"Our financial performance in the first quarter of 2008 was stable and profitable, despite ongoing capital markets disruption. I am particularly pleased with our credit metrics, which have been steady and at the low end of historic ranges over the past five quarters," said John K. Delaney, CapitalSource Chairman and CEO. "We believe the strength of our business will be enhanced by combining our commercial lending franchise with our new depository," added Delaney. "We have now filed our regulatory applications to form our California bank and look forward to working closely with our new regulators. Our agreement to acquire more than $5 billion in retail bank deposits is expected to close this summer."
"The renewal of two bank credit facilities in recent days secures important funding capacity. We were able to complete these renewals based upon the strength and quality of our business franchise," said Thomas A. Fink, CapitalSource Chief Financial Officer. "The performance of our core commercial finance business improved this quarter with increased loan yield relative to our benchmark of 30-day LIBOR, lower operating expenses as a percentage of assets, and increased Adjusted Return on Equity at 23.9%. Adjusted Earnings on a consolidated basis were negatively impacted by the sale of Agency securities in our residential mortgage investment portfolio," added Fink.
Assets Under Management
-- Assets under management were approximately $19.85 billion as of March 31, 2008, a decrease of $1.03 billion from the prior quarter, primarily due an $813 million reduction in the Company's residential mortgage portfolio to $5.3 billion. During the quarter ended March 31, 2008, the Company sold approximately $591 million in Agency MBS and subsequent to quarter-end completed an additional $1.5 billion in Agency MBS sales.
Commercial Finance Segment
-- Total commercial loans were approximately $9.8 billion at quarter end, a decrease of approximately $108 million from the prior quarter, as loan runoff outpaced loan growth.
-- Net investment income was $144.4 million for the quarter, a decrease of $1.8 million from the prior quarter, primarily due to lower interest and prepayment-related fee income, partially offset by lower interest expense.
-- Interest income was $224.4 million for the quarter, a decrease of $18.2 million from the prior quarter, directionally consistent with the decrease in LIBOR and prime rates during the quarter.
-- Yield on average interest-earning assets was 10.26% for the quarter, a decrease of 86 basis points from the prior quarter. The decrease was primarily due to a decrease in the average coupon rate of interest charged on loans (resulting from the decrease in LIBOR and prime rates during the quarter) and a decrease in prepayment-related fee income, partially offset by an increased core lending spread.
-- Core lending spread, defined as loan yield less prepayment-related fee income and average 30-day LIBOR, was 7.12%, an increase of 99 basis points compared to the prior quarter.
-- Prepayment-related fee income was $3.5 million for the quarter and contributed 14 basis points to yield, a decrease of $8.9 million or 35 basis points in contribution to yield from the prior quarter.
-- Provision for loan losses was $3.0 million for the quarter, bringing the total allowance for loan losses to $136.7 million, or 1.27% of total commercial assets, a decrease of 1 basis point from the prior quarter.
-- Cost of funds was 5.45% for the quarter, a decrease of 99 basis points from the prior quarter primarily due to declining interest rates. Overall borrowing spread to average one-month LIBOR was 2.15%, an increase of 62 basis points from the prior quarter, primarily due to short-term funding market volatility and greater amortization of deferred financing fees.
-- Leverage, as measured by the ratio of total debt-to-equity at the end of the quarter, was 4.37x, a decrease from 4.39x at the end of the prior quarter.
-- Net finance margin, defined as net investment income divided by average interest-earning assets, was 5.74% for the quarter, a decrease of 5 basis points from the prior quarter, primarily due to a decrease in yield on average interest-earning assets partially offset by lower borrowing costs.
-- Adjusted earnings contributed by the Commercial Finance segment was $113.5 million ($0.51 per diluted share), an increase of 28.3% compared to $88.5 million in the prior quarter.
Commercial Credit Metrics
-- Loans on non-accrual status, which the Company considers its primary credit metric, increased by 5 basis points from the prior quarter to 1.62% of commercial assets, below the average of 1.64% in the prior four quarters.
-- Loans 60 or more days contractually delinquent increased 1 basis point from the prior quarter to 0.69% of commercial assets, below the average of 0.77% in the prior four quarters.
