CapitalSource Inc. Q4 2008 Earnings Call Transcript

Feb.27.09 | About: CapitalSource, Inc. (CSE)

CapitalSource Inc. (NYSE:CSE)

Q4 2008 Earnings Call Transcript

February 27, 2009 8:30 am ET

Executives

Dennis Oakes – VP, IR

John Delaney – Chairman and CEO

Thomas Fink – SVP and CFO

Dean Graham – President and COO

Analysts

Sameer Gokhale – KBW

John Hecht – JMP Securities

Bob Napoli – Piper Jaffray

Scott Valentin – FBR Capital Markets

Operator

Hello, and welcome to the CapitalSource fourth quarter and full year 2008 earnings conference call. All participants will be in a listen-only mode. (Operator instructions) Please note this conference is being recorded.

Now I would like to turn the conference over to Dennis Oakes, Vice President of Investor Relations. Mr. Oakes you may begin.

Dennis Oakes

Thank you very much and good morning, everyone. And thanks for joining for the CapitalSource fourth quarter and full year 2008 results and our company update call. Because of the depth of information we are providing in our prepared remarks this morning, we expect today's session may run somewhat longer than usual.

With me are John Delaney, our Chairman and CEO; Dean Graham, our President, and Chief Operating Officer; and Tom Fink, our Chief Financial Officer.

The call is being web cast live on our Web site and a recording will be available beginning at approximately 12:00 noon today. 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 statements made on this 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 now to John Delaney. John?

John Delaney

Thanks, Dennis. And good morning everyone and thanks for joining us. While this is our earnings call for the fourth quarter – fourth quarter 2008 results, we will spend just a short amount of time on the actual results, and instead want to devote more time to additional areas that we think are important for you to understand.

We realize investors want to have as much information as possible about the company, and we are happy to provide it. We would like you to understand how we think about the business, and what the thought process is underlying the decisions we make. We always act in a manner we think will produce the best long-term success for the company, and believe we have made the right strategic moves. By providing this additional information today, we hope you will gain additional insight into the important challenges and opportunities facing us.

Specifically, this morning I will discuss the several components of value we see in the business, our strong capital position and credit with a particular focus on our legacy loan portfolio. Tom Fink, our CFO, will review our fourth quarter performance and talk about our funding and liquidity, and Dean will touch on a few aspects of CapitalSource Bank, and provide some parameters around which to think about our 2009 financial performance. And I will then add some summary points to make in conclusion.

Of course, we are also happy to answer any questions you have about these items, the quarter or other items during the Q&A session. But I want to reiterate that it is our hope that upon conclusion of this call, you will agree with our assessment that CapitalSource has greater potential and greater value than the current market implies. At a minimum, you will have all the facts, and you can make your own informed decisions. So to start, Tom will talk briefly about the fourth quarter results.

Thomas Fink

Thank you, John, and good morning everyone. I just got a few points to make about our results, as our release is very descriptive and we have a lot of additional information we also want to cover on the call today.

Also we did preview the quarter a few weeks ago, and the big drivers of our fourth quarter results are consistent with what we previewed. In short, the fourth quarter was a difficult quarter, both for the economy in general and also for CapitalSource. Our quarterly results were a net loss of $1.07 per diluted share, and adjusted earnings of $0.55 per diluted share.

As previously disclosed, the fourth-quarter results were impacted most significantly by the substantially higher provision for loan losses. John will give some more insight on credit a little later on this call, but in summary, in the fourth-quarter we recalibrated our credit outlook for what we see happening in the US economy, how it impacts specific loan situations, as well as how it informs our general view of the loss inherent in our portfolio.

Provision you see this quarter is consistent with what we – with that view as we funded higher charge-offs and funded a significant build in our reserves. The charge-offs this quarter were $184 million compared to $85 million in charge-offs during the third quarter, and $299 million for the full year.

We expect that we will see higher than normal charge-offs throughout 2009 and into 2010 though not at the level of the fourth quarter of 2008. This expectation drives the significant build in our allowance for future loan losses, specifically the allowance 12/31/2008 was $424 million or 3.89% of commercial lending assets. This compares to a loan-loss reserve of 1.48% at September 30.

Both our quarterly charge-offs and our 12/31 are slightly higher than what we previewed a few weeks ago with adjustments due to refinements as we completed our year-end review process. Clearly, this is a substantial build in our reserves, but we felt it was prudent to get in front of the deterioration now, and rather than expect to play catch-up in the future.

To be clear, we certainly expect to have additional provision for loan losses in 2009, but our expectation is that it will be at lower levels than what we saw this quarter.

In addition to credit, below the line other income and expense was the other major item impacting the results this quarter, and we had previewed that as well. As laid out in detail in the release, other income swung to a significant loss this quarter due to a variety of factors.

First, we had a $70 million gain on the repurchase and extinguishment of debt last quarter compared to just $4 million this quarter. Also, we had a $40 million loss on investments this quarter due to write-downs on certain cost-based investments and other than temporary impairments.

There was a $30 million mark-to-market loss on our Agency MBS in the residential mortgage investment portfolio due to the widening of mortgage spreads and a $21 million mark-to-market loss on derivatives related to swaps that we used to hedge interest rate risk in our commercial loan book. The loss was primarily due to the significant drop in short-term interest rates that occurred during the quarter.

Additionally, we had a $24 million loss that we had previously disclosed due to an exchange of convertible debt to common shares that occurred in October. And finally in aggregate of $32 million in losses due to other items such as write-downs in the value of REO, and net foreign currency losses.

Obviously, a number of things rose against us this quarter in other income, but let me make a couple of important points about other income going forward. First, it has been historically a source of much volatility in our GAAP results, and as we have discussed before, with our revocation of our REIT election, and the simplification of our business as we transformed to a bank, we believe that volatility from other income should be less going forward.

Second, some of the other income items this quarter were unusual in nature or one-time. And third, we expect that some of the losses that we saw in the fourth quarter will actually reverse somewhat in the first quarter. For example, the loss in the residential mortgage investment portfolio will be a $14 million gain in the first quarter, as we have now completely sold the Agency MBS in this portfolio.

Furthermore, that line-item simply will not exist in future quarters. Also, we would expect much lower derivative losses related to interest rate swaps going forward, the loss this quarter was due to the significant drop in short-term rates during the fourth quarter, and we are now in a very low interest rate environment. LIBOR, practically speaking cannot go much lower.

So far this quarter, LIBOR and swap spreads have been stable, and therefore we expect derivative gains and losses also to be stable and in fact we could see a reversal to a gain if short-term terms and forward swap rates start to rise.

So with those comments made, let me turn the call back to John.

John Delaney

Thanks Tom. Looking ahead at 2009 and beyond, let us review how we think about the business. I will start high level and then drill deeper. As many of you may have heard me say before, CapitalSource is in many respects a tale of two companies. Right now, we have distinctly different issues confronting our bank and non-bank entities. Accordingly, we have a two-pronged play offence and play defense strategy to address each appropriately.

Our play offence strategy centers around our bank. We have married our national middle market origination platform to a large stable depository funding platform, which positions us to capture attractive lending opportunities in a market with little liquidity.

