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Newcastle Investment Corp. (NYSE:NCT)

Q3 2013 Earnings Call

November 1, 2013, 8:30 AM ET

Executives

Sarah Watterson - Director, Investor Relations

Wesley Edens - Chairman of the Board

Kenneth Riis - Chief Executive Officer and President

Jonathan Brown - Interim Chief Financial Officer

Andrew White - Managing Director

Michael Reed - Director and Chief Executive Officer, GateHouse Media, Inc.

Analysts

Douglas Harter - Credit Suisse

Matthew Howlett - UBS

Bose George - KBW

Operator

Welcome to the Newcastle Investment Corp. third quarter 2013 earnings conference call. (Operator Instructions) I would now turn the call over to Sarah Watterson, Investor Relations. Please go ahead.

Sarah Watterson

Thank you, Laurie, and good morning. I'd like to welcome you to Newcastle's third quarter 2013 earnings call. Joining us today are Wes Edens, Chairman of the Board; Ken Riis, the CEO and President; Jon Brown, CFO; Andrew White, Head of Newcastle's Senior Housing Strategy; and Mike Reed.

Before I turn the call over to Wes, I would like to point out certain statements made today maybe forward-looking statements. Forward-looking statements are not statements of fact and that these statements describe the company's current beliefs regarding events that by their nature are uncertain and outside of the company's control. The company's actual results may differ materially from estimates or expectations described in any forward-looking statements. We caution you to not place undue reliance on any of the forward-looking statements. I also encourage you to view the disclaimers in our earnings release regarding forward-looking statements and expected returns.

I would now like to turn the call over to Wes Edens.

Wesley Edens

Thanks, Sarah. Welcome, everyone. So real briefly, we had a very busy and very productive quarter at Newcastle. Lot's of moving parts. We have a supplement, a reference has been posted that I think will help give a lot of clarity to the different segments of the business, but as there are lot of emerging trends that are coming through the business, and we will walk through them in a second.

First, in terms of financial performance. Cap income $28 million, $0.09 per diluted share. Core earnings of $24 million, $0.08 per diluted share. We had a dividend of $0.10 a share.

And as we showed at the first part of the presentation, we had a lot of cash on hand. The anticipation of the restructuring and spin-off of the media transaction, if you had invested that cash for the entire quarter and had converted the GateHouse debt into equity, both of which are in the process of happening as we speak, earnings would have been $11 million higher or $0.04 per share; so financially, a very, very good quarter.

The highlights, if you look through each one of the segments, and I'll turn it over to Jon Brown to walk through financials in a minute, and then have folks walk through each one of the business compliance. But each one of the segments we had were very busy.

In senior housing, the amount of invested capital at the end of the quarter is about the same as it was at the end of the second quarter, but that understates the level of activity with the future pipeline and committed to closing. So at the end of the second quarter we had $167 million of capital invested. In the third quarter $163 million, because we actually returned a little bit of capital.

Looking forward at the end of the year, based on what is already committed in closing right now, that jumps up $255 million in both the quality of the investments that were made in the quarter as well as the performance of the existing stuff on balance sheet have been terrific, and Andrew will talk about that in a second.

The debt business, which is both the legacy CDO businesses as well as a handful other balance sheet assets, also had a good quarter. And the credit markets have been supportive and have been very good in actually over the period of the quarter. Ken will walk through that. But there's been a lot of activity, both in terms of some of the underlying investments and also some of the financing and restructuring stuff that he has done.

And then lastly on the media side, we announced, during the quarter, the restructuring and the spin of that, just a second on that. So invested capital, we show, at the end of the Q3, $263 million that is roughly as just for what the amount of capital will be spent out here in the very near-term in the form of equity of New Media.

The New Media company is in bankruptcy, being restructuring right now and is expected to emerge very soon. We think that the timeline for that is next Wednesday, the 6, we'll have a confirmation hearing, to confirm that the company will come out and expect it actually be spun back out to us in the form of equity on about the November 12.

We have filed with the SEC to then spin that company out to shareholders. Every shareholder of Newcastle will also get a share of New Media. We've gotten one set of comments, expect to re-file in the next day or so. I think we're on track through the SEC hopefully in the month of December, and have that share of stock in hands around the first of year.

