##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, 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, 2006
 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
  þ o o
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TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005
    
    
    2Consolidated Statements of Income (unaudited) for the three and six months ended June 30, 2006 and 2005
    
    
    3Consolidated Statement of Shareholders Equity (unaudited) for the six months ended June 30, 2006
    
    
    4Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2006 and 2005
    
    
    5Notes to the Unaudited Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    29Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    51Item 4. Controls and Procedures
    
    
    51PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    52Item 1A. Risk Factors
    
    
    52Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    52Item 3. Defaults Upon Senior Securities
    
    
    52Item 4. Submission of Matters to a Vote of Security Holders
    
    
    52Item 5. Other Information
    
    
    53Item 6. Exhibits
    
    
    53Signatures
    
    
    54Index to Exhibits
    
    
    55
 1




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##### 



CapitalSource Inc.
 Consolidated Balance Sheets
 June 30,
    
    December 31,2006
    
    2005(Unaudited)($ in thousands)ASSETSCash and cash equivalents
    
    $
    302,055
    
    
    $
    323,896Restricted cash
    
    
    224,388
    
    
    
    284,785Mortgage-related receivables, net
    
    
    2,412,279
    
    
    
    39,438Mortgage-backed securities pledged, trading
    
    
    3,093,675
    
    
    
    323,370Receivables under reverse-repurchase agreements
    
    
    95,632
    
    
    
    33,243Loans held-for-sale
    
    
    42,221
    
    
    
    59,589Loans:Loans
    
    
    7,033,118
    
    
    
    5,894,911Less deferred loan fees and discounts
    
    
    (127,584
    )
    
    
    (120,407
    )Less allowance for loan losses
    
    
    (100,775
    )
    
    
    (87,370
    )Loans, net
    
    
    6,804,759
    
    
    
    5,687,134Property and equipment, net
    
    
    249,851
    
    
    
    11,502Investments
    
    
    161,550
    
    
    
    126,393Deferred financing fees, net
    
    
    49,805
    
    
    
    42,006Other assets
    
    
    133,640
    
    
    
    55,712Total assets
    
    $
    13,569,855
    
    
    $
    6,987,068LIABILITIES, NONCONTROLLING INTERESTS AND SHAREHOLDERS EQUITYLiabilities:Repurchase agreements
    
    $
    3,146,750
    
    
    $
    358,423Unsecured credit facilities
    
    
    460,000
    
    
    
    Secured credit facilities
    
    
    2,903,978
    
    
    
    2,450,452Term debt
    
    
    4,131,981
    
    
    
    1,779,748Convertible debt
    
    
    555,000
    
    
    
    555,000Subordinated debt
    
    
    283,504
    
    
    
    231,959Stock dividend payable
    
    
    
    
    
    
    280,720Cash dividend payable
    
    
    
    
    
    
    70,202Other liabilities
    
    
    79,689
    
    
    
    60,626Total liabilities
    
    
    11,560,902
    
    
    
    5,787,130Noncontrolling interests
    
    
    56,341
    
    
    
    Shareholders equity:Preferred stock (50,000,000 shares authorized; no shares outstanding)
    
    
    
    
    
    
    Common stock ($0.01 par value, 500,000,000 shares authorized;
175,840,043 and 141,705,766 shares issued; 174,540,043 and
140,405,766 shares outstanding, respectively)
    
    
    1,745
    
    
    
    1,404Additional paid-in capital
    
    
    1,950,721
    
    
    
    1,248,745Retained earnings
    
    
    26,406
    
    
    
    46,783Deferred compensation
    
    
    
    
    
    
    (65,729
    )Accumulated other comprehensive income (loss), net
    
    
    3,666
    
    
    
    (1,339
    )Treasury stock, at cost
    
    
    (29,926
    )
    
    
    (29,926
    )Total shareholders equity
    
    
    1,952,612
    
    
    
    1,199,938Total liabilities, noncontrolling interests and shareholders equity
    
    $
    13,569,855
    
    
    $
    6,987,068
  2




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##### 



CapitalSource Inc.
 Consolidated Statements of Income
 Three Months Ended June 30,
    
    Six Months Ended June 30,2006
    
    2005
    
    2006
    
    2005(Unaudited)($ in thousands, except per share data)Net investment income:Interest income
    
    $
    256,037
    
    
    $
    119,267
    
    
    $
    451,535
    
    
    $
    227,841Fee income
    
    
    36,603
    
    
    
    38,469
    
    
    
    78,145
    
    
    
    64,952Total interest and fee income
    
    
    292,640
    
    
    
    157,736
    
    
    
    529,680
    
    
    
    292,793Operating lease income
    
    
    6,694
    
    
    
    
    
    
    
    11,319
    
    
    
    Total investment income
    
    
    299,334
    
    
    
    157,736
    
    
    
    540,999
    
    
    
    292,793Interest expense
    
    
    153,918
    
    
    
    42,797
    
    
    
    251,700
    
    
    
    77,383Net investment income
    
    
    145,416
    
    
    
    114,939
    
    
    
    289,299
    
    
    
    215,410Provision for loan losses
    
    
    11,471
    
    
    
    5,047
    
    
    
    26,184
    
    
    
    14,949Net investment income after provision for loan losses
    
    
    133,945
    
    
    
    109,892
    
    
    
    263,115
    
    
    
    200,461Operating expenses:Compensation and benefits
    
    
    34,130
    
    
    
    30,588
    
    
    
    67,450
    
    
    
    51,954Other administrative expenses
    
    
    19,561
    
    
    
    10,521
    
    
    
    36,860
    
    
    
    19,775Total operating expenses
    
    
    53,691
    
    
    
    41,109
    
    
    
    104,310
    
    
    
    71,729Other income (expense):Diligence deposits forfeited
    
    
    1,103
    
    
    
    329
    
    
    
    3,370
    
    
    
    1,477(Loss) gain on investments, net
    
    
    (1,489
    )
    
    
    3,164
    
    
    
    (1,740
    )
    
    
    5,292Gain (loss) on derivatives
    
    
    6,124
    
    
    
    (80
    )
    
    
    6,650
    
    
    
    (7
    )Gain (loss) on residential mortgage investment portfolio
    
    
    4,035
    
    
    
    
    
    
    
    (2,071
    )
    
    
    Other income, net of expenses
    
    
    1,523
    
    
    
    2,321
    
    
    
    5,431
    
    
    
    3,282Total other income
    
    
    11,296
    
    
    
    5,734
    
    
    
    11,640
    
    
    
    10,044Noncontrolling interests expense
    
    
    1,230
    
    
    
    
    
    
    
    2,091
    
    
    
    Net income before income taxes and cumulative effect of
accounting change
    
    
    90,320
    
    
    
    74,517
    
    
    
    168,354
    
    
    
    138,776Income taxes
    
    
    17,531
    
    
    
    29,062
    
    
    
    30,641
    
    
    
    54,123Net income before cumulative effect of accounting change
    
    
    72,789
    
    
    
    45,455
    
    
    
    137,713
    
    
    
    84,653Cumulative effect of accounting change, net of taxes
    
    
    
    
    
    
    
    
    
    
    370
    
    
    
    Net income
    
    $
    72,789
    
    
    $
    45,455
    
    
    $
    138,083
    
    
    $
    84,653Net income per share:Basic
    
    $
    0.43
    
    
    $
    0.39
    
    
    $
    0.87
    
    
    $
    0.73Diluted
    
    $
    0.43
    
    
    $
    0.39
    
    
    $
    0.85
    
    
    $
    0.72Average shares outstanding:Basic
    
    
    168,866,621
    
    
    
    116,669,187
    
    
    
    159,309,225
    
    
    
    116,539,867Diluted
    
    
    170,569,836
    
    
    
    117,906,997
    
    
    
    162,515,548
    
    
    
    117,991,390Dividends declared per share
    
    $
    0.49
    
    
    $
    
    
    
    $
    0.98
    
    
    $
    
  3




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##### 



CapitalSource Inc.
 Consolidated Statement of Shareholders Equity
 Accumulated Other
    
    
    Treasury
    
    
    TotalCommon
    
    
    Additional
    
    
    Retained
    
    
    Deferred
    
    
    Comprehensive Income
    
    
    Stock,
    
    
    ShareholdersStock
    
    
    Paid-in Capital
    
    
    Earnings
    
    
    Compensation
    
    
    (Loss), net
    
    
    at cost
    
    
    Equity(Unaudited)($ in thousands)Total shareholders equity as of December 31, 2005
    
    $
    1,404
    
    
    $
    1,248,745
    
    
    $
    46,783
    
    
    $
    (65,729
    )
    
    $
    (1,339
    )
    
    $
    (29,926
    )
    
    $
    1,199,938Net income
    
    
    
    
    
    
    
    
    
    
    138,083
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    138,083Other comprehensive income:Unrealized gains, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,005
    
    
    
    
    
    
    
    5,005Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    143,088Cumulative effect of accounting change, net of taxes
    
    
    
    
    
    
    (370
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (370
    )Dividends paid
    
    
    
    
    
    
    2,125
    
    
    
    (158,412
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (156,287
    )Issuance of common stock, net
    
    
    327
    
    
    
    749,506
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    749,833Stock option expense
    
    
    
    
    
    
    4,409
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,409Exercise of options
    
    
    4
    
    
    
    3,323
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,327Restricted stock activity
    
    
    10
    
    
    
    (59,273
    )
    
    
    (48
    )
    
    
    65,729
    
    
    
    
    
    
    
    
    
    
    
    6,418Tax benefit on exercise of options
    
    
    
    
    
    
    2,244
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,244Tax benefit on vesting of restricted stock grants
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12Total shareholders equity as of June 30, 2006
    
    $
    1,745
    
    
    $
    1,950,721
    
    
    $
    26,406
    
    
    $
    
    
    
    $
    3,666
    
    
    $
    (29,926
    )
    
    $
    1,952,612
  4




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CapitalSource Inc.
 Consolidated Statements of Cash Flows
 Six Months Ended June 30,2006
    
    
    2005(Unaudited)($ in thousands)Operating activities:Net income
    
    $
    138,083
    
    
    $
    84,653Adjustments to reconcile net income to net cash
provided by operating activities:Stock option expense
    
    
    4,409
    
    
    
    180Restricted stock expense
    
    
    11,944
    
    
    
    7,933Loss on extinguishment of debt
    
    
    2,582
    
    
    
    Non-cash prepayment fee
    
    
    (8,353
    )
    
    
    Cumulative effect of accounting change, net of taxes
    
    
    (370
    )
    
    
    Amortization of deferred loan fees
    
    
    (43,143
    )
    
    
    (36,595
    )Interest on paid-in-kind loans
    
    
    (3,202
    )
    
    
    (5,202
    )Provision for loan losses
    
    
    26,184
    
    
    
    14,949Amortization of deferred financing fees and discounts
    
    
    17,763
    
    
    
    11,459Depreciation and amortization
    
    
    5,719
    
    
    
    1,314Benefit for deferred income taxes
    
    
    (5,684
    )
    
    
    (1,351
    )Non-cash loss (gain) on investments, net
    
    
    5,106
    
    
    
    (3,151
    )(Gain) loss on derivatives
    
    
    (6,650
    )
    
    
    7Unrealized loss on residential mortgage investment portfolio
    
    
    16,513
    
    
    
    Net increase in mortgage-backed securities pledged, trading
    
    
    (7,112
    )
    
    
    Amortization of discount on residential mortgage investments
    
    
    (7,798
    )
    
    
    Increase in loans held-for-sale, net
    
    
    (24,843
    )
    
    
    (3,791
    )(Increase) decrease in other assets
    
    
    (30,458
    )
    
    
    3,094Increase (decrease) in other liabilities
    
    
    3,547
    
    
    
    (14,549
    )Cash provided by operating activities
    
    
    94,237
    
    
    
    58,950Investing activities:Decrease in restricted cash
    
    
    60,397
    
    
    
    8,073Increase in mortgage-related receivables, net
    
    
    (2,442,119
    )
    
    
    Increase in
receivables under reverse-repurchase agreements, net
    
    
    (62,389
    )
    
    
    Increase in loans, net
    
    
    (1,168,978
    )
    
    
    (735,010
    )Acquisition of real estate, net of cash acquired
    
    
    (37,199
    )
    
    
    Acquisition of investments, net
    
    
    (14,612
    )
    
    
    (5,110
    )Acquisition of property and equipment, net
    
    
    (1,487
    )
    
    
    (2,669
    )Cash used in investing activities
    
    
    (3,666,387
    )
    
    
    (734,716
    )Financing activities:Payment of deferred financing fees
    
    
    (25,562
    )
    
    
    (12,451
    )Borrowings under repurchase agreements, net
    
    
    31,323
    
    
    
