CapitalSource Moves To Change Its Status
Changing to Bank Holding Company Would Qualify It for Federal Funds

By Alejandro Lazo
Washington Post Staff Writer
Thursday, November 6, 2008

When CapitalSource of Chevy Chase acquired the assets of a troubled California community bank in July, the deal provided the commercial lender with a well of deposits in a harsh credit environment.

Now CapitalSource is taking steps to become a bank holding company, making it eligible for federal funds under the Treasury Department's rescue plan.

If the commercial lender, whose midsize business clients include the high-end shoe retailer Jimmy Choo, is able to transform itself, it could use its new status and access to relatively cheap federal money to expand further into commercial banking, Wall Street and banking analysts said.

"They want to be able to go out and buy more banks," said Sameer Gokhale, an analyst who covers the company for Keefe, Bruyette & Woods.

CapitalSource declined to comment on the speculation. The company said last week that by year's end it would cease to be a real estate investment trust -- a publicly traded entity granted certain tax benefits -- in order to clear the way for its intended new status.

Separately last week, CapitalSource said it had amended its contract with Chief Financial Officer Thomas A. Fink to comply with any executive compensation requirements under the Treasury's plan. On a conference call discussing third-quarter earnings results yesterday, chief executive John K. Delaney further signaled he would be open to participating in the Treasury's programs.

"I hear some banks saying they don't want these benefits," Delaney said. "I still have not figured out why someone would not want these benefits based on the math, so you should assume that we're in that camp."

Several banks have voiced interest in using federal funds to finance acquisitions since the rescue plan was put into action last month. The prospect that banks could use the money to fund such purchases has prompted analysts to speculate the financial services industry could undergo a wave of mergers even more intense than previously predicted.

"People generally think that regional and smaller banks are going to be acquired and, because there is this brave new world out there, there are companies that want the flexibility and approval to buy them," said Bradley K. Sabel, a partner with the law firm Shearman & Sterling of New York.

Major firms have taken similar steps in recent weeks. Goldman Sachs and Morgan Stanley, the last two independent investment banks, said they would become bank holding companies in September. More recently, GMAC, the financing arm of General Motors, has reportedly been in negotiations with the Treasury to also change its status.

CapitalSource took control of Fremont Investment & Loan, based in Brea, Calif., in July, assuming Fremont's $5.6 billion in deposits and taking over its 22 branches. The 70-year-old bank was a major subprime mortgage lender until a year ago, when it agreed to a cease-and-desist order with the Federal Deposit Insurance Corp. Federal and state regulators had ordered the bank to raise capital or consider a sale.

Since then, CapitalSource has rebranded the branches as CapitalSource Bank, operating them as industrial bank branches, which provide limited services, taking certificates of deposits and selling money market funds.

CapitalSource's recent moves were one reason Bruce W. Harting, an analyst with Barclays Capital, wrote in a note that the firm should be able to weather the financial crisis despite posting disappointing third-quarter results yesterday.

CapitalSource said it had a profit of $8.1 million (31 cents per share) in the quarter ended Sept. 30, compared with $28.3 million ($1.02) in the third quarter a year ago. Investment income fell to $332.1 million from $400.9 million as the credit crunch continued to make it difficult for the firm to make loans. Shares for the firm closed down 11 cents, or 1.4 percent, yesterday at $7.78.