##### 



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 March 31, 2007
  Commission File
    No. 1-31753
  CapitalSource Inc.
 (Exact name of registrant as
    specified in its charter)
  Delaware

35-2206895(State of
    Incorporation)

(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
  Rule 12b-2
 þ o o
  Rule 12b-2 o þ




---



##### 



TABLE OF
    CONTENTS
  PagePART I. FINANCIAL
    INFORMATIONItem 1.


Financial StatementsConsolidated
    Balance Sheets as of March 31, 2007 (unaudited) and
    December 31, 2006


3Consolidated
    Statements of Income (unaudited) for the three months ended
    March 31, 2007 and 2006


4Consolidated
    Statement of Shareholders Equity (unaudited) for the three
    months ended March 31, 2007


5Consolidated
    Statements of Cash Flows (unaudited) for the three months ended
    March 31, 2007 and 2006


6Notes to the
    Unaudited Consolidated Financial Statements


7Item 2.


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


29Item 3.


Quantitative and
    Qualitative Disclosures about Market Risk


50Item 4.


Controls and
    Procedures


50PART II.
    OTHER INFORMATIONItem 1.


Legal
    Proceedings


51Item 1A.


Risk
    Factors


51Item 2.


Unregistered Sales
    of Equity Securities and Use of Proceeds


51Item 3.


Defaults Upon
    Senior Securities


51Item 4.


Submission of
    Matters to a Vote of Security Holders


51Item 5.


Other
    Information


51Item 6.


Exhibits


51Signatures


52Index to
    Exhibits


53   2




---



##### 



CapitalSource
    Inc.
  Consolidated Balance Sheets
  March 31,


December 31,2007


2006(Unaudited)($ in thousands)ASSETSCash and cash equivalents

$
308,770


$
396,151Restricted cash


135,550



240,904Mortgage-related receivables, net


2,239,257



2,295,922Mortgage-backed securities
    pledged, trading


3,372,329



3,502,753Receivables under
    reverse-repurchase agreements


26,315



51,892Loans held for sale


156,650



26,521Loans:Loans


8,455,570



7,771,785Less deferred loan fees and
    discounts


(124,380
)


(130,392
)Less allowance for loan losses


(125,236
)


(120,575
)Loans, net


8,205,954



7,520,818Direct real estate investments, net


805,650



722,303Investments


185,710



184,333Other assets


228,148



268,977Total assets

$
15,664,333


$
15,210,574LIABILITIES, NONCONTROLLING
    INTERESTS AND SHAREHOLDERS EQUITYLiabilities:Repurchase agreements

$
3,309,559


$
3,510,768Unsecured credit facilities


492,758



355,685Secured credit facilities


2,932,262



2,183,155Term debt


5,423,317



5,809,685Convertible debt


555,000



555,000Subordinated debt


485,453



446,393Other liabilities


202,852



200,498Total liabilities


13,401,201



13,061,184Noncontrolling
    interests


44,797



56,350Shareholders
    equity:Preferred stock
    (50,000,000 shares authorized; no shares outstanding)






Common stock ($0.01 par
    value, 500,000,000 shares authorized; 189,538,383 and
    182,752,290 shares issued, respectively; 188,238,383 and
    181,452,290 shares outstanding, respectively)


1,882



1,815Additional paid-in capital


2,302,393



2,139,421Accumulated deficit


(56,067
)


(20,735
)Accumulated other comprehensive
    income, net


53



2,465Treasury stock, at cost


(29,926
)


(29,926
)Total shareholders equity


2,218,335



2,093,040Total liabilities, noncontrolling
    interests and shareholders equity

$
15,664,333


$
15,210,574    3




---



##### 



CapitalSource
    Inc.
  Consolidated Statements of Income
  Three Months Ended March 31,2007


2006(Unaudited)($ in thousands, except pershare data)Net investment
    income:Interest income

$
289,554


$
195,498Fee income


50,027



41,542Total interest and fee income


339,581



237,040Operating lease income


20,288



4,625Total investment income


359,869



241,665Interest expense


186,649



97,782Net investment income


173,220



143,883Provision for loan losses


14,926



14,713Net investment income after
    provision for loan losses


158,294



129,170Operating expenses:Compensation and benefits


40,014



33,320Other administrative expenses


25,308



17,299Total operating expenses


65,322



50,619Other income
    (expense):Diligence deposits forfeited


862



2,267Gain (loss) on investments, net


6,163



(251
)(Loss) gain on derivatives


(2,255
)


526Loss on residential mortgage
    investment portfolio


(5,698
)


(6,106
)Other income, net of expenses


6,977



3,908Total other income


6,049



344Noncontrolling interests
    expense


1,330



861Net income before income taxes
    and cumulative effect of accounting change


97,691



78,034Income taxes


19,001



13,110Net income before cumulative
    effect of accounting change


78,690



64,924Cumulative effect of accounting
    change, net of taxes






370Net income

$
78,690


$
65,294Net income per share:Basic

$
0.44


$
0.44Diluted

$
0.43


$
0.42Average shares
    outstanding:Basic


179,324,672



149,722,991Diluted


181,743,884



154,450,572Dividends declared per
    share

$
0.58


$
0.49    4




---



##### 



CapitalSource
    Inc.
  Consolidated Statement of Shareholders
    Equity
  AccumulatedAdditional





Other


Treasury


TotalCommon


Paid-In


Accumulated


Comprehensive


Stock,


ShareholdersStock


Capital


Deficit


Income, Net


at Cost


Equity(Unaudited)($ in thousands)Total shareholders equity as
    of December 31, 2006

$
1,815


$
2,139,421


$
(20,735
)

$
2,465


$
(29,926
)

$
2,093,040Net income










78,690











78,690Other comprehensive income:Unrealized losses, net of tax














(2,412
)






(2,412
)Total comprehensive income






















76,278Cumulative effect of adoption of
    FIN 48










(5,702
)










(5,702
)Dividends paid






2,256



(108,320
)










(106,064
)Issuance of common stock, net


59



145,625















145,684Stock option expense






2,392















2,392Exercise of options


2



2,642















2,644Restricted stock activity


6



2,461















2,467Tax benefit on exercise of options






849















849Tax benefit on vesting of
    restricted stock grants






6,747















6,747Total shareholders equity as
    of March 31, 2007

$
1,882


$
2,302,393


$
(56,067
)

$
53


$
(29,926
)

$
2,218,335    5




---



##### 



CapitalSource
    Inc.
  Consolidated Statements of Cash Flows
  Three Months Ended March 31,2007


2006(Unaudited)($ in thousands)Operating activities:Net income

$
78,690


$
65,294Adjustments to reconcile net income
    to net cash provided by (used in) operating activities:Stock option expense


2,392



785Restricted stock expense


8,320



5,752Loss on extinguishment of debt






2,582Non-cash prepayment fee






(8,353
)Cumulative effect of accounting
    change, net of taxes






(370
)Amortization of deferred loan fees
    and discounts


(24,814
)


(20,158
)Paid-in-kind
    interest on loans


(6,103
)


