UNITED STATES SECURITIES AND
    EXCHANGE COMMISSIONWashington, D.C.
    20549
  Form 10-Q
  QUARTERLY REPORT PURSUANT TO
    SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934
  For the quarterly period ended June 30, 2008
   Commission File
    No. 1-31753
  CapitalSource Inc. (Exact name of
    registrant as specified in its charter)
   Delaware(State of
    Incorporation)

35-2206895(I.R.S. Employer
    Identification No.)   4445 Willard Avenue, 12th Floor
    Chevy Chase, MD 20815 (Address of Principal
    Executive Offices, Including Zip Code)
  (800) 370-9431 (Registrants telephone
    number, including area code)
   þ o
  12b-2
  Large
    accelerated
    filer þ
    Accelerated
    filer o
    Non-accelerated
    filer o
    Smaller
    reporting
    company o   Rule 12b-2 o þ




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##### 





TABLE OF
    CONTENTS
  PagePART I. FINANCIAL INFORMATIONItem 1.


Financial StatementsConsolidated Balance Sheets as of June 30, 2008 (unaudited)
    and December 31, 2007


3Consolidated Statements of Income (unaudited) for the three and
    six months ended June 30, 2008 and 2007


4Consolidated Statement of Shareholders Equity (unaudited)
    for the six months ended June 30, 2008


5Consolidated Statements of Cash Flows (unaudited) for the six
    months ended June 30, 2008 and 2007


6Notes to the Unaudited Consolidated Financial Statements


7Item 2.


Managements Discussion and Analysis of Financial Condition
    and Results of Operations


37Item 3.


Quantitative and Qualitative Disclosures about Market Risk


71Item 4.


Controls and Procedures


71PART II. OTHER INFORMATIONItem 1A.


Risk Factors


71Item 2.


Unregistered Sales of Equity Securities and Use of Proceeds


77Item 4.


Submission of Matters to a Vote of Security Holders


77Item 6.


Exhibits


78Signatures


79Index to Exhibits


80  2




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##### 



CapitalSource
    Inc.
  Consolidated
    Balance Sheets
  June 30,


December 31,2008


2007(Unaudited)($ in thousands)ASSETSCash and cash equivalents

$
169,667


$
178,699Restricted cash


428,955



513,803Mortgage-related receivables, net


1,907,229



2,041,917Mortgage-backed securities pledged, trading


1,606,475



4,060,605Loans held for sale


98,817



94,327Loans:Loans


9,329,068



9,773,410Less deferred loan fees and discounts


(169,954
)


(147,089
)Less allowance for loan losses


(141,128
)


(138,930
)Loans, net


9,017,986



9,487,391Direct real estate investments, net


1,007,699



1,017,604Investments


289,943



231,776Other assets


366,832



414,227Total assets

$
14,893,603


$
18,040,349LIABILITIES, NONCONTROLLING INTERESTS AND SHAREHOLDERS
    EQUITYLiabilities:Repurchase agreements

$
1,541,795


$
3,910,027Credit facilities


1,687,242



2,207,063Term debt


6,562,841



7,146,437Other borrowings


1,669,195



1,704,108Other liabilities


357,765



444,997Total liabilities


11,818,838



15,412,632Noncontrolling interests


15,246



45,446Shareholders equity:Preferred stock (50,000,000 shares authorized; no shares
    outstanding)






Common stock ($0.01 par value, 1,200,000,000 and
    500,000,000 shares authorized, respectively; 276,139,152
    and 220,704,800 shares issued and outstanding, respectively)


2,761



2,207Additional paid-in capital


3,586,096



2,902,501Accumulated deficit


(538,619
)


(327,387
)Accumulated other comprehensive income, net


9,281



4,950Total shareholders equity


3,059,519



2,582,271Total liabilities, noncontrolling interests and
    shareholders equity

$
14,893,603


$
18,040,349    3




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##### 



CapitalSource
    Inc.
  Consolidated
    Statements of Income
  Three Months Ended June 30,


Six Months Ended June 30,2008


2007


2008


2007(Unaudited)($ in thousands, except per share data)Net investment income:Interest income

$
254,222


$
311,184


$
562,547


$
600,738Fee income


41,267



45,056



74,908



95,083Total interest and fee income


295,489



356,240



637,455



695,821Operating lease income


24,210



22,118



51,900



42,406Total investment income


319,699



378,358



689,355



738,227Interest expense


160,083



200,291



349,028



386,940Net investment income


159,616



178,067



340,327



351,287Provision for loan losses


31,674



17,410



37,333



32,336Net investment income after provision for loan losses


127,942



160,657



302,994



318,951Operating expenses:Compensation and benefits


37,808



38,615



69,597



78,629Depreciation of direct real estate investments


8,990



7,390



17,906



14,152Other administrative expenses


23,844



20,438



50,648



38,984Total operating expenses


70,642



66,443



138,151



131,765Other income (expense):Diligence deposits forfeited


1,714



1,813



2,361



2,675(Loss) gain on investments, net


(4,827
)


17,002



(3,686
)


23,165Gain (loss) on derivatives


15,098



3,153



(23,013
)


898Gain (loss) on residential mortgage investment portfolio


9,060



(13,846
)


(46,317
)


(19,544
)Other income, net


19,241



12,957



14,542



19,934Total other income (expense)


40,286



21,079



(56,113
)


27,128Noncontrolling interests expense


283



1,272



1,580



2,602Net income before income taxes


97,303



114,021



107,150



211,712Income taxes


37,243



29,693



40,319



48,694Net income

$
60,060


$
84,328


$
66,831


$
163,018Net income per share:Basic

$
0.26


$
0.45


$
0.29


$
0.89Diluted

$
0.25


$
0.45


$
0.29


$
0.88Average shares outstanding:Basic


235,076,287



185,371,033



227,580,584



182,274,147Diluted


236,445,230



187,428,430



228,969,238



184,512,451Dividends declared per share

$
0.60


$
0.60


$
1.20


$
1.18    4




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##### 



CapitalSource
    Inc.



Consolidated
    Statement of Shareholders Equity  AccumulatedAdditional





Other


TotalCommon


Paid-In


Accumulated


Comprehensive


ShareholdersStock


Capital


Deficit


Income, Net


Equity(Unaudited)($ in thousands)Total shareholders equity as of December 31, 2007

$
2,207


$
2,902,501


$
(327,387
)

$
4,950


$
2,582,271Net income










66,831







66,831Other comprehensive income:Unrealized gains, net of tax














4,331



4,331Total comprehensive income


















71,162Dividends paid






4,105



(278,063
)






(273,958
)Issuance of common stock, net


550



629,284











629,834Stock option expense






3











3Exercise of options


1



325











326Restricted stock activity


3



11,132











11,135Beneficial conversion option on convertible debt






48,376











48,376Tax benefit on exercise of options






76











76Tax expense on vesting of restricted stock grants






(9,706
)










(9,706
)Total shareholders equity as of June 30, 2008

$
2,761


$
3,586,096


$
(538,619
)

$
9,281


$
3,059,519    5




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##### 



CapitalSource
    Inc.
  Consolidated
    Statements of Cash Flows
  Six Months Ended June 30,2008


2007(Unaudited)($ in thousands)Operating activities:Net income

$
66,831


$
163,018Adjustments to reconcile net income to net cash provided by
    (used in) operating activities:Stock option expense


3



3,909Restricted stock expense


18,541



16,662Gain on extinguishment of debt


(12,725
)


Amortization of deferred loan fees and discounts


(50,494
)


(49,772
)Paid-in-kind
    interest on loans


6,250



(12,031
)Provision for loan losses


37,333



32,336Amortization of deferred financing fees and discounts


52,569



17,418Depreciation and amortization


18,264



16,831Benefit for deferred income taxes


(8,104
)


(3,918
)Non-cash loss on investments, net


6,280



1,216Non-cash loss (gain) on property and equipment disposals


593



(1,408
)Unrealized loss (gain) on derivatives and foreign currencies, net


26,230



(958
)Unrealized loss on residential mortgage investment portfolio, net


31,664



29,950Net decrease (increase) in mortgage-backed securities pledged,
    trading


2,468,709



(812,546
)Amortization of discount on residential mortgage investments


(7,108
)


(17,318
)Decrease (increase) in loans held for sale, net


220,389



(162,524
)Decrease (increase) in other assets


48,710



(13,384
)Decrease in other liabilities


(83,725
)


(16,688
)Cash provided by (used in) operating activities


2,840,210



(809,207
)Investing activities:Decrease in restricted cash


84,848



19,254Decrease in mortgage-related receivables, net


122,765



139,241Acquisition of CS Advisors CLO II


(18,619
)


Decrease in receivables under reverse-repurchase agreements, net






25,655Decrease (increase) in loans, net


454,059



(926,074
)Acquisition of real estate, net of cash acquired


(10,121
)


(246,060
)Acquisition of investments, net


(75,743
)


(23,550
)Acquisition of property and equipment, net


(1,328
)


(3,559
)Cash provided by (used in) investing activities


555,861



(1,015,093
)Financing activities:Payment of deferred financing fees


(41,539
)


(11,387
)(Repayments) borrowings under repurchase agreements, net


(2,368,232
)


706,318(Repayments) borrowings on credit facilities, net


(526,180
)


1,132,201Borrowings of term debt






778,000Repayments of term debt


(588,154
)


(985,312
)(Repayments) borrowings under other borrowings


(195,868
)


75,630Proceeds from issuance of common stock, net of offering costs


599,679



216,208Proceeds from exercise of options


326



4,453Tax (expense) benefits on share-based payments


(9,630
)


3,650Payment of dividends


(275,505
)


(220,120
)Cash (used in) provided by financing activities


(3,405,103
)


1,699,641Decrease in cash and cash equivalents


(9,032
)


(124,659
)Cash and cash equivalents as of beginning of period


178,699



396,151Cash and cash equivalents as of end of period

$
169,667


$
271,492Supplemental information:Beneficial conversion option on convertible debt


48,376



Real estate acquired through foreclosure


46,464



Intangible lease liability adjustments


2,397



Assumption of intangible lease liability






28,554Assumption of term debt






44,627Assumption of note payable


25,107



Acquisition of real estate


2,120



78,627Conversion of noncontrolling interests into common stock


30,200



11,533    6




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##### 



CapitalSource
    Inc.



NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS  Note 1.
    Organization    
    First Mortgage Loans  Commercial loans that are
    secured by first mortgages on the property of the client;
    Senior Secured Asset-Based Loans  Commercial loans
    that are underwritten based on our assessment of the
    clients eligible collateral, including accounts
    receivable, real estate related receivables and inventory;
    Senior Secured Cash Flow Loans  Commercial loans that
    are underwritten based on our assessment of a clients
    ability to generate cash flows sufficient to repay the loan and
    maintain or increase its enterprise value during the term of the
    loan, thereby facilitating repayment of the principal at
    maturity;
    Direct Real Estate Investments  Investments in
    income-producing healthcare facilities that generally are leased
    through long-term,
    triple-net
    operating leases;
    Second Lien and Mezzanine Loans  Commercial loans,
    including subordinated mortgage loans, that come after a
    clients senior term loans in right of payment or upon
    liquidation;
    Equity Investments  Opportunistic equity investments,
    typically in conjunction with commercial financing relationships
    and on the same terms as other equity investors; and
    Residential Mortgage Investments  Investments in
    residential mortgage loans and residential mortgage-backed
    securities that constitute qualifying REIT assets.      Note 2.
    Summary
    of Significant Accounting Policies  Unaudited
    Interim Consolidated Financial Statements Basis of
    Presentation
  Form 10-Q Regulation S-X.
 7




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Form 10-K Form 10-K).
      Summary of Significant Accounting
    Policies Form 10-K.
  Fair
    Value Measurements
  Fair Value Measurements
              Note 3.
    New
    Accounting Pronouncements  SFAS 157-2, Effective Date of FASB Statement No. SFAS 157-2),
 8




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  SFAS 157-2, SFAS 157-2
  The
    Fair Value Option for Financial Assets and Financial Liabilities
  No. 06-11, Accounting for Income Tax Benefits of Dividends on
    Share-Based Payment Awards (EITF 06-11), EITF 06-11
  Business Combinations
  Noncontrolling Interests in Consolidated Financial
    Statements  An Amendment of ARB No. 51
  Disclosures about Derivative Instruments and Hedging
    Activities  An Amendment of FASB Statement
    No. 133 Accounting for Derivative instruments and Hedging Activities
 9




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 4.
    Mortgage-Related
    Receivables and Related Owners
    Trust Securitizations  Consolidation of Variable
    Interest Entities  An Interpretation of
    ARB No. 51
        June 30,


December 31,2008


2007($ in thousands)Mortgage-related receivables whose underlying mortgage loans are
    90 or more days past due or were in the process of foreclosure(1)

$
34,227


$
14,751Percentage of mortgage-related receivables


1.80
%(2)


0.72
%(2)     (1)
    
    Mortgage loans 90 or more days past due are also placed on
    non-accrual status.(2)
    
    By comparison, in their June 2008 Monthly Summary Reports
    (reflecting up to May 2008 performance), Fannie Mae and Freddie
    Mac reported single-family delinquency (SDQ) rates
    of 1.30% and 0.97%, respectively. The SDQ rates are based on
    loans 90 days or more delinquent or in foreclosure as of
    period end and in addition, the SDQ rate from Freddie Mac
    includes loans underlying their structured transactions. The
    comparable May 2008 statistic for mortgage-related receivables
    was 1.85%.     10




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Note 5.
    Residential
    Mortgage-Backed Securities and Certain Derivative
    Instruments        Note 6.
    Commercial
    Loans and Credit Quality   11




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Credit
    Quality
    June 30,


December 31,Commercial Loan Asset Classification

2008


2007($ in thousands)Loans 60 or more days contractually delinquent

$
109,075


$
74,298Non-accrual loans(1)


207,253



170,522Impaired loans(2)


509,298



318,945Less: loans in multiple categories


(288,910
)


(226,021
)Total

$
536,716


$
337,744Total as a percentage of total loans


5.69%



3.42%     (1)
    
    Includes commercial loans with aggregate principal balances of
    $58.3 million and $55.5 million as of June 30,
    2008 and December 31, 2007, respectively, which were also
    classified as loans 60 or more days contractually delinquent.
    Includes non-performing loans classified as held for sale that
    have an aggregate principal balance of $14.9 million as of
    June 30, 2008. As December 31, 2007, there were no
    nonperforming loans classified as held for sale.(2)
    
    Includes commercial loans with aggregate principal balances of
    $81.7 million and $55.5 million as of June 30,
    2008 and December 31, 2007, respectively, which were also
    classified as loans 60 or more days contractually delinquent,
    and commercial loans with aggregate principal balances of
    $192.4 million and $170.5 million as of June 30,
    2008 and December 31, 2007, respectively, which were also
    classified as loans on non-accrual status. The carrying values
    of impaired commercial loans were $502.1 million and
    $311.6 million as of June 30, 2008 and
    December 31, 2007, respectively, prior to the application
    of allocated reserves.  Accounting by
    Creditors for Impairment of a Loan and/or
   12




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Accounting for Debtors and Creditors for Troubled Debt
    Restructurings.
    Six Months Ended June 30,2008


2007($ in thousands)Balance as of beginning of period

$
138,930


$
120,575Provision for loan losses


30,436



32,336Charge offs, net


(28,238
)


(23,692
)Transfers to held for sale






(1,672
)Balance as of end of period

$
141,128


$
127,547   Real
    Estate Owned
      Note 7.
    Investments    June 30,


December 31,2008


2007($ in thousands)Investments carried at cost

$
120,496


$
127,183Investments carried at fair value:Investments available-for-sale


53,731



13,440Warrants


7,900



8,994Investments accounted for under the equity method


107,816



82,159Total

$
289,943


$
231,776  13




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  No. 99-20, Recognition of Interest Income on Purchased Beneficial
    Interests and Beneficial Interests that Continue to Be Held by a
    Transferor in Securitized Financial Assets No. 99-20). No. 99-20.
  Note 8.
    Guarantor
    Information  Borrowings, Form 10-K,
 14




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Balance Sheet
    June 30, 2008
  CapitalSource Finance LLCCombined


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.(Unaudited)($ in thousands)AssetsCash and cash equivalents

$
11


$
116,239


$
35,870


$
17,547


$



$
169,667Restricted cash






54,929



161,639



212,387







428,955Mortgage-related receivables, net














1,907,229







1,907,229Mortgage-backed securities pledged, trading














1,606,475







1,606,475Receivables under reverse-repurchase agreements






















Loans held for sale






9,312



12,203



77,302







98,817Loans:Loans






4,141,928



381,025



4,806,235



(120
)


9,329,068Less deferred loan fees and discounts






(27,859
)


(55,731
)


(86,834
)


470



(169,954
)Less allowance for loan losses










(106,353
)


(34,775
)






(141,128
)Loans, net






4,114,069



218,941



4,684,626



350



9,017,986Direct real estate investments, net














1,007,699







1,007,699Investment in subsidiaries


4,214,503







1,272,717



1,267,316



(6,754,536
)


Intercompany (due to) due from






















Intercompany note receivable


75,000



9



271,302



162,889



(509,200
)


Investments






113,636



63,207



113,100







289,943Other assets


22,843



35,322



44,733



284,844



(20,910
)


366,832Total assets

$
4,312,357


$
4,443,516


$
2,080,612


$
11,341,414


$
(7,284,296
)

$
14,893,603Liabilities, noncontrolling interests and shareholders
    equityLiabilities:Repurchase agreements

$



$



$



$
1,541,795


$



$
1,541,795Credit facilities


500,000



694,511



79,138



413,593







1,687,242Term debt






2,424,899







4,138,056



(114
)


6,562,841Other borrowings


741,504







521,765



405,926







1,669,195Other liabilities


11,334



4,521



49,974



312,852



(20,916
)


357,765Intercompany note payable






46,849



162,889



299,462



(509,200
)


Total liabilities


1,252,838



3,170,780



813,766



7,111,684



(530,230
)


11,818,838Noncontrolling interests






43







15,227



(24
)


15,246Shareholders equity:Preferred stock






















Common stock


2,761



















2,761Additional paid-in capital


3,586,096



656,176



(22,749
)


3,556,881



(4,190,308
)


3,586,096(Accumulated deficit) retained earnings


(538,619
)


603,531



1,274,819



648,038



(2,526,388
)


(538,619
)Accumulated other comprehensive income, net


9,281



12,986



14,776



9,584



(37,346
)


9,281Total shareholders equity


3,059,519



1,272,693



1,266,846



4,214,503



(6,754,042
)


3,059,519Total liabilities, noncontrolling interests and
    shareholders equity

$
4,312,357


$
4,443,516


$
2,080,612


$
11,341,414


$
(7,284,296
)

$
14,893,603  15




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##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Balance Sheet
    December 31, 2007
   CapitalSource Finance LLCCombined


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.($ in thousands)AssetsCash and cash equivalents

$



$
151,511


$
19,005


$
8,183


$



$
178,699Restricted cash






80,782



168,928



264,093







513,803Mortgage-related receivables, net














2,041,917







2,041,917Mortgage-backed securities pledged, trading














4,060,605







4,060,605Loans held for sale






78,675



15,652











94,327Loans:Loans






4,215,031



488,166



5,070,770



(557
)


9,773,410Less deferred loan fees and discounts






(37,052
)


(61,492
)


(49,053
)


508



(147,089
)Less allowance for loan losses










(107,611
)


(31,319
)






(138,930
)Loans, net






4,177,979



319,063



4,990,398



(49
)


9,487,391Direct real estate investments, net














1,017,604







1,017,604Investment in subsidiaries


3,777,732







1,079,432



1,217,739



(6,074,903
)


Intercompany note receivable


75,000



9



286,101



207,806



(568,916
)


Investments






122,240



39,536



70,000







231,776Other assets


18,046



48,729



113,104



255,504



(21,156
)


414,227Total assets

$
3,870,778


$
4,659,925


$
2,040,821


$
14,133,849


$
(6,665,024
)

$
18,040,349Liabilities, noncontrolling interests and shareholders
    equityLiabilities:Repurchase agreements

$



$
12,674


$



$
3,897,353


$



$
3,910,027Credit facilities


480,237



932,195







794,631







2,207,063Term debt






2,570,125







4,576,863



(551
)


7,146,437Other borrowings


780,630







535,991



387,487







1,704,108Other liabilities


27,640



18,634



79,793



340,092



(21,162
)


444,997Intercompany note payable






46,849



207,806



314,261



(568,916
)


Total liabilities


1,288,507



3,580,477



823,590



10,310,687



(590,629
)


15,412,632Noncontrolling interests






34







45,430



(18
)


45,446Shareholders equity:Preferred stock






















Common stock


2,207



















2,207Additional paid-in capital


2,902,501



524,914



90,979



3,256,263



(3,872,156
)


2,902,501(Accumulated deficit) retained earnings


(327,387
)


549,305



1,120,817



516,216



(2,186,338
)


(327,387
)Accumulated other comprehensive income, net


4,950



5,195



5,435



5,253



(15,883
)


4,950Total shareholders equity


2,582,271



1,079,414



1,217,231



3,777,732



(6,074,377
)


2,582,271Total liabilities, noncontrolling interests and
    shareholders equity

$
3,870,778


$
4,659,925


$
2,040,821


$
14,133,849


$
(6,665,024
)

