##### Table of Contents



UNITED STATES SECURITIES AND
    EXCHANGE COMMISSIONWashington, D.C.
    20549
  Form 10-Q
  QUARTERLY REPORT PURSUANT TO
    SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended September 30, 2007
  Commission File
    No. 1-31753
  CapitalSource Inc.
 (Exact name of registrant as
    specified in its charter)
   Delaware(State of
    Incorporation)

35-2206895(I.R.S. Employer
    Identification No.)    4445 Willard Avenue, 12th Floor
    Chevy Chase, MD 20815 (Address of Principal
    Executive Offices, Including Zip Code)
  (800) 370-9431 (Registrants Telephone
    Number, Including Area Code)
   þ o
  Rule 12b-2 þ o o
  Rule 12b-2 o þ




---



##### 



TABLE OF
    CONTENTS
  PagePART I. FINANCIAL INFORMATIONItem 1.


Financial StatementsConsolidated Balance Sheets as of
    September 30, 2007 (unaudited) and December 31,
    2006


3Consolidated Statements of Income (unaudited) for
    the three and nine months ended September 30, 2007 and
    2006


4Consolidated Statement of Shareholders
    Equity (unaudited) for the nine months ended September 30,
    2007


5Consolidated Statements of Cash Flows (unaudited)
    for the nine months ended September 30, 2007 and 2006


6Notes to the Unaudited Consolidated Financial
    Statements


7Item 2.


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


35Item 3.


Quantitative and Qualitative Disclosures about
    Market Risk


61Item 4.


Controls and Procedures


61PART II. OTHER INFORMATIONItem 1A.


Risk Factors


62Item 2.


Unregistered Sales of Equity Securities and Use
    of Proceeds


62Item 6.


Exhibits


62Signatures


63Index to Exhibits


64EX-3.2EX-4.20Exhibit 4.20.1EX-10.33EX-12.1EX-31.1EX-31.2EX-32   2




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##### Table of Contents



CapitalSource
    Inc.
  Consolidated
    Balance Sheets
  September 30,


December 31,2007


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

$
245,862


$
396,151Restricted cash


296,789



240,904Mortgage-related receivables, net


2,092,553



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


4,159,037



3,502,753Receivables under reverse-repurchase agreements


26,157



51,892Loans held for sale


352,030



26,521Loans:Loans


9,251,283



7,771,785Less deferred loan fees and discounts


(132,673
)


(130,392
)Less allowance for loan losses


(111,692
)


(120,575
)Loans, net


9,006,918



7,520,818Direct real estate investments, net


1,031,905



722,303Investments


190,104



184,333Other assets


351,329



268,977Total assets

$
17,752,684


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

$
4,030,477


$
3,510,768Credit facilities


2,701,685



2,251,658Term debt


6,550,232



5,809,685Other borrowings


1,612,258



1,288,575Other liabilities


322,477



200,498Total liabilities


15,217,129



13,061,184Noncontrolling interests


45,490



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






Common stock ($0.01 par value, 500,000,000 shares
    authorized; 208,540,632 and 182,752,290 shares issued,
    respectively; 208,540,632 and 181,452,290 shares
    outstanding, respectively)


2,085



1,815Additional paid-in capital


2,664,842



2,139,421Accumulated deficit


(181,336
)


(20,735
)Accumulated other comprehensive income, net


4,474



2,465Treasury stock, at cost






(29,926
)Total shareholders equity


2,490,065



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

$
17,752,684


$
15,210,574    3




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##### Table of Contents



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


Nine Months Ended September 30,2007


2006


2007


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

$
344,043


$
280,066


$
944,781


$
731,601Fee income


29,338



53,955



124,421



132,100Total interest and fee income


373,381



334,021



1,069,202



863,701Operating lease income


27,490



7,855



69,934



19,174Total investment income


400,871



341,876



1,139,136



882,875Interest expense


232,754



170,118



619,694



421,818Net investment income


168,117



171,758



519,442



461,057Provision for loan losses


12,353



24,849



44,690



51,033Net investment income after provision for loan losses


155,764



146,909



474,752



410,024Operating expenses:Compensation and benefits


38,309



33,924



116,937



101,374Other administrative expenses


26,824



19,307



79,961



56,167Total operating expenses


65,133



53,231



196,898



157,541Other income (expense):Diligence deposits forfeited


1,465



598



4,141



3,968(Loss) gain on investments, net


(1,984
)


7,223



21,181



5,483(Loss) gain on derivatives


(15,494
)


(5,074
)


(14,596
)


1,576(Loss) gain on residential mortgage investment portfolio


(30,225
)


2,291



(49,769
)


220Other income, net of expenses


(3,389
)


5,700



16,545



11,131Total other income


(49,627
)


10,738



(22,498
)


22,378Noncontrolling interests expense


1,182



1,259



3,784



3,350Net income before income taxes and cumulative effect of
    accounting change


39,822



103,157



251,572



271,511Income taxes


11,557



22,304



60,251



52,945Net income before cumulative effect of accounting change


28,265



80,853



191,321



218,566Cumulative effect of accounting change, net of taxes














370Net income

$
28,265


$
80,853


$
191,321


$
218,936Net income per share:Basic

$
0.15


$
0.47


$
1.03


$
1.34Diluted

$
0.15


$
0.47


$
1.02


$
1.32Average shares outstanding:Basic


191,976,931



171,777,989



185,522,634



163,373,576Diluted


193,607,986



173,354,891



187,636,502



166,028,844Dividends declared per share

$
0.60


$
0.49


$
1.78


$
1.47    4




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##### Table of Contents



CapitalSource
    Inc.
  Consolidated Statement of Shareholders
    Equity
  AccumulatedAdditional





Other


Treasury


TotalCommon


Paid-In


Accumulated


Comprehensive


Stock,


ShareholdersStock


Capital


Deficit


Income, Net


at Cost


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

$
1,815


$
2,139,421


$
(20,735
)

$
2,465


$
(29,926
)

$
2,093,040Net income










191,321











191,321Other comprehensive income:Unrealized gains, net of tax














2,009







2,009Total comprehensive income






















193,330Cumulative effect of adoption of FIN 48










(5,702
)










(5,702
)Dividends paid






7,412



(346,220
)










(338,808
)Issuance of common stock, net


258



488,828











29,926



519,012Stock option expense






5,694















5,694Exercise of options


3



4,690















4,693Restricted stock activity


9



14,070















14,079Beneficial conversion option on convertible debt






2,373















2,373Tax benefit on exercise of options






1,098















1,098Tax benefit on vesting of restricted stock grants






1,256















1,256Total shareholders equity as of September 30, 2007

$
2,085


$
2,664,842


$
(181,336
)

$
4,474






$
2,490,065    5




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##### Table of Contents



CapitalSource
    Inc.
  Consolidated Statements of Cash Flows
  Nine Months Ended September 30,2007


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

$
191,321


$
218,936Adjustments to reconcile net income to net cash (used in)
    provided by operating activities:Stock option expense


5,694



6,462Restricted stock expense


26,214



18,530Loss on extinguishment of debt






2,497Non-cash prepayment fee






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






(370
)Amortization of deferred loan fees and discounts


(66,844
)


(65,808
)Paid-in-kind
    interest on loans


(19,697
)


(7,021
)Provision for loan losses


44,689



51,033Amortization of deferred financing fees and discounts


31,262



28,551Depreciation and amortization


26,367



9,604Benefit for deferred income taxes


(3,741
)


(9,453
)Non-cash loss on investments, net


6,980



5,510Non-cash loss (gain) on property and equipment disposals


559



(472
)Unrealized loss (gain) on derivatives and foreign currencies, net


10,302



(195
)Unrealized loss on residential mortgage investment portfolio, net


60,310



8,702Net increase in mortgage-backed securities pledged, trading


(633,729
)


(331,767
)Amortization of discount on residential mortgage investments


(29,862
)


(22,786
)Increase in loans held for sale, net


(524,127
)


(60,154
)(Increase) decrease in other assets


(68,493
)


65,211Increase in other liabilities


73,904



35,423Cash used in operating activities


(868,891
)


(55,920
)Investing activities:Increase in restricted cash


(55,885
)


(78,164
)Decrease (increase) in mortgage-related receivables, net


216,333



(2,391,783
)Decrease (increase) in receivables under reverse-repurchase
    agreements, net


25,735



(19,663
)Increase in loans, net


(1,256,925
)


(1,365,905
)Acquisition of real estate, net of cash acquired


(253,182
)