    Borrowings on unsecured credit facilities, net
    
    
    460,000
    
    
    
    Borrowings on secured credit facilities, net
    
    
    495,705
    
    
    
    351,663Borrowings of term debt
    
    
    3,165,124
    
    
    
    1,153,160Repayments of term debt
    
    
    (845,333
    )
    
    
    (867,235
    )Borrowings of subordinated debt
    
    
    50,000
    
    
    
    Proceeds from issuance of common stock, net of offering costs
    
    
    440,097
    
    
    
    582Proceeds from exercise of options
    
    
    3,327
    
    
    
    534Tax benefits on share-based payments
    
    
    2,256
    
    
    
    Payment of dividends
    
    
    (226,628
    )
    
    
    Cash provided by financing activities
    
    
    3,550,309
    
    
    
    626,253Decrease in cash and cash equivalents
    
    
    (21,841
    )
    
    
    (49,513
    )Cash and cash equivalents as of beginning of period
    
    
    323,896
    
    
    
    206,077Cash and cash equivalents as of end of period
    
    $
    302,055
    
    
    $
    156,564Noncash transactions from investing and financing activities:Issuance of common stock
    
    $
    309,736
    
    
    $
    
  5




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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/or 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;
    
    Term B, Second Lien and Mezzanine Loans  Commercial loans, including subordinated
mortgage loans, that come after a clients senior loans in right of payment or upon
liquidation;
    
    Direct Real Estate Investments  Commercial investments in land, buildings and other
assets, including those that are purchased from and triple-net leased back to the current
operators through sale-leaseback transactions;
    
    Private Equity Co-Investments  Opportunistic equity investments, typically in
conjunction with commercial lending relationships and on the same terms as other equity
investors; and
    
    Residential Mortgage Investments  Investments in residential mortgage loans, residential
mortgage-backed securities and residential asset-backed securities that constitute
qualifying REIT assets.
  Entity
    
    PurposeCapitalSource TRS Inc.
    
    Subsidiary that owns interest in 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 commercial lending and investment business of
CapitalSource and manages our REIT operations.CSE Mortgage LLC
    
    Subsidiary that holds qualifying REIT assets of CapitalSource.CapitalSource Finance II Inc.
    
    Subsidiary of CapitalSource Finance LLC that holds certain
limited liability companies established in accordance with
credit facilities and term debt securitizations.
 6




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Note 2. Summary of Significant Accounting Policies
 Unaudited Interim Consolidated Financial Statements Basis of Presentation
    Summary of
Significant Accounting Policies
 Segment Reporting
 Disclosures about Segments of an
Enterprise and Related Information
 Mortgage-Related Receivables and Related Owner Trust Securitizations
 Consolidation of Variable Interest
Entities  An Interpretation of ARB No. 51,
 Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases
 7




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##### 



Note 3. Recently Issued Accounting Guidance
 Accounting for Uncertainty in Income Taxes  An Interpretation of FASB Statement No. 109 Accounting for Income Taxes.
 Note 4. Mortgage-Related Receivables
 , Summary of Significant
Accounting Policies,
  Note 5. Residential Mortgage-Backed Securities and Certain Derivative Instruments
  Accounting for Derivative
Instruments and Hedging Activities
 Accounting for
Certain Investments in Debt and Equity Securities
 8




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##### 



Summary of Significant Accounting Policies
   Note 6. Commercial Loans and Credit Quality
  Credit Quality
  June 30,
    
    
    December 31,Commercial Loan Asset Classification
    
    2006
    

    
    2005($ in thousands)Loans 60 or more days contractually delinquent
    
    $
    94,073
    
    
    $
    41,785Non-accrual loans(1)
    
    
    143,788
    
    
    
    137,446Impaired loans(2)
    
    
    235,552
    
    
    
    199,257Less: loans in multiple categories
    
    
    (193,243
    )
    
    
    (175,070
    )Total
    
    $
    280,170
    
    
    $
    203,418Total as a percentage of total loans
    
    
    3.91%
    
    
    
    3.40%
 
 (1)
    
    Includes commercial loans with an aggregate principal balance of $49.4 million and $37.6
million as of June 30, 2006 and December 31, 2005, respectively, which were also classified as
loans 60 or more days contractually delinquent.(2)
    
    Includes commercial loans with an aggregate principal balance of $49.4 million and $37.6
million as of June 30, 2006 and December 31, 2005, respectively, which were also classified as
loans 60 or more days contractually delinquent, and commercial loans with an aggregate
principal balance of $143.8 million and $137.4 million as of June 30, 2006 and December 31,
2005, respectively, which were also classified as loans on non-accrual status. The carrying
value of impaired commercial loans was $231.3 million and $194.6 million as of June 30, 2006
and December 31, 2005, respectively. Accounting by Creditors for Impairment of a Loan
 9




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##### 



Accounting for Debtors and Creditors for
Troubled Debt Restructurings.
  Six Months EndedJune 30,2006
    
    
    2005($ in thousands)Balance as of beginning of period
    
    $
    87,370
    
    
    $
    35,208Provision for loan losses
    
    
    25,883
    
    
    
    14,949Charge offs, net
    
    
    (12,478
    )
    
    
    (5,608
    )Balance as of end of period
    
    $
    100,775
    
    
    $
    44,549
 Note 7. Investments
  June 30,
    
    
    December 31,2006
    
    
    2005($ in thousands)Investments carried at cost
    
    $
    64,107
    
    
    $
    51,907Investments carried at fair value:Investments available-for-sale
    
    
    56,912
    
    
    
    50,461Warrants
    
    
    7,847
    
    
    
    10,259Investments accounted for under the equity method
    
    
    32,684
    
    
    
    13,766Total
    
    $
    161,550
    
    
    $
    126,393
   10




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##### 



Note 8. Borrowings
 Borrowings Borrowings
 Repurchase Agreements
   Credit Facilities
     11




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##### 



Term Debt
 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
 Note 9. Guarantor Information
  12




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##### 



Consolidating Balance Sheet
June 30, 2006
 CapitalSource Finance LLCCombined Non-
    
    Combined
    
    Other Non-Guarantor
    
    Guarantor
    
    Guarantor
    
    
    
    
    
    ConsolidatedCapitalSource Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    CapitalSource Inc.(Unaudited)($ in thousands)AssetsCash and cash equivalents
    
    $
    1,806
    
    
    $
    148,752
    
    
    $
    73,772
    
    
    $
    77,725
    
    
    $
    
    
    
    $
    302,055Restricted cash
    
    
    
    
    
    
    131,190
    
    
    
    74,800
    
    
    
    18,398
    
    
    
    
    
    
    
    224,388Mortgage-related receivables, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,412,279
    
    
    
    
    
    
    
    2,412,279Mortgage-backed securities pledged, trading
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,093,675
    
    
    
    
    
    
    
    3,093,675Receivables under reverse-repurchase agreements
    
    
    
    
    
    
    95,632
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    95,632Loans held-for-sale
    
    
    
    
    
    
    26,223
    
    
    
    15,998
    
    
    
    
    
    
    
    
    
    
    
    42,221Loans:Loans
    
    
    
    
    
    
    3,785,020
    
    
    
    623,320
    
    
    
    2,633,572
    
    
    
    (8,794
    )
    
    
    7,033,118Less deferred loan fees and discounts
    
    
    
    
    
    
    (41,198
    )
    
    
    (45,378
    )
    
    
    (41,008
    )
    
    
    
    
    
    
    (127,584
    )Less allowance for loan losses
    
    
    
    
    
    
    
    
    
    
    (83,278
    )
    
    
    (17,497
    )
    
    
    
    
    
    
    (100,775
    )Loans, net
    
    
    
    
    
    
    3,743,822
    
    
    
    494,664
    
    
    
    2,575,067
    
    
    
    (8,794
    )
    
    
    6,804,759Property and equipment, net
    
    
    
    
    
    
    27
    
    
    
    11,516
    
    
    
    238,308
    
    
    
    
    
    
    
    249,851Investment in subsidiaries
    
    
    2,914,688
    
    
    
    
    
    
    
    772,494
    
    
    
    1,094,451
    
    
    
    (4,781,633
    )
    
    
    Intercompany due from/(due to)
    
    
    52,367
    
    
    
    
    
    
    
    (142,366
    )
    
    
    89,999
    
    
    
    
    
    
    
    Intercompany note receivable
    
    
    
    
    
    
    2,909
    
    
    
    12,403
    
    
    
    
    
    
    
    (15,312
    )
    
    
    Investments
    
    
    
    
    
    
    46,301
    
    
    
    77,899
    
    
    
    37,350
    
    
    
    
    
    
    
    161,550Deferred financing fees, net
    
    
    12,592
    
    
    
    19,149
    
    
    
    8,592
    
    
    
    9,472
    
    
    
    
    
    
    
    49,805Other assets
    
    
    6
    
    
    
    776
    
    
    
    22,633
    
    
    
    118,243
    
    
    
    (8,018
    )
    
    
    133,640Total assets
    
    $
    2,981,459
    
    
    $
    4,214,781
    
    
    $
    1,422,405
    
    
    $
    9,764,967
    
    
    $
    (4,813,757
    )
    
    $
    13,569,855Liabilities, noncontrolling interests and shareholders
equityLiabilities:Repurchase agreements
    
    $
    
    
    
    $
    112,651
    
    
    $
    
    
    
    $
    3,034,099
    
    
    $
    
    
    
    $
    3,146,750Unsecured credit facilities
    
    
    460,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    460,000Secured credit facilities
    
    
    
    
    
    
    1,585,978
    
    
    
    
    
    
    
    1,318,000
    
    
    
    
    
    
    
    2,903,978Term debt
    
    
    
    
    
    
    1,708,095
    
    
    
    6,714
    
    
    
    2,417,172
    
    
    
    
    
    
    
    4,131,981Convertible debt
    
    
    555,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    555,000Subordinated debt
    
    
    
    
    
    
    
    
    
    
    283,504
    
    
    
    
    
    
    
    
    
    
    
    283,504Other liabilities
    
    
    13,847
    
    
    
    20,255
    
    
    
    37,736
    
    
    
    24,663
    
    
    
    (16,812
    )
    
    
    79,689Intercompany note payable
    
    
    
    
    
    
    15,312
    
    
    
    
    
    
    
    
    
    
    
    (15,312
    )
    
    
    Total liabilities
    
    
    1,028,847
    
    
    
    3,442,291
    
    
    
    327,954
    
    
    
    6,793,934
    
    
    
    (32,124
    )
    
    
    11,560,902Noncontrolling interests
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,345
    
    
    
    (4
    )
    
    
    56,341Shareholders equity:Preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock
    
    
    1,745
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,745Additional paid-in capital
    
    
    1,950,721
    
    
    
    246,182
    
    
    
    310,460
    
    
    
    2,754,886
    
    
    
    (3,311,528
    )
    
    
    1,950,721Retained earnings
    
    
    26,406
    
    
    
    526,286
    
    
    
    780,229
    
    
    
    155,833
    
    
    
    (1,462,348
    )
    
    
    26,406Accumulated other comprehensive income, net
    
    
    3,666
    
    
    
    22
    
    
    
    3,762
    
    
    
    3,969
    
    
    
    (7,753
    )
    
    
    3,666Treasury stock, at cost
    
    
    (29,926
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,926
    )Total shareholders equity
    
    
    1,952,612
    
    
    
    772,490
    
    
    
    1,094,451
    
    
    
    2,914,688
    
    
    
    (4,781,629
    )
    
    
    1,952,612Total liabilities, noncontrolling interests and
shareholders equity
    
    $
    2,981,459
    
    
    $
    4,214,781
    
    
    $
    1,422,405
    
    
    $
    9,764,967
    
    
    $
    (4,813,757
    )
    
    $
    13,569,855
 13




---



##### 



Consolidating Balance Sheet
 December 31, 2005
 CapitalSource Finance LLCCombined Non-
    
    Combined
    
    Other Non-Guarantor
    
    Guarantor
    
    Guarantor
    
    
    
    
    
    ConsolidatedCapitalSource Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    CapitalSource Inc.($
in thousands)AssetsCash and cash equivalents
    
    $
    2,038
    
    
    $
    145,065
    
    
    $
    156,571
    
    
    $
    20,222
    
    
    $
    
    
    
    $
    323,896Restricted cash
    
    
    
    
    
    
    125,832
    
    
    
    153,299
    
    
    
    5,654
    
    
    
    
    
    
    
    284,785Mortgage-related receivables, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39,438
    
    
    
    
    
    
    
    39,438Mortgage-backed securities pledged, trading
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    323,370
    
    
    
    
    
    
    
    323,370Receivables under reverse-repurchase agreements
    
    
    
    
    
