UPDATE 1-Wachovia sees dividend cut at CapitalSource, others

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Aug 29 (Reuters) - Wachovia Capital Markets expects dividend cuts at some commercial mortgage and specialty finance companies, including CapitalSource Inc (CSE.N) and Gramercy Capital Corp (GKK.N), as they negotiate the economic downturn.

Analyst Jim Shanahan expects Gramercy and Arbor Realty Trust (ABR.N) to lower their dividends in the third quarter and follow peers like iStar Financial (SFI.N), Capital Trust (CT.N) and Crystal River Capital CRZ.N, who have already announced cuts.

Capital Trust's dividend is probably one of the most susceptible to downward revision as the company has $662 million of repurchase obligations due in October, Shanahan said.

"Our dividend estimates reflect somewhat weaker fundamentals for commercial real estate going forward, but certainly not a disaster to any extent as we are still projecting modest earnings for our coverage universe and very low levels of additional credit losses beyond managements' expectations," Shanahan said.

Companies are strained to maintain dividend as they face rising cost of funds, increase in non-accruing loans, reduced liquidity in the secondary markets, lower fee income due to lower transaction volumes and restrictive capital markets.

SPECIALTY FINANCE

Among specialty finance companies, the analyst expects dividend reductions at CapitalSource, BlackRock Kelso Capital Corp (BKCC.O) and Highland Distressed Opportunities Inc HCD.N, with CapitalSource and Highland expected to cut dividend in the third quarter.

The dividend outlook is uncertain and "at-risk" for American Capital (ACAS.O), Allied Capital Corp (ALD.N) and Apollo Investment Corp (AINV.O), Shanahan said.

Ares Capital (ARCC.O) and KKR Financial (KFN.N) pose moderate risk of dividend reductions, he said.

However, the analyst projected dividend increases for Prospect Capital (PSEC.O) and Fifth Street Finance (FSC.N).

"While we do not expect a significant change to dividend policy (absent CSE and HCD) over the remainder of 2008, the future viability of dividends for certain companies could be an issue in 2009 or 2010 depending on how severe the downturn in the economy becomes," Shanahan said.

Wachovia downgraded BlackRock Kelso, Kayne Anderson Energy Development Co (KED.N) and NewStar Financial Inc (NEWS.O) to "market perform" from "outperform." (Reporting by Ratul Ray Chaudhuri in Bangalore; Editing by Himani Sarkar)