Linc, you seem to assume a Time Capsule is being used.
Kevin, I have the exact same problem - I have a 2 TB USB drive attached to my 10.8.3 iMac (which backs up fine), and a 10.8.3 MacBook Pro that can see it, select the disk for Time Machine backups, but fails with your same error message.
Console logs:
4/25/13 4:54:45.614 PM com.apple.backupd[572]: Starting manual backup
4/25/13 4:54:45.644 PM com.apple.backupd[572]: Attempting to mount network destination URL: afp://nathan@Megatron._afpovertcp._tcp.local/Back2Back
4/25/13 4:54:45.830 PM com.apple.backupd[572]: Mounted network destination at mount point: /Volumes/Back2Back-1 using URL: afp://nathan@Megatron._afpovertcp._tcp.local/Back2Back
4/25/13 4:55:01.199 PM com.apple.backupd[572]: Creating disk image /Volumes/Back2Back-1/flapjack.sparsebundle
4/25/13 5:01:34.359 PM com.apple.backupd[572]: Error 60 creating backup disk image
4/25/13 5:01:34.359 PM com.apple.backupd[572]: Failed to create disk image /Volumes/Back2Back-1/flapjack.sparsebundle, status: 60
4/25/13 5:01:44.374 PM com.apple.backupd[572]: Backup failed with error: 20
4/25/13 5:02:04.277 PM com.apple.backupd[572]: Failed to eject volume /Volumes/Back2Back-1 (FSVolumeRefNum: -107; status: -47; dissenting pid: 0)
4/26/13 9:31:09.720 AM com.apple.backupd[857]: Starting automatic backup
4/26/13 9:31:10.453 AM com.apple.backupd[857]: Network destination already mounted at: /Volumes/Back2Back-1
4/26/13 9:31:36.307 AM com.apple.backupd[857]: Creating disk image /Volumes/Back2Back-1/flapjack.sparsebundle
4/26/13 9:31:37.796 AM com.apple.backupd[857]: Error 17 creating backup disk image
4/26/13 9:31:37.796 AM com.apple.backupd[857]: Failed to create disk image /Volumes/Back2Back-1/flapjack.sparsebundle, status: 17
4/26/13 9:31:47.838 AM com.apple.backupd[857]: Backup failed with error: 20
Interestingly, if I delete (or rename) the .sparsebundle, it gets recreated the next time and fails at the exact same size - 10.7MB. (I can't actually delete it; 'The operation can’t be completed because the item “.afpDeleted107” is in use.')