    
    33,243
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33,243Loans held-for-sale
    
    
    
    
    
    
    17,378
    
    
    
    42,211
    
    
    
    
    
    
    
    
    
    
    
    59,589Loans:Loans
    
    
    
    
    
    
    4,087,078
    
    
    
    374,833
    
    
    
    1,440,828
    
    
    
    (7,828
    )
    
    
    5,894,911Less deferred loan fees and discounts
    
    
    
    
    
    
    (971
    )
    
    
    (100,123
    )
    
    
    (19,313
    )
    
    
    
    
    
    
    (120,407
    )Less allowance for loan losses
    
    
    
    
    
    
    
    
    
    
    (78,003
    )
    
    
    (9,367
    )
    
    
    
    
    
    
    (87,370
    )Loans, net
    
    
    
    
    
    
    4,086,107
    
    
    
    196,707
    
    
    
    1,412,148
    
    
    
    (7,828
    )
    
    
    5,687,134Property and equipment, net
    
    
    
    
    
    
    
    
    
    
    11,502
    
    
    
    
    
    
    
    
    
    
    
    11,502Investment in subsidiaries
    
    
    2,063,092
    
    
    
    
    
    
    
    655,627
    
    
    
    
    
    
    
    (2,718,719
    )
    
    
    Intercompany note receivable
    
    
    
    
    
    
    7,803
    
    
    
    35,288
    
    
    
    
    
    
    
    (43,091
    )
    
    
    Investments
    
    
    33,494
    
    
    
    21,210
    
    
    
    71,689
    
    
    
    
    
    
    
    
    
    
    
    126,393Deferred financing fees, net
    
    
    11,114
    
    
    
    22,868
    
    
    
    7,944
    
    
    
    80
    
    
    
    
    
    
    
    42,006Other assets
    
    
    20,110
    
    
    
    1,018
    
    
    
    19,839
    
    
    
    14,745
    
    
    
    
    
    
    
    55,712Total assets
    
    $
    2,129,848
    
    
    $
    4,460,524
    
    
    $
    1,350,677
    
    
    $
    1,815,657
    
    
    $
    (2,769,638
    )
    
    $
    6,987,068Liabilities and shareholders equityLiabilities:Repurchase agreements
    
    $
    
    
    
    $
    47,157
    
    
    $
    
    
    
    $
    311,266
    
    
    $
    
    
    
    $
    358,423Secured credit facilities
    
    
    
    
    
    
    1,938,273
    
    
    
    42,179
    
    
    
    470,000
    
    
    
    
    
    
    
    2,450,452Term debt
    
    
    
    
    
    
    1,774,475
    
    
    
    5,273
    
    
    
    
    
    
    
    
    
    
    
    1,779,748Convertible debt
    
    
    555,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    555,000Subordinated debt
    
    
    
    
    
    
    
    
    
    
    231,959
    
    
    
    
    
    
    
    
    
    
    
    231,959Stock dividend payable
    
    
    280,720
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    280,720Cash dividend payable
    
    
    70,202
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70,202Other liabilities
    
    
    3,661
    
    
    
    22,228
    
    
    
    41,112
    
    
    
    1,453
    
    
    
    (7,828
    )
    
    
    60,626Intercompany note payable
    
    
    20,327
    
    
    
    22,764
    
    
    
    
    
    
    
    
    
    
    
    (43,091
    )
    
    
    Total liabilities
    
    
    929,910
    
    
    
    3,804,897
    
    
    
    320,523
    
    
    
    782,719
    
    
    
    (50,919
    )
    
    
    5,787,130Shareholders equity:Preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock
    
    
    1,404
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,404Additional paid-in capital
    
    
    1,248,745
    
    
    
    278,656
    
    
    
    362,137
    
    
    
    1,025,690
    
    
    
    (1,666,483
    )
    
    
    1,248,745Retained earnings
    
    
    46,783
    
    
    
    377,492
    
    
    
    668,762
    
    
    
    7,248
    
    
    
    (1,053,502
    )
    
    
    46,783Deferred compensation
    
    
    (65,729
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (65,729
    )Accumulated other comprehensive loss, net
    
    
    (1,339
    )
    
    
    (521
    )
    
    
    (745
    )
    
    
    
    
    
    
    1,266
    
    
    
    (1,339
    )Treasury stock, at cost
    
    
    (29,926
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,926
    )Total shareholders equity
    
    
    1,199,938
    
    
    
    655,627
    
    
    
    1,030,154
    
    
    
    1,032,938
    
    
    
    (2,718,719
    )
    
    
    1,199,938Total liabilities and shareholders equity
    
    $
    2,129,848
    
    
    $
    4,460,524
    
    
    $
    1,350,677
    
    
    $
    1,815,657
    
    
    $
    (2,769,638
    )
    
    $
    6,987,068
 14




---



##### 



Consolidating Statement of Income
 Three Months Ended June 30, 2006
 CapitalSource Finance LLCCombined Non-
    
    Combined
    
    Other Non-Guarantor
    
    Guarantor
    
    Guarantor
    
    
    
    
    
    ConsolidatedCapitalSource Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income
    
    $
    
    
    
    $
    116,621
    
    
    $
    15,604
    
    
    $
    124,299
    
    
    $
    (487
    )
    
    $
    256,037Fee income
    
    
    
    
    
    
    47,791
    
    
    
    (22,505
    )
    
    
    11,317
    
    
    
    
    
    
    
    36,603Total interest and fee income
    
    
    
    
    
    
    164,412
    
    
    
    (6,901
    )
    
    
    135,616
    
    
    
    (487
    )
    
    
    292,640Operating lease income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,694
    
    
    
    
    
    
    
    6,694Total investment income
    
    
    
    
    
    
    164,412
    
    
    
    (6,901
    )
    
    
    142,310
    
    
    
    (487
    )
    
    
    299,334Interest expense
    
    
    7,647
    
    
    
    52,041
    
    
    
    7,006
    
    
    
    87,711
    
    
    
    (487
    )
    
    
    153,918Net investment (loss) income
    
    
    (7,647
    )
    
    
    112,371
    
    
    
    (13,907
    )
    
    
    54,599
    
    
    
    
    
    
    
    145,416Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    7,432
    
    
    
    4,039
    
    
    
    
    
    
    
    11,471Net investment (loss) income after provision for loan
losses
    
    
    (7,647
    )
    
    
    112,371
    
    
    
    (21,339
    )
    
    
    50,560
    
    
    
    
    
    
    
    133,945Operating expenses:Compensation and benefits
    
    
    
    
    
    
    1,375
    
    
    
    32,755
    
    
    
    
    
    
    
    
    
    
    
    34,130Other administrative expenses
    
    
    3,745
    
    
    
    689
    
    
    
    14,736
    
    
    
    3,978
    
    
    
    (3,587
    )
    
    
    19,561Total operating expenses
    
    
    3,745
    
    
    
    2,064
    
    
    
    47,491
    
    
    
    3,978
    
    
    
    (3,587
    )
    
    
    53,691Other income (expense):Diligence deposits forfeited
    
    
    
    
    
    
    
    
    
    
    1,103
    
    
    
    
    
    
    
    
    
    
    
    1,103Loss on investments, net
    
    
    
    
    
    
    
    
    
    
    (1,489
    )
    
    
    
    
    
    
    
    
    
    
    (1,489
    )Gain on derivatives
    
    
    
    
    
    
    624
    
    
    
    1,123
    
    
    
    4,377
    
    
    
    
    
    
    
    6,124Gain on residential mortgage investment portfolio
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,035
    
    
    
    
    
    
    
    4,035Other income, net of expenses
    
    
    76
    
    
    
    89
    
    
    
    4,945
    
    
    
    
    
    
    
    (3,587
    )
    
    
    1,523Earnings in subsidiaries
    
    
    84,105
    
    
    
    
    
    
    
    105,319
    
    
    
    47,872
    
    
    
    (237,296
    )
    
    
    Intercompany
    
    
    
    
    
    
    (5,701
    )
    
    
    5,701
    
    
    
    
    
    
    
    
    
    
    
    Total other income (expense)
    
    
    84,181
    
    
    
    (4,988
    )
    
    
    116,702
    
    
    
    56,284
    
    
    
    (240,883
    )
    
    
    11,296Noncontrolling interests expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,230
    
    
    
    
    
    
    
    1,230Net income before income taxes and cumulative effect of
accounting change
    
    
    72,789
    
    
    
    105,319
    
    
    
    47,872
    
    
    
    101,636
    
    
    
    (237,296
    )
    
    
    90,320Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,531
    
    
    
    
    
    
    
    17,531Net income before cumulative effect of accounting
change
    
    
    72,789
    
    
    
    105,319
    
    
    
    47,872
    
    
    
    84,105
    
    
    
    (237,296
    )
    
    
    72,789Cumulative effect of accounting change, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    $
    72,789
    
    
    $
    105,319
    
    
    $
    47,872
    
    
    $
    84,105
    
    
    $
    (237,296
    )
    
    $
    72,789
 15




---



##### 



Consolidating Statement of Income
 Six Months Ended June 30, 2006
 CapitalSource Finance LLCCombined Non-
    
    Combined
    
    Other Non-Guarantor
    
    Guarantor
    
    Guarantor
    
    
    
    
    
    ConsolidatedCapitalSource Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income
    
    $
    549
    
    
    $
    231,809
    
    
    $
    31,923
    
    
    $
    189,115
    
    
    $
    (1,861
    )
    
    $
    451,535Fee income
    
    
    
    
    
    
    76,731
    
    
    
    (24,016
    )
    
    
    25,430
    
    
    
    
    
    
    
    78,145Total interest and fee income
    
    
    549
    
    
    
    308,540
    
    
    
    7,907
    
    
    
    214,545
    
    
    
    (1,861
    )
    
    
    529,680Operating lease income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,319
    
    
    
    
    
    
    
    11,319Total investment income
    
    
    549
    
    
    
    308,540
    
    
    
    7,907
    
    
    
    225,864
    
    
    
    (1,861
    )
    
    
    540,999Interest expense
    
    
    12,953
    
    
    
    105,456
    
    
    
    12,533
    
    
    
    122,619
    
    
    
    (1,861
    )
    
    
    251,700Net investment (loss) income
    
    
    (12,404
    )
    
    
    203,084
    
    
    
    (4,626
    )
    
    
    103,245
    
    
    
    
    
    
    
    289,299Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    17,753
    
    
    
    8,431
    
    
    
    
    
    
    
    26,184Net investment (loss) income after provision for loan
losses
    
    
    (12,404
    )
    
    
    203,084
    
    
    
    (22,379
    )
    
    
    94,814
    
    
    
    
    
    
    
    263,115Operating expenses:Compensation and benefits
    
    
    
    
    
    
    2,306
    
    
    
    65,144
    
    
    
    
    
    
    
    
    
    
    
    67,450Other administrative expenses
    
    
    7,339
    
    
    
    1,237
    
    
    
    28,350
    
    
    
    7,053
    
    
    
    (7,119
    )
    
    
    36,860Total operating expenses
    
    
    7,339
    
    
    
    3,543
    
    
    
    93,494
    
    
    
    7,053
    
    
    
    (7,119
    )
    
    
    104,310Other income (expense):Diligence deposits forfeited
    
    
    
    
    
    
    
    
    
    
    3,370
    
    
    
    
    
    
    
    
    
    
    
    3,370Loss on investments, net
    
    
    
    
    
    
    
    
    
    
    (1,740
    )
    
    
    
    
    
    
    
    
    
    
    (1,740
    )Gain on derivatives
    
    
    
    
    
    
    1,035
    
    
    
    1,238
    
    
    
    4,377
    
    
    
    
    
    
    
    6,650Loss on residential mortgage investment portfolio
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,071
    )
    
    
    
    
    
    
    (2,071
    )Other income, net of expenses
    
    
    76
    
    
    
    318
    
    
    
    14,738
    
    
    
    (2,582
    )
    
    
    (7,119
    )
    
    
    5,431Earnings in subsidiaries
    
    
    157,750
    
    
    
    
    
    
    
    187,564
    
    
    
    102,997
    
    
    
    (448,311
    )
    
    
    Intercompany
    
    
    
    
    
    
    (13,330
    )
    
    
    13,330
    
    
    
    
    
    
    
    
    
    
    
    Total other income (expense)
    
    
    157,826
    
    
    
    (11,977
    )
    
    
    218,500
    
    
    
    102,721
    
    
    
    (455,430
    )
    
    
    11,640Noncontrolling interests expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,091
    
    
    
    
    
    
    
    2,091Net income before income taxes and cumulative effect of
accounting change
    
    
    138,083
    
    
    
    187,564
    
    
    
    102,627
    
    
    
    188,391
    
    
    
    (448,311
    )
    
