CapitalSource Inc. (NYSE:CSE)
Q3 2009 Earnings Call
November 2, 2009 8:30 am ET
Dennis Oakes - Senior Vice President of Investor Relations
John Delaney - Chairman and Chief Executive Officer
Don Cole - Chief Financial Officer
Tad Lowrey - President and CEO of CapitalSource Bank
Dean Graham - President and Chief Operating Officer
Bob Napoli – Piper Jaffray
John Hecht – JMP Securities
Don Fandetti – Citigroup
Mike Taiano – Sandler O’Neill
Scott Valentin – FBR Capital Markets
Moshe Orenbuch – Credit Suisse
(Operator Instructions) Welcome to the CapitalSource Third Quarter 2009 Earnings Conference Call. I would now like to turn the conference over to Dennis Oakes, Senior Vice President of Investor Relations.
Good morning everyone and thank you for joining this CapitalSource third quarter results and company update call. Joining me this morning are John Delaney, our Chairman and Chief Executive Officer, Don Cole, our Chief Financial Officer, Tad Lowrey, President and CEO of CapitalSource Bank, and Dean Graham our President and Chief Operating Officer.
This call is being webcast live on our website and a recording will be available beginning at approximately 12:00 noon Eastern today. Our earnings press release and website provide details on accessing the archived call. Earlier this morning, we also posted a slide presentation on our website that provides additional detail on certain topics which will be referred to during our prepared remarks.
Investors are urged to read the forward looking statements language in our earnings release, but essentially it says that 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.
John Delaney is first up this morning.
Our third quarter was successful in several respects. We significantly improved our cash position at the parent. We extended and paid down substantial debt that was otherwise maturing this year and next, thereby meaningfully reducing our cash needs over the next 18 months. We experienced a decline in charge-offs and modest improvement in the rate of increase of non-accrual and impaired loans while adding to reserves in anticipation of future commercial real estate losses.
At CapitalSource Bank net interest margin increased by over 100 basis points. Our loan origination pipeline is showing promising signs of strengthening and as we predicted, charge-offs and loan loss reserves were down significantly from second quarter levels.
As Don Cole will explain in more detail, our cash position at the parent improved from roughly $200 million to just over $300 million at September 30. This improvement resulted from a small equity raise we closed in July at the time of the senior secured note offering and loan payoffs in the syndicated bank facility along with no unusual draws on unfunded commitments.
With regard to credit in the quarter, there were no surprises about where credit problems were concentrated. As we have suggested on a number of occasions, we anticipate significant stress leading to elevated levels of charge-offs that will persist into next year largely a result of losses in our commercial real estate portfolio.
The third quarter continued recent credit performance trends. The non-media cash flow portfolio continues to stabilize with only $11 million of third quarter charge-offs. The healthcare, security, and technology portions of our portfolio have experienced very few losses. The stress remains concentrated in the commercial real estate book which comprises slightly less than 20% of the legacy portfolio and which I will speak about in more detail shortly.
Though charge-offs were directionally encouraging in the quarter we did see increases in non-accruals, 30 to 89 day delinquencies, impaired loans and troubled debt restructurings. This was no surprise to us. Though increasing, these credit measures did so at a slower pace then the increase from the first to the second quarter. The dollar amount of loans 90 plus days delinquent actually decreased from the second quarter and we added to reserves, raising our total allowances for loan losses by $70 million to $517 million or 5.5% of our commercial lending assets.
The reserve boost this quarter is largely attributable to near term expectations for continued pressure in our commercial real estate portfolio. In fact, we decided to add approximately $50 million as a judgmental addition to our general reserves out of continued concern about the commercial real estate market. We are aggressively managing our commercial real estate credit book to mitigated losses but also so that we can reach as soon as possible our inflection point of future charge-offs as compared to reserves. This will allow the return to profitability which could be as early as the first half of next year.
On our second quarter call in August we provided our estimates of the cumulative losses in our legacy loan portfolio by asset class. Consistent with the way we currently manage the business, designating the loans originated prior to July 2008, including those loans sold to CapitalSource Bank as “the legacy portfolio” we segmented the loans into 10 categories. Each category was assessed for loss history using a variety of bottoms up and statistical analysis.
We have updated this slide to show the third quarter credit performance and net loan balance changes. It was posted on our website this morning as slide 18 of the investor presentation we will refer to throughout this call. Importantly, we remain very comfortable with our original cumulative loss assumptions and continue to believe the total remaining provisions will fall within the projected range.
In addition to the updated cumulative loss slide, we have provided a new disclosure on slide 21 which shows the funding source for each of the asset classes in the cumulative loss analysis. We show for example, with respect to the roughly $1.4 billion of healthcare loans in our legacy portfolio that $605 million are in non-recourse securitizations or non-recourse credit facilities, $310 million are in the recourse syndicated bank facility, and $485 million are funded at CapitalSource Bank. This detail provides additional insight for investors seeking to analyze our legacy loan portfolio in greater depth.
With regard to commercial real estate in particular, which again is about 19% of our legacy portfolio, refinance options are scarce. Nearly every loan that matures therefore requires restructuring or extension and could, as a result, become classified as a troubled loan. Near term commercial real estate maturities are expected therefore to cause a continued increase in the percentage of loans in our various troubled loan categories.
As discuss previously, we expect many of our real estate loans that are not in default or have sponsors that are willing to defend their equity with cash or collateral, to extend by 12 to 24 months. While small, an example of such an extension that we thought would be useful that occurred in the third quarter is a small hotel located in Boca Raton, Florida.
We had an $11.6 million loan which matured in the quarter on a 121 room hotel located in Boca Raton, Florida. The loan had sufficient debt service coverage. The hotel’s performance has declined with the hospitality markets throughout 2008 and 2009. We explored numerous options before settling on a extension with the current borrower who agreed to pay down the loan by $2 million and committed to invest another $2 million into the hotel. CapitalSource will provide a one year extension under the existing terms.
Switching to loan production at CapitalSource Bank, we continue to see strength with approximately $350 million of new loan commitments close during the quarter. The pipeline of loan opportunities has strengthened considerably in the past three to four months with both August and September representing strong months for loan closings.
We had significant margin expansion at the bank as a result of the further reduction in our cost of funds and improved asset yields. Tad Lowrey and his team are doing an excellent job of lowering the cost of deposits while managing the overall level of deposits and holding on to a loyal depositor base. The bank has also successfully managed down the level of excess liquidity while re-deploying funds into higher yielding asset classes.