(1,274
)Provision for loan losses


14,926



14,713Amortization of deferred financing
    fees and discounts


8,078



7,767Depreciation and amortization


8,031



2,349Benefit for deferred income taxes


(1,606
)


(1,651
)Non-cash loss on investments, net


47



1,236Non-cash loss on property and
    equipment disposals


127



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


329



(526
)Unrealized loss on residential
    mortgage investment portfolio, net


5,207



17,366Net decrease (increase) in
    mortgage-backed securities pledged, trading


155,540



(103,214
)Amortization of discount on
    residential mortgage investments


(8,631
)


(1,468
)Increase in loans held for sale, net


(101,575
)


(77,981
)Decrease (increase) in other assets


11,468



(36,238
)Increase in other liabilities


1,976



6,423Cash provided by (used in)
    operating activities


152,402



(126,966
)Investing activities:Decrease in restricted cash


105,354



33,341Decrease (increase) in
    mortgage-related receivables, net


60,003



(2,493,503
)Decrease (increase) in receivables
    under reverse-repurchase agreements, net


25,577



(36,889
)Increase in loans, net


(699,761
)


(368,525
)Acquisition of real estate, net of
    cash acquired


(87,020
)


(7,180
)(Disposal) acquisition of
    investments, net


(8,506
)


26,564Acquisition of property and
    equipment, net


(2,800
)


(775
)Cash used in investing activities


(607,153
)


(2,846,967
)Financing activities:Payment of deferred financing fees


(2,097
)


(10,553
)(Repayments of) borrowings under
    repurchase agreements, net


(201,209
)


96,438Borrowings on unsecured credit
    facilities, net


137,073



250,000Borrowings on secured credit
    facilities, net


749,107



163,021Borrowings of term debt


40,000



2,449,382Repayments of term debt


(429,075
)


(398,215
)Borrowings of subordinated debt


36,593



50,000Proceeds from issuance of common
    stock, net of offering costs


134,151



395,837Proceeds from exercise of options


2,644



1,711Tax benefits on share-based payments


7,596



1,677Payment of dividends


(107,413
)


(143,777
)Cash provided by financing
    activities


367,370



2,855,521Decrease in cash and cash
    equivalents


(87,381
)


(118,412
)Cash and cash equivalents as of
    beginning of period


396,151



323,896Cash and cash equivalents as of end
    of period

$
308,770


$
205,484Noncash transactions from
    investing and financing activities:Issuance of common stock in
    connection with dividends and real estate acquisition

$



$
309,736Conversion of noncontrolling
    interests into common stock


11,533



    6




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
  Note 1.
    Organization    
    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/or
    inventory;
    First Mortgage Loans  Commercial loans that are
    secured by first mortgages on the property of the client;
    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  Commercial
    investments primarily in land and buildings, including those
    that are purchased from and leased back to the current operators
    through the execution of a long-term,
    triple-net
    operating lease;
    Term B, 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;
    Residential Mortgage Investments  Investments in
    residential mortgage loans and residential mortgage-backed
    securities that constitute qualifying REIT assets; and
    Equity Investments  Opportunistic equity investments,
    typically in conjunction with commercial lending relationships
    and on the same terms as other equity investors.    Entity

PurposeCapitalSource TRS Inc.

Subsidiary that owns CapitalSource
    Finance LLC that made a taxable REIT subsidiary election
    effective January 1, 2006.CapitalSource Finance LLC

Primary operating subsidiary of
    CapitalSource TRS Inc. that conducts the commercial lending,
    servicing and investment business of CapitalSource and manages
    our REIT operations.CapitalSource Finance II Inc.

Subsidiary of CapitalSource
    Finance LLC that holds certain limited liability companies
    established in accordance with credit facilities and term debt
    transactions.CSE Mortgage LLC

Subsidiary that holds the
    qualifying REIT assets of CapitalSource.     Note 2.
    Summary
    of Significant Accounting Policies  Unaudited
    Interim Consolidated Financial Statements Basis of
    Presentation
  Form 10-Q Regulation S-X.
 7




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Form 10-K Form 10-K).
      Summary
    of Significant Accounting Policies Form 10-K.
  Note 3.
    New
    Accounting Pronouncements  Accounting for
    Certain Hybrid Financial Instrument Accounting for Derivative Instruments
    and Hedging Activities Accounting for Transfers and
    Servicing of Financial Assets and Extinguishments of Liabilities
  Accounting for Servicing of Financial Assets  An
    Amendment of FASB Statement No. 140
  Accounting for Uncertainty in Income Taxes  An
    Interpretation of FASB Statement No. 109 Accounting for Income Taxes.
 8




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Income Taxes
  Fair Value Measurements
  The Fair Value Option for Financial Assets and Financial
    Liabilities
  Note 4.
    Mortgage-Related
    Receivables and Related Owners
    Trust Securitizations  Consolidation
    of Variable Interest Entities  An Interpretation of
    ARB No. 51
      Note 5.
    Residential
    Mortgage-Backed Securities and Certain Derivative
    Instruments   9




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  available-for-sale available-for-sale Investments.
  Residential
    Mortgage-Backed Securities and Certain Derivative
    Instruments Form 10-K, Accounting for Certain
    Investments in Debt and Equity Securities
  1-year
     10




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 6.
    Commercial
    Loans and Credit Quality    Credit
    Quality
    March 31,


December 31,Commercial Loan Asset Classification

2007


2006($ in thousands)Loans 60 or more days
    contractually delinquent

$
73,011


$
88,067Non-accrual loans(1)


153,794



183,483Impaired loans(2)


280,202



281,377Less: loans in multiple categories


(208,241
)


(230,469
)Total

$
298,766


$
322,458Total as a percentage of total
    loans


3.46%



4.11%     (1)
    
    Includes commercial loans with an aggregate principal balance of
    $41.5 million and $47.0 million as of March 31,
    2007 and December 31, 2006, respectively, which were also
    classified as loans 60 or more days contractually delinquent.(2)
    
    Includes commercial loans with an aggregate principal balance of
    $54.4 million and $47.0 million as of March 31,
    2007 and December 31, 2006, respectively, which were also
    classified as loans 60 or more days contractually delinquent,
    and commercial loans with an aggregate principal balance of
    $153.8 million and $183.5 million as of March 31,
    2007 and December 31, 2006, respectively, which were also
    classified as loans on non-accrual status. The carrying values
    of impaired commercial loans were $274.2 million and
    $275.3 million as of March 31, 2007 and
    December 31, 2006, respectively.  Accounting by Creditors for Impairment of a Loan
   11




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Accounting for Debtors and Creditors for Troubled Debt
    Restructurings.
    Three Months Ended March 31,2007


2006($ in thousands)Balance as of beginning of period

$
120,575


$
87,370Provision for loan losses


14,926



14,412Charge offs, net


(10,265
)


(276
)Balance as of end of period

$
125,236


$
101,506   Note 7.
    Investments    March 31,


December 31,2007


2006($ in thousands)Investments carried at cost

$
78,845


$
71,386Investments carried at fair value:Investments
    available-for-sale


48,702



61,904Warrants


7,705



6,908Investments accounted for under
    the equity method


50,458



44,135Total

$
185,710


$
184,333   other-than-temporary 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.
 12




