The commercial mortgage REITs started the week behind the proverbial eight-ball, as Monday’s sour news from CapitalSource Inc. (CSE) and a harsh downgrade of Capital Trust, Inc. (CT) set the week’s tone for the sector. It was all downhill from there. Capital Trust was downgraded from Neutral to Sell at UBS Investment Research (UBS), which said it believes that the overall CMBS market will remain weak into 2009 and commercial loan performance will deteriorate further. UBS also cited the company's low reserve levels compared to peers, believing that the firm will have to take meaningful reserve charges in future quarters. UBS slashed its price target from $27 to $19, as a result, saying that the Company’s premium to book was "unwarranted." Not surprisingly, Capital Trust shares tanked throughout the week, shedding 30 percent from last Friday's close to levels not seen since 2003. CapitalSource to End Run as REIT? Fresh off the announcement of its 30 million share secondary, CapitalSource, Inc. finally confirmed months of speculation that the company’s new depository strategy may jeopardize its REIT status. In a Monday morning 8-K filing, the company warned that it expected to "reevaluate" its dividend policy following the acquisition of 222 banking branches from now-bankrupt Fremont General Corp., and that it may decide to "retain a majority of our earnings, consistent with dividend policies of other commercial depository institutions." The company did say that it intended to remain a REIT for 2008, and would acquire the necessary REIT-compliant assets and make the necessary minimum distributions of taxable income to maintain qualification. However, CapitalSource had already warned investors in its first quarter 10-Q that "we [CSE] believe we already have paid substantially all of the dividends that will be required for 2008 to qualify as a REIT." In other strategic actions, CapitalSource confirmed the sale of $1.5 billion in agency-backed MBS during the second quarter as part of an "asset reduction strategy for residential mortgage investments," and amended its $1 billion unsecured credit facility to provide additional capital flexibility in consummating the Fremont acquisition. More Dividend Deaths Following in the footsteps of Crystal River Capital Inc.'s (CRZ) dividend slash, CBRE Realty Finance, Inc. (CBF) also cut its dividend significantly, slashing its payout by 33 percent from $0.15/share to just $0.10/share. It’s a 50 percent reduction in the dividend over the second quarter of 2007, but CBF’s depressed share price still leaves the stock with a 10 percent forward yield. The dividend news was even worse at twin trusts Vestin Realty Mortgage I, Inc. (VRTA) and Vestin Realty Mortgage II, Inc. (VRTB). The stocks of these two Vegas-based companies were in a freefall all week, ominously foretelling the ultimate suspension of their monthly dividend payments announced after the bell on Thursday. Although both companies reassured investors that they would remain compliant with REIT rules, neither trust could confirm when, or even if, the dividend would be reinstated. Editor’s note: Patrick Harden is a Certified Public Accountant with three years of experience in auditing publicly-traded real estate investment trusts. For the past two years, he has been involved in the mortgage finance industry as a member of the financial reporting group at a publicly-traded mortgage bank. His column covering mortgage REITs runs every Friday. Disclosure: The author held no other positions in publicly-traded firms mentioned herein when this story was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.