(66,375
)Acquisition of investments, net


(36,642
)


(22,978
)Acquisition of property and equipment, net


(4,337
)


(2,780
)Cash used in investing activities


(1,364,903
)


(3,947,648
)Financing activities:Payment of deferred financing fees


(35,421
)


(37,874
)Borrowings under repurchase agreements, net


519,709



269,867Borrowings on credit facilities, net


448,281



507,538Borrowings of convertible debt


245,151



Borrowings of term debt


1,859,927



4,495,533Repayments of term debt


(1,201,986
)


(1,229,379
)Borrowings of subordinated debt


75,629



131,685Proceeds from issuance of common stock, net of offering costs


507,479



498,931Proceeds from exercise of options


4,693



5,283Tax benefits on share-based payments


2,354



3,311Payment of dividends


(342,311
)


(314,080
)Cash provided by financing activities


2,083,505



4,330,815(Decrease) increase in cash and cash equivalents


(150,289
)


327,247Cash and cash equivalents as of beginning of period


396,151



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

$
245,862


$
651,143Noncash transactions from investing and financing
    activities:Issuance of common stock in connection with dividends and real
    estate acquisition

$



$
309,736Conversion of noncontrolling interests into common stock


11,533



Acquisition of real estate


110,675



Assumption of term debt


71,027



Assumption of intangible lease liability


28,554



Real estate acquired through foreclosure


12,791



   6




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##### Table of Contents



CapitalSource
    Inc.
  NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS
  Note 1.  Organization
    
    First Mortgage Loans  Commercial loans that are
    secured by first mortgages on the property of the client;
    Senior Secured Asset-Based Loans  Commercial loans
    that are underwritten based on our assessment of the
    clients eligible collateral, including accounts
    receivable, real estate related receivables
    and/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 term loans in right of payment or upon
    liquidation;
    Direct Real Estate Investments  Commercial
    investments primarily in land and buildings, that are leased to
    clients through the execution of long-term,
    triple-net
    operating leases;
    Equity 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 and residential mortgage-backed
    securities that constitute qualifying REIT assets.      Note 2.  Summary
    of Significant Accounting Policies
  Unaudited
    Interim Consolidated Financial Statements Basis of
    Presentation
  Form 10-Q Regulation S-X. Form 10-K Form 10-K).
   7




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##### Table of Contents



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




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##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  The
    Fair Value Option for Financial Assets and Financial Liabilities
  No. 06-11, Accounting for Income Tax Benefits of Dividends on
    Share-Based Payment Awards (EITF 06-11), EITF 06-11 EITF 06-11 EITF 06-11
  Note 4.
    Mortgage-Related
    Receivables and Related Owners
    Trust Securitizations  Consolidation of Variable Interest
    Entities  An Interpretation of ARB No. 51
        Note 5.
    Residential
    Mortgage-Backed Securities and Certain Derivative
    Instruments   9




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##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Investments.
        Note 6.
    Commercial
    Loans and Credit Quality   10




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##### Table of Contents



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


December 31,2007


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

$
71,664


$
88,067Non-accrual loans(1)


169,390



183,483Impaired loans(2)


332,716



281,377Less: loans in multiple categories


(221,553)



(230,469)Total

$
352,217


$
322,458Total as a percentage of total loans


3.66%



4.11%     (1)
    
    Includes commercial loans with an aggregate principal balance of
    $21.0 million and $47.0 million as of
    September 30, 2007 and December 31, 2006,
    respectively, which were also classified as loans 60 or more
    days contractually delinquent. Includes non-performing loans
    classified as held for sale that have an aggregate principal
    balance of $3.0 million as of September 30, 2007. As
    of December 31, 2006, there were no loans classified as
    held for sale that were placed on non-accrual status.(2)
    
    Includes commercial loans with an aggregate principal balance of
    $55.1 million and $47.0 million as of
    September 30, 2007 and December 31, 2006,
    respectively, which were also classified as loans 60 or more
    days contractually delinquent, and commercial loans with an
    aggregate principal balance of $166.4 million and
    $183.5 million as of September 30, 2007 and
    December 31, 2006, respectively, which were also placed on
    non-accrual status. The carrying values of impaired commercial
    loans were $326.1 million and $275.3 million as of
    September 30, 2007 and December 31, 2006, respectively.  Accounting by Creditors for Impairment of a Loan
   11




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##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Accounting for Debtors and Creditors
    for Troubled Debt Restructuring
    Nine Months Ended September 30,2007


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

$
120,575


$
87,370Provision for loan losses


44,460



50,732Charge offs, net


(51,671
)


(35,443
)Transfers to held for sale


(1,672
)


Balance as of end of period

$
111,692


$
102,659   Note 7.
    Investments    September 30,


December 31,2007


2006($ in thousands)Investments carried at cost

$
81,270


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


32,490



61,904Warrants


8,093



6,908Investments accounted for under the equity method


68,251



44,135Total

$
190,104


$
184,333   No. 99-20, Recognition of Interest Income on Purchased Beneficial
    Interests and Beneficial Interests that Continue to Be Held by a
    Transferor in Securitized Financial Assets.
 12




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##### Table of Contents



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




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##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Balance Sheet
    September 30, 2007
  CapitalSource Finance LLCCombined


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$



$
124,507


$
44,321


$
77,034


$



$
245,862Restricted cash






34,942



89,981



171,866







296,789Mortgage-related receivables, net














2,092,553







2,092,553Mortgage-backed securities pledged, trading














4,159,037







4,159,037Receivables under reverse-repurchase agreements






26,157















26,157Loans held for sale






16,356



2,800



332,874







352,030Loans:Loans






4,586,465



624,320



4,040,925



(427
)


9,251,283Less deferred loan fees and discounts






(35,652
)


(56,529
)


(40,492
)






(132,673
)Less allowance for loan losses










(88,090
)


(23,602
)






(111,692
)Loans, net






4,550,813



479,701



3,976,831



(427
)


9,006,918Direct real estate investments, net














1,031,905







1,031,905Investment in subsidiaries


3,600,457







1,095,877



1,234,996



(5,931,330
)


Intercompany due from (due to)


7,314







(8,899
)


1,585







Intercompany note receivable


75,000







128,318







(203,318
)


Investments






132,972



31,930



25,202







190,104Other assets


32,851



37,806



95,711



218,737



(33,776
)


351,329Total assets

$
3,715,622


$
4,923,553


$
1,959,740


$
13,322,620


$
(6,168,851
)

$
17,752,684Liabilities, noncontrolling interests and shareholders
    equityLiabilities:Repurchase agreements

$



$
38,100


$



$
3,992,377


$



$
4,030,477Credit facilities


410,238



1,487,993



110,033



693,421







2,701,685Term debt






2,282,875



6,131



4,261,647



(421
)


6,550,232Other borrowings


797,777







529,044



285,437







1,612,258Other liabilities


17,542



18,677



79,536



240,504



(33,782
)


322,477Intercompany note payable














203,318



(203,318
)


Total liabilities


1,225,557



3,827,645



724,744



9,676,704



(237,521
)


15,217,129Noncontrolling interests






47







45,459



(16
)


45,490Shareholders equity:Preferred stock






















Common stock


2,085



















2,085Additional paid-in capital


2,664,842



538,927



203,099



3,093,276



(3,835,302
)


2,664,842(Accumulated deficit) retained earnings


(181,336
)


551,977



1,026,677



502,406



(2,081,060
)


(181,336
)Accumulated other comprehensive income, net


4,474



4,957



5,220



4,775



(14,952
)


4,474Treasury stock, at cost










































Total shareholders equity


2,490,065



1,095,861



1,234,996



3,600,457



(5,931,314
)


2,490,065Total liabilities, noncontrolling interests and
    shareholders equity

$
3,715,622


$
4,923,553


$
1,959,740


$
13,322,620


$
(6,168,851
)

$
17,752,684  14




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##### Table of Contents



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


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
157


$
238,224


$
46,723


$
111,047


$



$
396,151Restricted cash






55,631



122,655



62,618







240,904Mortgage-related receivables, net














2,295,922







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














3,502,753







3,502,753Receivables under reverse-repurchase agreements






51,892















51,892Loans held for sale






26,521















26,521Loans:Loans


52



4,050,786



762,653



2,968,938



(10,644
)


7,771,785Less deferred loan fees and discounts






(33,348
)


(58,203
)


(38,841
)






(130,392
)Less allowance for loan losses










(101,938
)