    
    168,354Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30,641
    
    
    
    
    
    
    
    30,641Net income before cumulative effect of accounting
change
    
    
    138,083
    
    
    
    187,564
    
    
    
    102,627
    
    
    
    157,750
    
    
    
    (448,311
    )
    
    
    137,713Cumulative effect of accounting change, net of taxes
    
    
    
    
    
    
    
    
    
    
    370
    
    
    
    
    
    
    
    
    
    
    
    370Net income
    
    $
    138,083
    
    
    $
    187,564
    
    
    $
    102,997
    
    
    $
    157,750
    
    
    $
    (448,311
    )
    
    $
    138,083
 16




---



##### 



Consolidating Statement of Income
 Three Months Ended June 30, 2005
 CapitalSource Finance LLCCombined Non-
    
    CombinedGuarantor
    
    Guarantor
    
    
    
    
    
    ConsolidatedCapitalSource Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income
    
    $
    
    
    
    $
    99,501
    
    
    $
    20,412
    
    
    $
    (646
    )
    
    $
    119,267Fee income
    
    
    
    
    
    
    15,106
    
    
    
    23,363
    
    
    
    
    
    
    
    38,469Total interest and fee income
    
    
    
    
    
    
    114,607
    
    
    
    43,775
    
    
    
    (646
    )
    
    
    157,736Interest expense
    
    
    4,178
    
    
    
    38,299
    
    
    
    966
    
    
    
    (646
    )
    
    
    42,797Net investment (loss) income
    
    
    (4,178
    )
    
    
    76,308
    
    
    
    42,809
    
    
    
    
    
    
    
    114,939Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    5,047
    
    
    
    
    
    
    
    5,047Net investment (loss) income
after provision for loan losses
    
    
    (4,178
    )
    
    
    76,308
    
    
    
    37,762
    
    
    
    
    
    
    
    109,892Operating expenses:Compensation and benefits
    
    
    
    
    
    
    834
    
    
    
    29,754
    
    
    
    
    
    
    
    30,588Other administrative expenses
    
    
    136
    
    
    
    300
    
    
    
    10,085
    
    
    
    
    
    
    
    10,521Total operating expenses
    
    
    136
    
    
    
    1,134
    
    
    
    39,839
    
    
    
    
    
    
    
    41,109Other income (expense):Diligence deposits forfeited
    
    
    
    
    
    
    
    
    
    
    329
    
    
    
    
    
    
    
    329Gain on investments, net
    
    
    
    
    
    
    
    
    
    
    3,164
    
    
    
    
    
    
    
    3,164(Loss) gain on derivatives
    
    
    
    
    
    
    (252
    )
    
    
    172
    
    
    
    
    
    
    
    (80
    )Other income, net of expenses
    
    
    
    
    
    
    1,791
    
    
    
    530
    
    
    
    
    
    
    
    2,321Earnings in subsidiaries
    
    
    78,831
    
    
    
    
    
    
    
    80,446
    
    
    
    (159,277
    )
    
    
    Intercompany
    
    
    
    
    
    
    3,733
    
    
    
    (3,733
    )
    
    
    
    
    
    
    Total other income
    
    
    78,831
    
    
    
    5,272
    
    
    
    80,908
    
    
    
    (159,277
    )
    
    
    5,734Net income before income taxes
    
    
    74,517
    
    
    
    80,446
    
    
    
    78,831
    
    
    
    (159,277
    )
    
    
    74,517Income taxes
    
    
    29,062
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,062Net income
    
    $
    45,455
    
    
    $
    80,446
    
    
    $
    78,831
    
    
    $
    (159,277
    )
    
    $
    45,455
 17




---



##### 



Consolidating Statement of Income
 Six Months Ended June 30, 2005
 CapitalSource Finance LLCCombined Non-
    
    CombinedGuarantor
    
    Guarantor
    
    
    
    
    
    ConsolidatedCapitalSource Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    CapitalSource Inc.(Unaudited)($ in thousands)Net investment income:Interest income
    
    $
    
    
    
    $
    194,981
    
    
    $
    34,156
    
    
    $
    (1,296
    )
    
    $
    227,841Fee income
    
    
    
    
    
    
    24,508
    
    
    
    40,444
    
    
    
    
    
    
    
    64,952Total interest and fee income
    
    
    
    
    
    
    219,489
    
    
    
    74,600
    
    
    
    (1,296
    )
    
    
    292,793Interest expense
    
    
    8,377
    
    
    
    68,605
    
    
    
    1,697
    
    
    
    (1,296
    )
    
    
    77,383Net investment (loss) income
    
    
    (8,377
    )
    
    
    150,884
    
    
    
    72,903
    
    
    
    
    
    
    
    215,410Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    14,949
    
    
    
    
    
    
    
    14,949Net investment (loss) income
after provision for loan losses
    
    
    (8,377
    )
    
    
    150,884
    
    
    
    57,954
    
    
    
    
    
    
    
    200,461Operating expenses:Compensation and benefits
    
    
    
    
    
    
    1,247
    
    
    
    50,707
    
    
    
    
    
    
    
    51,954Other administrative expenses
    
    
    294
    
    
    
    430
    
    
    
    19,051
    
    
    
    
    
    
    
    19,775Total operating expenses
    
    
    294
    
    
    
    1,677
    
    
    
    69,758
    
    
    
    
    
    
    
    71,729Other income (expense):Diligence deposits forfeited
    
    
    
    
    
    
    
    
    
    
    1,477
    
    
    
    
    
    
    
    1,477Gain on investments, net
    
    
    
    
    
    
    
    
    
    
    5,292
    
    
    
    
    
    
    
    5,292Gain (loss) on derivatives
    
    
    
    
    
    
    789
    
    
    
    (796
    )
    
    
    
    
    
    
    (7
    )Other income, net of expenses
    
    
    
    
    
    
    2,463
    
    
    
    819
    
    
    
    
    
    
    
    3,282Earnings in subsidiaries
    
    
    147,447
    
    
    
    
    
    
    
    157,437
    
    
    
    (304,884
    )
    
    
    Intercompany
    
    
    
    
    
    
    4,978
    
    
    
    (4,978
    )
    
    
    
    
    
    
    Total other income
    
    
    147,447
    
    
    
    8,230
    
    
    
    159,251
    
    
    
    (304,884
    )
    
    
    10,044Net income before income taxes
    
    
    138,776
    
    
    
    157,437
    
    
    
    147,447
    
    
    
    (304,884
    )
    
    
    138,776Income taxes
    
    
    54,123
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54,123Net income
    
    $
    84,653
    
    
    $
    157,437
    
    
    $
    147,447
    
    
    $
    (304,884
    )
    
    $
    84,653
 18




---



##### 



Consolidating Statement of Cash Flows
Six Months Ended June 30, 2006
 CapitalSource Finance LLCCombined Non-
    
    Combined
    
    Other Non-
    
    
    
    
    
    ConsolidatedCapitalSource
    
    Guarantor
    
    Guarantor
    
    Guarantor
    
    
    
    
    
    CapitalSourceInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    Inc.(Unaudited)($ in thousands)Operating activities:Net income
    
    $
    138,083
    
    
    $
    187,564
    
    
    $
    102,997
    
    
    $
    157,750
    
    
    $
    (448,311
    )
    
    $
    138,083Adjustments to reconcile net income to net cash (used in) provided by operating activities:Stock option expense
    
    
    4,409
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,409Restricted stock expense
    
    
    
    
    
    
    
    
    
    
    11,944
    
    
    
    
    
    
    
    
    
    
    
    11,944Loss 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
    
    
    
    
    
    
    (24,462
    )
    
    
    15,202
    
    
    
    (33,883
    )
    
    
    
    
    
    
    (43,143
    )Interest on paid-in-kind loans
    
    
    
    
    
    
    5,158
    
    
    
    (4,804
    )
    
    
    (3,556
    )
    
    
    
    
    
    
    (3,202
    )Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    17,753
    
    
    
    8,431
    
    
    
    
    
    
    
    26,184Amortization of deferred financing fees and discounts
    
    
    1,431
    
    
    
    12,079
    
    
    
    262
    
    
    
    3,991
    
    
    
    
    
    
    
    17,763Depreciation and amortization
    
    
    
    
    
    
    4
    
    
    
    1,452
    
    
    
    4,263
    
    
    
    
    
    
    
    5,719Benefit for deferred income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,684
    )
    
    
    
    
    
    
    (5,684
    )Non-cash loss on investments, net
    
    
    
    
    
    
    
    
    
    
    5,106
    
    
    
    
    
    
    
    
    
    
    
    5,106Gain on derivatives
    
    
    
    
    
    
    (1,035
    )
    
    
    (1,238
    )
    
    
    (4,377
    )
    
    
    
    
    
    
    (6,650
    )Unrealized loss on residential mortgage investment portfolio
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,513
    
    
    
    
    
    
    
    16,513Net increase in mortgage-backed securities pledged, trading
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,112
    )
    
    
    
    
    
    
    (7,112
    )Amortization of discount on residential mortgage investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,798
    )
    
    
    
    
    
    
    (7,798
    )(Increase) decrease in loans held-for-sale, net
    
    
    
    
    
    
    (51,056
    )
    
    
    26,213
    
    
    
    
    
    
    
    
    
    
    
    (24,843
    )Decrease in intercompany note receivable
    
    
    
    
    
    
    4,894
    
    
    
    22,885
    
    
    
    
    
    
    
    (27,779
    )
    
    
    Decrease (increase) in other assets
    
    
    20,104
    
    
    
    242
    
    
    
    (2,630
    )
    
    
    (56,192
    )
    
    
    8,018
    
    
    
    (30,458
    )Increase (decrease) in other liabilities
    
    
    11,835
    
    
    
    (3,042
    )
    
    
    (1,821
    )
    
    
    5,559
    
    
    
    (8,984
    )
    
    
    3,547Net transfers with subsidiaries
    
    
    (863,138
    )
    
    
    (33,035
    )
    
    
    (68,876
    )
    
    
    516,738
    
    
    
    448,311
    
    
    
    Cash (used in) provided by operating activities
    
    
    (687,276
    )
    
    
    97,311
    
    
    
    115,722
    
    
    
    597,225
    
    
    
    (28,745
    )
    
    
    94,237Investing activities:(Increase) decrease in restricted cash
    
    
    
    
    
    
    (5,358
    )
    
    
    78,499
    
    
    
    (12,744
    )
    
    
    
    
    
    
    60,397Increase in mortgage-related receivables, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,442,119
    )
    
    
    
    
    
    
    (2,442,119
    )Increase in receivables under reverse-repurchase agreements, net
    
    
    
    
    
    
    (62,389
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (62,389
    )Decrease (increase) in loans, net
    
    
    
    
    
    
    362,559
    
    
    
    (315,343
    )
    
    
    (1,217,160
    )
    
    
    966
    
    
    
    (1,168,978
    )Acquisition of real estate, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (37,199
    )
    
    
    
    
    
    
    (37,199
    )Disposal (acquisition) of investments, net
    
    
    33,484
    
    
    
    (19,400
    )
    
    
    (10,751
    )
    
    
    (17,945
    )
    
    
    
    
    
    
    (14,612
    )Acquisition of property and equipment, net
    
    
    
    
    
    
    (29
    )
    
    
    (1,458
    )
    
    
    
    
    
    
    
    
    
    
    (1,487
    )Cash provided by (used in) investing activities
    
    
    33,484
    
    
    
    275,383
    
    
    
    (249,053
    )
    
    
    (3,727,167
    )
    
    
    966
    
    
    
    (3,666,387
    )Financing activities:Payment of deferred financing fees
    
    
    (2,909
    )
    
    
    (8,360
    )
    
    
    (910
    )
    
    
    (13,383
    )
    
    
    
    
    
    
    (25,562
    )Decrease in intercompany note payable
    
    
    (20,327
    )
    
    
    (7,452
    )
    
    
    
    
    
    
    
    
    
    
    27,779
    
    
    
    Borrowings (repayments) under repurchase agreements, net
    
    
    
    
    
    
    65,495
    
    
    
    
    
    
    
    (34,172
    )
    
    
    
    
    
    
    31,323Borrowings on unsecured credit facilities, net
    
    
    460,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    460,000(Repayments of) borrowings on secured credit facilities, net
    
    
    
    
    
    
    (352,295
    )
    
    
    
    
    
    
    848,000
    
    
    
    
    
    
    
    495,705Borrowings of term debt
    
    
    
    
    
    
    715,763
    
    
    
    1,491
    
    
    
    2,447,870
    
    
    
    
    
    
    
    3,165,124Repayments of term debt
    
    
    
    
    
    
    (782,158
    )
    
    
    (49
    )
    
    
    (63,126
    )
    
