CapitalSource, Inc. Q3 2008 Earnings Call Transcript

CapitalSource, Inc. (CSE)

Q3 2008 Earnings Call Transcript

November 5, 2008, 8:30 am ET

Executives

Dennis Oakes – VP, IR

John Delaney – Chairman and CEO

Thomas Fink – CFO

Analysts

Robert Napoli – Piper Jaffray

Donald Fandetti – Citigroup

Andrew Wessel – JP Morgan

Sameer Gokhale – KBW

Michael Taiano – Sandler O'Neill

John Hecht – JMP Securities

Moshe Orenbuch – Credit Suisse

Omotayo Okusanya – UBS

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2008 CapitalSource, Inc. earnings conference call. My name is Dan and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host for today's call, Mr. Dennis Oakes, Vice President of Investor Relations. Please proceed, sir.

Dennis Oakes

Thank you, Dan, and good morning, everyone. Thank you for joining us for the CapitalSource third quarter 2008 earnings conference call. With me today are John Delaney, our Chairman and CEO, and Tom Fink, our Chief Financial Officer.

This call is being webcast live on our Web site and a recording of the call will be available beginning at approximately 10:30 a.m. Eastern Time this morning. Our earnings press release and Web site provide details on accessing the archived call.

Investors are urged to read the forward-looking statements language in our earnings release, but essentially, it says the statements made on this earnings call, which are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All forward-looking statements, including statements regarding future financial operating results, involve risks, uncertainties and contingencies, many of which are beyond the control of CapitalSource and which may cause actual results to differ materially from anticipated results.

CapitalSource is under no obligation to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise, and we expressly disclaim any obligation to do so. More detailed information about risk factors can be found in our reports filed with the SEC.

I will turn the call over to John Delaney. John?

John Delaney

Thanks, Dennis. And good morning, everyone. It's certainly an understatement to say that the financial markets in the third quarter and into the fourth quarter have been very turbulent. The world economy seems to have experienced the equivalent of a hundred year flood on nearly a weekly basis, and the economic news keeps getting worse. CapitalSource has been impacted by these macro events, but we were not distracted from our core lending business and credit discipline.

Many of the numbers this quarter need explanation and some context. And I will provide in my remarks this morning kind of an overview of those. Importantly, the quarter, which was a profitable quarter, included the formation of CapitalSource Bank, the acquisition of more than $5 billion in retail deposits, our return to the lending market as a result of the dependable and available capital at the bank. And period ending liquidity at our bank was over $2 billion.

Three additional events of importance occurred in recent days. We were approved by the State of California for a commercial bank charter. We have filed the necessary applications with the Federal Reserve Bank to become a bank holding company. Both are necessary steps in our transition from the present industrial bank charter that we have to full commercial banking status.

And last Thursday, our board voted to take the steps necessary to end our status as a real estate investment trust beginning in 2009.

Our view of the very challenging economic environment is best characterized as degrees of stress. Put another way, we are managing the business around various scenarios of the depth of the recession. On a probabilistic basis, we see that there is a deep recession, though we also have scenarios for something more mild and for something worse.

Based on this expectation of a deep recession, our business plan has a number of areas of focus, including first, make very safe loans at high spreads. In order to make safe loans in this environment, we are focused on low leverage, senior and asset-based transactions with healthy companies in defensive industries. We view ourselves as an important source of credit to credit starved small to mid-sized businesses.

Second, use our relative position of strength at CapitalSource Bank to acquire other depositories and grow our retail banking footprint in California.

Third, engage in active and proactive portfolio management to manage our legacy portfolio in order to minimize credit losses. And fourth, convert all of the company's operations to commercial banking and bank holding company status.

Returning to the quarter, I am disappointed that market conditions prevented our planned IPO of our Healthcare Net Lease business last month. We continue to evaluate our next steps and remain committed to finding an efficient path to make that business a separately traded healthcare REIT in a way that enhances the business and creates value for our shareholders.

Last week, we announced a decision of our board of directors to revoke the company's REIT election in 2009. Though we are disappointed about giving up the tax benefits of REIT status, our decisions to de-REIT does not preclude the formation of CapitalSource Healthcare REIT even if an IPO or another transaction is not completed until some time in 2009.

In addition, with our planned sale of the REIT mortgage compliance portfolio in 2009, CapitalSource will have a debt to equity ratio net of available cash of approximately 3.4 to 1, which makes our capital ratios very, very high. And on a consolidated basis, our business will be significantly simplified.

Let me now return to credit. I would describe our charge-offs and reserve boost this quarter as proactive, prudent and appropriate. We constantly monitor the credit performance of our portfolio and adjust our reserve assumptions, both specific and general each quarter. The higher charge-offs and reserves in the quarter reflect our updated view of the impact of the current and anticipated economic stress on our portfolio.

First, specific reserves and charge-offs were higher as the expected performance and valuation of every troubled borrower was meaningfully discounted to reflect the current economic distress. In addition, a number of older loans, which had been in work out for some time, significantly influenced the charge-off number this quarter. Given current economic conditions, we determined that the near-term performance improvement was not realistic and the loans should be marked as such.

In fact, four such loans accounted for over 50% of the total charge-offs in the quarter. Most of the large specific reserves and charge-offs were loans to borrowers that had been struggling under company specific problems, such as execution failures or customer losses.

The subsequently large impairment and charge-offs were due to the sudden and sharp change in the economic outlook as a result of recent financial market disruption, changing our view of the future prospects of these businesses. The remaining loans that were written off in the quarter were smaller loans in the corporate finance and commercial real estate business.

There are no trends in our overall portfolio that we view as systemic or unmanageable, and we firmly believe that our sound and proven underwriting capabilities, senior debt orientation, healthy spreads, prudent risk management and proactive reserve policy will cushion any unanticipated losses.

We believe the current recession will last for a number of quarters and have upwardly adjusted our policy reserves accordingly. This adjustment is entirely consistent with the general reserve policy we have followed for some time. We set policy reserves in a range based on historical charge-offs at the low end, which is our historical experience, and on the upper bound, we used the historical charge-offs plus any specific reserves, assuming a total loss on those loans.

We then set the actual policy percentage as a point within the range. This quarter, we calibrated ourselves to a higher point in the range. Thus, our policy reserve was doubly impacted by the increased charge-offs and the aforementioned adjustment in the policy level.

