NewStar Financial's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.12.14 | About: NewStar Financial, (NEWS)

NewStar Financial, Inc. (NASDAQ:NEWS)

Q4 2013 Earnings Conference Call

February 12, 2014 10:00 ET


Robert Brown - Head, Corporate Strategy

Tim Conway - Chairman and Chief Executive Officer

John Bray - Chief Financial Officer


Tai DiMaio - KBW


Good day, ladies and gentlemen, and welcome to the NewStar Financial’s Fourth Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) And as a reminder, today’s conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Robert Brown, Head of Corporate Strategy. Sir, you may begin.

Robert Brown - Head, Corporate Strategy

Thanks, Syed. Thanks everyone for joining us for our earnings conference call where we will be discussing our fourth quarter and fiscal year 2013 results. With me today are Tim Conway, Chairman and Chief Executive Officer of NewStar Financial and John Bray, our Chief Financial Officer.

Before I turn the call over to Tim, I want to remind you that we have posted a presentation on the Investor Relations section of our website, Also available on our website is our financial results press release, which was filed on Form 8-K with the SEC this morning. This presentation and our financial results press release contain additional materials related to this conference call that we may refer to during our remarks today, including information with respect to certain non-GAAP financial measures. This call is also being webcast simultaneously on our website and the recording of the call will be available beginning at approximately 1 PM Eastern Time today. Our press release and website provide details on accessing the archived call.

Also before we begin, I need to inform you that statements in this earnings call, which are not historical facts, maybe deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All forward-looking statements, including without limitation statements regarding future financial operating results and statements related to any plans to raise additional capital involve risks, uncertainties and contingencies, many of which are beyond NewStar’s control and which may cause actual results to differ materially from anticipated results.

Factors that could affect our results and cause them to materially differ from those contained in the forward-looking statements include uncertainties related to market conditions generally and for securities of specialized commercial finance companies like NewStar in particular. More detailed information about these and other risk factors can be found in our press release issued this morning and in the Risk Factors section as updated in our quarterly reports on Form 10-Q.

NewStar is under no obligation to and we especially disclaim any such obligation to update or alter our forward-looking statements, whether as a result of information, future events or otherwise, except when required by law. NewStar plans to file its Form 10-K with the SEC on or before March 17 and urges shareholders to refer to that document for more complete information concerning the company’s financial results.

Now, I would like to turn the call over to NewStar’s Chairman and Chief Executive Officer, Tim Conway.

Tim Conway - Chairman and Chief Executive Officer

Thanks Rob and thanks for joining the call. As Rob mentioned, we have posted a slide presentation and I will refer to a few pages of it during my remarks. I will focus my comments on loan growth, market conditions and company strategy and John Bray, our CFO will discuss the financial results in detail and I will close with a review of our outlook for 2014.

We posted another good quarter with net income of $6.4 million, or $0.12 per diluted share. For the year, we earned $24.6 million after-tax, an increase of about 3% from last year. For 2013, book value per share increased just over 5%, or $0.62 to $12.68. We finished the year with exceptionally strong loan origination volume in the fourth quarter, which enabled us to grow our portfolio by 15% in the quarter and by 26% for the year. Most asset quality measures were in line with our expectations and we continue to execute on our funding plans with demonstrated access to capital as usual.

Strong origination volume in the quarter helped us to complete the initial ramp of the Arlington Fund ahead of schedule. We plan to increase the size of the fund in 2014 as we continue to grow this aspect of our business. As I mentioned last quarter, we have continued to invest in our asset origination platforms. The new offices we have opened and the origination talent we have added to our leveraged finance asset-based lending and equipment finance businesses are paying dividends and enabling us to increase market share. We now have 22 bankers calling directly on targeted customers and a total of 64 people dedicated to our origination efforts. Origination volume was $550 million in the quarter, up from $280 million in the third quarter and the momentum we have built is clearly carried into the often seasonably slow first quarter.