(18,637
)






(120,575
)Loans, net


52



4,017,438



602,512



2,911,460



(10,644
)


7,520,818Direct real estate investments, net














722,303







722,303Investment in subsidiaries


3,030,807







926,709



1,133,651



(5,091,167
)


Intercompany (due to) due from


(98,737
)






(138,447
)


237,184







Intercompany note receivable


75,000



2,137



11,194







(88,331
)


Investments






118,380



31,710



34,243







184,333Other assets


20,770



25,741



61,024



187,088



(25,646
)


268,977Total assets

$
3,028,049


$
4,535,964


$
1,664,080


$
11,198,269


$
(5,215,788
)

$
15,210,574Liabilities, noncontrolling interests and shareholders
    equityLiabilities:Repurchase agreements

$



$
63,260


$



$
3,447,508


$



$
3,510,768Credit facilities


355,685



998,972







897,000







2,251,657Term debt






2,504,472



10,729



3,295,558



(1,074
)


5,809,685Other borrowings


555,000







446,393



287,183







1,288,576Other liabilities


24,324



29,220



73,307



108,863



(35,216
)


200,498Intercompany note payable






13,331







75,000



(88,331
)


Total liabilities


935,009



3,609,255



530,429



8,111,112



(124,621
)


13,061,184Noncontrolling interests






8







56,350



(8
)


56,350Shareholders equity:Preferred stock






















Common stock


1,815



















1,815Additional paid-in capital


2,139,421



564,687



272,828



2,777,426



(3,614,941
)


2,139,421(Accumulated deficit) retained earnings


(20,735
)


359,678



857,927



250,613



(1,468,218
)


(20,735
)Accumulated other comprehensive income, net


2,465



2,336



2,896



2,768



(8,000
)


2,465Treasury stock, at cost


(29,926
)


















(29,926
)Total shareholders equity


2,093,040



926,701



1,133,651



3,030,807



(5,091,159
)


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

$
3,028,049


$
4,535,964


$
1,664,080


$
11,198,269


$
(5,215,788
)

$
15,210,574  15




---



##### Table of Contents



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


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
1,616


$
125,781


$
21,674


$
198,732


$
(3,760
)

$
344,043Fee income






11,901



9,554



7,883







29,338Total interest and fee income


1,616



137,682



31,228



206,615



(3,760
)


373,381Operating lease income














27,490







27,490Total investment income


1,616



137,682



31,228



234,105



(3,760
)


400,871Interest expense


17,464



63,354



11,594



144,102



(3,760
)


232,754Net investment (loss) income


(15,848
)


74,328



19,634



90,003







168,117Provision for loan losses










11,264



1,089







12,353Net investment (loss) income after provision for loan losses


(15,848
)


74,328



8,370



88,914







155,764Operating expenses:Compensation and benefits


93



6,260



31,935



21







38,309Other administrative expenses


10,665



1,482



12,550



11,454



(9,327
)


26,824Total operating expenses


10,758



7,742



44,485



11,475



(9,327
)


65,133Other income (expense):Diligence deposits forfeited










1,465











1,465Gain (loss) on investments, net






1,553



(3,537
)










(1,984
)Gain (loss) on derivatives






2,232



3,234



(20,960
)






(15,494
)Loss on residential mortgage investment portfolio














(30,225
)






(30,225
)Other income, net of expenses






4,799



1,755



(616
)


(9,327
)


(3,389
)Earnings in subsidiaries


54,871







71,335



41,991



(168,197
)


Intercompany






(3,854
)


3,854











Total other income


54,871



4,730



78,106



(9,810
)


(177,524
)


(49,627
)Noncontrolling interests expense






(16
)






1,201



(3
)


1,182Net income before income taxes


28,265



71,332



41,991



66,428



(168,194
)


39,822Income taxes














11,557







11,557Net income

$
28,265


$
71,332


$
41,991


$
54,871


$
(168,194
)

$
28,265  16




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Three Months Ended September 30, 2006
  CapitalSource Finance LLCCombined


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
3


$
98,673


$
33,637


$
148,195


$
(442
)

$
280,066Fee income






28,171



4,528



21,256







53,955Total interest and fee income


3



126,844



38,165



169,451



(442
)


334,021Operating lease income














7,855







7,855Total investment income


3



126,844



38,165



177,306



(442
)


341,876Interest expense


11,382



55,564



5,527



98,087



(442
)


170,118Net investment (loss) income


(11,379
)


71,280



32,638



79,219







171,758Provision for loan losses










25,551



(702
)






24,849Net investment (loss) income after provision for loan losses


(11,379
)


71,280



7,087



79,921







146,909Operating expenses:Compensation and benefits






1,218



32,706











33,924Other administrative expenses


3,998



802



14,138



4,150



(3,781
)


19,307Total operating expenses


3,998



2,020



46,844



4,150



(3,781
)


53,231Other income (expense):Diligence deposits forfeited






(128
)


726











598Gain on investments, net










7,223











7,223(Loss) gain on derivatives






(1,656
)


874



(4,292
)






(5,074
)Gain on residential mortgage investment portfolio














2,291







2,291Other income, net of expenses






4,411



4,985



85



(3,781
)


5,700Earnings in subsidiaries


96,230







51,781



45,911



(193,922
)


Intercompany






(20,079
)


20,079











Total other income (expense)


96,230



(17,452
)


85,668



43,995



(197,703
)


10,738Noncontrolling interests expense






29







1,232



(2
)


1,259Net income before income taxes and cumulative effect of
    accounting change


80,853



51,779



45,911



118,534



(193,920
)


103,157Income taxes














22,304







22,304Net income before cumulative effect of accounting change


80,853



51,779



45,911



96,230



(193,920
)


80,853Cumulative effect of accounting change, net of taxes






















Net income

$
80,853


$
51,779


$
45,911


$
96,230


$
(193,920
)

$
80,853  17




---



##### Table of Contents



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


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
10,688


$
357,968


$
71,068


$
519,299


$
(14,242
)

$
944,781Fee income






54,659



42,860



26,902







124,421Total interest and fee income


10,688



412,627



113,928



546,201



(14,242
)


1,069,202Operating lease income














69,934







69,934Total investment income


10,688



412,627



113,928



616,135



(14,242
)


1,139,136Interest expense


37,870



178,760



34,644



382,662



(14,242
)


619,694Net investment (loss) income


(27,182
)


233,867



79,284



233,473







519,442Provision for loan losses










39,310



5,380







44,690Net investment (loss) income after provision for loan losses


(27,182
)


233,867



39,974



228,093







474,752Operating expenses:Compensation and benefits


951



17,027



98,938



21







116,937Other administrative expenses


38,044



4,592



42,856



29,036



(34,567
)


79,961Total operating expenses


38,995



21,619



141,794



29,057



(34,567
)


196,898Other income (expense):Diligence deposits forfeited










4,141











4,141Gain (loss) on investments, net






21,182



(1
)










21,181(Loss) gain on derivatives






2,197



(583
)


(16,210
)






(14,596
)Loss on residential mortgage investment portfolio














(49,769
)






(49,769
)Other income, net of expenses






13,371



38,555



(814
)


(34,567
)


16,545Earnings in subsidiaries


257,498







241,935



189,260



(688,693
)


Intercompany






(7,033
)


7,033











Total other income


257,498



29,717



291,080



122,467



(723,260
)


(22,498
)Noncontrolling interests expense






38







3,754



(8
)


3,784Net income before income taxes


191,321



241,927



189,260



317,749



(688,685
)


251,572Income taxes














60,251







60,251Net income

$
191,321


$
241,927


$
189,260


$
257,498


$
(688,685
)

$
191,321  18




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Income
    Nine Months Ended September 30, 2006
  CapitalSource Finance LLCCombined


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
552


$
330,482


$
65,560


$
337,310


$
(2,303
)

$
731,601Fee income






104,902



(19,488
)


46,686







132,100Total interest and fee income


552



435,384



46,072



383,996



(2,303
)


863,701Operating lease income














19,174







19,174Total investment income


552



435,384



46,072



403,170



(2,303
)


882,875Interest expense


24,335



161,020



18,060



220,706



(2,303
)


421,818Net investment (loss) income


(23,783
)


274,364



28,012



182,464







461,057Provision for loan losses










43,304



7,729







51,033Net investment (loss) income after provision for loan losses


(23,783
)


274,364



(15,292
)


