CapitalSource Raising Cash, Diluting

By Travis Johnson, Stock Gumshoe, June 19, 2008

CapitalSource (CSE), which I own, is raising some new capital — $400 million+ with the sale of 30 million shares. They say it’s because of opportunity that they see in the current credit markets, an opportunity that the CEO has said he’s been seeing coming all year with the credit crunch (borrowers are in need but there aren’t as many lenders, so covenants and rates are improving).

Will probably drop the shares by a dollar or so, maybe 10% — I’d be surprised if they drop the full 13-14% that would match the dilution for current shareholders of the offering, but it’s certainly possible if the market remains weak in the coming days. Unless they have trouble placing the new shares, which would be surprising, I’m not worried at the moment and will continue to hold CSE shares … and possibly buy more if the price falls further, since the good news of closing the deal for Fremont’s deposits (the deal is made, but it’s not yet closed) might also help the shares over the long run.

With about $2 billion expected to be available from Fremont’s deposits for investing in CSE’s portfolio, and this new $400 million in cash, CSE should have a lot more dry powder in the form of money to lend while lending is tight.

This one could be uncertain for quite a while, though, since the acquisition of a bank changes their makeup significantly and would mean they’ll either have to buy a lot of mortgages to continue being classified as a REIT, or sell off their mortgage portfolio (which is high quality) and their healthcare net lease business and become a specialty lender with a deposit bank for lower-cost funding.

Should be an interesting few months as they sort through their options, but certainly one option means they would retain a lot more of their earnings in order to grow (which they’re not allowed to do as a REIT), and that would mean a lot of yield-focused investors would flee, regardless of the soundness of the strategy.

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