-A Trust.

Other Investments

The Parent Company has made investments in some of our borrowers in connection with the loans provided to them. These investments usually include equity interests such as common stock, preferred stock, limited liability company interests, limited partnership interests and warrants.

Loan Portfolio Composition

The Other Commercial Finance loan balances reflected in the portfolio statistics below include loans held for sale of $18.0 million and $191.1 million as of March 31, 2011 and December 31, 2010, respectively.

As of March 31, 2011 and December 31, 2010, the composition of the Other Commercial Finance loan portfolio by loan type was as follows:


	March 31, 2011				December 31, 2010
	($ in thousands)

Commercial	$	1,785,882	86	%	$	2,209,064	88	%
Real estate		181,969	9			192,096	8
Real estate — construction		105,053	5			108,539	4

Total(1)	$	2,072,904	100	%	$	2,509,699	100	%


(1)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

As of March 31, 2011, the scheduled maturities of the Other Commercial Finance loan portfolio by loan type were as follows:


	Due in		Due in
	One Year		One to		Due After
	or Less		Five Years		Five Years		Total
	($ in thousands)

Commercial	$	517,252	$	1,210,234	$	58,396	$	1,785,882
Real estate		74,612		98,312		9,045		181,969
Real estate — construction		65,002		40,051		—		105,053

Total(1)	$	656,866	$	1,348,597	$	67,441	$	2,072,904


(1)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

As of March 31, 2011, approximately 54% of the adjustable rate loan portfolio comprised loans that are subject to an interest rate floor and were accruing interest. Due to low market interest rates as of March 31, 2011, 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 2.10% as of March 31, 2011. 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 March 31, 2011, the composition of Other Commercial Finance loan balances by adjustable rate index and by loan type was as follows:


	Loan Type
					Real Estate—
	Commercial		Real Estate		Construction		Total		Percentage
	($ in thousands)

1-Month LIBOR	$	756,931	$	91,983	$	—	$	848,914		41	%
2-Month LIBOR		46,827		—		—		46,827		2
3-Month LIBOR		215,758		—		—		215,758		10
6-Month LIBOR		34,631		—		—		34,631		2
1-Month EURIBOR		33,787		—		—		33,787		2
Prime		395,162		8,097		38,570		441,829		21

Total adjustable rate loans		1,483,096		100,080		38,570		1,621,746		78
Fixed rate loans		50,699		25,687		—		76,386		4
Loans on non-accrual status		252,087		56,202		66,483		374,772		18

Total loans(1)	$	1,785,882	$	181,969	$	105,053	$	2,072,904		100	%


(1)		Excludes the impact of deferred loan fees and discounts and the allowance for loan losses. Includes lower of cost or fair value adjustments on loans held for sale.

On April 1, 2011, our largest commercial loan, with an outstanding balance of $325 million, was fully paid off. As of March 31, 2011, this loan was earning interest based on a rate of 1-month LIBOR and was due in 3.5 years. The balance of this loan is included in the outstanding balance of loans as of March 31, 2011 detailed above.

Credit Quality and Allowance for Loan Losses

Consolidated

The outstanding unpaid principal balances of non-performing loans in our consolidated loan portfolio as of March 31, 2011 and December 31, 2010 were as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Non-accrual loans
Commercial	$	272,291	$	366,417
Real estate		99,739		131,758
Real estate — construction		177,337		200,611

Total loans on non-accrual	$	549,367	$	698,786

Accruing loans contractually past-due 90 days or more
Commercial	$	2,264	$	3,244
Real estate		6,238		6,238
Real estate — construction		38,569		39,806

Total accruing loans contractually past-due 90 days or more	$	47,071	$	49,288

Troubled debt restructurings(1)
Commercial	$	115,427	$	118,988
Real estate		102,343		35,689

Total troubled debt restructurings	$	217,770	$	154,677

Total non-performing loans
Commercial	$	389,982	$	488,649
Real estate		208,320		173,685
Real estate — construction		215,906		240,417

Total non-performing loans	$	814,208	$	902,751


(1)		Excludes non-accrual loans and accruing loans contractually past-due 90 days or more.

Potential problem loans are loans that are not considered non-performing loans, as disclosed above, but loans where management is aware of information regarding potential credit problems of a borrower that leads to serious doubts as to the ability of such borrowers to comply with the loan repayment terms. Such defaults could eventually result in the loans being reclassified as non-performing loans. We had $83.0 million in potential problem loans as of December 31, 2010, primarily related to an impaired loan that was restructured during the first quarter of 2011. We had no such potential problem loans as of March 31, 2011.

Of our non-accrual loans, $33.6 million were 30-89 days delinquent and $235.3 million were over 90 days delinquent as of March 31, 2011, and $22.4 million were 30-89 days delinquent and $270.5 million were over 90 days delinquent as of December 31, 2010. Accruing loans 30-89 days delinquent were $13.0 million and $5.4 million as of March 31, 2011 and December 31, 2010, respectively.

Many of our real estate construction loans include an interest reserve that is established upon origination of the loan. We recognize interest income from the reserve during the construction period as long as the interest is deemed collectible. As part of our ongoing credit review process, we monitor the construction of the underlying real estate to determine whether the project is progressing as originally planned. If we determine that adverse changes have occurred such that full payment of principal and interest is no longer expected, we will place the loan on non-accrual status and establish a specific reserve or charge off a portion of the principal balance, as appropriate.

We maintain a comprehensive credit policy manual that is supplemented by specific loan product underwriting guidelines. Among other things, the credit policy manual sets forth requirements that meet the regulations enforced by both the FDIC and the DFI. Several examples of such requirements are the loan-to-value limitations for real estate secured loans, various real estate appraisal and other third-party reports standards, and collateral insurance requirements.

Our underwriting guidelines outline specific underwriting standards and minimum specific risk acceptance criteria for each lending product offered, including the use of interest reserves. For additional information, see Credit Risk Management section included in our Form 10-K for the year ended December 31, 2010.

We maintain servicing procedures for real estate construction loans, the objective of which is to maintain the proper relationship between the loan amount funded and the value of the collateral securing the loan. The principal servicing tasks include, but are not limited to:


	•	Monitoring construction of the project to evaluate the work in place, quality of construction (compliance with plans and specifications) and adequacy of the budget to complete the project. We generally use a third party consultant for this evaluation, but also maintain frequent contact with the borrower to obtain updates on the project.

	•	Monitoring compliance with the terms and conditions of the loan agreement, which contains important construction and leasing provisions.

	•	Reviewing and approving advance requests per the loan agreement which establishes the frequency, conditions and process for making advances. Typically, each loan advance is conditioned upon funding only for work in place, certification by the construction consultant, and sufficient funds remaining in the loan budget to complete the project.

Additionally, our risk rating policies require that the assignment of a risk rating should consider whether the capitalization of interest may be masking other performance related issues. The adequacy of the interest reserve generally is evaluated each time a risk rating conclusion is required or rendered with particular attention paid to the underlying value of the collateral and its ongoing support of the transaction. Obtaining updated third-party valuations is considered when significant negative variances to expected performance exist. Generally, our policy on updating appraisals is to obtain current appraisals subsequent to the impairment date if there are significant changes to the underlying assumptions from the most recent appraisal. Some factors that could cause significant changes include the passage of more than twelve months since the time of the last appraisal; the volatility of the local market; the availability of financing; the inventory of competing properties; new improvements to, or lack of maintenance of, the subject property or competing surrounding properties; a change in zoning; environmental contamination; or failure of the project to meet material assumptions of the original appraisal. We generally consider appraisals to be current if they are dated within the past twelve months. However, we may obtain an updated appraisal on a more frequent basis if in our determination there are significant changes to the underlying assumptions from the most recent appraisal. As of March 31, 2011, $92.7 million of our collateral dependent loans had an appraisal older than twelve months. The fair value of the collateral for these loans was determined through inputs outside of appraisals, including actual and comparable sales transactions, broker price opinions and other relevant data.

