Newcastle Investment Corp.Q3 2009 Earnings Call Transcript

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Newcastle Investment Corp. (NCT) Q3 2009 Earnings Call November 6, 2009 1:00 PM ET


Nadean Finke - IR

Ken Riis - President and CEO

Brian Sigman - CFO


Matthew Howlett - Fox-Pitt Kelton

David Fick - Stifel Nicolaus


Good afternoon. My name is [Lori] and I will be your conference operator. At this time, I would like to welcome everyone to the Newcastle’s Third Quarter Earnings 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). Thank you. I will now turn the call over to Nadean Finke. Please go ahead.

Nadean Finke

Thank you, [Lori], and good afternoon, everyone. I would like to welcome all of you to Newcastle's third quarter Earnings 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, may be forward-looking statements. Our actual results may differ materially from these estimates or expectations in any forward-looking statements.

These statements represent the company's beliefs regarding events that by their nature are uncertain and outside of 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 the 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?

Ken Riis

Thanks, Nadean. Good afternoon, everyone, and thank you for joining our third quarter earnings call. We had a productive third quarter as we continue to improve our liquidity position in the company.

Currently we have $74 million of unrestricted cash and $49 million on non agency recourse debt, a $49 million liquidity improvement since the end of the second quarter. We continue to be able to meet our non-agency recourse obligations and currently have $25 million of excess cash.

Although I am happy that the company is in a positive liquidity position, we still have a lot of work to do. In the next several months, we plan to use our excess liquidity to reduce our liabilities and deleverage our balance sheet.

We will continue to look for opportunities to buy back our CDO liabilities. In 2009, we have repurchased $210 million of CDO bonds at an average price of $0.11 on the dollar. In addition, we may look for other ways to deleverage.

As you may know, we filed with the SEC documents regarding a potential transaction with our preferred shares. The transaction has not commenced and is currently being reviewed by the SEC. I cannot comment on the potential transactions, as we are in a quiet period. If and when we do proceed, we will then be able to discuss and answer questions, but not a lot to say at this point.

As it relates to our third quarter, there are a few things I would like to highlight. We had a lot of activity relating to our CDOs. First, we used $17 million of unrestricted cash to repurchase $150 million of bonds in three of our CDOs. We repurchased these bonds as follows, $34 million of the CDO VIII, $54 million of CDO IX, and $63 million of CDO X bonds were repurchased in the quarter.

For GAAP purposes, we recorded a $133 million gain on the extinguishment of this debt and we also canceled these bonds within our CDOs, lowering the amount of outstanding notes and increasing the over collateralization or OC cushions in these deals. The positive impact of this activity is not reflected in our October 30 OC percentages, but is reflected in the updated numbers described in our press release as of the October remittance reports.

Secondly, we continue to receive asset repayments in our portfolio with the majority of these pay downs experienced in our CDOs. In the third quarter, we had $158 million of CDO asset pay downs compared to $106 million in the second quarter of 2009. As a result, we currently have $127 million of restricted cash to invest. Reinvesting this cash would be accretive to earnings and could build over collateralization in our CDOs.

Finally, as we have seen over the past three quarters, we produced solid operating cash flows from our portfolio. In the third quarter, we generated $60 million of operating cash net of expenses with 68% of our cash coming from three of our CDOs, CDOs VIII, IX, and X. We are highly focused on the cash receipts from these three CDOs.

If we can maintain a positive OC cushion in these deals, our operating cash flow should remain fairly stable. The risk to that stability is the extent of asset downgrades and the negative impact on the cash flow triggers in each CDO. With that said, we are working hard to mitigate this risk.

Now moving on to the markets. We continue to see deterioration in loan quality, especially in the commercial real estate sector. Loan delinquencies continue to rise and property values are in decline. We don't expect any improvement in this trend until there is resurgence in lending and a clear path for the majority of the commercial real estate borrowers to refinance maturing debt.

On the positive side, as we expected, credit spreads continue to tighten. For example, in the third quarter AAA-rated CMBS spreads tightened 200 basis points and have continued to tighten since quarter end. Looking ahead, we think credit spreads will be volatile, but tightened going into year-end and as demand outstrips supply.

Now I will turn it over to Brian Sigman, our CFO, to discuss in more detail our third-quarter financial results. Brian?

Brian Sigman

Thanks, Ken, and good afternoon, everyone. So today based on Ken's broad review, I will drill down on our liquidity and financial results for the quarter.

Our liquidity; currently we have $74 million of unrestricted cash and $127 million of restricted cash for reinvestment in our CDOs, of which $125 million is from CDOs VIII, IX, and X. We also have the following recourse debt, excluding our junior subordinated notes, $36 million financing non-agency real estate securities loans and properties, and $13 million financing manufacturing housing loans.