I will concentrate the balance of my remarks on a more detailed look at the loans in our commercial real estate portfolio. Don Cole will talk in depth about overall credit performance in the quarter as well as some of the key drivers of our financial results. Tad will provide more detail on the bank’s performance and Dean will provide some thoughts on what is clearly an improving environment for new loans. I will then wrap up with some final thoughts before we take questions.
We thought it would be helpful this quarter to provide a more in-depth look at our commercial real estate portfolio as there is significant public focus on commercial real estate and it is the one area of our portfolio which has not yet stabilized. At September 30 there were 75 loans in our legacy commercial real estate portfolio which totaled about $1.6 billion. The portfolio is composed of all property types including hospitality, industrial, office, retail, multi-family, land and condominium asset classes which have all suffered in the current economy.
Of the 75 loans, 60 are first lien and 15 are second lien. About one half of our commercial real estate loans will mature over the next five quarters which means we will experience most of the pain in this portfolio by the end of next year. The expectation for future losses is another factor in our $50 million addition to policy reserves this quarter tied to commercial real estate.
Last quarter we highlighted two areas of particular concern in the portfolio; land loans and second lien loans. As you know, we took significant charge offs in both categories in the second quarter and we did so again this quarter, taking an additional $31 million in second lien and $22 million against the land portfolio.
Our land loans are larger and we expect divergent outcomes. $294 million of our land loans are for infill urban tracks, mostly in Manhattan and San Francisco where the real estate markets should recover over a reasonable period of time and we should get most or potentially all of our money back. Based on the continued equity support from the sponsors in these situations our assumptions in these cases appear valid. In total, we have marked our land portfolio by 26%.
As of 9/30 we had 15 second lien loans totaling $120 million with specific reserves totaling $7 million and general reserves totaling $19.1 million. 70% of the remaining second lien loans are fully performing and we have taken total marks against our second lien portfolio of over 54%. In the current quarter we recognized $69 million of charge-offs in our total commercial real estate portfolio compared to $90 million in the second quarter. We had recognized also REO losses this quarter of about $2.3 million.
Though we have completed only a few property sales we are experiencing recovery rates on problem commercial real estate assets in the range of 50% to 60% versus historical recoveries that were obviously much higher.
We believe we have a very good handle on the future performance of the remaining loans in our commercial real estate portfolio. Though there is still sufficient uncertainty about the prospects for economic recovery and that our range of expected losses is therefore necessarily broad.
As shown on the cumulative loss slide, which is slide 18, we anticipate remaining commercial real estate provisions in the range of $33 million on the low end to $198 million on the high end. This compares I think favorably to our to-date total mark on the commercial real estate portfolio of $370 million or 23%. We regularly review the entire commercial real estate portfolio looking six months forward with an eye towards loans that can support an extension and those that will be problems. Ordering updated appraisals is a part of that process which itself has triggered credit issues.
A new policy statement issued last Friday by the FDIC and other banking regulators, however, suggests a change in the accounting and classification treatment for performing loans on which current appraised values have declined below the outstanding loan amount. We are still analyzing these new guidelines which run 33 pages but expect that some of our legacy loans in CapitalSource Bank will be positively affected.
A good example that we think puts this situation and this new guidance in context is a loan to a Raleigh, North Carolina, hotel operator that we have that’s operated by a national flat. Despite softer operating performance the borrower has continued to cover its debt service, in other words, it has positive debt service. As the loan neared maturity, consistent with bank underwriting guidelines, we commissioned an appraisal this past quarter. The new appraisal indicated the building was worth $5.5 million less then our loan, obviously the appraisal is dramatically reduced from the original appraisal.
This $5.5 million reduction of value less then the loan forced us under prior banking guidance to incur a $5.5 million charge, impair the entire $32 million loan balance, and place the loan on non-accrual, despite our belief that we will recover the entire loan and despite the fact that the loan is current and has positive debt service coverage. This “appraisal event” which caused a loss and added to our credit stats in this quarter is typical of the commercial real estate environment we are dealing with.
Absent the new regulatory guidance the forced classification of this performing asset solely based on appraisal will tend to force banks to sell performing assets at discounts, harming the bank, and contributing to selling pressure in commercial real estate. The new policy will help mitigate the automatic re-characterization of an extending performing loan as a classified asset at CapitalSource Bank due to these appraisal events and will likely improve our credit statistics. We will not, however, use the new guidance to artificially delay inevitable losses inherent in our portfolio.
I would also like to say that we applaud the actions of the regulators. It is smart, measured, and fair. It aligns a banks interest and incentives with economic reality and does not allow a bank to defer true problem situations. It in no way encourages the extend and pretend practices that the media and other parties interested in banks dumping loans, likes to allege. The new rules provide banks with needed latitude to retain loans viewed as “money good” but for these appraisal events.
It is likely in our judgment that the hotel loan I just discussed performing in all respects but for the results of the appraisal would now not incur the non-accrual treatment we imposed last quarter and other loans would likely fall into that category as well. We intend to continue addressing credit issues promptly and forthrightly in order to further reserve currently for anticipated future losses.
To sum up, we expect the commercial real estate portion of our portfolio will be the area that shows the greatest stress in terms of credit performance over the next several quarters. We do not yet see the stabilization that has clearly occurred in other portions of our book such as the cash flow portfolio or even media but do expect to see similar stability in our commercial real estate book in 2010. This is not because we are predicting a dramatic improvement in the commercial real estate market; our views are quite contrary to that, but because of where we are in reserving against our book.
Maturing commercial real estate loans over the next five quarters will contribute to an up-tick in the number of non-performing loans, though the new FDIC guidance could mitigate that impact. We will continue to reserve adequately and to view conservatively the future performance of the real estate portion of our portfolio. We will also be aggressive and opportunistic in selling loans or otherwise disposing of troubled assets where appropriate.
What we are very focused on is estimating when our inflection point on reserves will occur. By inflection point I mean the moment when our reserve build will be sufficient and we can begin to release reserves. Our actions this quarter move us closer to that point. In fact, we have a view that for several of our categories we are very near or at that point. Our estimated cumulative loss expectations which are unchanged from last quarter support that view.
This quarter’s additional commercial real estate related reserve boost leaves us to conclude that the inflection point for commercial real estate could occur as early as the middle of 2010. Though others may be counting on the market to rebound before taking charges, we have taken an aggressive and we believe realistic view of likely commercial real estate performance, as we have established our reserve charge-offs in non-accrual levels.