174,735







410,024Operating expenses:Compensation and benefits






3,524



97,850











101,374Other administrative expenses


11,340



2,039



42,488



11,200



(10,900
)


56,167Total operating expenses


11,340



5,563



140,338



11,200



(10,900
)


157,541Other income (expense):Diligence deposits forfeited






(128
)


4,096











3,968Gain on investments, net










5,483











5,483(Loss) gain on derivatives






(621
)


2,112



85







1,576Gain on residential mortgage investment portfolio














220







220Other income, net of expenses


76



4,729



19,723



(2,497
)


(10,900
)


11,131Earnings in subsidiaries


253,983







239,349



148,912



(642,244
)


Intercompany






(33,409
)


33,409











Total other income (expense)


254,059



(29,429
)


304,172



146,720



(653,144
)


22,378Noncontrolling interests expense






29







3,327



(6
)


3,350Net income before income taxes and cumulative effect of
    accounting change


218,936



239,343



148,542



306,928



(642,238
)


271,511Income taxes














52,945







52,945Net income before cumulative effect of accounting change


218,936



239,343



148,542



253,983



(642,238
)


218,566Cumulative effect of accounting change, net of taxes










370











370Net income

$
218,936


$
239,343


$
148,912


$
253,983


$
(642,238
)

$
218,936  19




---



##### Table of Contents



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


Combined


Other Non-Non-Guarantor


Guarantor


Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
191,321


$
241,927


$
189,260


$
257,498


$
(688,685
)

$
191,321Adjustments to reconcile net income to net cash used in
    operating activities:Stock option expense






344



5,350











5,694Restricted stock expense






3,136



23,078











26,214Amortization of deferred loan fees and discounts






(18,526
)


(27,597
)


(20,721
)






(66,844
)Paid-in-kind
    interest on loans






(4,747
)


(11,163
)


(3,787
)






(19,697
)Provision for loan losses










39,310



5,379







44,689Amortization of deferred financing fees and discounts


2,885



11,173



349



16,855







31,262Depreciation and amortization






236



2,456



23,675







26,367Benefit for deferred income taxes














(3,741
)






(3,741
)Non-cash loss on investments, net






3,232



3,748











6,980Non-cash (gain) loss on property and equipment disposals






(1,347
)


766



1,140







559Unrealized loss (gain) on derivatives and foreign currencies, net






(6,569
)


15,392



1,479







10,302Unrealized loss on residential mortgage investment portfolio, net














60,310







60,310Net increase in mortgage-backed securities pledged, trading














(633,729
)






(633,729
)Amortization of discount on residential mortgage investments














(29,862
)






(29,862
)Increase in loans held for sale, net






(114,487
)


(38,435
)


(371,205
)






(524,127
)Decrease (increase) in intercompany note receivable






2,137



(117,124
)






114,987



(Increase) decrease in other assets


(13,683
)


249



(20,387
)


(42,802
)


8,130



(68,493
)(Decrease) increase in other liabilities


(7,072
)


(10,253
)


(8,685
)


98,480



1,434



73,904Net transfers with subsidiaries


(645,444
)


(77,536
)


(407,115
)


441,410



688,685



Cash used in operating activities


(471,993
)


28,969



(350,797
)


(199,621
)


124,551



(868,891
)Investing activities:Decrease (increase) in restricted cash






20,689



32,674



(109,248
)






(55,885
)Decrease in mortgage-related receivables, net














216,333







216,333Decrease in receivables under reverse-repurchase agreements, net






25,735















25,735Increase in loans, net


52



(381,974
)


142,708



(1,007,494
)


(10,217
)


(1,256,925
)Acquisition of real estate, net of cash acquired














(253,182
)






(253,182
)Acquisition of investments, net






(16,787
)


(1,394
)


(18,461
)






(36,642
)Disposal (acquisition) of property and equipment, net






33



(4,370
)










(4,337
)Cash used in investing activities


52



(352,304
)


169,618



(1,172,052
)


(10,217
)


(1,364,903
)Financing activities:Payment of deferred financing fees


(1,283
)


(19,211
)


(2,287
)


(12,640
)






(35,421
)(Decrease) increase in intercompany note payable






(13,331
)






128,318



(114,987
)


(Repayments of) borrowings under repurchase agreements, net






(25,160
)






544,869







519,709Borrowings on (repayments of) credit facilities, net


54,552



489,021



110,033



(205,325
)






448,281Borrowings of convertible debt


245,151



















245,151Borrowings of term debt






737,347



232



1,121,695



653



1,859,927Repayments of term debt






(959,048
)


(4,830
)


(238,108
)






(1,201,986
)Borrowings of subordinated debt










75,629











75,629Proceeds from issuance of common stock, net of offering costs


507,479



















507,479Proceeds from exercise of options


4,693



















4,693Tax benefits on share based payments














2,354







2,354Payment of dividends


(338,808
)










(3,503
)






(342,311
)Cash provided by financing activities


471,784



209,618



178,777



1,337,660



(114,334
)


2,083,505Decrease in cash and cash equivalents


(157
)


(113,717
)


(2,402
)


(34,013
)






(150,289
)Cash and cash equivalents as of beginning of period


157



238,224



46,723



111,047







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

$



$
124,507


$
44,321


$
77,034


$



$
245,862  20




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidating
    Statement of Cash Flows
    Nine Months Ended September 30, 2006
  CapitalSource Finance LLCCombined





Other NonNon-Guarantor


Combined Guarantor


-Guarantor





ConsolidatedCapitalSource Inc.


Subsidiaries


Subsidiaries


Subsidiaries


Eliminations


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

$
218,936


$
239,343


$
148,912


$
253,983


$
(642,238
)

$
218,936Adjustments to reconcile net income to net cash (used in)
    provided by operating activities:Stock option expense






55



6,407











6,462Restricted stock expense






450



18,080











18,530Loss on extinguishment of debt














2,497







2,497Non-cash prepayment fee










(8,353
)










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










(370
)










(370
)Amortization of deferred loan fees






(33,534
)


6,936



(39,210
)






(65,808
)Interest on
    paid-in-kind
    loans






6,365



(11,373
)


(2,013
)






(7,021
)Provision for loan losses










43,304



7,729







51,033Amortization of deferred financing fees and discounts


2,284



16,750



331



9,186







28,551Depreciation and amortization






34



2,220



7,350







9,604Benefit for deferred income taxes














(9,453
)






(9,453
)Non-cash loss on investments, net










5,510











5,510Non-cash (gain) loss on property and equipmnt disposals






(740
)


268











(472
)Loss (gain) on derivatives






678



(844
)


(29
)






(195
)Unrealized loss on residential mortgage investment portfolio














8,702







8,702Net increase in mortgage-backed securities pledged, trading














(331,767
)






(331,767
)Amortization of discount on residential mortgage investments














(22,786
)






(22,786
)Decrease (increase) in loans held for sale, net






2,346



(62,500
)










(60,154
)Decrease in intercompany note receivable






5,284



23,380







(28,664
)


Decrease (increase) in other assets


20,110



(817
)


(4,586
)


38,705



11,799



65,211Increase in other liabilities


11,977



821



29,876



5,896



(13,147
)


35,423Net transfers with subsidiaries


(923,633
)


(96,974
)


(88,451
)


466,820



642,238



Cash (used in) provided by operating activities


(670,326
)


140,061



108,747



395,610



(30,012
)


(55,920
)Investing activities:Decrease (increase) in restricted cash






17,502



(49,955
)


(45,711
)






(78,164
)Increase in mortgage-related receivables, net














(2,391,783
)






(2,391,783
)Increase in receivables under reverse-repurchase agreements, net






(19,663
)














(19,663
)Decrease (increase) in loans, net






75,404



(301,032
)


(1,142,428
)


2,151



(1,365,905
)Acquisition of real estate, net of cash acquired














(66,375
)






(66,375
)Disposal (acquisition) of investments, net


33,683



(26,835
)


(10,114
)


(19,712
)






(22,978
)Acquisition of property and equipment, net






(605
)


(2,175
)










(2,780
)Cash provided by (used in) investing activities


33,683



45,803



(363,276
)


(3,666,009
)


2,151



(3,947,648
)Financing activities:Payment of deferred financing fees


(3,026
)


(18,922
)


(3,526
)


(12,400
)






(37,874
)Decrease in intercompany note payable


(20,327
)


(8,337
)










28,664



Borrowings under repurchase agreements, net






13,273







256,594







269,867Borrowings on unsecured credit facilities, net


465,000



















465,000(Repayments of) borrowings on secured credit facilities, net






(1,128,462
)