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 8.
    Guarantor
    Information   13




---



##### 



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


Combined


Other Non-





ConsolidatedCapitalSource


Guarantor


Guarantor


Guarantor





CapitalSourceInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


Inc.(Unaudited)($ in thousands)ASSETSCash and cash equivalents

$



$
192,414


$
56,048


$
60,308


$



$
308,770Restricted cash






14,347



62,727



58,476







135,550Mortgage-related receivables, net














2,239,257







2,239,257Mortgage-backed securities pledged,
    trading














3,372,329







3,372,329Receivables under
    reverse-repurchase agreements






26,315















26,315Loans held for sale






120,776



35,874











156,650Loans:Loans


1,612



4,083,080



1,022,892



3,355,838



(7,852
)


8,455,570Less deferred loan fees and
    discounts






(36,926
)


(45,927
)


(41,527
)






(124,380
)Less allowance for loan losses










(103,974
)


(21,262
)






(125,236
)Loans, net


1,612



4,046,154



872,991



3,293,049



(7,852
)


8,205,954Direct real estate investments, net














805,650







805,650Investment in subsidiaries


3,113,355







928,795



1,186,563



(5,228,713
)


Intercompany (due to) due from


(10,361
)






(280,422
)


290,783







Intercompany note receivable


75,000







9,960







(84,960
)


Investments






122,473



33,927



29,310







185,710Other assets


25,859



24,246



75,752



145,138



(42,847
)


228,148Total assets

$
3,205,465


$
4,546,725


$
1,795,652


$
11,480,863


$
(5,364,372
)

$
15,664,333LIABILITIES, NONCONTROLLING
    INTERESTS AND SHAREHOLDERS EQUITYLiabilities:Repurchase agreements

$



$
38,378


$



$
3,271,181


$



$
3,309,559Unsecured credit facilities


400,000



50,660



42,098











492,758Secured credit facilities






1,366,895







1,565,367







2,932,262Term debt






2,136,374



10,540



3,277,969



(1,566
)


5,423,317Convertible debt


555,000



















555,000Subordinated debt










485,453











485,453Other liabilities


32,130



15,684



70,999



133,172



(49,133
)


202,852Intercompany note payable






9,961



(1
)


75,000



(84,960
)


Total liabilities


987,130



3,617,952



609,089



8,322,689



(135,659
)


13,401,201Noncontrolling
    interests






(11
)






44,819



(11
)


44,797Shareholders
    equity:Preferred stock






















Common stock


1,882



















1,882Additional paid-in capital


2,302,393



557,279



263,836



2,774,016



(3,595,131
)


2,302,393(Accumulated deficit) retained
    earnings


(56,067
)


371,382



922,372



338,984



(1,632,738
)


(56,067
)Accumulated other comprehensive
    income, net


53



123



355



355



(833
)


53Treasury stock, at cost


(29,926
)


















(29,926
)Total shareholders equity


2,218,335



928,784



1,186,563



3,113,355



(5,228,702
)


2,218,335Total liabilities, noncontrolling
    interests and shareholders equity

$
3,205,465


$
4,546,725


$
1,795,652


$
11,480,863


$
(5,364,372
)

$
15,664,333  14




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Balance Sheet
    December 31, 2006
  CapitalSource Finance LLCCombined Non-


Combined


Other Non-CapitalSource


Guarantor


Guarantor


Guarantor





ConsolidatedInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
157


$
238,224


$
46,723


$
111,047


$



$
396,151Restricted cash






55,631



122,655



62,618







240,904Mortgage-related receivables, net














2,295,922







2,295,922Mortgage-backed securities pledged,
    trading














3,502,753







3,502,753Receivables under
    reverse-repurchase agreements






51,892















51,892Loans held for sale






26,521















26,521Loans:Loans


52



4,050,786



762,653



2,968,938



(10,644
)


7,771,785Less deferred loan fees and
    discounts






(33,348
)


(58,203
)


(38,841
)






(130,392
)Less allowance for loan losses










(101,938
)


(18,637
)






(120,575
)Loans, net


52



4,017,438



602,512



2,911,460



(10,644
)


7,520,818Direct real estate investments, net














722,303







722,303Investment in subsidiaries


3,030,807







926,709



1,133,651



(5,091,167
)


Intercompany (due to) due from


(98,737
)






(138,447
)


237,184







Intercompany note receivable


75,000



2,137



11,194







(88,331
)


Investments






118,380



31,710



34,243







184,333Other assets


20,770



25,741



61,024



187,088



(25,646
)


268,977Total assets

$
3,028,049


$
4,535,964


$
1,664,080


$
11,198,269


$
(5,215,788
)

$
15,210,574LIABILITIES, NONCONTROLLING
    INTERESTS AND SHAREHOLDERS EQUITYLiabilities:Repurchase agreements

$



$
63,260


$



$
3,447,508


$



$
3,510,768Unsecured credit facilities


355,685



















355,685Secured credit facilities






998,972







1,184,183







2,183,155Term debt






2,504,472



10,729



3,295,558



(1,074
)


5,809,685Convertible debt


555,000



















555,000Subordinated debt










446,393











446,393Other liabilities


24,324



29,220



73,307



108,863



(35,216
)


200,498Intercompany note payable






13,331







75,000



(88,331
)


Total liabilities


935,009



3,609,255



530,429



8,111,112



(124,621
)


13,061,184Noncontrolling
    interests






8







56,350



(8
)


56,350Shareholders
    equity:Preferred stock






















Common stock


1,815



















1,815Additional paid-in capital


2,139,421



564,687



272,828



2,777,426



(3,614,941
)


2,139,421(Accumulated deficit) retained
    earnings


(20,735
)


359,678



857,927



250,613



(1,468,218
)


(20,735
)Accumulated other comprehensive
    income, net


2,465



2,336



2,896



2,768



(8,000
)


2,465Treasury stock, at cost


(29,926
)


















(29,926
)Total shareholders equity


2,093,040



926,701



1,133,651



3,030,807



(5,091,159
)


2,093,040Total liabilities, noncontrolling
    interests and shareholders equity

$
3,028,049


$
4,535,964


$
1,664,080


$
11,198,269


$
(5,215,788
)

$
15,210,574  15




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Three Months Ended March 31, 2007
  CapitalSource Finance LLCCombined Non-


Combined


Other Non-CapitalSource


Guarantor


Guarantor


Guarantor





ConsolidatedInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
7,450


$
113,038


$
23,889


$
152,915


$
(7,738
)

$
289,554Fee income






22,749



18,839



8,439







50,027Total interest and fee income


7,450



135,787



42,728



161,354



(7,738
)


339,581Operating lease income














20,288







20,288Total investment income


7,450



135,787



42,728



181,642



(7,738
)


359,869Interest expense


10,266



54,688



14,662



114,771



(7,738
)


186,649Net investment (loss) income


(2,816
)


