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Newcastle Investment Corp. (NYSE:NCT)

Q4 2008 Earnings Call

March 16, 2009 1:00 PM ET

Executives

Nadean Finke - Investor Relations

Kenneth M. Riis - Chief Executive Officer and President

Brian C. Sigman - Chief Financial Officer

Analysts

Joshua Barber - Stifel Nicolaus

Matthew Howlett - Fox-Pitt Kelton

Operator

Good afternoon. My name is Charlotte (ph) and I will be your conference operator today. At this time, I would like to welcome everyone to the Newcastle Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

I would now like to turn the call over to Ms. Nadean Finke. Please go ahead.

Nadean Finke

Thank you Charlotte and good afternoon everyone. I would like to welcome all of you to Newcastle's fourth quarter and year-end 2008 earnings conference call. Joining us today are, Ken Riis, our CEO and President, and Brian Sigman, our Chief Financial Officer.

I would also like to point out that statements today, which are not historical facts maybe forward-looking statements. Actual results may differ materially from the estimates or expectation in any forward-looking statement. These statements represent the company's beliefs regarding events that by their nature are uncertain and outside the company's control. So you should not place undue reliance on any of these statements. I would encourage you to review the forward-looking statement disclaimer in our quarterly earnings release, including recommendation to review the risk factors contained in our annual and quarterly reports filed with the SEC.

Now I would like to turn the call over to Ken Riis. Ken?

Kenneth M. Riis

Thanks Nadean. We appreciate everyone taking their time to join us this afternoon. Clearly the financial markets and economic environment has been very difficult in 2008 and certainly most challenging that I have ever experienced. There has been extraordinary stress on our business and our competitors as the deterioration of the overall economy and the ongoing weakness in the residential and commercial real estate markets continues into 2009.

Just as an example, in the fourth quarter alone prices of AAA rated commercial mortgage-backed securities declined 21% as credit spreads widened about 330 basis points. Over the same period, prices of BBB rated CMBS securities declined about 51%. Since year end, spreads continue to widen. As a result, we are experiencing an acceleration in the decline of asset prices and a virtual closing of the debt and equity markets constricting access to capital for many companies like ours.

On previous calls we have discussed our concerns about deteriorating market conditions, and now I would like to touch upon a few highlights of our proactive response to these challenging market conditions. Since the third quarter of 2007, we are focused on strengthening our balance sheet and liquidity. Our goal has been to reduce recourse debt exposure to minimize mark-to-market and margin call risks, manage debt maturities and manage the credit risk in our underlying portfolio. These areas are focused with the right priorities.

As of today, we have eliminated all debt subject to margin calls on our non-agency investments. At the peak, we had $833 million of recourse financings on our non-agency portfolio. Today we have $111 million of non-agency recourse debt without any mark-to-market provisions or requirements to make margin calls if the value of the assets were to decline further.

We have also eliminated corporate level equity and leverage covenants from our debt agreements. Today we have $40 million of unrestricted cash, the remaining $111 million of recourse debt on our non-agency investments has a fixed pay down schedule over the next 15 months. And we have $50 million of debt on liquid Fannie Mae and Freddie Mac securities.

With respect to our fourth quarter results, our GAAP operating results were negatively impacted by the $2.6 billion impairment which Brian Sigman, our CFO will review in greater detail. I would like to mention though that this impairment is a non-cash charge and has no current impact on our cash flow or ability to meet debt covenants.

In fact, the $2.6 billion impairment -- of the $2.6 billion impairment, we can only economically lose up to $262 million, since most of the assets are financed with non-recourse debt and our exposure to loss is limited to the aggregate amount of our investment in these assets less any related non-recourse debt. Also changing our intent to hold the assets to maturity allows us to retain the flexibility to sell assets, which is an important tool to have during these difficult markets.

I would like to highlight that our operating income before impairments and net of preferred dividends was $24 million or $0.45 per share in the fourth quarter. As for underlying credit performance of our commercial assets, delinquencies on our commercial portfolio is still relatively low at 3%. We do expect delinquencies to get worse and we expect significant modifications and extensions to occur on the underlying loans.

We are also focused on our over collateralization tests in our CDOs which can have significant impact on the company's cash flows. A schedule of these tests have been included in our 10-K and most recently we added those to our press release for the fourth quarter.

