PacWest Bancorp (PACW) 2004 Q1 法說會逐字稿

Good day and welcome to the CapitalSource first quarter 2004 earnings conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Finance Director, Mr. Tony Skarupa. Please go ahead.

Thank you, Patty, and good evening. Joining us today are John Delaney, Chairman and Chief Executive Officer of CapitalSource; and Tom Fink, our Chief Financial Officer. Before I turn the call over to John Delaney, I want to inform you that this call is being webcast simultaneously on the Investor Relations section of our website at www.CapitalSource.com. Furthermore, a recording of the call will be available on the website beginning at a approximately 8:30 PM Eastern Time, and our press release and website provide details on accessing the archived call.

Also, before we begin, I need to inform you that statements on this earnings 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 and operating results involve risks, uncertainties, and contingencies, many of which are beyond CapitalSource's control, and which may cause actual results to differ materially from anticipated results. More detailed information about these risk factors can be found in our annual report as filed with the Securities and Exchange Commission on Form 10-K on March 12, 2004. CapitalSource is under no obligation to, and we expressly disclaim any such obligation, to update or alter our forward-looking statements; whether as a result of new information, future events, or otherwise. Now I would like to turn the call over to CapitalSource's Chairman and Chief Executive Officer, John Delaney.

Thank you, Tony. Good evening, everyone. We appreciate you carving out time to join us tonight. I'm very pleased to report that our earnings for the first quarter were 20 cents per diluted share, or $23.9 million. Adjusted for taxes for prior periods and the significant equity gains we saw last year, this was an approximately 111% increase in pro forma net income from our first quarter of 2003, and a 10% increase from our fourth quarter of 2003. The major drivers of these strong results are combined -- are our continued strong asset growth, credit performance in line with our expectations, strong risk adjusted yields, and improving funding costs and operating efficiencies in the business. Let me now take a moment to comment briefly on each of these areas.

Regarding asset growth, we ended the first quarter with over $2.7 billion of funded loans, a $336 million increase from the fourth quarter. In the first quarter, we closed 47 new loans. Our asset growth continues to look very strong in the second quarter. The month of April, even excluding the effects of the SLP acquisition I will speak about in a minute, is turning out to be one of the best months we have had in terms of net asset growth. The success we are having attracting new customers is a reflection of the deep penetration and market leadership position of our various businesses in their respective markets. Regarding credit, we had a $2.3 million chargeoff in the first quarter which had no real P&L impact since we had already taken specific reserves that were equal to the approximate amount of the charge. In fact, our specific reserves on this credit were within 5% of the actual amount of the final chargeoff, which is the way the system is supposed to work. This quarter we had approximately $3 million of new specific reserves.

As I discussed before, the credit side of the business will be lumpy but, in general, I view the performance of the portfolio from a credit perspective to be very strong. General reserves increased in line with our normal methodology. Regarding yields, both core yields and yields derived from fee income were very strong. Strength in core yields is expected. The uptick in fee income is related to certain prepayment activity in the portfolio. Other income, which is comprised of fees from our FHA/HUD processing business, gains from equity investments and a few other things was very light this quarter. This is another lumpy item which we expect to be higher in the second quarter based on recent activity in the FHA business. Regarding cost of funds. Cost of funds continued to trend down on a normalized basis. We completed a convertible debt offering in the first quarter, which Tom will touch on in a few minutes and which we view as a particularly attractive financing for the company.

Our operating efficiency ratio improved for the quarter due to our ability to continue to leverage the infrastructure. We have said many times in the past that we have built most of the front end of the business across the last few years and as we grow the business we will see improving operating efficiencies. This quarter is an example of that. Now, let me touch on some of the highlights from our three business groups.