81,099



28,066



66,871







173,220Provision for loan losses










12,301



2,625







14,926Net investment (loss) income after
    provision for loan losses


(2,816
)


81,099



15,765



64,246







158,294Operating expenses:Compensation and benefits


637



5,333



34,044











40,014Other administrative expenses


11,931



957



15,229



8,504



(11,313
)


25,308Total operating expenses


12,568



6,290



49,273



8,504



(11,313
)


65,322Other income
    (expense):Diligence deposits forfeited










862











862Gain on investments, net






6,095



68











6,163Loss on derivatives






(278
)


(1,915
)


(62
)






(2,255
)Loss on residential mortgage
    investment portfolio














(5,698
)






(5,698
)Other income, net of expenses






2,298



15,992







(11,313
)


6,977Earnings in subsidiaries


94,074







81,518



64,446



(240,038
)


Intercompany






(1,429
)


1,429











Total other income


94,074



6,686



97,954



58,686



(251,351
)


6,049Noncontrolling interests
    expense






(20
)






1,353



(3
)


1,330Net income before income
    taxes


78,690



81,515



64,446



113,075



(240,035
)


97,691Income taxes














19,001







19,001Net income

$
78,690


$
81,515


$
64,446


$
94,074


$
(240,035
)

$
78,690   16




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Three Months Ended March 31, 2006
  CapitalSource Finance LLCCombinedNon-


Combined


Other Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
556


$
115,188


$
16,319


$
64,816


$
(1,381
)

$
195,498Fee income






28,940



(1,511
)


14,113







41,542Total interest and fee income


556



144,128



14,808



78,929



(1,381
)


237,040Operating lease income














4,625







4,625Total investment income


556



144,128



14,808



83,554



(1,381
)


241,665Interest expense


5,313



53,415



5,527



34,908



(1,381
)


97,782Net investment (loss) income


(4,757
)


90,713



9,281



48,646







143,883Provision for loan losses










10,321



4,392







14,713Net investment (loss) income after
    provision for loan losses


(4,757
)


90,713



(1,040
)


44,254







129,170Operating expenses:Compensation and benefits






931



32,389











33,320Other administrative expenses


3,597



548



13,614



3,072



(3,532
)


17,299Total operating expenses


3,597



1,479



46,003



3,072



(3,532
)


50,619Other income
    (expense):Diligence deposits forfeited










2,267











2,267Loss on investments, net










(251
)










(251
)Gain on derivatives






411



115











526Loss on residential mortgage
    investment portfolio














(6,106
)






(6,106
)Other income, net of expenses






229



9,793



(2,582
)


(3,532
)


3,908Earnings in subsidiaries


73,648







82,246



55,125



(211,019
)


Intercompany






(7,628
)


7,628











Total other income (expense)


73,648



(6,988
)


101,798



46,437



(214,551
)


344Noncontrolling interests
    expense














861







861Net income before income taxes
    and cumulative effect of accounting change


65,294



82,246



54,755



86,758



(211,019
)


78,034Income taxes














13,110







13,110Net income before cumulative
    effect of accounting change


65,294



82,246



54,755



73,648



(211,019
)


64,924Cumulative effect of accounting
    change, net of taxes










370











370Net income

$
65,294


$
82,246


$
55,125


$
73,648


$
(211,019
)

$
65,294  17




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Cash Flows
    Three Months Ended March 31, 2007
  CapitalSource Finance LLCCombinedNon-


Combined


Other Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
78,690


$
81,515


$
64,446


$
94,074


$
(240,035
)

$
78,690Adjustments to reconcile net income
    to net cash (used in) provided by operating activities:Stock option expense






176



2,216











2,392Restricted stock expense






1,340



6,980











8,320Amortization of deferred loan fees
    and discounts






(7,411
)


(11,171
)


(6,232
)






(24,814
)Paid-in-kind
    interest on loans






1,920



(6,126
)


(1,897
)






(6,103
)Provision for loan losses










12,301



2,625







14,926Amortization of deferred financing
    fees and discounts


880



3,049



109



4,040







8,078Depreciation and amortization






40



782



7,209







8,031Benefit for deferred income taxes














(1,606
)






(1,606
)Non-cash (gain) loss on
    investments, net






(188
)


235











47Non-cash loss on property and
    equipment disposals






95



32











127Unrealized loss (gain) on
    derivatives and foreign currencies, net






336



(270
)


263







329Unrealized loss on residential
    mortgage investment portfolio, net














5,207







5,207Net decrease in mortgage-backed
    securities pledged, trading














155,540







155,540Amortization of discount on
    residential mortgage investments














(8,631
)






(8,631
)Increase in loans held for sale, net






(65,701
)


(35,874
)










(101,575
)Decrease in intercompany note
    receivable






2,137



1,234







(3,371
)


(Increase) decrease in other assets


(5,910
)


(696
)


(14,260
)


15,133



17,201



11,468Increase (decrease) in other
    liabilities


7,489



(13,219
)


(2,670
)


24,293



(13,917
)


1,976Net transfers with subsidiaries


(154,733
)


(79,790
)


125,225



(130,737
)


240,035



Cash (used in) provided by
    operating activities


(73,584
)


(76,397
)


143,189



159,281



(87
)


152,402Investing activities:Decrease in restricted cash






41,284



59,928



4,142







105,354Decrease in mortgage-related
    receivables, net














60,003







60,003Decrease in receivables under
    reverse-repurchase agreements, net






25,577















25,577Increase in loans, net


(1,560
)


(51,819
)


(267,506
)


(376,084
)


(2,792
)


(699,761
)Acquisition of real estate, net of
    cash acquired














(87,020
)






(87,020
)Acquisition of investments, net






(5,403
)


(1,403
)


(1,700
)






(8,506
)Acquisition of property and
    equipment, net






(483
)


(2,317
)










(2,800
)Cash (used in) provided by
    investing activities


(1,560
)


9,156



(211,298
)


(400,659
)


(2,792
)


(607,153
)Financing activities:Payment of deferred financing fees


(59
)


(772
)


(1,079
)


(187
)






(2,097
)Decrease in intercompany note
    payable






(3,370
)


(1
)






3,371



Repayments of repurchase
    agreements, net






(24,881
)






(176,328
)






(201,209
)Borrowings on unsecured credit
    facilities, net


44,315



50,660



42,098











137,073Borrowings on secured credit
    facilities, net






367,923







381,184







749,107Borrowings of term debt






492







40,000



(492
)


40,000Repayments of term debt






(368,621
)


(177
)


(60,277
)






(429,075
)Borrowings of subordinated debt










36,593











36,593Proceeds from issuance of common
    stock, net of offering costs


134,151



















134,151Proceeds from exercise of options


2,644



















2,644Tax benefits on share based payments














7,596







7,596Payment of dividends


(106,064
)










(1,349
)






(107,413
)Cash provided by financing
    activities


74,987



21,431



77,434



190,639



2,879



367,370(Decrease) increase in cash and
    cash equivalents


(157
)


(45,810
)


9,325



(50,739
)