As first evidenced of this view we have charged off or reserved for 23% of our legacy commercial real estate portfolio as of September 30. At these levels we are beginning to approach the most draconian views of cumulative losses in diverse senior oriented commercial real estate portfolios. As we approach our inflection point we believe earnings will return and when we reach our inflection point we expect the earnings of the company will turn markedly.
Don will now take over and provide his perspective on the quarter.
As John mentioned I will focus my remarks on our third quarter credit performance, though I will also touch on parent company liquidity and some of the key drivers of our third quarter financial results.
We continue to aggressively manage our credit book and do see modestly encouraging signs of stabilization in several areas. Looking at slides five and eight of our investor presentation, shows commercial loan charge-offs in the quarter were down nearly 20% to $135 million as compared to $167 million in the second quarter. At September 30 our total allowance was $517 million including $426 million of policy reserves and $91 million of specific reserves tied to individual loans.
Non-accruals at the end of the third quarter were $994 million an increase of $110 million from June 30. Nearly 70% of non-accrual loans are in the commercial real estate or residential mortgage re-discount portfolios and $530 million of non-accrual loans were current as of 9/30. Overall, 30 to 89 day delinquencies were up $14 million to $132 million while our 90 plus day delinquencies were down $16 million to $396 million.
We recorded the loan loss provision in the quarter of $17 million related to the owner trusts, reducing our net equity in that portfolio to approximately $3.5 million. The remaining equity is the limit of our economic exposure in that $1.5 billion mortgage non-recourse portfolio which a remnant of our time as a RE.
Looking at the loan portfolio as whole, all or a portion of 84 loans were charged off in the third quarter from a total pool of over 1,000 loans. Slide nine shows that approximately 51% of the charge-offs were for commercial real estate, consistent with the second quarter amount of 54%, 8% were for non-media cash flow loans compared to 15% in the second quarter, 21% were for the media loans compared to 23% in the prior quarter, 4% were for asset based loans compared to 1% in the second quarter, and 15% were for mortgage re-discount loans compared to 7% in the second quarter.
Similar to the second quarter, less than 1% of charge-offs were for healthcare assets. Charge-offs were taken on 25% cash flow loans totaling approximately $10 million and 24 commercial real estate loans totaling $68 million. We also took additional charge-offs of $20 million this quarter in our residential mortgage re-discount portfolio. The balance of our re-discount portfolio of close to $1.7 billion continues to perform very well.
We experienced less than $5 million in losses in general asset based lending which is principally comprised of our security lending and general re-discount businesses. We also took additional charges this quarter totaling approximately $29 million in the media portion of our cash flow portfolio. We have taken substantial losses on the advertising based portions of that portfolio including radio, television, and publications. The remaining media loans, many with a technology component such as web hosting and data centers, are performing better then those reliant on ad revenue.
We have added a new slide to the investor presentation today which shows the charge-off trends over the past four quarters in the same asset classes we are using for analysis of the legacy loan portfolio. Slide nine shows the improving trends in cash flow lending and a few other areas as we have described. We also believe the strong actions we have taken to mark down second lien real estate and media loans will likely begin to be reflected in downward charge-off trends in those areas starting next quarter. Nevertheless, we continue to maintain a very cautious outlook on credit through the first half of 2010.
As our non-accrual and impaired loan numbers move up from quarter to quarter it is important to remember as we have pointed out on previous occasions, that when we take a specific mark on a non-performing loan the entire loan balance goes into a non-performing category. For example, a $3 million charge on a $25 million loan causes the remaining $22 million to be added to a troubled loan category. A significant portion of the $135 million in charge-offs in the quarter were related to loans that had been previously reserved for. Looking forward, we believe the quarter end allowance level of 5.5% of commercial lending assets is both prudent and adequate.
As we have explained before, many loans that are “impaired” are classified as such due to various accounting rules which are unrelated to our expectation of collecting all or most of our original loan amount due under a modified loan agreement. Similarly, 53% of our loans on non-accrual are current which means we have stopped accruing interest in anticipation of future quarters when we expect our borrowers will not be able to fully mean their debt obligations but we are still being paid interest when it is due and that reduces our outstanding principal balance.
At 9/30 54% of loans on non-accrual had no specific reserve, indicating we have no current expectation of losing money on the principal amount of the original loan. Slide eight of the investor presentation shows a breakdown of net troubled loans including the delinquencies, non-accruals, and impaired loans that make up that number. Net troubled loans in the third quarter excluding any double counting of assets in multiple categories, were 14.2% of our commercial lending assets compared to 12.9% in the prior quarter. The fairly modest increase of only $59 million from the second quarter combined with the lower level of charge-offs is encouraging.
Turning briefly to the funding profile for our legacy loan portfolio on slide 21, at quarter’s end approximately 52% of our loan portfolio was funded in non-recourse securitizations or non-recourse credit facilities, 35% was funded in CapitalSource Bank and 13% was pledged to our syndicated facility. We have four credit facilities, three are non-recourse and the syndicated bank facility is recourse. The collateral package for each of the three non-recourse credit facilities is limited to their specific loan pools. At September 30 the four facilities had a collective outstanding principal balance of $827 million.
During the third quarter we completed the process of renewing our credit facilities and extending their durations to better match the scheduled maturity of the underlying loans. By extending the terms of our credit facilities to more closely match the duration of their assets we have eliminated short term liquidity needs relating to the funding of those assets and achieved on of our major strategic goals for 2009.
The one facility that was not extended to 2012 is the Euro denominated facility which has a current balance of approximately 98 million Euros. The facility will mature in May of 2010 but we intend to renew it. It is over-collateralized with an advance rate of 43% and the loan pool continues to generate sufficient excess spread to pay down the facility over time.
In early July we closed on a $300 million issuance of senior secured notes due in 2014 and made a payment of that amount to the syndicated bank facility extending lenders which satisfied the condition of their extension approval and reduced the commitment amount from $900 million to $600 million. In the quarter, we made an additional $50 million commitment reduction in principal payment to take the total committed amount to $550 million, with $438 million of the syndicated loan now extended until March 2012 our remaining commitment to the extending lenders begins amortizing on a monthly basis in April of next year.
After applying the proceeds from our HUD financing is anticipated to the earliest scheduled amortization payments the next cash amortization payment will not be required until the fourth quarter 2010. The non-extending lenders must be paid off a total of $112 million by March of next year.