Corporate Finance enjoyed a strong first quarter. We continue to see good opportunities in Corporate Finance which, as most of you know, is our business where we provide principally senior debt to finance middle market leveraged buyouts. I will reiterate the two trends I noticed last quarter because they are proving to continue. First, leveraged buyout volume is up. And this is creating significantly more deal flow for our Corporate Finance group. Second, competition has also increased but only on larger deals, which is not our core market. Once again, we plan on defending and feel confident we can successfully defend our market leadership position in smaller -- financing smaller leveraged buyouts.

Healthcare Finance continues to enjoy a strong pipeline and had a productive quarter, although net asset growth was lower than in prior quarters due to high paydowns and payoffs. We are also expanding the significant asset based and structuring capabilities in this business by growing our debtor-in-possession and restructuring finance business. This month we won a significant transaction in this area that we think will help catapult the business. Like Healthcare, Structured Finance enjoys a strong pipeline but had net asset growth lower than in prior quarters due to payoffs. Real estate finance, which we highlighted last quarter as having upside potential relative to our current projections is off to a very good start. Let me touch on two areas regarding which we have received frequent questions across the last few weeks.

The first area is competition. Particularly related to some of the BDC RICs that have been organized. Two comments here. First, we have said in the past that we expect that our business will have periods of greater competition from time to time. We tend to think that all three of our lending groups will not experience increased competition at the same time. We believe that, based on the market focus and high barriers to entry, our lending groups are less directly affected by competition. I would say that this first wave of new competition has proven both of these points. First evidence of this being the very strong originations we are experiencing for the first four months of the year. Second point is we view the emergence of several blindpool BDC RICs as not material to CapitalSource for really two reasons.

First, based on leverage limitations imposed on the BDC RIC structure and based also on their own stated business plans, we think these entities will focus more on mezzanine and equity related acquisitions. CapitalSource's portfolio is over 96% senior secured debt and is therefore in a very different business. Second, our business units generally focus on smaller transactions in niche, less efficient markets that require a committed market presence and specialized skill sets. We think these new entrants will have a very different orientation than our business, more of an asset management approach.

The second area is interest rate risk. With one inconsequential caveat, CapitalSource is interest rate insensitive. The vast majority of our assets and liabilities are floating rate. Long-term increases in rates will have one principal effect on our business, which is to raise our return on equity. The caveat I'm referring to is the rate floors we inserted in many of our transactions which effectively causes our unusually high net interest margin to return to our targeted net interest margins when rates rise. As has been detailed in the public filings, with respect to which Tom will go into more detail, the effect of these floors is a completely quantifiable impact on our net interest income that we have already factored into our business.

Let me conclude by commenting on an acquisition that we are announcing with this earnings release. Last week we closed on the acquisition of the assets of SLP Capital. SLP Capital is one of the largest independent specialty finance companies servicing the North American security alarm industry. Since its inception in 1990, SLP has provided more than $400 million in debt capital to security alarm companies. We purchased SLP's loan portfolio and acquired SLP's Embrasure division, the leading provider of web-enabled revenue management billing software developed specifically for the security alarm industry. We were fortunate not only to acquire this portfolio of assets that meets our high standards for return and credit performance, but also to be able to initiate a security alarm lending program as a new tuck-in program in our structured finance lending group. This transaction and the retention of management key personnel and the high quality servicing platform will further broaden CapitalSource's product offerings. Total fundings associated with this transaction amounted to approximately $90 million. And with this, I will turn the call over to Tom to comment on our financial results.

Thank you, John. Our earnings were released this afternoon after the market closed, I hope all of you have had a chance to see the press release. If a nutshell, our first quarter results were very solid. Our net income was $23.9 million for EPS of 20 cents per diluted share. Which, after adjusting for the strong equity gains we saw last quarter, was up this quarter by 2 cents per share or 11%. As John mentioned in his remarks, some of the highlights this quarter were good growth in the portfolio, very strong yield, improvements in cost of funds, and improvements in operating efficiencies. So let me drill down on those a bit.