With that, I'm going to pause and turn it over to Jon Brown to walk through the finance. Jon?

Jonathan Brown

Hi, everyone, and thanks, Wes. I'm going to provide a quick overview of our results. In the third quarter we generated GAAP income of $28 million or $0.09 per diluted share. This included core earnings of $24 million or $0.08 per diluted share. On September 20, we declared a common dividend of $0.10 per share or $29 million.

If we had invested our $120 million of average uninvested cash at management's expected returns in the beginning of the quarter, and if the GateHouse debt had converted to equity and we obtained our anticipated GateHouse debt facility, the full quarter earnings would have increased by $11 million or $0.04 per share. Although, this does not serve as a proxy for our expectations of next quarter, we hope our result will become more normalized, once the intended spin-off of New Media is complete.

To provide more information on our third quarter, we posted our third quarter supplemental disclosures on our website, and you'll notice we included detailed asset performance data for each of our primary business lines in the appendices as well. We look forward to updating you on our progress in the coming quarters.

I will now hand the call to Andrew White to discuss our senior living investments.

Andrew White

Thanks, Jon. So this morning, I'm going to share a few comments on the healthcare market generally, and I'll talk about the operating performance of our existing portfolio, our recent acquisition activity and our pipeline.

Starting first with the overall market. We continue to feel very good about our strategy in the context of the overall market. This continues to be a large and highly fragmented space and so we feel very good about our prospects for continuing to source accretive deals.

The industry continues to be supported by favorable supply demand dynamics, so we also feel very good about our prospects for continued NOI growth. There has been a fair bit of conversation around new construction nationwide, but I think it's worth commenting on the fact that this is really something that needs to be evaluated market-by-market.

The reality is that the majority of construction activity is concentrating in the handful of markets like New York and Boston and Houston. And in our existing portfolio, we have very little exposures to the markets that are heating up with new construction. We're also being very selective about the markets where we're making new investments.

The other macro issue we're commenting on is the overall rate environment. There has obviously been a fair bit of volatility over the last quarter, but rates and our debt financing costs are more or less unchanged since the end of last quarter.

Turning now to the operating performance for our existing portfolio. For Q3, our same-store portfolio generated 19% levered yields versus 17% last quarter. In weighted average, we've owned this portfolio about seven months. We're on track to stabilize north of 20%, well ahead of our original guidance.

For Q3, our total portfolio, which includes the investments we made in Q3, generated 16% levered yields. For the quarter, we closed on five acquisitions, 19 properties, $300 million of asset value and about $100 million of equity invested. The targeted returns for those acquisitions are consistent with our existing portfolio, which means 12% levered yields initially and stabilized levered yields in excess to 20%.

Looking forward, we continue to build our pipeline. We've invested a little under $200 million of equity thus far, $163 million net of refinancings. And we have $300 million of assets in contract now, which represents an incremental $100 million of equity investments, which would take our total equity invested to a little under $300 million and $255 million net of refinancings.

We also have a near-term pipeline of over $1 billion in transactions. And as we have previously stated, this includes a mix of both large deals and single-asset deals, so it's a bit hard to predict the timing, but we feel good about the progress.

With that, I'll turn the call back over to Wes.

Wesley Edens

Thanks. Great, thanks. Ken, do you want to walkthrough the debt investments side.

Kenneth Riis

Thanks, Wes. I will review the debt business. As of September 30, we owned $2.1 billion of assets, $1.7 billion of legacy securities and loans and $360 million of Fannie Mae and Freddie Mac ARMs. The $1.7 billion of legacy portfolio continues to perform very well and create good opportunities for us.

We ended the quarter with an overall price of 78% of par, an increase of 1 point or $20 million in the quarter and the overall credit risk continues to improve. In the quarter, we repurchased $25 million of CDO IX debt back at a price of 86% of par. So again, sourced $25 million at a good discount, assuming no collapse of CDO IX, and held to maturity, we expect this investment will generate a 21% of leverage return for the Newcastle.

Another thing I want to highlight, which happened such subsequent to quarter-end is in October, we sold a $90 million mezzanine loan. The borrower wanted to certain concessions in a restructuring that we weren't comfortable giving, so we negotiated the sale of the debt at par and received a $3.5 million of fees in the sale. So as an example of the upside in our portfolio and our legacy book, that's just one example. There is more of that to come.