Our play defense strategy for our non-bank entities, which we will spend most of our time on this morning centers around our efforts to simplify the business, and solve the issues stemming from the breakdown of the capital markets, and the massive balance sheet deleveraging, which is affecting the economy and financial firms in particular.

2009 is a transition year for us. We have revoked our REIT election, we have as of this week completed the unwinding of the Agency MBS portion of the residential mortgage investment portfolio and we are transitioning to a bank. This transaction will take time to complete.

Outside of CapitalSource Bank, we are managing our legacy portfolio to minimize credit losses and working to revise and extend our existing credit facilities for that portion of the legacy portfolio that is not match funded.

As I said at the start of the call, we do believe there is significant value in our business, certainly more value than the market currently is giving us credit for. From a value perspective, we view the business as having 4 component parts. First, we have CapitalSource Bank in the commercial lending asset platform that is married with it. We believe this business is very well positioned because it is a clean and well capitalized bank, paired with a first rate asset platform.

At year-end the CapitalSource Bank balance sheet showed $6 billion in assets, including $1.9 billion of cash and liquid marketable securities. The bank holds the "A" Participation Interest, which is a highly secure investment in paying down rapidly to provide even more liquidity, and the bank has approximately $2.7 billion of our loan portfolio.

It is a clean portfolio with currently no delinquencies or non-accruals, but a good measure of our reserves based on our macro view of the economy. The bank has $5 billion of deposits, but our branch network, we believe, can support twice the amount of deposits without the need to add a single branch. Most of our 63,000 customers have been purchasing CDs in our branches for three years or more. So, we also view our deposits as sticky.

We have access to other sources of funding as well including FHLB advances, but we currently don't forecast the need to access them due to the already strong liquidity and deposit franchise of the bank.

From a value perspective, CapitalSource Bank has a $916 million book value. We believe this is a great and highly desirable asset that one day when markets return will be worth some multiple of book, and today at a minimum is worth book.

Second, we have our healthcare net lease business, which we also call CapitalSource Healthcare REIT. With our revocation of our REIT status at CapitalSource in December, we took steps to preserve the REIT status of this business as it is comparable to other publicly traded healthcare REITs.

In our Healthcare REIT business, we own approximately $1 billion of healthcare sale-and-leaseback assets with only $330 million of property specific debt. The sale-and-leaseback assets are long-term financings to well manage and strong cash flow in nursing homes. We view these as highly defensive investments and they are a very attractive place to be investing in today's environment.

We believe that our book value in our Healthcare REIT business is certainly worth that number if not more based on a market comparable analysis.

The third value component we have is $4.6 billion of our commercial loans that are permanently match funded in commercial loan term securitizations with $3.6 billion of debt. We essentially own a 29% residential interest in this pool of loans. There are 6 securitizations outstanding that make up the pool. They fall into two broad categories. Four high leveraged securitizations worth $3.3 billion of loans set against $3 billion of debt.

Our residual investment is approximately $350 million or approximately 11% of the assets, which caps our economic losses. One of these securitizations are 2006-A securitization, where we have $1.2 billion of assets and approximately $1 billion of term debt, as a replenishment feature, that has in the past been a source of funding to us. That is as existing assets in the securitizations repay, we have been able to pledge new assets from our non-bank portfolio into that pool.

The replenishment period is still open. So, we may have opportunities in 2009 to put a little more in. In addition to replenishment, the deal is structured with a $200 million liquidity tranche to fund unfunded commitments as needed in the future. There is currently $94 million of available liquidity capacity remaining.

The remaining two securitizations, low leverage securitizations if you will, have approximately $1.2 billion of loans with approximately $560 million of equity in them. We will include a detailed listing of the debt and equity in each of these securitizations has of 12/31/08 in our upcoming 10-K. The important point to stress is that those securitizations are match funded and non-recourse to CapitalSource. They have generally performed within our expectations though we currently have funded certain delinquent reserves accounts as required.

At present, these securitizations have funded delinquency reserves totaling $60 million. Finally, there is everything else. The fourth component of the business. Here we own $2.3 billion of loans or approximately 24% of our total commercial portfolio, $165 million of equity investments including $92 million of REO and our residual interest of approximately $70 million in our owner trust portfolio.

When you add it all up, we have $916 million of equity in the bank, approximately $650 million of equity and related party debt in CS healthcare REIT. $910 million of equity in the securitizations, and $1.2 billion of equity in the parent company loans pledged to credit facilities. That is how we think about the value of the business.

In terms of funding risk, we view three of the four components namely the Bank, the Healthcare REIT business, and the term securitizations as having no funding risks. Also, if you look at our principal asset, our commercial loan portfolio 28% is in the Bank and 48% is in match funded commercial loans term securitizations, leaving only 24% that is not match funded.

So, the only funding risk exists at the parent in that fourth component. Here the funding is our credit facilities and subordinate debt funding.

Let me turn the call back to Tom to go over this part of the portfolio, these credit facilities in detail.

Thomas Fink

Thanks John. First, let me start with an overview of the credit facilities including the general terms and the covenants in those facilities. In particular, I will talk about the amendment that we completed this week with respect to our principal facility. And I will also lay out our strategy with respect to the credit facilities and then discuss liquidity.

We have currently six credit facilities, which we divide into two groups, the syndicated credit facility, which is recourse debt to CapitalSource, and then five structured credit facilities, which are non-recourse to CapitalSource. The structured facilities have names like CSE Funding III, CS Europe, and CSE QRS Funding I.

In the 10-K, we will have a table similar to the tables we have had in prior filings listing the various facilities by name and some basic information about them. However, let me give you some other pertinent facts. First, the reason we have so many credit facilities is historical. When we were a REIT, we needed separate facilities for the REIT and for our taxable REIT subsidiary. Also, we have relationships with multiple lenders, and oftentimes they prefer to have a direct relationship with us through a single bilateral credit facility.

Second, each of these credit facilities is a secured credit facility with a specific collateral package. In essence, and in legal terms, the five structured credit facilities have many of the characteristics of securitizations secured by commercial loans. We own the residual in those credit facility securitizations just like we do in the term securitizations, John discussed earlier. However, a key distinction is that these credit facilities have a much shorter duration and are not therefore match funding loans.

The syndicated credit facility is different. It is traditional corporate debt and is recourse to us. It is senior secured debt of CapitalSource Inc. The collateral package for each of the structured facilities is just their specific loan pool. The collateral package for the syndicated facilities loans that is loans not pledged to the structured facilities, as well as other assets including the pledge of the bank stock, healthcare REIT stock and other assets.

At 12/31, the six facilities collectively had total principal outstanding of $1.4 billion and this breaks down to $972 million on the syndicated facility and $473 million on the structured facilities. The structured facility balance has ranged from $16 million at the small-end to $166 million and $176 million for the two large ones.

The loan collateral securing the structured facilities totaled $950 million giving them an average advance rate of about 50%. The syndicated facility is secured by a $1.6 billion of loans giving the banks an average advance rate of 64% on the loans. The banks are also secured by other assets as I mentioned a moment ago, making the total collateral package for the syndicated facility over $4 billion. In the aggregate, this amounts to a collateral-to-debt ratio of over 4.2 times.