As has been the case since the inception of the company, we continue to have very limited loss experience in about one-half of our business, including the Healthcare Real estate, Healthcare Credit, Rediscount and Security businesses. The areas where we expect the current economic conditions will have the greatest impact is our leveraged buyout finance business and commercial real estate business, which are also where our current losses are concentrated.

The conditions for making new loans, as one of the very few lenders with real liquidity and currently active in the middle market are extraordinary. As one of my colleagues said recently, it is almost like selling oxygen on the moon, no competition and you can name your price. We are seeing opportunities across all of our business and making new loans weekly with wide spreads, tight structures, low leverage and high LIBOR floors. Nearly, all of our new loans are being made within CapitalSource Bank.

In addition to our direct originations, we are taking advantage of extremely attractive opportunities in the secondary market. Our buy desk team is seeing numerous deals at steep discounts for very safe credits. These opportunities are the result of the continuing lack of liquidity, which limits buyers and continues to force sellers to unload high quality assets.

Before concluding, I want to touch on the "A" participation interest we acquired as part of the deposited asset purchase when we formed CapitalSource Bank in July. As of September 30th, the interest was down to $1.6 billion, which is less than 35% of the total outstanding loan balance of approximately $4.7 billion. With our entitlement to 70% of the monthly principal payments and the extensive underwriting we conducted on the portfolio, we remain very comfortable with the performance of this participation.

Looking out over the next five quarters, I am confident about our ability to manage our credit within the bounds of our historic experience, meaningfully, grow our commercial loan portfolio in our bank by making safe loans at high returns, complete the transition to a commercial bank, maintain a healthy balance sheet and continue to opportunistically make moves that will strengthen the CapitalSource enterprise, produce high returns on equity and add to long-term shareholder value.

I'll now turn the call over to Tom Fink, who'll provide his perspective on the quarter and address some of the changes to our financials with the formation of CapitalSource Bank.

Thomas Fink

Thank you, John, and good morning. As reported, we had profitable results this quarter with net income of $8 million or $0.03 per share and adjusted earnings of $82.2 million or $0.30 per share. As John has already discussed, our results compared to last quarter were primarily impacted by higher provisions during the third quarter.

Away from the bottom-line results, formation of CapitalSource Bank and the commencement of operations this quarter was very important for us, both strategically and in terms of its impact on our financial statement and operating metrics this quarter. Accordingly, I will spend a minute reviewing some of the changes in our statement that are due to CapitalSource Bank as well as highlight some other noteworthy items for the quarter.

In terms of the presentation of the statement themselves, we have some new line items on the balance sheet this quarter. John has already mentioned the $1.6 billion "A" participation interest we acquired in the third quarter along with approximately $5 billion in deposits and the bank branches and certain other assets from Fremont Investment & Loan.

As we've discussed before, that transaction was completed in late July and with it, we are able to commence operations of CapitalSource Bank in a very meaningful way with immediate scale in terms of the size and breadth of its bank branch network and deposit gathering capabilities.

Also, importantly for the future, the assets we acquired in that transaction created a highly liquid balance sheet at CapitalSource Bank. The "A" participation interest itself is expected to completely amortize over the next 12 months or so and the other assets we acquired were essentially cash.

At September 30th, we continued to have significant liquidity over $1.8 billion at CapitalSource Bank in the form of cash, short-term or highly liquid, high quality investments. You can see those highly liquid, high quality investments at the bank on our balance sheet as $797 million of marketable securities, which is a new item on the balance sheet this quarter.

We also are showing goodwill as a discrete item on the balance sheet this quarter due to its significance as a result of the Fremont transaction. This increase in goodwill this quarter to approximately $180 million and virtually all of our goodwill for that matter is related to the bank assets acquisition.

Elsewhere on the balance sheet this quarter, and on the income statement, we are breaking out some items in more detail as well. The reason for this is that for FDIC reporting purposes, we are now considered a bank holding company, since we own a significant financial institution. This classification requires a slightly different presentation of our financial statements, even though we are not yet legally a bank holding company.

For example, we began showing accrued interest receivable this quarter as a discrete asset on the balance sheet. Previously, this had been included in other assets. Also on the income statement, we have separated our interest income into discrete items by major asset classification and have done the same with interest expense by liability classification. Each of these is a requirement of the bank holding company classification.

In terms of our segment reporting, we continue to have three reportable segments. CapitalSource Bank is included in our primary commercial lending segment, and as we noted in our earnings press release, we have now renamed that segment Commercial Banking to clearly reflect in the name the significance of the activities of CapitalSource Bank, both making commercial loans and conducting a banking business with over 65,000 customers.

During the quarter, our consolidated balance sheet grew in size, again, primarily due to CapitalSource Bank. At September 30th, we had $19.9 billion in assets, up from $14.9 billion at June 30th. Most of this growth was in the commercial banking segment, where assets increased $3.6 billion due primarily to the acquisition of the "A" participation interest and approximately $2 billion in cash.

The ending balance of commercial loans in our commercial banking segment this quarter was $9.4 billion, essentially unchanged from the ending balance of the second quarter. However, our average balance was down $328 million. As we have stated before, going forward, we expect to grow our commercial loan portfolio through CapitalSource Bank, and the ending in average balances of commercial loans this quarter clearly shows this starting to occur. As these metrics imply, we saw some shrinkage in the commercial loan portfolio early in the quarter with loan growth resuming in the latter part of the quarter after the commencement of operations of the bank.

In terms of our other operating metrics, some of our usual commercial banking metrics were affected somewhat this quarter by the formation and growth of CapitalSource Bank, in particular, since the balance sheet was bigger, primarily due to the increase in interest earning assets. Total interest income for the commercial banking segment was also up. Interest income in the segment was up $26 million this quarter to $227 million, primarily due to the acquisition of the "A" participation interest.

Yield on interest earning assets in the segment was down however. Yield this quarter was 8.36%, down 139 basis points from the previous quarter, primarily because the acquisition of the "A" participation interest and the growth in cash and high quality liquid assets in the bank earn interest at a lower rate than our average commercial loans. We expect yield to increase over time, as we continue to grow our commercial loan portfolio, turning this cash and liquidity into higher interest earning loan.

Yield on our loans is therefore the more indicative measure to look at this quarter to understand the performance of our commercial loan portfolio. Loan yield was 9.54% this quarter, down 56 basis points, with most of this change in loan yield explained by the change in prepayment related fee income this quarter. Prepayment related fee income is a typical source of quarter-to-quarter loan yield variation and was 15 basis points this quarter compared to 46 basis points in the second quarter.