Five of the 25 loans that comprise our real estate construction portfolio as of March 31, 2011 have been extended, renewed or restructured since origination. These modifications have occurred for various reasons including, but not limited to, changes in business plans, work-out efforts that were best achieved via a restructuring or discounted payoff.

In considering the performing status of a real estate construction loan, the current payment of interest, whether in cash or through an interest reserve, is only one of the factors used in our analysis. Our impairment analysis generally considers the loan’s maturity, the likelihood of a restructuring of the loan and if that restructuring constitutes a troubled debt restructuring, whether the borrower is current on interest and principal payments, the condition of underlying assets and the ability of the borrower to refinance the loan at market terms. Although an interest reserve may mitigate a delinquency that could cause impairment, other issues with the loan or borrower may lead to an impairment determination. Impairment is then measured based on a fair market or discounted cash flow

value to assess the current value of the loan relative to the principal balance. If the valuation analysis indicates that repayment in full is doubtful, the loan will be placed on non-accrual status and designated as non-performing.

Interest income recognized on the real estate construction loan portfolio was $1.8 million and $9.6 million for the three months ended March 31, 2011 and March 31, 2010, respectively. Cumulative capitalized interest on real estate construction loans in our portfolio as of March 31, 2011 and December 31, 2010 was $83.9 million and $86.4 million, respectively. As of March 31, 2011 and December 31, 2010, $215.9 million, or 80.4%, and $240.4 million, or 81.9%, respectively, of the total real estate construction loan portfolio was non-performing.

The decrease in the non-performing loan balance from December 31, 2010 to March 31, 2011 is primarily due to payoffs, charge offs, sales, and foreclosures on those loans, and a decrease in the number of loans that became non-performing during 2010.

The activity in the allowance for loan losses for the three months ended March 31, 2011 and March 31, 2010 was as follows:


	Three Months Ended
	March 31,
	2011			2010
	($ in thousands)

Balance as of beginning of period	$	329,122		$	586,696
Charge offs:
Commercial		(80,730	)		(35,147	)
Real estate		(3,843	)		(36,923	)
Real estate — construction		(11,889	)		(39,192	)

Total charge offs		(96,462	)		(111,262	)
Recoveries:
Commercial		1,105			—
Real estate		11,391			—
Real estate — construction		917			6

Total recoveries		13,413			6

Net charge offs		(83,049	)		(111,256	)
Charge offs upon transfer to held for sale		(7,608	)		(8,187	)
Provision for loan losses:
General		(28,066	)		24,281
Specific		72,875			194,659

Total provision for loan losses		44,809			218,940

Balance as of end of period	$	283,274		$	686,193

Allowance for loan losses ratio		4.65	%		8.58	%

Provision for loan losses ratio (annualized)		2.99	%		11.10	%

Net charge offs as a percentage of average loans outstanding (annualized)		5.90	%		5.87	%

Our allowance for loan losses decreased by $45.8 million to $283.3 million as of March 31, 2011 from $329.1 million as of December 31, 2010. This decrease comprised a $28.1 million decrease in general reserves and a $17.7 million decrease in specific reserves on impaired loans as further described below.

The decrease in the general reserves was primarily due to a shift in the loan mix reflecting a decrease in non-impaired loans in categories with the greatest historical loss experience, lowered estimated losses to reflect that an increased percentage of our non-impaired loan portfolio has been originated in recent years where the credit outcome is expected to be more favorable, and a reduction in the amount of unpaid principal balance of non-impaired loans due

to loan payoffs, principal payments and loan sales. As of March 31, 2011, the unpaid principal balance of non-impaired loans had decreased to $5.3 billion and the general reserves allocated to that portfolio had decreased to $222.1 million, representing an effective reserve percentage of 4.2%. As of December 31, 2010, the unpaid principal balance of non-impaired loans was $5.4 billion and the general reserves allocated to that portfolio were $250.2 million, representing an effective reserve percentage of 4.6%. The lower effective reserve percentage reflects the lower historical losses generally experienced by the non-impaired loans remaining in our portfolio as of March 31, 2011.

The decrease in specific reserves for the three months ended March 31, 2011 was related to new specific reserves of $86.4 million, which were offset by recoveries of $13.4 million and net charge-offs of $90.7 million taken during the period. The carrying values of our impaired loans reflect incurred losses that are inherent in our loan portfolio.

We employ a formal quarterly process to both identify impaired loans and record appropriate specific reserves based on available collateral and other borrower-specific information. As of March 31, 2011, the unpaid principal balance of impaired loans was $752.1 million with a specific allowance attributable to that portfolio of $61.2 million. Additionally, as of March 31, 2011, $267.3 million of the original legal balance of that portfolio had been previously charged off as collection was deemed remote for portions of these loans. The total prior charge offs and specific reserves as of March 31, 2011 of $328.4 million represented an expected total loss of 32% of the legal balance of $1.0 billion (the March 31, 2011 balance plus amounts previously charged off). As of December 31, 2010, the unpaid principal balance of impaired loans was $931.2 million with a specific allowance attributable to that portfolio of $79.0 million. Additionally, as of December 31, 2010, $463.1 million of the original legal balance of that portfolio had been previously charged off as collection was deemed remote for portions of these loans. The total prior charge offs and specific reserves as of December 31, 2010 of $505.3 million represented an expected total loss of 37.2% of the legal balance of $1.4 billion (the December 31, 2010 balance plus amounts previously charged off).

CapitalSource Bank Segment

The outstanding unpaid principal balances of non-performing loans in the CapitalSource Bank loan portfolio as of March 31, 2011 and December 31, 2010 were as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Non-accrual loans
Commercial	$	20,203	$	45,919
Real estate		43,537		70,438
Real estate — construction		110,854		131,940

Total loans on non-accrual	$	174,594	$	248,297

Accruing loans contractually past-due 90 days or more
Commercial	$	186	$	272

Total accruing loans contractually past-due 90 days or more	$	186	$	272

Troubled debt restructurings(1)
Real estate	$	102,343	$	35,689

Total troubled debt restructurings	$	102,343	$	35,689

Total non-performing loans
Commercial	$	20,389	$	46,191
Real estate		145,880		106,127
Real estate — construction		110,854		131,940

Total non-performing loans	$	277,123	$	284,258


(1)		Excludes non-accrual loans and accruing loans contractually past-due 90 days or more.

We had one $76.2 million potential problem loan as of December 31, 2010. We had no such potential problem loans as of March 31, 2011.

Of our non-accrual loans, $1.7 million and $3.9 million were 30-89 days delinquent, and $56.3 million and $69.8 million were over 90 days delinquent as of March 31, 2011 and December 31, 2010, respectively. Accruing loans 30-89 days delinquent were $3.6 million and $5.3 million as of March 31, 2011 and December 31, 2010, respectively.