(87,381
)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

$



$
192,414


$
56,048


$
60,308


$



$
308,770  18




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Cash Flows
  Three
    Months Ended March 31, 2006
  Capital Source Finance LLCCombinedNon-


Combined


Other Non-





ConsolidatedCapitalSource


Guarantor


Guarantor


Guarantor





CapitalSourceInc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
65,294


$
82,246


$
55,125


$
73,648


$
(211,019
)

$
65,294Adjustments to reconcile net income
    to net cash (used in) provided by operating activities:Stock option expense


785



















785Restricted stock expense










5,752











5,752Loss on extinguishment of debt














2,582







2,582Non-cash prepayment fee










(8,353
)










(8,353
)Cumulative effect of accounting
    change, net of taxes










(370
)










(370
)Amortization of deferred loan fees
    and discounts






(9,583
)


6,692



(17,267
)






(20,158
)Paid-in-kind
    interest on loans






2,207



(2,164
)


(1,317
)






(1,274
)Provision for loan losses










10,321



4,392







14,713Amortization of deferred financing
    fees and discounts


632



5,928



153



1,054







7,767Depreciation and amortization






2



712



1,635







2,349Benefit for deferred income taxes














(1,651
)






(1,651
)Non-cash loss on investments, net










1,236











1,236Unrealized gain on derivatives and
    foreign currencies, net






(411
)


(115
)










(526
)Unrealized loss on residential
    mortgage investment portfolio, net














17,366







17,366Net increase in mortgage-backed
    securities pledged, trading














(103,214
)






(103,214
)Amortization of discount on
    residential mortgage investments














(1,468
)






(1,468
)Decrease (increase) in loans
    held-for-sale,
    net






1,982



(79,963
)










(77,981
)Decrease (increase) in intercompany
    note receivable






1,061



(23,125
)






22,064



Decrease (increase) in other assets


20,036



420



(1,561
)


(59,511
)


4,378



(36,238
)Increase (decrease) in other
    liabilities


3,613



184



(10,265
)


17,807



(4,916
)


6,423Net transfers with subsidiaries


(651,702
)


(177,213
)


89,164



528,732



211,019



Cash (used in) provided by
    operating activities


(561,342
)


(93,177
)


43,239



462,788



21,526



(126,966
)Investing activities:Decrease (increase) in restricted
    cash






48,039



22,212



(36,910
)






33,341Increase in mortgage-related
    receivables, net














(2,493,503
)






(2,493,503
)Increase in receivables under
    reverse-repurchase agreements, net






(36,889
)














(36,889
)Decrease (increase) in loans, net






505,621



(329,903
)


(544,781
)


538



(368,525
)Acquisition of real estate, net of
    cash acquired














(7,180
)






(7,180
)Disposal (acquisition) of
    investments, net


33,405







(6,841
)










26,564(Acquisition) disposal of property
    and equipment, net






(32
)


(923
)


180







(775
)Cash provided by (used in)
    investing activities


33,405



516,739



(315,455
)


(3,082,194
)


538



(2,846,967
)Financing activities:Payment of deferred financing fees


(2,450
)


(89
)


(1,525
)


(6,489
)






(10,553
)Increase (decrease) in intercompany
    note payable


24,640



(2,576
)










(22,064
)


Borrowings under repurchase
    agreements, net






31,613







64,825







96,438Borrowings on unsecured credit
    facilities, net


250,000



















250,000(Repayments of) borrowings on
    secured credit facilities, net






(51,223
)


65,244



149,000







163,021Borrowings of term debt










1,512



2,447,870







2,449,382Repayments of term debt






(398,194
)


(21
)










(398,215
)Borrowings of subordinated debt










50,000











50,000Proceeds from issuance of common
    stock, net of offering costs


395,837



















395,837Proceeds from exercise of options


1,711



















1,711Tax benefits on share based payments














1,677







1,677Payment of dividends


(143,777
)


















(143,777
)Cash provided by (used in)
    financing activities


525,961



(420,469
)


115,210



2,656,883



(22,064
)


2,855,521(Decrease) increase in cash and
    cash equivalents


(1,976
)


3,093



(157,006
)


37,477







(118,412
)Cash and cash equivalents as of
    beginning of period


2,038



145,065



156,571



20,222







323,896Cash and cash equivalents as of end
    of period

$
62


$
148,158


$
(435
)

$
57,699


$



$
205,484  19




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 9.
    Direct
    Real Estate Investments    March 31,


December 31,2007


2006Land

$
93,800


$
91,543Buildings


691,825



607,833Furniture


38,255



34,395Accumulated depreciation


(18,230
)


(11,468
)Total

$
805,650


$
722,303     Note 10.
    Borrowings  Borrowings Form 10-K.
  Repurchase
    Agreements
    Credit
    Facilities
       20




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Term
    Debt
  series 2004-2
  Subordinated
    Debt
  2007-1 (2007-1 2007-1 2007-1 2007-1 2007-1
  2007-1 2007-1 2007-1
  Note 11.
    Shareholders
    Equity  Common
    Stock Shares Outstanding
    Outstanding as of
    December 31, 2006


181,452,290Issuance of common stock


5,892,651Exercise of options


185,725Restricted stock and other stock
    grants, net


707,717Outstanding as of March 31,
    2007


188,238,383   Dividend
    Reinvestment and Stock Purchase Plan
    Note 12.
    Income
    Taxes   21




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
          Three Months Ended March 31,2007


2006Federal statutory rate


35.0
%


35.0
%Benefit of REIT election


(17.8
)


(14.6
)State income taxes, net of federal
    tax benefit


1.6



2.7Other


0.7



(0.2
)Estimated annual effective income
    tax rate


19.5



22.9Discrete item  Benefit
    for reversal of net deferred tax liabilities(1)






(6.1
)Current quarter effective income
    tax rate


19.5
%


16.8
%     (1)
    
    In connection with our REIT election, we reversed net deferred
    tax liabilities of $4.7 million, relating to REIT
    qualifying activities, into income during the three months ended
    March 31, 2006.    New Accounting
    Pronouncements
   22




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Note 13.
    Comprehensive
    Income    Three Months Ended March 31,2007


2006($ in thousands)Net income

$
78,690


$
65,294Unrealized (loss) gain on
    available-for-sale
    securities, net of tax


(2,704
)


612Unrealized gain on foreign
    currency translation, net of tax


620



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


(328
)


1,270Comprehensive income

$
76,278


$
67,176     March 31,


December 31,2007


2006($ in thousands)Unrealized gain on
    available-for-sale
    securities, net of tax

$
10


$
2,714Unrealized loss on foreign
    currency translation, net of tax


(206
)


(826
)Unrealized gain on cash flow
    hedges, net of tax


249



577Accumulated other comprehensive
    income, net

$
53


$
2,465  23




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 14.
    Net
    Income per Share    Three Months Ended March 31,2007