Total pay downs on credit facilities in the third quarter were $423 million reducing the aggregate principal balance from $1.2 billion to $0.8 billion. Total equity in the four credit facilities is now approximately $1.1 billion. Further updated details about each of the facilities as of September 30 including the collateral distribution, number of loans, seniority of loans, and weighted average remaining term are posted on our website as slide 23. We have also updated the slides showing the current balances in our securitizations and that can be seen on slide #24 in the presentation.
Pay downs of roughly $200 million occurred in the third quarter reducing the issued debt balance from $3.1 billion to $2.9 billion. Our current equity and owned debt in those securitizations remains approximately $1 billion.
As John mentioned, we expect to receive the approximately $120 million in net proceeds from the HUD financings of certain of our healthcare net lease assets before the end of the year, though 75% of those proceeds will go to the syndicated bank lenders. Approximately $77 million of that amount will go to the extending lenders. We anticipate that pay offs within the $1.2 billion loan collateral pool will then fund the remaining required amortization on the syndicated bank facility through 2012.
John also spoke about improved liquidity and strong capital positions but I’d like to elaborate a bit on both of those areas. Over the past few quarters we have been maintaining a consistent cash level at the parent in the range of $175 to $275 million but we were a bit higher at 9/30. With predictable and manageable cash uses until 2011 and the HUD mortgage proceeds coming later this year I expect our unrestricted cash will continue in that range over the next few quarters which we view as an adequate and comfortable level.
Unfunded commitments at the parent were down slightly at $2.1 billion and up slightly at CapitalSource Bank to approximately $840 million. We have refreshed the loan by loan and bottoms up analysis of unfunded commitments we provided on our second quarter call and our fundamental view of likely funding outside the bank over the next four quarters is unchanged. Based on the lack of any unusual pattern of draws over the past four quarters we remain comfortable with our projections.
Additionally, a reminder that approximately $270 million of our unfunded commitments are related to loans funded in the 2006-A securitization which has a remaining capacity to fund unfunded commitments of $80 million at September 30. Our expectation for actual funding on those loans indicates that $80 million in 06-A will cover the entire amount. The CS funding seven facility also has remaining capacity of approximately $63 million for unfunded commitments.
We have provided an updated slide #25 as part of the investor presentation which includes unfunded commitment estimates. Given our current and anticipated cash position, together with our experience and projections about unfunded commitments we remain comfortable with our cash flow profile throughout the balance of this year and all of 2010.
The capital position at the parent company, which stood at over $1.2 billion of tangible common equity at September 30, is also strong. On a consolidated basis our tangible common equity was $2.2 billion and the tangible common equity, the total assets ratio was 15.9% at quarter end.
Our net loss this quarter was $274 million or $0.87 per diluted share compared to a net loss of $247 million in the prior quarter. Similar to the second quarter the two principal drivers were credit charges which I have spoken about in detail, and the additional deferred tax asset allowance we recorded this quarter. The DTA allowance is a non-cash charge on the income taxes line of our income statement.
As I described when we first set up the reserve last quarter, the allowance was created based on accounting literature that indicates that companies with a recent history of cumulative GAAP losses are unable to rely on future forecasted earnings to offset future tax deductions. With one additional subsidiary that incurred losses in the third quarter we increased the valuation allowance by approximately $149 million or $0.47 per share bringing the total allowance to $286 million.
It is very important to remember that this reserve in no way reflects managements belief about its future profitability as we strongly expect to return to sustained profitability at the end of this credit cycle, nor does it have any impact on our legal right to utilize these tax deductions in the future under existing tax laws.
We are asked frequently about quarterly sources and uses of cash. At a high level, in addition to interest, fee income and loan payoffs on our loan portfolio and servicing fees from our term securitizations and credit facilities, third quarter sources included $274 million of net proceeds from the issuance of the senior secured notes, $77 million of net equity proceeds, $75 million from loan sales, $25 million in funding from our real estate securitization capacity and the operating lease income from our healthcare net lease assets.
Uses, in addition to debt service and operating costs included repayment of credit facilities totaling $423 million, funding of unfunded commitments of $25 million, and the third quarter dividend of $3 million. Our quarterly operating expenses were down slightly from the second quarter and there were no unusual cash expense items in the quarter. As John indicated, the result was a net cash position at 9/30 that was approximately $100 million higher then at June 30.
I will now turn the call over to Tad Lowrey who will review the quarter from a CapitalSource Bank perspective.
I’d like to lead off with some good news. That is that we had a solid rise in our net interest margin, our net interest margin increased by over 100 basis points from the prior quarter to 4.04%. This substantial jump in the margin is primarily due to the ongoing decline in our cost of funds as higher priced CDs roll off and new CDs are issued with recent rates being as low as 1.5%.
In addition, we’re seeing improvements in our asset yields particularly as the A participation interest pays off and we continue to redeploy those funds from this low yielding asset into higher yielding loans and investments. New loans in the quarter averaged an all in yield of approximately 7.5% so new loan yields have also continued to hold, further improving our operating margins.
In the third quarter we lowered our deposit cost of funds to slightly over 2% which was a decline of 58 basis points from the prior quarter while at the same time retaining over 80% of our maturing timed deposits. It should be noted, however, that with the prolonged low interest rate environment, nearly all of our higher rate CDs have now re-priced to current market levels so future reductions and our cost of funds are not expect to be material. A byproduct of the quarterly cost of funds reduction was modest runoff in deposits of about $157 million leaving us with a total of $4.4 billion in deposits at September 30.
On the liquid side, although we have actively lowered the offered rates on these accounts, they continue to grow and they now comprise 18% of our retail deposit base versus 15% at the beginning of the year. We expect the decline in the cost of funds to bottom out over the next several months; however, we still anticipate the overall cost of funds will remain below 2% until late 2010 when a projected rise in interest rates is expected based on the forward Libor curve.
In September we began an effort to increase the weighted average remaining maturity of our CD book by emphasizing longer term products. We’re starting to see some success in that areas as the weighted average remaining maturity increased from 4.6 months in June to 5 months in September. During the quarter we also saw improvements in our yield on interest earning assets due to the high yields on the A participation and our core loan book as well as a slight improvement in the yield of our investment portfolio. Despite the overall decline in assets our net interest spread improved to $55 million compared to $42 million in the prior quarter.
During the quarter we closed on approximately $350 million in new loan commitments while funding approximately $228 million of those same commitments. We expect many of these new borrowers will ultimately draw on the remaining committed amounts as they post new collateral or meet other conditions.