1,171,000







42,538Borrowings of term debt






2,044,066



4,400



2,447,870



(803
)


4,495,533Repayments of term debt






(1,063,398
)


(49
)


(165,932
)






(1,229,379
)Borrowings of subordinated debt










131,685











131,685Proceeds from issuance of common stock, net of offering costs


498,931



















498,931Proceeds from exercise of options


5,283



















5,283Tax benefits on share-based payments














3,311







3,311Payment of dividends


(311,256
)










(2,824
)






(314,080
)Cash provided by (used in) financing activities


634,605



(161,780
)


132,510



3,697,619



27,861



4,330,815(Decrease) increase in cash and cash equivalents


(2,038
)


24,084



(122,019
)


427,220







327,247Cash 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

$



$
169,149


$
34,552


$
447,442


$



$
651,143  21




---



##### Table of Contents



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


December 31,2007


2006($ in thousands)Land

$
110,519


$
91,543Buildings


904,182



607,833Furniture


51,747



34,395Accumulated depreciation


(34,543
)


(11,468
)Total

$
1,031,905


$
722,303     Note 10.
    Borrowings  Borrowings Form 10-K.
  Repurchase
    Agreements
    Credit
    Facilities
   22




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
                 23




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Term
    Debt
  series 2004-2
    series 2003-2 2005-1
    Other
    Borrowings
    September 30,


December 31,2007


2006($ in thousands)Subordinated debt

$
529,044


$
446,393Convertible debt


797,778



555,000Mortgage debt


285,436



287,182Total

$
1,612,258


$
1,288,575   Subordinated
    Debt
  2007-1 (2007-1 2007-1 2007-1 2007-1 2007-1
  2007-1 2007-1 2007-1
  2007-2 (2007-2 2007-2 2007-2 2007-2
 24




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  2007-2
  2007-2 2007-2
  Convertible
    Debt
    AmountOutstanding


AmountPrior


Outstandingto Exchange


at Completion ofSecurities

Offers


Exchange Offers($ in thousands)3.50% Senior Convertible Notes due 2034

$
330,000


$
8,4461.25% Senior Convertible Notes due 2034


225,000



47,6204.00% Senior Subordinated Convertible Notes due 2034






321,5541.625% Senior Subordinated Convertible Notes due 2034






177,380Total

$
555,000


$
555,000        25




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    EITF 96-19, Debtors Accounting for a Modification or Exchange of
    Debt Instruments
      Guarantor Information
         26




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
              No. 98-05, Accounting for Convertible Securities with Beneficial
    Conversion Features or Contingently Adjustable Conversion
    Ratios
  Borrowings Form 10-K.
  Mortgage
    Debt
   27




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 11.
    Shareholders
    Equity  Common
    Stock Shares Outstanding
    Outstanding as of December 31, 2006


181,452,290Issuance of common stock


24,246,651Sale of treasury stock


1,300,000Exercise of options


332,821Restricted stock and other stock grants, net


1,208,870Outstanding as of September 30, 2007


208,540,632   Dividend
    Reinvestment and Stock Purchase Plan
    Note 12.
    Income
    Taxes     28




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Nine MonthsEnded September 30,2007


2006Federal statutory rate


35.0
%


35.0
%Benefit of REIT election


(13.0
)


(16.1
)State income taxes, net of federal tax benefit


1.8



1.4Other


0.2



0.9Effective income tax rate before discrete items


24.0



21.2Discrete item  Benefit for reversal of net deferred
    tax liabilities(1)






(1.7
)Effective income tax rate


24.0
%


19.5
%     (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 nine months ended
    September 30, 2006.    New Accounting
    Pronouncements
     29




---



##### Table of Contents



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


Nine Months EndedSeptember 30,


September 30,2007


2006


2007


2006($ in thousands)Net income

$
28,265


$
80,853


$
191,321


$
218,936Unrealized (loss) gain on available-for-sale securities, net of
    tax


(606
)


(177
)


(3,404
)


2,371Unrealized gain on foreign currency translation, net of tax


3,528







5,709



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


(833
)


(1,381
)


(296
)


1,075Comprehensive income

$
30,354


$
79,295


$
193,330


$
222,382     September 30,


December 31,2007


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

$
(690
)

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


4,883



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


281



577Accumulated other comprehensive income, net

$
4,474


$
2,465  30




---



##### Table of Contents



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


Nine Months EndedSeptember 30,


September 30,2007


2006


2007


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

$
28,265


$
80,853


$
191,321


$
218,936Average shares  basic


191,976,931



171,777,989



185,552,634



163,373,576Basic net income per share

$
0.15


$
0.47


$
1.03


$
1.34Diluted net income per share:Net income

$
28,265


$
80,853


$
191,321


$
218,936Average shares  basic


191,976,931



171,777,989



185,522,634



163,373,576Effect of dilutive securities:Stock dividend declared














1,080,124Option shares


161,394



330,551



453,770



397,791Unvested restricted stock


1,415,679



1,180,952



1,493,333



1,146,656Stock units


53,982



24,442



40,507



17,045Non-managing member units














Convertible debt(1)






40,957



126,258



13,652Written call option














Average shares  diluted


193,607,986



173,354,891



187,636,502



166,028,844Diluted net income per share

$
0.15


$
0.47


$
1.02


$
1.32     (1)
    
    For the nine months ended September 30, 2007, the
    conversion premiums on the 1.25% Debentures and
    1.625% Debentures represented dilutive shares based on a
    conversion price of $23.22.    Three Months Ended


Nine Months EndedSeptember 30,


September 30,2007


2006


2007


2006Stock options


8,543,433



8,309,478



3,792,836



3,926,149Non-managing member units


1,996,855



2,510,818



2,148,280



2,271,692Shares subject to a written call option


7,401,420



7,401,420



7,401,420



7,401,420    31




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 15.
    Stock-Based
    Compensation    Share-Based
    Payment
      Stock-Based Compensation Form 10-K.
  Note 16.
    Commitments
    and Contingencies  Guarantors Accounting and Disclosure Requirements for
    Guarantees, Including Indirect Guarantees of Indebtedness of
    Others.
  Accounting for Conditional
    Asset Retirement Obligations  An Interpretation of
    FASB No. 143
 32




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Note 17.
    Segment
    Data  Disclosures about Segments of an
    Enterprise and Related Information Organization
  Three Months Ended September 30,2007


2006Commercial


Residential





Commercial


ResidentialLending


Mortgage


Consolidated


Lending


Mortgage


Consolidated& Investment


Investment


Total


& Investment


Investment


Total($ in thousands)Total interest and fee income

$
279,310


$
94,071


$
373,381


$
252,873


$
81,148


$
334,021Operating lease income


27,490







27,490



7,855







7,855Interest expense


143,602



89,152



232,754



96,872



73,246



170,118Provision for loan losses


11,938



415



12,353



24,849







24,849Operating expenses(1)


63,783



1,350



65,133



51,081



2,150



53,231Other income (expense)(2)


(19,402
)


(30,225
)


(49,627
)


8,447



2,291



10,738Noncontrolling interests expense


1,182







1,182



1,259







1,259Net income (loss) before income taxes


66,893



(27,071
)


39,822



95,114



8,043



103,157Income taxes


11,557







11,557



22,304







22,304Net income (loss)

$
55,336


$
(27,071
)

$
28,265


$
72,810


$
8,043


$
80,853   33




---



##### Table of Contents



CapitalSource
    Inc.
  NOTES TO
    THE UNAUDITED CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Nine Months Ended September 30,2007


2006Commercial


Residential





Commercial


ResidentialLending


Mortgage


Consolidated


Lending


Mortgage


Consolidated& Investment


Investment


Total


& Investment


Investment


Total($ in thousands)Total interest and fee income

$
810,841


$
258,361


$
1,069,202


$
679,228


$
184,473


$
863,701Operating lease income


69,934







69,934



19,174







19,174Interest expense


377,366



242,328



619,694



250,967



170,851



421,818Provision for loan losses


44,275



415



44,690



50,732



301



51,033Operating expenses(1)


191,529



5,369



196,898



151,183



6,358



157,541Other income (expense)(2)


27,271



(49,769
)


(22,498
)


22,158



220



22,378Noncontrolling interests expense


3,784







3,784



3,350







3,350Net income (loss) before income taxes and cumulative effect of
    accounting change


291,092



(39,520
)