At December 31, our credit facilities had a total committed capacity of $2.6 billion giving us undrawn capacity of approximately $1.2 billion, all but $100 million of that undrawn capacity was in the structured facilities, which would require the pledge of additional loan collateral in order to fully draw it.

Given our strategy to originate all new loans at CapitalSource Bank, this was more unused capacity than we need. Therefore, subsequent to year-end, we amended three of the structured facilities and reduced their commitment – their capacity such that the total committed capacity as of today is $1.8 billion or about $330 million of undrawn capacity.

Included in this $1.8 billion is the fact that we also met the required step down payments on the syndicated facility early to bring that commitment down from $1.70 billion to $995 million currently.

Collectively, these reductions in excess unused commitment will save us approximately $3 million in unused line fees on an annualized basis. Clearly, the lenders in these facilities are very well collateralized. Some of these facilities have maturities beginning this spring, some of those have additional one-year amortization periods, however, all of these facilities reached their final maturities or the end of their amortization periods across the next 13 to 14 months.

We are in negotiations to renew the three structured facilities that mature in March and April. However, our broader strategy is to address these near-term maturities and those facilities with maturity dates that are further out. We would like to obtain additional duration or term, and since the historical reasons for having so many individual facilities no longer exists, we would like to see if we can combine some or all of the facilities.

We think that combining the facilities would be in the lenders interest in the sense that it provides them with a broader and more diverse collateral pool. We have an excellent working relationship with our bank partners, and are confident of our ability to complete negotiations that will provide adequate funding capacity for our needs in 2009.

Quickly accomplishing the most recent amendment with the support of over 90% of the syndicate banks is a good illustration of why we are confident about the ultimate outcome of those discussions. Part of the reason we have such good relationship with our banks is because of their significant level of over collateralization. Another is that they understand well our banking strategy. And a third reason in my judgment is that they see us through CapitalSource Bank, as being a vital provider of loans to small and mid-sized businesses in this difficult economy.

And they understand the important policy implications of providing much-needed capital at this critical time. Turning now to the covenants, we have a variety of financial covenants in each of our credit facilities. I would like to spend a couple of minutes reviewing the covenants in the syndicated facility, because it is our largest facility by far and the only one with recourse to us.

The structured facilities have a more limited (inaudible) covenants but their recourse is limited to the specific collateral pool. The original agreement and various amendments to the syndicated facility have been previously filed with the SEC, but for investor convenience, we will be filing a single composite agreement incorporating the latest amendment as an exhibit to our 10-K.

The syndicated facility agreement is a complex legal document. So, I will only provide a high-level overview of the covenants on the call now. But generally speaking, I would also like to point out that terms like charge-offs that have a specific meaning for GAAP are used also in connection with the syndicated facility, but are defined differently for the purposes of the covenants.

So looking at the source material is essential for those who want to fully understand the covenant details. Briefly, the five principal covenants we track with respect to the syndicated facility and their trigger points are as follows; we have a tangible net worth covenant where we must maintain a minimum tangible net worth. This covenant is based on a formula, which starts with a certain amount and adds to its equity proceeds raised in various percentages from different points in time.

Boiling it all down, the current covenant level is that we must maintain $2.4 billion, $2,462 million to be precise of tangible net worth and we currently have over $2.8 billion. We also have a maximum leverage covenant, which is the debt-to-equity ratio, which is defined in such a way that deposits are actually not included in that.

The covenant level is six times debt-to-equity until the first quarter and 3.5 times thereafter. We are currently at 3.56 times at the end of December. However, this lower level is okay because we no longer have the Agency MBS, which is very highly leveraged, and as defined deposits are not included in the debt calculation.

We have two charge-off covenants. These measure our ratio of charge-offed loans to an average balance. There are two tests. One is for the non-bank portfolio, and one is for the entire portfolio. And here again, we use a defined term that includes GAAP charge-offs plus loans with specific reserves, loans that are more than 180 days delinquent, and 50% of insolvent or foreclosed loans that are not otherwise included in the test.

The covenant level is 6.5% and we are currently at 4%. This is a covenant that we amended in increased the level most recently. The charge off covenant for the pool, excluding the bank is similar definition, and the covenant level was 8.5% through the first quarter, going to 10% thereafter and our actual level at fourth-quarter of 2008 is 4.77%.

We have a minimum interest average covenant, which is measured based on the defined definition of EBITDA, adjusted EBITDA. This includes of earnings before interest, tax, and depreciation but also adds back the gains and losses on our residential mortgage portfolio, derivatives gains and losses, non-cash equity compensation, and other items. The covenant level is 1.5 times until the third quarter of 2009, and 1.7 times thereafter.

The fourth-quarter compliance was waived, of course, in connection with the waiver.

And then finally we have an available asset test, which is basically to make sure that there remains a sufficient level of collateral for the banks, and it is covenant defined as available assets divided by the amount of debt, and we have to maintain a ratio of 1.1 times. At the fourth-quarter, we were at 1.3 times.

As you have seen from our recent filings, we have taken a number of steps lately with respect to our credit facilities. To put all these in perspective, in December, we amended the syndicated facility. This was done in anticipation of the downturn in the economy and the pressure we thought it would bring to our portfolio, and therefore to our future covenant compliance.

In the amendment, we specifically modified the charge-off covenants to give us more room, and in exchange we made the syndicated facility a secured facility and agree to higher pricing. We knew at the time that we might need additional flexibility on that or other covenants in the future. So part of our decision in securing this facility, and I think we were right about this, was that by putting the banks in a good collateral position than, they will be able to be more flexible with us in the future.

About two weeks ago, we subsequently asked for and received a waiver of the fourth-quarter interest average covenant. This was based on the size of our expected provision in the fourth quarter, and with a temporary solution. Due to the nature of that covenant as it then existed, specifically that was trailing four quarter test, we knew then and told the banks that we would need to seek a more permanent solution via an amendment to that certain financial covenant. Just this week, actually on Wednesday we received the bank’s approval for that amendment.

We have also sought and received waivers with respect to certain financial covenants or other credit facilities as well. In connection with all this, we have assessed the adequacy of the cushion with respect to these amended covenants, and believe that the cushions are sufficient for us going forward. This amendment was done based on these forecasts, and without going into all of the details, these forecasts are based on our view of the economy, which happens to be a view that is generally similar to the views articulated last week by the Federal Reserve suggesting that the recession will last throughout 2009.

The last topic I want to address is liquidity. First, in terms of the framework, it is important to understand that we manage liquidity of CapitalSource Bank separately from the rest of CapitalSource. We call the latter that is CapitalSource Inc and all of the non-bank subsidiaries, the parent company. John has already walked through how liquid the bank currently is as well as the strength of our branch network.

We assume the bank will be retaining its earnings for at least the next 2.5 years and we do not forecast any dividends coming to us from the bank nor do we expect to make any additional capital investments in the bank. At the parent company, our liquidity sources are significantly more constrained now than they have been in the past, due primarily to the market conditions that exist.

The commercial loan securitization markets are not open, and the other capital markets remain in a much disrupted state. However, it is also true that our liquidity needs at the parent company are also generally less than they have been historically. Specifically, our business plan is to not make new loans at the parent, and that all new loans will be originated at CapitalSource Bank.