    
    
    
    
    
    (845,333
    )Borrowings of subordinated debt
    
    
    
    
    
    
    
    
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    50,000Proceeds from issuance of common stock, net of offering costs
    
    
    440,097
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    440,097Proceeds from exercise of options
    
    
    3,327
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,327Tax benefits on share-based payments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,256
    
    
    
    
    
    
    
    2,256Payment of dividends
    
    
    (226,628
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (226,628
    )Cash provided by (used in) financing activities
    
    
    653,560
    
    
    
    (369,007
    )
    
    
    50,532
    
    
    
    3,187,445
    
    
    
    27,779
    
    
    
    3,550,309(Decrease) increase in cash and cash equivalents
    
    
    (232
    )
    
    
    3,687
    
    
    
    (82,799
    )
    
    
    57,503
    
    
    
    
    
    
    
    (21,841
    )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
    
    $
    1,806
    
    
    $
    148,752
    
    
    $
    73,772
    
    
    $
    77,725
    
    
    $
    
    
    
    $
    302,055
 19




---



##### 



Consolidating Statement of Cash Flows
 Six Months Ended June 30, 2005
 CapitalSource Finance LLCCombined Non-
    
    CombinedGuarantor
    
    Guarantor
    
    
    
    
    
    ConsolidatedCapitalSource Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    CapitalSource Inc.(Unaudited)($ in thousands)Operating activities:Net income
    
    $
    84,653
    
    
    $
    157,437
    
    
    $
    147,447
    
    
    $
    (304,884
    )
    
    $
    84,653Adjustments to reconcile net income to net cash (used
in) provided by
operating activities:Stock option expense
    
    
    180
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    180Restricted stock expense
    
    
    7,933
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,933Amortization of deferred loan fees
    
    
    
    
    
    
    
    
    
    
    (36,595
    )
    
    
    
    
    
    
    (36,595
    )Interest on paid-in-kind loans
    
    
    
    
    
    
    120
    
    
    
    (5,322
    )
    
    
    
    
    
    
    (5,202
    )Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    14,949
    
    
    
    
    
    
    
    14,949Amortization of deferred financing fees and discounts
    
    
    1,163
    
    
    
    9,834
    
    
    
    462
    
    
    
    
    
    
    
    11,459Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    1,314
    
    
    
    
    
    
    
    1,314Benefit for deferred income taxes
    
    
    (1,351
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,351
    )Non-cash gain on investments, net
    
    
    
    
    
    
    
    
    
    
    (3,151
    )
    
    
    
    
    
    
    (3,151
    )(Gain) loss on derivatives
    
    
    
    
    
    
    (788
    )
    
    
    795
    
    
    
    
    
    
    
    7Increase in loans held-for-sale, net
    
    
    
    
    
    
    (3,791
    )
    
    
    
    
    
    
    
    
    
    
    (3,791
    )Decrease in intercompany note receivable
    
    
    
    
    
    
    
    
    
    
    5,570
    
    
    
    (5,570
    )
    
    
    Decrease in other assets
    
    
    153
    
    
    
    1,881
    
    
    
    1,060
    
    
    
    
    
    
    
    3,094Increase (decrease) in other liabilities
    
    
    793
    
    
    
    3,258
    
    
    
    (17,304
    )
    
    
    (1,296
    )
    
    
    (14,549
    )Net transfers with subsidiaries
    
    
    (94,486
    )
    
    
    (499,395
    )
    
    
    288,997
    
    
    
    304,884
    
    
    
    Cash (used in) provided by operating activities
    
    
    (962
    )
    
    
    (331,444
    )
    
    
    398,222
    
    
    
    (6,866
    )
    
    
    58,950Investing activities:Decrease (increase) in restricted cash
    
    
    
    
    
    
    10,093
    
    
    
    (2,020
    )
    
    
    
    
    
    
    8,073Increase in loans, net
    
    
    
    
    
    
    (354,565
    )
    
    
    (381,741
    )
    
    
    1,296
    
    
    
    (735,010
    )Acquisition of investments, net
    
    
    
    
    
    
    
    
    
    
    (5,110
    )
    
    
    
    
    
    
    (5,110
    )Acquisition of property and equipment, net
    
    
    
    
    
    
    5
    
    
    
    (2,674
    )
    
    
    
    
    
    
    (2,669
    )Cash used in investing activities
    
    
    
    
    
    
    (344,467
    )
    
    
    (391,545
    )
    
    
    1,296
    
    
    
    (734,716
    )Financing activities:Payment of deferred financing fees
    
    
    (154
    )
    
    
    (12,267
    )
    
    
    (30
    )
    
    
    
    
    
    
    (12,451
    )Decrease in intercompany note payable
    
    
    
    
    
    
    (5,570
    )
    
    
    
    
    
    
    5,570
    
    
    
    Borrowings on secured credit facilities, net
    
    
    
    
    
    
    264,271
    
    
    
    87,392
    
    
    
    
    
    
    
    351,663Borrowings of term debt
    
    
    
    
    
    
    1,141,825
    
    
    
    11,335
    
    
    
    
    
    
    
    1,153,160Repayments of term debt
    
    
    
    
    
    
    (744,973
    )
    
    
    (122,262
    )
    
    
    
    
    
    
    (867,235
    )Proceeds from issuance of common stock, net of offering costs
    
    
    582
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    582Proceeds from exercise of options
    
    
    534
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    534Cash provided by (used in) financing activities
    
    
    962
    
    
    
    643,286
    
    
    
    (23,565
    )
    
    
    5,570
    
    
    
    626,253Decrease in cash and cash equivalents
    
    
    
    
    
    
    (32,625
    )
    
    
    (16,888
    )
    
    
    
    
    
    
    (49,513
    )Cash and cash equivalents as of beginning of period
    
    
    
    
    
    
    170,532
    
    
    
    35,545
    
    
    
    
    
    
    
    206,077Cash and cash equivalents as of end of period
    
    $
    
    
    
    $
    137,907
    
    
    $
    18,657
    
    
    $
    
    
    
    $
    156,564
 20




---



##### 



Note 10. Shareholders Equity
 Common Stock Shares Outstanding
  Outstanding as of December 31, 2005
    
    
    140,405,766Issuance of common stock
    
    
    33,269,789Exercise of options
    
    
    419,051Restricted stock and other stock grants, net
    
    
    445,437Outstanding as of June 30, 2006
    
    
    174,540,043
 Dividend Reinvestment and Stock Purchase Plan
  Note 11. Income Taxes
   21




---



##### 



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Federal statutory rate
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %Benefit of REIT election
    
    
    (17.4
    )
    
    
    
    
    
    
    (16.1
    )
    
    
    State income taxes, net of federal tax benefit
    
    
    0.5
    
    
    
    3.8
    
    
    
    1.5
    
    
    
    3.8Other
    
    
    1.3
    
    
    
    0.2
    
    
    
    0.6
    
    
    
    0.2Estimated annual effective income tax rate
    
    
    19.4
    
    
    
    39.0
    
    
    
    21.0
    
    
    
    39.0Discrete item  Benefit for reversal of net deferred tax liabilities(1)
    
    
    
    
    
    
    
    
    
    
    (2.8
    )
    
    
    Current quarter effective income tax rate
    
    
    19.4
    %
    
    
    39.0
    %(2)
    
    
    18.2
    %
    
    
    39.0
    %(2)
 
 (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 six months ended June
30, 2006.(2)
    
    We provided for income taxes on the income earned for the three and six months ended June 30,
2005 based on a 39.0% effective tax rate. However, we provided for income taxes on the total
income earned in 2005 based on a 38.8% effective tax rate. This decrease in the effective tax
rate was the result of both a reconciliation of our previous provision for income taxes with
actual tax expense for 2004 plus a change in the estimated tax rate for 2005 which was
accounted for in the third quarter 2005.  Note 12. Comprehensive Income
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005($ in thousands)Net income
    
    $
    72,789
    
    
    $
    45,455
    
    
    $
    138,083
    
    
    $
    84,653Unrealized gain (loss) on available-for-sale securities, net of tax
    
    
    1,937
    
    
    
    40
    
    
    
    2,549
    
    
    
    (290
    )Unrealized gain (loss) on cash flow hedges, net of tax
    
    
    1,186
    
    
    
    (300
    )
    
    
    2,456
    
    
    
    (268
    )Comprehensive income
    
    $
    75,912
    
    
    $
    45,195
    
    
    $
    143,088
    
    
    $
    84,095
  June 30,
    
    December 31,2006
    
    2005($ in thousands)Unrealized gain (loss) on available-for-sale securities, net of tax
    
    $
    1,731
    
    
    $
    (818
    )Unrealized gain (loss) on cash flow hedges, net of tax
    
    
    1,935
    
    
    
    (521
    )Accumulated
other comprehensive income (loss), net
    
    $
    3,666
    
    
    $
    (1,339
    )
 22




---



##### 



Note 13. Net Income per Share
  Three Months Ended June 30,
    
    Six Months Ended June 30,2006
    
    2005
    
    2006
    
    2005($ in thousands, except per share data)Basic net income per share:Net income
    
    $
    72,789
    
    
    $
    45,455
    
    
    $
    138,083
    
    
    $
    84,653Average shares  basic
    
    
    168,866,621
    
    
    
    116,669,187
    
    
    
    159,309,225
    
    
    
    116,539,867Basic net income per share
    
    $
    0.43
    
    
    $
    0.39
    
    
    $
    0.87
    
    
    $
    0.73Diluted net income per share:Net income
    
    $
    72,789
    
    
    $
    45,455
    
    
    $
    138,083
    
    
    $
    84,653Average shares  basic
    
    
    168,866,621
    
    
    
    116,669,187
    
    
    
    159,309,225
    
    
    
    116,539,867Effect of dilutive securities:Stock dividend declared(1)
    
    
    
    
    
    
    
    
    
    
    1,629,138
    
    
    
    Option shares
    
    
    384,842
    
    
    
    730,320
    
    
    
    434,331
    
    
    
    799,055Unvested restricted stock
    
    
    1,299,293
    
    
    
    502,812
    
    
    
    1,129,508
    
    
    
    648,701Stock units
    
    
    19,080
    
    
    
    4,678
    
    
    
    13,346
    
    
    
    3,767Non-managing member units
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Convertible debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Written call option
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Average shares  diluted
    
    
    170,569,836
    
    
    
    117,906,997
    
    
    
    162,515,548
    
    
    
    117,991,390Diluted net income per share
    
    $
    0.43
    
    
    $
    0.39
    
    
    $
    0.85
    
    
    $
    0.72
 
 (1)
    
    All conditions were not met for inclusion in the basic net income per share calculation until
such shares were issued on January 25, 2006.  Note 14. Stock-Based Compensation
 Equity Incentive Plan
  Adoption of SFAS No. 123(R)
 Share-Based Payment Accounting for Stock-Based Compensation Accounting for Stock Issued to Employees Statement of Cash Flows.
 23




---



##### 



Three Months Ended
    
    
    Six Months EndedJune 30, 2005
    
    
    June 30, 2005($ in thousands, except per share data)Net income as reported
    
    $
    45,455
    
    
    $
    84,653Add back: Stock-based
compensation expense from
options included in
reported net income, net of
tax
    
    
    29
    
    
    
    109Deduct: Total stock-based
compensation expense
determined under fair
value-based method for all
option awards, net of tax
    
    
    (595
    )
    
    
    (1,076
    )Pro forma net income
    
    $
    44,889
    
    
    $
    83,686Net income per share:Basic  as reported
    
    $
    0.39
    
    
    $
    0.73Basic  pro forma
    
    $
    0.38
    
    
    $
    0.72Diluted  as reported
    
    $
    0.39
    
    
    $
    0.72Diluted  pro forma
    
    $
    0.38
    
    
    $
    0.71
  24




---



##### 



Stock Options
  Weighted
    
    
    Weighted AverageAverage
    
    
    RemainingExercise
    
    
    Contractual Life
    
    
    AggregateOptions
    
    
    Price
    
    
    (in years)
    
    
    Intrinsic Value($ in thousands)Outstanding as of December 31, 2005
    
    
    2,587,312
    
    
    $
    15.34Granted
    
    
    7,902,912
    
    
    
    23.71Exercised
    
    
    (419,051
    )
    
    
    8.51Forfeited
    
    
    (143,756
    )
    
    
    18.99Outstanding as of June 30, 2006
    
    
    9,927,417
    
    
    $
    22.24
    
    
    
    9.48
    
    
    $
    14,206Vested or expected to vest as of June 30, 2006
    
    
    8,331,355
    
    
    $
    22.03
    
    
    
    1.51
    
    
    $
    13,628Exercisable as of June 30, 2006
    
    
    2,614,313
    
    
    $
    20.54
    
    
    