In addition, at quarters end we also had approved commitments that were pending closed of an additional $351 million. Although typically not all of these approved commitments end up closing. As you can see, overall activity was clearly higher in the quarter though we have not yet quite reached our run rate for quarterly funded loan productions.
Lastly, in terms of loan production, I want to point out that over the past few quarter we have made a concerted effort to reduce our whole sizes and concentration risk in loan classes that have historically shown risk volatility. This us begun to increase the granularity of our portfolio and over time will reduce the risk posed by large single exposures. We have also successfully sold off certain impaired and classified assets as prices that were at or near our book value. Some of these deals closed in October.
Moving to credit quality, at quarter end the ratio of non-performing loans to core loans which for purposes of this measure excludes the A participation interest, was 6.1% up from 3% in the prior quarter. Although this is a substantial increase, $151 million of the $184 million of our non-performing loans are current at this time.
Additionally, while each of these non-performing loans is deemed to be impaired, the total amount of the impairment is currently estimated at $15 million. Total delinquencies 30 or more days past due increased to $51 million from $5 million at June 30 with the change largely driven by two loans which totaled $38 million that were less than 90 days past due at September 30.
Our charge-offs and reserves in the third quarter were at a more normalized level, $13 million compared to the elevated levels of $70 million in the prior quarter which was the result of charge-offs of two large land loans. Because of the large credit exposures and the characteristics of commercial real estate loans I expect our future charge-offs to continue the volatility. As our legacy loans continue to season I believe we will see continued increases in non-accruals and delinquencies with a particular focus on CRE loans (commercial real estate).
In the quarter we incurred provisions of $48 million and after $13 million in charge-offs we added $35 million net to our reserves bringing our total allowance for loan losses to $127 million or 4.2% of core loans. Of that amount, $110 million is a general reserve and the remaining $17 million is specific.
Our capital levels remain among the highest in the industry. Total risk based capital at September 30 was 16.75% and our tangible common ratio was 12.71%. The A participation continues to pay down in line with our expectations and at a rate consistent with recent months. In the third quarter, the balance was reduced by $173 million to a remaining balance of $714 million which now represents 20% of the total underlying collateral value. An additional payment of $60 million has been received in October further reducing the balance. We continue to believe that the participation will be fully repaid sometime in 2010.
Early Don spoke about the unfunded commitments at the parent company. In our experience at the Bank has been very similar to that. That is we have seen very little movement on a net basis with our approximately $840 million of unfunded commitments. We continue to carry ample on and off balance sheet liquidity in the event these commitments fund at a higher level but if they do it will also provide us with an additional loan and margin growth.
We completed our conversion to new core banking application which was a new and more robust technology platform in early August. The new system not only adds functionality and efficiencies to today’s retail banking operations but it also positions us for the future as we consider new business models and new product offerings. The system has also allowed us to enhance our internet presence allowing our existing customers account access and online account openings. For now we intend to continue to rely on our retail branch franchise as the primary deposit gathering channel.
In closing, our relationship with our regulators at the FDIC and the DFI remains positive. We completed our first annual regulatory exam successfully in September. Completing our first full year of operation and our first annual exam were significant strategic goals in our 2009 business plan and we’re very pleased with the progress that has been made since we opened for business in July of last year.
Next up is Dean Graham who will discuss the competitive environment for new loans.
As both John and Tad mentioned, we have seen continued and steady improvement in overall lending activity and there is an increased level of transactions throughout our loan origination pipeline. M&A activity is increasing as companies are beginning to borrow again for acquisitions as well as for growth. We continue to see more deals, issue more term sheets, and make more loan commitments in the past 12 weeks then we have in any comparable period in the prior 12 months.
As market conditions are slowly improving we also continue to see attractive refinance opportunities. Of particular note, healthcare and technology lending continue to be stable and active verticals for our deal teams. Despite overall lending activity increasing, however, the transaction closure rate continues to remain relatively low because of ongoing differences in valuation expectations between buyers and sellers.
In general we are making loans to strong borrowers with tight legal structures and low leverage at attractive spreads. As we enter 2010 it is our expectation that opportunities will continue to emerge in greater volume and that there will be more opportunities to make selective, attractive portfolio acquisitions. Though we focus on senior debt, increasing liquidity for subordinate debt allows us to pursue opportunities to make loans and sell off the junior interest to subordinate debt purchasers to mitigate risk.
I will now provide some more granular detail about out lending pipeline. As I mentioned, we continue to see very good activity in healthcare where we are making asset based working capital loans and senior secured real estate loans to senior housing operators. We are also seeing modest activity in our leveraged lending business where we provide senior debt to sponsors in connection with middle market company acquisitions. Our leverage lending business focuses on well capitalized borrowers, sponsors who are looking to purchase stable, profitable businesses with strong EBITDA margins while keeping senior leverage generally below three times.
Despite the economic downturn we are also seeing very attractive select lending opportunities in the commercial real estate market. Banks are beginning to unload CRE loans and we are now seeing more frequent opportunities to lend to borrowers who are repurchasing CRE debt at attractive discounts. We are currently reviewing a number of cash flowing stabilized properties with no lease up risk and strong sponsorship.
While we have not yet seen an equivalent pickup in our re-discount business, as borrowers continue to resist more stringent loan structures with lower advance rates and higher pricing, the business remains active. We closed two re-discount loans at CapitalSource Bank in the third quarter totaling $65 million. Our re-discount book continues to perform well with the exception of mortgage re-discount and we are also refinancing top clients into CapitalSource Bank upon their natural maturity.
In addition to coupon yields in the L400 to L700 range we are also generally receiving up front fees, back end fees, yield maintenance, and interest rate floors in most of the new loans we are financing in CapitalSource Bank. Competition in liquidity remains scare so we are well positioned to capture market share and we expect these conditions will continue for several more quarters.
There are not yet enough transactions in the marketplace, however, which we feel are sufficiently safe and attractive to reach our quarterly loan production goals on a sustainable basis. As the economy improves we are confident of our ability to achieve a consistent quarterly run rate of $300 to $350 million in new funded loan production at CapitalSource Bank.
In addition to the modest stabilization in credit performance which Don described, we also are beginning to see some encouraging signs of improved financial performance among our borrowers in recent months. We regularly and carefully monitor the performance of our portfolio companies, have begun to see some early signs of stability in many areas. Though it is hard to say we have seen upturn it is fair to say we have seen a modest improvement in general business conditions.