Funding the new originations in the portfolio, formerly [ph] was the largest use of our liquidity at the parent company, and no longer exists with respect to new loans. To be clear, we do have unfunded commitments at the parent company for existing loans in our portfolio, but we do not expect to be funding any new loans at the parent.

Having said all this, our liquidity at the parent is lower now than it had been in the past due to the deleveraging that has occurred across the markets generally. How that impacts us is through lower advance rates on our credit facilities, which is something we have seen occur over the last 18 months.

Our current parent company liquidity is approximately $265 million, comprised of unrestricted cash at the parent company and available amounts that we can immediately borrow under our credit facilities. The bank's liquidity is closer to $2 billion.

Our liquidity forecast for the parent company indicates that we have sufficient liquidity to conduct our business. Our forecast is based upon a fundamental assumption that we will be able to renew credit facilities as they mature as well as other assumptions about expected inflows and outflows. We intend to generate sufficient liquidity at the parent company to fund our estimated commitments with respect to existing commercial loans, the redemption in March 2009 of the convertible debt totaling approximately $118 million, our step down obligations of $300 million by the end of 2009 under the syndicated bank facility, and for operating expenses.

Sources of liquidity for the parent that we expect to be able to access include cash flows from operations, including interest and principal repayments on loans and lease payments, new borrowings under our credit facilities, replenishments under our 2006-A term debt securitization that John mentioned earlier, long-term HUD financing of direct real estate investments that were currently pursuing through HUD, other mortgage loans on lease properties and tax-free funds related to our net loss position in 2008 and carry back to prior periods.

We also anticipate generating liquidity via the sale of loans, real estate investments, and REO. And just to reiterate, our forecast is that we do have sufficient liquidity to conduct the parent company business. John.

John Delaney

Thanks Tom. Following that detailed liquidity discussion, let me review our capital levels at both the bank and parent. Our capital at the parent company at year-end 2008 was $1.9 billion, our risk-weighted capital at the parent using the required bank methodology was 20.6%. CapitalSource Bank continues to maintain a strong capital position with a year-end risk-based capital ratio of 17.4%, well above the well capitalized threshold.

I would add, since I'm about to talk about credit that the bank currently has no delinquent loans of no loans at non-accrual status as well. So let me turn now to our credit performance in the fourth quarter. Over the past six months, we have all witnessed dramatic deterioration in the economic environment. We have attempted to incorporate these circumstances into our expected portfolio performance in order to properly manage our portfolio in these turbulent times and adequately provide for losses that could materialize, as the financial and economic pressures further affect our borrowers.

Historically, our losses have been almost exclusively been company specific problems as we have carefully underwritten our loans and shied away from or pulled out of certain sectors that we felt had weak fundamentals. Over the past couple of quarters, however, we have seen declines in revenues in EBITDA in companies in certain sectors within our portfolio and dramatic declines in asset values, pushing performing companies in those sectors to work up and struggling companies to liquidation.

In the current environment, we have taken a conservative view on future performance writing down a number of loans to liquidation value over the past two quarters with the goal of putting a fence around existing problem assets. We have also built a large pool of reserves to anticipate issues that are imminent problems. Our fourth-quarter credit charges can be divided into three large blocks. First, we increased specific reserves by $54 million; second, we charged-off $184 million of loans; and finally, we increased our policy reserves or our general reserves by $206 million.

Each element reflects the view that severe economic stress will continue to impact our borrowers throughout 2009. Regarding our charge-offs, in addition to specific reserves in the fourth quarter, approximately 53% of $180 million of charge-offs were in cash flow loans, 40% in structured finance, and 7% in healthcare.

Charge-offs were taken on 34 borrowers from among our total pool of 679 borrowers. And the five largest charge-offs accounted for approximately $75 million. The healthcare losses were primarily from one loan, a very public bankruptcy of a nursing home operator in Connecticut, which has brought to light both mismanagement and misrepresentation by its former owner. CapitalSource has now been awarded four of those homes by the bankruptcy court at settlement of our claim. We have new operators running those facilities and will sell them over time.

The cash flow loans written off in the quarter include 20 borrowers totaling approximately $96.5 million. The two largest charge-offs represent $29 million combined. Of the $96 million, 51% of the charge-offs were related to borrowers in the consumer sector, either retailers or consumer services. 19% were related to media borrowers, and 21% were related to manufacturing companies.

The structured finance charge-off losses were evenly distributed between the real estate business and the rediscount finance business. Except for an isolated fraud, the losses were related to the collapse in residential real estate. Our real estate losses were taken in a combination of residential land and development loans. Rediscount losses were the fraud and related to mortgage lenders hurt by residential real estate collapse.

Although we have experienced stress in the mortgage rediscount business, the balance of the rediscount book continues to perform very well. Similar to several loans charged-off in the third quarter, about $18 million of fourth-quarter charge-offs were older loans from ‘03 to ‘05 that had been problems for some time. We previously had a reasonable expectation of collecting all or some of our initial loans, but the significant economic deterioration in the fourth quarter eliminated or substantially reduced those expectations. As a result, we added the charge-offs or specific reserves for these older loans.

With regard to incremental specific reserves, that is reserves against specific loans rather than policy reserves, we added approximately $54 million to specific reserves in the quarter. Our specific reserves at 12/31/08 totaled approximately $87 million. Our expectation is that specific reserves will move to charge-offs within four quarters. At the end of the quarter, the breakdown on specific reserves was cash flow 62%, structured finance 38%, and healthcare less than 1%.

Overall, I would characterize healthcare as performing in line with historic experience that has very few problems barring this one isolated situation I addressed.

Issues in our corporate finance book are rising mainly when a company's liquidity run short in this economic environment, and its financial sponsor, its owner, reaches a decision they will not put any additional money in the deal forcing it to distress sale.

Commercial real estate has now entered a real cyclical downturn, which would lead to more write-offs and workouts depending upon how much longer this cycle lasts. With 98% senior position in commercial real estate, and continuing average LTVs based on regularly updated appraisals estimate it to be in the 60% to 70% range across our whole book. We believe that our experience will be somewhat better than the broader commercial real estate market.

It should be noted, however, that today’s environment creates uncertainty about the value of any asset. Finally, we recalibrated our policy reserves for the entire book of existing loans establishing levels near the top of the range of our internal methodology. We also applied similarly conservative discounts to problem loans resulting in much larger specific reserves.

As a result, we have substantially boosted total reserves to $424 million, policy reserves increased to $336 million, up from $130 million at the end of September. Of the total allowance, approximately 50% was for cash flow loans, 25% for real estate loans, and 25% for asset-based loans.

The current reserve levels are well above historic rates, consistent with our negative bias regarding credit outcomes. As evidence of our effort to anticipate problems, we have always considered non-accruals to be our primary forward credit statistics. As we have conservatively put loans on non-accruals that maybe current in payments but warrant concern regarding future repayment.

At 12/31/08, we had non-accruals of $440 million or 4% of commercial assets, which is 164 basis points higher than the third quarter. Conversely at 12/31, loans 60 or more days delinquent or 1.75% of commercial lending assets, which is unchanged from the third quarter. In addition to anticipating future issues, we believe that the relative difference between the two metrics also enables us to build additional cushion as we collect interest over half of our non-accrual loans, but do not take it into income.