So what's next? Clearly these are difficult markets to look into the future. We do know that there have been many government initiatives that may help the credit markets return to some sense of normalcy and I am hopeful that they do. That said, we will continue to focus on our liquidity and balance sheet to aid us in managing our debt maturities as well as future funding commitments. In addition, our priorities going forward will be to aggressively manage our existing investment portfolio and focus on optimizing the cash flow generate from those assets.

Secondarily, we will look to make prudent asset sales to increase liquidity and operational flexibility, and look for additional opportunities to buyback our own debt securities at significant discounts. In the fourth -- in the first quarter 2009, we acquired 15 million of CDO liabilities at significant discounts.

With that, I would like to turn it over to Brian Sigman and give you -- to give you some more details regarding our fourth quarter and our full year financial results. Brian?

Brian C. Sigman

Thanks Ken. Good afternoon everyone. First I'll address our current liquidity position; second our financial results for the fourth quarter, and lastly we'll close with some key points.

First and foremost our liquidity. Although, Ken mentioned it before I think it bears repeating. We have now completely eliminated our exposure to mark-to-market debt on our non-agency recourse financing. In addition, as opposed to talking about cushion on our equity related covenants, we are pleased to having said eliminated them with respect to all our recourse financings. So currently we have $40 million of unrestricted cash and $79 million of restricted cash in our CDOs.

We have the following recourse debt excluding our trust preferred security. One; $91 million financing non-agency real estate securities and loans. Two; $20 million financing manufactured housing loans, and three; 49 million financing in Fannie Mae and Freddie Mac securities. Additionally, we have one future funding commitment for which we are committed to fund approximately $40 million outside of our CDOs.

Looking ahead to the remainder of 2009, we will be required to make approximately $56 million of principal payments under our non-agency recourse financing with $32 million of that due through 930 and the rest due in the fourth quarter.

Additionally, in 2009, we currently expect to find approximately $21 million under our future funding commitment. About $10 million through 930 and $11 million in the fourth quarter.

Our financial results for the fourth quarter. In the fourth quarter of 2008 our operating income before impairments and net of the preferred dividend was $0.45 per share. We also had $1.95 per share of GAAP losses excluding impairment due to the following four items.

One; a loss of $1.19 per share on the sale of $139 million of loans, $316 million of securities and the termination of approximately $380 million notional of swaps. Two; a loss of $0.50 per share due to the decrease in value on $94 million of loans that where financed with total return swaps and were treated as derivatives for GAAP.

In the fourth quarter, we terminated the reminder of our total return swaps by selling the underlying loans. Three; a loss of $0.27 per share due to derivative ineffectiveness and four; $0.01 per share income earned on exit fees and loan resolutions.

Our impairment charge. As Ken mentioned in the fourth quarter in accordance with GAAP, we recorded an impairment charge of $49.98 per share or $2.6 billion. At the end of the fourth quarter, as we do every quarter, we evaluate our intent and ability to hold our assets until recovery.

Future market events in the fourth quarter and their impact on us as well as our expectation that challenging conditions will continue, we determine that under current accounting rules, we could no longer express the intent and ability to hold our assets until they recover in their prices.

And our 10-K to be filed today, we have discussed this charge in detail including a breakout by type, credit versus non-credit and a breakout between non-recourse financings versus recourse financings. To highlight a few of the points in the 10-K; if the entire charge was realized at December 31st, we only would have economically lost $262 million as most of our assets are financed with non-recourse debt where our economic loss cannot exceed our invested equity and the non-recourse financing structures. $2.4 billion of the charge was related to assets financed within these non-recourse structures. $2.1 billion of the charge was related to investments on which we do not currently expect future credit losses.

And going forward, our GAAP earnings will increase as the $2.3 billion loss that we recorded in access of our economic exposure will ultimately be reversed over time, either through amortization or as gains at the deconsolidation or termination of the non-recourse financing structures. Aiming the above three components gets us to our GAAP loss for the quarter of $2.7 billion or $51.48 per share.

And lastly some key points. Although I said this on the last call, we all know how important the dividend determination process is to industries and we. So I'd like to walk through our process again. At the end of the quarter, our Board will meet to determine a dividend for the prior quarter. In making the decision they consider several factors, including cash flow generated from operations, expected run rate earnings, current liquidity, potential investment opportunities and estimated taxable income.

All their purchases in the fourth quarter were made from restricted cash within our CDOs. So to be clear, we do not use any of their unrestricted cash to the purchases detailed in the press release.

Our manager, principals of Fortress and also so of Newcastle collectively own 10% of our outstanding common shares. And our investors can be assured that the decisions we are making are intended to be in the best long-term interest of the company.