    9.05
    
    
    $
    8,099
   Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Dividend yield
    
    
    8.35
    %
    
    
    
    
    
    
    8.34
    %
    
    
    Expected volatility
    
    
    20
    %
    
    
    31
    %
    
    
    20
    %
    
    
    31
    %Risk-free interest rate
    
    
    4.99
    %
    
    
    3.93
    %
    
    
    4.98
    %
    
    
    3.96
    %Expected life
    
    9.9 years
    
    6.0 years
    
    9.7 years
    
    6.0 years
   Three and Six MonthsEndedJune 30, 2006Dividend yield
    
    
    8.25
    %Expected volatility
    
    
    20
    %Risk-free interest rate
    
    
    5.00
    %Expected life
    
    10.0 years
 25




---



##### 



Restricted Stock
  WeightedAverageGrant-DateShares
    
    
    Fair ValueNonvested as of December 31, 2005
    
    
    3,873,124
    
    
    $
    22.08Granted
    
    
    1,387,099
    
    
    
    23.61Vested
    
    
    (690,329
    )
    
    
    22.67Forfeited
    
    
    (102,759
    )
    
    
    22.24Nonvested as of June 30, 2006
    
    
    4,467,135
    
    
    $
    22.46
  Note 15. Commitments and Contingencies
 Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others.
  26




---



##### 



Note 16. Operating Segments
 Summary of Significant Accounting Policies
 Three Months Ended June 30, 2006Commercial
    
    
    ResidentialLending &
    
    
    MortgageInvestment
    
    
    Investment
    
    
    Consolidated Total($ in thousands)Total interest and fee income
    
    $
    216,686
    
    
    $
    75,954
    
    
    $
    292,640Operating lease income
    
    
    6,694
    
    
    
    
    
    
    
    6,694Interest expense
    
    
    81,262
    
    
    
    72,656
    
    
    
    153,918Provision for loan losses
    
    
    11,471
    
    
    
    
    
    
    
    11,471Operating expenses(1)
    
    
    51,737
    
    
    
    1,954
    
    
    
    53,691Other income(2)
    
    
    7,261
    
    
    
    4,035
    
    
    
    11,296Noncontrolling interests expense
    
    
    1,230
    
    
    
    
    
    
    
    1,230Net income before income taxes and cumulative effect of
accounting change
    
    
    84,941
    
    
    
    5,379
    
    
    
    90,320Income taxes
    
    
    17,531
    
    
    
    
    
    
    
    17,531Net income before cumulative effect of accounting change
    
    
    67,410
    
    
    
    5,379
    
    
    
    72,789Cumulative effect of accounting change, net of taxes
    
    
    
    
    
    
    
    
    
    
    Net income
    
    $
    67,410
    
    
    $
    5,379
    
    
    $
    72,789Total assets
    
    $
    7,931,088
    
    
    $
    5,638,767
    
    
    $
    13,569,855
 Six Months Ended June 30, 2006Commercial
    
    
    ResidentialLending &
    
    
    MortgageInvestment
    
    
    Investment
    
    
    Consolidated Total($ in thousands)Total interest and fee income
    
    $
    426,356
    
    
    $
    103,324
    
    
    $
    529,680Operating lease income
    
    
    11,319
    
    
    
    
    
    
    
    11,319Interest expense
    
    
    154,095
    
    
    
    97,605
    
    
    
    251,700Provision for loan losses
    
    
    25,883
    
    
    
    301
    
    
    
    26,184Operating expenses(1)
    
    
    100,102
    
    
    
    4,208
    
    
    
    104,310Other income (expense)(2)
    
    
    13,711
    
    
    
    (2,071
    )
    
    
    11,640Noncontrolling interests expense
    
    
    2,091
    
    
    
    
    
    
    
    2,091Net income (loss) before income taxes and
cumulative effect of accounting change
    
    
    169,215
    
    
    
    (861
    )
    
    
    168,354Income taxes
    
    
    30,641
    
    
    
    
    
    
    
    30,641Net income (loss) before cumulative effect of
accounting change
    
    
    138,574
    
    
    
    (861
    )
    
    
    137,713Cumulative effect of accounting change, net of taxes
    
    
    370
    
    
    
    
    
    
    
    370Net income (loss)
    
    $
    138,944
    
    
    $
    (861
    )
    
    $
    138,083Total assets
    
    $
    7,931,088
    
    
    $
    5,638,767
    
    
    $
    13,569,855
 
 (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. Summary of Significant Accounting Policies.
 27




---



##### 



Note 17. Subsequent Event
  28




---



##### 



ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
  Managements Discussion and Analysis of
Financial Condition and Results of Operations Risk Factors
  Overview and Highlights
   
    
    Structured Finance,which generally engages in commercial and residential real estate
lending and also provides asset-based lending to finance companies;
    
    Healthcare and Specialty Finance,which generally provides asset-based revolving lines of
credit, first mortgage loans, sale-leaseback financing, equipment financing and other senior
and mezzanine loans to healthcare businesses and a broad range of other companies; and
    
    Corporate Finance,which generally provides senior and mezzanine loans principally to
businesses backed by private equity sponsors.
  29




---



##### 



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




---



##### 



Other Income.
 Operating Expenses.
 Income Taxes.
 Adjusted Earnings.
 Operating Results for the Three and Six Months Ended June 30, 2006
  
    
    Significant growth in our commercial loan portfolio;
    
    Purchases of investments in residential mortgage loans and mortgage-backed securities;
    
    Increased borrowings to fund our growth;
    
    Increased operating expenses, consisting primarily of higher employee compensation directly
related to increases in the number of our employees;
    
    Addition of operating lease income related to our sale-leaseback transactions;
    
    Increase in short-term interest rates;
    
    Decreased lending and borrowing spreads; and
    
    A decrease in our effective tax rate.
 31




---



##### 



Three Months Ended June 30,
    
    
    
    
    
    
    
    
    
    Six Months Ended June 30,2006
    
    2005
    
    $ Change
    
    % Change
    
    2006
    
    2005
    
    $ Change
    
    % Change($ in thousands)
    
    
    
    
    
    ($ in thousands)Interest income
    
    $
    256,037
    
    
    $
    119,267
    
    
    $
    136,770
    
    
    
    115
    %
    
    $
    451,535
    
    
    $
    227,841
    
    
    $
    223,694
    
    
    
    98
    %Fee income
    
    
    36,603
    
    
    
    38,469
    
    
    
    (1,866
    )
    
    
    (5
    %)
    
    
    78,145
    
    
    
    64,952
    
    
    
    13,193
    
    
    
    20
    %Operating lease income
    
    
    6,694
    
    
    
    
    
    
    
    6,694
    
    
    
    N/A
    
    
    11,319
    
    
    
    
    
    
    
    11,319
    
    
    
    N/AInterest expense
    
    
    153,918
    
    
    
    42,797
    
    
    
    111,121
    
    
    
    260
    %
    
    
    251,700
    
    
    
    77,383
    
    
    
    174,317
    
    
    
    225
    %Provision for loan losses
    
    
    11,471
    
    
    
    5,047
    
    
    
    6,424
    
    
    
    127
    %
    
    
    26,184
    
    
    
    14,949
    
    
    
    11,235
    
    
    
    75
    %Operating expenses
    
    
    53,691
    
    
    
    41,109
    
    
    
    12,582
    
    
    
    31
    %
    
    
    104,310
    
    
    
    71,729
    
    
    
    32,581
    
    
    
    45
    %Other income, net of expenses
    
    
    11,296
    
    
    
    5,734
    
    
    
    5,562
    
    
    
    97
    %
    
    
    11,640
    
    
    
    10,044
    
    
    
    1,596
    
    
    
    16
    %Noncontrolling interests expense
    
    
    1,230
    
    
    
    
    
    
    
    1,230
    
    
    
    N/A
    
    
    2,091
    
    
    
    
    
    
    
    2,091
    
    
    
    N/AIncome taxes
    
    
    17,531
    
    
    
    29,062
    
    
    
    (11,531
    )
    
    
    (40
    %)
    
    
    30,641
    
    
    
    54,123
    
    
    
    (23,482
    )
    
    
    (43
    %)Cumulative effect of accounting
change, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    370
    
    
    
    
    
    
    
    370
    
    
    
    N/ANet income
    
    
    72,789
    
    
    
    45,455
    
    
    
    27,334
    
    
    
    60
    %
    
    
    138,083
    
    
    
    84,653
    
    
    
    53,430
    
    
    
    63
    %
  Six Months Ended June 30,2006
    
    
    2005Weighted
    
    
    Net
    
    
    Average
    
    
    Weighted
    
    
    Net
    
    
    AverageAverage
    
    
    Investment
    
    
    Yield/
    
    
    Average
    
    
    Investment
    
    
    Yield/Balance
    
    
    Income
    
    
    Cost
    
    
    Balance
    
    
    Income
    
    
    Cost($ in thousands)Interest earning assets:Interest income
    
    
    
    
    
    $
    451,535
    
    
    
    8.54
    %
    
    
    
    
    
    $
    227,841
    
    
    
    9.37
    %Fee income
    
    
    
    
    
    
    78,145
    
    
    
    1.48
    
    
    
    
    
    
    
    64,952
    
    
    
    2.67Total interest earning assets(1)
    
    $
    10,658,010
    
    
    
    529,680
    
    
    
    10.02
    
    
    $
    4,902,992
    
    
    
    292,793
    
    
    
    12.04Total direct real estate investments
    
    
    173,496
    
    
    
    11,319
    
    
    
    13.16
    
    
    
    
    
    
    
    
    
    
    
    Total income earning assets
    
    
    10,831,506
    
    
    
    540,999
    
    
    
    10.07
    
    
    
    4,902,992
    
    
    
    292,793
    
    
    
    12.04Total interest bearing liabilities(2)
    
    
    9,087,398
    
    
    
    251,700
    
    
    
    5.59
    
    
    
    3,912,351
    
    
    
    77,383
    
    
    
    3.99Net finance spread
    
    
    
    
    
    $
    289,299
    
    
    
    4.48
    %
    
    
    
    
    
    $
    215,410
    
    
    
    8.05
    %Net finance margin
    
    
    
    
    
    
    
    
    
    
    5.39
    %
    
    
    
    
    
    
    
    
    
    
    8.86
    %
 
 (1)
    
    Interest earning assets include cash, restricted cash, mortgage-related receivables, mortgage-backed
securities, loans, asset-backed securities 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 June 30, 2006 and 2005
  Interest Income
   Fee Income
  Operating Lease Income
  Interest Expense
   Net Finance Margin
  33




---



##### 



Three Months Ended June 30,2006
    
    
    2005Weighted
    
    
    Net
    
    
    Average
    
    
    Weighted
    
    
    Net
    
    
    AverageAverage
    
    
    Investment
    
    
    Yield/
    
    
    Average
    
    
    Investment
    
    
    Yield/Balance
    
    
    Income
    
    
    Cost
    
    
    Balance
    
    
    Income
    
    
    Cost($ in thousands)Interest earning assets:Interest income
    
    
    
    
    
    $
    180,083
    
    
    
    10.45
    %
    
    
    
    
    
    $
    119,267
    
    
    
    9.52
    %Fee income
    
    
    
    
    
    
    36,603
    
    
    
    2.12
    
    
    
    
    
    
    
    38,469
    
    
    
    3.07Total interest earning assets(1)
    
    $
    6,910,554
    
    
    
    216,686
    
    
    
    12.57
    
    
    $
    5,023,928
    
    
    
    157,736
    
    
    
    12.59Total direct real estate investments.
    