251,572



264,328



7,183



271,511Income taxes


60,251







60,251



52,945







52,945Net income (loss) before cumulative effect of accounting change


230,841



(39,520
)


191,321



211,383



7,183



218,566Cumulative effect of accounting change, net of taxes














370







370Net income (loss)

$
230,841


$
(39,520
)

$
191,321


$
211,753


$
7,183


$
218,936Total assets as of September 30, 2007

$
11,298,736


$
6,453,948


$
17,752,684Total assets as of December 31, 2006

$
9,235,449


$
5,975,125


$
15,210,574     (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.
 34




---



##### Table of Contents



ITEM 2.
    MANAGEMENTS
    DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
    OPERATIONS  CAUTIONARY
    NOTE REGARDING FORWARD-LOOKING STATEMENTS
  Form 10-Q, Form 10-Q Form 10-K Form 10-K), Form 8-K Form 10-Q
    Form 10-Q.
  Overview
    and Highlights
      
    Structured Finance,which generally engages in commercial
    real estate finance and also provides asset-based lending to
    finance companies;
    Healthcare and Specialty Finance,which generally
    provides first mortgage loans, asset-based revolving lines of
    credit, real estate lease financing and cash flow loans to
    healthcare businesses and a broad range of other
    companies; and
    Corporate Finance,which generally provides senior and
    subordinate loans through direct origination and participation
    in widely syndicated loan transactions.   35




---



##### Table of Contents



Recent
    Developments
  Pending
    Acquisition of TierOne Corporation
    Impact of
    Recent Market Conditions
        Consolidated
    Results of Operations
   36




---



##### Table of Contents



Explanation
    of Reporting Metrics
  Interest Income.
  Fee Income.
  Operating Lease Income.
  Interest Expense.
  Provision for Loan Losses.
  Other Income, net of expenses.
  Operating Expenses.
  Income Taxes.
 37




---



##### Table of Contents



Adjusted Earnings.
  Operating
    Results for the Three and Nine Months Ended September 30,
    2007
    
    Mark to market losses on our Residential Mortgage Investment
    Portfolio;
    Losses on derivatives and other investments in our Commercial
    Lending and Investment Segment;
    Reduced prepayment-related fee income and reduced gains on
    equity sales;
    Growth in our commercial loan portfolio;
    Increased operating lease income related to our direct real
    estate investments;
    Decreased operating expenses as a percentage of average assets;
    and
    Decreased lending and borrowing spreads.    Three Months Ended








Nine Months EndedSeptember 30,








September 30,2007


2006


$ Change


% Change


2007


2006


$ Change


% Change($ in thousands)Interest income

$
344,043


$
280,066


$
63,977



23
%

$
944,781


$
731,601


$
213,180



29
%Fee income


29,338



53,955



(24,617
)


(46
)%


124,421



132,100



(7,679
)


(6
)%Operating lease income


27,490



7,855



19,635



250
%


69,934



19,174



50,760



265
%Interest expense


232,754



170,118



62,636



37
%


619,694



421,818



197,876



47
%Provision for loan losses


12,353



24,849



(12,496
)


(50
)%


44,690



51,033



(6,343
)


(12
)%Operating expenses


65,133



53,231



11,902



22
%


196,898



157,541



39,357



25
%Other income, net of expenses


(49,627
)


10,738



(60,365
)


(562
)%


(22,498
)


22,378



(44,876
)


(201
)%Noncontrolling interests expense


1,182



1,259



(77
)


(6
)%


3,784



3,350



434



13
%Income taxes


11,557



22,304



(10,747
)


(48
)%


60,251



52,945



7,306



14
%Cumulative effect of accounting change, net of taxes














N/A







370



(370
)


(100
)%Net income


28,265



80,853



(52,588
)


(65
)%


191,321



218,936



(27,615
)


(13
)%  38




---



##### Table of Contents



Nine Months Ended September 30,2007


2006Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


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





$
944,780



8.33
%





$
731,601



8.49
%Fee income






124,421



1.10







132,100



1.53Total interest earning assets(1)

$
15,612,542



1,069,201



9.43


$
11,527,276



863,701



10.02Total direct real estate investments


909,240



69,934



10.28



203,011



19,174



12.63Total income earning assets


16,071,782



1,139,135



9.48



11,730,287



882,875



10.06Total interest bearing liabilities(2)


13,852,181



619,694



5.98



9,901,508



421,818



5.70Net finance spread





$
519,441



3.50
%





$
461,057



4.36
%Net finance margin










4.32
%










5.26
%     (1)
    
    Interest earning assets include cash, restricted cash,
    mortgage-related receivables, RMBS, loans, and investments in
    debt securities.(2)
    
    Interest bearing liabilities include repurchase agreements,
    secured and unsecured credit facilities, term debt, convertible
    debt and subordinated debt.  Comparison
    of the Three Months Ended September 30, 2007 and
    2006
    Interest
    Income
      Fee
    Income
   39




---



##### Table of Contents



Operating
    Lease Income
  triple-net
  Interest
    Expense
      Net
    Finance Margin
   40




---



##### Table of Contents



Three Months Ended September 30,2007


2006Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


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





$
249,972



10.11
%





$
198,918



10.28
%Fee income






29,338



1.19







53,955



2.79Total interest earning assets(1)

$
9,813,180



279,310



11.30


$
7,678,450



252,873



13.07Total direct real estate investments


1,065,068



27,490



10.24



261,376



7,855



11.92Total income earning assets


10,878,248



306,800



11.19



7,939,826



260,728



13.03Total interest bearing liabilities(2)


8,821,916



143,601



6.46



6,139,327



96,872



6.26Net finance spread





$
163,199



4.73
%





$
163,856



6.77
%Net finance margin










5.95
%










8.19
%     (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
      Operating
    Expenses
   41




---



##### Table of Contents



42




---



##### Table of Contents



Adjusted
    Earnings
    Three Months EndedSeptember 302007


2006($ in thousands, exceptper share data)Net income

$
28,265


$
80,853Add:Real estate depreciation and amortization(1)


8,570



3,087Amortization of deferred financing fees(2)


7,491



7,031Non-cash equity compensation


11,336



8,640Net realized and unrealized losses on residential mortgage
    investment portfolio, including related derivatives(3)


32,425



1,123Unrealized losses on derivatives and foreign currencies, net


16,464



6,937Unrealized losses on investments, net


8,452



404Provision for loan losses


12,353



24,849Recoveries(4)






Less:Charge offs(5)


27,796



11,000Nonrecurring items






Cumulative effect of accounting change, net of taxes






Adjusted earnings

$
97,560


$
121,924Net income per share:Basic  as reported

$
0.15


$
0.47Diluted  as reported

$
0.15


$
0.47Average shares outstanding:Basic  as reported


191,976,931



171,777,989Diluted  as reported


193,607,986



173,354,891Adjusted earnings per share:Basic

$
0.51


$
0.71Diluted(6)

$
0.50


$
0.70Average shares outstanding:Basic


191,976,931



171,777,989Diluted(7)


195,604,841



175,865,709     (1)
    
    Depreciation and amortization for direct real estate investments
    only. Excludes depreciation for corporate leasehold
    improvements, fixed assets and (1) other non-real estate
    items.(2)
    
    Includes amortization of deferred financing fees and other
    non-cash interest expense.(3)
    
    Includes adjustments to reflect the realized gains and losses
    and the period change in fair value of RMBS and related
    derivative instruments.(4)
    
    Includes all recoveries on loans during the period.(5)
    
    To the extent we experience losses on loans for which we
    specifically provided a reserve prior to January 1, 2006,
    there will be no adjustment to earnings. All charge offs
    incremental to previously established allocated reserves will be
    deducted from net income.(6)
    
    Adjusted to reflect the impact of adding back noncontrolling
    interests expense of $1.3 million for the three months
    ended September 30, 2006, 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 the
    three months ended September 30, 2006.(7)
    
    Adjusted to include average non-managing member units of
    2,510,818 for the three months ended September 30, 2006,
    which are considered dilutive to adjusted earnings per share,
    but are antidilutive to GAAP net income per share. 43




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##### Table of Contents



Comparison
    of the Nine Months Ended September 30, 2007 and
    2006
    Interest
    Income
      Fee
    Income
    Operating
    Lease Income
  triple-net
  Interest
    Expense
   44




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##### Table of Contents



Net
    Finance Margin
      Nine Months Ended September 30,2007


2006Weighted


Net


Average


Weighted


Net


AverageAverage


Investment


Yield/


Average


Investment


Yield/Balance


Income


Cost


Balance


Income


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





$
686,420



10.07
%





$
547,128



10.32
%Fee income






124,421



1.83







132,100



2.49Total interest earning assets(1)

