Up until this year John Delaney's CapitalSource of Chevy Chase, Md., public since 2003, earned a nice return making hundreds of loans, secured by assets like accounts receivable, to small businesses, many of them in health care. Now the company is a real estate investment trust. It's a bit of a stretch, considering that these tax-favored vehicles generally own only real estate or loans on real estate.
Here's how he did it. First Delaney dumped non-real-estate loans into a taxable subsidiary. Then CapitalSource bought $5 billion of low-yielding mortgage paper to get its real estate portfolio up to 75% of total assets, from 40%, to comply with the rules. Next he put his real estate assets into an untaxed subsidiary and, following REIT rules, paid out CapitalSource's historical earnings in a $351 million dividend to shareholders.
Here's why he did it. REITs, which must disburse 90% of their earnings to shareholders, pay no taxes. Delaney believes the recap will lower CapitalSource's overall tax rate to 21% this year from 39%, increasing profits by $70 million if earnings meet Wall Street expectations. The REIT recently traded at $23, three times book value.
Delaney, 42, has his detractors. In the last six years CapitalSource has grown into a $4 billion (market cap) enterprise by making pricey secured loans--often as high as four percentage points over Libor--and thumping borrowers at the first sign of trouble. He has 540 employees, who have originated 940 loans totaling $6.4 billion to the oft-neglected: buyout shops, health care outfits and real estate developers, usually with revenues of less than $250 million. Last year CapitalSource earned $165 million on revenue of $459 million. Hurried growth and annual return on equity of 15% have caused some investors to wonder about the quality of Delaney's loans.
But powerful backers believe in him. The son of a Wood-Ridge, N.J. union electrician, Delaney got a law degree from Georgetown but wanted to run something.
For $15,000 he bought a home health care operator but realized the real dough was in lending to these outfits, not running them. Supported by longtime mentor John Rowe, his uncle and former chief of insurer Aetna , Delaney started HealthCare Financial Partners in 1993. He got $25 million to help finance the business after a friend introduced him to Thomas Steyer, founder of Farallon Capital Management, a $16.4 billion hedge fund. Delaney took HealthCare Financial public and sold it in 1999 for $493 million to Heller Financial (now part of GE Capital).
Delaney pocketed $30 million. With $5 million of that he launched CapitalSource in 2000 in Washington, D.C., near his home in Maryland, persuading Jason Fish, a Farallon partner, to join him. The tiny office they shared with three credit officers flooded with sewage--belying the fact that CapitalSource was at the time the richest startup ever. Delaney raised $542 million, $190 million of it from Farallon. "We never questioned whether to back them," says Steyer.
As the market tanked and regional banks trimmed loans to small companies, Delaney stepped in. He financed buyouts for LBO firms like Century Park Capital Partners, which used a $10 million CapitalSource loan to buy Kids Line, a maker of infant bedding products. By 2004 CapitalSource had handed out $1.7 billion of such buyout loans. When other lenders jumped back in, Delaney concentrated on nursing homes, surgery centers, physician practices and the like. Because he knows these sectors, he can move quickly and charge a bundle, as in the case of nursing home operator Senior Health Management, which had 30 days to purchase 40 nursing homes that Kindred Healthcare needed to unload fast. CapitalSource provided a $100 million mortgage loan within a week.
Rapid dealmaking has a cost. Delaney's nonperformers jumped to 2.3% of loans by Dec. 31, 2005, compared with 0.53% a year earlier. Hedge funds and others piled on, shorting 11.5 million CapitalSource shares, 9% of the outstanding, helping drive the stock down 27% in the first nine months of 2005. "The crux of the issue is they think credit statistics will get worse," says Delaney. "I think they will stabilize."
He sure stuck it to the short-sellers with the REIT conversion. On top of being required to return shares to the lender they borrowed them from, shorts also must pay dividends on those shares. Now short positions are down to 6.8 million shares. The stock has risen 13% in the last year. (Delaney's stake is valued at $178 million; Farallon, which has sold a net $128 million in shares, holds $670 million worth.)
A more important aim of the conversion is to pursue new business by writing higher-quality, safer loans. In the past, to achieve that 15% return on equity Delaney had to deal with dicier companies. Now, because of the REIT's tax advantages, he can achieve comparable returns with lower interest rates paid by higher-quality customers. For example, Delaney says a recent $211 million lease loan to five companies for 38 nursing homes would not have been profitable enough before the conversion.
To keep those profits coming--and hold CapitalSource's charge-offs steady at 0.27% of loans--Delaney plays hardball. He acted forcefully against Foss Manufacturing, the Hampton, N.H. textilemaker. After the company's board discovered inflated accounts receivable had been used to overdraw on its credit line and forced the resignation of Stephen Foss, the former Tycodirector and compensation committee member under Dennis Kozlowski, CapitalSource cut off funds, forcing the company into Chapter 11. Delaney believes he will get back a chunk of his $30 million loan and has banded together with other creditors to consider legal action against Steve Foss.
He also moved fast to protect a $39 million secured loan to World Health Alternatives, a Pittsburgh medical staffing company that filed for bankruptcy in February after its chief executive resigned in the wake of an accounting problem. Delaney pushed World Health to a $53 million sale, financed with debt from CapitalSource, to Jackson Healthcare Staffing. Furious unsecured creditors tried to stop the deal, arguing that the "quick fire sale" left them out in the cold.
Tough. With Delaney, business is personal. "When I think people have broken the rules," he says, "I get very upset."
https://www.forbes.com/forbes/2006/0522/128.html#38878e6d364d
for insurance companies they were like how tf can we allow them to siphon 20 bil from sick patients? 