$
18,040,349  16




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Three Months Ended June 30, 2008
  CapitalSource Finance LLCCombined


Combined


OtherCapitalSource


Non-Guarantor


Guarantor


Non-Guarantor





ConsolidatedInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income

$
1,060


$
90,961


$
13,948


$
149,315


$
(1,062
)

$
254,222Fee income






12,911



10,289



18,084



(17
)


41,267Total interest and fee income


1,060



103,872



24,237



167,399



(1,079
)


295,489Operating lease income














24,210







24,210Total investment income


1,060



103,872



24,237



191,609



(1,079
)


319,699Interest expense


22,763



35,240



12,650



90,492



(1,062
)


160,083Net investment (loss) income


(21,703
)


68,632



11,587



101,117



(17
)


159,616Provision for loan losses










25,312



6,362







31,674Net investment (loss) income after provision for loan losses


(21,703
)


68,632



(13,725
)


94,755



(17
)


127,942Operating expenses:Compensation and benefits


426



3,677



33,705











37,808Depreciation of direct real estate investments














8,990







8,990Other administrative expenses


13,149



1,784



16,003



2,130



(9,222
)


23,844Total operating expenses


13,575



5,461



49,708



11,120



(9,222
)


70,642Other income (expense):Diligence deposits forfeited






4



1,710











1,714Loss on investments, net






(1,123
)


(3,241
)


(463
)






(4,827
)Gain (loss) on derivatives






4,403



(4,821
)


15,516







15,098Gain on residential mortgage investment portfolio














9,060







9,060Other income, net






3,113



25,878



(528
)


(9,222
)


19,241Earnings in subsidiaries


95,338







66,838



28,729



(190,905
)


Intercompany






(2,809
)


5,815



(3,006
)






Total other income


95,338



3,588



92,179



49,308



(200,127
)


40,286Noncontrolling interests expense






(76
)






362



(3
)


283Net income before income taxes


60,060



66,835



28,746



132,581



(190,919
)


97,303Income taxes














37,243







37,243Net income

$
60,060


$
66,835


$
28,746


$
95,338


$
(190,919
)

$
60,060  17




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Three Months Ended June 30, 2007
  CapitalSource Finance LLCCombined


Combined


OtherCapitalSource


Non-Guarantor


Guarantor


Non-Guarantor





ConsolidatedInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income

$
1,622


$
119,149


$
25,505


$
167,652


$
(2,744
)

$
311,184Fee income






19,683



14,793



10,580







45,056Total interest and fee income


1,622



138,832



40,298



178,232



(2,744
)


356,240Operating lease income














22,118







22,118Total investment income


1,622



138,832



40,298



200,350



(2,744
)


378,358Interest expense


10,140



60,718



8,388



123,789



(2,744
)


200,291Net investment (loss) income


(8,518
)


78,114



31,910



76,561







178,067Provision for loan losses










15,744



1,666







17,410Net investment (loss) income after provision for loan losses


(8,518
)


78,114



16,166



74,895







160,657Operating expenses:Compensation and benefits


221



5,434



32,960











38,615Depreciation of direct real estate investments














7,390







7,390Other administrative expenses


15,448



2,153



15,077



1,687



(13,927
)


20,438Total operating expenses


15,669



7,587



48,037



9,077



(13,927
)


66,443Other income (expense):Diligence deposits forfeited










1,813











1,813Gain on investments, net






13,534



3,468











17,002Gain (loss) on derivatives






243



(1,902
)


4,812







3,153Loss on residential mortgage investment portfolio














(13,846
)






(13,846
)Other income, net






6,274



20,808



(198
)


(13,927
)


12,957Earnings in subsidiaries


108,515







88,756



82,822



(280,093
)


Intercompany






(1,750
)


1,750











Total other income


108,515



18,301



114,693



73,590



(294,020
)


21,079Noncontrolling interests expense






74







1,200



(2
)


1,272Net income before income taxes


84,328



88,754



82,822



138,208



(280,091
)


114,021Income taxes














29,693







29,693Net income

$
84,328


$
88,754


$
82,822


$
108,515


$
(280,091
)

$
84,328  18




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Six Months Ended June 30, 2008
  CapitalSource Finance LLCCombined


Combined


OtherCapitalSource


Non-Guarantor


Guarantor


Non-Guarantor





ConsolidatedInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income

$
2,254


$
197,717


$
26,285


$
338,548


$
(2,257
)

$
562,547Fee income






21,987



23,937



29,022



(38
)


74,908Total interest and fee income


2,254



219,704



50,222



367,570



(2,295
)


637,455Operating lease income














51,900







51,900Total investment income


2,254



219,704



50,222



419,470



(2,295
)


689,355Interest expense


42,026



78,541



24,577



206,140



(2,256
)


349,028Net investment (loss) income


(39,772
)


141,163



25,645



213,330



(39
)


340,327Provision for loan losses










28,469



8,864







37,333Net investment (loss) income after provision for loan losses


(39,772
)


141,163



(2,824
)


204,466



(39
)


302,994Operating expenses:Compensation and benefits


681



6,311



62,605











69,597Depreciation of direct real estate investments














17,906







17,906Other administrative expenses


24,538



3,527



35,783



5,245



(18,445
)


50,648Total operating expenses


25,219



9,838



98,388



23,151



(18,445
)


138,151Other income (expense):Diligence deposits forfeited






96



2,265











2,361Loss on investments, net






(548
)


(2,067
)


(857
)


(214
)


(3,686
)(Loss) gain on derivatives






(5,066
)


22,087



(40,034
)






(23,013
)Loss on residential mortgage investment portfolio














(46,317
)






(46,317
)Other income, net






(1,702
)


37,372



(2,683
)


(18,445
)


14,542Earnings in subsidiaries


132,036







120,206



88,416



(340,658
)


Intercompany






(3,806
)


9,804



(5,998
)






Total other income


132,036



(11,026
)


189,667



(7,473
)


(359,317
)


(56,113
)Noncontrolling interests expense






99







1,487



(6
)


1,580Net income before income taxes


67,045



120,200



88,455



172,355



(340,905
)


107,150Income taxes














40,319







40,319Net income

$
67,045


$
120,200


$
88,455


$
132,036


$
(340,905
)

$
66,831  19




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Six Months Ended June 30, 2007
  CapitalSource Finance LLCCombined


Combined


OtherCapitalSource


Non-Guarantor


Guarantor


Non-Guarantor





ConsolidatedInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income

$
9,072


$
232,187


$
49,394


$
320,567


$
(10,482
)

$
600,738Fee income






42,432



33,632



19,019







95,083Total interest and fee income


9,072



274,619



83,026



339,586



(10,482
)


695,821Operating lease income














42,406







42,406Total investment income


9,072



274,619



83,026



381,992



(10,482
)


738,227Interest expense


20,406



115,406



23,050



238,560



(10,482
)


386,940Net investment (loss) income


(11,334
)


159,213



59,976



143,432







351,287Provision for loan losses










28,045



4,291







32,336Net investment (loss) income after provision for loan losses


(11,334
)


159,213



31,931



139,141







318,951Operating expenses:Compensation and benefits


858



10,767



67,004











78,629Depreciation of direct real estate investments














14,152







14,152Other administrative expenses


27,379



3,110



30,306



3,429



(25,240
)


38,984Total operating expenses


28,237



13,877



97,310



17,581



(25,240
)


131,765Other income (expense):Diligence deposits forfeited










2,675











2,675Gain on investments, net






19,629



3,536











23,165(Loss) gain on derivatives






(35
)


(3,817
)


4,750







898Loss on residential mortgage investment portfolio














(19,544
)






(19,544
)Other income, net






8,572



36,800



(198
)


(25,240
)


19,934Earnings in subsidiaries


202,589







170,274



147,268



(520,131
)


Intercompany






(3,179
)


3,179











Total other income


202,589



24,987



212,647



132,276



(545,371
)


27,128Noncontrolling interests expense






54







2,553



(5
)


2,602Net income before income taxes


163,018



170,269



147,268



251,283



(520,126
)


211,712Income taxes














48,694







48,694Net income

$
163,018


$
170,269


$
147,268


$
202,589


$
(520,126
)

$
163,018  20




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Cash flows
    Six Months Ended June 30, 2008
  CapitalSource Finance LLCCombined


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.(Unaudited)($ in thousands)Operating activities:Net income

$
67,045


$
120,200


$
88,455


$
132,036


$
(340,905
)

$
66,831Adjustments to reconcile net income to net cash (used in)
    provided by operating activities:Stock option expense






(140
)


143











3Restricted stock expense






1,401



17,140











18,541(Gain) loss on extinguishment of debt










(14,245
)


1,520







(12,725
)Amortization of deferred loan fees and discounts






(19,560
)


(15,662
)


(15,272
)






(50,494
)Paid-in-kind
    interest on loans






2,103



(92
)


4,239







6,250Provision for loan losses










28,470



8,863







37,333Amortization of deferred financing fees and discounts


20,475



16,693



2,187



13,214







52,569Depreciation and amortization






216



1,925



16,123







18,264Benefit for deferred income taxes














(8,104
)






(8,104
)Non-cash loss on investments, net






3,432



2,929



(81
)






6,280Non-cash loss (gain) on property and equipment disposals










593











593Unrealized loss (gain) on derivatives and foreign currencies, net






4,142



18,680



3,408







26,230Unrealized loss on residential mortgage investment portfolio, net














31,664







31,664Net decrease in mortgage-backed securities pledged, trading














2,468,709







2,468,709Amortization of discount on residential mortgage investments














(7,108
)






(7,108
)(Increase) decrease in loans held for sale, net






51,558







168,831







220,389Decrease in intercompany note receivable










14,799



44,917



(59,716
)


(Increase) decrease in other assets


(868
)


17,899



89,690



(57,765
)


(246
)


48,710Decrease in other liabilities


(17,075
)


(13,344
)


(30,168
)


(23,384
)


246



(83,725
)Net transfers with subsidiaries


(400,221
)


115,067



(239,505
)


183,284



341,375



Cash (used in) provided by operating activities


(330,644
)


299,667



(34,661
)


2,965,094



(59,246
)


2,840,210Investing activities:Decrease in restricted cash






25,853



7,289



51,706







84,848Decrease in mortgage-related receivables, net














122,765







122,765Acquisition of CS Advisors CLO II














(18,619
)






(18,619
)Decrease in loans, net






131,688



64,882



258,396



(907
)


454,059Acquisition of real estate, net of cash acquired














(10,121
)






(10,121
)Disposal (acquisition) of investments, net






2,825



(26,906
)


(51,662
)






(75,743
)Disposal (acquisition) of property and equipment, net






164



(1,492
)










(1,328
)Cash provided by investing activities






160,530



43,773



352,465



(907
)


555,861Financing activities:Payment of deferred financing fees


(15,155
)