We saw good growth in the portfolio this quarter of $336 million. And, with the strong start we have had in the second quarter, the volume we see in the pipeline, and the alarm servicing portfolio purchased earlier this month, we feel very good about the ability to grow the business this year by the $1.2 billion we discussed in January. Some of the nuance behind the growth story this quarter is that our Corporate Finance lending group was a very strong grower. As John mentioned, Corporate Finance continues to have a very good opportunity in the market right now with lots of deal flow and they are taking advantage of it. However, Corporate Finance also was helped this quarter by seeing no loan prepayments, whereas the other two groups, Structured Finance and Healthcare Finance, did experience significant prepayments and paydowns. This demonstrates some of the lumpiness in our business both on the loan growth and prepayment side which we speak about on every one of these calls. But the point to emphasize that we continue to see good growth opportunities across each of the lending groups and the pipeline is very strong for all of the groups.

As we also mentioned in previous calls, when we have prepayments is usually correlates to an enhancement in yield and we saw a good bit of that with a very strong yield performance this quarter. Yield for the quarter was 12.18%, up from 11.75 last quarter. Dissecting the yield a little bit, prepayment related activity contributed 133 basis points this quarter compared to 76 basis points last quarter. Yield from interest income was in line with expectations at 9.08% compared to 9.14 last quarter, and yield from recurring fee income was also in line with expectations at 1.77% this quarter compared to 1.85 last quarter. Cost of funds was much improved this quarter at 2.97% versus 3.44. In part from a favorable benefiting from a favorable comparison due to the accounting changes we made last quarter. However, on an apples to apples basis, cost of funds was 13% -- excuse me, 13 basis points lower in this quarter. In our last year we have diversified our sources of funding and now have four different credit facilities in addition to very strong reception in the capital market. This decrease in cost of funds is due in part to our funding the growth of the business with lower cost sources of funds.

Going forward, assuming interest rates do not change and assuming no prepayments; which have the opposite effect on cost of funds as they do on yield but to a much lesser extent, we expect cost of funds to improve modestly. One reason for this is that during March we completed a $225 million convertible debenture offering with a five year fixed interest rate of 1.25%. As John mentioned in his remarks, this is a very attractive financing for us and it has attractive economics and has allowed us to further diversify our funding source. Another reason we expect cost of funds to improve somewhat is that we currently are in the final stages of renewing or amending some of our credit facilities and expect those facilities to come online at lower program fees than in the past. This is probably an appropriate place to talk about interest rates and give some further texture to what John said about effective rising rates on CapitalSource's business. As most of you know, CapitalSource is primarily a floating rate borrower and floating rate lender. Let me first make clear what we mean when we say rate.

I'm talking about short-term rates such as prime, 30-day LIBOR, or commercial paper. Although longer term rates have risen in recent weeks, the short-term indices against which we borrow and lend stayed flat or maybe down a few basis points this quarter. The exposure CapitalSource has to rising rates is primarily due to the floating rate loans we have with interest rate floors that are in the money. The rates on these loans will not increase until the contractual rate exceeds the level of the floors. We make regular disclosure in our SEC filings about the extent of these loans or floors and also make disclosure about the market risks that show our net interest income being reduced as rate rises. However, it is important to understand what this market risk disclosure is -- namely, an interest rate shock analysis made at a point in time on a static pooled portfolio. In other words, the analyses in our 10-K, 10-Q, and other SEC filings assumes that rates jump up 100, 200, 300 basis points immediately and stay there at those levels. These analyses also assume that we do not make any new loans.