We are predominantly a floating rate lender with approximately 70% of our commercial lending assets bearing interest as a spread to LIBOR. Weighted average LIBOR was essentially unchanged in the quarter, up 3 basis points to 2.62%, so whereas changes in short-term interest rate indices has historically had a pronounced effect on overall yield in the last few quarters it was more muted this quarter.

On the right side of the balance sheet, the most significant item in the commercial banking segment this quarter is the addition of approximately $5 billion in deposits to our funding mix. Also, in connection with our initial sale of loans to CapitalSource Bank, we repaid approximately $1.7 billion of our credit facility and term debt. These changes were the primary drivers of the increase in total liabilities to $16.8 billion this quarter.

The net increase in liabilities this quarter resulted in increased total interest expense as well. However, as expected, the addition of a significant amount of deposit funding to the mix has had a beneficial effect on our cost of funds. Cost of funds in the commercial banking segment was 5.2% this quarter, down 20 basis points.

We expect the benefit of deposits on cost of funds to be greater in the future for two reasons. First, we only had the benefit of deposits for approximately two months this quarter since CapitalSource Bank began operations in late July.

Second, as we grow our commercial banking business through CapitalSource Bank, over the long-term, we expect to also gather more deposits at the bank and increase the percentage of our segment funding that comes from deposits.

In addition, when we fully complete the transition to a commercial bank, we will be able to expand our deposit offerings to customers, including lower cost and no cost forms of deposits.

Since the formation of CapitalSource Bank in July, the balance of deposits has not changed much, and it is important to note that we don't expect them to change that much in the very near future. Simple reason is that we have so much liquidity at the bank that we can fund a significant amount of loan growth at the bank by just converting existing cash into loans. However, we do expect deposits to ultimately increase as needed to fund increased lending.

We ended the quarter with approximately $5 billion of deposits. At quarter end, deposits provide approximately 45% of our total funding in the commercial banking segment, and the cost of deposits for the quarter was approximately 3.37%.

In terms of our other segments, our Healthcare Net Lease segment was relatively unchanged this quarter. The only real change in asset balances for the quarter was the result of normal depreciation of our net lease properties. Lease revenues were up in the quarter compared to the relatively low number last quarter due to a negative adjustment we had made in the second quarter. The lease revenues that you see in the third quarter represent a more normal run rate for the lease properties.

And as John mentioned, we were disappointed that market conditions compelled us to delay the planned IPO of CapitalSource Healthcare REIT. However, the Healthcare Net Lease business remains a very valuable business to us, and we will continue to assess market conditions and consider all alternatives to better position that business for the growth potential we see in that market and realize for our shareholders the value that we have built.

Importantly, as John mentioned earlier, and it's an important point, so I'll repeat it. The decision by CapitalSource itself to no longer be a REIT next year does not preclude the IPO of the Healthcare Net Lease business or any other transaction for that matter.

In our Residential Mortgage Investment segment, in the third quarter, we saw the normal principal runoff of the mortgage related receivables and agency MBS. We made no acquisitions or sales of these assets this quarter. However, due to the formation of CapitalSource Bank, we did add some assets to the portfolio during the quarter to keep the REIT in balance. These new investments were in the form of short-term agency discount notes and treasury bills and were recorded as restricted cash due to their short-term nature and the fact they serve as collateral for some repo financing in that segment.

As John mentioned earlier that the board's recent decision to revoke our re-election next year, we expect to maintain the Residential Mortgage Investment portfolio through year end, but will look to sell it early next year. Accordingly, I anticipate that we will not continue the Residential Mortgage Investment segment after we de-REIT next year and sell the portfolio.

In connection with our overall results, I also want to comment on a few other points about other income. As in the past several quarters, we continue to see this quarter some volatility in our bottom-line performance driven by changes in the various individual categories of other income.

Looking forward several quarters, I would expect our overall earnings volatility to be reduced due to the strategic transformation CapitalSource is making.

For the quarter ended September 30th, other income was $28 million, down $12 million from the second quarter. One of the items contributing to this total is the gain or loss on our Residential Mortgage Investment portfolio. This has been and continue to be this quarter, significant source of earnings volatility.

This quarter, the RMIP had a loss of $27 million primarily due to the widening of spreads on agency MBS. This was a $36 million negative swing from last quarter's gain of $9 million. Once we sell the Residential Mortgage portfolio next year, this significant source of earnings volatility will no longer exist.

In terms of the other components of other income, this quarter we saw a $25 million increase in loss on investments, primarily due to the write-down of certain cost-based investments and warrants. We also saw a $70 million gain on the early retirement of debt, as we opportunistically repurchased some of our existing debt at significant discounts.

To sum up, we are pleased with the profitable quarter, in spite of the unprecedented economic and market conditions that in large part drove our increased provisioning and charge-offs this quarter. As we have discussed, CapitalSource is in the process of completing an important transformation of its business. In its simplest terms, we will no longer be a REIT and our core commercial lending business will increasingly take place in CapitalSource Bank.

We are transforming to a commercial bank model, hence the segment name change to Commercial Banking and we also own a valuable Healthcare Property REIT business that is housed in our Healthcare Net Lease segment.

Let me conclude by reiterating that our transformation that is well under way is beginning to show on the financial statements and after another quarter or two, as we work through all of the remaining steps and changes, the transformation will begin to show clearly in our results.

Importantly, in our Commercial Banking business, we are very well-positioned with favorable market conditions, significant liquidity, strong balance sheet and a relatively large and clean depository with a clear ability to grow. We were profitable in this current, unprecedented economy and we are making progress towards our goal of a mid-teens return on equity after tax.

With that, I'll turn the call back to Dennis.

Dennis Oakes

Thank you, Tom. We're ready now for your questions, but ask callers to limit yourself to one question and one follow-up so we can get to as many individuals as possible. For the first question, please, Dan.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Robert Napoli from Piper Jaffray. Please proceed.

