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CapitalSource (NYSE:CSE)

Q3 2011 Earnings Call

October 27, 2011 5:30 pm ET

Executives

James J. Pieczynski - Co-Chief Executive Officer and Director

John K. Delaney - Chairman and Member of Asset, Liability & Credit Policy Committee

Donald F. Cole - Chief Financial Officer

Dennis Oakes - Senior Vice President of Investor Relations

Douglas H. Lowrey - Chief Executive Officer of CapitalSource Bank, President of CapitalSource Bank and Director of CapitalSource Bank

Analysts

Henry J. Coffey - Sterne Agee & Leach Inc., Research Division

Donald Fandetti - Citigroup Inc, Research Division

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Scott Valentin - FBR Capital Markets & Co., Research Division

John Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

Mark C. DeVries - Barclays Capital, Research Division

Michael P. Taiano - Sandler O'Neill + Partners, L.P., Research Division

Operator

Good afternoon, and welcome to the CapitalSource Inc. Third Quarter 2011 Earnings Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Dennis Oakes. Please go ahead.

Dennis Oakes

Thank you, Amy. Good afternoon and welcome to the CapitalSource Third Quarter 2011 Earnings Call. With me today are John Delaney, Executive Co-Chairman; Co-Chief Executive Officer, Jim Pieczynski; CapitalSource Bank President and CEO, Tad Lowrey; and Chief Financial Officer, Don Cole.

This call is being webcast live on our company website, and a recording will be available later this evening. Our earnings press release and website provide details on accessing the archived call. We also have posted a presentation on our website, which provides additional detail on certain topics, which will be referred to during our prepared remarks.

Investors are urged to carefully read the forward-looking statements language in our earnings release, but essentially, it says the following: 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. And finally, more detailed information about risk factors can be found in our reports filed with the SEC.

John will begin the prepared portion of the call, and after Don concludes his remarks, we will take your questions. John?

John K. Delaney

Thank you, Dennis, and good afternoon, everyone. During the third quarter we made substantial progress on our share repurchase program, cut our recourse debt in half, had the largest quarterly loan growth in more than 4 years, and produced another quarter of very solid financial performance at CapitalSource Bank.

My remarks today will address our return of capital activity and examine how well we are positioned after celebrating the third anniversary of CapitalSource Bank this past July. Jim will then provide more detail on new loan production and our continued efforts to reduce operating expenses. Tad will elaborate on the bank performance, and Don will focus on the significant balance sheet deleveraging in the quarter and our sources of parent liquidity.

As investors know firsthand, the third quarter was a turbulent one for financial services and the financial markets in general. Increased volatility and the downward pressure on financial stocks from June through September, did, however, work to our benefit from the perspective of our share repurchase activities.

During the quarter, we acquired just shy of 50 million of our shares, which was well beyond our expectations and reduced total outstanding shares by 15%, which is obviously very significant. We purchased those shares at an average price of $6.19. After utilizing approximately $309 million of available repurchase authority during the third quarter, we had approximately $66 million remaining at quarter end. Given that progress and consistent with the intentions we've announced in the past, our board this week increased our share repurchase authority by another $200 million.

We expect to pay some of our share repurchases through the end of next year to be more measured than this past quarter, however, as you would expect our rate of buybacks will be dependent upon certain liquidity factors including the pace of loan repayments and satisfaction of cash obligations, particularly the $175 million of convertible debentures puttable next July, which is the only remaining near-term recourse debt we have.

Based on our liquidity projections and taking into account our normal operating cash, needs, we are extremely confident in our ability to redeem the converts next July, while maintaining a steady pace of share repurchases.

As I mentioned it earlier, we celebrated the third anniversary of the formation of CapitalSource Bank during the quarter. Since the bank was established in July 2008, we have nearly doubled its loan portfolio while building a healthy net interest margin, producing a solid return on asset and carrying very high capital and liquidity levels. In fact, our bank's performance compares favorably with nearly any comparable back in the country on each of those measures.

Since inception, we have operated under a California industrial bank charter, which is consistent with our extremely efficient and stable deposit gathering strategy in the current very low interest rate environment. But we've also made clear our longer-term intention to convert to a traditional commercial charter.

Well, the bank has grown, the parent company's loan portfolio and debt have declined dramatically. In just the last 2 years, we have gone from $5.7 billion of loans and $5 billion of recourse and non-recourse debt at the parent on September 30, 2009, to only $1.3 billion of loans and total debt of less than $1 billion at the end of the third quarter. Importantly, $346 million of the remaining debt is non-recourse securitizations and another $437 million are Trust Preferred Securities, which do not mature for more than 20 years. The relative split of consolidated assets has flipped from 61% at the parent and 39% at the bank 2 years ago to 22% and 78% respectively as of today.