The activity in the allowance for loan losses for the three months ended March 31, 2011 and 2010 was as follows:


	Three Months Ended
	March 31,
	2011			2010
	($ in thousands)

Balance as of beginning of period	$	124,878		$	152,508
Charge offs:
Commercial		(50	)		(3,682	)
Real estate		(3,727	)		(13,355	)
Real estate — construction		(11,530	)		(857	)

Total charge offs		(15,307	)		(17,894	)
Recoveries:
Commercial		—			—
Real estate		11,369			—
Real estate — construction		831			—

Total recoveries		12,200			—

Net charge offs		(3,107	)		(17,894	)
Charge offs upon transfer to held for sale		(43	)		—
Provision for loan losses:
General		7,217			20,568
Specific		4,025			67,136

Total provision for loan losses		11,242			87,704

Balance as of end of period	$	132,970		$	222,318

Allowance for loan losses ratio		3.31	%		6.92	%

Provision for loan losses ratio (annualized)		1.14	%		11.07	%

Net charge offs as a percentage of average loans outstanding (annualized)		0.33	%		2.31	%

Our allowance for loan losses increased by $8.1 million to $133.0 million as of March 31, 2011 from $124.9 million as of December 31, 2010. This increase was comprised of a $7.2 million increase in general reserves and a $0.9 million increase in specific reserves on impaired loans.

The increase in general reserves was primarily due to an increase in non-impaired loans due to originations. As of March 31, 2011, the unpaid principal balance of non-impaired loans had increased to $3.8 billion and the general reserves allocated to that portfolio were $130.2 million, representing an effective reserve percentage of 3.5%. As of December 31, 2010, the unpaid principal balance of non-impaired loans was $3.5 billion and the general reserves allocated to that portfolio were $123.0 million, representing an effective reserve percentage of 3.5%.

The increase in specific reserves for the three months ended March 31, 2011 was related to new specific reserves of $16.2 million, which were offset by recoveries of $12.2 million and net charge-offs of $3.1 million taken

during the period. The carrying values of our impaired loans reflect incurred losses that are inherent in our loan portfolio.

Given our loss experience, we consider our higher-risk loans within the commercial real estate portfolio to be loans secured by collateral that have not reached stabilization. As of March 31, 2011 and December 31, 2010, commercial real estate loans that have not reached stabilization had an outstanding principal balance of $163.5 million and $178.8 million, respectively. This amount was net of cumulative charge offs taken on these loans of $19.9 million and $21.0 million, respectively. There was no specific reserve allocated to these loans as of March 31, 2011 and December 31, 2010.

During the three months ended March 31, 2011 and 2010, loans with an aggregate carrying value of $96.2 million and $54.9 million, respectively, as of their respective restructuring dates, were involved in troubled debt restructurings (“TDRs”). Loans involved in these TDRs are assessed as impaired, generally for a period of at least one year following the restructuring, assuming the loan performs under the restructured terms and the restructured terms were at market. The specific reserves allocated to loans that were involved in TDRs were $0.1 million as of March 31, 2011. There were no specific reserves allocated to loans that were involved in TDRs as of December 31, 2010.

During 2010, CapitalSource Bank restructured three commercial real estate loans into new loans using an “A note / B note” structure in which the B note component has been fully charged off. The contractual principal balances of these three loans prior to the restructurings totaled $91.6 million. In connection with the restructurings, $8.8 million of debt was forgiven and charged off, and $4.9 million was collected as principal payments, leaving $59.9 million of A notes and $18.2 million of B notes. In March 2011, one of these A / B note arrangements with an aggregate carrying value of $21.1 million as of December 31, 2010 was repaid in full, including the previously charged off B note. As of March 31, 2011, the aggregate carrying value of the remaining two A notes was $35.6 million, and as of December 31, 2010, the aggregate carrying value of the three A notes was $56.5 million. The B notes had no aggregate carrying value as of March 31, 2011 and December 31, 2010. During the three months ended March 31, 2011, one of the A notes that is a TDR with an aggregate carrying value of $23.5 million was no longer classified as impaired as it performed in accordance with market-based restructured terms for twelve consecutive months.

The workout strategy discussed above results in the A note equaling a balance the borrower can service and is underwritten to a loan to value ratio based on the current collateral valuation. The A note may be assigned an internal risk rating of pass based on the revised terms and management’s assessment of the borrower’s ability and intent to repay. The A note is structured at a market interest rate, and the A note debt service is typically covered by the in-place property operations allowing it to be placed on accrual status. The reduced loan amount induces the borrower to continue to support the loan and maintain the collateral despite the observed reduction in the collateral value. The B note usually bears no interest or an interest rate significantly below the market rate. The A note contains amortization provisions, and the B note requires amortization only after the full repayment of the A note.

Accrual status for each loan, including restructured A notes, is considered on a loan by loan basis. The newly established principal balance of the A note is set at a level where the borrower is expected to keep the loan current and where the underlying collateral value adequately supports the loan. The revised structure is intended to allow the A loan to be placed on accrual status.

All loans that have undergone this A note / B note restructuring are considered TDRs. The A notes are deemed impaired and remain so classified for at least one year from the date of the restructuring. After one year, the A notes are evaluated quarterly to determine if the loan performance has complied with the terms of the TDR such that the impairment classification may be removed.

Other Commercial Finance Segment

The outstanding unpaid principal balances of non-performing loans in Other Commercial Finance loan portfolio as of March 31, 2011 and December 31, 2010 were as follows:


	March 31,		December 31,
	2011		2010
	($ in thousands)

Non-accrual loans
Commercial	$	252,088	$	320,498
Real estate		56,202		61,320
Real estate — construction		66,483		68,671

Total loans on non-accrual	$	374,773	$	450,489

Accruing loans contractually past-due 90 days or more
Commercial	$	2,078	$	2,972
Real estate		6,238		6,238
Real estate — construction		38,569		39,806

Total accruing loans contractually past-due 90 days or more	$	46,885	$	49,016

Troubled debt restructurings(1)
Commercial	$	115,427	$	118,988

Total troubled debt restructurings	$	115,427	$	118,988

Total non-performing loans
Commercial	$	369,593	$	442,458
Real estate		62,440		67,558
Real estate — construction		105,052		108,477

Total non-performing loans	$	537,085	$	618,493


(1)		Excludes non-accrual loans and accruing loans contractually past-due 90 days or more.

We had $6.8 million in potential problem loans as of December 31, 2010. We had no such potential problem loans as of March 31, 2011.

Of our non-accrual loans, $31.9 million and $18.5 million were 30-89 days delinquent, and $179.0 million and $200.7 million were over 90 days delinquent as of March 31, 2011 and December 31, 2010, respectively. Accruing loans 30-89 days delinquent were $9.4 million and $0.1 million as of March 31, 2011 and December 31, 2010, respectively.

The activity in the allowance for loan losses for the three months ended March 31, 2011 and 2010 was as follows:


	Three Months Ended
	March 31,
	2011			2010
	($ in thousands)

Balance as of beginning of period	$	204,244		$	434,188
Charge offs:
Commercial		(80,680	)		(31,465	)
Real estate		(116	)		(23,568	)
Real estate — construction		(359	)		(38,335	)

Total charge offs		(81,155	)		(93,368	)
Recoveries:
Commercial		1,105			—
Real estate		22			—
Real estate — construction		86			6

Total recoveries		1,213			6

Net charge offs		(79,942	)		(93,362	)
Charge offs upon transfer to held for sale		(7,565	)		(8,187	)
Provision for loan losses:
General		(35,283	)		3,713
Specific		68,850			127,523

Total provision for loan losses		33,567			131,236

Balance as of end of period	$	150,304		$	463,875

Allowance for loan losses ratio		7.25	%		9.69	%

Provision for loan losses ratio (annualized)		6.57	%		11.12	%

Net charge offs as a percentage of average loans outstanding (annualized)		14.97	%		8.06	%

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 according to the contractual terms of the original loan agreement. In this regard, impaired loans include those 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 well as loans that we have assessed as impaired, but for which we ultimately expect to collect all payments.