(17,742
)


(222
)


(8,420
)






(41,539
)Decrease in intercompany note payable










(44,917
)


(14,799
)


59,716



Repayments of repurchase agreeements, net






(12,674
)






(2,355,558
)






(2,368,232
)Borrowings on (repayments of) credit facilities, net


19,763



(244,333
)


79,429



(381,039
)






(526,180
)Borrowings of term debt






(437
)










437



Repayments of term debt






(220,283
)






(367,871
)






(588,154
)Repayments of other borrowings










(26,537
)


(169,331
)






(195,868
)Proceeds from issuance of common stock, net of offering costs


599,679



















599,679Proceeds from exercise of options


326



















326Tax expense on share based payments














(9,630
)






(9,630
)Payment of dividends


(273,958
)










(1,547
)






(275,505
)Cash provided by (used in) financing activities


330,655



(495,469
)


7,753



(3,308,195
)


60,153



(3,405,103
)Increase (decrease) in cash and cash equivalents


11



(35,272
)


16,865



9,364







(9,032
)Cash and cash equivalents as of beginning of period






151,511



19,005



8,183







178,699Cash and cash equivalents as of end of period

$
11


$
116,239


$
35,870


$
17,547


$



$
169,667  21




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Cash Flows
    Six Months Ended June 30, 2007
  CapitalSource Finance LLCCombined Non-


Combined


Other Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


CapitalSource Inc.(Unaudited)($ in thousands)Operating activities:Net income

$
163,018


$
170,269


$
147,268


$
202,589


$
(520,126
)

$
163,018Adjustments to reconcile net income to net cash (used in)
    provided by operating activities:Stock option expense






234



3,675











3,909Restricted stock expense






2,245



14,417











16,662Amortization of deferred loan fees and discounts






(13,326
)


(22,381
)


(14,065
)






(49,772
)Paid-in-kind
    interest on loans






(1,467
)


(8,401
)


(2,163
)






(12,031
)Provision for loan losses










28,046



4,290







32,336Amortization of deferred financing fees and discounts


1,724



7,421



224



8,049







17,418Depreciation and amortization






148



1,577



15,106







16,831Benefit for deferred income taxes














(3,918
)






(3,918
)Non-cash (gain) loss on investments, net






1,182



34











1,216Non-cash loss on property and equipment disposals






(1,442
)


34











(1,408
)Unrealized loss (gain) on derivatives and foreign currencies, net






(230
)


3,600



(4,328
)






(958
)Unrealized loss on residential mortgage investment portfolio, net














29,950







29,950Net decrease in mortgage-backed securities pledged, trading














(812,546
)






(812,546
)Amortization of discount on residential mortgage investments














(17,318
)






(17,318
)Increase in loans held for sale, net






(75,253
)


(87,271
)










(162,524
)Decrease (increase) in intercompany note receivable






2,137



(39,648
)






37,511



(Increase) decrease in other assets


(9,294
)


(2,587
)


(42,131
)


5,294



35,334



(13,384
)Increase (decrease) in other liabilities


24,149



(12,097
)


(5,008
)


2,038



(25,770
)


(16,688
)Net transfers with subsidiaries


(303,559
)


(262,239
)


(115,430
)


161,102



520,126



Cash (used in) provided by operating activities


(123,962
)


(185,005
)


(121,395
)


(425,920
)


47,075



(809,207
)Investing activities:Decrease (increase) in restricted cash






24,707



28,780



(34,233
)






19,254Decrease in mortgage-related receivables, net














139,241







139,241Decrease in receivables under reverse-repurchase agreements, net






25,655















25,655Increase in loans, net


52



(83,280
)


(80,072
)


(754,102
)


(8,672
)


(926,074
)Acquisition of real estate, net of cash acquired














(246,060
)






(246,060
)(Acquisition) disposal of investments, net






(12,703
)


357



(11,204
)






(23,550
)Disposal (acquisition) of property and equipment, net






126



(3,685
)










(3,559
)Cash provided by (used in) investing activities


52



(45,495
)


(54,620
)


(906,358
)


(8,672
)


(1,015,093
)Financing activities:Payment of deferred financing fees


(58
)


(8,992
)


(2,066
)


(271
)






(11,387
)(Decrease) increase in intercompany note payable






(13,331
)






50,842



(37,511
)


(Repayments of) borrowings repurchase agreeements, net






(25,020
)






731,338







706,318Borrowings on credit facilities, net


120,964



327,509



89,935



593,793







1,132,201Borrowings of term debt






738,892







40,000



(892
)


778,000Repayments of term debt






(844,903
)


(207
)


(140,202
)






(985,312
)Borrowings under other borrowings










75,630











75,630Proceeds from issuance of common stock, net of offering costs


216,208



















216,208Proceeds from exercise of options


4,453



















4,453Tax benefits on share based payments














3,650







3,650Payment of dividends


(217,814
)










(2,306
)






(220,120
)Cash provided by financing activities


123,753



174,155



163,292



1,276,844



(38,403
)


1,699,641Decrease in cash and cash equivalents


(157
)


(56,345
)


(12,723
)


(55,434
)






(124,659
)Cash and cash equivalents as of beginning of period


157



238,224



46,723



111,047







396,151Cash and cash equivalents as of end of period

$



$
181,879


$
34,000


$
55,613


$



$
271,492  22




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 9.
    Direct
    Real Estate Investments  triple-net
  June 30,


December 31,2008


2007($ in thousands)Land

$
106,797


$
106,620Buildings


910,413



902,863Furniture and equipment


51,814



51,545Accumulated depreciation


(61,325
)


(43,424
)Total

$
1,007,699


$
1,017,604   Note 10.
    Borrowings  Borrowings Form 10-K.
  Repurchase
    Agreements
    Credit
    Facilities
       23




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      2007-A
      Term
    Debt
  series 2004-1
  2007-A 2007-A Credit Facilities
  Other
    Borrowings
    June 30,


December 31,2008


2007($ in thousands)Convertible debt, net(1)

$
741,503


$
780,630Subordinated debt


494,220



529,877Mortgage debt


332,988



341,086Notes payable


74,640



52,515Single purpose loan financing


25,844



Total

$
1,669,195


$
1,704,108     (1)
    
    Amounts presented are net of $59.3 million and
    $19.7 million in beneficial conversion options, net of
    amortization, as of June 30, 2008 and December 31,
    2007, respectively.  Subordinated
    Debt
   24




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Single
    Purpose Loan Financing
    Note 11.
    Shareholders
    Equity  Common
    Stock Shares Outstanding
    Outstanding as of December 31, 2007


220,704,800Issuance of common stock


54,561,511Exercise of options


47,983Restricted stock and other stock grants, net


824,858Outstanding as of June 30, 2008


276,139,152     Dividend
    Reinvestment and Stock Purchase Plan
   25




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Equity
    Offering
    Note 12.
    Income
    Taxes         26




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 13.
    Comprehensive
    Income    Three Months Ended


Six Months EndedJune 30,


June 30,2008


2007


2008


2007($ in thousands)Net income

$
60,060


$
84,328


$
66,831


$
163,018Unrealized loss on available-for-sale securities, net of tax


(718
)


(94
)


(5,021
)


(2,798
)Unrealized gain on foreign currency translation, net of tax


366



1,561



10,128



2,181Unrealized (loss) gain on cash flow hedges, net of tax


(22
)


864



(776
)


536Comprehensive income

$
59,686


$
86,659


$
71,162


$
162,937     June 30,


December 31,2008


2007($ in thousands)Unrealized loss on available-for-sale securities, net of tax

$
(5,410
)

$
(389
)Unrealized gain on foreign currency translation, net of tax


14,477



4,349Unrealized gain on cash flow hedge, net of tax


214



990Accumulated other comprehensive income, net

$
9,281


$
4,950   Note 14.
    Net
    Income per Share    Three Months Ended


Six Months EndedJune 30,


June 30,2008


2007


2008


2007($ in thousands, except per share data)Basic net income per share:Net income

$
60,060


$
84,328


$
66,831


$
163,018Average shares  basic


235,076,287



185,371,033



227,580,584



182,274,147Basic net income per share

$
0.26


$
0.45


$
0.29


$
0.89Diluted net income per share:Net income

$
60,060


$
84,328


$
66,831


$
163,018Average shares  basic


235,076,287



185,371,033



227,580,584



182,274,147Effect of dilutive securities:Option shares


72,268



558,360



82,885



599,957Unvested restricted stock


1,165,813



1,259,472



1,196,722



1,415,191Stock units


130,862



41,207



109,047



33,769Conversion premium on the Debentures(1)






198,358







189,387Average shares  diluted


236,445,230



187,428,430



228,969,238



184,512,451Diluted net income per share

$
0.25


$
0.45


$
0.29


$
0.88     (1)
    
    For the three and six months ended June 30, 2007, the
    conversion premiums on the 1.25% Debentures and
    1.625% Debentures represented the dilutive shares based on
    conversion prices of $24.05. 27




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Three Months Ended


Six Months EndedJune 30,


June 30,2008


2007


2008


2007Stock options


8,703,256



123,771



8,715,502



72,950Non-managing member units


740,590



1,996,855



1,359,834



2,225,248Shares subject to a written call option


7,401,420



7,401,420



7,401,420



7,401,420     3.5% Senior Convertible Debentures due 2034

$
21.631.25% Senior Convertible Debentures due 2034


20.694.0% Senior Subordinated Convertible Debentures due 2034


21.631.625% Senior Subordinated Convertible Debentures due 2034


20.697.25% Senior Subordinated Convertible Debentures due 2037


27.09     Note 15.
    Stock-Based
    Compensation        Stock-Based Compensation Form 10-K.
 28




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 16.
    Commitments
    and Contingencies  Guarantors Accounting and Disclosure Requirements for
    Guarantees, Including Indirect Guarantees of Indebtedness of
    Others.
    Accounting for Conditional Asset Retirement
    Obligations  An Interpretation of FASB
    No. 143
    Note 17.
    Derivative
    Instruments  Residential
    Mortgage-Backed Securities and Certain Derivative Instruments,
 29




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Note 18.
    Fair
    Value Measurements  New Accounting
    Pronouncements
  Fair
    Value Determination
      Assets
    and Liabilities
  Residential
    Mortgage-Backed Securities
  Investments in Debt and Equity
    Securities
  Investments
    The Equity Method of Accounting for
    Investments in Common Stock
 30




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Warrants
    Derivative
    Assets and Liabilities
    Loans
    Held for Investment
    Assets
    and Liabilities Carried at Fair Value on a Recurring
    Basis
    Fair Value


Quoted Prices in


Significant Other


SignificantMeasurement as of


Active Markets for


Observable


UnobservableJune 30, 2008


Identical Assets (Level 1)


Inputs (Level 2)