CapitalSource Bank has performed exceptionally well during its first 3 years. By any measure, we have successfully integrated the historically diverse and strong specialty lending platform of CapitalSource with a California branch-based depository. Doing so has eliminated all dependency on the capital markets to fund our growth.

For a variety of reasons, we experienced some personnel redundancy between the bank and the parent during these initial years of our existence, particularly in our accounting, treasury, and IT departments. We were able to successfully navigate through the de novo period despite a somewhat cumbersome structure because we started the bank with a very solid and deep management team led by Tad Lowrey.

Going forward, we expect to take full advantage of all synergies we can achieve between the 2 organizations and ultimately move virtually all CapitalSource employees into our bank.

While shrinking to achieve efficiencies in certain administrative support areas of the organization, we have been actively hiring new members for our origination teams, as our middle market and small-business lending franchise continues to expand and grow. As a specialty lender with a track record of growth, supported by strong liquidity, abundant capital and experienced management, we are attracting extremely talented and very experienced professionals to join our lending team -- our lending platform, and Jim will describe this in greater detail in a few minutes.

Consistent with our efforts to streamline the organization, and recognizing that we have reached point where the vast majority of our assets are in CapitalSource Bank, which is based in Los Angeles, we are today announcing changes to the executive structure of the consolidated organization that recognizes that geographic shift.

Steve Museles will step down from his co-CEO role at December 31, though he will stay on for a time in a consulting capacity to assist Jim on a variety of tasks, and he will also continue as a member of our Board of Directors.

Jim will thereafter be the sole CEO of the parent. Don Cole will be succeeded as CFO on January 1, 2012, by John Bogler, who will also retain his current role as CFO of CapitalSource Bank. For those who don't know, both Jim and John are based in California. Tad Lowrey will continue as CEO of CapitalSource Bank, and I will remain as Executive Chairman, with my time and attention focused on capital allocation and strategic growth initiatives.

Well, obvious to those who know them, it should be noted that it has been a special privilege for me and all of us to work with my friends Steve and Don. They have consistently performed to a very high standard in a number of important areas across our 11 years together, including their most recent postings. Among their many, many achievements they deserve particular credit for taking lead roles in managing the bank formation process and the parent balance sheet repositioning activities. These have been critically important to the company, and these responsibilities are now complete.

We have achieved remarkable success over the last 3 years despite the challenges presented by the financial crisis, and we expect CapitalSource Bank will continue to perform at a very high level in the months and years ahead.

Jim's up next. Jim?

James J. Pieczynski

Thank you, John, and good afternoon to everybody. Loan growth at CapitalSource Bank in the third quarter was $334 million even after taking into consideration that we sold $108 million non-performing loan. This is the highest level of quarterly growth since formation of the bank. It is also the first quarter in more than 4 years that we have had net loan growth on a consolidated basis.

Total funded loans added in the quarter of $619 million, represents only the second time that our quarterly production at the bank has exceeded $600 million. The other time, was the first quarter of this year.

Growth in the quarter was broad-based with the largest concentrations in technology, healthcare, real estate, equipment finance, commercial real estate, and multifamily. Market volatility, particularly in August, created opportunities for syndicated loan purchases during the quarter totaling $84 million or 13% of our total production. In many instances, we were able to buy an incremental piece of a syndicated loan where we participated initially, but had not received our full requested allocation.

In other circumstances, we were able to purchase loans we knew well because we had underwritten them but ultimately passed on final participation because the yields had been too low. As the credit spreads on those same loans widened and they traded at a discount to par, we made opportunistic purchases, which resulted in yields meeting our hurdle rates.

The total loan portfolio at CapitalSource Bank as of September 30 was $4.5 billion, which is $688 million or 18% higher than the loan balance at year end 2010. It is clear, therefore, that we can expect net loan growth this year to be in excess of 20%. This is a remarkable achievement given current economic conditions and the lack of loan and balance sheet growth reported by most other banks.

As John mentioned, we have been actively hiring across our entire lending platform to support current and future growth. Specifically, since August 1, we have hired 13 individuals to join our commercial real estate, healthcare real estate, professional practice, healthcare credit, security, and small-business lending teams. The high-caliber of professionals we are attracting is evidenced by the group's average of 17.5 years of lending experience in their respective fields of expertise.

Though we are expanding to support growth, we are simultaneously taking the steps necessary to generate efficiencies as we integrate the bank and the parent. It is worth noting that we have made considerable progress in reducing consolidated operating expenses from $278 million in 2009, to $216 million on an annualized basis for the 9 months ended September 30, which represents a reduction of 22% over the 2-year period.

We expect to realize additional savings on the compensation and benefits line as we eliminate duplicative functions between the bank and the parent. In addition, we continue to reduce the utilization of outside services, related principally to loan workouts along with general tax and accounting services at the parent company. Our long-term operating expense target remains at 2% of assets. We have been close to that target at CapitalSource Bank in recent quarters, including 207 basis points in the third quarter. Reflecting the savings at the parent mentioned above, we expect consolidated operating expense for 2012 to be lower than the full year 2011.