During the three months ended March 31, 2011 and 2010, loans with an aggregate carrying value of $58.6 million and $145.9 million, respectively, as of their respective restructuring dates, were involved in TDRs. Additionally, loans involved in these TDRs are assessed as impaired, generally for a period of at least one year following the restructuring, assuming the loan performs under the restructured terms and the restructured terms were at market. The specific reserves allocated to loans that were involved in TDRs were $50.1 million and $35.5 million as of March 31, 2011 and December 31, 2010, respectively.

The decrease in the provision for loan losses for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was primarily driven by a decrease in specific reserve provision related to impaired commercial and real estate construction loans. Our loans in categories with the greatest historical loss experience continue to pay off. Additionally, the majority of our new originations are in categories with lower historical loss experience. Due to the large individual credit exposures and characteristics of real estate loans, the level of charge offs in this area has been volatile in the past. However, we have few remaining large real estate loans in our portfolio and believe that we have appropriately reserved for all incurred losses. As of March 31, 2011 and December 31,

2010, the total outstanding principal balance of these higher-risk loans was $73.6 million and $84.5 million, respectively.

Liquidity and Capital Resources

Liquidity is a measure of our sources of funds available to meet our obligations as they arise. We require cash to fund new and existing loan commitments, repay and service indebtedness, make new investments, fund net deposit outflows and pay expenses related to general business operations. Our primary sources of liquidity are cash and cash equivalents, new borrowings and deposits, proceeds from asset sales, servicing fees from securitizations, principal and interest collections, and additional equity and debt financings.

We separately manage the liquidity of CapitalSource Bank and the Parent Company as required by regulation. Our liquidity management is based on our business plans for the Parent Company and CapitalSource Bank and assumptions related to expected cash inflows and outflows that we believe are reasonable. These business plans include the assumption that substantially all newly originated loans will be funded by CapitalSource Bank.

As of March 31, 2011, we had $1.7 billion of unfunded commitments to extend credit, of which $936.3 million were commitments of CapitalSource Bank and $810.7 million were commitments of the Parent Company. Due to their nature, we cannot know with certainty the aggregate amounts we will be required to fund under these unfunded commitments. In many cases, our obligation to fund unfunded commitments is subject to our clients’ ability to provide collateral to secure the requested additional fundings, the collateral’s satisfaction of eligibility requirements, our clients’ ability to meet specified preconditions to borrowing, including compliance with the loan agreements, and/or our discretion pursuant to the terms of the loan agreements. In other cases, however, there are no such prerequisites or discretion to future fundings by us, and our clients may draw on these unfunded commitments at any time. We forecast adequate liquidity to fund the expected borrower draws under these commitments. To the extent there are unfunded commitments with respect to a loan that is owned partially by CapitalSource Bank and the Parent Company, unless our client is in default, CapitalSource Bank is obligated in some cases, pursuant to intercompany agreements, to fund its portion of the unfunded commitment before the Parent Company is required to fund its portion. Our failure to satisfy our full contractual funding commitment to one or more of our clients could create breach of contract and lender liability for us and irreparably damage our reputation in the marketplace.

Unless otherwise specified, the figures presented in the following paragraphs are based on current forecasts and take into account activity since March 31, 2011. The information contained in this section should be read in conjunction with, and is subject to and qualified by the information set forth in our Risk Factors and the Cautionary Note Regarding Forward Looking Statements in our Form 10-K.

CapitalSource Bank Liquidity

The most significant variable in CapitalSource Bank’s liquidity management is our expectation regarding the net loan and deposit growth. CapitalSource Bank’s primary sources of liquidity include: deposits, payments of principal and interest on loans and securities, cash equivalents, and borrowings from the FHLB SF. Secondary sources of liquidity may also include: capital contributions and borrowings from the Parent Company, bank borrowings, and the issuance of debt securities. We intend to maintain sufficient liquidity at CapitalSource Bank to meet depositor demands and fund loan commitments and operations as well as to maintain liquidity ratios required by our regulators.

CapitalSource Bank’s primary uses of liquidity include: funding new and existing loans, purchasing investment securities, funding net deposit outflows, and paying operating expenses, including intercompany payments to the Parent Company for origination and other services performed on CapitalSource Bank’s behalf. CapitalSource Bank operates in accordance with the conditions imposed and contractual agreements entered in connection with regulatory approvals obtained upon its formation, including requirements that CapitalSource Bank maintain a total risk-based capital ratio of not less than 15%, capital levels required for a bank to be considered “well-capitalized” under relevant banking regulations, and a ratio of tangible equity to tangible assets of not less than 10%. In addition, we have a policy to maintain 10% of CapitalSource Bank’s assets in unencumbered cash, cash equivalents and investments. In accordance with regulatory guidance, we have identified, modeled and planned for the financial, capital and liquidity impact of various events and scenarios that would cause a large outflow of deposits, a reduction in borrowing capacity, a material increase in loan funding obligations, a material increase in credit costs or any

combination of these events. We anticipate that CapitalSource Bank would be able to maintain sufficient liquidity and ratios in excess of its required minimum ratios in these events and scenarios.

For information on CapitalSource Bank’s primary sources of liquidity, see Note 8, Deposits, and Note 10, Borrowings, in our consolidated financial statements for the three months ended March 31, 2011 and in our audited consolidated financial statements in our Form 10-K for the year ended December 31, 2010.

Parent Company Liquidity

The Parent Company’s need for liquidity is based on our expectation that the balance of our existing loan portfolio and other assets held in the Parent Company will run off over time. The Parent Company’s primary sources of liquidity include cash and cash equivalents, principal and interest payments, asset sales, and servicing fees from securitizations. A portion of the proceeds from some of these sources is required to be used to make net proceeds offers on our 2014 Senior Secured Notes. The Parent Company also has access to secondary sources of liquidity including bank borrowings and the issuance of debt securities, subject to restrictions under existing indebtedness; and the issuance of additional shares of equity. CapitalSource Bank is prohibited from paying dividends until July 2011 without consent from our regulators. We do not anticipate that dividends from CapitalSource Bank will provide any liquidity to fund the operations of the Parent Company for the near term future.

The Parent Company’s primary uses of liquidity include interest and principal payments on our existing debt, operating expenses, possible share repurchases, any dividends that we may pay, and the funding of unfunded commitments. The Parent Company is required to repurchase its 3.5% and 4.0% Convertible Debentures at the option of the noteholders on July 15, 2011. As of March 31, 2011, outstanding balances on the 3.5% and 4.0% Convertible Debentures were $8.4 million and $272.1 million, respectively. We currently intend to repurchase these Convertible Debentures with cash at or prior to July 15, 2011.

Pursuant to agreements with our regulators, 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 the capital levels of CapitalSource Bank 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 our regulators, the Parent Company has provided a $150.0 million unsecured revolving credit facility to CapitalSource Bank that CapitalSource Bank may draw on at any time it or the FDIC deems necessary. As of March 31, 2011, there were no amounts outstanding under this facility.