Robert Napoli – Piper Jaffray

Thank you. Good morning. Few questions, one question and a follow-up, I guess, but the first question would be on the credit. John, I think I heard you say that you felt comfortable that in this environment, post this quarter, that you can maintain credit losses within historical expected ranges. Did I hear that correctly? And can you give a little more color on where the credit losses came from. Were there one or two very large loans included in those charge-offs or –

John Delaney

Well, we said that about half of the charge-offs were in four loans that had been kind of problem loans for some time. All of our kind of charge-offs that we experienced this quarter and therefore most of the reason to justify the reserve bill was due to transactions in either our kind of generalist corporate finance business, or our commercial real estate business. We're not seeing any real issues emerging from our specialty businesses at all. So yes, I would say the part of your question there was where it was concentrated, it was concentrated in commercial real estate and our general corporate finance business, which is very consistent. Starting about a year ago, we started to, I think, pretty openly frame what part of the portfolio is subject to more economic stress. And we said about half the portfolio is subject to more economic stress than the other half and that we thought that charge-offs and increased reserve pressure would come out of that half of the portfolio, which is exactly what's happening. So there is really no change to that. I do believe that the company's credit performance will continue to kind of outpace any kind of peer group for us, in part, because a lot of our portfolio is defensive in orientation because of the big healthcare in concentration and a few other businesses, and because we have a senior debt orientation. I would expect credit performance in this kind of an economic condition to be significantly magnified for mezzanine lenders, for example, than for senior lenders. And so I would expect us to continue to perform well.

As I said in my remarks, we're very cautious about the environment. We kind of view ourselves – we kind of use three scenarios, right, something mild, something deep and something much worse, and I think we're thinking about the world in terms of this being deep. And so, lot of the data that's coming out from September and October, as you know, Bob, is pretty darn negative, and so we're mindful of that as we look ahead. But I expect the company to perform well from a credit perspective, particularly, on a relative basis, not relative to prior performance when we had unusually pristine credit performance in a good economic time, but relative to other peer groups.

Robert Napoli – Piper Jaffray

Thanks. My follow-up question is just on liquidity, just a little. Obviously, the bank has massive liquidity. Outside of the bank, though, I'd just like a little more clarity. You have the little over $5 billion of term debt, including warehouse lines. You have converts and I don't – $900 million of converts when they're – one of those portable, and then you have the mezzanine debt. If you could give a little more color on some of the challenges or regarding those items.

John Delaney

I'll turn that over to Tom and I wouldn't use the word "challenge" to characterize any of that. I'll start with that, but I'll turn it over to Tom to give more detail.

Thomas Fink

Sure. Good morning, Bob.

Robert Napoli – Piper Jaffray

Good morning.

Thomas Fink

Well, by definition, right, the liquidity is more limited outside the bank than in the bank because we don't have access to deposit funding outside the bank, but that doesn't, as John said, describe – or making you describe things as challenging. We've done a lot of work already. Things that we've already talked about along the way to push out a lot of our near-term credit facility, maturities or renewals, things that were coming up in 2008. So we really don't have any material points or anything coming up certainly this year. The next mile post, you mentioned our convertibles. We do have one series of convertibles that we expect to be redeemed in March of 2009, March 15th of 2009, and that's the series which we issued back in 2004 that we also completed pursuant to an 8K that we filed. In fact, it will be an exchange, repurchasing that debt and issuing stock in exchange for that. So that total is now about $180 million in terms of the March obligation. Our unsecured credit facility has a March 2010 maturity date on it, so that's a far ways out.

In terms of other things to mention there, obviously, the Healthcare re-IPO, all the proceeds of that would have come to CapitalSource, so there would have been some positive liquidity impacts related to that. However, part of our plan all along with that business was to put certain financing in place with respect to those assets, and those plans are continuing. So as that happens that liquidity will still come to CapitalSource as well. So I think our position, in terms of the liquidity outside of the bank is certainly very stable and all the steps that we have taken, I think, so far this year, have put us in a pretty good position there.

Robert Napoli – Piper Jaffray

Have you bought back anymore debt this quarter so far at a discount?

Thomas Fink

A tiny piece, I would say.

Robert Napoli – Piper Jaffray

Okay. Thank you.

Operator

Your next question comes from the line of Donald Fandetti from Citi. Please proceed.

Donald Fandetti – Citigroup

Good morning. John, I was wondering if you can give us a little more color on what you're hearing from your middle market corporate borrowers, and talk a little bit about the last few months in the business and what their outlook is.

John Delaney

Sure, Don. I mean, it depends on the profile of the company, obviously. We've got a lot of middle market borrowers in the healthcare business and which I would say view this environment as completely kind of unaffecting them. We have a lot of middle market borrowers in, for example, that we've built a growing kind of security alarm and kind of defense, if you will, oriented business. And I think they're generally experiencing decent growth right now even through the economic times. So that part of the middle market borrowers is not experiencing anything.

Then you go to the other segments of the portfolio, which include retail, media, and then kind of our generalist practices which have manufacturing companies and consumer product companies, and then we also have a technology business. The technology business is not really seeing any material effects. Obviously, there is some softening in how they're viewing the world next year, but most of the businesses are pretty well positioned defensively. But those other three areas – or the other four areas, retail, media, consumer products and kind of business services, I think we've seen more kind of slowdown, if you will, or more pressure on the media companies than we're already seeing. I would say the retail businesses have held in there surprisingly well, would be my view. I think most of them are gearing up for a pretty tough holiday season and adjusting their projections downward quite a bit for the next year. So that's kind of what's happening in that sector.

And as far as business services and consumer products, we haven't seen anything yet, but I think the numbers we'll start seeing soon, right, which will start reflecting the September-October performance, I expect them to be soft based on what I'm seeing in kind of larger companies that have information kind of coming out already. So I would describe it as mixed, the results in general, with certain companies doing fine and feeling pretty good, and other companies that are a little more in the center of the center experiencing some softness already and gearing up for some softness in the future.

Donald Fandetti – Citigroup

Okay.

Operator

Your next question comes from the line of Andrew Wessel from JP Morgan. Please proceed.

Andrew Wessel – JP Morgan

Hey, guys, good morning. Just I guess a couple – one follow-up on credit. You talked about the four loans that had been – you'd been focusing on for a while that caused the majority of the charge-off. Could you kind of give any detail on why those were outliers or maybe talk about one of the loans as kind of a case study, so we can understand what a more typical charge-off might be? And then also, I guess, back to Bob's question about the range going forward, you haven't talked about staying within that historic kind of top 125 basis points of the range. Is that still out there or is it possible you're even going higher than that?