Before turning the call over to Tad, I want to mention one other aspect of our transition to a pure bank model with the vast majority of our consolidated assets at CapitalSource Bank. As of January 1, 2012, we have completed the steps necessary to formally designate our Los Angeles office as headquarters for the company. Doing so, however, will not diminish our major presence in Chevy Chase, Maryland as the majority of our credited administration, many of our originators, our legal department, and other support professionals will remain there.

We will also continue to have originators, credit teams, and other employees spread throughout the country. This decentralized model is the foundation of our national direct origination franchise, and will be unaffected by the headquarters shift.

Tad will now provide his perspective on the operations of CapitalSource Bank during the third quarter. Tad?

Douglas H. Lowrey

Thank you, Jim, and good afternoon, everyone. As the third quarter results have demonstrated, the growth and profitability story at CapitalSource Bank goes beyond the loan growth which Jim spoke about. Our net interest income was up 2% in the quarter, as the benefits of loan growth more than offset the decline in the net interest margin.

The risk base capital and leverage ratios remained exceptionally strong at 18.1% and 13.5% respectively. Total assets rose 3% to $6.5 billion and are now up 10% year-over-year. Deposits were 2% higher for the quarter and 6% over the same period in the prior year at nearly $4.9 billion, even as our deposit costs have continued to drop. Our net interest margin at 4.94% and our fully taxed return on average assets of 1.55%, are solid by any measure of bank performance, despite modest declines from second quarter levels.

As I've said on previous calls, the bank's net interest margin at the end of last year and the start of this year has been inflated by accelerated discount amortization from an unsustainably high level of loan payoffs. That pace is now subsided to a more reasonable level, so our current margin reflects a positive trade-off of near-term benefits, which is the accelerated amortization for longer-term earnings growth -- from the longer-term earnings rooted in the loan growth, excuse me.

From the day the bank has been formed, we've had excess cash and investments on our balance sheet. The significant loan growth in this quarter allowed us to redeploy close to $200 million of that liquidity into new loans which produces significantly higher yield than our investment portfolio. We will continue to draw down on that liquidity over the next several quarters.

Credit metrics were significantly improved in the quarter. In particular, non-accrual loans declined by 51%, and now stand at $108 million and total non-performing assets, including REO, dropped to just 1.78% of total assets.

We took a $14 million provision, $12 million of which related to specific reserves, and net charge-offs were only $4 million compared to $23 million in the prior period. Total loan loss reserves increased by a net $10 million and now stand at $119 million, which are more than 1% of non-accrual loans.

Over the past couple of years, our credit metrics have improved dramatically and our portfolio also reflects much smaller whole sizes across our different lending groups, yet we still carry a healthy allowance against loan losses of 2.62% of the loan portfolio.

Looking ahead to the fourth quarter. We expect continued loan and overall asset growth funded primarily with growth in our low cost, retail deposit base. We expect our net interest margin will contract a bit further as a result of competitive pressures, general market conditions and mix shift, but to still remain in the 4.75% to 5% range.

Although predicting the future is always difficult, we feel very comfortable with our current business model and the extremely strong bank balance sheet, which mitigates exposure to interest rate, liquidity and capital risks. In addition, we have no fee-based businesses with our current banking customers, so we're unaffected by regulatory changes impacting certain consumer products such as credit cards and debit cards.

We will continue to position ourselves to pursue the commercial charter, which ultimately will allow us to consider expansion of our product offerings and create greater opportunities for growth via acquisitions.

We can't afford to be patient, however, since our current model, with its diverse and national specialty lending platform has plenty of runway for expansion.

Moving to the right side of our balance sheet. We’re very comfortable with our deposit gathering capacity. Our deposits have grown modestly this year through September 30, and we intend to more proactively begin raising deposits in the coming months. In fact, total deposits are projected to approach $6 billion by the end of next year in order to fund anticipated loan growth. As a result, we expect our cost of deposits to tick up slightly from the third quarter level, which is currently 110 basis points.

Don will now provide a review of the third quarter from the parent company perspective, and examine sources of liquidity for the share repurchase program. Don?

Donald F. Cole

Thank you, Tad, and good afternoon, everyone. My remarks today will focus on the very substantial debt production in the third quarter, as well as certain aspects of the accounting treatment of those transactions. I also want to provide some insight into our sources of liquidity at the parent, since return of excess capital via share buybacks remains a top strategic priority, and then I'll touch briefly on consolidated credit performance.