-- Net charge-offs were $5.2 million, a decrease of $0.7 million from the prior quarter. As a percentage of average commercial assets, annualized net charge-offs for the quarter were 22 basis points, unchanged from the prior quarter.
-- Allowance for loan losses was $136.7 million, a decrease of $2.2 million from the prior quarter. As a percentage of commercial loans at quarter end, loan loss reserves were 1.40%, a decrease of 1 basis point from the prior quarter.
Healthcare Net Lease Segment
-- Direct real estate investments were consistent with the prior quarter at approximately $1.02 billion, decreasing $0.6 million from the prior quarter due primarily to depreciation, partially offset by the purchase of one property.
-- Operating lease income was approximately $27.7 million for the quarter, an increase of $0.6 million from the prior quarter.
-- Adjusted earnings contributed by the Healthcare Net Lease segment was approximately $13.9 million ($0.06 per diluted share), an increase of 6.9% compared to $13.0 million in the prior quarter.
Consolidated Other Income
-- Gain (loss) on investments, net was $1.1 million in the first quarter, improved from a loss of ($0.2) million in the prior quarter primarily due to realized gains of $1.9 million on certain cost based investments and dividends received of $1.0 million, partially offset by write-downs of $2.2 million on other cost based investments.
-- Other (expense) income, net was ($4.7) million compared to $4.3 million in the prior quarter, primarily due to foreign currency losses partially offset by gains on asset sales and third party management fees.
-- Loss on the residential mortgage investment portfolio was $55.4 million or 105 basis points of the portfolio, compared to $25.4 million in the prior quarter, primarily due to the net change in fair value of Agency MBS and related derivatives. In Adjusted Earnings for the quarter, the Company realized a loss of $28.0 million related to the residential mortgage investment portfolio, primarily due to a $20.6 million realized loss as a result of the sale of Agency MBS during the quarter.
-- Loss on derivatives was $38.1 million, compared to $31.6 million in the prior quarter. These net unrealized losses were primarily due to the unrealized net change in the fair value of interest rate swaps used in hedging certain assets and liabilities to minimize the Company's exposure to interest rate movements. Hedge accounting is not applied to these interest rate swaps. As a result, movements in the net fair value of hedging instruments are reported in Other (Expense) Income, while changes in the fair value of hedged exposures are not.
Funding and Liquidity
-- During the quarter, the Company raised $169.3 million through the issuance of approximately 14.06 million shares of common stock under its Dividend Reinvestment and Stock Purchase Plan (DRIP).
-- Following the quarter end, the Company renewed two credit facilities with five participating lenders totaling approximately $1.2 billion, including:
-- A $1 billion facility to finance real estate loans and real estate-related asset based loans was renewed on April 25, 2008 and matures on April 23, 2010.
-- A $220 million facility to finance commercial loans was renewed on April 30, 2008 and matures on April 29, 2009.
-- Total committed credit facility capacity at April 30, 2008 was $4.6 billion.
Operating Expenses
-- Operating expenses as a percentage of average total assets declined in the quarter to 1.51%, an improvement of 7 basis points from 4Q '07. Head count of 535 at March 31, 2008 was down from 562 at December 31, 2007.
Income Tax Rate
-- The overall effective tax rate in the quarter, expressed as a percentage of consolidated pre-tax GAAP net income, was 31.2%.
Adjusted Return on Equity
-- Consolidated adjusted return on average equity, defined as Adjusted Earnings divided by average GAAP equity, was 16.48% for the quarter, an increase of 13 basis points from the prior quarter. The accompanying Financial Supplement provides a detailed reconciliation of GAAP net income to Adjusted Earnings.
Share Count
-- Weighted average shares outstanding, dilutive to Adjusted Earnings, were 221.5 million shares for the quarter ended March 31, 2008, compared to 211.6 million shares at the end of the prior quarter.
Dividends
-- A regular quarterly cash dividend of $0.60 per common share was paid on March 31, 2008 to common shareholders of record as of March 17, 2008. -- CapitalSource