At December 31, 2008 we had $2.4 billion of notional or our hedges, currently this amount only $76 million, is held outside of our CDOs.

And finally, I would like to point out two additional disclosures in our 10-K filing that we think many of you will find helpful. The first is cash received in the fourth quarter from our CDOs which we also included in the press release. And the second is a new section regarding our updated liquidity position.

Next, I will turn it over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joshua Barber of Stifel Nicolaus.

Joshua Barber - Stifel Nicolaus

I was wondering if you guys could give us a little bit of an update on your OC and IC tests given the amount of down grades we've seen from the rating agencies since December 31st. Have any of those failed any additional tests?

Kenneth Riis

Yeah, then you will see this in the 10-K. We don't redo the chart but we talk specifically, and I know it's about the current position of them. And currently portfolios seven, eight and nine are failing; although we expect to be able to fix eight before the next determination date. And if you read the 10-K later today that'll kind of give you some more guidance on the future there.

Joshua Barber - Stifel Nicolaus

Okay. And just in respect to your liquidity, what other assets would you have available if you needed to monetize some assets just either repay that or to meet your funded commitments, if you needed to at some point later this year?

Kenneth Riis

You will see in the 10-K our table of unlevered assets with a segment of the unlevered assets. There is not much; most of its budgeted (ph) at this point that you can refer to the 10-K later.

Joshua Barber - Stifel Nicolaus

Thanks.

Operator

Your next question comes from Matthew Howlett of Fox-Pitt Kelton.

Matthew Howlett - Fox-Pitt Kelton

Alright guys, thanks for taking my question and congratulations on getting the term financing on the CDO facility. Just getting back to the CDO triggers, have you looked at, haven't got chance to read the K. So to make sure that's in there but on CDO X, XI where you have most of your basic capital. And then also I guess, five and six, those are primarily seasoned CMBS assets and is it, and probably announced can you look out to really next year too and if you're pretty confident that those won't be downgraded and eventually thrift or may be been able to model that out?

Kenneth Riis

It's very difficult, this is Ken, and its very difficult to project out what the ratings is going to do relating to the downgrades of assets. What we do, do is in our credit analysis, we impair assets that we think will have credit impairment over the license that's holding them or to maturity. So that's all the best that I can help you with regarding that.

Matthew Howlett - Fox-Pitt Kelton

And then...

Kenneth Riis

Right now in this market it's very difficult to project out what the rate agencies are going to do. And you're right they have been downgrading a lot of assets in the last few weeks even and our triggers reflect that.

Matthew Howlett - Fox-Pitt Kelton

It just seems like the downgrades are mostly in '06, '07, CMBS, I could be wrong, but you do have fairly seasoned book of CMBS. Backing from the top line, just remind us what other remedies you have to fix a CDO, or maybe selling just buying back some of the debt, does that de-lever the structure or to bring the par value in, or do you need to go inside the structure and buy out a CCC bucket asset or replace it?

Kenneth Riis

No, buying back the debt doesn't really fix the OC triggers. So any cash generated in the CDOs through pay downs or sales, you can reinvest those cash flows on most of our CDOs and potentially generate over collateralization that way depending on where you reinvest your assets, what dollar price you buy the assets there?

Matthew Howlett - Fox-Pitt Kelton

Would it make sense to do that for the CDO IX where it generated six million in cash in the quarter to go on and buy something on that par to put on your own balance sheet; will that make sense?

Brian Sigman

Well I'll put this way. We have a pretty good amount of flexibility in managing our CDOs, so we're intensely focused on that. I don't really want to just focus on one way to fix them, but we are all over making sure that they continue the cash flow and to the extent we can, we're going to continue to have them cash flow.

Matthew Howlett - Fox-Pitt Kelton

Okay, fair enough. Just one other house keeping question, in terms of the management fees, inside the CDO, the collateral management fee, how much were those total last quarter and that goes directly to Newcastle shareholders. Is that correct?

Kenneth Riis

Yeah, the collateral management fee does go to the -- goes to Newcastle shareholders. And Brian....

Brian Sigman

We don't breakout the of course in that senior fee and sub fee. I don't have those numbers on.

Matthew Howlett - Fox-Pitt Kelton

Okay, we'll take a look at it. Thanks again.

Kenneth Riis

Yes.

Operator

You have no further question at this time.

Nadean Finke

Thanks again everyone for joining us this afternoon. We really appreciate it. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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