During the quarter, we reduced our total debt by over $700 million or 43% in 4 ways. First, we retired $281 million of convertible debentures as scheduled in mid-July. Second, we redeemed nearly all of the $300 million Senior Secured Notes via a tender offer and open market purchases. Third, we purchased $75 million of our 7.25% 2012 convertible debentures in the open market. And fourth, payments collected on our term securitizations reduced the associated non-recourse debt by $65 million to a balance of just $346 million.

As a result of this substantial debt reduction, the only remaining recourse debt instruments outstanding are the $174 million of 2012 convertible debentures puttable next July, and $437 million of Trust Preferred Securities, which have maturities that do not begin until 2034.

As I mentioned, the 3 remaining securitizations on our balance sheet are nonrecourse, and the debt continues to steadily pay down as the associated loan balances decline.

Our progress this quarter is consistent with a very deliberate effort to delever our balance sheet over the past couple of years. Looking back just 8 quarters, we had over $5 billion of debt at September 30, 2009. So our current debt level is 81% lower than just 2 years ago.

During the quarter, we paid a premium of $78 million to redeem the 12.75% Senior Secured Notes, which had a scheduled maturity of July 2014. In addition to gaining substantial flexibility for our share repurchase program, resulting from the elimination of certain restrictive covenants in those notes, we will save approximately $108 million in cash interest payments through the original maturity date. Given the amount of cash we had available as compared to other investment opportunities, we felt that this was a good trade for us.

The income statement impact of the note redemption in the third quarter goes beyond the cash premium, because we also had to account for accelerated fee and discount amortization on the notes, which added another $33 million to the loss in the quarter.

Putting aside the total onetime expense of $114 million related to early debt retirement this quarter, net income would've been $0.11 per share as compared to $0.05 per share in the second quarter.

Because we presently have a valuation allowance established for our deferred tax asset, we don't get the full tax benefit from the loss in the quarter in the income statement, rather the tax benefit of the loss contributed to the increase in our valuation allowance to $474 million at quarter end. On the other hand, the loss in the quarter actually caused a reversal of approximately $13 million of DTA valuation allowance that we had taken in prior quarters this year, which is the reason for the tax benefit recorded in the third quarter income statement.

I will turn now to the parent company unrestricted cash position at the end of the third quarter and the expected sources of cash in future quarters, which will be used for share repurchases and the redemption of the 7.25 convertible debentures which are puttable next July.

At September 30, we had $252 million of unrestricted cash on hand at the parent, despite the expenditure of over $1 billion to reduce debt and buyback shares during the third quarter. This will provide sufficient liquidity for share repurchases over the short term. Going forward, however, we expect additional cash generation from several sources. First, we are now receiving all interest and principal payments on the parent company non-securitized legacy loans, which no longer have any associated credit facility debt. That balance declined by $57 million in the third quarter to $732 million. But projecting the pace of payouts in future quarters is challenging. Generally, we believe that the high-level of prepayments we saw earlier this year, particularly for cash flow loans which were generated by a wave of refinancing, are behind us.

Given that expectation, contractual maturities and the credit profile this remaining group of legacy loans, we expect paydowns in future quarters will be uneven. A second source of potential parent liquidity would be the actual sale of some of those non-securitized loans to the bank, a related party transaction, which is permitted, under certain specific circumstances. We have a number of fully performing loans to solid borrowers who we would like to retain as customers at CapitalSource Bank. We intend therefore to explore sale opportunities in the normal course of business and within regulatory guidelines.

A third source of liquidity comes from quarterly tax sharing payments we routinely receive from the bank, as the bank tax liability is offset at the consolidated level by parent losses.

A fourth potential source of liquidity will be bank dividends. Following the expiration of the 3 year de novo order, the bank is now permitted to pay dividends to the parent subject to legal and regulatory limits, and the bank's ability to utilize the capital.

And finally, we will opportunistically consider parent company loan sales if a deal makes economic sense, taking into account our marks on a particular asset and the loss of future income resulting from a sale.

Though we have these several sources of liquidity, our core needs at the parent are very limited, particularly following repayment of the high coupon Senior Secured Notes. As we think about the appropriate level of liquidity to maintain at the parent, the answer is dependent upon satisfying our near-term cash needs, such as repaying the converts, and holding cash to support general operating expenses, which are now quite modest, and will be further reduced with the movement of nearly all employees into the bank. Cash flow generated beyond these 2 obligations can be utilized for stock buyback and dividends.

Touching briefly on consolidated credit. We saw generally encouraging trends in the quarter, with non-accruals and total non-performing assets both declining by more than 30%. Charge-offs declined by 70% from the prior quarter to $26 million, which is the lowest level in over 3 years.

We did record a $35 million loan loss provision resulting in a net $9 million increase in the total consolidate loan loss allowance compared to June 30. While that is in the high end of the range we have recorded in recent quarters, it should be noted that a gain on sale of $10 million was recorded related to the sale of troubled loans. From a pure credit perspective, it would be appropriate to think of these recoveries as an offset to the current period provision. However, due to the accounting treatment of held for sale loans, these gain was recorded in other income.

