Full Description

CapitalSource Inc. is a commercial lender that provides financial products to middle market businesses. Through its wholly owned subsidiary, CapitalSource Bank, the Company provides depository products and services in southern and central California. It operates through three segments: Commercial Banking, Healthcare Net Lease and Residential Mortgage Investment. The Commercial Banking segment comprises the Company’s commercial lending and banking business activities. The Healthcare Net Lease segment comprises its direct real estate investment business activities. The Residential Mortgage Investment segment comprises the Company’s remaining residential mortgage investment and other investment activities, in which it formerly engaged to optimize its qualification as a real estate investment trust (REIT). In addition to its Commercial Banking and Healthcare Net Lease segments, the Company has three primary commercial lending businesses: Healthcare and Specialty Finance, Corporate Finance and Structured Finance. In July 2008, the Company acquired approximately $5.2 billion of deposits, the commercial real estate participation interest (the A Participation Interest) and 22 retail banking branches from Fremont Investment & Loan (FIL) and commenced operations of CapitalSource Bank.

The Healthcare and Specialty Finance business generally provides first mortgage loans, asset-based revolving lines of credit, and cash flow loans to healthcare businesses, and to a lesser extent, a range of other companies. It also makes investments in income-producing healthcare facilities, particularly long-term care facilities. The Corporate Finance business generally provides senior and subordinate loans through direct origination and participation in syndicated loan transactions. The Structured Finance business generally engages in commercial and residential real estate finance, and also provides asset-based lending to finance companies.

Commercial Banking Segment

The Company’s primary commercial lending products, services and investments include depository products and services, senior secured loans, first mortgage loans, equity investments, and Term B, second lien and mezzanine loans. Through CapitalSource Bank’s 22 branches in southern and central California, the Company provides savings and money market accounts, individual retirement account (IRA) products and certificates of deposit. A loan is a senior loan when the Company has a first priority lien in the collateral securing the loan. Asset-based loans are collateralized by specified assets of the client, generally the client’s accounts receivable and/or inventory. Cash flow loans are made based on the Company’s assessment of a client’s ability to generate cash flows sufficient to repay the loan and to maintain or increase its enterprise value during the term of the loan. Its senior cash flow term loans generally are secured by a security interest in all or substantially all of a client’s assets. In some cases, the equity owners of a client pledge their stock in the client to the Company as further collateral for the loan.

A first mortgage loan is a loan secured by a senior mortgage on real property. CapitalSource Inc. makes mortgage loans to clients, including owners and operators of senior housing, and skilled nursing facilities; owners and operators of office, industrial, hospitality, multi-family and residential properties; resort and residential developers, and hospitals and companies backed by private equity firms that frequently obtain mortgage-related financing in connection with buyout transactions. A Term B loan is a loan that shares a first priority lien in a client’s collateral with the client’s other senior debt but that comes after other senior secured debt in order of payment preference, and accordingly, generally involves greater risk of loss than other senior secured loans. Term B loans are senior loans, and therefore, are included with senior secured loans in the Company’s portfolio statistics. A second lien loan is a loan that has a lien on the client’s collateral that is junior in order of priority and also comes after the senior debt in order of payment. A mezzanine loan is a loan that may not share in the same collateral package as the client’s senior loans, may have no security interest in any of the client’s assets and is junior to any lien holder both as to collateral (if any) and payment.

The Company acquired equity in some borrowers at the same time and on substantially the same terms as the private equity sponsor that invested in the borrower with the Company’s loan proceeds. These equity investments generally represented less than 5% of a borrower’s equity. Since the formation of CapitalSource Bank, the Company has ceased making these equity investments. As of December 31, 2008, the Company’s total commercial portfolio had outstanding balance of $10.9 billion. Included in these amounts were loans, the A Participation Interest, loans held for sale, and $93.3 million of related interest receivables (collectively, Commercial Lending Assets) as of December 31, 2008.

As of December 31, 2008, the Company owned $642.7 million in marketable securities, available for sale. Included in these marketable securities, available for sale, were discount notes issued by Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal Home Loan Bank (FHLB) (Agency Discount Notes), callable notes issued by Fannie Mae, Freddie Mac, FHLB and Federal Farm Credit Bank (Agency Callable Notes), bonds issued by the FHLB (Agency Debt), commercial and residential mortgage-backed securities issued and guaranteed by Fannie Mae, Freddie Mac or Government National Mortgage Association (Ginnie Mae), and a corporate debt security issued by Wells Fargo & Company (Corporate Debt). As of December 31, 2008, the A Participation Interest had an outstanding balance of $1.4 billion, which includes $3.7 million of related accrued interest receivable.

Healthcare Net Lease Segment

CapitalSource Inc. invests in income-producing healthcare facilities, principally long-term care facilities in the United States. These facilities are generally leased through long-term, triple-net operating leases. Under a typical triple-net lease, the client agrees to pay a base monthly operating lease payment, subject to annual escalations, and all facility operating expenses, including real estate taxes, as well as make capital improvements. As of December 31, 2008, the Company’s direct real estate investments consisted primarily of land and buildings.

Residential Mortgage Investment Segment

While the Company was a REIT, it invested in residential mortgage-backed securities (RMBS), which are securities collateralized by residential mortgage loans. These securities include agency RMBS, and RMBS issued by non-government-sponsored entities that are credit-enhanced through the use of subordination or in other ways that are inherent in a corresponding securitization transaction (non-agency RMBS). Substantially all of its agency and non-agency RMBS are collateralized by adjustable-rate mortgage loans, including hybrid adjustable rate mortgage loans. The Company owns beneficial interests in special-purpose entities (SPEs) that acquired and securitized pools of residential mortgage loans. The Company is the primary beneficiary of these SPEs. The SPEs’ interest in the underlying mortgage loans constitutes, for accounting purposes, receivables secured by the underlying mortgage loans.