The Parent Company is subject to financial and non-financial covenants under our indebtedness, including, with respect to restricted payments, leverage, servicing standards, and limitations on incurring or guaranteeing indebtedness, refinancing existing indebtedness, repaying subordinated indebtedness, making investments, dividends, distributions, redemptions or repurchases of our capital stock, selling assets, creating liens and engaging in a merger, sale or consolidation. If we were to default under our indebtedness by violating these covenants or otherwise, our investors’ remedies would include the ability to, among other things, transfer servicing to another servicer, foreclose on collateral, and/or accelerate payment of all amounts payable under such indebtedness.

In addition, upon the occurrence of specified servicer defaults, the holders of the asset-backed notes issued in our term debt securitizations may elect to terminate us as servicer of the loans and appoint a successor servicer or replace us as cash manager. If we were terminated as servicer, we would no longer receive our servicing fee. In addition, because there can be no assurance that any successor servicer would be able to service the loans according to our standards, the performance of our loans could be materially adversely affected and income generated from those loans significantly reduced.

In December 2010, our Board of Directors authorized the repurchase of $150.0 million of our common stock over a period of up to two years. In December 2010, we repurchased 1,415,000 shares of our stock in open market transactions for a total purchase price of $9.9 million. All shares repurchased under this plan were retired upon settlement. There were no additional repurchases during the three months ended March 31, 2011. For additional information, see Note 12, Shareholders’ Equity, in our audited consolidated financial statements in our Form 10-K for the year ended December 31, 2010.

As of March 31, 2011, the Parent Company had one secured credit facility with an aggregate commitment of $40.0 million. There was no outstanding balance as of March 31, 2011, and we terminated this credit facility on April 12, 2011.

Commitments, Guarantees & Contingencies

As of March 31, 2011 and December 31, 2010, we had unfunded commitments to extend credit to our clients of $1.7 billion and $1.9 billion, respectively. Additional information on these contingencies is included in Note 19, Commitments and Contingencies, in our audited consolidated financial statements for the year ended December 31, 2010, included in our Form 10-K, and Liquidity and Capital Resources — Parent Company Liquidity herein.

We have non-cancelable operating leases for office space and office equipment, which expire over the next fourteen years and contain provisions for certain annual rental escalations. For additional information, see Note 19, Commitments and Contingencies, in our audited consolidated financial statements in our Form 10-K for the year ended December 31, 2010.

We provide standby letters of credit in conjunction with several of our lending arrangements and under certain of our property leases. For additional information, see Note 16, Commitments and Contingencies, in our accompanying consolidated financial statements.

In connection with certain securitization transactions, we have made customary representations and warranties regarding the characteristics of the underlying transferred assets and collateral. Prior to any securitization transaction, we generally performed due diligence with respect to the assets to be included in the securitization transaction and the collateral to ensure that they satisfy the representations and warranties. In our capacity as originator and servicer in certain securitization transactions, we may be required to repurchase or substitute loans which breach a representation and warranty as of their date of transfer to the securitization or financing vehicle.

Credit Risk Management

Credit risk is the risk of loss arising from adverse changes in a client’s or counterparty’s ability to meet its financial obligations under agreed-upon terms. Credit risk exists primarily in our loan and derivative portfolios and the portion of our investment portfolio comprised of non-agency MBS, non-agency ABS and CMBS. The degree of credit risk will vary based on many factors including the size of the asset or transaction, the credit characteristics of the client, the contractual terms of the agreement and the availability and quality of collateral. We manage credit risk of our derivatives and credit-related arrangements by limiting the total amount of arrangements outstanding with an individual counterparty, by obtaining collateral based on the nature of the lending arrangement and management’s assessment of the client, and by applying uniform credit standards maintained for all activities with credit risk.

As appropriate, the Parent Company and CapitalSource Bank credit committees evaluate and approve credit standards and oversee the credit risk management function related to our loans and other investments. Their primary responsibilities include ensuring the adequacy of our credit risk management infrastructure, overseeing credit risk management strategies and methodologies, monitoring economic and market conditions having an impact on our credit-related activities, and evaluating and monitoring overall credit risk and monitoring our client’s financial condition and performance.

Substantially all new loans have been originated at CapitalSource Bank, and we maintain a comprehensive credit policy manual for those loans that is supplemented by specific loan product underwriting guidelines. Among other things, the credit policy manual sets forth requirements that meet the regulations enforced by both the FDIC and the state of California’s Department of Financial Institutions. Examples of such requirements include the loan to value limitations for real estate secured loans, standards for real estate appraisals and other third-party reports, and collateral insurance requirements.

Our underwriting guidelines outline specific underwriting standards and minimum specific risk acceptance criteria for each lending product offered. Loan types defined within these guidelines have three broad categories, within our commercial, real estate, and real estate construction loan portfolios. These categories include asset-based loans, cash flow loans, and real estate loans, and each of these broad categories has specific subsections that define in detail the following:


	•	Loan structures, which includes the lien positions, amortization provisions and loan tenors;

	•	Collateral descriptions and appropriate valuation methods;

	•	Underwriting considerations which include minimum diligence and verification requirements; and

	•	Specific risk acceptance criteria which enumerate for each loan type the minimum acceptable credit performance standards. Examples of these criteria include maximum loan-to-value amounts for real estate loans, maximum advance rate amounts for asset-based loans and minimum historical and projected debt service coverage amounts for all loans.

We measure and document each loan’s compliance with our specific risk acceptance criteria at underwriting. If at underwriting, there is an exception to these criteria, an explanation of the factors that mitigate this additional risk is considered before an approval is granted.

Credit risk management for our loan portfolios begins with an assessment of the credit risk profile of a client based on an analysis of the client’s financial position. As part of the overall credit risk assessment of a client, each commercial credit exposure or transaction is assigned a risk rating that is subject to approval based on defined credit approval standards. While rating criteria vary by product, each loan rating focuses on the same two factors: the client’s ability to repay the loan and the adequacy of collateral. Subsequent to loan origination, risk ratings are reassessed on an ongoing basis. If necessary, risk ratings are adjusted to reflect changes in the client’s financial condition, cash flow or financial situation. When managing the loan portfolio and making credit decisions, we consider various portfolio credit statistics and trends. Some examples include the risk ratings trends for loan types and various credit concentrations (by loan type, by client business, by real estate collateral property type, and by real estate collateral location among other factors).

Concentrations of Credit Risk

In our normal course of business, we engage in lending activities with clients primarily throughout the United States. As of March 31, 2011, the single largest industry concentration was healthcare and social assistance, which made up approximately 20% of our loan portfolio. As of March 31, 2011, taken in the aggregate, non-healthcare real estate loans, which was our largest loan concentration, made up approximately 29% of our loan portfolio. As of March 31, 2011, the largest geographical concentration was California, which made up approximately 13% of our loan portfolio.