Additionally, as Jim indicated, this is the first quarter in several years where the consolidated loan portfolio increased, which also contributed to the higher provision.

It is not unreasonable to expect that the provision will continue to bounce around a bit until the legacy portfolio is completely behind us. You will recall for example that last quarter was under $2 million. We still view credit as stable to improving and feel very comfortable with our total allowance for loan losses, which remained at 3.6% of total loans at quarter end.

Operator, we are now ready for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Mike Taiano at Sandler O'Neill.

Michael P. Taiano - Sandler O'Neill + Partners, L.P., Research Division

I guess, Don, could you just walk me through the provision at the parent was higher than I thought. And I thought you, guys, had fully reserved for the legacy books. Could you maybe just walk me through the dynamics of that and maybe what, going forward, you would expect to be kind of more of a normalized run rate if there is one?

Donald F. Cole

Sure. I mean again to sort of answer the last part of that question I think in the end that's sort of saying it's a little bit hard to get to a normalized run rate. And I appreciate the beginning of your question. Obviously, we still feel very good about the reserve position and with the portfolio shrinking, we do not expect to see material provisions at the parent going forward. I think the way the mechanics work this quarter, if you look at the parent company portfolio, there was very little by way of loan reduction this quarter. In essence the way the mechanics of it worked by mix, I think the loans that are paid off this quarter tends to be some of the better performing loans that had very little marks associated against them. So essentially, there was little change in what I would call overall general allowance because the loans that were paid off were such good ones and therefore essentially what ended up happening is that the few loans that had specific provisions against them sort of bled down to the allowance. But as I mentioned, sort of at the end there were those gains on sale and more than half of that number was in the parent. So again from a credit perspective, you should think about taking the parent reserve and offsetting it by, I think it was about $6 million of the $10 million were associated with parent company loans.

Michael P. Taiano - Sandler O'Neill + Partners, L.P., Research Division

All right. And then I guess on the subject of the management changes, I just want to make sure I understand the redundancy, I guess, issue between the bank and the parent. Is that basically the rationale on the senior management changes? And then I think also there was a couple of other changes one of your Directors I guess is leaving as well as your Chief Accounting Officer. I was just wondering if that was sort part of the same thing? And then with respect to expenses going into next year, you said they were lower. Can you give us maybe some sense of obviously directionally lower but some sense of magnitude?

John K. Delaney

Sure. This is John I'll start and then -- on kind of some of the management and director changes you're referring to, and I'll turn it over to Jim to discuss the expense levels. I think you largely summarized it that there have been very significant redundancies as it relates to the 2 businesses because when we obviously started the bank, the bank was a robust institution, it was a new institution. And because of our structure it had to be, and continues to be a very kind of independent institution. So it needed its own management team obviously and it needed many of its own kind of core services or functions, if you will. And then the parent had to maintain those as well. In addition, we just had a lot of things to do in terms of integrating and transitioning the business from the activities largely being focused at the bank -- I mean at the parent, which is the way they were before we acquired the bank, and then transitioning them to the bank. So for both, the redundancies that you alluded to and just the sheer amount of kind of the things we had to get done across the last several years, we had a broader and deeper team than you would normally have for an enterprise of this size. But as things have increasingly shifted to the bank, and we've been able to kind of check off the list at some of these major initiatives we had to do, we're now in a position where we can have a consolidated team, executing against the business plan. And so that's really what was happening with the management changes. So I think you summarized it pretty well there. As it relates to the director who stepped down, Eric Eubank, which we disclosed. Eric's been on the board of the company for 11 years, since we started the business, and was really just -- he was one of the original investors in the company. And he's been a terrific board member and a good friend to all of us, and it was just kind of a natural time for him to step down based on his schedule. So I wouldn't -- I mean, that's just the normal thing that happens with board members from time to time. That's how I would characterize that. So as it relates to the expense question, Jim?

James J. Pieczynski

As it relates to the operating expenses, as I talked about we were at $216 million level on an annualized basis for this year. In terms of where we're expecting next year, obviously, we're expecting to be lower. And in terms of the direction and the magnitude of it, we expected to be closer to the 5% to 10% range from a total reduction.

Michael P. Taiano - Sandler O'Neill + Partners, L.P., Research Division

Okay. Great. Just one last quick one. Is a special dividend under consideration at with the board or are you exclusively just focused on share buybacks at this point?

Donald F. Cole

I wouldn't say we're exclusively focused on share buybacks. I think what we've said in the past and what remains to be the case is there's a very significant amount of excess capital in this business. We took a big swing at returning a lot of that this past quarter. And again I like to say that buying back your stock is not really returning capital as investing in the company, but utilizing that excess capital, we obviously took a very meaningful swing at it this past quarter, and we're going to continue to do that. But we don't think that share repurchases are necessarily the only thing we'll pursue. We'll look at special dividend should that be appropriate. And then just making adjustments to our normal dividend policy, which is also something that we will be considering.