And while this is a standard set of assumptions customary in disclosures of this type, I don't think they are particularly realistic when applied to CapitalSource. First of all, we don't believe rates will jump up 200 or 300 basis points. Rather, if rates rise we would expect them to move up in some incremental fashion, perhaps a series of smaller rate increases. Second, we definitely do not have a static pool. Our loan portfolio is changing and growing. In fact, our loan growth guidance of $1.2 billion this year equates to a 50% year-over-year growth rate. All of these new loans are coming on at current market rate and, if they have floors, they are not so deeply in the money as the loans we made over the last three years when rates were higher. Third, with the completion of our convertible debt offering in March, we now have some fixed -- some low cost fixed rate funding in the capital structure. As discussed in January, when we look at our business, we do model in rates rising during the second half of this year. And we have run various other scenarios as well. And assuming that we originate loans consistent with our plan and that rates rise in some orderly progression, we see that less than 1% of our forecasted net income is at risk with changes in interest rate.

Operating expenses were another good story this quarter. Operating expenses were roughly flat in terms of dollars compared to last quarter at $22.3 million and down 41 basis points on the percentage of assets. During the quarter, employment increased by 25 people to 310. And other than compensation and benefits, which you would expect to rise with more employees, we saw decreases in every operating expense category except for rent and marketing. Rent was up due to our expansion in our Chevy Chase headquarters and our Chicago office, and marketing increased quarter to quarter due to the timing of trade show attendance, advertising and some other marketing expense. Part of this favorable operating expense comparison is due to some one-time items we discussed in the prior quarter, but we are generally pleased with our performance this quarter and with our progress on the fundamental story of improving expenses over time as a percentage of assets.

We will continue to see the effects of these operating efficiencies in the future and reiterate our expectation that operating expenses for this year overall will be in the 3 to 3.25% area. The acquisition and subsequent integration of SLP will likely cause an increase in our operating expense ratio in the second quarter and will push us to the higher end of our expected range for the year. One other subtlety I would like to draw out is that the linkage between the performance of the company and operating expenses as a percentage of assets. After interest expense, people-related costs are our largest expense. Salary and bonus expense are the largest components of operating expense. But people also are our most important assets. And this year we are working to create strong alignment between the financial performance of the business and compensation. Overall, this is a very good thing, but in quarters where we have outstanding financial results you should expect that operating expenses as a percentage of assets will go up.

Bottom line, we have inherent operating leverage in the business, I've spoken about this before, and we expect to continue to see trends towards lower operating expenses as a percentage of assets. All I'm saying now is for good reason there may be a little noise in that metric from time to time. Those are the highlights for the quarter. As I said at the beginning, it was a very solid quarter for us. And with that I will turn it back to John for questions.

Okay. I think we should just open it up for questions.

Thank you. Today's question and answer session will be conducted electronically. [Caller Instructions] We'll pause for just a moment to give everyone an opportunity to signal for questions. Our first question today is from Bob Napoli from Piper Jaffray.

Good afternoon. Question on the SLP Capital acquisition. What did you find attractive about that segment? And are you looking at making niche acquisitions? Should we expect to see more niche-type acquisitions from your guys over the next several quarters?

Yeah, Bob, I think -- There is a lot of things we liked about the business. First of all, it was -- it is an asset-based practice area. We are always trying to build up as many asset-based oriented businesses as we can in the portfolio. So it meets all the basic kind of criteria from a risk adjusted turn perspective. We think if these loans are structured right the risk of credit loss is very small. The unlevered yield on the portfolio is consistent with what we are looking for the rest of our business. They are all floating rate transactions. The term of the loans is very similar to the term of the loans we write in the rest of our businesses. So if you didn't know what the specific purpose of the loan was for, the characteristics of these loans are very similar to everything else that we do.

We also like their focus or their niche, if you will, the business understands the alarm industry very well. They understand how effectively to finance companies in that industry. They have got a track record of doing that. They've built a proprietary system. They have a proprietary underwriting model. So we found it to be a very nice niche. We have been looking at the business for several years and really hadn't found anything that was that interesting until this opportunity had come around. The company has been in business for over ten years. As I said, they built a proprietary system. We just thought it was a very nice business that fits nicely into our Structured Finance group which, as you know, is really a collection of focused asset-based lending practice areas. And I think we will look from time to time for other kind of similar tuck-in acquisitions that fit within the management structure we already have in place.