Inputs (Level 3)($ in thousands)AssetsMortgage-backed securities pledged, trading

$
1,606,475


$



$
1,606,475


$
Investments carried at fair value:Investments available-for-sale


53,731







408



53,323Warrants


7,900











7,900Other assets held at fair value:Derivative assets


50,402







50,402



Total assets

$
1,718,508


$



$
1,657,285


$
61,223LiabilitiesOther liabilities held at fair value:Derivative liabilities

$
180,523


$



$
180,523


$
  31




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Realized and UnrealizedGains (Losses)Total


Purchases,Realized


Sales,Included in


and


Issuances,








UnrealizedBalance as of





Other


Unrealized


and


Transfers


Balance as of


GainsApril 1,


Included in


Comprehensive


Gains


Settlements,


In (Out)


June 30,


(Losses)2008


Income


Income, Net


(Losses)


net


of Level 3


2008


(1)($ in thousands)AssetsInvestments carried at fair value:Investments available-for- sale

$
55,084


$
412


$
(1,114
)

$
(702
)

$
(1,059
)

$



$
53,323


$
(1,760
)Warrants


9,917



(983
)


(2
)


(985
)


(1,032
)






7,900



(69
)Total assets

$
65,001


$
(571
)

$
(1,116
)

$
(1,687
)

$
(2,091
)

$



$
61,223


$
(1,829
)     (1)
    
    Represents unrealized gains (losses) relating to
    assets/liabilities held as of June 30, 2008.    Loss onInterest

Loss on

Residential MortgageIncome

Investments, net

Investment Portfolio($ in thousands)Total gains (losses) included in earnings for the period

$
2,508


$
(1,117
)

$
(1,963
)Unrealized gains (losses) relating to assets still held at
    reporting date


1,451



(203
)


(1,963
)     Realized and UnrealizedGains (Losses)Total


Purchases,Realized


Sales,Included in


and


Issuances,








UnrealizedBalance as of





Other


Unrealized


and


Transfers


Balance as of


GainsJanuary 1,


Included in


Comprehensive


Gains


Settlements,


In (Out)


June 30,


(Losses)2008


Income


Income, Net


(Losses)


net


of Level 3


2008


(1)($ in thousands)AssetsInvestments carried at fair value:Investments available-for- sale

$
13,198


$
1,553


$
(8,223
)

$
(6,670
)

$
46,795


$



$
53,323


$
(8,775
)Warrants


8,994



(44
)


(18
)


(62
)


(1,032
)






7,900



531Total assets

$
22,192


$
1,509


$
(8,241
)

$
(6,732
)

$
45,763


$



$
61,223


$
(8,244
)     (1)
    
    Represents unrealized gains (losses) relating to
    assets/liabilities held as of June 30, 2008. 32




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Loss onInterest

(Loss) Gain on

Residential MortgageIncome

Investments, net

Investment Portfolio($ in thousands)Total gains (losses) included in earnings for the period

$
4,482


$
(351
)

$
(2,623
)Unrealized gains (losses) relating to assets still held at
    reporting date


2,377



224



(2,623
)   Assets
    Carried at Fair Value on a Nonrecurring Basis
    Quoted Prices in








Total LossesFair Value


Active Markets


Significant Other


Significant


Three Months


Six MonthsMeasurement as


for Identical


Observable Inputs


Unobservable


Ended


Endedof June 30, 2008


Assets (Level 1)


(Level 2)


Inputs (Level 3)


June 30, 2008


June 30, 2008($ in thousands)AssetsLoans held for investment(1)

$
91,888


$



$



$
91,888


$
(13,684
)

$
(18,414
)Investments carried at cost


2,572











2,572



(3,023
)


(3,920
)Investments accounted for under the equity method


8,062











8,062



(214
)


(214
)Total assets

$
102,522


$



$



$
102,522


$
(16,921
)

$
(22,548
)     (1)
    
    Represents impaired loans held for investment measured at fair
    value of the loans collateral less transaction costs as
    provided for by SFAS No. 114. Transaction costs were not
    significant as of the balance sheet date.  Note 19.
    Segment
    Data  Disclosures about Segments of an
    Enterprise and Related Information,
   33




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Three Months Ended June 30, 2008ResidentialCommercial


Healthcare


Mortgage


ConsolidatedFinance


Net Lease


Investment


Total($ in thousands)Total interest and fee income

$
242,886


$
354


$
52,249


$
295,489Operating lease income






24,210







24,210Interest expense


108,425



10,859
(1)


40,799



160,083Provision for loan losses


27,465







4,209



31,674Operating expenses(2)


57,843



11,380



1,419



70,642Other income (expense)(3)


33,880



(1,416
)


7,822



40,286Noncontrolling interests (income) expense


(369
)


652







283Net income before income taxes


83,402



257



13,644



97,303Income taxes


37,243











37,243Net income

$
46,159


$
257


$
13,644


$
60,060Total assets as of June 30, 2008

$
10,122,131


$
1,070,537


$
3,700,935


$
14,893,603   Three Months Ended June 30, 2007ResidentialCommercial


Healthcare


Mortgage


ConsolidatedFinance


Net Lease


Investment


Total($ in thousands)Total interest and fee income

$
272,653


$
198


$
83,389


$
356,240Operating lease income






22,118







22,118Interest expense


111,852



10,661
(1)


77,778



200,291Provision for loan losses


17,410











17,410Operating expenses(2)


55,082



9,482



1,879



66,443Other income (expense)(3)


34,925







(13,846
)


21,079Noncontrolling interests (income) expense


(186
)


1,458







1,272Net income (loss) before income taxes


123,420



715



(10,114
)


114,021Income taxes


29,693











29,693Net income (loss)

$
93,727


$
715


$
(10,114
)

$
84,328Total assets as of June 30, 2007

$
9,481,561


$
1,104,580


$
6,575,549


$
17,161,690   34




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Six Months Ended June 30, 2008ResidentialCommercial


Healthcare


Mortgage


ConsolidatedFinance


Net Lease


Investment


Total($ in thousands)Total interest and fee income

$
500,899


$
847


$
135,709


$
637,455Operating lease income






51,900







51,900Interest expense


222,068



21,655
(1)


105,305



349,028Provision for loan losses


30,436







6,897



37,333Operating expenses(2)


110,980



22,553



4,618



138,151Other expense(3)


(5,877
)


(1,416
)


(48,820
)


(56,113
)Noncontrolling interests (income) expense


(486
)


2,066







1,580Net income (loss) before income taxes


132,024



5,057



(29,931
)


107,150Income taxes


40,319











40,319Net income (loss)

$
91,705


$
5,057


$
(29,931
)

$
66,831Total assets as of June 30, 2008

$
10,122,131


$
1,070,537


$
3,700,935


$
14,893,603   Six Months Ended June 30, 2007ResidentialCommercial


Healthcare


Mortgage


ConsolidatedFinance


Net Lease


Investment


Total($ in thousands)Total interest and fee income

$
531,238


$
294


$
164,289


$
695,821Operating lease income






42,406







42,406Interest expense


214,616



19,148
(1)


153,176



386,940Provision for loan losses


32,336











32,336Operating expenses(2)


110,265



18,520



2,980



131,765Other income (expense)(3)


46,672







(19,544
)


27,128Noncontrolling interests (income) expense


(457
)


3,059







2,602Net income (loss) before income taxes


221,150



1,973



(11,411
)


211,712Income taxes


48,694











48,694Net income (loss)

$
172,456


$
1,973


$
(11,411
)

$
163,018Total assets as of June 30, 2007

$
9,481,561


$
1,104,580


$
6,575,549


$
17,161,690     (1)
    
    Interest expense in our Healthcare Net Lease segment includes
    interest on its secured credit facility and mortgage debt as
    well as an allocation of interest on its allocated intercompany
    debt.(2)
    
    Operating expenses of our Healthcare Net Lease segment include
    depreciation of direct real estate investments, professional
    fees, an allocation of overhead expenses (including compensation
    and benefits) and other direct expenses. In our Residential
    Mortgage Investment Segment, operating expenses include an
    allocation of overhead expenses, compensation and benefits,
    professional fees paid to our investment manager and other
    direct expenses.(3)
    
    Other (expense) income for our Residential Mortgage Investment
    segment includes the net of interest income and expense accruals
    related to certain of our derivatives along with the changes in
    fair value of our Agency MBS and related derivatives. 35




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Summary of Significant Accounting Policies.
  Note 20.
    Subsequent
    Events        Form S-11 No. 333-152825)
 36




---



##### 



ITEM 2.
    MANAGEMENTS
    DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
    OPERATIONS  CAUTIONARY
    NOTE REGARDING FORWARD-LOOKING STATEMENTS
  Form 10-Q, Form 10-Q Form 10-Q, Form 10-K Form 10-K), Form 10-Q Form 10-Q
    Form 10-Q.
  Overview
    and Highlights
     37




---



##### 



Segment Data
    healthcare-related triple-net
    and/or
    
    Corporate Finance, which generally provides senior and
    subordinate loans through direct origination and participation
    in widely syndicated loan transactions;
    Healthcare and Specialty Finance, which, including our
    Healthcare Net Lease segment activities, generally provides
    first mortgage loans, asset-based revolving lines of credit, and
    other cash flow loans to healthcare businesses and a broad range
    of other companies and makes investments in income-producing
    healthcare facilities, particularly long-term care
    facilities; and
    Structured Finance, which generally engages in commercial
    and residential real estate finance and also provides
    asset-based lending to finance companies.    Deposit
    Based Funding
   38




---



##### 



de novo
      REIT
    Status
    CapitalSource
    Healthcare REIT
   39




---



##### 



Form S-11 No. 333-152825)
    Dividend
    Policy
    Impact
    of Recent Market Conditions
         40




---



##### 



Consolidated
    Results of Operations
      Explanation
    of Reporting Metrics
  Interest Income.
  Fee Income.
  Operating Lease Income.
  Interest Expense.
 41




---



##### 



Provision for Loan Losses.
  Other Income.
  Operating Expenses.
  Income Taxes.
  Adjusted Earnings.
 42




---



##### 



Operating
    Results for the Three and Six Months Ended June 30,
    2008
    
    Mark to market losses on our Residential Mortgage Investment
    Portfolio;
    Gains and losses on derivatives and other investments in our
    Commercial Finance segment;
    Increased balance of our commercial loan portfolio;
    Decreased provision for loan losses;
    Increased operating lease income related to our direct real
    estate investments;
    Increases in operating expenses;
    Increased lending spreads;
    Increased borrowing spreads; and
    Reduced prepayment-related fee income and reduced gains on
    equity sales.    Three Months Ended








Six Months EndedJune 30,








June 30,2008


2007


$ Change


% Change


2008


2007


$ Change


% Change($ in thousands)Interest income

$
254,222


$
311,184


$
(56,962
)