You can find the required amortization of this $49 million of debt in our press release and 10-Q. Additionally, we have $41 million of 30-day repo financing collateralized by Freddie Mac or agency securities, and we currently have no future funding commitments.

Now on to our financial results for the quarter. We had GAAP income of $0.94 per share, and let me explain the components of that. Our net interest income less our expenses and net of accrued preferred dividends resulted in income of $12 million or $0.22 per share. Additionally, we had another income of $2.44 per share due to the following three items.

One, a gain of $2.51 per share on the repurchase of $150 million of our own CDO debt at an average price of $0.11 on the dollar with a current rating of BBB. Two, a loss of $0.03 per share on the sale of 42 million faces of securities. Three, a net loss of $0.04 per share primarily due to a decrease in value of some of our derivatives.

In the quarter, we booked impairment charges on our securities of $1.85 per share and we booked income of $0.13 per share due to an increase in fair value on our loan portfolio, which we classify as held for sale. Adding these components of $0.22, $2.44, $0.13, and subtracting the $1.85 gets us to our GAAP income for the quarter of $0.94 per share.

Lastly, some key points. In addition to the $150 million face of CDO bonds we repurchased using unrestricted cash, we also invested $81 million of restricted cash in our CDOs using it to purchase 102 million face of new CMBS, ABS, and REIT debt as we detailed in our press release.

At September 30, we had $2.4 billion of notional on our derivatives. However, of this amount only $71 million is held outside of our non-recourse financing structures.

In the quarter, we received $17 million of cash receipts from our CDOs, including $2 million of non-recurring fees as we detailed in our filings. Of our seven CDOs, four were passing their respective tests during the quarter and three were failing their OC test. In the deals that were failing we did continue to receive senior management fees throughout the entire quarter.

Finally, I would like to point out some additional information that we have added to our press release and 10-Q both relating to our CDOs. First, in our CDO table we have added the face amount of assets on negative watch for possible downgrade by at least one rating agency as of September 30 by CDO. Second, we have included the OC percentages, cushion percentages for our CDOs as of our latest remittance report.

Now I will turn it over to the operator.

Questions-and-Answers Sessions


(Operator Instructions). Your first question comes from the line of Matthew Howlett, Fox-Pitt Kelton.

Matthew Howlett - Fox-Pitt Kelton

On the capital management side, you have this excess cash. I know you really can't talk about the preferred tender that’s out there. It looks like it's going to cost you somewhere between $40 million and $45 million, but how do you manage that cash going forward?

You are buying back CDO debt at huge discounts, but possibly you can tender for the preferred. There is TRuPS outstanding. You could even possibly buy back common or even redeploy that capital. How do we look at that over the next six months?

Sort of how do you look at deploying that excess capital? Are you more focused on getting this preferred done? If you continue to see CDO liabilities at this price, would you continue buying that back?

There are a lot of things to weigh. How do you look at things over the next six months? What is more accretive to shareholders? Any sort of color you can give us on that end?

Ken Riis

Well, we can't talk about the preferred transaction right now, because it's not a transaction yet, because there is nothing to talk about. What we are always trying to do is do what is most accretive to the shareholders. Buying back CDO debt as we have so far this year has been very accretive to shareholders and has been helpful to keeping cash flow going on our CDOs or in some of our CDOs. So those are all good things.

It's hard for us to project forward what we are going to do next, but what we try to do is be as detailed as possible in our press release and filings so that you can take it as it comes, and that is sort of what we are doing.

Matthew Howlett - Fox-Pitt Kelton

Would everything be on the table? In other words, could that include common stock, could it includes trust preferred, and could it include just redeploying into unlevered assets?

Ken Riis

Yes, we are looking at everything. There is no specific focus right now.

Matthew Howlett - Fox-Pitt Kelton

Well, it's certainly a good opportunity to have. Just in terms of the CDO debt you bought back, is any of that AAA or is that all sort of subordinate? Are you seeing a lot of that up, do you have the opportunity to buy more, is it out there? Is it out there for bid?

Ken Riis

It doesn't trade that often. Obviously, we are the first call when it comes up. We purchased it on a weighted average price of $0.11 on the dollar. You can actually get from our Q; we don't mark our AAA CDOs that low so in essence you can figure out that is not the AAAs. Its classes below that.

Matthew Howlett - Fox-Pitt Kelton

Then just switching to the OC test, that those looked like they improved significantly in October as you bought back some of the debt.

In terms of the watch list, it sounds like that didn't really change quarter-to-quarter, yet stuff probably last, some stuff that was downgraded and some stuff that was probably replaced that. How far along are we on S&P's sort of downgrade revisions? I mean they announced in May they were going to revise or downgrade, so how far along are we in that process?

