CapitalSource Finally Gets a Clue

A few months ago, I suggested that CapitalSource's (CSE) operational execution was being hindered by its overly broad SuperREIT structure.

At that time, it seemed pretty obvious to me that CapitalSource could unlock significant value by selling off its poorly performing residential mortgage portfolio, spinning off its profitable healthcare net lease REIT as a separate entity, and restructuring its corporate loan portfolio as a BDC.

I wasn't surprised, then, when CapitalSource announced some strategic changes in the wake of the Fremont bank purchase.

Closing the asset acquisition and commencing the operations of CapitalSource Bank may have other strategic implications for us in light of current market conditions.

1. Dividend Policy. As previously announced, we declared a $0.60 dividend for the second quarter of 2008, payable on or about June 30 to our stockholders of record on June 16. Upon the closing of the asset acquisition from FIL, we expect to reevaluate our dividend policy and may decide to retain a
   majority of our earnings, consistent with dividend policies of other commercial depository institutions, to redeploy in attractive lending opportunities, subject to satisfying our minimum distribution requirements to qualify as a REIT for 2008.
2. Possible Healthcare Net Lease Transaction. With our focus on our commercial lending activities, we expect to continue to explore ways to monetize our investment in our healthcare net lease assets, including a possible initial public offering of the common shares of an entity holding these assets.
3. REIT Status. We intend to qualify to be taxed as a REIT for 2008, which may require us to acquire a significant amount of additional residential mortgage or other real estate assets due to the addition of the assets and operations of CapitalSource Bank to those of our existing taxable REIT subsidiaries. As we assess the impact of a depository franchise on our overall business operations, we intend to reexamine the strategic rationale for our REIT election, and we may determine not to elect to qualify as a REIT beginning in 2009 or thereafter.

So perhaps CapitalSource has gotten a clue. It wasn't maximizing the REIT structure, failing to properly manage its agency portfolio and making most of its profit in its corporate loan TRS. Perhaps the new CapitalSource will be able to improve GAAP earnings by focusing on the commerce financing business as a C-corp and utilizing cheap depositary funding.

In any case, the implication for CSE shareholders is that the Company will be transforming from an income stock to a growth stock by the end of 2008. CSE will likely materially reduce the dividend going forward. Look for CapitalSource to sell off its agency portfolio early in 2009 and also spinoff its healthcare net lease portfolio shortly thereafter.

Disclosure: none

Comments

[lobodoug]

The Market sure did not like these proposals, selling of CSE at a significant discount. I may join the selloff. I usually buy growth stocks, but I bought CSE in an IRA account for the dividend. It may become a growth stock I like, but it will take more than acquiring a bank to keep me around. There are other stocks I feel offer me a better chance for solid returns on a growth basis.

[Plantinseeds]

I will continue to hold CSE. CSE was not or is not just an income stock.
It always was an income/growth play.
I am glad that they are moving more to the growth side.
If you want income plays then energy trusts far outperform in the dividen arena.

[jjrg]

We recently refinanced a $34m credit facility we had in place with Capital Source. Though the loan was performing, CSE has been impossible to deal with since its problems began. Not only are they slow to make decisions but management displayed a complete lack of integrity and reason in their dealings with us. Things did work out as our new facility is considerably less expensive. However, I question wether this is an institution in which one would want to invest.