(18
)%

$
562,547


$
600,738


$
(38,191
)


(6
)%Fee income


41,267



45,056



(3,789
)


(8
)


74,908



95,083



(20,175
)


(21
)Operating lease income


24,210



22,118



2,092



9



51,900



42,406



9,494



22Interest expense


160,083



200,291



(40,208
)


(20
)


349,028



386,940



(37,912
)


(10
)Provision for loan losses


31,674



17,410



14,264



82



37,333



32,336



4,997



15Depreciation of direct real estate investments


8,990



7,390



1,600



22



17,906



14,152



3,754



27Other operating expenses


61,652



59,053



2,599



4



120,245



117,613



2,632



2Other income (expense)


40,286



21,079



19,207



91



(56,113
)


27,128



(83,241
)


(307
)Noncontrolling interests expense


283



1,272



(989
)


(78
)


1,580



2,602



(1,022
)


(39
)Income taxes


37,243



29,693



7,550



25



40,319



48,694



(8,375
)


(17
)Net income


60,060



84,328



(24,268
)


(29
)


66,831



163,018



(96,187
)


(59
)   Six Months Ended June 30,2008


2007Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


Cost($ in thousands)Interest earning assets:Interest income





$
562,547



7.43
%





$
600,738



8.29
%Fee income






74,908



0.99







95,083



1.31Total interest earning assets(1)

$
15,184,475



637,455



8.42


$
14,620,118



695,821



9.60Total direct real estate investments


1,068,280



51,900



9.74



830,035



42,406



10.30Total income earning assets


16,252,755



689,355



8.51



15,450,153



738,227



9.64Total interest bearing liabilities(2)


13,674,303



349,028



5.12



13,278,448



386,940



5.88Net finance spread





$
340,327



3.39
%





$
351,287



3.76
%Net finance margin










4.20
%










4.59
%    (1)
    
    Interest earning assets include cash, restricted cash,
    mortgage-related receivables, RMBS, loans, and investments in
    debt securities.(2)
    
    Interest bearing liabilities include repurchase agreements,
    secured and unsecured credit facilities, term debt, convertible
    debt and subordinated debt. 43




---



##### 



Operating
    Expenses
      Income
    Taxes
    Comparison
    of the Three Months Ended June 30, 2008 and
    2007
   44




---



##### 



Commercial
    Finance Segment
    Three Months EndedJune 30,2008


2007


$ Change


% Change($ in thousands)Interest income

$
201,626


$
227,597


$
(25,971
)


(11
)%Fee income


41,260



45,056



(3,796
)


(8
)Interest expense


108,425



111,852



(3,427
)


(3
)Provision for loan losses


27,465



17,410



10,055



58Operating expenses


57,843



55,082



2,761



5Other income


34,249



35,111



(862
)


(2
)Income taxes


37,243



29,693



7,550



25Net income


46,159



93,727



(47,568
)


(51
)   Interest
    Income
    Fee
    Income
    Interest
    Expense
    Net
    Finance Margin
   45




---



##### 



Three Months Ended June 30,2008


2007Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


Cost($ in thousands)Interest earning assets:Interest income





$
201,626



8.09
%





$
227,597



10.08
%Fee income






41,260



1.66







45,056



2.00Total interest earning assets(1)

$
9,992,540



242,886



9.75


$
9,053,082



272,653



12.08Total interest bearing liabilities(2)


8,053,850



108,425



5.40



7,327,650



111,852



6.12Net finance spread





$
134,461



4.35
%





$
160,801



5.96
%Net finance margin










5.40
%










7.12
%     (1)
    
    Interest earning assets include cash, restricted cash, loans and
    investments in debt securities.(2)
    
    Interest bearing liabilities include repurchase agreements,
    secured and unsecured credit facilities, term debt, convertible
    debt and subordinated debt.  Provision
    for Loan Losses
    Operating
    Expenses
    Other
    Income
     46




---



##### 



Healthcare
    Net Lease Segment
    Three Months EndedJune 30,2008


2007


$ Change


% Change($ in thousands)Interest income

$
347


$
198


$
149



75
%Fee income


7







7



N/AOperating lease income


24,210



22,118



2,092



9Interest expense


10,859



10,661



198



2Depreciation of direct real estate investments


8,990



7,390



1,600



22Other operating expenses


2,390



2,092



298



14Other expense


(1,416
)






(1,416
)


N/ANoncontrolling interests expense


652



1,458



(806
)


(55
)Net income


257



715



(458
)


(64
)   Operating
    Lease Income
  triple-net
  Net
    Finance Margin
    Depreciation
    of Direct Real Estate Investments
    Residential
    Mortgage Investment Segment
    Three Months EndedJune 30,2008


2007


$ Change


% Change($ in thousands)Interest income

$
52,249


$
83,389


$
(31,140
)


(37
)%Interest expense


40,799



77,778



(36,979
)


(48
)Provision for loan losses


4,209







4,209



N/AOperating expenses


1,419



1,879



(460
)


(24
)Other income (expense)


7,822



(13,846
)


21,668



156Net income (loss)


13,644



(10,114
)


23,758



235  47




---



##### 



Interest
    Income
    Interest
    Expense
    Provision
    for loan losses
    Operating
    Expenses
    Other
    Income (Expense)
  other-than-temporary
 48




---



##### 



Non-GAAP Adjusted
    Earnings
    Three Months Ended June 30,2008


2007($ in thousands, except per share data)Net income

$
60,060


$
84,328Add:Real estate depreciation and amortization(1)


8,459



7,896Amortization of deferred financing fees(2)


26,810



6,823Non-cash equity compensation


12,030



9,859Net realized and unrealized losses (gains) on residential
    mortgage investment portfolio, including related derivatives(3)


(57,022
)


15,846Unrealized gains on derivatives and foreign currencies, net


(33,140
)


(1,287
)Unrealized losses on investments, net


4,475



1,170Provision for loan losses


32,028



17,410Recoveries(4)


(356
)


Less:Charge offs


24,237



13,625Nonrecurring items






Adjusted earnings

$
29,107


$
128,420Net income per share:Basic  as reported

$
0.26


$
0.45Diluted  as reported

$
0.25


$
0.45Average shares outstanding:Basic  as reported


235,076,287



185,371,033Diluted  as reported


236,445,230



187,428,430Adjusted earnings per share:Basic

$
0.12


$
0.69Diluted(5)

$
0.12


$
0.68Average shares outstanding:Basic


235,076,287



185,371,033Diluted(6)


236,445,230



189,425,285     (1)
    
    Depreciation and amortization for direct real estate investments
    only. Excludes depreciation for corporate leasehold
    improvements, fixed assets and other non-real estate items.(2)
    
    Includes amortization of deferred financing fees and other
    non-cash interest expense.(3)
    
    Includes adjustments to reflect realized and unrealized gains
    and losses related to residential mortgage investments held in
    our portfolio as of the balance sheet date and related
    derivative instruments.(4)
    
    Includes all recoveries on loans during the period.(5)
    
    Adjusted to reflect the impact of adding back noncontrolling
    interests expense totaling $1.3 million for the three
    months ended June 30, 2007, to adjusted earnings due to the
    application of the if-converted method on non-managing member
    units, which were considered dilutive to adjusted earnings per
    share, but were antidilutive to GAAP net income per share.(6)
    
    Adjusted to include average non-managing member units of
    1,996,855 for the three months ended June 30, 2007, which
    were considered dilutive to adjusted earnings per share, but are
    antidilutive to GAAP net income per share. 49




---



##### 



Comparison
    of the Six Months Ended June 30, 2008 and
    2007
    Commercial
    Finance Segment
    Six Months EndedJune 30,2008


2007


$ Change


% Change($ in thousands)Interest income

$
426,009


$
436,155


$
(10,146
)


(2
)%Fee income


74,890



95,083



(20,193
)


(21
)Interest expense


222,068



214,616



7,452



3Provision for loan losses


30,436



32,336



(1,900
)


(6
)Operating expenses


110,980



110,265



715



1Other (expense) income


(5,391
)


47,129



(52,520
)


(111
)Income taxes


40,319



48,694



(8,375
)


(17
)Net income


91,705



172,456



(80,751
)


(47
)   Interest
    Income
    Fee
    Income
    Interest
    Expense
   50




---



##### 



Net
    Finance Margin
      Six Months Ended June 30,2008


2007Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


Cost($ in thousands)Interest earning assets:Interest income





$
426,009



8.51
%





$
436,155



10.07
%Fee income






74,890



1.50







95,083



2.20Total interest earning assets(1)

$
10,037,634



500,899



10.01


$
8,731,605



531,238



12.27Total interest bearing liabilities(2)


8,210,315



222,068



5.42



7,108,002



214,616



6.09Net finance spread





$
278,831



4.59
%





$
316,622



6.18
%Net finance margin










5.57
%










7.31
%     (1)
    
    Interest earning assets include cash, restricted cash, loans and
    investments in debt securities.(2)
    
    Interest bearing liabilities include repurchase agreements,
    secured and unsecured credit facilities, term debt, convertible
    debt and subordinated debt.  Provision
    for Loan Losses
    Operating
    Expenses
    Other
    (Expense) Income
     51




---



##### 



Healthcare
    Net Lease Segment
    Six Months EndedJune 30,2008


2007


$ Change


% Change($ in thousands)Interest income

$
829


$
294


$
535



182
%Fee income


18







18



N/AOperating lease income


51,900



42,406



9,494



22Interest expense


21,655



19,148



2,507



13Depreciation of direct real estate investments


17,906



14,152



3,754



27Other operating expenses


4,647



4,368



279



6Other expense


(1,416
)






(1,416
)


N/ANoncontrolling interests expense


2,066



3,059



(993
)


(32
)Net income


5,057



1,973



3,084



156   Operating
    Lease Income
  triple-net
  Interest
    Expense
    Net
    Finance Margin
    Depreciation
    of Direct Real Estate Investments
   52




---



##### 



Residential
    Mortgage Investment Segment
    Six Months EndedJune 30,2008


2007


$ Change


% Change($ in thousands)Interest income

$
135,709


$
164,289


$
(28,580
)


(17
)%Interest expense


105,305



153,176



(47,871
)


(31
)Provision for loan losses


6,897







6,897



N/AOperating expenses


4,618



2,980



1,638



55Other expense


(48,820
)


(19,544
)


(29,276
)


(150
)Net loss


(29,931
)


(11,411
)


(18,520
)


(162
)   Interest
    Income
    Interest
    Expense
    Provision
    for Loan Losses
    Operating
    Expenses
    Other
    Expense
   53




---



##### 



Non-GAAP Adjusted
    Earnings
    Six Months Ended June 30,2008


2007($ in thousands, except per share data)Net income

$
66,831


$
163,018Add:Real estate depreciation and amortization(1)