Our allowance for loan losses now stand at 222% of delinquent loans, and 96% of loans on non-accruals. In order to test our reserve assumptions, we have performed a shock [ph] analysis on our entire portfolio after reviewing data from past recessionary periods such as 1981 to 1982, and 90 to 91 and several third-party studies suggest such as the S&P LCD survey on projected defaults, and recoveries from leveraged loans published this past December. Our analysis anticipates historic high default rates, and severe losses despite the fact that senior secured loans have historically averaged fairly strong recoveries in the high 80s.

Data we have reviewed suggests, however, that in a worst-case scenario recoveries could bottom out in the 50% to 60% range. The shock analysis of our corporate finance book, for example, assumes a 100% default rate on all non-performing loans. We have also estimated default rate on our performing loans, worse than anything experienced since World War II, resulting in an accumulative default rate in excess of any seen in the past 30 years.

We have then assumed recoveries below their lowest levels in 20 years. A similar analysis has been applied to our entire commercial real estate and rediscount portfolio, where we have looked at historic cap rates, assuming that those rates widened to historic levels last seen when interest rates exceeded 12%. And that any loan with the resulting LTV greater than 90% results in a 100% loss of that increment above 90%. We did not apply this methodology to the healthcare or certain specialty lending businesses. As we have said on many occasions, we believe our healthcare and specialty lending businesses like our security finance business are more resistant to the macroeconomic conditions that are affecting the rest of our parent company portfolio, and continue therefore to expect very modest losses.

Having used these conservative assumptions in our shock analysis, we believe our reserves are adequate for the foreseeable future. In conclusion, our credit losses reflect the combination of economic stress, borrower issues, and a conservative realistic approach to future recoveries given current market conditions. I would like to emphasize that our specialty businesses with their defensive structures and deep industry expertise have performed better than the general lending market, and we expect that to continue.

I would also emphasize that CapitalSource Bank presently has no delinquent loans and no loans on non-accrual status.

I have asked Dean to provide a few observations about the fourth quarter, about CapitalSource Bank, and about our view of the business going forward. As our president and chief operating officer, I thought it would be helpful that Dean do this at future investor calls. Dean.

Dean Graham

Thanks John. The fourth quarter was challenging but it closed the year with significant accomplishment for CapitalSource as we positioned the company for long-term success principally with the formation of CapitalSource Bank. The opening of CapitalSource Bank in July of 2008 capped a long strategic effort to secure a depository to fund our business separate and distinct from the capital markets.

CapitalSource Bank is now the vehicle for our future growth and profitability. Beginning with the January one, revocation of our REIT status, 2009 will be a year in which we intend to dramatically simplify our business, and advance our transformation to a bank. Over the next few years as our legacy book runs off, more and more of our commercial assets will reside in the bank, more of our loans will be funded with low-cost deposits, and our margins and profitability will grow accordingly.

CapitalSource Bank will be at the forefront of what we believe will be a new breed of banks emerging in response to the current financial and economic crisis. CapitalSource has a fully built out, high-quality asset origination and credit management platform, which is now married to a substantial retail branch network that provides access to stable, low-cost deposit funding, which can expand with our future growth.

Overall, our strategy is to operate with less financial leverage, concentrating on our core middle-market lending activities. The collapse of the capital markets will allow banks to regain their prominence in commercial and industrial lending. By focusing on the commercial borrower, this new breed of banks like CapitalSource can improve credit performance and drive higher returns. Some banks will not be able to take advantage of this trend, because of asset quality issues or capital shortages.

Clean depositories like CapitalSource Bank should enjoy a significant and sustained market opportunity. CapitalSource will continue to conduct its lending activities across multiple industries and sectors, and we will continue to favor healthcare because of its defensive and steady characteristics in times of economic stress. Our credit strategy remains in place. We will maintain our core focus on senior and asset-based transactions with healthy companies in defensive industries.

As we have said on other occasions, we see ourselves as a reliable source of credit to small and mid-sized companies that currently have few places to turn for capital to buy, build or grow their businesses.

Looking out over the next three years, we thought it would be helpful to provide certain projections relating to some of the most important and high-level drivers of our business. In 2009, we expect all commercial lending assets, which include loans, loans held for sale, sale of lease-backeds [ph], related accrued interest and the "A" Participation Interest to average approximately $11.4 billion. This compares to a year-end 2008 balance of approximately $11.9 billion. The decline during 2009 relates primarily to the expected pay down of the "A" Participation Interest. Excluding the "A" Participation Interest, we anticipate commercial lending assets will average $10.6 billion in 2009 and say our leasebacks will average $970 million.

We anticipate new originations at CapitalSource Bank of approximately $1.4 billion in 2009. We anticipate this loan growth will be offset by loan payoffs in our legacy book at the parent and payoffs at the bank keeping lending assets relatively flat for 2009.

We estimate this year's commercial banking segment interest, fee, and operating lease income will be approximately $925 million to $975 million, and estimate interest expense will be approximately $375 million to $400 million producing net investment income for this segment of approximately $525 million to $600 million. We're modeling the forward on month LIBOR curve averaging 87 basis points for 2009 and rising to 2.75% by 2011.

We anticipate run rate operating expenses, net of depreciation and amortization to be approximately $60 million per quarter during 2009. We expect charge-offs for the year which should come from existing reserves to be in the range of $300 million to $400 million and expect to decrease reserves during the year by $125 million to $150 million.

We expect the highest charge-offs and specific reserves to come in the first quarter and then decline modestly throughout the year. The only credit expense that will run through our P&L therefore is $175 million to $250 million that will be added to reserves during the year as charge-offs are incurred.

For 2010 and 2011, we are projecting loan growth in the bank in excess of $2 billion per year. We expect overall commercial asset growth will remain modest to relatively flat as new loan production in the bank will likely be offset by normal loan payoffs.

Net investment income should grow annually at a rate of 10% to 15% during this period as more of our business is funded with lower cost deposits, and our use of higher cost warehouse credit facilities declines. We will also see a greater impact from loans made at higher spreads since the formation of CapitalSource Bank, and we expect to continue to achieve operating efficiencies that will keep operating expenses flat to down from current levels.

In conclusion, we are very well positioned to prudently grow the bank in a deliberate and profitable way over the next three years. Our first six months of operations have been a success, and we have established an excellent working relationship with our regulators. Though general M&A activity is down throughout the economy, we are seeing excellent opportunities in healthcare, secondary loans and other parts of our business and are consistently underwriting new loans at high spreads with tight structures in a market with few competitors.

I will turn the call back to John now to conclude before we take questions.

John Delaney

Thanks Dean. To sum up our key messages this morning, we have a clear strategy in place to achieve long-term success. There are some short-term hurdles that will be difficult at times, but we believe entirely manageable. The business is therefore about execution. We have strategically done what we can. We have a bank which is the only future for lending and we have kept our leverage low, which provides us the type of capital levels we need to manage through the cycle.