I will now turn the call back to John for closing comments.
Before we take your questions this morning I want to summarize what I view as the key messages in our call this morning. First, though charge-offs were down in the quarter, loan loss provisions and other credit stats reflected increases in problems loans, largely relating to the lack of refinance options for CapitalSource Commercial Real Estate borrowers whose loans are maturing. Commercial Real Estate remains the largest area of concern and we are proactively managing these situations.
Otherwise the areas of stress and the magnitude of the problems in losses were both encouraging and consistent with our expectations for the quarter. We remain confident about the accuracy of our longer term predictions for cumulative losses in our legacy loan portfolio.
Second, liquidity significantly improved in the quarter as we completed the process of extending our large syndicated bank facility, raise debt equity and made substantial payments on our debt. Once again, unfunded commitments were of little consequence in the quarter and we remain comfortable with our liquidity profile through the balance of this year and all of 2010.
Finally, the significantly higher net interest margin in pre-provision earnings at CapitalSource Bank are strong signs of its future growth prospects. Completion of our one year regulatory exam and a well managed deposit profile which continues to reduce our cost of funds were also important accomplishments in the quarter.
We fully realize that much hard work remains as we manage the credit performance of our legacy loan portfolio and grow the bank in the coming months. It is our hope that our key drivers will soon turn and it is our view that many of them will turn at the same time. I can assure you that the entire senior management team and all of our colleagues at CapitalSource are working hard to achieve our strategic goals and to get to the other side of this credit and still liquidity crisis.
We are now ready for questions.
(Operator Instructions) Your first question comes from Bob Napoli – Piper Jaffray
Bob Napoli – Piper Jaffray
On the write down of deferred tax asset I think you actually wrote down more then what your 10-Q said you had. Is there anything left in deferred tax and what changed given that you’re closer to your inflection point? I heard your comment but what changed from last quarter to this quarter to cause the write off?
I think as we mentioned the last quarter, the way we reserve for these in the second quarter is after we de-read it we created several tax lend fees. Some of the tax lends had these trailing 12 quarter loss at the end of 6/30 and we reserved for those at that point in time. One of the other ones, which was our subsidiary that had a lot of our real estate business, was not reserved for because it had cumulative earnings. With the increase in reserves the charge-offs focused on real estate. That entity moved closer to this cumulative loss position or would be there in the short future. Based on that accounting literature we reserved for the rest of that.
The reason why the total increase is more then what we said we had at the 10-Q at last quarter is because of the loss we had this period increases the overall deferred tax asset and therefore the reserve is bigger. If you think about it, $100 million of losses would create, I’m just using rough number, another $40 million of deferred tax assets at a 40% tax rate and then you reserve for that amount. Basically that’s why that number is larger.
In terms of any left over deferred tax assets we have one sub that has about $40 million of deferred tax assets that are unreserved for as of September 30.
Bob Napoli – Piper Jaffray
You expect that to fourth quarter, first quarter probably be reserved for.
In our current forecast with that entity it’s actually one of our securitizations that has low op ex and a very low cost of funds. We expect that deferred tax asset not to require a reserve.
It’s somewhat mechanical is another way to think about it. When you hit a trigger it happens.
Bob Napoli – Piper Jaffray
Based upon this chart you only have, according to your analysis, the worst case scenario is another $440 million of provisions against the legacy portfolio. Would you expect that to be pretty front end loaded if you look at that over four quarters you would expect the biggest chunks of that in fourth and first quarter of next year?
Really what’s happening is the provisions are getting front loaded in general. We don’t expect that the $439 million which is the total of all the worst cases, we do not expect that to be the number. We expect the number to be in the mid point in the range. We would expect there to be, it’s our view if you look at the low and the high on commercial real estate, let’s start there. Under either scenario there’s more provisions coming. We expect to be in the mid point of most of these ranges so you can do the math there on the commercial real estate. The ranges are roughly $30 to $200 million low to high. We expect it to come in the mid point of the range and we would expect that to occur in the next two quarters would be our view.
At this point we’re not necessarily expecting more to come from the other categories as we feel like we’re reasonably within the midpoint of the range. Obviously that’s subject to change as we do our work. I would expect this stuff to come in the other categories to potentially not be that front loaded would be my view. I think what’s happening is we’re pulling forward all the commercial real estate stuff because as I said its only 75 loans. We obviously know all those loans very well at this point.
Most of us on the senior management team know the bid and ask between underlying negotiations with the borrowers on all those loans at this point. I think we have a very good sense as to what’s going to happen there and when it’s going to happen. Due to the fact the commercial real estate loans have shorter term terms you tend to see more front loading in this one.
Bob Napoli – Piper Jaffray
One category that stands out is the time share is like way below its range yet why are the charge-offs so low there on the time share versus what you expect?
We haven’t seen anything. Our expectations like many is driven by the continued consumer pressure, unemployment continuing to be soft and some expectations that we could have some softness here, although we haven’t seen it yet.
Bob Napoli – Piper Jaffray
I heard the cost of funds is pretty much done correcting at the bank and not a lot more upside there. On the asset yield side how much more margin expansion do you expect to get over the next few quarters?
I think it’s our view that the loans we are originating new loans at these consistently high spreads so the margin expansion will be a formula based on how many of those loans we can originate.
It’s purely a function, assuming the market doesn’t change and we haven’t seen a change in the market, it’s purely a function of putting some of this liquidity that’s earning a very low rate of interest, into loans and reinvesting the I-Star which is Libor 150 into Libor loans that are closer to 500 and 600.
Your next question comes from John Hecht – JMP Securities
John Hecht – JMP Securities
You mentioned I believe around $1 billion of CRE loans maturing in the next four quarters. Can you give us a sense for the maturity schedule within those four quarters?
I think the number was about $800 million across five quarters, if I recall $797 million across five quarters. I don’t have an aging.
My sense it was chunky so it’s not level so it’s not necessarily front loaded. If I were modeling I would probably assume its sort of close to level although some quarters are higher then others but I don’t have the aging schedule in front of me.
John Hecht – JMP Securities
Thinking about that in light of the FDIC guidelines that mentioned earlier, obviously it sounds like within the bank that could be helpful by providing you more flexibility in terms of recognizing problems where the borrower might be up to date gives you more flexibility in terms of when you might or might not want to sell a loan. Might that be the case outside the bank where you can extrapolate these new guidelines and use that to provide more flexibility outside the bank with the CRE portfolio as well?