17,219



14,658Amortization of deferred financing fees(2)


38,763



12,332Non-cash equity compensation


18,544



20,571Net realized and unrealized (gains) losses on residential
    mortgage investment portfolio, including related derivatives(3)


(29,628
)


23,381Unrealized losses (gains) on derivatives and foreign currencies,
    net


14,492



(959
)Unrealized losses on investments, net


9,132



1,217Provision for loan losses


37,689



32,336Recoveries(4)


(356
)


Less:Charge offs


30,313



23,876Nonrecurring items






Adjusted earnings

$
142,373


$
242,678Net income per share:Basic  as reported

$
0.29


$
0.89Diluted  as reported

$
0.29


$
0.88Average shares outstanding:Basic  as reported


227,580,584



182,274,147Diluted  as reported


228,969,238



184,512,451Adjusted earnings per share:Basic

$
0.63


$
1.33Diluted(5)

$
0.62


$
1.31Average shares outstanding:Basic


227,580,584



182,274,147Diluted(6)


228,969,238



186,737,699     (1)
    
    Depreciation and amortization for direct real estate investments
    only. Excludes depreciation for corporate leasehold
    improvements, fixed assets and other non-real estate items.(2)
    
    Includes amortization of deferred financing fees and other
    non-cash interest expense.(3)
    
    Includes adjustments to reflect realized and unrealized gains
    and losses related to residential mortgage investments held in
    our portfolio as of the balance sheet date and related
    derivative instruments.(4)
    
    Includes all recoveries on loans during the period.(5)
    
    Adjusted to reflect the impact of adding back noncontrolling
    interests expense totaling $2.6 million for the six months
    ended June 30, 2007, respectively, to adjusted earnings due
    to the application of the if-converted method on non-managing
    member units, which were considered dilutive to adjusted
    earnings per share, but were antidilutive to GAAP net income per
    share.(6)
    
    Adjusted to include average non-managing member units of
    2,225,248 for the six months ended June 30, 2007, which
    were considered dilutive to adjusted earnings per share, but are
    antidilutive to GAAP net income per share. 54




---



##### 



Financial
    Condition
  Commercial
    Finance Segment
  Portfolio
    Composition
    June 30,


December 31,2008


2007($ in thousands)Commercial loans, net

$
9,427,885


$
9,867,737Equity investments


287,621



227,144Total

$
9,715,506


$
10,094,881   Commercial
    Lending Portfolio Composition
    June 30, 2008


December 31, 2007($ in thousands)Composition of loan portfolio by loan type:Senior secured loans(1)

$
5,475,500



58
%

$
5,695,167



58
%First mortgage loans(1)


2,720,814



29



2,995,048



30Subordinate loans


1,231,571



13



1,177,522



12Total

$
9,427,885



100
%

$
9,867,737



100
%Composition of loan portfolio by business:Corporate Finance

$
2,783,694



30
%

$
2,979,241



30
%Healthcare and Specialty Finance


2,871,619



30



2,934,666



30Structured Finance


3,772,572



40



3,953,830



40Total

$
9,427,885



100
%

$
9,867,737



100
%     (1)
    
    Includes Term B loans. 55




---



##### 



Number


Average


Number of


Average Loanof Loans


Loan Size


Clients


Size per Client($ in thousands)Composition of loan portfolio by business:Corporate Finance


508


$
5,480



251


$
11,090Healthcare and Specialty Finance


383



7,498



264



10,877Structured Finance


226



16,693



184



20,503Overall loan portfolio


1,117


$
8,440



699


$
13,488     Due in


Due inOne Year


One to


Due Afteror Less


Five Years


Five Years


Total($ in thousands)Scheduled maturities by loan type:Senior secured loans(1)

$
754,179


$
4,482,864


$
238,457


$
5,475,500First mortgage loans(1)


1,088,291



1,528,516



104,007



2,720,814Subordinate loans


50,958



562,795



617,818



1,231,571Total

$
1,893,428


$
6,574,175


$
960,282


$
9,427,885     (1)
    
    Includes Term B loans.    Adjustable


FixedRates


Rates


Total($ in thousands)Composition of loan portfolio by loan type:Senior secured loans(1)

$
5,441,810


$
33,690


$
5,475,500First mortgage loans(1)


2,431,415



289,399



2,720,814Subordinate loans


1,091,082



140,489



1,231,571Total

$
8,964,307


$
463,578


$
9,427,885Percentage of total loan portfolio


95%



5%



100%     (1)
    
    Includes Term B loans.   56




---



##### 



Credit
    Quality and Allowance for Loan Losses
    June 30,


December 31,Commercial Loan Asset Classification

2008


2007($ in thousands)Loans 60 or more days contractually delinquent

$
109,075


$
74,298Non-accrual loans(1)


207,253



170,522Impaired loans(2)


509,298



318,945Less: loans in multiple categories


(288,910)



(226,021)Total

$
536,716


$
337,744Total as a percentage of total loans


5.69%



3.42%     (1)
    
    Includes commercial loans with aggregate principal balances of
    $58.3 million and $55.5 million as of June 30,
    2008 and December 31, 2007, respectively, which were also
    classified as loans 60 or more days contractually delinquent.
    Includes non-performing loans classified as held for sale that
    have an aggregate principal balance of $14.9 million as of
    June 30, 2008. As December 31, 2007, there were no non
    performing loans classified as held for sale.(2)
    
    Includes commercial loans with aggregate principal balances of
    $81.7 million and $55.5 million as of June 30,
    2008 and December 31, 2007, respectively, which were also
    classified as loans 60 or more days contractually delinquent,
    and commercial loans with aggregate principal balances of
    $192.4 million and $170.5 million as of June 30,
    2008 and December 31, 2007, respectively, which were also
    classified as loans on non-accrual status. The carrying values
    of impaired commercial loans were $502.1 million and
    $311.6 million as of June 30, 2008 and
    December 31, 2007, respectively, prior to the application
    of allocated reserves.  Accounting by Creditors for
    Impairment of a Loan and/or
  Accounting for Debtors and Creditors for Troubled Debt
    Restructurings
   57




---



##### 



Investments
      Healthcare
    Net Lease Segment
  Direct
    Real Estate Investments
  triple-net triple-net
  Residential
    Mortgage Investment Segment
  Portfolio
    Composition
    June 30,


December 31,2008


2007($ in thousands)Mortgage-related receivables(1)

$
1,907,229


$
2,041,917Residential mortgage-backed securities:Agency(2)


1,606,475



4,060,605Non-Agency(2)


2,322



4,632Total

$
3,516,026


$
6,107,154     (1)
    
    Represents secured receivables that are backed by
    adjustable-rate residential prime mortgage loans.(2)
    
    See following paragraph for a description of these securities.   58




---



##### 



Mortgage-Related
    Receivables and Related Owner Trust Securitizations
    Credit
    Quality and Allowance for Loan Losses
    June 30,


December 31,2008


2007($ in thousands)Mortgage-related receivables whose underlying mortgage loans are
    90 or more days past due or were in the process of foreclosure(1)

$
34,227


$
14,751Percentage of mortgage-related receivables


1.80
%(2)


0.72
%(2)     (1)
    
    Mortgage loans 90 or more days pass due are also placed on
    non-accrual status.(2)
    
    By comparison, in their June 2008 Monthly Summary Reports
    (reflecting up to May 2008 performance), Fannie Mae and Freddie
    Mac reported single-family delinquency (SDQ) rates
    of 1.30% and 0.97%, respectively. The SDQ rates are based on
    loans 90 days or more delinquent or in foreclosure as of
    period end and in addition, the SDQ rate from Freddie Mac
    includes loans underlying their structured transactions. The
    comparable May 2008 statistic for mortgage-related receivables
    was 1.85%.     59




---



##### 



Financing
      Market Risk Management
  Liquidity
    and Capital Resources
         60




---



##### 



and/or
    Cash
    and Cash Equivalents
     61




---



##### 



Sources
    and Uses of Cash
        Deposits
    Borrowings
  Borrowings Form 10-K Borrowings
       62




---



##### 



Repurchase
    Agreements
    Credit
    Facilities
      Principal


Interest

MaturityCommitment


Outstanding


Rate(1)

Date($ in thousands)Secured Credit Facilities:CS Funding III

$
150,000


$



LIBOR + 2.00%

April 29, 2009CS Funding VII


400,000
(2)


170,000


CP + 2.25%

March 31, 2009CS Funding VIII


50,388



50,388


CP + 0.75%

July 19, 2010CSE QRS Funding I


815,000
(2)





CP/LIBOR + 2.00%

April 24, 2009CSE QRS Funding II


380,000
(2)


22,000


CP + 2.25%

March 31, 2009CS Europe(3)


390,075



195,048


EURIBOR + 1.00%(4)

September 30, 2010Total Secured Credit Facilities


2,185,463



437,436
(5)Unsecured Credit Facilities:CS Inc.


1,070,000



769,739


LIBOR + 3.0%(6)

March 13, 2010Total credit facilities

$
3,255,463


$
1,207,175     (1)
    
    As of July 31, 2008, the one-month LIBOR was 2.46%; the
    one-month EURIBOR was 4.48%; the CP rate for CS Funding VIII was
    2.71%; and the blended CP/LIBOR rate for CSE QRS Funding I was
    2.43%; the CP rates for CS Funding VII were 2.67%; the CP rates
    for CSE QRS Funding II were 2.66%.(2)
    
    Upon termination of the revolving period, there is an
    amortization period of up to one year.(3)
    
    CS Europe is a 250 million facility and the amounts
    presented were translated to United States Dollars
    (USD) using the spot rate as of June 30, 2008.(4)
    
    Borrowings in Euro or British Pounds Sterling (GBP)
    are at EURIBOR or GBP LIBOR + 1.00%, respectively, and
    borrowings in USD are at LIBOR + 1.00%.(5)
    
    The aggregate outstanding collateral balance pledged to our
    secured credit facilities as of July 31, 2008 was
    $1.2 billion.(6)
    
    LIBOR + 3.0% or at an alternative base rate, which is the
    greater of the prime rate for USD borrowings or the Federal
    Funds Rate + 1.50%, or for foreign currency borrowings, at the
    prevailing EURIBOR + 3.0% or GBP LIBOR +3.0%. 63




---



##### 



Term
    Debt
    Owner
    Trust Term Debt
    Convertible
    Debt
    Subordinated
    Debt
      Mortgage
    Debt
    Debt
    Covenants
  and/or
  Equity
   64




---



##### 



Commitments,
    Guarantees & Contingencies
    Commitments and
    Contingencies
  Commitments and Contingencies
     65




---



##### 



Credit
    Risk Management
  agreed-upon
    Commercial
    Finance Segment
      Residential
    Mortgage Investment Segment
    Concentrations
    of Credit Risk
   66