Our low leverage and strong capital position will cushion us from what is likely to be a prolonged and very difficult credit and liquidity environment. We fully expect to come out the other end of this with a valuable commercial lending oriented bank. In Dean Graham, our President of CapitalSource; and Tad Lowrey, the President of CapitalSource Bank, we have two very talented and capable managers well positioned to execute against our plan despite this difficult environment and investors should be confident of their abilities and stewardship. Dean and Tad are fully engaged in our “play-offense” strategy working together to build CapitalSource into a profitable and valuable enterprise.

I will have a higher level of focus throughout 2009 on managing our play defense strategy, which includes managing credit outcomes from our legacy book and managing our financing relationships. As I said at the outset, we understand the legitimate need of investors to have a new level of detail about couple of companies similar to what we have provided today. We also realize this is not a one-time true up of outstanding information. We intend therefore to continue to provide detailed disclosures of relevant information on a quarterly basis based on investor increase. So with that operator I think it's time to open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Sameer Gokhale of KBW. Please go ahead.

Sameer Gokhale – KBW

Hi thanks and good morning. I had question firstly on the pay downs of the portfolio. I think the commentary in the press release said that the pay-offs were about $95 million in the quarter, and I think that's quite a bit lower than it has been in the past. Is that simply because, you know, in situations where you have loans you know, historically loans have been taken out in refinancing type situations or M&A, and maybe there has been a drop-off in that activity and that is why you saw the decrease in the loan pay downs, you know, some perspective on that would be helpful.

John Delaney

Yes Sameer. I think your insight is dead on accurate. This is obviously a much less liquid environment, and I would say historically the vast majority of our loans prepaid way before their maturity based on some kind of transaction that was occurring around them, either a recapitalization of their business or selling their business, some acquisition they were doing that caused them to need to redo their debt structure. And with that kind of volume down, there is not really a transaction, if you will, that drives an early prepayment, and so we're expecting that to continue throughout ‘09.

Sameer Gokhale – KBW

Okay, and then, you know, as far as the unrestricted cash at the full co [ph] could you remind me again how much that was at the end of the year, and then could you reconcile that you give some very good commentary about the different aspects of the business and liquidity, but I just wanted to get a sense for the reconciliation between you know, cash you have with the parent, unrestricted cash there verses the decision to issue $61 million I think of stock it was, you know, at $3.15 a share to pay off part of the portable debt. You know if you can shed some color on that that would be helpful.

Thomas Fink

Sure, Sameer. I'll take the question and just see if you understand me. When we say liquidity, we measure not the just the cash, unrestricted cash but also immediate availability under our credit facilities and those things are very bunchable [ph]. We can drop the facilities to have more cash or pay them down and have more availability. So, at the end of the year there was $1.3 billion of cash and cash equivalents most of that obviously being at the bank about $1.2 billion of that. So just north of $100 million dollars of cash and cash equivalents at the parent, and as I reported already on the call, you know, our liquidity today is certainly well in excess of that number and part of that as we mentioned we had told the Agency MBS portfolio, and those trades have all now settled, and there was certainly a return of our, you know, haircut capital as well as the gain we had in the first quarter to the company which increased liquidity.

Sameer Gokhale – KBW

So the reason for issuing that equity of like $61 million, I think was that a function of the fact that you've seen asset pay downs decrease significantly, and that decline in asset pay downs was greater than what you had anticipated because I think at a recent conference John you had mentioned that, you know, there was enough cash. It sounded like to pay off all the, you know, the maturing of the portable convertible bonds. I just wanted to get some sense for that.

John Delaney

You know actually, it was, you know, just I would say cushion for us, I mean we had and do have, you know, certainly enough cash to pay down that debt even before the exchange but you know, our simple decision was we decided we'd rather have $60 million more liquidity than $60 million less.

Sameer Gokhale – KBW

Okay, and then just one other question. In terms of the credit losses, you know, you talked about the losses by business segment, and I was curious if you were to look at it another way, which is by type of loan, you know, for example mezzanine loans. You know how much of your credit losses were driven by the mezzanine loan portfolio and is that all concentrated pretty much in the corporate finance book?

John Delaney

Sameer, I don't believe and if I'm wrong I will follow up with you, but I'm fairly certain that none of the credit losses in the quarter were related to mezzanine loans.

Sameer Gokhale – KBW

Okay, that's great.

John Delaney

There is a chance I’m wrong about that and if so I will correct it but that's my sense and Dean is nodding as well and then Tom. So I think, you know, we are pretty confident that is the answer but if it is different I will get back to you. But let's put it this way, if there was some it was very small.

Sameer Gokhale – KBW

So are you currently still originating mezz loans or is that –

John Delaney

No.

Sameer Gokhale – KBW

You're not.

John Delaney

No, we are not.

Sameer Gokhale – KBW

Okay.

John Delaney

Mezz loans are not – we don’t view mezz loans as bankable assets.

Sameer Gokhale – KBW

All right.

John Delaney

And since the bank is the source of funding, we are no longer in the mezzanine business.

Sameer Gokhale – KBW

Okay.

John Delaney

That’s it, we were ever a big player in that business to begin with. There was more, you know, I would say opportunistic stuff that we did around the edges, but going forward, mezzanine loans don't have leans, even though there are not specific rules in which the regulators per se. We think loans without leans are not eligible bank assets.

Sameer Gokhale – KBW

Okay, that's great. Thank you.

Operator

Thank you. Our next question comes from John Hecht of JMP Securities. Please go ahead.

John Hecht – JMP Securities

Good morning. Thanks for taking my questions. A couple of just questions for kind of near-term modeling perspective, I did, you know, some additional costs for deposits going into Q4 that smoothed out into Q1. Can you give us a sense where deposit costs are going right now?

Thomas Fink

Yes. Sure John. I think you know, the deposit costs now are significantly lower. We dealt with certainly increased local competition if you will, in the fourth quarter and we are currently offering deposits or raising capital at significantly lower levels. I don't have the weekly, you know, pricing in front of me here but if the weighted average interest rate in the portfolio was about 3.4%, we are currently raising deposits at conservatively less than that, and I won’t say it is about 150 to 200 basis points less than that.

John Hecht – JMP Securities

Okay, and can you give us – can you characterize the yields, which you are bringing on in terms of new originations at the bank.

John Delaney

Sure, John this is John. We're not really looking at opportunities in terms of new direct originations unless they have kind of underwritten yields in today's environment of LIBOR 700 to 800, typically with some kind of floor on LIBOR.

John Hecht – JMP Securities

And then John if I could ask you, you know, how are your sponsors that you work with historically, how are they responding when borrowers get into financial stress. Are you able to reach out to them and get them to recap the company with more equity. What is the character of the kind of discussions in that regard at this point?

John Delaney

Yes, I would say that one of the reasons that we've seen an up-tick in credit charges is because sponsors are less prone to do that and they have been in the past. I mean sponsors obviously live in a real world as well, and they see what's going on. So, if they have – in the past if there was a company that had experienced some operating difficulty and had a liquidity issue, I would say prior to the last 6 to 9 months, a kind of 9 out of 10 of those situations would go towards some type of restructuring in the debt, whereby sponsors would put in capital to provide liquidity to the business and may or may not have a pay down of our debt associated with it, and would typically involve us easing up on amortization payments would be the typical kind of work out one on one [ph].

