Back in January, CapitalSource made its REIT status official, and thus made a lot of progress toward lowering its cost of funds and separating its real estate securitization activities from the rest of its securitization program. After pricing the CapitalSource Real Estate Loan Trust 2006-A just over a week ago, the separation is complete.

The $1.3 billion 144a transaction, for which Wachovia Securities acted as lead manager, is the company's first securitization backed purely by commercial real estate loans. Many of the loans are on healthcare properties, specifically long-term care facilities with skilled nursing. Previously, the company had financed its commercial loan portfolio by putting those assets into the CapitalSource Commercial Loan Trust, which also securitized asset-based and cash flow based loans, according to someone familiar with the situation. To date, the company has done 10 securitizations, and the previous nine were done through the Commercial Loan Trust.

More than just giving its real estate balance sheet a place of its own, analysts said, CapitalSource's real estate securitization program reflects changes to its overall business strategy.

Soon after achieving REIT status, the company also began providing sale-leaseback financing, wherein the firm sells its commercial real estate assets and leases the property back from the buyer. At the rate CapitalSource is originating those deals, it could have as much as $800 million in sale-leaseback loans on its balance sheet by yearend, said David Chiaverini, a research analyst at BMO Capital Markets who focuses on specialty finance companies.

Excluding sale-leaseback deals, CapitalSource is expected to write $8 billion in corporate loans by the end of the year, he said.

Revenue from sale-leaseback deals can be securitized, and some market players familiar with CapitalSource say the company is weighing the pros and cons of doing that, depending on whether they can aggregate enough of the deals and obtain favorable pricing for a transaction. The trick, market sources said, is raising ABS investors' comfort level with an asset class that typically produces very homogenous portfolios, despite geographic diversity in certain deals. Therefore, investors might look to buy protection on bonds secured by those leases.

Operating from its Chevy Chase, Md. headquarters, CapitalSource started out providing middle-market loan clients with senior and mezzanine loans that average about $7 million, which sometimes financed M&A activities. Over the years, however, their corner of the capital markets became flooded with liquidity, BMO's Chiaverini said.

"They feel the cash flow lending opportunities are not as ripe as the ones in commercial real estate," Chiaverini said. Although that business at CapitalSource is by no means shrinking, it is not growing as quickly as the company's real estate business. He added: "There is so much liquidity in the middle-market M&A market, that pricing has gotten tight."

CapitalSource got a blended rate of 40 basis points over Libor on its recent securitization.

CapitalSource's real estate focus has allowed the company, auspiciously, to aggregate its balance sheet at a much faster rate than if it focused on asset-based and cash flow loans. Those assets typically amortize after three or four years. Real estate loans, on average, have terms of seven years, significantly slowing down runoff from its balance sheet. Analysts expect the company to grow its loan portfolio by $600 million between the third and fourth quarter of this year.

"Originating longer-duration real estate assets allows their balance sheet to grow bigger each quarter since those assets are stickier," Chiaverini said.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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