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Executives

Nadean Finke – IR

Ken Riis – President and CEO

Brian Sigman – CFO

Analysts

Matthew Howlett – Macquarie

David Fick – Stifel Nicolaus

Newcastle Investment Corp. (NCT) Q4 2009 Earnings Call Transcript February 19, 2010 11:00 AM ET

Operator

Good afternoon. At this time, I would like to welcome everyone to the Newcastle fourth quarter and year-end earnings call.

I would now like to hand the conference over to Nadean Finke. Please go ahead.

Nadean Finke

Thank you, Christine. Good morning, everyone. I would like to welcome all of you today, February 19, 2010, to Newcastle’s fourth quarter 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 may be forward-looking statements. Our actual results may differ materially from the 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 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 statements disclaimer in our earnings release, including the recommendation to review the risk factors contained in our annual reports filed with the SEC.

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

Ken Riis

Thanks, Nadean. Good morning, everyone; and thank you for joining us for our fourth quarter and year end 2009 earnings call. 2009 was a tough year for the markets we invest in, as loan defaults accelerated, ending the year at historically high levels.

On the positive side, risk premiums decreased, resulting in tighter credit spreads in the second half of 2009. For example, in the second half of 2009, AAA rated CMBS spread tightened approximately 300 basis points and have stabilized since year-end. Looking ahead in 2010, we are hopeful that interest rates will remain low, which should increase capital for new loans, improve liquidity in the market, and tighten credit spreads further.

Since we spoke last, at Newcastle, we have focused on two things; maximizing cash generated from our portfolio and utilizing some of our excess liquidity to deleverage our balance sheet.

In this regard, we had success. First, we continue to pass our Over Collateralization tests in CDOs VIII, IX, and X. These CDOs produced $12 million of cash, which was the main contributor to our net operating cash flow generated in the fourth quarter. Secondly, we de-leveraged our balance sheet. We reduced non-agency recourse debt by $20 million, and repurchased $37 million of CDO liabilities for $8 million, realizing a gain of $29 million. We then repurchased $52 million of our junior subordinated notes at approximately $0.33 on the dollar, and eliminated $4 million dollars of annual interest expense in this transaction.

Today, we have $59 million of unrestricted cash and $29 million of non-agency recourse debt, which gives us $30 million of excess liquidity available for investment or other corporate uses. In addition to our cash on balance sheet, we currently have $201 million of restricted CDO cash to invest in the three CDOs that generate significant cash flow to the company. Our goal is to invest this cash in stable credit assets yielding 8% to 9%. We will focus on securities that are priced at a discount to help build over-collateralization cushions in these CDOs.

In the near term, we will continue to look for opportunities to buy back debt at a discount and deleveraging ways that are accretive to shareholders. For the full-year 2009, we repurchased $250 million of CDO liabilities at an average price of $0.12 on the dollar and realized a gain of $215 million. It is hard to project how much and at what price we can buy back our CDO liabilities, but with $4 billion of debt outstanding, repurchasing this debt at steep discounts will be a major focus of ours in 2010.

Over the past year, I am proud of our ability to generate positive operating cash from our portfolio, increase liquidity, and reduce recourse debt. Despite our progress today, I feel we are too reliant upon the cash flows from CDOs XIII, IX, and X. In the past, we have done a good job maximizing the cash from these yields, but there is still much to do. Today, the visibility of future cash flows is quarter to quarter, and very hard to predict. Our goal in 2010 is to further deleverage our balance sheet and therefore position the company to generate stable recurring cash flows. Unfortunately, we aren't there yet, and we still have a lot to do.

I will now turn it over to Brian Sigman, our CFO, to discuss in more detail our financial results. Brian?

Brian Sigman

Thanks, Ken, and good morning everyone. So today, based on Ken’s broader view of Newcastle and the market, I will drill down on our liquidity, financial results for the quarter, and finish with some key points.

Our liquidity; currently, we have $59 million of unrestricted cash and $200 million of restricted cash for investment at our CDOs, primarily all of which is in CDOs VIII, IX, and X. We also have the following recourse debt excluding our junior subordinated notes

$21 million financing non-agency real estate securities loans and properties, and $8 million financing manufactured housing loans. As we have noted, all of this $29 million of debt is due through September 30 of this year. Additionally, we have a $49 30-day repo financing collateralized by Freddie Mac or agency securities. We currently have four interest rate swaps for the notional $69 million outside of our non-recourse financing structures and we have no future funding imminent.

Now on to our financial results for the quarter. We had GAAP income of $0.31 per share, and let me explain the components of that. Our net interest income, less our expenses and net of approved preferred dividends resulted in income of $13 million or $0.24 per share. Additionally, we had other income of $0.58 per share due to the following three items; one, a gain of $0.55 per share on the repurchase of $37 million of our own CDO debt at an average price of $0.21 on the dollar with a current average rating of DDD+ that was originally rated AA+. Two, a gain of $0.07 per share on the sale of $51 million face of securities. And three, a net loss of $0.04 per share primarily due to hedge ineffectiveness on some of our derivatives.

In the quarter, we booked additional impairment charges on our securities of $1.80 per share. However, we booked offsetting income of $1.29 per share on our held-for-sale loans due to net increase in their market values. Adding these components of $0.24, $0.58, and $1.29, and then subtracting the $1.80; gets us to our GAAP income for the quarter of $0.31 per share.

And lastly, some key points. As of December 31, 2008, we had a net operating loss carry forward of $182 million and a net capital loss carry forward of $199 million. These carry forward losses can generally be used to offset ordinary taxable income and taxable gains in future years. The net operating and capital loss carry forwards as of December 31, 2009 will be subject to the finalization of our 2009 tax return later in this year in September. However, we do not think we had a dividend requirement for 2009. In addition to the CDO bonds we repurchased using unrestricted cash, we also invested $59 million in restricted cash in our CDOs to purchase $79 million face of new CMBS and ABS. We purchased these in an average unlevered yield close to 14%, with a single A rating.