2006($ in thousands, except share data)Basic net income per
    share:Net income

$
78,690


$
65,294Average shares  basic


179,324,672



149,722,991Basic net income per share

$
0.44


$
0.44Diluted net income per
    share:Net income

$
78,690


$
65,294Average shares  basic


179,324,672



149,722,991Effect of dilutive securities:Stock dividend declared






3,276,377Option shares


641,556



483,869Unvested restricted stock


1,570,909



959,723Stock units


26,331



7,612Non-managing member units






Conversion premium on the
    1.25% Debentures(1)


180,416



Written call option






Average shares  diluted


181,743,884



154,450,572Diluted net income per share

$
0.43


$
0.42     (1)
    
    For the three months ended March 31, 2007, the conversion
    premium on the 1.25% Debentures represented the dilutive
    shares based on a conversion price of $24.61.    Note 15.
    Stock-Based
    Compensation   24




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Share-Based
    Payment
      Stock-Based Compensation Form 10-K.
  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
   25




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 17.
    Segment
    Data  Organization
  Three Months Ended March 31, 2007Commercial


ResidentialLending &


Mortgage


ConsolidatedInvestment


Investment


Total($ in thousands)Total interest and fee income

$
258,681


$
80,900


$
339,581Operating lease income


20,288







20,288Interest expense


111,251



75,398



186,649Provision for loan losses


14,926







14,926Operating expenses(1)


64,221



1,101



65,322Other income (expense)(2)


11,747



(5,698
)


6,049Noncontrolling interests expense


1,330







1,330Net income (loss) before income
    taxes


98,988



(1,297
)


97,691Income taxes


19,001







19,001Net income (loss)

$
79,987


$
(1,297
)

$
78,690Total assets as of March 31, 2007

$
9,939,143


$
5,725,190


$
15,664,333Total assets as of December 31, 2006

$
9,235,449


$
5,975,125


$
15,210,574   Three Months Ended March 31, 2006Commercial


ResidentialLending &


Mortgage


ConsolidatedInvestment


Investment


Total($ in thousands)Total interest and fee income

$
209,670


$
27,370


$
237,040Operating lease income


4,625







4,625Interest expense


72,833



24,949



97,782Provision for loan losses


14,412



301



14,713Operating expenses(1)


48,365



2,254



50,619Other income (expense)(2)


6,450



(6,106
)


344Noncontrolling interests expense


861







861Net income (loss) before income
    taxes and cumulative effect of accounting change


84,274



(6,240
)


78,034Income taxes


13,110







13,110Net income (loss) before cumulative
    effect of accounting change


71,164



(6,240
)


64,924Cumulative effect of accounting
    change, net of taxes


370







370Net income (loss)

$
71,534


$
(6,240
)

$
65,294     (1)
    
    Operating expenses of our Residential Mortgage Investment
    segment consist primarily of direct expenses related to
    compensation and benefits, professional fees paid to our
    investment manager and other direct expenses.(2)
    
    Other income (expense) 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 investments and related derivatives. 26




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Summary of Significant Accounting Policies.
  Note 18.
    Subsequent
    Events    AmountAmount


OutstandingOutstanding


at Completion ofSecurities

at March 31, 2007


Exchange Offers3.50% Senior Convertible
    Notes due 2034

$
330,000,000


$
8,446,0001.25% Senior Convertible
    Notes due 2034


225,000,000



47,620,0004.00% Senior Subordinated
    Convertible Notes due 2034






321,554,0001.625% Senior Subordinated
    Convertible Notes due 2034






177,380,000Total

$
555,000,000


$
555,000,000       Borrowings Form 10-K.
     27




---



##### 



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     28




---



##### 



ITEM 2.
    MANAGEMENTS
    DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
    OPERATIONS  CAUTIONARY
    NOTE REGARDING FORWARD-LOOKING STATEMENTS
  Form 10-Q,
  Managements Discussion and Analysis of Financial
    Condition and Results of Operations Risk
    Factors Form 10-K Form 10-K).
  Form 10-Q.
  Overview
    and Highlights
      
    Healthcare and Specialty Finance,which generally
    provides first mortgage loans, asset-based revolving lines of
    credit, real estate lease financing and cash flow loans to
    healthcare businesses and a broad range of other companies;
    Structured Finance,which generally engages in commercial
    and residential real estate finance and also provides
    asset-based lending to finance companies; and
    Corporate Finance,which generally provides senior and
    subordinate loans through direct origination and participation
    in widely syndicated loan transactions.   29




---



##### 



Consolidated
    Results of Operations
    Explanation
    of Reporting Metrics
  Interest Income.
  Fee Income.
  Operating Lease Income.
  Interest Expense.
  Provision for Loan Losses.
  Other Income.
 30




---



##### 



Operating Expenses.
  Income Taxes.
  Adjusted Earnings.
  Operating
    Results for the Three Months Ended March 31,
    2007
    
    Significant growth in our commercial loan portfolio;
    Increased operating lease income related to our direct real
    estate investments;
    Increased borrowings to fund our growth;
    Increased operating expenses, including higher employee
    compensation;
    Improvement in our credit metrics; and
    Decreased lending and borrowing spreads. 31




---



##### 



Three Months Ended March 31,2007


2006


$ Change


% Change($ in thousands)Interest income

$
289,554


$
195,498


$
94,056



48
%Fee income


50,027



41,542



8,485



20
%Operating lease income


20,288



4,625



15,663



339
%Interest expense


186,649



97,782



88,867



91
%Provision for loan losses


14,926



14,713



213



1
%Operating expenses


65,322



50,619



14,703



29
%Other income, net of expenses


6,049



344



5,705



1,658
%Noncontrolling interests expense


1,330



861



469



54
%Income taxes


19,001



13,110



5,891



45
%Cumulative effect of accounting
    change, net of taxes






370



(370
)


100
%Net income


78,690



65,294



13,396



21
%     Three Months Ended March 31,2007


2006Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


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





$
289,554



8.27
%





$
195,498



9.08
%Fee income






50,027



1.43







41,542



1.93Total interest earning assets(1)

$
14,207,472



339,581



9.70


$
8,731,522



237,040



11.01Total direct real estate
    investments


786,623



20,288



10.46



126,848



4,625



14.79Total income earning assets


14,994,095



359,869



9.73



8,858,370



241,665



11.06Total interest bearing
    liabilities(2)


12,860,904



186,649



5.89



7,307,304



97,782



5.43Net finance spread





$
173,220



3.84
%





$
143,883



5.63
%Net finance margin










4.69
%










6.59
%     (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. 32




---



##### 



Comparison
    of the Three Months Ended March 31, 2007 and
    2006
    Interest
    Income
    Residential Mortgage-Backed Securities and Certain Derivative
    Instruments
  Fee
    Income
    Operating
    Lease Income
  triple-net
 33




---



##### 



Interest
    Expense
      Net
    Finance Margin
   34




---



##### 



Three Months Ended March 31,2007


2006Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


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





$
208,654



10.04
%





$
168,128



10.18
%Fee income






50,027



2.41







41,542



2.51Total interest earning assets(1)

$
8,430,913



258,681



12.45


$
6,699,752



209,670



12.69Total direct real estate investments


786,623



20,288



10.46



126,848



4,625



14.79Total income earning assets


9,217,536



278,969



12.27



6,826,600



214,295



12.73Total interest bearing
    liabilities(2)