Selected information pertaining to our largest credit relationships as of March 31, 2011 was as follows:


								Amount of					Allowance		Date of Last	Amount of
Loan			% of Total					Loan(s) at		Loan			for Loan	Underlying	Collateral	Last
Balance			Portfolio			Loan Type	Industry	Origination		Commitment		Performing	Losses	Collateral(1)	Appraisal	Appraisal
								($ in thousands)


$	371,270(2	)		6.1	%	Commercial and Real Estate	Health Care and Social Assistance	$	607,180	$	371,270	Yes	$—	Stock pledge	N/A	N/A

	227,738			3.7		Commercial and Real Estate - Construction	Accommodation and Food Services and Finance and Insurance		173,663		255,957	Partial(3)	—	Timeshare receivables	N/A	N/A(3)

	201,310			3.3		Real Estate	Accommodation and Food Services		5,006		205,212	Yes	—	Portfolio of vacation properties	December 2006 - November 2010	$627,851(4)

	116,107			1.9		Real Estate - Construction	Accommodation and Food Services		60,130		141,731	No	—	Hotel	June 2010	$182,000(5)


$	916,425			15.0	%			$	845,979	$	974,170


(1)		Represents the primary collateral securing the loan. In certain cases, there may be additional types of collateral.

(2)		Our total loan balance of $371.3 million, comprised of a commercial loan with a balance of $325.0 million and a real estate loan with a balance of $46.3 million, was repaid in full on April 1, 2011.

(3)		The collateral that secures our loan balance of $227.7 million as of March 31, 2011 primarily consists of timeshare receivables and timeshare real estate that had a total value of $734.1 million as of March 31, 2011. Total senior debt, including our loan balance, secured by the collateral was $321.3 million as of March 31, 2011. This credit relationship includes multiple loans, one of which, with a balance of $38.6 million, is non-performing.

(4)		Total senior debt, including our loan balance, was $277.8 million as of March 31, 2011.

(5)		Total senior debt, including our loan balance, was $196.0 million as of March 31, 2011.

Non-performing loans in our portfolio of loans held for investment may include non-accrual loans, accruing loans contractually past due, or TDRs. Our remediation efforts on these loans are based upon the characteristics of each specific situation. The various remediation efforts that we may undertake include, among other things, one of or a combination of the following:


	•	request that the equity owners of the borrower inject additional capital;

	•	require the borrower to provide us with additional collateral;

	•	request additional guaranties or letters of credit;

	•	request the borrower to improve cash flow by taking actions such as selling non-strategic assets or reducing operating expenses;

	•	modify the terms of our debt, including the deferral of principal or interest payments, where we will appropriately classify the modification as a TDR;

	•	initiate foreclosure proceedings on the collateral; or

	•	sell the loan in certain cases where there is an interested third-party buyer.

There were 111 credit relationships in the non-performing portfolio as of March 31, 2011, and our largest non-performing credit relationship totaled $116.1 million and comprised 14.3% of our total non-performing loans. This credit relationship comprises real estate construction loans to a borrower in the accommodation and food services industry. The primary collateral supporting these loans is a hotel. These loans were originated in June 2007. The outstanding loan balances as of March 31, 2011 for this relationship are inclusive of charge offs taken to reduce the outstanding loan balances to the estimated fair value of the collateral based upon an appraisal received in 2010.

TDRs are loans that have been restructured as a result of deterioration in the borrower’s financial position and for which we have granted a concession to the borrower that we would not have otherwise granted if those conditions did not exist. Our concession strategies in TDRs are intended to minimize our economic losses as

borrowers experience financial difficulty and provide an alternative to foreclosure. The success of these strategies is highly dependent on our borrowers’ ability and willingness to repay under the restructured terms of their loans. Continued adverse changes in the economic environment or in borrower performance could negatively impact the outcome of these strategies.

A summary of concessions granted by loan type, including the accrual status of the loans as of March 31, 2011 and December 31, 2010 is as follows:


	March 31, 2011						December 31, 2010
	Non-accrual		Accrual		Total		Non-accrual		Accrual		Total
	($ in thousands)

Commercial
Interest rate and fee reduction	$	3,361	$	—	$	3,361	$	24,185	$	—	$	24,185
Maturity extension		92,279		78,618		170,897		104,872		79,481		184,353
Payment deferral		11,031		12,022		23,053		18,235		4,189		22,424
Multiple concessions		45,833		25,280		71,113		57,912		35,121		93,033

		152,504		115,920		268,424		205,204		118,791		323,995

Real estate
Interest rate and fee reduction		2,098		—		2,098		1,880		—		1,880
Maturity extension		5,597		35,601		41,198		25,910		35,471		61,381
Payment deferral		—		67,246		67,246		—		—		—
Multiple concessions		1,379		—		1,379		—		—		—

		9,074		102,847		111,921		27,790		35,471		63,261

Real estate — construction
Maturity extension		148,121		—		148,121		153,982		—		153,982
Multiple concessions		—		—		—		13,875		—		13,875

		148,121		—		148,121		167,857		—		167,857

Total	$	309,699	$	218,767	$	528,466	$	400,851	$	154,262	$	555,113

We have experienced losses incurred on some TDRs subsequent to their initial restructuring. These losses include both additional specific reserves and charge offs on the restructured loans. The majority of such losses has been incurred on our commercial loans and is primarily due to the borrowers’ failure to consistently meet their financial forecasts that formed the bases for our restructured loans. Examples of circumstances that resulted in the borrowers not being able to meet their forecasts included acquisitions of other businesses that did not have the expected positive impact on financial results, significant delays in launching products and services, and continued deterioration in the pricing estimates of businesses and product lines that the borrower expected to sell to generate proceeds to repay the loan. In certain of these cases, the TDRs occurred prior to 2008, and the borrowers performed under the terms of the restructured loans for a period of time before their operations were negatively impacted by recent market conditions.

Losses incurred on TDRs since their initial restructuring by concession and loan type for the three months ended March 31, 2011 and 2010 were as follows:


	Three Months Ended
	March 31,
	2011		2010
	($ in thousands)

Commercial
Interest rate and fee reduction	$	18,728	$	4,723
Maturity extension		5,561		8,628
Payment deferral		7,443		547
Multiple concessions		27,140		3,061

		58,872		16,959
Real estate
Maturity extension		—		257

		—		257
Real estate — construction
Maturity extension		11,795		12,899
Multiple concessions		—		1,993

		11,795		14,892

Total	$	70,667	$	32,108

Of the additional losses recognized on commercial loan TDRs since their initial restructuring for the three months ended March 31, 2011, 0.4% related to loans for which the initial TDR on the borrower occurred prior to 2008, 41.1% related to loans that had additional modifications subsequent to their initial TDRs, and all related to loans that were on non-accrual status as of March 31, 2011. We recognized approximately $0.2 million of interest income for the three months ended March 31, 2011 on the commercial loans that experienced losses during this period.

Of the additional losses recognized on commercial loan TDRs since their initial restructuring for the three months ended March 31, 2010, 25.8% related to loans that had additional modifications subsequent to their initial TDRs, and all of the additional losses related to loans that were on non-accrual status as of March 31, 2010. We recognized approximately $0.2 million of interest income for the three months ended March 31, 2010 on the commercial loans that experienced losses during this period.

Market Risk Management

Market risk is the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions such as interest rate fluctuations. This risk is inherent in the financial instruments associated with our operations and/or activities, which result in the recognition of assets and liabilities in our consolidated financial statements, including loans, securities, short-term borrowings, long-term debt, trading account assets and liabilities and derivatives.

The primary market risk to which we are exposed is interest rate risk, which is inherent in the financial instruments associated with our operations, primarily including our loans and borrowings. Our traditional loan products are non-trading positions and are reported at amortized cost. Additionally, debt obligations that we incur to fund our business operations are recorded at historical cost. While U.S. generally accepted accounting principles (“GAAP”) requires a historical cost view of such assets and liabilities, these positions are still subject to changes in economic value based on varying market conditions.