John Delaney

Well, let me break that to two components, right, which is the four borrowers that are higher charge-offs and what's happening there without going into specific company details because most of these companies, when they're in workouts – when they're dealing with charge-offs, there is some sensitivity around the company disclosure, our position with the company, et cetera that make it hard to kind of talk about on an open conference call. But I would say which – what's really happened there is the workouts across the company kind of fall into a couple of different categories. You have asset based workouts, which tend – generally perceived pretty quickly. We take aggressive action and liquidate the collateral. In commercial real estate, things generally move pretty quickly as well, which is you either work out some restructuring with the borrower where they typically have to infuse equity into the project or the situation or you move towards foreclosure and then you foreclose on the asset. It becomes REO and you get an appraisal. You mark it to market, and then you sell it. And so those tend to be pretty straightforward. In kind of what I would call kind of the larger corporate finance business, the workouts tend to be more complicated because your immediate reaction is not to liquidate the collateral that underlies your loan because your primary source of repayment is through the business, because you've lent more on an enterprise basis. And so what typically do is engage in some form of workout with the private equity sponsor that owns the company. That can involve a whole variety of situations. The good situation is they put money in to support the company in bad situations or they don't put money in to support the company, but they work with you to bring in turnaround people and look to turn the business around and then either refinance you out or sell the business.

And it's that latter category where you're making judgments about, (A) the likelihood of the turnaround; (B) how long it will take; and (C) what the recoveries will be. I would say in those – in that category where based on the current environment, we are kind of, if you will, whacking the assumptions much harder than we ever have, and I would say viewing some of these recoveries are moved from the possible to the highly unlikely. And so that's really what occurred in most of the situations, the four larger situations, which I think is totally appropriate and totally prudent, because if you were evaluating a business plan right now, which is what some of these turnarounds tend to be, you would obviously have a very dim view of the likelihood of successfully executing against a business plan when you consider the headwinds we're facing.

So I think what really changes is the assumptions. The analogy would be if you foreclosed upon commercial real estate now and you had it appraised, which is in many ways a simpler process. The assumptions that go to those appraisals will be more conservative than they've been in the past about what the cap rate of the asset is, et cetera, and it translates into a lower appraised value. When that – if you apply that same kind of approach to these enterprise value loans, what you're really doing is saying the prospects of the business are much worse. The likelihood of achieving some level of turnaround is much lower and therefore, we need to reduce our pairing value in the asset. And that's really what happens.

Andrew Wessel – JP Morgan

Okay, great. And then on the – I guess my follow-up will be on compensation expense in the quarter, kind of a housekeeping thing. It was down pretty significantly from the previous quarter, I would have thought, with the bank than it would have been up with possibly a higher headcount or something of that nature. Can you give us some guidance on what we should be expecting going forward from a compensation line?

John Delaney

Sure. Well, just in OpEx in general, I mean, it was down in the quarter for a couple of reasons, or principally, because as we outlined in the release, some change in our incentive-based comp accrual for this year, just, I think reflecting the realities of 2008, offset by the increases you point out of op expense related to the bank. Those two things offset somewhat a net reduction, but somewhat offset by the increase in the expense of the bank. However, for the bank, you really only have two months, just over two months of activity there, not a full quarter's worth, so to kind of give you a sense for that, if I was to look at this quarter and say, on a run rate basis, what would it look like, based on the new incentive comp accruals and fully loaded, if you will, for the bank, probably a number around $70 million is the right number there with the comp line itself being probably 35 million, 36 million of it.

Andrew Wessel – JP Morgan

Right. Thanks a lot.

John Delaney

Okay.

Operator

Your next question comes from the line of Sameer Gokhale from KBW. Please proceed, sir.

Sameer Gokhale – KBW

Thank you. In those two businesses you highlighted, the LBO finance and then the CRE business, what percentage of each of those businesses consist of the '06 and '07 vintages if you can just remind us of that. And then just in both those businesses, were those charges taken for senior loans or were those mezz loans if you can remind me of that. And then I just have a quick follow-up.

John Delaney

Well, we're digging through some of the data. I think they're all senior loans.

Thomas Fink

Yes.

John Delaney

So I think that's pretty – most of what we do is senior lending so –

Sameer Gokhale – KBW

Okay. And then on the '06, '07 vintage?

John Delaney

I don't know if we have the charge-offs by vintage in front of us here.

Thomas Fink

I don't have the origination dates.

John Delaney

Those loans have been in the portfolio – those have generally been problem loans for some time, so it's I would – and we didn't originate all that much, seven across the whole portfolio, and we did it in the early part, not in the second half, so we'll get back to you on that, but I would assume they're pre-'07 vintage loans.

Sameer Gokhale – KBW

I actually meant more in terms of the end of period loan portfolio and sounds like if you look at both of those businesses, is it safe to say something like 65% 70% of the loan portfolio themselves are kind of the '06, '07 vintages?

John Delaney

I think that's probably fair to say.

Sameer Gokhale – KBW

Okay. And then just the follow-up was – I think, Tom, you talked about the debentures and what was puttable in March of '09. Would you anticipate if those debentures are put to you, would you anticipate repaying those by issuing stock like you did in the most recent transaction? And then if you were to become a bank holding company, does that constitute a change of structure in any way which would make the remaining – I think there is another 500 million, 550 million on top of that debt. Would that also become puttable in '09 if you were to change the structure?

Thomas Fink

Well, just to answer your last question first there, no. I mean, there is no impact related to us becoming a bank holding company or otherwise that would affect that debt. With respect to those convertible debt that are redeemable in March of 2009, again, about $180 million of remaining balance there, our requirement is to pay cash upon a redemption like that. So I would say – I would describe as what we did earlier – not this month, but in October as being opportunistic and don't currently have any other plans to do that with respect to the rest of it.

Sameer Gokhale – KBW

Okay, thanks. I'll get back in the queue.

John Delaney

Yes. And since you – just if can just go on for one more second, since you touched on funding, I think important point that I missed, because Bob Napoli also asked a similar question about this is that with respect to the non-bank business, a very large percentage of our assets are housed in permanent matched funded securitization. So we've about $4.6 billion of loan balance funded with securitization, so that's very important because going forward, we're growing the business through the bank and the non-bank part of the business is sort of a stable portfolio that mostly is match funded.

Sameer Gokhale – KBW

Okay. Thank you.

John Delaney

Yes.

Operator

Your next question comes from the line of Mike Taiano from Sandler O'Neill. Please proceed.

Michael Taiano – Sandler O'Neill

Hi, thanks. A question or a clarification on how you report the credit performance for the participation interest. Is there any impact on your credit numbers from that? And I noticed you said that the – I guess the credit reporting will be different on your call reports. Can you just go through that a little bit?