Operator

The next question is from Kyle Joseph at JMP Securities.

Kyle M. Joseph

I had 2 questions for you guys. I was hoping you could give us a run through of the inflows and outflows of MPAs going back to the credit question, specifically the -- I want to understand the specific reserve, the specific cash flow reserve, which will get bumped up from 2Q to 3Q?

Donald F. Cole

In terms of the inflows and outflows in NPA or the reserve, I mean, essentially I think we talked about that there were, I think, the presentation talks about 3 cash flow loans and 1 real estate loan. And so if you think back quarters ago, we used to have several of these and many of which had $10 million or more marks. There were no loans that had $10 million level even sort of specific provision taken this period. And again if you look back prior quarters, this level of specific provisioning is not that out of the range of where we've been. I think the big difference is in past quarters we intended to release a little bit more of the general allowance where the portfolio was shrinking. I think it's just a national situation of a few loans that were in the cash flow position that went bad in the quarter. And again it was these 3; 2 in the parent, and 1 in the bank. But nothing that unusual and frankly not a really large uptick in inflows to NPA. I think it was just slightly higher this quarter than last quarter. And again last quarter was one of our lowest that we've had certainly since the crisis. So I'm not sure if that answers the full question, if you had more specific numbers you're looking for.

Kyle M. Joseph

No, that works. In terms of cash generation at the parent, you guys, it sounded like you're going to focus less on selling parent assets to third parties and work on selling them to the bank. Is that because you're seeing bids kind of below the bookmarks, or I guess you want to retain the assets that you have?

Donald F. Cole

Relative to the loans that we're looking to sell from the parent to the bank, the only loans that we are considering selling are the loans that are non-classified loans, that are good past rated credits. And we have the ability to do that pursuant to the regulations that are out there. So from our perspective, we view it that these are actually good loans where we want to retain the customer and by moving them into the bank that's the best alternative for us. So it's the loans that we view it as the loans we're going to sell are the loans that we're not able to move into the bank as opposed to the way you would phrase the question where are we selling them because we -- are we not selling loans to the bank because there's problems associated with it. So we're going to be -- we're going to sell the good loans to the bank, and sell declassified assets to the outside world.

John K. Delaney

I was just going to say I'm not sure our appetite changed that in terms of selling the bad loans to the outside world. We've been working through our problem assets all this time. I think, we might have a slightly higher appetite now that we can actually use whatever cash we generate for our buyback program now that the Senior Secured Notes and the limits they had on buybacks are eliminated.

Operator

[Operator Instructions] Our next question comes from Mark DeVries of Barclays Capital.

Mark C. DeVries - Barclays Capital, Research Division

Is there any way you can give us a sense of how big the asset sales could be over the next quarter or 2? How much of a source of liquidity you'd expect from that versus just loan paydowns?

John K. Delaney

I think it's important to put this in context which is our approach to dealing with assets at the parent has been consistent across the last several quarters, and will stay consistent across the next several quarters, which is if it's an attractive asset sale, and we think it's a good decision for the company, we'll do it. If it's not an attractive asset sale, we're not going to do it. There's no sense of kind of fire-saling assets at the company at all. We're going to look prudently at doing that. And I wouldn't read too much into any comments we're making that our approach or trajectory is going to change dramatically in terms of how we deal with assets in parent. Fortunately, the assets at parent have run down very nicely and very quickly through their normal course. There's been asset sales that have occurred as part of that, but they've also been just normal paydowns. And the mix of that may change slightly over time with asset sales could be higher than paydowns. But I don't think you should interpret this to be any kind of a major course change.

Douglas H. Lowrey

Could I add to that, John? The only thing I think has changed this quarter is this ability that we've identified to potentially sell assets from the parent to the bank. And that's in the size range of $100 million to $120 million.

John K. Delaney

And I'll just add one last thing. Let's not forget about 40% of the parent company loans are in these non-recourse securitizations that still have very attractive debt associated with them. They have very strong yields, and we consider those very attractive assets for us to continue to make good returns on.

Mark C. DeVries - Barclays Capital, Research Division

And then just one follow-up, do you have any updated thoughts on what this quarter's results means for the timing of the realization -- for the reversal of the DTA allowance?

John K. Delaney

Sure I'll take that. I don't think it overall changes our view. I think one question we often got was if we did do this and it led to a significant expense in one quarter, would that expense in and of itself stop your multiple quarters of earnings? Well, I think just as we do and just as we talk about it, the accounts can see as sort of a onetime thing where we're actually just taking some expense now to replace some expense that would've been greater later. So actually I think this makes the future even more foreseeable than what the profitable, easier to forecast profits going forward. So I don't think it really sort of delays that approach, I think we had said in the past that we didn't see this happening before the end of the year. I think it's probably a 2012 event at this point if I had to guess. But I don't think this quarter and the loss associated with the debt extinguishment has any impact, really, on our belief about when this will come back.