Interest Rate Risk Management

Interest rate risk in our normal course of business refers to the change in earnings that may result from changes in interest rates, primarily various short-term interest rates, including LIBOR-based rates and the prime rate. We attempt to mitigate exposure to the earnings impact of interest rate changes by conducting the majority of our lending and borrowing on a variable rate basis. The majority of our loan portfolio bears interest at a spread to the LIBOR rate or a prime-based rate with most of the remainder bearing interest at a fixed rate. Approximately half of our borrowings bear interest at a spread to LIBOR or CP, with the remainder bearing interest at a fixed rate. Our deposits are fixed rate, but at short terms. We are also exposed to changes in interest rates in certain of our fixed rate loans and investments. We attempt to mitigate our exposure to the earnings impact of the interest rate changes in these assets by engaging in hedging activities as discussed below. For additional information, see Note 17, Derivative Instruments, in our consolidated financial statements for the three months ended March 31, 2011.

The estimated changes in net interest income for a 12-month period based on changes in the interest rates applied to the combined portfolios of our segments as of March 31, 2011, were as follows ($ in thousands):


Rate Change
(Basis Points)

+ 200	$	16,291
+ 100		2,885
+ 50		745
−50		1,597
−100		1,735
−200		1,544

For the purpose of the above analysis, we included loans, investment securities, borrowings, deposits and derivatives. In addition, we assumed that the size of the current portfolio remains the same as the existing portfolio as of March 31, 2011. Loans, investment securities and deposits are assumed to be replaced as they run off. The new loans, investment securities and deposits are assumed to have interest rates that reflect our forecast of prevailing market terms. We also assumed that LIBOR does not fall below 0.15% for loans and borrowings, and that the prime rate does not fall below 3.0% for loans.

As of March 31, 2011, approximately 50% of the aggregate outstanding principal amount of our loans had interest rate floors and were accruing interest. Of the loans with interest rate floors, approximately 93% had contractual rates below the interest rate floor and the floor was providing a benefit to us. The loans with contractual interest rate floors as of March 31, 2011 were as follows:


	Amount		Percentage of
	Outstanding		Total Portfolio
	($ in thousands)

Loans with contractual interest rates:
Below the interest rate floor	$	2,973,756		48	%
Exceeding the interest rate floor		7,187		1
At the interest rate floor		60,107		1
Loans with interest rate floors on non-accrual		147,547		2
Loans with no interest rate floor		2,897,126		48

Total	$	6,085,723		100	%

We enter into interest rate swap agreements to minimize the economic effect of interest rate fluctuations specific to our fixed rate debt and certain fixed rate loans. We also enter into additional basis swap agreements to hedge basis risk between our LIBOR-based term debt and the prime-based loans pledged as collateral for that debt. These basis swaps modify our exposure to interest rate risk by synthetically converting fixed rate and prime rate loans to one-month LIBOR. Our interest rate hedging activities partially protect us from the risk that interest collected under fixed-rate and prime rate loans will not be sufficient to service the interest due under the one-month LIBOR-based term debt.

We also use interest rate swaps to hedge the interest rate risk of certain fixed rate debt. These interest rate swaps modify our exposure to interest rate risk by synthetically converting fixed rate debt to one-month LIBOR.

We have also entered into relatively short-dated forward exchange agreements to minimize exposure to foreign currency risk arising from foreign currency denominated loans.

Critical Accounting Estimates

Accounting policies are integral to understanding our Management’s Discussion and Analysis of Financial Condition and Results of Operations. The preparation of the consolidated financial statements in conformity with GAAP requires management to make certain judgments and assumptions based on information that is available at the time of the financial statements in determining accounting estimates used in the preparation of such statements. Our significant accounting policies are described in Note 2, Summary of Significant Accounting Policies, in our audited consolidated financial statements for the year ended December 31, 2010, included in our Form 10-K. Accounting estimates are considered critical if the estimate requires management to make assumptions and judgments about matters that were highly uncertain at the time the accounting estimate was made and if different estimates reasonably could have been used in the reporting period, or if changes in the accounting estimate are reasonably likely to occur from period to period that would have a material impact on our financial condition, results of operations or cash flows. We have established detailed policies and procedures to ensure that the assumptions and judgments surrounding these areas are adequately controlled, independently reviewed and consistently applied from period to period. Management has discussed the development, selection and disclosure of these critical accounting estimates with the Audit Committee of the Board of Directors and the Audit Committee has reviewed our disclosure related to these estimates. Our critical accounting estimates are described in Critical Accounting Estimates within Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K for the year ended December 31, 2010.

Supervision and Regulation

This is an update to certain sections from our discussion of Supervision and Regulation in our Form 10-K. For further information and discussion of supervision and regulation matters, see Item I. Business — Supervision and Regulation, in our Form 10-K for the year ended December 31, 2010. Together with the discussion of supervision and regulation matters in our Form 10-K for the year ended December 31, 2010, the following describes some of the more significant laws, regulations, and policies that affect our operations, but 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.

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”). CapitalSource Bank’s deposits are insured up to the maximum amounts permitted by law.

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 a contractual supervisory agreement with the Parent Company and CapitalSource Bank (the “Parent Company Agreement”) to examine the Parent Company and the relationship and transactions between it 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 Securities and Exchange Commission. We are required to file periodic reports with these regulators and provide any additional information that they may require.

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.

CapitalSource Bank will complete its initial three year de novo period in July 2011. Based on communications from the FDIC, we expect that the conditions contained in the FDIC Order granting deposit insurance that prohibit the payment of dividends by CapitalSource Bank, require certain reporting by the Parent Company (some of which are required under other laws and regulations) and impose limitations on organizational changes and intercompany contractual arrangements will cease to apply after July 2011. The rest of the conditions contained in such Order will effectively remain in place after July 2011 pursuant to the continued existence of the contractual agreements between the Parent Company, CapitalSource Bank and the FDIC until such time as we apply for and are granted relief by the FDIC from the requirements of these agreements. Among these remaining conditions is the requirement that CapitalSource Bank maintain a total risk-based capital ratio of not less than 15% to be supported by the Parent Company. Notwithstanding the termination of any of the conditions, CapitalSource Bank will remain subject to bank safety and soundness requirements as well as to various regulatory capital requirements established by federal and state regulatory agencies, including any new conditions that our regulators may determine.

Under current FDIC guidance, CapitalSource Bank is required to file a revised business plan for years four to seven of an expanded de novo period. During this time period, CapitalSource Bank may be subject to increased supervision than would otherwise not be applicable to a bank that has been in existence longer than three years, including enhanced FDIC supervision for compliance examinations and Community Reinvestment Act evaluations.

There are periodic examinations by the DFI and the 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 credit 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.

Pursuant to the Parent Company Agreement, the Parent Company has consented to examination by the FDIC for purposes of monitoring compliance with the laws and regulations applicable to CapitalSource Bank and its affiliates. The Parent Company and CapitalSource Bank also are parties to a Capital Maintenance and Liquidity Agreement (the “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 or exceed the levels required for a bank to be considered “well-capitalized” under the relevant banking regulations. Additionally, pursuant to requirements of the CMLA, the Parent Company has provided, and is required to continue to provide, a $150.0 million unsecured revolving credit facility that CapitalSource Bank may draw on at any time it or the FDIC deems necessary. The Parent Company Agreement also requires the Parent Company to maintain the capital levels of CapitalSource Bank at the levels required in the CMLA.