Thomas Fink

Sure. The "A" participation interest is a loan, accounted for as a loan, it is a loan. We are not showing it in our – if you look at our balance sheet, you see it listed separately from loans. And the reason for that is for us it's a single large asset. We kind of folded it in the loans it would really distort all of our average balances and all the other metrics that you all are used to looking at. So we show it as a separate item. I think the point about the call reporting at the bank has to do with the fact that there are underlying assets there and we are also not including in our credit stats the credit stats of those underlying loans, because with respect to the "A" participation interest, it's completely irrelevant. As John mentioned, we're entitled to 70% of the amortization principal collections that come in. The current balance is only 35% of the underlying loan balance, so if some percentage of those loans are delinquent, it really doesn't impact the credit performance of that business. So we certainly, because it's a loan, consider it with respect to impairment, and obviously, it's extremely well secured and there is no reserve that we have on it, and we expect that loan to be – the "A" participation interest to fully pay off over the next 12 months as I said.

Michael Taiano – Sandler O'Neill

Okay. Thanks. And then I just had a follow-up. With respect to the bank holding company application, can you give us some sense of what the timing would be in terms of getting approval for that, and then also do you have any interest at all in applying for the TARP?

John Delaney

Sure. I think it's probably not appropriate for us to comment on the timing other than to make kind of two general observations. The first is that this filing, these areas, disapproval that we have from the State California in the commercial bank holding company, we always anticipated and was part of the business plan that we filed when we acquired the assets of Fremont.

And in fact, our preference at the time would have gone direct to – would be to go direct to state bank and bank holding company status, but I think everyone viewed acquiring it as an ILC as the best decision at the time, because everyone was concerned us, the sellers, the regulators, about the deal getting done quickly. And so the fastest path was to buy it with effectively, the same charter the company had. And so this conversion was always embedded in our business plan and we had, in fact, started the process, meetings with the regulators that we were required to meet with, et cetera, in early October. Late September, early October is when we really started this conversion process, so we've been at it for a while. I don't want to comment specifically on timing because that probably wouldn't be appropriate, other than to say that this has been in process for some time.

As far as the various benefits that are available to banks from the government, we view them as attractive and I think would avail ourselves of whatever we thought was appropriate and whatever we (inaudible) for. So I think you should assume that we're actively pursuing all of those things – again, without commenting specifically, which wouldn't be appropriate, but in terms of our position, I hear some banks saying they don't want these benefits. I still have not been able to figure out why someone would not want these benefits based on the math. So you should assume that we're in that camp.

Michael Taiano – Sandler O'Neill

So just to clarify, so just the fact that you guys seem to have a significant amount of capital at this stage wouldn't necessarily preclude you from pursuing additional funds from the government?

John Delaney

It's like anything else. If the funds are very attractive – the purpose of these funds, and I'm actually a big believer in the preferred stock program as an alternative to the asset purchase program, because I think it's lot more efficient and you get a lot more bang for your buck. The purpose of these funds is to encourage lending and it's a very, very difficult economic environment, as we all know. And one of the ways out in this difficult economic environment is to have credit in the system and banks really still aren't lending, even though they're getting this capital. We have been lending consistently since we acquired the bank. We view it as an attractive lending environment. You have to be careful, you have to be focused, and you have to structure deals in a very tight manner. I think the more capital you have particularly if it's very attractive capital like this, it just puts you in a position to do more lending, but I think lending in '08 and '09 will turn out to be some of the best lending that's been done. So I think anything that puts us in a position to do more lending, and doesn't come with too high a cost, we would take and so I think this capital from the government falls squarely in that category.

In other words, it positions us to do more lending, even though we have 16% capital and even though CapitalSource on a consolidated basis may have the highest capital levels of any bank holding company in the country, more capital still positions us to do more lending. The game today is liquidity and to the extent we can access more liquidity at a very low cost. That just feels like not only the right answers for our shareholders, which totally is, but it feels like what we should be doing. And so that's kind of our orientation on that.

Michael Taiano – Sandler O'Neill

Okay. And do you need the – do you feel you need the bank holding company to be eligible for this or you think without it even if it came after the deadline, you'd still be eligible?

John Delaney

I think – again, these are very fact specific questions. I think it's fair to say that the profile of our bank is exactly the kind of bank that they want to have get this capital. The other thing that's worth noting I think is – and I think again, this is appropriate. I think the point is to put this capital in the hands of strong banks, right, because they want strong banks to lend and they want strong banks to buy weak banks. And again that, that I think is the absolute right policy orientation. So I think we clearly fall into the category of people they want to have access to capital.

Michael Taiano – Sandler O'Neill

Great. Thanks very much.

John Delaney

Sure.

Operator

Your next question comes from the line of John Hecht from JMP Securities. Please proceed.

John Hecht – JMP Securities

Good morning. Thanks for taking my questions. First question is related to margins. In the context of LIBOR, which has moved markedly lower in the past few weeks along with your asset and liability sensitive to LIBOR, along with the deposits, what can you tell us to expect in terms of near-term margin movement? Also in that is how many loans are at their LIBOR floors and details around that?

Thomas Fink

Sure. With respect to margin, I think we clearly expect the margins to improve. As I tried to highlight in my remarks, we're sitting on basically a lot of cash and liquid investment principally at the bank, and just turning that into loans will do a lot to improve the margins. The cost of funds – so if you look at the various components, loan yield was down a little bit this quarter, principally due to, as I mentioned, the prepayment related fee income being down. That's a number it moves around every quarter and we certainly talked about that at length in prior quarters. And so we'll expect to see some volatility there. Some of the other – the rest of the decrease in loan yield in the quarter was explained by – obviously, with an increase in non-accruals, there is some income you're not getting this quarter that you had last quarter.

That explains virtually all of the remaining variance. There is a little bit of noise this quarter related to prime based loans where even though LIBOR was pretty flat in the quarter, prime – average prime was down. So on those loans we were down a little bit. Prime-based loans are about 24% of our total commercial lending assets. So going forward, what do we think is going to happen with loan yield. As we continue to make new loans in this new environment, all other things being equal, we would expect loan yield to increase, right, because there's just higher spread available.

In terms of cost of funds in the business, we talked about – I already talked about the beneficial effect to deposits. We expect that benefit to grow as we have a greater percentage of deposits in the business. Away from the deposit business, I would say our cost of funds on our other sources of funds was high this quarter. If you do the math on it, the commercial segment was about 375 basis points over LIBOR. Part of the reason it was high was because during the quarter, we sold some loans into the bank. We used the proceeds to pay down those sources of funding and in some cases, permanent lease, which resulted in acceleration of deferred financing fees. So kind of cutting through all that. I would expect over the new few quarters in the commercial segment our non-bank cost of funds to be more like 300 over. So those are kind of the big components for, said, but I think the most powerful thing in terms of the margins is going to be deploying the cash and liquidity we have and investing it in higher interest earning assets, namely commercial loans.