$
9,114,113



810,841



11.90


$
7,086,281



679,228



12.81Total direct real estate investments


909,240



69,934



10.28



203,011



19,174



12.63Total income earning assets


10,023,353



880,775



11.75



7,289,292



698,402



12.81Total interest bearing liabilities(2)


8,008,884



377,366



6.30



5,609,304



250,967



5.98Net finance spread





$
503,409



5.45
%





$
447,435



6.83
%Net finance margin










6.71
%










8.21
%     (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.   45




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##### Table of Contents



Provision
    for Loan Losses
    Other
    Income
  break-up
      Operating
    Expenses
      Income
    Taxes
   46




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##### Table of Contents



Adjusted
    Earnings
    Nine Months EndedSeptember 30,2007


2006($ in thousands, exceptper share data)Net income

$
191,321


$
218,936Add:Real estate depreciation and amortization(1)


23,675



7,350Amortization of deferred financing fees(2)


19,823



21,976Non-cash equity compensation


31,908



24,993Net realized and unrealized losses on residential mortgage
    investment portfolio, including related derivatives(3)


55,805



1,782Unrealized losses (gains) on derivatives and foreign currencies,
    net


15,504



(196
)Unrealized losses on investments, net


9,669



5,510Provision for loan losses


44,690



51,034Recoveries(4)






Less:Charge offs(5)


51,671



11,276Nonrecurring items(6)






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






370Adjusted earnings

$
340,724


$
315,014Net income per share:Basic  as reported

$
1.03


$
1.34Diluted  as reported

$
1.02


$
1.32Average shares outstanding:Basic  as reported


185,552,634



163,373,576Diluted  as reported


187,636,502



166,028,844Adjusted earnings per share:Basic

$
1.84


$
1.93Diluted(7)

$
1.82


$
1.89Average shares outstanding:Basic


185,522,634



163,373,576Diluted(8)


189,784,782



168,300,536     (1)
    
    Depreciation and amortization for direct real estate investments
    only. Excludes depreciation for corporate leasehold
    improvements, fixed assets and other non-real estate items.(2)
    
    Includes amortization of deferred financing fees and other
    non-cash interest expense.(3)
    
    Includes adjustments to reflect the realized gains and losses
    and the period change in fair value of RMBS and related
    derivative instruments.(4)
    
    Includes all recoveries on loans during the period.(5)
    
    To the extent we experience losses on loans for which we
    specifically provided a reserve prior to January 1, 2006,
    there will be no adjustment to earnings. All charge offs
    incremental to previously established allocated reserves will be
    deducted from net income.(6)
    
    Represents the write-off of a net deferred tax liability
    recorded in connection with our conversion to a REIT for the
    nine months ended September 30, 2006.(7)
    
    Adjusted to reflect the impact of adding back noncontrolling
    interests expense $3.4 million for the nine months ended
    September 30, 2006, 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 the
    nine months ended September 30, 2006.(8)
    
    Adjusted to include average non-managing member units of
    2,271,692 for the nine months ended September 30, 2006,
    respectively, which are considered dilutive to adjusted earnings
    per share, but are antidilutive to GAAP net income per share. 47




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##### Table of Contents



Financial
    Condition
  Commercial
    Lending & Investment Segment
  Portfolio
    Composition
    September 30,


December 31,2007


2006($ in thousands)Commercial loans, net

$
9,629,470


$
7,850,198Direct real estate investments, net


1,031,905



722,303Equity investments


178,574



150,090Total

$
10,839,949


$
8,722,591   Commercial
    Lending Portfolio Composition
    September 30, 2007


December 31, 2006($ in thousands)Composition of loan portfolio by loan type:Senior secured loans(1)

$
5,456,046



57
%

$
4,704,166



60
%First mortgage loans(1)


3,057,652



32



2,542,222



32Subordinate loans


1,115,772



11



603,810



8Total

$
9,629,470



100
%

$
7,850,198



100
%Composition of loan portfolio by business:Structured Finance

$
3,841,265



40
%

$
2,839,716



36
%Healthcare and Specialty Finance


3,083,636



32



2,775,748



35Corporate Finance


2,704,569



28



2,234,734



29Total

$
9,629,470



100
%

$
7,850,198



100
%     (1)
    
    Includes Term B loans.    Number


Average


Number of


Average Loanof Loans


Loan Size


Clients


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


265


$
14,495



218


$
17,620Healthcare and Specialty Finance


415



7,430



299



10,313Corporate Finance


457



5,918



216



12,521Overall loan portfolio


1,137



8,469



733



13,137  48




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##### Table of Contents



Due in


Due inOne Year


One to


Due Afteror Less


Five Years


Five Years


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

$
743,875


$
4,371,032


$
341,139


$
5,456,046First mortgage loans(1)


1,194,903



1,714,295



148,454



3,057,652Subordinate loans


127,855



453,251



534,666



1,115,772Total

$
2,066,633


$
6,538,578


$
1,024,259


$
9,629,470     (1)
    
    Includes Term B loans.    Adjustable


FixedRates


Rates


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

$
5,392,334


$
63,712


$
5,456,046First mortgage loans(1)


2,706,738



350,914



3,057,652Subordinate loans


982,388



133,384



1,115,772Total

$
9,081,460


$
548,010


$
9,629,470Percentage of total loan portfolio


94%



6%



100%     (1)
    
    Includes Term B loans.   49




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##### Table of Contents



Credit
    Quality and Allowance for Loan Losses
    September 30,


December 31,2007


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

$
71,664


$
88,067Non-accrual loans(1)


169,390



183,483Impaired loans(2)


332,716



281,377Less: loans in multiple categories


(221,553
)


(230,469
)Total

$
352,217


$
322,458Total as a percentage of total loans


3.66%



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


3.30%



3.76%     (1)
    
    Includes commercial loans with an aggregate principal balance of
    $21.0 million and $47.0 million as of
    September 30, 2007 and December 31, 2006,
    respectively, which were also classified as loans 60 or more
    days contractually delinquent. Includes non-performing loans
    classified as held for sale that have an aggregate principal
    balance of $3.0 million as of September 30, 2007. As
    of December 31, 2006, there were no loans classified as
    held for sale that were placed on non-accrual status.(2)
    
    Includes commercial loans with an aggregate principal balance of
    $55.1 million and $47.0 million as of
    September 30, 2007 and December 31, 2006,
    respectively, which were also classified as loans 60 or more
    days contractually delinquent, and commercial loans with an
    aggregate principal balance of $166.4 million and
    $183.5 million as of September 30, 2007 and
    December 31, 2006, respectively, which were also placed on
    non-accrual status.(3)
    
    Commercial assets include commercial loans, loans held for sale,
    receivables under reverse-repurchase agreements and direct real
    estate investments.  Accounting by Creditors for Impairment of a Loan and/or
  Accounting for Debtors and Creditors
    for Troubled Debt Restructurings
   50




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##### Table of Contents



Direct
    Real Estate Investments
  triple-net triple-net
  Equity
    Investments
      Residential
    Mortgage Investment Segment
  Portfolio
    Composition
    September 30,


December 31,2007


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

$
2,092,553


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


4,159,037



3,502,753Non-Agency(3)


11,530



34,243Total

$
6,263,120


$
5,832,918     (1)
    
    Represents secured receivables that are backed by adjustable
    rate, prime residential mortgage loans that are further
    described in Note 4, Mortgage-Related Receivables and
    Related Owners Trust Transactions, in our accompanying
    unaudited consolidated financial statements for the three and
    nine months ended September 30, 2007.(2)
    
    Represent mortgage-backed securities (MBS) whose
    payments of principal and interest are guaranteed by Fannie Mae
    or Freddie Mac. See the following paragraph for a description of
    these securities.(3)
    
    See following paragraph for a description of these securities.   51




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##### Table of Contents



Mortgage-Related Receivables and Related Owners
    Trust Securitizations
  Credit
    Quality and Allowance for Loan Losses
    September 30,


September 30,2007


2006Mortgage-related receivables whose underlying mortgage loans are
    90 or more days past due or are in the process of foreclosure

$
9,192


$
2,364Percentage of mortgage-related receivables


0.44
%(1)


0.10
%Foreclosed assets

$
1,335



Percentage of mortgage-related receivables


0.06
%


     (1)
    