Limitations on Dividends and other Distributions

The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions. The Federal Deposit Insurance Corporation Improvement Act prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if, after such transaction, the institution would be undercapitalized.

In addition to the restrictions imposed under federal law, banks chartered under California law generally may only pay cash dividends to the extent such payments do not exceed the lesser of retained earnings of the bank or the bank’s net income for its last three fiscal years (less any distributions to shareholders during this period). In the event a bank desires to pay cash dividends in excess of such amount, the bank may pay a cash dividend with appropriate

regulatory approval in an amount not exceeding the greatest of the bank’s retained earnings, the bank’s net income for its last fiscal year or the bank’s net income for its current fiscal year.

The federal banking agencies also have the authority to prohibit a depository institution from engaging in business practices which are considered to be unsafe or unsound, possibly including payment of dividends or other payments under certain circumstances even if such payments are not expressly prohibited by statute.


ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certain financial market risks, which are discussed in detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Market Risk Management section of this Form 10-Q and our Form 10-K. In addition, for additional information on our derivatives, see Note 17, Derivative Instruments, in our consolidated financial statements for the three months ended March 31, 2011, and Note 22, Credit Risk, in our audited consolidated financial statements for the year ended December 31, 2010 included in our Form 10-K.


ITEM 4.	CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of our management, including our Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Co-Chief Executive Officers and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2011. There have been no changes in our internal control over financial reporting during the three months ended March 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION


ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

A summary of our repurchases of shares of our common stock for the three months ended March 31, 2011 was as follows:


							Maximum Number
							of Shares (or
					Total Number of		Approximate
					Shares Purchased		Dollar Value)
	Total Number				as Part of Publicly		that May
	of Shares		Average		Announced Plan		Yet be Purchased
	Purchased(1)		Price Paid		or Programs		Under the Plans(2)

January 1 — January 31, 2011		325,589	$	7.08		325,000		—
February 1 — February 28, 2011		3,836		7.63		—		—
March 1 — March 31, 2011		16,655		7.40		—		—

Total		346,080	$	7.10		325,000	$	140,085,757


(1)		Includes the number of shares acquired as payment by employees of applicable statutory minimum withholding taxes owed upon vesting of restricted stock granted under our Third Amended and Restated Equity Incentive Plan.

(2)		In December 2010, our Board of Directors authorized the repurchase of up to $150.0 million of our common stock over a period of up to two years. Any share repurchases made under the stock repurchase plan will be made through open market purchases or privately negotiated transactions. The amount and timing of any repurchases will depend on market conditions and other factors and repurchases may be suspended or discontinued at any time. In December 2010, we repurchased 1,415,000 shares of our common stock under the share repurchase plan, at an average price of $7.01 per share for a total purchase price of $9.9 million. Of these purchases, purchases of 325,000 shares at an average price of $7.08 per share were settled in January 2011, which, for accounting purposes, were recorded in December 2010. All shares repurchased under the share repurchase plan were retired upon settlement. There were no additional repurchases during the three months ended March 31, 2011.


ITEM 5.	OTHER INFORMATION

On April 29, 2011 CapitalSource Bank filed its Consolidated Reports of Condition and Income for A Bank With Domestic Offices Only — FFIEC 041, for the quarter ended March 31, 2011 (the “Call Report”) with the Federal Deposit Insurance Corporation (“FDIC”).


ITEM 6.	EXHIBITS

(a) Exhibits

The Index to Exhibits attached hereto is incorporated herein by reference.

INDEX TO EXHIBITS


Exhibit
No			Description

	3	.1	Second Amended and Restated Certificate of Incorporation (composite version; reflects all amendments through May 1, 2008) (incorporated by reference to exhibit 3.1 to the Form 10-Q filed by CapitalSource on May 12, 2008).
	3	.2	Amended and Restated Bylaws (composite version; reflects all amendments through February 16, 2011)(incorporated by reference to exhibit 3.1 to the Form 8-K filed by CapitalSource on February 18, 2011).
	10	.1*	CapitalSource Bank Chief Executive Officer and Chief Financial Officer Compensation program.†
	12	.1	Ratio of Earnings to Fixed Charges.†
	31	.1.1	Rule 13a — 14(a) Certification of Chairman of the Board and Co-Chief Executive Officer.†
	31	.1.2	Rule 13a — 14(a) Certification of Chairman of the Board and Co-Chief Executive Officer.†
	32		Rule 13a — 14(a) Certification of Chief Financial Officer.†
	99	.1	CapitalSource Bank’s Consolidated Reports of Condition and Income For A Bank with Domestic Office only-FFIEC 041, for the quarter ended March 31, 2011.†
	101	.INS	XBRL Instance Document†
	101	.SCH	XBRL Taxonomy Extension Schema Document†
	101	.CAL	XBRL Taxonomy Calculation Linkbase Document†
	101	.LAB	XBRL Taxonomy Label Linkbase Document†
	101	.PRE	XBRL Taxonomy Presentation Linkbase Document†
	101	.DEF	XBRL Taxonomy Definition Document†


†		Filed herewith.

*		Management contract or compensatory plan or arrangement.


		Page

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010		3
	Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2011 and 2010		4
	Consolidated Statement of Shareholders’ Equity (unaudited) for the three months ended March 31, 2011		5
	Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2011 and 2010		6
	Notes to the Unaudited Consolidated Financial Statements		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		49
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		82
Item 4.	Controls and Procedures		82

PART II. OTHER INFORMATION
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		83
Item 5.	Other Information		83
Item 6.	Exhibits		83
Signatures			84
Index to Exhibits			85
Exhibit 10.1
Exhibit 12.1
Exhibit 31.1.1
Exhibit 31.1.2
Exhibit 31.2
Exhibit 32
Exhibit 99.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT


								Accumulated
			Additional					Other		Total
	Common		Paid-in		Accumulated			Comprehensive		Shareholders’
	Stock		Capital		Deficit			Income, net		Equity
	(Unaudited)
	($ in thousands)

Total shareholders’ equity as of December 31, 2010	$	3,232	$	3,911,341	$	(1,870,572	)	$	9,941	$	2,053,942
Net income		—		—		3,159			—		3,159
Other comprehensive income:
Unrealized gain, net of tax		—		—		—			14,425		14,425

Total comprehensive income		—		—		—			—		17,584
Dividends paid		—		28		(3,250	)		—		(3,222	)
Stock option expense		—		1,372		—			—		1,372
Exercise of options		1		353		—			—		354
Restricted stock activity		—		1,406		—			—		1,406

Total shareholders’ equity as of March 31, 2011	$	3,233	$	3,914,500	$	(1,870,663	)	$	24,366	$	2,071,436


Date: May 3, 2011		/s/ STEVEN A. MUSELES Steven A. Museles Director and Co-Chief Executive Officer (Principal Executive Officer)


Date: May 3, 2011		/s/ JAMES J. PIECZYNSKI James J. Pieczynski Director and Co-Chief Executive Officer (Principal Executive Officer)


Date: May 3, 2011		/s/ DONALD F. COLE Donald F. Cole Chief Financial Officer (Principal Financial Officer)


Date: May 3, 2011		/s/ BRYAN D. SMITH Bryan D. Smith Chief Accounting Officer (Principal Accounting Officer)