Across the last quarter and continuing through the rest of this year we are making the policies at the bank and the parent symmetrical. I think its fair to say that some of the guidance like appraisal events that inform decisions in the bank because that was our view of the prior regulatory guidance, now there’s new regulatory guidance, which again we think is the smart right thing to do. I would say that in the past CapitalSource may not have used that same approach on some of its situations but since we’ve had the bank and a general desire to have symmetry between the two organizations I think it’s fair to say that a lot of the bank practices have been incorporated into the parent’s practices.
In the past, I think directionally the goal has been to make the policies more symmetrical and so certain regulatory guidance has informed where the parent’s been going directionally on accounting issues. There may be some impact also on parent legacy assets. I will reiterate what John said in his remarks too which is we’re not going to use this an opportunity to push off known losses this will only really impact performing loans for which we think we’ll fully collect over time.
John Hecht – JMP Securities
On that last comment, I know you’ll be conservative in your application and I know it’s early because this was put out late last week. Do you have a sense for of your impaired assets that are current, can you give us a sense of the portion of those that might not have been impaired using these rules or is it too early to give me a sense there?
I think it’s too early. It feels to us like, this came out Friday, late in the afternoon. Many of us, including myself were frantically reading this into Friday evening trying to understand it. I actually thought it was really smart, if you’ve taken a look at it you’ll see that they provide its policy statement with updated guidance. They say very clearly it replaces prior guidance.
What’s very good is they gave examples, there are multiple pages of examples because sometimes it hard to overlay guidance no matter how much they try to be clear on the situations. They provide lots of hypothetical situations. When you read those things you’ll see that they’re not actually going to allow people to hold clearly problem assets as good assets. Land loans, construction loans; all that kind of stuff is still going to be problematic as it should be. We unfortunately have some of them.
There are certain hypothetical that we thought compared very square with situations we have. My own judgment there were two situations this quarter that were probably $50 million in total size where they were similar fact set which is loan occurring have positive debt service coverage and you were extending because of the lack of refinancing options of the borrower and the appraisals come in and indicate that the loan to value is really high or slightly under water and you’re forced to put those loans on non-accrual and actually take charges against them.
Again, without a deep dive and this is not a formal opinion of the company but it appears to me that looking at the hypothetical that those two loans, for example, would not have fallen into problem loan categories with this guidance in place, perhaps. Whether there’s more in the portfolio that would fit into that category the answer is probably yes but what we were really focused on was the situations that were occurring this quarter because of the timely nature of this.
I would second what John said is we’ve had some of our folks who do this work day to day reviewing it and we don’t have feedback from them yet. I would expect that we have a mix. It will benefit us dramatically on CRE where the borrowers are in good shape or supportive of the property itself is providing debt service coverage. We haven’t provided an analysis yet or even calculated one but I would expect it to be a mix on some assets, it will help us on others it won’t.
What it does is it allows, the problem that we’re experiencing and I think others are as well is that within our commercial real estate portfolio again which is 19% legacy loans, there’s clearly a lot of bad loans there that we’ve already taken charges on, we’ve already taken big reserves on and there’s some situations that are coming up for the end of their maturity in the next year that we’re concerned about. There’s probably one handful of good sized situations that we’re concerned about.
Then what was also happening was you had a lot of situations where the example I explained on the call where by most people’s judgment the loan was an okay loan, not a loan you’d make today but based on the coverage and the borrowers support you would expect to have that loan paid off at par at some point in the future. Those things were being forced into these problem loan buckets. In some ways those things were getting lumped in with the loans that were truly bad.
The psychology got so bad that from time to time we actually had some very good loans that had very appropriate loan to values where borrowers were calling you up at the end of the term and expecting you to give them a discount upon payoff. You’d say what are you talking about. They watched the media and they talk about how bad real estate is how everyone is selling it at discounts, people with good loans expected to get relief at maturity. Literally we had situations where people would expect to get a discount when a totally performing loan that has plenty of additional coverage and good loan to value came up for maturity, that’s how bad the psychology was getting.
Hopefully there’s a bit of a change in psychology that the real problem real estate loans in which, let’s face it, are land related, construction related, residential construction related in particular acquisitions all those things are clearly big problems absent support by the borrowers. One of the things we feel marginally better about is that our land portfolio is about 60% real urban infill with deep pocketed owners who have shown a pattern of putting money in to support the property. We have less suburban acquisition development land stuff; we don’t have as much of that.
Let’s face it; the land in the acquisition development stuff is all problematic right by and large. Assets that were 70% loan to value and have gone to 90% to 95% and are current we like many think they’ll hopefully get good recovery on those assets and this gives you relief on classifying those and hopefully changes the psychology on some of the more performing asset classes. I actually think this guidance is quite huge in my own judgment.
Your next question comes from Don Fandetti – Citigroup
Don Fandetti – Citigroup
Your cash flow loans have held up relatively well just given the economic distress. I was curious how concerned you are about a lag there or are you feeling pretty confident by your statement that you might get the profitability?
Unfortunately we’ve taken 13.4% marks against cash flow loans already. We never entered that business thinking we’d have 13.4% cumulative losses. We’ve excluded the media cash flow for that which is a much higher number over 30%. I think part of the reason we feel better about it is, which we do, is because we are seeing stabilized trends.
We think the nature of those deals are such that most of the companies that are more affected by the adverse economic conditions have already presented that, those kind of facts so we’re seeing it. We don’t see any particular areas in that portfolio that we expect to have a hard second dip if you will. We think the reserve levels we have are certainly sufficient. I think we, on the margin, feel better about that part of the business at this point.
Your next question comes from Mike Taiano – Sandler O’Neill
Mike Taiano – Sandler O’Neill
I had a question on the bank. Could you possibly give us a little bit more color on the loans that are being originated at the bank, composition, average term of those loans? Along those lines, what is the current duration gap at the bank running these days?
Duration gap, are you talking about the balance sheet as of today?
Mike Taiano – Sandler O’Neill
Yes, your average duration of the assets versus your liabilities you have today.
The liabilities are other then a few home loan bank advances are all retail deposits, that average is about five months. The average term of our loan book is probably closer to two and three years. Of course all the loans adjust on a monthly basis, 68% of the loans are on floors. Despite the duration what’s going to happen is we’re going to have outside margins continue until interest rates go up and then when interest rates go up our deposit costs will start creeping up and the loan yields will not go up until Libor passes through those floors.
