CapitalSource decides to buy back stock

CapitalSource is returning money to its shareholders through a $175 million stock buyback initiative, a move the Chevy Chase-based speciality finance firm said will delay its application to become a bank holding company by at least 18 months.

Chairman John Delaney announced the decision during CapitalSource’s recent second-quarter earnings call, explaining the strategy would maximize shareholder value with the least amount of risk.

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“Rather than having the capital pile up and sit around [waiting] for some opportunity to put it to work, it’s more efficient and shareholder friendly to return the capital,” Delaney said in an interview, noting that CapitalSource has about $1 billion in capital to date. “We think the stock is cheap, so a buyback is a better proposition for shareholders.”

CapitalSource has been winding down its operations for the past three years, since acquiring troubled California thrift Fremont Investment & Loan in July 2008. Now called CapitalSource Bank, the institution, with $6.3 billion in assets and 21 branches, is the sole vehicle for the parent company’s loan originations these days, according to Delaney.

Through the three months ending June 30, CapitalSource Bank closed just under $550 million in new loans, resulting in a 4.7 percent increase in the loan portfolio balance despite payoffs and charge-offs totaling $350 million. Interest income increased 15 percent from the prior year to $90.5 million, though net income dipped 26 percent year over year to $28 million because of a higher income tax expense.

Becoming a bank holding company is one of the most direct ways for CapitalSource to convert the bank’s industrial charter to a commercial charter. The move would allow the institution to diversify its product offerings, but Delaney stressed that delaying the application should have little or no impact on its profitability and growth projections.

In an analyst note, Scott Valentin of FBR Capital Markets agreed that postponing the application has no short-term financial implications, but may reduce CapitalSource’s “opportunity to participate in failed-bank acquisitions that would have provided additional earnings and increased core deposits, which ... would have benefited the stock price.”

Delaney maintains that the company has enough capital for acquisitions, but there are no attractive prospects in the market. During the recent earnings call, he said CapitalSource would consider bank deals in California that would allow for cross-selling opportunities to business customers.

The company plans to file its commercial charter application with the Federal Reserve once its balance sheet has little outstanding debt, loans or assets, Delaney said. Within the past two years, the company has whittled down its total loans to roughly $1.4 billion at the end of June from $5 billion.

CapitalSource considered several options before authorizing the capital deployment plan, including splitting into two public companies and selling its assets in bulk. At the start of the year, it seemed CapitalSource was entertaining a sale, when J.P. Morgan Chase was hired to advise on offers.