Great. Thank you.

We will go next to Don Destino from JMP Securities.

I have two questions. One credit and one follow-on on SLP. First on SLP, this might apply to future acquisitions as well, what -- what is it about -- looks like you bought the assets at very close to book value and you got the origination in the platform thrown in. Are these just kind of capital starved companies that think they will do better under the umbrella of CapitalSource or why do you get opportunities to buy portfolios like this at attractive rates?

That is a very good question because we think there are a fair number of companies that have assets ranging from $100 to $250 million in size that have good niches, they understand their business very well, they have lots of experience; but the niche is such that they can't get to the scale they need to really get to the next level. And we've seen several situations like this. And I think CapitalSource is in a very good position to take advantage of this trend because we, in fact, are a very good home for these companies; because we understand them, we understand the market, we understand their orientation which is to be a focused lender, deliver a superior service to the customer, get paid a premium for the expertise. So we're used to running companies like that and we can kind of fold them into our business and let them run, you know, autonomously from an origination and customer service perspective, recognizing they have to also fold into our kind of credit model and that we can help them grow much faster. So I think there is a very -- actually fairly significant opportunities with other companies like this. We look at these things from time to time.

Got it.

And in terms of the structure of the deal, it was really a -- kind of a couple of different components to it. Their business broke down into -- their portfolio broke down into kind of two buckets -- a performing bucket and then a nonperforming bucket based on some strategies that they pursued in the past that weren't as successful as their core business. In other words, they pursued some equity investing opportunities and mezzanine opportunities; but the core senior debt business had performed very well. And so what we did is we bought the core senior debt business which is the $70 million of loans that we purchased. And then we made a loan on the residual portfolio, effectively a rediscount loan structured very similar to the way we would structure any rediscount loan. And as part of completing both those transactions we also effectively purchased the business, which principally was buying a software platform that they had developed that's called Embrasure; which can be used both by their customers and by third-party customers. It's really a servicing platform. And we are bringing on all the key members of the team. I think the way you described the acquisition was very accurate in that we bought the portfolio at about par and we picked up a very solid team of people and their whole business platform.

Got it.

And we'll look to do more of those if we can.

Fantastic. Then a quick credit question. Is there any common characteristics of the loans that were -- that made up the $3.2 million of specific reserves, that represent any specific weakness, was it more than one loan or any color on there?

No, I mean, you know, like we had said in the second quarter in the -- I'm sorry, in the third quarter when we took a large specific reserve last year-- in the third quarter of last year, that we expected there to be a credit loss related to this transaction. That chargeoff was finally realized this year and our specific reserve was, as I said, within 5% of the amount of the ultimate chargeoff. And the specific reserves we're taking this quarter are in line with our business. There is nothing -- we don't draw any conclusion from them. It is just, you know, at this the point with the size of the portfolio we have we will have some problem situations and our job is to be pretty aggressive about identifying them, trying to work them out as best we can but also recognizing if we have exposure and if so taking a specific reserve against it; and that's really all that is happening this quarter.

Perfect. Thank you very much.

We have a question from Mike Hodes from Goldman Sachs.

Hi. Good afternoon. Really two questions. First on credit. It looks to me that there was about a 50% loss on this loan that you took a chargeoff in in the quarter. I was just wondering, you know, as you look forward, is that kind of consistent with the loss severity that you are thinking about more broadly or is this somewhat of an outlier? And then secondly, in terms of asset growth, it looks like between the first quarter showing and the SLP capital purchase that you're kind of comfortably ahead of plan for the year and I was wondering if you think at this point that you're going to be, you know, somewhat ahead of the billion two or so target for -- for calendar year '04?