Ken Riis

I think as it relates to just S&P, remember about three or four months ago they came out with a big list of CMBS securities that they put on negative watch. As time has gone on, I say they are about halfway through the actions that they are going to take on those securities. So probably will last through year-end, maybe past year.

It's hard to speculate what their timing is on actually doing a downgrade or affirmation on securities they put on negative watch, but I would say they are about halfway through it.

Matthew Howlett - Fox-Pitt Kelton

On then on the loan side you had a pickup in delinquencies on the B notes. Is there any potential to modify those delinquent loans and what are you doing in terms of possibly getting them current? Are there substantial recoveries to be made on those? What can you tell us about that portfolio?

Ken Riis

I think on those loans there isn't a lot of restructuring to take place on the ones that are delinquent now. We are part of the capital structure. It's not the whole loan, so it's not just up to us to negotiate with the borrower. You usually have multiple parties, five to 10 parties that are involved in renegotiating loans.

So I don't think there is a lot of upside to recovery or in terms of bringing those loans current, I will put it that way, if that was your question.

Matthew Howlett - Fox-Pitt Kelton

Then just last question, you used to provide an adjusted book value number in the press release. That might be in the Q, I don't see it anywhere today. What is that number? Is it roughly unchanged from where it was in the first quarter of around $20?

Ken Riis

Yes, I think we stopped providing that a couple of quarters ago. Actually you can figure out from the Q, and if you want it, we can do it offline. It's a lot of components on our fair value table, but we are really more focused now on liquidity and cash flows from operations. That adjusted number really is not a focus of ours anymore.


Your next question comes from the line of David Fick of Stifel Nicolaus.

David Fick - Stifel Nicolaus

Just going back to the prior question on rating agency actions, do your CDOs have significant numbers of barely ratable securities? What I am really trying to get to is, are there downgrades that could occur which would cause you to breach covenants even without technically tripping the OC test?

Brian Sigman

Well, there are different buckets within the deal, so it's not necessarily just assets get downgraded to default, if that is what you are asking. So there are certain other buckets. They are not as big an effect as when it goes into default.

Ken Riis

What could happen, we could have a downgrade of a security. Most of them are securities deal so the collateral in our CDOs, most of them are rated by rating agencies.

So if you could have a downgrade, let's say from a BBB to a BB rating on an asset, which had no impact on our over collateralization test. So really it's the extent of the downgrade, how many notches it gets downgraded will determine the impact on our over collateralization in each CDO.

So it's really hard for us to speculate what that will be. We just sort of react to it as it comes, but again, a lot of the downgrades may not impact our OC calculation at all.

David Fick - Stifel Nicolaus

Well, I am talking about outside of your OC calculation. We are seeing some CDOs where there are separate tests for investment grade status. Aside from tripping your OC tests, are there other things where simply your proportion of investment-grade securities could be impacted by downgrades or does that not exist in your CDOs?

Ken Riis

No, we have sort of a target in the portfolio in collateral quality tests as to how much has to be investment-grade and how much isn't, but if you fail those sort of collateral tests, it doesn't impact the cash flows related to the transaction. It may restrict your reinvestment or something like that but it doesn't impact the cash flows.

What we highlight in our press releases are in the triggers within the CDOs that impact cash flow to us.

David Fick - Stifel Nicolaus

Then lastly, you had a big jump in OC compliance in CDOs VIII, IX, and X. What created that?

Brian Sigman

We don't give specifics on what it was, but it can be like we talk about there are a lot of cash in these deals, a lot of pay downs that are happening. So we reinvest those at lower prices. You have some deals, where we are able to buy back some CDO debt and cancel it, so it's a few factors.

Ken Riis

The majority of it was the repurchase of the CDO liabilities and then canceling those notes within the trust.

David Fick - Stifel Nicolaus

How do you feel today as you look forward across your loan portfolio about recoveries compared to a few months ago? Are you expecting repayments to maintain pace or do you think this wave of maturities over the next year that everybody is talking about will impact your borrower's ability to meet their maturities?

Brian Sigman

When we project out the performance of our portfolio, we definitely take into consideration the maturity of the loan and its ability to refinance. That is all reflected in our impairments and on our assets. I don't expect a lot more impairments coming down the road, but that could change.


Thank you. At this time there are no further questions. I will now return the call to Nadean Finke for final remarks.

Nadean Finke

Thanks, everyone, for joining us this afternoon. We look forward to speaking to you next quarter. Thank you.


Thank you. That does conclude today's Newcastle third quarter earnings call. You may now disconnect.

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