Finally, I want to go over our CDO VI sale. About two years ago, we repurchased the whole $257 million senior class at 66% of par investing a $170 million. Today, that class size has paid down to $110 million. We restructured that class and sold a new senior $99 million class to a third-party, generating $88 million or approximately $88 million of proceeds.

So to date, on a $170 million investment, we would have generated $238 million of cash flow for the company and we will also retain a junior piece of $11 million on our balance sheet. So the overall economic gain in this transaction will end up being $80 million and generated 24% IRR for Newcastle.

The other great thing about it is, in this transaction we'll have received $47 million of cash from our balance sheet to reinvest. And if invest that, our expected returns, it will be $0.02 accretive per year per share for shareholders, so a-half-a-penny a quarter or $0.02 for the overall year.

I'll hand over it to Wes.

Wesley Edens

Just a few other words on the media investment. So the New Media company that will be spun out here at beginning of the year is really two discrete investments, so it was a portfolio of newspapers that was bought from Dow Jones, the Local Media Group. You can turn to Page 15 of the supplement that was a total purchase of $87 million. We took out a loan of $33 million. The net investment equity is about $54 million.

And then GateHouse itself, which is a little bit of a moving target, the total amount of debt at GateHouse is $1.2 billion. The conversion of that into equity was at $0.40, so $480 million. And we intend to put a financing in place at the time of emergence of bankruptcy of $150 million, which is partially done at this point. This is a net equity investment between the two. The company on day one will be about $330 million for the GateHouse properties, about $50 million for the Dow Jones, that the total equity footings will be then $384 million.

The performance of those assets collectively over the quarter was actually very consistent and quite good with our projections, but we think that the kind of the net investment return on as converted basis in the equity earnings will be about 19%, so about $76 million on the [ph] $204 million of total equity.

So that's what the economic profile of the company will look like on day one. We think there is lots of exciting stuff around that. And once we finish the bankruptcy and have our investment completed, we'll probably host an Investor Call some time in the next quarter on that.

Last thing I would say is that on the bigger picture, which is the strategy of rotating out the capital that's in the debt business into the senior housing business that Andrew talked about has been proceeding with kind of great base. We're excited about the amount of capital we deployed in the sector right now. But we're more excited about the results that have been generated on a current return basis.

An Andrew said there is a pipeline of the same kind of one-by-one or small portfolios of assets we've bought that is very robust. There are also a handful of larger transactions, one in particular that would really be catalytic if we were able to get this sorted out. And if that came in short-term that would probably give us that kind of the heft to the business to be a standalone business one way or the other.

So that's exciting, when you think returns on our portfolio and the opportunities and returns of those companies on a standalone basis in the sector in the low-to-mid single digit. So we're very excited about where that stands. There could be some good news about that, we hope so.

So with that, let me pause. Operator, we're ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Douglas Harter of Credit Suisse.

Douglas Harter - Credit Suisse

The rationales to restructure CDO VI as opposed to try to collapse it?

Kenneth Riis

If you look at the capital structure of CDO VI, there are some holders of debt that really don't have any asset value to them anymore, so there is a $170 million of assets and there is about $270 million of sort of outstanding liabilities. So when you go back to some of those holders, we can't, they are unwilling to sell at massive discounts, so really we expect recovery really only up to the one B Class and we owned all the senior class.

So for us there is not a lot of upside in collapsing unless we can buyback sort of the underwater debt at very, very low dollar prices or nominal price of $0.01 or something because there is no recovery to those. So anyway for us this was a quicker way to sort of execute and raise capital, but also we're not really leaving a whole lot of optionality on the table in terms of collapsing. Although as a collateral manager we will continue to manage the transaction and still have the right to collapse in the future if the opportunity presents itself.

Douglas Harter - Credit Suisse

And just I guess staying on the CDOs, it looks like the cash flow from the net investment spread decline in both VIII and IX, could you just tell us what's behind that?

Kenneth Riis

Basically that's from some of the pay downs of the assets within the deals.

Operator

Our next question comes from the line of Matthew Howlett of UBS.