Operator

That the next question comes from Steven Alexopoulous at JPMorgan.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

In terms of now expecting a more measured case of buybacks, is there a range that you could share with us where you think you might be quarter to quarter, maybe a targeted range?

Douglas H. Lowrey

No, unfortunately, there's not, because there's a lot of variables that go into this, including the stock price. So it really is hard to predict. I mean if we would have given you our prediction last quarter, we would've clearly been much less than we actually did. So I think it really is hard to provide a specific range because one of the most important variables in that decision tree is something we don't know, which is the price of the stock.

John K. Delaney

And I think the other variable on top of that, as you kind of try to think about it, as maybe you're modeling it is, I think what we said in my remarks is we have very limited cash needs at the parent at this point. We ultimately will need to retire the remaining 175 of converts. But after that the OpEx expense level at the parent is going to be very modest. So it really is about as we can generate cash off the asset. So whether it's a bank loan sale Tad talked about, or whatever bank dividends occur, that's when we look to kind of deploy the cash. So it's really follow the cash and solve for it that way. We're not going to look to hold a considerable amount of cash on our parent balance sheet going forward.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Got you. And then on the margin, just wondering why -- I just wanted more color why you're guiding to so much margin pressure from where we ended up this quarter. Is this additional reduction from lower discount accretion?

Douglas H. Lowrey

This is Tad. It's a combination, Steve, of a number of factors. I'll start with the right-hand side of the balance sheet. Part of this is we expect to pay up for deposits since we're talking about raising a significant level of deposits. And so far, we have overestimated our funds' costs each and every quarter, and hopefully we will do that again. On the left hand side of the balance sheet, we have a pretty significant mix shift there with multifamily and small-business loans, which come in at lower yields and also just a normal competitive pressure combined with the fact that we did have significant levels of accretion in quarter 1 and quarter 2 and most of the larger loans really not forecasting levels of prepayments in general as high as we had before. So if prepayment slowed down, that's actually a good thing for loan growth, but we will lose the onetime pickups from the accretion.

Operator

The next question comes from Don Fandetti at Citigroup.

Donald Fandetti - Citigroup Inc, Research Division

Clearly, the loan growth looks like it's been pretty healthy, possibly accelerating. I was wondering if you can comment on whether or not you think that's sustainable and you cited, or someone cited some increased competition. We're seeing other financial institutions doing more in the middle market space, can you talk about the competitive landscape as well?

Donald Fandetti - Citigroup Inc, Research Division

Well, I think that the competitive landscape does change and changes on a regular basis. In terms of what do we think in terms of sustainability of originations going forward. We've obviously -- we had communicated to the world that we would be at that $400 million to $500 million range a quarter, and we've clearly been in excess of that on a regular basis. So we feel very good about where the origination environment is right now. I think one of the areas of opportunity, and I touched on it in my remarks was the opportunities that were there in the leverage lending market in the third quarter, that quite frankly, weren't expected and weren't anticipated. And given the dislocation, we were able to do a significant amount of pick-up in activity in that space. I think one of the areas that is also boding well for us is for a while we were worried about the securitization markets coming back and what would that do relative in terms of impacting our real estate lending both on the healthcare real estate side and the commercial real estate side. And that it seems like the activity in the securitization space has definitely slowed down as well. So when I sit there and look at the market, although yes, there's more competition in there. I'd also think there are a lot of areas out there that are helping us, and I feel like we've got a significantly greater tailwind this quarter than I thought we even had at the end of last quarter.

Operator

The next question comes from Henry Coffey at Stern Agee.

Henry J. Coffey - Sterne Agee & Leach Inc., Research Division

I was just wondering if you could help me with some -- first with some of the simple questions. Changeable book is calculated at, I've got a number of about 556, is that accurate?

Donald F. Cole

That sounds right in the range. I think book is about 619 and there's about $173 million of intangibles, so it sounds like you're right in the range, Henry.

Henry J. Coffey - Sterne Agee & Leach Inc., Research Division

The buyback, Don, if I'm listening to correctly -- maybe you've already answered my question, when you have the cash you're going to buy back shares. You're not going to wait for another market selloff before you start writing checks, is that correct? I mean given the favorable impact on your remaining shareholders, does it really matter what you pay for the stock?