I'll start with your credit question, Michael. Your analysis is pretty dead on. The deal that we took a chargeoff on was a loan that had been in our portfolio for some time. As I said, we took a specific reserve against it initially in the third quarter of 2003. The loan had two components to it, it had a revolver and a very small term loan. And, you know, we worked out the transaction, the business liquidated, and the loss that we ultimately took was about 50% of the amount of the loan when we -- when we started the liquidation process. And what that was was really the term loan and a little stuff piece of the revolver. Because the collateral didn't perform as well in the liquidation -- we didn't think it would perform as well based on the time of the year and factors like that.

Again, there's not -- you know, I would say that the credit profile of the business right now, I think, is very good. The portfolio is performing at our expectations, if not better; but from time to time we will have some problem deals and hopefully they're not that significant. And, you know, the chargeoff that we took this quarter which, again, we really -- to some extent we recognized that loss in the third quarter last year when we specifically reserved a certain amount against the deal, which turned out to be almost exactly the amount of the chargeoff. Then the deal that we're taking a specific reserve on this quarter, we clearly think is a problem and we're writing the loan down quite significantly. As it relates to asset growth, you know, it would be fairly easy to conclude perhaps that our asset growth is accelerating and in fact we are having a very good first four months. But at this point we are not really changing our guidance of a billion two of net originations. We think we'd like to see a few more data points before we would come off that point. But from an asset growth perspective we are off to a good start this year.

And then just lastly, could you give us by category the loan balances at end of March so we can get a better feel for the growth by segment?

Sure. Hold on one second.

Yeah.

Just passing the book over here so.

Mike.

Yes?

Corporate Finance ended the -- these are approximate numbers now. Ended the quarter with a portfolio of about $1.2 billion. Healthcare was $713 million. Structured Finance about $785.

Terrific. Thanks a lot, guys.

We'll go next to Joel Houck from Wachovia.

Okay, thanks. Just a few questions. One, I hear your comments about specific reserve, but it looks like you're ramping up general reserves in light of the fact there weren't any delinquencies at the end of March. Is this just an abundance of caution or some other signalling effect here?

I don't think there is really any signalling effect there, Joel. As you know, we have two different kinds of reserves, general and specific. The general are driven by a methodology of formula where we rate every loan in the portfolio and depending on whether it's a cash flow loan or real estate or asset backed and whether it's senior or subordinated; depending on the internal loan rating we come up with a value that goes into the general reserve and what you see there is just reflecting the mix in the business. The specific reserves did increase from $2.7 million to $3.7 million quarter-over-quarter. Specific reserves are 14 basis points of that 84 basis points allowance that we have. That tells you that the general reserve is 70 basis points.

Okay. And did you guys identify which segment the chargeoff came from?

We did not.

Can you?

Sure. It is in the Corporate Finance group.

Okay. That would seem to make the most sense.

Yeah. The interesting thing about it, though, it was actually an asset-based loan in the Corporate Finance group, so it was a fairly unconventional loan that the Corporate Finance group makes. It was a loan we made early in the company. It was an asset-based loan that had a stretch piece with it. So it was in the Corporate Finance group, but it was a very unCorporate Finance group-type loan in terms of how it was structured.

Okay. And then just lastly you talked about a high level of prepayments in the first quarter. Is that seasonal or is it just coincidental? I mean it seemed like, based on fourth quarter net growth and what you're saying about April that, you know, Q2 might be more in line with fourth quarter and opposed to first quarter.

We actually made a comment similar to this in a prior quarter when we had what we thought was unusually high prepayment related fee income in that it wasn't indicative of a lot of prepayments, just very high fees with respect to those loans that prepaid. And I would say that was the phenomena we saw in this quarter as well. Without getting into too much detail, I think the actual amount of the loans that completely paid off in the first quarter was less than the amount of loans that completely paid off in the prior two quarters.

Okay, that is helpful. Thanks, Tom.

And we have a question from Matt Diehl from Smith Barney.

Yeah, I think it's a little bit of a follow-on from the last one which is if you look out over the next several quarters, the balance of '04, could you just remind us of kind of as the -- in the context of the age of the overall portfolio to what extent we are starting to see maturities, starting to see normal paydowns in addition to opportunistic ones, what that looks like for the balance of the year?