John Hecht – JMP Securities

And on that front, I think John referred to both new loan opportunities and secondary loan opportunities, (inaudible) 270 odd million of originations this quarter. Can you characterize this more? Where're you finding more opportunity? What kind of spreads are you finding those at?

John Delaney

Hey, John, this is John. I would say that – and that was the funding this quarter. The approvals and things that are set for funding is quite a bit larger than that, more than 2X that in terms of just activity. We're seeing them on both fronts. I would say that we're really focused from a direct origination perspective in our healthcare business and a few of our other businesses that we view more defensive and we have some of the biggest pipelines we've ever had in those businesses. And the new origination spreads are kind of 6 to 700 over LIBOR with 300 basis points upfront and very tight structures.

There are some secondary opportunities that we've been pursuing which fall into two categories, existing loans that we have in our portfolio where we sold pieces of the credit to other lenders and we have an opportunity to buy them back, and then just some secondary opportunities in credits that we're familiar with, where we're buying some in the secondary market at call it 900 to 1200 over LIBOR. And these are all bank eligible loans, which means they're not kind of pick toggle high leverage situations. These are things that fit kind of a higher underwriting standard that we believe is appropriate for the bank. So I would say the real challenge is the secondary market presents better return opportunities than the primary market, which is one of the problems with the primary market, which is why should you make loans when you can buy loans at a better spread. And borrowers can't really borrow at the kind of spreads where you can buy loans. That situation will ultimately fix itself. How long that will take is not clear, maybe two or three quarters. But – so I think our view is to essentially continue to push direct originations at high spreads and businesses that we view as our real franchise businesses that we think the type of loans we originate are very safe in this environment and to push hard originations there.

I think for secondary stuff, the secondary stuff we're looking at is more in the corporate finance world where you can buy kind of very strong credits at spreads much wider than where you can originate new middle market credits with companies that are not as strong. So that's where the focus is on the secondary side. But I don't want you to conclude that the vast majority of what we're doing is secondary. We're still doing lots and lots of direct origination. We just see the secondary opportunities as somewhat unique and kind of more focused on certain parts of our business.

John Hecht – JMP Securities

Okay. Thanks very much.

Operator

Your next question comes from the line of Moshe Orenbuch from Credit Suisse. Please proceed.

Moshe Orenbuch – Credit Suisse

Yes, thanks. Most of my questions actually has been answered. I was just wondering, John, if you could just flesh out a little bit more about how you think the interplay between the liquidity that you do have and kind of the bank guidelines in terms of the amount of opportunities that you will have available. And again since you said (inaudible) in the secondary market seems like that should be – I don't want to say limitless opportunities, but how do you kind of narrow those down?

John Delaney

Well, the way we're looking at it, we have lots of excess liquidity in the bank. The bank liquidity is obviously growing as well, because the (inaudible) paying down and we have the ability to raise deposits, right, because we have plenty of capital. We've let deposits shrink in part because we don't need all the deposits we have and we didn't want to be competing on rate. I think that's turned out to be the right decision because now the markets actually firming up and a little bit of the insanity that was going on in terms of bidding up the positive to starting the pass, as people like WaMu and Wachovia have been absorbed.

So the question is what do we do with the bank cash because it's plentiful and we want to optimize it. We need to optimize it not only with our very high credit standards, but also with the credit standards for the bank, which do filter out certain things that we would consider appropriate and safe loans, but don't necessarily meet kind of a higher threshold for the bank. And so the strategy has been, let's pick our best business as businesses where real franchise value and businesses where the kind of loans they originate are safe in this market, and let's push those hard on a direct origination basis, and that's what we've been doing. And then in other businesses like corporate finance, for example, you can buy a piece of the senior debt to Wrigley's, which is kind of a 28% loan to value senior loan to the largest candy company in the world with Warren Buffet and the Mars family as your sponsor. You can buy that loan at 600 over LIBOR and so it's very hard for a middle market leverage buyout to compare to that from a risk adjusted return perspective.

So we've obviously broadened the number of things we're looking at as an alternative to direct corporate finance originations to include secondary stuff. The problem is there is a tremendous amount of secondary stuff out there and everyone's talking about how great the deals are, and you hold up one prism, the deals are great, which is the loans will be covered on a loan to value basis, but when you hold up another prism, you say to yourself, it will be impossible for these companies to refinance out this debt, and the likelihood of bankruptcy is actually quite high, even though it's a very big, substantial business, just because the capital structures are irreplaceable and will be that way for some time. So I would say we have generally not waded in and bought just secondary big deal LBL [ph] paper in abundance in part because we think a lot of that stuff is not bank eligible, even if the loan is technically covered on a loan to value basis and in part because we think, again, while the loan may be covered, there's probably going to be a lot of noise in those credits in maybe not even '09, but in '10.

So what we've tended to focus on in the secondary stuff is just this kind of more limited couple of handfuls of deals that we think were very well structured didn't necessary seek a lot of leverage. They're trading at good discounts, but not as deep a discount as some of these other things I mentioned, and tend to be in industries we know a little more about. So for example, we've looked at a lot of healthcare secondary paper, stuff like that. So it is a huge opportunity out there, but when you approach it with a bank balance sheet, which we are, you do screen out a lot of things, and I think there is good merit to a lot of that actually, because again, I think a lot of these things are covered on a loan to value basis, but you sit back and unless there is a dramatic change in the capital markets, it will be impossible to refinance out, these debt capital structures. And so what's going to happen? How is the interplay going to be between the lenders and these highly levered, out of the money private equity sponsors? What tactics will they take to try to recover some equity value, et cetera? And I just don't think we want to be in the middle of any of that stuff, particularly with a bank balance sheet.

Moshe Orenbuch – Credit Suisse

Great, thanks.

Operator

Your last question comes from the line of Omotayo Okusanya from UBS. Please proceed.

Omotayo Okusanya – UBS

Hi, yes, good morning. A quick question, kind of given how soft the credit markets mean, what are you generally seeing in regards to your interest only loans as these loans are coming up for maturity? And is that a concern for you going forward if the market kind of remain as tough as they have been for the next six months?