In the fourth quarter, CDO V failed its OC test. Therefore, we now only have three CDOs that are passing their respective tests. In the four deals that were failing their OC test, we did continue to see senior management fees throughout the quarter. In the fourth quarter, we received $13 million of cash receipts from our CDOs, which is down from the $17 million received in the third quarter. The $13 million received this quarter includes $2 million of senior management fees and $1 million of non-recurring fees.

In addition, CDO VII failed two additional OC tests, thereby triggering an event to default and allowing us to be removed as the collateral manager. At this point, we have not been removed as the collateral manager and are therefore still receiving senior management fees. However, as long as the EOD continues, we will not be permitted to purchase or sell any collateral in CDO VII.

And now, we will take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Matthew Howlett with Macquarie.

Matthew Howlett – Macquarie

Great, guys. Thanks for taking my question; and congratulations on all the hard work in turning around the company. Just a few questions, first, on the CDO cash flows this quarter versus last quarter. CDO VIII and CDO X were down about $1 million, a little over $1 million sequentially. I know there were some one-time – there were some less principal prepayments, but any one-time issues that drove it in the quarter? Do you not get interest in those months in some of those CDOs from some of the underlying collateral?

Ken Riis

Yes, there are some timing issues. We do have some re-debt that pays every six months and I think we had some more restricted cash on average that probably worked down the interest in the quarter. Also, obviously, any additional actual defaults on assets would also hurt the amount of interest income.

Matthew Howlett – Macquarie

Great. Got you, okay. So it is more of a timing issue than just an overall trend. And then, on that note, CDO IX, you mentioned on the footnote that the divested loan could erode, so you virtually follow the excess OC, but you still have a significant amount of unrestricted cash. How much unrestricted cash is in CDO IX, and you know, once that is redeployed, do you feel like the OC cushion to be rebuilt and to what extent?

Ken Riis

Well, in CDO IX, we had $26 million of unrestricted cash at 12/31. Really, the $200 million is mostly in – it is $110 million in CDO VIII and $57 million in CDO X. You know, we don't give guidance on where we think the OC is going to go. Obviously, Stuyvesant will be a big hit to that field, but we can’t predict where it is going to go in the future.

Matthew Howlett – Macquarie

Got you. That is not – I know it is defaulted, but has it technically defaulted in the CDOs, I mean, has it reflected yet in the –

Ken Riis

Yes, for the OC test, which is kind of why we disclosed it, it is actually not technically defaulted, although it is very, very imminent, which is why we chose to kind of obviously make this one stand out.

Matthew Howlett – Macquarie

Got you, okay. And then just on the overall collateral trends, the mezz and B-Notes delinquency trends were obviously stable out on that one loan. There was slight pickup in CMBS downgrades. I know S&P was going through their methodology, and then I know Ken you mentioned about they were sort of – third quarter they were 50% of the way through. Where are they now, you still have $1 billion on watch for downgrade and any color you can give us on that?

Ken Riis

Well, you know, it is really hard to project the timing of their downgrades, but I would say, you know, right now, they are a little bit more than 50% through their downgrades that they announced three quarters ago, but you know, as they get through that, you know, other rating agencies or even S&P may put other securities on downgrades. So it is sort of an ebb and flow, and you know, so that is why we disclosed how much we currently have, and yes, you are right, it is about $1 billion right now.

Matthew Howlett – Macquarie

Okay. You can’t really tell or not whether all that will be downgraded or whether – I mean, there is no way at this point, just on quarter by quarter.

Ken Riis

Yes, I think you just got to look quarter by quarter in this. We want to highlight it as a risk, but you know, it is really hard to project – some get affirmed and some get downgraded, so we extended the downgrades, it is really hard to predict, really.

Matthew Howlett – Macquarie

Got you. And then the last question, just on the excess cash, $60 million, a lot of opportunities, CDO debt looks like you are picking up really distressed prices, but at the same time, you know, you tried to tender for the preferreds in December, which failed. I mean, what can you tell us what that excess cash, where you looked at the play going forward?

Ken Riis

Well, you know, as I mentioned, we are focused on buying our CDO liabilities back at a discount, and you know, it is the main focus of ours and that is where we are very focused right now. But, we are looking at all opportunities in the marketplace to build shareholder value and buying back CDO debt is just one of those.

Matthew Howlett – Macquarie

Great. Thanks, guys.

Operator

Your next question comes from David Fick with Stifel Nicolaus.

David Fick – Stifel Nicolaus

I appreciate the clarity on the CDO test, especially with respect to Stuy Town. Can you talk to us a little bit about where you stand today with respect to your preferred shareholders, now that you have five quarters of dividends in arrearage and it doesn’t look like you have any other plans to start paying?

Ken Riis

We don’t have imminent plans to start paying the dividend, but your question is where do we stand with our preferred shareholders?

David Fick – Stifel Nicolaus

Have you had any conversations there about the two Board seats that they have a right to pick up or any other conversations with anyone representing those preferred shareholders?

Ken Riis

No, we haven't had any discussions regarding that.

David Fick – Stifel Nicolaus

Okay, thanks.

Ken Riis

Yes.

Operator

There are no further questions at this time.

Nadean Finke

Thank you, Christine. Thanks everyone for joining us today and we look forward to speaking to you next quarter. Thank you.

Operator

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

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Source: Newcastle Investment Corp. Q4 2009 Earnings Call Transcript
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