During the quarter, we purchased $218 million of loans from the NewStar Credit Opportunity Fund that we have managed for third-party institutional investors. The purchase was completed in connection with the ongoing wind down of the fund as we returned capital to the funds investors. As the investment manager and a co-lender, we were uniquely positioned to acquire the portfolio, which was comprised of a diversified pool of 56 seasoned loans each of which we already had some exposure to on our balance sheet. The portfolio was purchased at near par and had an attractive weighted average yield of 6.23%. Solid origination coupled with the purchase of the portfolio enabled us to grow outstandings net of the consolidated Arlington Fund to $2.2 billion, a 17% increase since the beginning of the year, net of run off, which continues to be somewhat higher than expectations.

As you can see on Slide 4, most of our credit metrics improved during the quarter. Charge offs, allowance and credit costs continued to decline. NPAs were the only negative credit metric as we placed three legacy loans on non-accrual status for the quarter. John will provide more detail on our credit cost, but I want to emphasize this increase in NPAs does not in anyway signal the beginning of the trend.

Our overall objective is to enhance the value of the franchise for shareholders. And on Slide 5 we have highlighted some of our major accomplishments for the year. We made significant progress in several key areas in 2013. We added six new originators to call on targeted middle market customers and originated $1.3 billion in loans, about 25% more than we originated last year. We also raised $200 million of corporate debt and completed our seventh CLO on attractive terms demonstrating our leadership as a middle market CLO issuer and relevering the balance sheet to 3.2 times.

We reduced NPAs from 4% to 3% and credit provision decreased by more than 20% to 50 basis points of average loans. We also launched the $300 million Arlington Fund and built our new equipment finance business to a run rate origination volume of $80 million. Importantly, we continued to build our credit track record. As you can see on Slide 9 we now have cumulative annual default and loss rates of 72 basis points and 34 basis points respectively in our leverage finance business.

Turning to market conditions beginning on Slide 12, we are still seeing increased capital allocations into the loan and fixed income markets with new CLO issuance and positive flows into loan funds as investors search for higher yielding short duration assets. Banks are competing aggressively as well, although we believe that the banking regulators have become focused on excessively levered, poorly structured deals that are being sold in broadly syndicated market. We have seen some banks pull back from the market as they assess regulatory concerns. I believe that these issues will ultimately highlight the relative value of middle market not only in terms of pricing but leverage levels and deal structures as well.

The core middle-market lender universe remains largely unchanged as new capital flowing into the loan market has primarily been allocated to investment strategies targeting larger, more liquid syndicated loans. On the last few calls we indicated that middle market deal metrics have stabilized, while leverage had continued to climb in the broadly syndicated market. And the data we are observing again this quarter reinforces that conclusion as you can see on Slide 14. Pricing has also stabilized in the middle-market after defining for more than a year. You can see on Slide 15 middle market term loan yields fell to 5.85% for the quarter, but rebounded to 6.1% in December. This quarter yields on our directly originated leveraged finance loans were just north of 6%, which is largely consistent with where they were last quarter.

With that, I will turn it over to John to discuss our financial results and after John finishes I will close with our outlook and guidance for 2014. John?

John Bray - Chief Financial Officer

Thank you, Tim. Our consolidated financial results were shown on Page 17 and 18 of the presentation posted to our website. Like last quarter, our financial results include the consolidation of the Arlington Fund. As Tim said consolidated net income for the quarter was $6.4 million or $0.13 per share and $0.12 per diluted share, and for the year $24.6 million or $0.46 per diluted share. Our outstanding shares at the end of the fourth quarter were 48.7 million, basic and diluted shares were 48.7 million and 53 million, respectively. For the year basic and diluted shares were 48.2 million and 53.2 million, respectively.

If you turn to the next slide, it shows that new loan originations was $550 million in the fourth quarter and $1.3 billion for the year. These numbers as Tim mentioned include $218 million portfolio purchase from the NewStar Credit Opportunities Fund. During December the NewStar Credit Opportunities Fund called the outstanding notes of its CLO and as part of the process we purchased $218 million of outstanding loans from NewStar Credit Opportunities. The loans were a combination of term loans and revolvers. The term loans were purchased at par while revolvers were purchased at a discount of 96. NewStar treated the acquisition as a pooled purchase of loans and the discount will be amortized into income as a yield adjustment. We would expect to establish a post acquisition allowance for any losses which could subsequently arise on the acquired loans.