---



##### 



Derivative
    Counterparty Credit Risk
    Market
    Risk Management
  and/or
  Derivative Instruments
  Interest
    Rate Risk Management  Commercial Finance
    Segment & Healthcare Net Lease Segment
   67




---



##### 



12-month
  Estimated (Decrease)Increase inRate Change

Net Interest Income(Basis Points)

Over 12 Months($ in thousands)−100

$
22,560−50


10,680+ 50


(9,360
)+ 100


(15,600
)       Amount


Percentage ofOutstanding


Total Portfolio($ in thousands)Loans with contractual interest rates:Exceeding the interest rate floor

$
551,253



6
%At the interest rate floor


47,368



1Below the interest rate floor


3,254,347



34Loans with no interest rate floor


5,574,917



59Total

$
9,427,885



100
%         Interest
    Rate Risk Management  Residential Mortgage Investment
    Segment
   68




---



##### 



Estimated (Decrease)Rate Change

Increase


Percentage of Total(Basis Points)

in Fair Value


Segment Assets($ in thousands)−100

$
(496
)


(0.013
)%−50


149



0.004+ 50


(368
)


(0.010
)+ 100


(465
)


(0.013
)       Critical
    Accounting Estimates
  Managements Discussion and Analysis of Financial
    Condition and Results of Operations Summary of Significant Accounting Policies Critical Accounting
    Estimates Managements Discussion and
    Analysis of Financial Condition and Results of Operations Form 10-K
  Fair
    Value Measurements
   69




---



##### 



Fair Value Measurements ,
                  
    Selection of third-party market data sources;
    Evaluation of the expected reliability of the estimate;
    Reliability, timeliness and cost of alternative valuation
    methodologies; and
    Selection of proxy instruments, as necessary.   70




---



##### 



ITEM 3.
    QUANTITATIVE
    AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  Managements Discussion and
    Analysis of Financial Condition and Results of Operations Market Risk Management Form 10-Q Form 10-K. Derivative Instruments Credit Risk Form 10-K.
  ITEM 4.
    CONTROLS
    AND PROCEDURES  Rule 13a-15
 PART II.
    OTHER INFORMATION ITEM 1A.  RISK
    FACTORS  Our business faces many risks. The risks described below may
    not be the only risks we face. Additional risks that we do not
    yet know of or that we currently believe are immaterial may also
    impair our business operations. If any of the events or
    circumstances described in the following risks actually occur,
    our business, financial condition
 71




---



##### 



or results of operations could suffer, and the trading price
    of our securities could decline. As a result, you should
    consider all of the following risks, together with all of the
    other Risk Factors set forth in our Annual Report on
    Form 10-K
    for the year ended December 31, 2007, as filed with the SEC
    on February 29, 2008 (the
    Form 10-K)
    and our Quarterly Report on
    Form 10-Q
    for the quarter ended March 31, 2008, as filed with the SEC
    on May 12, 2008 and the other information in this Quarterly
    Report on
    Form 10-Q,
    the
    Form 10-K
    and our future filings with the SEC before deciding to invest in
    our securities.
  Overview
      de novo
    Risk
    Factors
  We may
    fail to realize all of the anticipated benefits of the
    acquisition.
   72




---



##### 



We may
    fail to maintain or raise additional deposits at CapitalSource
    Bank.
    The
    Participation Interest may not pay down to the extent necessary
    to avoid losses for the new bank.
    Compliance
    with applicable regulations could be more costly than expected
    and could negatively impact our business.
   73




---



##### 



California
    Law
    Federal
    Law
    Safety
    and Soundness Standards
        Capital
    Standards
   74




---



##### 



Limitations
    on Dividends
    Other
    Regulation
   75




---



##### 



We
    expect the acquisition will require us to acquire additional
    real estate assets to optimize our REIT structure.
    Our
    cash dividends are not guaranteed and may fluctuate; we could
    reduce or eliminate dividends on our common stock.
    We may
    not be successful in effecting the initial public offering of
    our healthcare net lease business or realizing the expected
    amount of proceeds for our account through that transaction,
    which could impair our liquidity position.
  Form S-11 No. 333-152825)
  It is
    likely we will determine not to qualify as a REIT beyond 2008
    and the effects of this change in tax status could have adverse
    implications on our liquidity.
     76




---



##### 



ITEM 2.
    UNREGISTERED
    SALES OF EQUITY SECURITIES AND USE OF PROCEEDS    Shares Purchased


Maximum NumberTotal Number


Average


as Part of Publicly


of Shares that Mayof Shares


Price Paid


Announced Plans


Yet be PurchasedPurchased(1)


per Share


or Programs


Under the PlansApril 1  April 30, 2008


106,568


$
11.60







May 1  May 31, 2008


11,431



15.35







June 1  June 30, 2008


45,024



13.58







Total


163,023


$
12.41     (1)
    
    Represents the number of shares acquired as payment by employees
    of applicable statutory minimum withholding taxes owed upon
    vesting of restricted stock granted under our Third Amended and
    Restated Equity Incentive Plan.  ITEM 4.
    SUBMISSION
    OF MATTERS TO A VOTE OF SECURITY HOLDERS    Election of Directors
  Nominee

In Favor


WithheldFrederick W. Eubank, II


197,950,294



8,162,437Jason M. Fish


203,057,299



3,055,432Timothy M. Hurd


197,982,712



8,130,019     Director

Term EndsWilliam G. Byrnes


2009 Annual MeetingJohn K. Delaney


2009 Annual MeetingAndrew B. Fremder


2010 Annual MeetingSara L. Grootwassink


2009 Annual MeetingC. William Hosler


2010 Annual MeetingLawrence C. Nussdorf


2010 Annual Meeting  77




---



##### 



Ratification of Auditors
  In Favor


Against


Abstained205,352,119



364,384



396,228   . Amendment to the Authorized Share of Common
    Stock 
  In Favor


Against


Abstained189,833,753



15,578,741



700,237   . Amendment to the Equity Incentive Plan 
  In Favor


Against


Abstained


Broker Non-Votes103,993,876



37,818,891



644,026



63,655,938   ITEM 6.
    EXHIBITS     78




---



##### 



Signatures      Date: August 8, 2008

/s/  JOHN
    K. DELANEYJohn
    K. Delaney
    Chairman of the Board and Chief Executive Officer (Principal
    Executive Officer)Date: August 8, 2008

/s/  THOMAS
    A. FINKThomas
    A. Fink
    Chief Financial Officer
    (Principal Financial Officer)Date: August 8, 2008

/s/  DONALD
    F. COLEDonald
    F. Cole
    Chief Accounting Officer
    (Principal Accounting Officer)  79




---



##### 



INDEX TO
    EXHIBITS  ExhibitNo

Description2
.1

Purchase and Assumption Agreement, dated April 13, 2008, among
    Fremont General Corporation, Fremont General Credit Corporation,
    Fremont Investment and Loan, CapitalSource Inc. and
    CapitalSource TRS Inc. (incorporated by reference to exhibit 2.1
    to the Form 8-K filed by CapitalSource on April 17, 2008).3
.1

Second Amended and Restated Certificate of Incorporation
    (composite version; reflects all amendments through May 1, 2008)
    (incorporated by reference to exhibit 3.1 to the Form 10-Q filed
    by CapitalSource on May 12, 2008).3
.2

Amended and Restated Bylaws (composite version; reflects all
    amendments through October 30, 2007) (incorporated by reference
    to exhibit 3.2 to the Form 10-Q filed by CapitalSource on
    November 9, 2007).10
.1

Amended and Restated Sale and Servicing Agreement, dated as of
    April 28, 2006, by and among CSE QRS Funding I LLC, as the
    seller, CSE Mortgage LLC, as the Originator and as the Servicer,
    each of the Purchasers and Purchaser Agents from time to time
    party thereto, Wachovia Capital Markets, LLC, as the
    Administrative Agent and as the WBNA Agent, and Wells Fargo
    Bank, National Association, as the Backup Servicer and as the
    Collateral Custodian (composite version; reflects all amendments
    through April 24, 2008) (incorporated by reference to exhibit
    10.1 to the Form 10-Q filed by CapitalSource on May 12, 2008).10
.2

Second Amended and Restated Sale and Servicing Agreement, dated
    as of May 8, 2008, by and among CapitalSource Real Estate Loan
    LLC, 2007-A, as the Seller, CSE Mortgage LLC, as the Originator
    and Service, the Issuers from time to time party thereto, the
    Liquidity Banks from time to time party thereto, Citicorp
    North America, Inc., as the Administrative Agent and Wells
    Fargo Bank, National Association, as the Backup Servicer and as
    the Collateral Custodian (composite version; reflects all
    amendments through May 8, 2008)(incorporated by reference to
    exhibit 10.2 to the Form 10-Q filed by CapitalSource on May 12,
    2008).10
.3

Sale and Servicing Agreement, dated as of May 8, 2008, by and
    among CS Funding VII Depositor LLC, as the Seller, CapitalSource
    Finance LLC, as the Servicer and Originator, the Issuers from
    time to time party thereto, the Liquidity Banks from time to
    time party thereto, Citicorp North America, Inc., as the
    Administrative Agent and Wells Fargo Bank, National Association,
    as the Backup Servicer and as the Collateral Custodian
    (incorporated by reference to exhibit 10.3 to the Form 10-Q
    filed by CapitalSource on May 12, 2008).10
.4

Credit Agreement dated as of March 14, 2006, as amended as of
    June 30, 2006, December 20, 2006, June 29, 2007, December 19,
    2007 and June 26, 2008 by and among CapitalSource Inc., as
    Initial Borrower, CapitalSource TRS Inc., CapitalSource Finance
    LLC, CSE Mortgage LLC, CapitalSource SF TRS Inc., CapitalSource
    International Inc., the several banks and other financial
    institutions parties thereto, Wachovia Bank, National
    Association, as Administrative Agent, Swingline Lender, and
    Issuing Lender, and Bank of America, N.A., as Issuing Lender
    (composite version; reflects all amendments through June 26,
    2008) (incoporated by reference to exhibit 10.1 to the Form 8-K
    filed by CapitalSource on June 27, 2008).10
.5

Third Amended and Restated Equity Incentive Plan (composite
    version; reflects all amendments through May 1,
    2008)(incorporated by reference to exhibit 10.4 to the Form 10-Q
    filed by CapitalSource on May 12, 2008).10
.6

Form of Restricted Stock Agreement (2008).10
.7

Form of Restricted Stock Unit Agreement (2008).10
.8

Form of Non-Qualified Option Agreement (2008).12
.1

Ratio of Earnings to Fixed Charges.31
.1

Rule 13a  14(a) Certification of Chairman of the
    Board and Chief Executive Officer.31
.2

Rule 13a  14(a) Certification of Chief Financial
    Officer.32


Section 1350 Certifications.     
    
    Filed herewith.   80