7,258,442



111,251



6.22



5,322,890



72,833



5.55Net finance spread





$
167,718



6.05
%





$
141,462



7.18
%Net finance margin










7.38
%










8.40
%     (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
    Other
    Income
  break-up
     35




---



##### 



Operating
    Expenses
      Income
    Taxes
   36




---



##### 



Adjusted
    Earnings
    Three Months Ended March, 312007


2006Net income

$
78,690


$
65,294Add:Real estate depreciation(1)


6,762



1,390Amortization of deferred financing
    fees(2)


5,508



6,902Non-cash equity compensation


10,712



6,536Net unrealized loss on residential
    mortgage investment portfolio, including related derivatives(3)


7,180



4,447Unrealized loss (gain) on
    derivatives and foreign currencies, net


328



(251
)Unrealized loss on investments, net


47



1,236Provision for loan losses


14,926



14,713Recoveries(4)






Less:Charge offs(5)


10,250



276Nonrecurring items(6)






4,725Cumulative effect of accounting
    change, net of taxes






370Adjusted earnings

$
113,903


$
94,896Net income per share:Basic  as reported

$
0.44


$
0.44Diluted  as reported

$
0.43


$
0.42Average shares
    outstanding:Basic  as reported


179,324,672



149,722,991Diluted  as reported


181,743,884



154,450,572Adjusted earnings per
    share:Basic

$
0.64


$
0.63Diluted(7)

$
0.63


$
0.61Average shares
    outstanding:Basic


179,324,672



149,722,991Diluted(8)


184,200,063



156,236,043     (1)
    
    Depreciation 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 the period change in fair value
    of RMBS and related derivative instruments.(4)
    
    Includes all recoveries on loans during the period.(5)
    
    To the extent we experience losses on loans for which we
    specifically provided a reserve prior to January 1, 2006,
    there will be no adjustment to earnings. All charge offs
    incremental to previously established allocated reserves will be
    deducted from net income.(6)
    
    Represents the write-off of a net deferred tax liability
    recorded in connection with our conversion to a REIT for the
    three months ended March 31, 2006.(7)
    
    Adjusted to reflect the impact of adding back noncontrolling
    interests expense of $1.3 million and $0.9 million for
    the three months ended March 31, 2007 and 2006,
    respectively, to adjusted earnings due to the application of the
    if-converted method on non-managing member units, which are
    considered dilutive to adjusted earnings per share, but are
    antidilutive to GAAP net income per share for all periods
    presented.(8)
    
    Adjusted to include average non-managing member units of
    2,456,179 and 1,785,471 for the three months ended
    March 31, 2007 and 2006, respectively, which are considered
    dilutive to adjusted earnings per share, but are antidilutive to
    GAAP net income per share. 37




---



##### 



Financial
    Condition
  Commercial
    Lending & Investment Segment
  Portfolio
    Composition
    March 31,


December 31,2007


2006($ in thousands)Commercial loans

$
8,638,535


$
7,850,198Direct real estate investments


805,650



722,303Equity investments


158,100



150,090Total

$
9,602,285


$
8,722,591   Commercial
    Lending Portfolio Composition
    March 31,


December 31,2007


2006($ in thousands)Composition of loan portfolio by
    loan type:First mortgage loans(1)

$
2,814,286



33
%

$
2,542,222



32
%Senior secured asset-based loans(1)


2,759,381



32



2,599,014



33Senior secured cash flow loans(1)


2,350,718



27



2,105,152



27Subordinate loans


714,150



8



603,810



8Total

$
8,638,535



100
%

$
7,850,198



100
%Composition of loan portfolio by
    business:Healthcare and Specialty Finance

$
2,786,793



32
%

$
2,775,748



35
%Structured Finance


3,381,091



39



2,839,716



36Corporate Finance


2,470,651



29



2,234,734



29Total

$
8,638,535



100
%

$
7,850,198



100
%     (1)
    
    Includes Term B loans.    Average LoanNumber


Average


Number of


Size perof Loans


Loan Size


Clients


Client($ in thousands)Composition of loan portfolio by
    business:Healthcare and Specialty Finance


441


$
6,319



302


$
9,228Structured Finance


283



11,947



229



14,765Corporate Finance


405



6,100



189



13,072Overall loan portfolio


1,129



7,651



720



11,998  38




---



##### 



Due in


Due inOne Year


One to


Due Afteror Less


Five Years


Five Years


Total($ in thousands)Scheduled maturities by loan type:First mortgage loans(1)

$
911,131


$
1,734,633


$
168,522


$
2,814,286Senior secured asset-based loans(1)


264,219



2,384,529



110,633



2,759,381Senior secured cash flow loans(1)


305,143



1,797,326



248,249



2,350,718Subordinate loans


81,448



195,713



436,989



714,150Total

$
1,561,941


$
6,112,201


$
964,393


$
8,638,535     (1)
    
    Includes Term B loans.    Adjustable


FixedRates


Rates


Total($ in thousands)Composition of loan portfolio by
    loan type:First mortgage loans(1)

$
2,527,831


$
286,455


$
2,814,286Senior secured asset-based loans(1)


2,728,673



30,708



2,759,381Senior secured cash flow loans(1)


2,332,263



18,455



2,350,718Subordinate loans


583,687



130,463



714,150Total

$
8,172,454


$
466,081


$
8,638,535Percentage of total loan portfolio


95%



5%



100%     (1)
    
    Includes Term B loans.   39




---



##### 



Credit
    Quality and Allowance for Loan Losses
    March 31,


December 31,Commercial Loan Asset Classification

2007


2006($ in thousands)Loans 60 or more days
    contractually delinquent

$
73,011


$
88,067Non-accrual loans(1)


153,794



183,483Impaired loans(2)


280,202



281,377Less: loans in multiple categories


(208,241
)


(230,469
)Total

$
298,766


$
322,458Total as a percentage of total
    loans


3.46%



4.11%Total as a percentage of all
    commercial assets(3)


3.16%



3.76%     (1)
    
    Includes commercial loans with an aggregate principal balance of
    $41.5 million and $47.0 million as of March 31,
    2007 and December 31, 2006, respectively, which were also
    classified as loans 60 or more days contractually delinquent.(2)
    
    Includes commercial loans with an aggregate principal balance of
    $54.4 million and $47.0 million as of March 31,
    2007 and December 31, 2006, respectively, which were also
    classified as loans 60 or more days contractually delinquent,
    and commercial loans with an aggregate principal balance of
    $153.8 million and $183.5 million as of March 31,
    2007 and December 31, 2006, respectively, which were also
    classified as loans on non-accrual status.(3)
    
    Commercial assets include commercial loans, loans held for sale,
    receivables under reverse-repurchase agreements and direct real
    estate investments.  Accounting by Creditors for Impairment of a Loan and/or
  Accounting for Debtors and Creditors for Troubled Debt
    Restructurings.
   40




---



##### 



Direct
    Real Estate Investments
  triple-net triple-net
  Equity
    Investments
      Residential
    Mortgage Investment Segment
  Portfolio
    Composition
    March 31,