    
    219,632
    
    
    
    6,694
    
    
    
    12.22
    
    
    
    
    
    
    
    
    
    
    
    Total income earning assets
    
    
    7,130,186
    
    
    
    223,380
    
    
    
    12.57
    
    
    
    5,023,928
    
    
    
    157,736
    
    
    
    12.59Total interest bearing liabilities(2)
    
    
    5,356,722
    
    
    
    81,262
    
    
    
    6.08
    
    
    
    4,038,993
    
    
    
    42,797
    
    
    
    4.25Net finance spread
    
    
    
    
    
    $
    142,118
    
    
    
    6.49
    %
    
    
    
    
    
    $
    114,939
    
    
    
    8.34
    %Net finance margin
    
    
    
    
    
    
    
    
    
    
    7.99
    %
    
    
    
    
    
    
    
    
    
    
    9.18
    %
 
 (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
  34




---



##### 



Operating Expenses
   Income Taxes
  35




---



##### 



Adjusted Earnings
  Net income
    
    $
    72,789Add:Real estate
depreciation (1)
    
    
    2,220Amortization of deferred financing fees
    
    
    7,525Non-cash equity compensation
    
    
    9,817Net
unrealized gains on residential mortgage investment portfolio, including related derivatives (2)
    
    
    (3,770
    )Unrealized gain on derivatives and foreign currencies, net
    
    
    (6,882
    )Unrealized loss on investments, net
    
    
    3,870Provision for loan losses
    
    
    11,571Recoveries (3)
    
    
    Less:Charge offs (4)
    
    
    Non-recurring items
    
    
    Cumulative effect of accounting change, net of taxes
    
    
    Adjustment
for income taxes (5)
    
    
    (9,633
    )Adjusted earnings
    
    $
    87,507Net income per share:Basic  as reported
    
    $
    0.43Diluted  as reported
    
    $
    0.43Average shares outstanding:Basic  as reported
    
    
    168,866,621Diluted  as reported
    
    
    170,569,836Adjusted earnings per share:Basic
    
    $
    0.52Diluted (6)
    
    $
    0.51Average shares outstanding:Basic
    
    
    168,866,621Diluted (7)
    
    
    173,080,654
 
 (1)
    
    Depreciation for direct real estate investments only. Excludes depreciation for corporate
leasehold improvements, fixed assets and other non-real estate items.(2)
    
    Includes adjustments to reflect the period change in fair value of residential mortgage-backed
securities and related derivatives.(3)
    
    Includes all recoveries on loans during the period.(4)
    
    To the extent we experience losses on loans for which we specifically provided prior to
January 1, 2006, there will be no adjustment to earnings. All charge offs incremental to
previously provided for losses will be deducted from net income.(5)
    
    Adjustments to net income shown on a pre-tax basis. Adjustment for income taxes made for TRS
items assuming a 38.6% tax rate for the three months ended June 30, 2006.(6)
    
    Adjusted to reflect the impact of adding back noncontrolling
interests expense of $1.2 million 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.(7)
    
    Adjusted to include average non-managing member units of
2,510,818 which are considered dilutive to adjusted earnings per
share, but are antidilutive to GAAP net income per share. 36




---



##### 



Comparison of the Six Months Ended June 30, 2006 and 2005
  Interest Income
   Fee Income
  Operating Lease Income
  Interest Expense
   Net Finance Margin
  37




---



##### 



Six Months Ended June 30,2006
    
    
    2005Weighted
    
    
    Net
    
    
    Average
    
    
    Weighted
    
    
    Net
    
    
    AverageAverage
    
    
    Investment
    
    
    Yield/
    
    
    Average
    
    
    Investment
    
    
    Yield/Balance
    
    
    Income
    
    
    Cost
    
    
    Balance
    
    
    Income
    
    
    Cost($ in thousands)Interest earning assets:Interest income
    
    
    
    
    
    $
    348,211
    
    
    
    10.35
    %
    
    
    
    
    
    $
    227,841
    
    
    
    9.37
    %Fee income
    
    
    
    
    
    
    78,145
    
    
    
    2.32
    
    
    
    
    
    
    
    64,952
    
    
    
    2.67Total interest earning assets(1)
    
    $
    6,785,120
    
    
    
    426,356
    
    
    
    12.67
    
    
    $
    4,902,992
    
    
    
    292,793
    
    
    
    12.04Total direct real estate investments
    
    
    173,496
    
    
    
    11,319
    
    
    
    13.16
    
    
    
    
    
    
    
    
    
    
    
    Total income earning assets
    
    
    6,958,616
    
    
    
    437,675
    
    
    
    12.68
    
    
    
    4,902,992
    
    
    
    292,793
    
    
    
    12.04Total interest bearing liabilities(2)
    
    
    5,339,899
    
    
    
    154,095
    
    
    
    5.82
    
    
    
    3,912,351
    
    
    
    77,383
    
    
    
    3.99Net finance spread
    
    
    
    
    
    $
    283,580
    
    
    
    6.86
    %
    
    
    
    
    
    $
    215,410
    
    
    
    8.05
    %Net finance margin
    
    
    
    
    
    
    
    
    
    
    8.22
    %
    
    
    
    
    
    
    
    
    
    
    8.86
    %
 
 (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
   38




---



##### 



Operating Expenses
   Income Taxes
  39




---



##### 



Adjusted Earnings
  Net income
    
    $
    138,083Add:Real estate
depreciation (1)
    
    
    3,610Amortization of deferred financing fees
    
    
    14,427Non-cash equity compensation
    
    
    16,353Net
unrealized losses on residential mortgage investment portfolio, including related derivatives (2)
    
    
    677Unrealized gain on derivatives and foreign currencies, net
    
    
    (7,133
    )Unrealized loss on investments, net
    
    
    5,106Provision for loan losses
    
    
    26,284Recoveries (3)
    
    
    Less:Charge offs (4)
    
    
    276Non-recurring items
    
    
    Cumulative effect of accounting change, net of taxes
    
    
    370Adjustment
for income taxes (5)
    
    
    (23,540
    )Adjusted earnings
    
    $
    173,221Net income per share:Basic  as reported
    
    $
    0.87Diluted  as reported
    
    $
    0.85Average shares outstanding:Basic  as reported
    
    
    159,309,225Diluted  as reported
    
    
    162,515,548Adjusted earnings per share:Basic
    
    $
    1.09Diluted (6)
    
    $
    1.06Average shares outstanding:Basic
    
    
    159,309,225Diluted (7)
    
    
    164,665,696
 
 (1)
    
    Depreciation for direct real estate investments only. Excludes depreciation for corporate
leasehold improvements, fixed assets and other non-real estate items.(2)
    
    Includes adjustments to reflect the period change in fair value of residential mortgage-backed
securities and related derivatives.(3)
    
    Includes all recoveries on loans during the period.(4)
    
    To the extent we experience losses on loans for which we specifically provided prior to
January 1, 2006, there will be no adjustment to earnings. All charge offs incremental to
previously provided for losses will be deducted from net income.(5)
    
    Adjustments to net income shown on a pre-tax basis. Adjustment for income taxes made for TRS
items assuming a 38.6% tax rate for the six months ended June 30, 2006. Also included for the
six months ended June 30, 2006 is the write-off of a $4.7 million net deferred tax liability
recorded in connection with our conversion to a REIT.(6)
    
    Adjusted to reflect the impact of adding back noncontrolling
interests expense of $2.1 million 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.(7)
    
    Adjusted to include average non-managing member units of
2,150,148, which are considered dilutive to adjusted earnings per
share, but are antidilutive to GAAP net income per share. 40




---



##### 



Financial Condition
 Commercial Lending & Investment Segment
 Commercial Lending Portfolio Composition
  June 30, 2006
    
    
    December 31, 2005($ in thousands)Composition of loan portfolio by loan type:First mortgage loans(1)
    
    $
    2,953,042
    
    
    
    41
    %
    
    $
    1,970,709
    
    
    
    33
    %Senior secured asset-based loans(1)
    
    
    2,285,502
    
    
    
    32
    
    
    
    2,022,123
    
    
    
    34Senior secured cash flow loans(1)
    
    
    1,626,220
    
    
    
    23
    
    
    
    1,740,184
    
    
    
    29Mezzanine loans
    
    
    306,207
    
    
    
    4
    
    
    
    254,727
    
    
    
    4Total
    
    $
    7,170,971
    
    
    
    100
    %
    
    $
    5,987,743
    
    
    
    100
    %Composition of loan portfolio by lending business:Structured Finance
    
    $
    2,444,522
    
    
    
    34
    %
    
    $
    1,909,149
    
    
    
    32
    %Healthcare and Specialty Finance
    
    
    3,104,461
    
    
    
    43
    
    
    
    2,281,419
    
    
    
    38Corporate Finance
    
    
    1,621,988
    
    
    
    23
    
    
    
    1,797,175
    
    
    
    30Total
    
    $
    7,170,971
    
    
    
    100
    %
    
    $
    5,987,743
    
    
    
    100
    %
 
 (1)
    
    Includes Term B loans, which are loans that share a first priority lien on the clients
collateral with the lenders on the clients senior loan, but that come after a senior secured
loan in order of payment priority preference upon a borrowers liquidation.  Average LoanNumber
    
    
    Average
    
    
    Number of
    
    
    Size Perof Loans
    
    
    Loan Size
    
    
    Clients
    
    
    Client($ in thousands)Composition of loan portfolio by lending business:Structured Finance
    
    
    203
    
    
    $
    12,042
    
    
    
    171
    
    
    $
    14,295Healthcare and Specialty Finance
    
    
    454
    
    
    
    6,838
    
    
    
    316
    
    
    
    9,824Corporate Finance
    
    
    299
    
    
    
    5,425
    
    
    
    128
    
    
    
    12,672Overall loan portfolio
    
    
    956
    
    
    
    7,501
    
    
    
    615
    
    
    
    11,660
  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
    
    $
    659,257
    
    
    $
    2,018,059
    
    
    $
    275,726
    
    
    $
    2,953,042Senior secured asset-based loans
    
    
    195,948
    
    
    
    2,081,376
    
    
    
    8,178
    
    
    
    2,285,502Senior secured cash flow loans
    
    
    253,967
    
    
    
    1,307,735
    
    
    
    64,518
    
    
    
    1,626,220Mezzanine loans
    
    
    66,932
    
    
    
    135,915
    
    
    
    103,360
    
    
    
    306,207Total
    
    $
    1,176,104
    
    
    $
    5,543,085
    
    
    $
    451,782
    
    
    $
    7,170,971
 41




---



##### 



Adjustable
    
    
    FixedRates
    
    
    Rates
    
    
    Total($ in thousands)Composition of loan portfolio by loan type:First mortgage loans
    
    $
    2,552,803
    
    
    $
    400,239
    
    
    $
    2,953,042Senior secured asset-based loans
    
    
    2,253,355
    
    
    
    32,147
    
    
    
    2,285,502Senior secured cash flow loans
    
    
    1,620,799
    
    
    
    5,421
    
    
    
    1,626,220Mezzanine loans
    
    
    242,737
    
    
    
    63,470
    
    
    
    306,207Total
    
    $
    6,669,694
    
    
    $
    501,277
    
    
    $
    7,170,971Percentage of total loan portfolio
    
    
    93%
    
    
    
    7%
    
    
    
    100%
  Credit Quality and Allowance for Loan Losses
  June 30,
    
    
    December 31,Commercial Loan Asset Classification
    
    2006
    
    
    2005($ in thousands)Loans 60 or more days contractually delinquent
    
    $
    94,073
    
    
    $
    41,785Non-accrual loans(1)
    
    
    143,788
    
    
    
    137,446Impaired loans(2)
    
    
    235,552
    
    
    
    199,257Less: loans in multiple categories
    
    
    (193,243
    )
    
    
    (175,070
    )Total
    
    $
    280,170
    
    
    $
    203,418Total as a percentage of total loans
    
    
    3.91%
    
    
    
    3.40%
 
 (1)
    
    Includes commercial loans with an aggregate principal balance of $49.4 million and $37.6
million as of June 30, 2006 and December 31, 2005, respectively, which were also classified as
loans 60 or more days contractually delinquent.(2)
    
    Includes commercial loans with an aggregate principal balance of $49.4 million and $37.6
million as of June 30, 2006 and December 31, 2005, respectively, which were also classified as
loans 60 or more days contractually delinquent, and commercial loans with an aggregate
principal balance of $143.8 million and $137.4 million as of June 30, 2006 and December 31,
2005, respectively, which were also classified as loans on non-accrual status. Accounting by
Creditors for Impairment of a Loan
 Accounting for Debtors and Creditors for Troubled Debt Restructurings.
 42




---



##### 



Direct Real Estate Investments
  Investments
   Residential Mortgage Investment Segment
 Portfolio Composition
  Market Risk Management Residential Mortgage-Backed Securities and Certain Derivative Instruments
 Summary of Significant Accounting Policies
 Credit Quality and Allowance for Loan Losses
  43




---



##### 



Financing
  Quantitative and Qualitative Disclosures About Market
Risk
 Liquidity and Capital Resources
      Cash and Cash Equivalents
  44




---



##### 



Borrowings
 Borrowings Borrowings
  Repurchase Agreements
   45




---



##### 



Credit Facilities
  Term Debt
  Debt Covenant Compliance
  Off-Balance Sheet Transactions
 Credit Risk
 Funding-Related Commitments
 Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others.
 Guarantee to Special Purpose Entity
 Consolidation of
Variable Interest Entities  An Interpretation of ARB No. 51 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
 Market Risk Management
 Derivatives and Off-Balance Sheet Financial Instruments, Quantitative and Qualitative Disclosures About Market Risk
 Derivatives  Commercial Lending & Investment Segment
  46