John Delaney

Well, no, the – a lot of the interest-only loans we have, for example, lot our asset-based revolvers are interest-only loans, and those loans have always been interest-only loans and if they're still in conformance, we would view ourselves as rolling the revolver, probably at higher spreads, right? So on its face, the answer is no. I think to the extent we have interest-only loans in our commercial real estate world, for example, where refinancing was a more appropriate outcome, the question is going to be do we have the right loan to value? If we have the right loan to value, I'm not worried about it because the owners of the business will have to find something to do or we'll just take the property and sell it. So I think the answer on interest-only loans, which on their face are not problematic, because, for example, in my judgment, the safest loans that anyone can make are asset-based revolvers and they are interest-only loans, right? So I want to make sure people don't hold up interest-only loans against a light of negatively all the time because often times, some of your safest loans are interest-only loans. I think you're probably referring to more interest-only loans in commercial real estate, which do have refinancing risk and refinancing takeout. I think it all depends, if you go in with the right loan to value. If you went in with the right loan to value, even with deterioration in value, which has occurred because I think it's fair to say, there has been massive deterioration in asset values across every asset class, right? So everyone's loan to values are higher, right?

And so the question is do you have enough loan to value? Because if someone won't refinance you out – if it's commercial loans it's pretty straightforward to plan. They either refinance you out or you foreclose because even in a liquidity starved market, there's a bid for most assets, sometimes just a low bid by an all equity bidder. And so our view is we're not going to play the game of extensions and all those kind of things as much in real estate. We think we're in a good loan to values and if people don't pay us off, we'll move to foreclose and we'll either have to sell the asset or we'll foreclose and sell the asset. Again, I want to put this in context. Commercial – we're not a – commercial real estate is 17% of our portfolio, right, so we're not talking about a company that's dominated with commercial real estate, but we do have some and we've obviously thought a lot about it, about what our plan is going to be. And we feel in the vast majority of our situations, we're in a pretty good spot from a loan to value situation, and should loans come up for maturity, we think we'll work through them fine.

Omotayo Okusanya – UBS

Okay. Just one quick follow-up question. Given that you guys have tried a few moving parts over the next few months, can you talk a little bit about how your sense of prioritize that, whether it's still looking for opportunities (inaudible) the healthcare, REIT, focusing on CapitalSource Bank, winding down the REIT. Can you talk a little bit about the prioritizing all those things you're going to be juggling as well as your view of potential opportunities and risks that you could see over the next six months to nine months?

John Delaney

Right. You're showing a lot of insight into our business because that is one of the issues we're dealing with, which we have lots of things moving around and we're trying to kind of lock down on what our plan is on all these things. So let me try to go through it as best we can, right.

The first thing, which is the de-REITing, that doesn't necessarily have a lot of that – there is a lot of things that have to be done there, but really, from a balance sheet perspective, the two things we're going to do is in January, we're going to sell our Agency Portfolio, which is mark-to-market and we should be able to liquidate that in a pretty efficient way. And then we have this Owners Trust portfolio, where we have relatively small equity investment in a large pool of matched funded residential assets. And it's our view we're going to try to look to sell that as well. That's a more complicated asset to sell because it's not an agency, but it's essentially a residual interest in a pool, high quality loans that, by the way, still performing pretty darn well. So we – and we like doing that because we think when we're done, we've got this low-levered balance sheet and the company looks simpler, little over three to one leverage and I think people could get that much easier, and it eliminates a lot of noise and distraction that we've unfortunately suffered through for something that was supposed to be a lot easier than it turned out to be in fairness. So that's one component.

The second component is kind of the regulatory front, which we essentially have been at that nonstop since June because this whole thing about becoming a bank and becoming a bank holding company, this is not some new, last minute, run around because of the stuff that's come out from the government. This was part of our business plan way back and we had started it already, and we had always planned for this to be kind of a round year-endish kind of thing, give or take a few months. And so that's kind of a work stream that's been going on for some time and again, there is complexity associated with it, but it's continuing what we've been doing, right, so that's kind of our view there. And then it comes down to, okay, those are kind of the more structural aspects that we're doing, which are kind of two separate work streams. Then it comes down to – okay, what about the balance sheet in terms of how we make money? We're very – I think we're up and running with a fairly refined view as to what we want to do on the lending side. It's taken some time to both get things ramped up again, right, and also to get things ramped up with this new extra filter of what's appropriate for a regulated depository. I think we've figured that out and I think we're kind of firing on all cylinders, recognizing there is still some more tweaks we want to do, but we're generally firing on all cylinders on the lending side, making loans, engaging in smart, sensible lending. We've kind of got our asset allocation headset on. In other words, we kind of know where we want to focus and then it's just about finding the right opportunities and doing the credit work, et cetera. So that's working pretty well.

And then there is the ongoing portfolio management challenges. We have a legacy portfolio of assets that we manage in a very intense, proactive way, and obviously, based on what's going on in the market, part of our asset management headset moves little more towards special servicing because you do anticipate there being pressure on more of the borrowers and you just have to be ready to deal with that. So that kind of is – that's always been a very strong part of our business with lots of talented people and they're up for the challenge. So those are kind of the four kind of obvious things we should be doing day to day. And then what would complicate things, and what I would say we're not necessarily looking for is there is a lot of strategic stuff that are coming our way. The number of opportunities we're seeing to both buy asset platforms and depository platforms is pretty darn significant, and just sorting through those things does take time. I don't think we have a refined view at this point as to what we want to do. We don't feel like we need a lot on the asset side. There is always things that could be additive and useful, but don't – we're not really actually looking for stuff on the asset side.

And on the depository side, if there was a detractive depository in California that enhanced our footprint and also allowed us to have more services, because we are going to be a commercial bank, we do want to offer more services to the borrowers. And we're going to have to build that stuff because the bank doesn't have a lot of it right now. If things came in that enhanced that, I think we would look at them, but I think as you're pointing out which again, I said is pretty insightful we do have a lot going on. So I think as stuff comes in, it's got to be held to a pretty darn high standard for why we would do it, because we don't really feel like we have to do anything, that we've got a pretty good business plan in front of us, and a very good opportunity. We've got a lot of wood to chop for a few more quarters to get it all where we want it to be, but that's kind of how I view the business.

Omotayo Okusanya – UBS

Thank you very much. Best of luck.

John Delaney

Thank you.

Dennis Oakes

Thank you everybody for listening, and just a reminder that the call will be archived on our Web site later today.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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