    By comparison, in its September 2007 Monthly Summary Report,
    Fannie Mae reported a serious delinquency rate (SDQ) of 0.71%
    for August 2007, for conventional single family loans that are
    three months or more past due or in foreclosure process while,
    in its September 2007 Monthly Volume Summary, Freddie Mac
    reported an SDQ of 0.46% for August 2007, for comparable types
    of single family loans. The comparable August 2007 statistic for
    the mortgage-related receivables was 0.43%.    Financing
       52




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##### Table of Contents



Market Risk Management
  Liquidity
    and Capital Resources
          and/or
 53




---



##### Table of Contents



Cash
    and Cash Equivalents
      Sources
    and Uses of Cash
        Borrowings
  Borrowings Form 10-K Borrowings
    Repurchase
    Agreements
   54




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##### Table of Contents



Credit
    Facilities
      September 30, 2007Committed


PrincipalCapacity


Outstanding($ in thousands)Unsecured credit facility scheduled to mature February 19,
    2008

$
75,607


$
60,010Secured credit facility scheduled to mature March 26, 2008


300,000



110,150Secured credit facility scheduled to mature August 1, 2008


1,500,000



1,001,000Unsecured credit facility scheduled to mature March 13, 2009


1,070,000



520,271Secured credit facility scheduled to mature April 10, 2009


470,000
(1)


202,186Secured credit facility scheduled to mature April 27, 2009


1,400,000
(1)


378,800Secured credit facility scheduled to mature June 27, 2009


700,000
(1)


314,621Secured credit facility scheduled to mature July 19, 2010


114,647



114,647Total

$
5,630,254


$
2,701,685     (1)
    
    Credit facility is subject to 364-day liquidity renewal. On
    termination or maturity, amounts due under the credit facility
    may, in the absence of a default, be repaid from proceeds from
    amortization of the collateral pool.  Borrowings
  Term
    Debt
  Borrowings
  Subordinated
    Debt
  Borrowings
 55




---



##### Table of Contents



Convertible
    Debt
  Borrowings
  Mortgage
    Debt
  Borrowings
  Debt
    Covenants
    Equity
    Commitments,
    Guarantees & Contingencies
     56




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##### Table of Contents



Consolidation of Variable
    Interest Entities  An Interpretation of ARB
    No. 51, Accounting for Transfers and
    Servicing of Financial Assets and Extinguishments of
    Liabilities
      Credit
    Risk Management
  agreed-upon
    Commercial
    Lending & Investment Segment
      Residential
    Mortgage Investment Segment
   57




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##### Table of Contents



Concentrations
    of Credit Risk
    Derivative
    Counterparty Credit Risk
    Market
    Risk Management
  and/or
  Derivative Instruments Form 10-K.
 58




---



##### Table of Contents



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

Net Interest Income(Basis Points)

Over 12 Months($ in thousands)−100

$
(6,480
)−50


(4,080
)+ 50


5,280+ 100


10,440       Amount


Percentage ofOutstanding


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

$
3,320,969



35
%At the interest rate floor


40,156



Below the interest rate floor


288,794



3Loans with no interest rate floor


5,979,551



62Total

$
9,629,470



100
%        59




---



##### Table of Contents



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

Increase


Percentage of Total(Basis Points)

in Fair Value


Segment Assets($ in thousands)−100

$
(3,734
)


(.06
)%−50


(644
)


(.01
)+ 50


(858
)


(.01
)+ 100


(3,504
)


(.05
)         Critical
    Accounting Estimates
   60




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##### Table of Contents



Critical Accounting Estimates Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations Form 10-K
  ITEM 3.
    QUANTITATIVE
    AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  Market Risk Management Managements Discussion and
    Analysis of Financial Condition and Results of Operations Form 10-Q, Quantitative and Qualitative Disclosures
    about Market Risk Form 10-K Form 8-K Derivative Instruments Form 10-K.
  ITEM 4.
    CONTROLS
    AND PROCEDURES  Rule 13a-15
 61




---



##### Table of Contents



PART II.
    OTHER INFORMATION
  ITEM 1A.
    RISK
    FACTORS  Risk Factors Form 10-K Form 8-K
  ITEM 2.
    UNREGISTERED
    SALES OF EQUITY SECURITIES AND USE OF PROCEEDS    Shares Purchased


Maximum NumberTotal Number


Average


as Part of Publicly


of Shares that Mayof Shares


Price Paid


Announced Plans


Yet be PurchasedPurchased(1)


per Share


or Programs


Under the PlansJuly 1  July 31, 2007


95,947


$
24.59







August 1  August 31, 2007


11,989



18.94







September 1  September 30, 2007


8,862



17.74







Total


116,798



23.49     (1)
    
    Represents the number of shares acquired as payment by employees
    of applicable statutory minimum withholding taxes owed upon
    vesting of restricted stock granted under the CapitalSource Inc.
    Third Amended and Restated Equity Incentive Plan.  ITEM 6.
    EXHIBITS     62




---



##### Table of Contents



Signatures
      Date: November 8, 2007

/s/  JOHN
    K. DELANEYJohn
    K. Delaney
    Chairman of the Board and Chief Executive Officer (Principal
    Executive Officer)Date: November 8, 2007

/s/  THOMAS
    A. FINKThomas
    A. Fink
    Chief Financial Officer
    (Principal Financial Officer)Date: November 8, 2007

/s/  DAVID
    C. BJARNASONDavid
    C. Bjarnason
    Chief Accounting Officer
    (Principal Accounting Officer)  63




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##### Table of Contents



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 (as amended on October 30,
    2007). 4
.1

Form of Certificate of Common Stock of CapitalSource Inc.
    (incorporated by reference to the same-numbered exhibit to the
    registrants Registration Statement on Form 8-A/2B/A dated
    May 22, 2006).4
.20

Indenture dated as of July 30, 2007, by and between
    CapitalSource Inc., as Obligator, and Wells Fargo Bank, N.A., as
    Trustee. 4
.20.1

First Supplemental Indenture dated as of July 30, 2007, by
    and between CapitalSource Inc., as Issuer, CapitalSource Finance
    LLC, as Guarantor, and Wells Fargo Bank, N.A., as Trustee. 4
.21

Form of 7.250% Senior Subordinated Convertible Note due 2037
    (incorporated by reference to the exhibit 4.2 to the
    registrants Current Report for form 8-K dated July 2,
    2007).10
.33*

Summary of Non-employee Director Compensation. 10
.74

First Amendment to the Note Purchase Agreement, dated as of
    August 2, 2007, among CapitalSource Funding VII Trust, as
    Issuer, CS Funding VII Depositor LLC, as Depositor,
    CapitalSource Finance LLC, as Loan Originator, and Citigroup
    Global Markets Realty Corp., as Purchaser (incorporated by
    reference to the same numbered exhibit to the registrants
    Current Report on Form 10-Q for the quarter ended June 30,
    2007).10
.75

First Amendment to the Sale and Servicing Agreement, dated as of
    August 2, 2007, by and among CapitalSource Funding VII
    Trust, as Issuer, as the Issuer, and CS Funding VII Depositor
    LLC, as Depositor, and CapitalSource Finance LLC, as Loan
    Originator and Servicer, and Wells Fargo Bank, National
    Association, as Indenture Trustee, Collateral Custodian and
    Backup Servicer (incorporated by reference to the same numbered
    exhibit to the registrants Current Report on Form 10-Q for
    the quarter ended June 30, 2007).10
.82

Sale and Servicing Agreement, dated as of September 10,
    2007, by and among CapitalSource Real Estate Loan LLC
    2007-A, as
    the Seller, CSE Mortgage LLC, as the Originator and as the
    Servicer, Citicorp North America, Inc., as the Administrative
    Agent, and Wells Fargo Bank, National Association, as the Backup
    Servicer and as the Collateral Custodian. (incorporated by
    reference to the exhibit 10.82 to the registrants
    Current Report on
    Form 8-K
    dated September 10, 2007)10
.83

Sale and Contribution Agreement, dated as of September 10,
    2007, by and between CapitalSource Real Estate Loan LLC
    2007-A, as
    the Buyer and CSE Mortgage LLC, as the Seller (incorporated by
    reference to the same numbered exhibit to the registrants
    Current Report on
    Form 8-K
    dated September 10, 2007)12
.1

Ratio of Earnings to Fixed Charges.31
.1

Rule 13a  14(a) Certification of Chairman and
    Chief Executive Officer (Principal 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.   64