---



##### 



Derivatives  Residential Mortgage Investment
Segment
  Accounting for Derivative Instruments and Hedging Activities Accounting for Certain Investments in Debt and Equity Securities
 Quantitative and Qualitative Disclosures About Market Risk
 Commercial Lending & Investment Segment
  Market Risk Management
 47




---



##### 



Estimated (Decrease)Increase inNet Interest IncomeRate Change (Basis Points)
    
    Over 12 Months($ in thousands)100
    
    $
    (10,666
    )50
    
    
    (5,819
    )+ 50
    
    
    6,312+ 100
    
    
    12,636
   Amount
    
    
    Percentage ofOutstanding
    
    
    Total Portfolio($ in thousands)Loans with contractual interest rates:Exceeding the interest rate floor
    
    $
    4,003,808
    
    
    
    56
    %At the interest rate floor
    
    
    8,819
    
    
    
    Below the interest rate floor
    
    
    16,385
    
    
    
    Loans with no interest rate floor
    
    
    3,141,959
    
    
    
    44Total
    
    $
    7,170,971
    
    
    
    100
    %
  Residential Mortgage Investment Segment
   Market Risk Management
 48




---



##### 



Estimated Decrease in
    
    Percentage ofRate Change (Basis Points)
    
    Fair Value
    
    Total Segment Assets($ in thousands)100
    
    $
    (3,218
    )
    
    
    (0.06
    )%50
    
    
    (364
    )
    
    
    (0.01
    )+ 50
    
    
    (406
    )
    
    
    (0.01
    )+ 100
    
    
    (1,729
    )
    
    
    (0.03
    )
  Critical Accounting Policies
 Critical Accounting Policies Managements Discussion and Analysis of Financial Condition and Results of Operations
 Interest Income on Mortgage-Related Receivables and Mortgage-Backed Securities
 Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Assets Accounting for Certain Loans or Debt Securities Acquired in a
Transfer
  Mortgage-Related Receivables and Related Owner Trust Securitizations
  49




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##### 



Income Taxes
   50




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##### 



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Managements Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures about Market Risk Derivatives
and Off-Balance Sheet Financial Instruments
 ITEM 4. CONTROLS AND PROCEDURES
  51




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##### 



PART II. OTHER INFORMATION
 ITEM 1. LEGAL PROCEEDINGS
  ITEM 1A. RISK FACTORS
 Risk Factors
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  1. Election of Directors
 Nominee
    
    In Favor
    
    WithheldWilliam G. Byrnes
    
    
    137,810,915
    
    
    
    829,370John K. Delaney
    
    
    137,693,363
    
    
    
    946,922Sara L. Grootwassink
    
    
    137,408,280
    
    
    
    1,232,005Thomas F. Steyer
    
    
    130,116,861
    
    
    
    8,523,424
  Director
    
    Term EndsAndrew B. Fremder
    
    2007 Annual MeetingTully M. Friedman
    
    2007 Annual MeetingPaul R. Wood
    
    2007 Annual MeetingFrederick W. Eubank, II
    
    2008 Annual MeetingJason M. Fish
    
    2008 Annual MeetingTimothy M. Hurd
    
    2008 Annual MeetingDennis P. Lockhart
    
    2008 Annual Meeting
 52




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##### 



Ratification of Auditors
 In Favor
    
    Against
    
    Abstained137,640,821
    
    983,784
    
    15,669
 Amendment and Restatement of the Equity Incentive Plan
 In Favor
    
    Against
    
    Abstained114,365,593
    
    13,534,123
    
    29,696
 Amendment and Restatement of the Companys Charter to Establish Stock Ownership Limits
 In Favor
    
    Against
    
    Abstained127,243,845
    
    650,385
    
    35,186
 ITEM 5. OTHER INFORMATION
  ITEM 6. EXHIBITS
 (a) Exhibits
  53




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##### 



Signatures
  CAPITALSOURCE INC.Date: August 9, 2006
    /s/   JOHN K. DELANEYJohn K. DelaneyChairman of the Board and Chief Executive Officer
(Principal Executive Officer) Date: August 9, 2006
    /s/   THOMAS A. FINKThomas A. FinkChief Financial Officer
(Principal Financial Officer) 54




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##### 



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 Exhibit 3 to the registrants Registration Statement on
Form 8-A/A dated May 22, 2006).4.3
    
    Indenture dated as of October 30, 2002, by and between CapitalSource
Commercial Loan Trust 2002-2, as Issuer, and Wells Fargo Bank
Minnesota, National Association, as Indenture Trustee (incorporated by
reference to the same-numbered exhibit to the registrants Registration
Statement on Form S-1 (Reg. No. 333-106076)).4.4
    
    Indenture dated as of April 17, 2003, by and between CapitalSource
Commercial Loan Trust 2003-1, as Issuer, and Wells Fargo Bank
Minnesota, National Association, as Indenture Trustee (incorporated by
reference to the same-numbered exhibit to the registrants Registration
Statement on Form S-1 (Reg. No. 333-106076)).4.5
    
    Indenture dated as of September 17, 2003, between CapitalSource Funding
II Trust and Wells Fargo Bank Minnesota, National Association, as
Indenture Trustee (incorporated by reference to the same-numbered
exhibit to the registrants Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003).4.6
    
    Indenture dated as of November 25, 2003, by and between CapitalSource
Commercial Loan Trust 2003-2, as Issuer, and Wells Fargo Bank
Minnesota, National Association, as Indenture Trustee (incorporated by
reference to the same-numbered exhibit to the registrants Registration
Statement on Form S-1 (Reg. No. 333-112002)).4.7
    
    Indenture dated as of March 19, 2004, by and among CapitalSource Inc.,
as Issuer, U.S. Bank National Association, as Trustee, and
CapitalSource Holdings LLC and CapitalSource Finance LLC, as
Guarantors, including form of Senior Convertible Debenture Due 2034
(incorporated by reference to the same-numbered exhibit to the
registrants Quarterly Report on Form 10-Q for the quarter ended March
31, 2004).4.7.1
    
    First Supplemental Indenture dated as of October 18, 2004, by and among
the registrant, CapitalSource Holdings Inc. and CapitalSource Finance
LLC, as Guarantors, and U.S. Bank National Association, as Trustee
(incorporated by reference to Exhibit 4.1.1 to the registrants
Registration Statement on Form S-3 (Reg. No. 333-118744)).4.8
    
    Indenture dated as of June 22, 2004, by and among CapitalSource
Commercial Loan Trust 2004-1, as Issuer, and Wells Fargo Bank
Minnesota, National Association, as Indenture Trustee (incorporated by
reference to the same-numbered exhibit to the registrants Quarterly
Report on Form 10-Q for the quarter ended June 30, 2004).4.9
    
    Indenture dated as of October 28, 2004, by and between CapitalSource
Commercial Loan Trust 2004-2, as the Issuer, and Wells Fargo Bank,
National Association, as the Indenture Trustee (incorporated by
reference to the same-numbered exhibit to the registrants Current
Report on Form 8-K dated October 28, 2004).4.10
    
    Indenture dated as of July 7, 2004, by and among CapitalSource Inc., as
Issuer, U.S. Bank National Association, as Trustee, and CapitalSource
Holdings LLC and CapitalSource Finance LLC, as Guarantors, including
form of 3.5% Senior Convertible Debenture Due 2034 (incorporated by
reference to Exhibit 4.1 to the registrants Registration Statement on
Form S-3 (Reg. No. 333-118738)).4.10.1
    
    First Supplemental Indenture dated as of October 18, 2004, by and among
the registrant, CapitalSource Holdings Inc. and CapitalSource Finance
LLC, as Guarantors, and U.S. Bank National Association, as Trustee
(incorporated by reference to Exhibit 4.1.1 to the registrants
Registration Statement on Form S-3 (Reg. No. 333-118738)).4.11
    
    Indenture dated as of April 14, 2005, by and between CapitalSource
Commercial Loan Trust 2005-1, as the Issuer, and Wells Fargo Bank,
National Association, as the Indenture Trustee (incorporated by
reference to the same-numbered exhibit to the registrants Current
Report on Form 8-K dated April 20, 2005).4.12
    
    Junior Subordinated Indenture, dated as of November 21, 2005, among
CapitalSource Finance LLC, as Issuer, CapitalSource Inc., as Guarantor,
and Wilmington Trust Company, as Trustee (incorporated by reference to
the same-numbered exhibit to the registrants Annual Report on Form
10-K for the year ended December 31, 2005).4.13
    
    Junior Subordinated Indenture, dated as of December 14, 2005, among
CapitalSource Finance LLC, CapitalSource Inc. and JPMorgan Chase Bank,
National Association, as Trustee (incorporated by reference to the
same-numbered exhibit to the registrants Annual Report on Form 10-K
for the year ended December 31, 2005).4.14
    
    Indenture dated as of April 11, 2006, by and between CapitalSource
Commercial Loan Trust 2006-1, as the Issuer, and Wells Fargo Bank,
National Association, as the Indenture Trustee (incorporated by
reference to the same-numbered exhibit to the registrants Current
Report on Form 8-K dated April 17, 2006).
 55




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##### 



ExhibitNo
    
    Description4.15
    
    Junior Subordinated Indenture, dated as of February 22, 2006, among
CapitalSource Finance LLC, as Issuer, CapitalSource Inc., as Guarantor,
and JPMorgan Chase Bank, National Association, as Trustee (incorporated
by reference to the same-numbered exhibit to the registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2006).10.12*
    
    Third Amended and Restated Equity Incentive Plan.10.33*
    
    Summary of Non-employee Director Compensation (incorporated by
reference to the same-numbered exhibit to the registrants Current
Report on Form 8-K dated May 3, 2006).10.55
    
    Sale and Servicing Agreement, dated as of April 11, 2006, by and among
CapitalSource Commercial Loan Trust 2006-1, as the Issuer,
CapitalSource Commercial Loan LLC, 2006-1, as the Trust Depositor,
CapitalSource Finance LLC, as the Originator and as the Servicer, and
Wells Fargo Bank, National Association, as the Indenture Trustee and as
the Backup Servicer (incorporated by reference to the same-numbered
exhibit to the registrants Current Report on Form 8-K dated April 17,
2006).10.58*
    
    Employment Agreement, dated as of June 6, 2006, between CapitalSource
Inc. and John K. Delaney (incorporated by reference to Exhibit 10.1 to
the registrants Current Report on Form 8-K dated June 8, 2006).10.59*
    
    Employment Agreement, dated as of June 6, 2006, between CapitalSource
Inc. and Jason M. Fish (incorporated by reference to Exhibit 10.2 to
the registrants Current Report on Form 8-K dated June 8, 2006).10.60*
    
    Non-Qualified Option Agreement, dated as of June 6, 2006, between
CapitalSource Inc. and John K. Delaney (included as Exhibit A of the
Employment Agreement incorporated by reference to the registrants
Current Report on Form 8-K dated June 8, 2006).10.61*
    
    Non-Qualified Option Agreement, dated as of June 6, 2006, between
CapitalSource Inc. and John K. Delaney (included as Exhibit B of the
Employment Agreement incorporated by reference to the registrants
Current Report on Form 8-K dated June 8, 2006).10.62*
    
    Non-Qualified Option Agreement, dated as of June 6, 2006, between
CapitalSource Inc. and Jason M. Fish (included as Exhibit A of the
Employment Agreement incorporated by reference to the registrants
Current Report on Form 8-K dated June 8, 2006).10.63
    
    Sale and Servicing Agreement, dated as of June 30, 2006, by and among
CSE QRS Funding II LLC, as Seller, CSE Mortgage LLC, as Originator and
Servicer, Citigroup Global Markets Realty Corp., as the Administrative
Agent and as the Citigroup Agent, and Wells Fargo Bank, National
Association, as the Backup Servicer and Collateral Custodian
(incorporated by reference to the same-numbered exhibit to the
registrants Current Report on Form 8-K dated July 7, 2006).10.64
    
    Sale and Contribution Agreement, dated as of June 30, 2006, between QRS
Funding II LLC, as Buyer, and CSE Mortgage LLC, as Seller (incorporated
by reference to the same-numbered exhibit to the registrants Current
Report on Form 8-K dated July 7, 2006).10.65
    
    Amended and Restated Sale and Servicing Agreement, dated as of July 28,
2006, among CSE QRS Funding II LLC, as Seller, CSE Mortgage LLC, as
Originator and Servicer, Citigroup Global Markets Realty Corp., as
Administrative Agent and as Citigroup Agent, Wells Fargo Bank, National
Association, as Backup Servicer and Collateral Custodian, MICA Funding,
LLC as a Purchaser and Swiss Re Financial Products Corporation as
Micas Purchaser Agent (incorporated by reference to the same-numbered
exhibit to the registrants Current Report on Form 8-K dated August 3,
2006).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. 56