They put in money to provide the business with liquidity. We ease up on amortization, so that their money isn’t going directly to pay us down, but it gives the business liquidity to work through whatever the problem was. That was typically what happened in most situations. In many of those situations than it typically worked out where the additional liquidity allowed the company to get through whatever kind of problem they had, which might have just been some execution issue they ran into, et cetera. I would say in this environment sponsors are obviously much less inclined to do that for a whole variety of reasons, ranging from we think in general there is a bias of sponsors not to draw down capital, even though they have committed funds, their investors actually don't want to draw the money down.

So, there is that kind of a general bias across the private equity industry, but secondly, I think, they obviously are very cautious about the environment and are very concerned about putting additional money in companies that are having issues. And so what happens there is it has been our experience at CapitalSource that if we end up actually putting money and to try to fix the business, it generally has – the outcomes haven’t been as good as we would have liked. So, we are really doing in this environment, if the sponsor is not willing to put money in, we then just proceed to liquidate the company, and there is a higher percentage of that occurring than it has been in the past.

John Hecht – JMP Securities

And on that latter point, when you go into liquidation and I assume this has impacted where you are coming out on your general reserve assumptions. What type of recoveries are you getting in the senior secured situation?

John Delaney

Well, you know, I think it varies. I mean what we have been able to do in certain situations is actually when a sponsor is not willing to put money in, prior to us even go into liquidation or work out, we sell the loan – we sell the loan to someone who really wants to take over the business at a lower price. We’ve generally seen kind of bids $0.40, $0.50 on the dollar.

John Hecht – JMP Securities

Okay, and then –

John Delaney

And then we avoid, you know, then the loan is owned by someone who wants to own the business, and they use the loan as a way of owning the business.

John Hecht – JMP Securities

Okay, thanks very much for the color on that, and the last question is for Tom on the covenants with the recourse facility. The charge-offs covenants, are those rolling fourth-quarter charge-offs covenants are they, you know, one quarter limit?

Thomas Fink

Yes, there used to be rolling four quarter and now the new formulation of it which gives us considerably more room is that quarterly.

John Hecht – JMP Securities

Okay, thanks very much guys.

John Delaney

Thank you John.

Operator

Thank you, our next question comes from Bob Napoli of Piper Jaffray.

Bob Napoli – Piper Jaffray

Thank you, good morning. Lots of great additional information. I was wondering if Dean could reread the guidance, just kidding. We will go through the transcript.

John Delaney

Yes.

Bob Napoli – Piper Jaffray

But the question, first of all I guess on the dividend. Are you intending to keep the dividend? I guess it is about $60 million in cash or I mean or do you have any thoughts about suspending the dividend until the economy improves?

John Delaney

Yes, you know, we're not declaring our dividend at this point. I think our view is that we will probably pay some kind of dividend this year, but I would anticipate it being lower than we paid in the fourth quarter.

Bob Napoli – Piper Jaffray

Okay, and I just – make sure I understood that the guidance the Dean was giving was for the overall company right.

John Delaney

Yes.

Bob Napoli – Piper Jaffray

And, you know, but I thought I heard this, you expect your loan, commercial loan balances to be generally flat through the year with growth at the bank offsetting run off in the non-bank.

Dean Graham

Well, that maybe run-off of the iStar loan. It is a very meaningful part of the run off. So that's the real driver of why loan growth is also flat.

Bob Napoli – Piper Jaffray

So you would have positive loan growth this year excluding if you back out iStar, commercial lending assets, you're expecting to have modest growth in ‘09 with obviously growth in the bank and offset by shrinkage in the non-bank. Is that clear?

John Delaney

Yes, loans would be if iStar didn’t exist, right if you back iStar out and you did kind of a net number then average loans would be up.

Bob Napoli – Piper Jaffray

Okay. An incremental margins then I guess on your loans versus the current margin.

John Delaney

Well, you know, the "A" Participation is a negative margin business right now, right.

Bob Napoli – Piper Jaffray

Okay.

John Delaney

So to the extent we – because that "A" Participation is LIBOR plus 150, that has no LIBOR floor. Right, so that's a very low yielding investment. And so that creates really negative margin relative to our cost of funds. So, clearly if we replace the "A" Participation with other loans, you will see a very dramatic increase in margin.

Bob Napoli – Piper Jaffray

Okay. Tom the covenants and the credit facilities that you had gone over kind of some key credit facilities you need to have renewed over the next several months. Could you go through that one more time?

Thomas Fink

Sure. We have a couple of facilities that are coming due in – well let me start with the syndicate facility, which I spent a lot of time talking about. That is due March of 2010. We have one of the credit facilities which is – one of the structured facilities, which has $176 million drawn on it which has a maturity date of March 2010 that also has an amortization period – excuse me, has a maturity at March 2009, has an amortization period for up to a full year, so effectively March 2010 on that. We have another credit facility, with you know, $74 million that is drawn that has a maturity date in April 2009, and we have a credit facility with $16 million drawn that has got a maturity date of April 2009 but a one-year extension period. So, those three that we were talking about specifically –

Bob Napoli – Piper Jaffray

And which you have about $260 million drawn against those three.

Thomas Fink

Correct.

Bob Napoli – Piper Jaffray

And –

Thomas Fink

And then most of that is in, obviously in facilities that have, you know, a one-year amortization period.

Bob Napoli – Piper Jaffray

And your hope is to renew each of those facilities.

Thomas Fink

Yes, I would say my expectation that we will renew those facilities.

Bob Napoli – Piper Jaffray

Okay. The Healthcare REIT that you had gone through John, the equity capital within the Healthcare REIT.

John Delaney

Yes.

Bob Napoli – Piper Jaffray

What is that?

John Delaney

Well, the Healthcare REIT, our investment in the assets is $1 billion and it has $330 million of property specific debt.

Bob Napoli – Piper Jaffray

Okay. Now and is that – can you in this market I'm not looking at the Healthcare REITs held up better than most of the markets, and now if your asset is a better asset, can you sell any of those assets at book value or is there just no real market.

Thomas Fink

Yes, we think we can.

John Delaney

We think we can. You know, that sector has generally held up very well. It didn't hold up for the 1 or 2 weeks we tried to do an IPL of it, and then it remarkably recovered as soon as we pulled our deal. So I think that market – there is obviously some very good fundamentals there. Our healthcare refocuses in particular our nursing homes, we think it is the best place to be, we think Healthcare REITs would have more of an orientation towards assisted living and independent living will come under pressure but the nursing home REITs will actually do better, and I can get into why we think that if you'd like, but we think our orientation is, it is a very defensive and solid portfolio. The cash flows are strong, the coverage is very good and there is financing available for these type of assets through the HUD programs. And that if anything are getting kind of more liquidity, and these assets are eligible for that either for us there is a borrower or for people who want to buy our assets who get the HUD mortgage to buy them. So, we think that you know that there is a very solid asset of the – I mean listen it's a very solid asset of the company, it is a very valuable asset for the company, it produces lots of cash flow but it is also an asset that we can access liquidity against we believe.