I don't think we have any specific guidance with respect to prepayments which is, I think, what you're getting at, Matt. I would say that the vast majority of our prepayments are more opportunistic prepayments than things coming due at the end of the term. Typically what happens at the end of the term, as you know, the Corporate Finance deals tend to amortize down over the term. The asset-based deals, assuming everything is going well, we actively try to renew them at the end of the term. So the term is really somewhat of an inconsequential event in terms of a prepayment, because it's either a deal we like and we want to roll it. And if it's a Corporate Finance deal, the balance is pretty darn low by the end, it's either paid down to almost nothing or there's a small balance.

So most of--the portfolio tends to be pretty dynamic, growing companies, companies doing acquisitions, companies involved in all kinds of deals. Most of the prepayment activities comes from some larger strategic event related to the borrower than it tying to the term, which is one of the reasons why it's hard for us to predict it. I think clearly over time we'll develop a much better model for predicting how these opportunistic repayments will occur because after awhile there probably will be some pattern or trend that we can recognize on a static pool basis. I don't think we can do it at this point.

Okay, thanks.

We'll take a question from Bruce Harting from Lehman Brothers.

You had us beat pretty good on both the C line and the interest--net interest income line and kind of socked it away in reserves. Generally, what it your philosophy going to be going forward in quarters like this? Is there -- you know, am I reading that right, are you setting up more reserves and kind of making the number? And then the other question on the expected offerings of more apollo-like deals, you gave a great answer on why you think, you know, you won't be overlapping with them; but specifically when you are -- when your people are out in the field and you see transactions that are a little bigger than you typically like to work on, would you be referring those out to other lenders or how do you make that cutoff in the field and is there a chance to collect some referral fees with not only these organizations, but banks? And why not take a participation and slightly larger transactions? In other words, is there anything to do in that area? Thank you.

Yeah, there is. I will answer the latter part of the question first, Bruce. Historically we looked at our market as kind of a $1 to $5 million on the low end to $40 million on the high side market depending upon the business. Corporate Finance doesn't start til $5 or $10 million and the other groups will do smaller deals, but we were kind of topping out at $40 million transactions. The additional liquidity that exists in the market when combined with the reputation that CapitalSource is gaining in the market as doing good credit work; when combined with the fact that we actually now have a syndication capability; a fellow who has tremendous experience in the area and runs that business for us out of Chicago, makes us a much sought after partner in terms of many lenders wanting to buy into our transactions. Both groups that we might compete with from time to time and also other groups that tend to be more of a passive asset management approach to the business. They just want to buy paper from lenders that they perceive as doing good credit work.

And so we're taking advantage of that and we've really stretched our deal sizes to do--you know, depending if it's a cash hold deal or an asset-based deal; we'll look at transactions up to about $100 million, because for all effective purposes that's really the same market. For us, the difference between a $40 and $80 million deal is pretty significant because one we can hold and the other we have to bring in partners. But in terms of the, kind of, referral sources we call on all the time, there as likely to refer us a $30 million deal as they will a $70 million deal; because it's all considered kind of small to middle-market stuff. So we have been much more active in going after larger deals and bringing in partners to buy into our transaction; and we feel very confident at this point that, basically any deal we want to do, that is in kind of that $40 to $100 million range that we can find a partner, and several of them, to buy into a piece of the deal.

Regardless of what type of deal it is, across all three of these groups. So we are taking advantage of that and some of these new BDC RICs would be one example of that. And you know, just to add some more texture to the BDC RIC discussion, I mean, these--if all these entities actually get done that will be potentially a half a dozen new entrants into the market with $3 to $4 billion of equity capital which they could leverage and it seems like a lot of money in the market. But it's my view that if Bank of America and CitiGroup were to get 5% more aggressive in their middle-market lending activities, that would have more of an affect than these guys getting into the market; because that's really the scale of the market and the scale of some of the traditional participants that have been in this market in the past and are not really in it anymore because of their own strategic reasons. That's one of the reasons we're not that concerned about it, it's a pretty darn big market and there's lots of room in it and the niches that we focus on are much harder to get into. You have to spend a lot of time building a market presence developing the expertise. So that's kind of the answer to your second question.