Matthew Howlett - UBS

Can you just walk us through the capital deployment, what the cash on hand versus the pipeline that we have? You have $92 million in contract, that's obviously presumably funded with the $120 million net in cash. Does that cash include what you freed up in CDO VI?

And then walk us through once you get that deployed to fund the $150 million to $200 million, what you're calling near-term pipeline, what would you look towards, the VIII or IX to collapse, would you go to the other debt or could you get proceeds from the GateHouse debt? If you could just kind of walkthrough a little bit, how you see it shaking out?

Wesley Edens

Well, we expect to fund the ordinary course investments on the senior housing business through cash on hand as well as from incremental capital coming out of the debt business. And it's not a precise walk forward that when we run our numbers out for the next couple of quarters we've got sufficient capital to fund everything that we've got in the pipeline right now. And I expect that that will continue.

What will change that a little bit is if we were able to buy one of these larger portfolios, we'd probably have to go and raise capital, if that was something that came in the past, it'd be a happy day because it would be a chunk of capital at very, very attractive prices. But we have done a good job, I think the company, has done a good job of managing both the flow of capital out of the debt business and in the deployment of it on the senior housing side. And maybe you can walkthrough with John at some point as you like, but those numbers look like they're going to be fine to us.

Matthew Howlett - UBS

And then we talked about the collapse. Obviously, CDO VIII & IX are delevering, the debt businesses are still generating terrific returns. Ken, you mentioned a mezzanine loan that you're refinancing, was that outside the CDOs? And how do we flip between the other investments you have here on Page 22 and then the CDO VIII and IX? What would you look to get rid of first?

Kenneth Riis

Well, first of all, the $90 million mezzanine loan that I highlighted, that was in our CDOs. That was a good result for us, even though we know we're getting capital back to deleverage the CDO, but we extracted a good time in flashing the restructuring and then the sales of the loans.

Matthew Howlett - UBS

Do you feel like the CDO VIII and CDO IX could be monetized as easily as you did CDO VI? Is it trickier than that or I guess, you've got some MH securitizations. Are those just as easy to deconsolidate and sell?

Kenneth Riis

Well, the CDO VII and IX, yes, you're right, they are generating still good returns and good cash flows for us. So it's all about the timing. I think as assets payoff and deleverage the transactions then we will look to potentially harvest the capital out of those transactions. But right now, they're generating good returns and good cash flows to us.

So it's all about timing of prepayments of the assets in the CDOs and then the redeployment in two other investments that generate similar returns, but in senior housing even if it's a slightly lower return initially, it's a positive thing for us, because that capital will be traded at a higher returns than our CDO assets would.

Operator

Your next question comes from the line of Bose George of KBW.

Bose George - KBW

Actually when you think about the earnings power of ex the New Media spend, actually where do you think that kind of comes out?

Wesley Edens

I'm sorry, could you be little more precise in the question. Are you saying what do we think the run rates earnings are going to be post the New Media?

Bose George - KBW

Exactly.

Jonathan Brown

I think as we said the New Media, we expect to be about $0.02 to a little bit more cents per share per quarter. So if you look at our current run rate, and that's not in our current run rate, so you throw that in there and you think about where we're talking about being after that in there and then you just back that out, we should be in that range. We don't typically give guidance on specific numbers.

Bose George - KBW

So if I add back kind of the $0.04, it gets you fully normalized and then pull out the remainder. That makes sense. And then actually switching to that large transaction, can you give us any sort of ballpark of how big it is?

Wesley Edens

Well, there are two different things that we're looking at. The one that I think is most actionable would be a capital deployment of a $152 million to $200 million, so it's quite large and that's the equity component of it. But it's a little bit hard to know exactly how it's all going to shake out. Look there is something that we think has got problem, and that we think can happen sooner rather than later, but it's very much of a work in progress right now.

Operator

At this time, there are no further questions. So now I will turn the call to Wes Edens for any additional or closing remarks.

Wesley Edens

Well, thanks everyone for calling in. It's a continued evolution of the changing of the balance sheet and we try to be clear. If you have further questions please follow-up with all of us. Thanks much.

Operator

That does conclude today's Newcastle Investment Corp. third quarter 2013 earnings conference call. You may now disconnect.

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