Mike Taiano – Sandler O’Neill
You had mentioned you have been trying to extend out the duration on the deposits is that along those lines to narrow that gap over time?
Yes, its taking advantage of what we feel are historically low interest rate environment and to mitigate that when it ultimately happens. We’ve had only modest success with that. When we say long term we’re not talking five year CDs we’re talking 12, 15, and 18 months CDs versus three and six month CDs. Consumers just are not willing to extend at today’s rates and the premium required to incent them to do that we think is too great. We have had some success with that without impacting our cost to funds to any great degree.
Mike Taiano – Sandler O’Neill
On the loan origination the composition there, are the terms, in other words two to three years is that generally consistent with what you’ve done in the past?
Yes, we haven’t really changed the pricing on these and the terms, things of that nature. What we’ve done is tried to move to lower whole sizes. The average in this quarter was probably below $15 million, in the $13 million size range. As we’ve talked about in the past, we tried to emphasize healthcare loans so a large percentage of what we’re doing now are either asset based healthcare or healthcare real estate so those do get classified in our real estate category but we think of those as healthcare loans.
We’re still looking at commercial real estate along the lines that both Dean and John described there. I’d say a great percentage of the deals are healthcare related in some way. We’re still seeing a few cash flow deals just not very many. There’s not a real concentration there after you take those first two categories.
Mike Taiano – Sandler O’Neill
You also said the transaction closing rate was still relatively low. Can you share what that is and where it stands relative to the past?
I can’t comment on that.
We don’t have a specific number. Both Tad and I have gone back several quarters to look. In general if you were to benchmark the closing rate today versus the closing rate in ’05, ’06, and ’07 it’s substantially lower today for all the reasons we identified. It is increasing and particularly as we mentioned it has increased substantially in the past 12 weeks. There’s a trend and we’re watching it.
Mike Taiano – Sandler O’Neill
On the healthcare RE lease back business any update there on progress of either perhaps selling it or monetizing it, I know you had said six to 24 months but was wondering if there’s any narrowing of that gap?
I think it’s fair to say we’ve got several good options we’re considering. We’re evaluating those as we speak.
Your next question comes from Scott Valentin – FBR Capital Markets
Scott Valentin – FBR Capital Markets
With regard to the regulatory exam that just finished, are the results of that exam have they been finalized and if they have are they reflected in the numbers this quarter?
We’ve had an exit meeting with management and we’ve had an exit meeting with our Board. It’s final to that extent. We don’t have a written report yet. We expect to get a written report within the next few weeks. We don’t expect it to tell us anything different. Yes, any impact from that exam is already in the numbers you have.
Scott Valentin – FBR Capital Markets
I know that the guidance came out Friday, I was curious did the examiners at all, if they had a heads up or were anticipating that that guidance maybe internally were they applying the new rules or is that on a go forward basis?
They were not applying these rules. My guess is they were not even aware of those yet. They probably learned when we did. I think this came from a higher level so I think it’s new to the exam staff as well.
Scott Valentin – FBR Capital Markets
I think you mentioned in the commentary about portfolio acquisition maybe buying a portfolio of loans or assets. I was wondering if you had particular asset types in mind and on the flip side if you’re seeing more clearly the market maybe if you’ve thought about loan sales maybe?
We have thought about loan sales. We’ve actually sold some loans; we sold some loans this quarter which we thought was the right thing to do which drove some of the charge-off numbers. I would say we’re looking at two asset classes; we’re looking at healthcare and we also have a strong interest in the SBA lending business because we think is a good asset for the bank so we’re looking there.
Scott Valentin – FBR Capital Markets
Do you happen to have a dollar amount or maybe the loan types you sold during the quarter?
We put the $75 million total and it was highly concentrated towards commercial real estate.
$70 to $75 million and CRE focused. Cash flow loans that we sold that didn’t close second quarter. It was marked; we sold it at the mark or above the mark. We committed to sell it in the third quarter and it didn’t close until the fourth quarter.
Scott Valentin – FBR Capital Markets
You said you took a slight purchase price on the [inaudible] it sounds like that drove some additional charge-offs this quarter?
Some were marked as specific reserve so that was part of the charge-off. I think on average there were some slight additional marks and we actually sold the loans.
Scott Valentin – FBR Capital Markets
The prices are running in line that 50% to 60% severity, recovery rate?
Some of the loans we’ve sold were not necessarily what I would consider all problem assets. I think when the 50% to 60% recovery rate relates to capital sources moving on the collateral that’s where we’re really seeing those kinds of recovery rates. Obviously you can sell some more performing commercial real estate loans even in this market at higher then that.
Scott Valentin – FBR Capital Markets
The liquidity outlook you mentioned you’re very comfortable with liquidity through 2010. It raises the question about 2011 there are some significant maturities coming in 2011. Can you talk about the strategy you have, I don’t know if the healthcare assets are entailed in generating liquidity and looking at maybe restructure, repay some of those maturities in 2011?
I wouldn’t read our focus on 2010 as negative on 2011. In terms of commenting on liquidity and forecasting we’re still in ’09 and we really only talk about ’10 at this point. We’re not sitting here worried about our ’11 liquidity we just haven’t done, are not in a position to talk about our liquidity forecasting out that far.
When you say significant maturities I think there’s only the one convertible put date that comes up in July of that year which is about $330 million. As John mentioned, we are obviously very aware of it and determining what our strategy is for dealing with it. We have almost two full years to do that.
Your last question comes from Moshe Orenbuch – Credit Suisse
Moshe Orenbuch – Credit Suisse
I was hoping we could talk a little bit about capital levels at the bank. The ratios are there, if you have cash that you could put in if you needed to grow the portfolio could you talk a little bit about how that looks over the next couple of quarters. Would you see the bank getting back to profitability or would you see that capital levels declining.
First, we’ve run our own set of stress tests in the bank on our portfolio which includes the legacy stuff and the $1 billion of new stuff that we made. Based on our outlook of that and future origination net growth, we still have about $700 million of I-Star repayments coming in that’s funding a lot of our growth. We don’t see any need for capital at the bank. The two drivers there are loan growth and future provisioning. If we’re off on either of those then I’ll let John talk about the source of funding for that.
The parent has liquidity to invest in the bank if necessary but we don’t believe we’re going to have to do that, that’s our view. The bank has good reserve levels you should note that also.
Thank you very much. That wraps up our call. Just a reminder, the replay will be available later this morning.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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