The first question is, you know, we take reserves based on the approach that we've always used which is we rate our portfolio, we take general reserves based on how these loans rate. We rate every loan differently and depending upon the type of loan it is; if it's a cash hold deal or an asset-based deal and depending on how it rates we take different reserves against it. So as or portfolio mix changes, you'll actually see the general reserves move up a little bit. For example, this quarter the Corporate Finance group because a larger part of the portfolio; by a pretty small degree but it actually has an effect on the general reserve bucket because we take higher reserves on the Corporate Finance deals. Similarly, if you would see the portfolio migrate more into healthcare, you would actually see the general reserves as a percentage of the portfolio go down. So that's how we take general reserves and specific reserves are based on our assessment of a deal that we think we have a likelihood of losing money on; and determining kind of what that probability weighted loss is and then specifically reserve against it. And that's how we apply that methodology regardless of the top line performance of the business.

If I could just add a little bit to that, Bruce, also. You know, the implication in your statement of socking away reserves I would disagree with because as we rates loans as a company and as we manage a portfolio, it all starts in the lending groups; and then the loan ratings that are developed in the lending groups ultimately go through the credit department which is headed up by Bryan Corsini, our Chief Credit Officer, and that's all done before anybody has any idea what the results of the company are. In fact, me as the Chief Financial Officer, I don't have any input into the amount of the reserves that are calculated. That's all strictly done within the lending groups with the oversight of credit.

Thank you.

We'll go next to Moshe Orenbuch, please go ahead.

Thanks. John, I think last quarter you had mentioned that you had hired a healthcare leasing group and, obviously, you've got the security services. Are there any other areas that you're kind of augmenting the marketing effort? Anything else we should be looking at?

No, I think--no I think right now, you know, we are constantly looking at things that fit in well. The Healthcare group is rounded out nicely at this point. They offer real estate, receivable, cash flow, and equipment financing. The Corporate Finance group's in all the businesses it's ever going to be in which is senior and some opportunistic, mezzanine, cash flow lending. And the Structured Finance group is the group that we could be looking at some new things for just because they're charter is broader than the other businesses. Structured Finance really has as it's charter to work--you know, to be an asset-oriented lending platform that specific expertise matters. So it's a little broader in it's charter than the other groups. I wouldn't say it's our "other business" in terms of Healthcare, Corporate and other; but we feel we have a very strong management team in there and as we look at new opportunities, it's a very natural place to put those opportunities; provided their asset-based and provided, you know, there's some specific expertise that's required to make it successful in the business.

So I think, you know, Structured is in several businesses right now. It's in real estate and it's got a couple of different real estate products. It's in lender finance, which is financing smaller finance companies. It's in the resort finance business, which is very much like lender finance, because a lot of the transactions have a receivable component to it. And now it's in this security alarm finance business which, again, is an asset-oriented business and it levers the skill set that exists within that group. So I tend to think that if we do look at new things, it'll more be in the Structured Finance group, just because the other groups, you know, are very focused and their markets are huge. Structured Finance, aside from real estate, which is a huge market is a good place where we can collect some smaller niche lending platforms and have them plug into a disciplined, well run business platform. That's a long-winded answer and I'm not sure I said anything, but that was my best shot.

Thanks, John.

That does conclude today's question-and-answer session. At this time I would like to turn the call back over to Tony Skarupa for any additional or closing remarks.

I think that concludes our call for this evening. Thanks so much for participating.

That does conclude today's conference call. Thank you for your participation. You may now disconnect.