December 31,2007


2006($ in thousands)Mortgage-related receivables(1)

$
2,239,257


$
2,295,922Residential mortgage-backed
    securities:Agency(2)


3,372,329



3,502,753Non-Agency(2)


27,610



34,243Total

$
5,639,196


$
5,832,918    (1)
    
    Represents secured receivables that are backed by adjustable
    rate residential prime mortgage loans.(2)
    
    See following paragraph for a description of these securities.  available-for-sale
  Mortgage-Related
    Receivables and Related Owners Trust Securitizations
 41




---



##### 



Credit
    Quality and Allowance for Loan Losses
    Financing
      Market Risk Management
  Liquidity
    and Capital Resources
     42




---



##### 



and/or
  Cash
    and Cash Equivalents
      Sources
    and Uses of Cash
        Borrowings
   43




---



##### 



Form 10-K.
    Repurchase
    Agreements
    Credit
    Facilities
          Term
    Debt
  series 2004-2
 44




---



##### 



Subordinated
    Debt
  2007-1 (2007-1 2007-1 2007-1 2007-1 2007-1
  2007-1 2007-1 2007-1
  Debt
    Covenant Compliance
    Equity
    Commitments,
    Guarantees & Contingencies
    Consolidation of Variable Interest Entities  An
    Interpretation of ARB No. 51,
 45




---



##### 



Accounting for Transfers and
    Servicing of Financial Assets and Extinguishments of
    Liabilities
      Credit
    Risk Management
  agreed-upon
    Commercial
    Lending & Investment Segment
      Residential
    Mortgage Investment Segment
   46




---



##### 



Concentrations
    of Credit Risk
    Derivative
    Counterparty Credit Risk
    Market
    Risk Management
  and/or
  Derivative Instruments Form 10-K.
 47




---



##### 



Interest
    Rate Risk Management  Commercial Lending &
    Investments Segment
    12-month
  Estimated (Decrease)Increase inRate Change

Net Interest Income(Basis Points)

Over 12 Months($ in thousands)−100

$
(11,660
)−50


(6,980
)+ 50


8,350+ 100


16,330       Amount


Percentage ofOutstanding


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

$
3,734,700



43
%At the interest rate floor


70,211



1Below the interest rate floor


57,643



1Loans with no interest rate floor


4,775,981



55Total

$
8,638,535



100
%        48




---



##### 



Interest
    Rate Risk Management  Residential Mortgage Investment
    Segment
        Estimated (Decrease)Rate Change

Increase


Percentage of Total(Basis Points)

in Fair Value


Segment Assets($ in thousands)−100

$
(2,888
)


(0.05
)%−50


8



+ 50


(996
)


(0.02
)+ 100


(2,894
)


(0.05
)         Critical
    Accounting Estimates
   49




---



##### 



Critical Accounting Estimates Managements Discussion and Analysis of Financial
    Condition and Results of Operations Form 10-K
  ITEM 3.
    QUANTITATIVE
    AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  Market Risk Management Managements Discussion and
    Analysis of Financial Condition and Results of Operations Form 10-Q Quantitative and Qualitative Disclosures
    about Market Risk Form 10-K Derivative
    Instruments Form 10-K.
  ITEM 4.
    CONTROLS
    AND PROCEDURES  Rule 13a-15
 50




---



##### 



PART II.
    OTHER INFORMATION  ITEM 1.
    LEGAL
    PROCEEDINGS    ITEM 1A.
    RISK
    FACTORS  Risk Factors Form 10-K,
  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 PlansJanuary 1 
    January 31, 2007


17,970


$
26.81







February 1 
    February 28, 2007


166,894



26.57







March 1  March 31,
    2007


38,818



24.13







Total


223,682


$
26.17     (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 the CapitalSource Inc.
    Third Amended and Restated Equity Incentive Plan.  ITEM 3.
    DEFAULTS
    UPON SENIOR SECURITIES    ITEM 4.
    SUBMISSION
    OF MATTERS TO A VOTE OF SECURITY HOLDERS    ITEM 5.
    OTHER
    INFORMATION    ITEM 6.
    EXHIBITS     51




---



##### 



Signatures    CAPITALSOURCE INC.Date: May 10, 2007

/s/  JOHN K. DELANEYJohn K. DelaneyChairman of the Board and Chief Executive Officer(Principal Executive Officer)Date: May 10, 2007

/s/  THOMAS
    A.
    FINKThomas
    A. FinkChief Financial Officer(Principal Financial Officer)Date: May 10, 2007

/s/  DAVID
    C.
    BJARNASONDavid
    C. BjarnasonChief Accounting Officer(Principal Accounting
    Officer)  52




---



##### 



INDEX TO
    EXHIBITS  ExhibitNo

Description3
.1

Second Amended and Restated
    Certificate of Incorporation (incorporated by reference to the
    same-numbered exhibit to the registrants Current Report on
    Form 8-K
    dated May 3, 2006).3
.2

Amended and Restated Bylaws
    (incorporated by reference to the same-numbered exhibit to the
    registrants Quarterly Report on
    Form 10-Q
    for the quarter ended June 30, 2003).4
.1

Form of Certificate of Common
    Stock of CapitalSource Inc. (incorporated by reference to the
    same-numbered exhibit to the registrants Registration
    Statement on
    Form S-1
    (Reg.
    No. 333-106076)).10
.12*

CapitalSource Inc. Third Amended
    and Restated Equity Incentive Plan, as amended, dated as of
    March 8, 2007 (incorporated by reference to the
    same-numbered exhibit to the registrants Current Report on
    Form 8-K
    dated March 13, 2007).10
.23.1

Amended Call Option Transaction
    Confirmation, dated as of April 4, 2007, between
    CapitalSource Inc. and JPMorgan Chase Bank.10
.23.2

Amended Warrant Transaction
    Confirmation, dated as of April 4, 2007, between
    CapitalSource Inc. and JPMorgan Chase Bank.10
.23.3

Call Option Transaction
    Confirmation, dated as of April 4, 2007, between
    CapitalSource Inc. and JPMorgan Chase Bank.10
.36.2*

Amendment No. 2 to Employment
    Agreement, dated as of February 1, 2007, between
    CapitalSource Inc. and Dean C. Graham (incorporated by reference
    to the same numbered exhibit to the registrants Annual
    Report on
    Form 10-K
    for the year ended December 31, 2006).10
.69*

Consulting Agreement, dated as of
    January 2, 2007, between CapitalSource Inc. and Jason M.
    Fish (incorporated by reference to the same numbered exhibit to
    the registrants Annual Report on
    Form 10-K
    for the year ended December 31, 2006).10
.70*

Form of Restricted Unit Agreement
    (incorporated by reference to the same-numbered exhibit to the
    registrants Current Report on
    Form 8-K
    dated March 13, 2007).12
.1

Ratio of Earnings to Fixed
    Charges.31
.1

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

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


Section 1350
    Certifications.     
    
    Filed herewith.*
    
    Management contract or compensatory plan or arrangement.   53