Bob Napoli – Piper Jaffray

And now why would you not have sold some of those assets instead of having to convert you know, I mean it is pretty dilutive.

John Delaney

Yes, I mean there's a timing implication to all these things. The HUD mortgage takes three or four months at best to get done, so.

Bob Napoli – Piper Jaffray

On the convert side, is there any thoughts about having additional converts – allowing additional converts to trade into common as opposed to paying them off.

John Delaney

No. There are no other converts due till 2011 and then 2012 for that.

Bob Napoli – Piper Jaffray

Okay, and then if I understood Dean on the allowance and charge off, the way you expect that allowance ratio to trend through the year. The reserves, you expect that reserve ratio to decline gradually through the year, the reserve dollars and percentage. Is that right?

Dean Graham

Yes, that's right Bob.

Bob Napoli – Piper Jaffray

You know with – what is your feeling with the reserves that you take – that you took in the fourth quarter to being able to generate profitability in 2009.

Dean Graham

Well, let me just say a couple of things Bob. Number one, you know of the reserve that we posted only $83 million of it is, I believe, allocated to specific loans. The rest is what we call positive provision or a general provision. So, we do believe there is more loss again in the portfolio, but it certainly hasn't been specifically identified. So we feel good about where we are with the reserves. I think, you know, the single biggest challenge to, you know, profitability from a GAAP perspective certainly in the first quarter would be the exchange transaction we did do and disclosed the other week, which would result in a $58 million non-cash charge.

Bob Napoli – Piper Jaffray

Right, excluding that.

Dean Graham

Yes, so excluding that I think we'll certainly be profitable this year.

John Delaney

If you go through the math on the guidance Dean gave, it will indicate that the business will be profitable.

Bob Napoli – Piper Jaffray

Okay, and last question the deferred tax asset. I would imagine then you are generating profitability in ’09 that we would then see that deferred tax asset reverse –

John Delaney

Yes. And obviously it depends on the level of taxable income but – and also since you made that point, you know, that's one of the I guess, benefits of the (inaudible), if you will, that we could reload the balance sheet with deferred tax assets from the REIT.

Bob Napoli – Piper Jaffray

Thank you.

Operator

Thank you. (Operator instructions) Our next question comes from Scott Valentin of FBR Capital Markets. Please go ahead.

Scott Valentin – FBR Capital Markets

Good morning, and thanks for the additional details. It was very helpful. Just two quick housekeeping questions, one, I know the bank itself with bank charter now. Any status in the bank holding company for the parent and then I guess I believe you did apply for TARP, I am just curious if there is any update on that.

John Delaney

You know, the bank holding company application I would describe is in process, which we think is, you know, reasonable. We did not receive expedite treatment for our application, and so I would describe this in the normal queue, which is generally pretty lengthy, kind of 6 to 9 months and so that's where we are with the bank holding company. And you know as far as TARP is concerned, obviously TARP would be a consideration of the company unless we were bank holding company, which is not likely to happen for a while. So, it's kind of our view that there is probably a low probability. The bank is eligible for TARP, but it is our sense that the bank based on its capital levels doesn't need any capital. So that's kind of how the TARP kind of analysis plays out.

Scott Valentin – FBR Capital Markets

Okay, thanks. And then on (inaudible), I guess the ABS program that the Fed is setting up. I guess they are making allocation for CMBS, and I was wondering if you thought maybe about is it possible, would it make sense to maybe participate on that on the CMBS side, maybe refinance some real estate, commercial real estate.

John Delaney

I would say we are looking at that and tracking that, but I think a lot more details need to be forthcoming before we could have the deal.

Scott Valentin – FBR Capital Markets

Okay, and then a final question, on the unfunded commitments you have, what would be the maximum exposure if every borrower drew down the commitment and then, you know, to mitigate that are you taking any actions?

Thomas Fink

Well, the total unfunded commitments across the entire portfolio is about just north of $3.5 billion, and you know some portion of that is in the bank and some is out and we do a lot, you know, analysis around that and now that we are no longer funding new loans that is the single biggest thing we think about with respect to liquidity at the parent. So, we believe with respect to our expectations about how that portfolio is going to fund and you have to remember, you know, a lot of these things are discretionary. There is, you know, there may be a commitment outstanding but you know, just like we would have to pledge loans to our credit facilities. They would have to pledge collateral to us and they simply don't have it, so we think it's a manageable number.

John Delaney

We give kind of loan by loan analysis on that to come up with our forecast of what is going to borrow under those things, and it comes that a lot of them fall in the category of discretion, a lot of them fall in the category collateral dependent, a lot of them fall in the categories where there is a default with a borrower, and there is no ability to draw a commitment. So it's a lot of loan by loan analysis.

Scott Valentin – FBR Capital Markets

Okay, I guess just to your point earlier about just the portion at the holding company, I mean the bank has plenty of liquidity, just curious as to how much of that may be – might be at the holding company.

John Delaney

Right, well and I think also an important point is with respect to the loans that are in the bank that there also may be a balance at the parent. You know, the first obligation of fund is at the bank. But you know, I mean the larger portion of it is certainly at the parent but again, you know, with the amount of it that we expect to fund is much smaller. You know, also with respect to our secured facilities to the extent we are or would fund the loan. That is new collateral that we can pledge those facilities, it sounds like we potentially have to come out of the pocket dollar after dollar for those fundings, and as I did mention we did step down the – what we believe to be excess commitments in those facilities and that is in part based on our view that those things are not going to be funded.

Scott Valentin – FBR Capital Markets

Thanks very much.

Operator

Thank you. Our last question is a follow-up question from Bob Napoli of Piper Jaffray.

Bob Napoli – Piper Jaffray

Hi, just a simple question. Of the loans you have outstanding what is the dollar amount of healthcare. I mean you mix in healthcare with specialty, and how much do you – I mean of the growth, what percentage of your portfolio. I mean do you have, you know, any kind of broad perspective of what percentage of healthcare will become of the portfolio.

John Delaney

I think our healthcare assets are about – Tom has taken the number about 2.5 billion.

Bob Napoli – Piper Jaffray

Okay.

John Delaney

$2.8 billion I think actually.

Thomas Fink

Yes, so to be specific there is about $330 million in healthcare ABL, about $1.2 billion in healthcare real estate, and then about $1 billion as you mentioned already on that.

Bob Napoli – Piper Jaffray

And then $200 million of healthcare cash flow.

John Delaney

Correct. 2.7 to 2.8, Bob.

Bob Napoli – Piper Jaffray

Okay, I mean of the additional loans that you are making, I mean what – can you give a feel for the mix of loans that you're adding by sector. Just a very rough figure?

Thomas Fink

Yes, I mean I would say that healthcare business is about half of what we were doing.

Bob Napoli – Piper Jaffray

Okay that's it. Thanks.

John Delaney

One other thing since I've got it open right here. Sameer asked a question earlier about a mezzanine loan in the charge-offs. There was about $60 million of charge-offs related to mezzanine or subordinate loans in the charge off number. I will just use this as an opportunity to answer that question more specifically.

Dennis Oakes

Thank you very much operator. That concludes our call for today.

Operator

Thank you. The conference has now concluded. You may disconnect your lines.

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