Donald F. Cole

Look, I think it matters what we pay for the stock because we're depending on the -- the price does matter. But to your earlier point I don't know that we'll be looking for significant pullbacks in markets before we stay aggressive because we still think there's a buy in our stock where it is now. So I think we said that cash is obviously a big variable, but John did say price is a variable. So it will enter into our thoughts when we do accumulate the cash how we deploy it. It's hard to predict those things because we don't know where markets will go and our stock price will go, but I don't want you to over read into my statement that we would buy back shares at any price versus other options.

Henry J. Coffey - Sterne Agee & Leach Inc., Research Division

And maybe -- I'll get off the line, but if you could comment briefly on the dynamic of selling loans -- your own loans back to the bank? Do regulators need to step in to approve? Or is it just normal underwriting process?

Douglas H. Lowrey

This is Tad again. We’re in a unique situation -- well let me start all over. No, the regulators typically don't need to approve something like that as long as it is within the guidelines that are published. And the size of this is within the guidelines that are published. And we foresee it happening. As a de novo institution we are required to required to continue to file business plans for another 4 years. And those business plans are subject to regulatory approval. And this sale is a part of that business plan. So while the loan sale is not subject to approval, the business plan in general is, despite having said all of that, it's within the guidelines, and we think it will happen. But I think you should think of it as a onetime event.

Henry J. Coffey - Sterne Agee & Leach Inc., Research Division

And not something soon, more of a 2012 or sooner?

Douglas H. Lowrey

Either this quarter or next quarter, if that's ballpark enough for you.

Operator

The next question comes from John Stilmar, SunTrust.

John Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

Tad, just really quickly, can you walk me through what the overage yields on the marginal loans were -- was this quarter? And in terms of the commentary with the leveraged loan market for cash flow loans and we've continued to see banks be very competitive through the credit -- through the volatility in the third quarter for many of the different lending markets. Is really the competition for where you made some of those loans, really the capital markets -- did the capital market gave you this opportunity? Over I'm just kind of more clarity about how we should think about the current period versus maybe future periods given future loan mix?

James J. Pieczynski

Sure, this is Jim. If you look at our portfolio, if you look at the weighted average yield on the portfolio that we had for the quarter, we were at -- our yield was at this level at 612 was our underwritten, all-in, yield. If you do further expand on what you asked about relative to the cash flow lending, our cash flow yields were roughly at around the 6.5% level, when you kind of take them and weigh them. So in terms of the originations, the cash flow loans that we did, which were in technology, healthcare and security, that's where we were able to get a fair amount of loans in the secondary markets. And yes to answer your question, that's a function where the opportunities came because of the dislocation in the capital markets. When you look at the rest of the portfolio and the other business lines that we had, those are largely all direct originations where our competitors were either banks or other direct lenders that were out there.

Operator

Our next question comes from Scott Valentin at FBR Capital Market.

Scott Valentin - FBR Capital Markets & Co., Research Division

Just as it pertains to cash flow from the banks, the bank dividend. I assume you want to maintain certain capital levels at the bank. Right now you have a lot of excess capital are there any guidelines or ranges you want to keep at the bank so you can get a sense how much cash could be thrown off from the bank withholding company.

Douglas H. Lowrey

Yes, we do have a guideline and of course that's the published risk based capital of 15%, we're currently at 18%. So we have a significant cushion there. We also have a pretty significant growth expectations over the next 5 quarters. But we're also spending off a lot of earnings as a result of that, and actually enough earnings to fund that level of growth. So we would like to draw that capital down. We're really not eligible to pay a dividend until the first quarter of next year because under state of California rules, it's based on your prior earnings. And so in our case we don't know that level until we close the books for the year. And then we would expect to declare that the dividend subject to our growth expectations, Internal Stress test, things of that nature, in the first quarter. Going forward after that initial dividend, we would expect to adopt a payout policy at the bank based on a percentage of earnings up to the parent. But it's a little bit early to start thinking about that.

Scott Valentin - FBR Capital Markets & Co., Research Division

Just going back to the originations. Of the $619 million this quarter, just trying to get a sense of how much was purchased maybe in leveraged loan market, and I apologize if missed that if you said it, but how much was purchased and leveraged loan market and how much was kind of the other originations?

Donald F. Cole

I think we had discussed that. The amount that was purchased in the leverage loan market was $84 million, for that and all originations.

Scott Valentin - FBR Capital Markets & Co., Research Division

And one final question, I saw there's a shelf filed tonight, I'm just curious, given the excess capital position, is it just a technical file and to keep it valid, or is there an intent there on filing?

Donald F. Cole

I don't think there's an intent on issue, is a better question. I think it was just a technical filing to keep it going.

John K. Delaney

There's clear no intent on it. No misunderstanding about that. But there is some reasons why it makes sense to keep this shelf open. But no one should ever interpret that to mean that there's any intent to sell anything serious at this point.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Dennis Oakes for any closing remarks.

Dennis Oakes

Thank you, Amy. No, that's it, and thank you, everybody, for listening. And again, a replay of this call will be on our website later this evening.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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