Of our total funded volume for the quarter $499 million was retained on NewStar’s balance sheet, $50 million was allocated to Arlington Fund which had an outstanding balance of $173 million at the end of the fourth quarter. The $499 million retained on the balance sheet was comprised of $445 million of leveraged finance loans, $22 million of commercial real estate, $20 million of equipment finance and $12 million of ABL loans.

On the right hand side you can see the total revenue was $25 million for the quarter and $100 million for the year. Consolidated net interest income was $21 million for the quarter and $86.8 million for the year. New loan originated from the quarter had an average yield of 5.8% reflecting attractive growth of value compared to other fixed income investment alternatives.

Non-interest income was $3.8 million for the fourth quarter and $13.5 million for the year. For the quarter asset management fees were $500,000. We generated $600,000 of placement and structuring fees, $500,000 from unused fees, $300,000 from amendment fees and we also have $700,000 revenue related to our OREO property operations. The decline from the third quarter was primarily due to certain items in the prior quarter that did not repeat in Q4. As of December 31, we held around 12 equity interests that have been retained in connection with debt restructuring. These positions had a book value of less than $7 million at the end of 2013. A majority of the equity positions that we own are carried at a nominal value and we believe that they – they also offer some upside in future quarters as we have seen in the past.

The next slide shows our net interest margin, which widened to 3.41% for Q4 compared to 3.35% for the third quarter as net interest income increased primarily due to the acceleration of deferred fee income due to payoffs and restructurings, higher average interest earning assets and improvement in the portfolio yield, partially offset by write-down of accrued interest on loans placed on non-performing status. The net interest margin for the full year was 3.9%. The yield on our performing loans was 6.59% for the fourth quarter. The drag from NPAs reduced the overall portfolio by approximately 22 basis points to 6.37% which was up slightly from 6.33% the prior quarter. Our cost for funds was steady at 2.93% for the fourth quarter.

If you turn to the next slide, credit performance, you will see the total provision for credit losses for Q4 was $2.3 million, down slightly from last quarter. We reported $1.8 million of net specific provision in Q4, down from $2.4 million for the prior quarter. The allowance for the credit losses increased slightly to $41.9 million, primarily due to the growth in our loan portfolio and additional specific charges in the quarter. If you exclude the Arlington assets and the NCOF purchase, the allowance ratio would have been 2.16% at December 31, which is consistent with last quarter. Our two OREO properties had an aggregate value of $13 million as of December 31, our non-performing loan rate was up to 3.6% as we placed three legacy impaired loans on non accrual while one loan was returned to accrual status, but the rate improved when compared to last year.

The next slide provides a greater detail regarding the mix of our loan portfolio. On a consolidated basis, our loan portfolio increased by 15% since last quarter and 26% since year end reflecting new originations for the NewStar Credit Opportunities purchase as well as the consolidation of Arlington. Our consolidated leveraged finance loans were over $2 billion or 85% of our portfolio, up 34% from year end. Business credit/leasing increased 20% from year end and the real estate portfolio dropped 31% as planned.

Our managed portfolio of loans which was made up of the NewStar Credit Opportunities Fund – the remaining NewStar Credit Opportunities Fund and Arlington Fund totaled $266 million, down from $547 million last quarter, due to sales and the call – the calling of the CLO in NewStar Credit Opportunities Fund. The largest single obligor concentration was 1.4% of the total loan portfolio. The top 10 obligors represented approximately 9.5% of the portfolio and just under 97% of our portfolio was comprised of senior secured first lien loans.

If you turn to the next slide, which shows our loan portfolio by vintage, more than 87% of the portfolio at 12/31 was originated post-crisis. Moreover, all of our business credit portfolio, 86% of leverage portfolio was also originated post-crisis. All of our loans originated since 2000 – all of our loans originated since 2008, only two loans totaling $11 million have defaulted.

Next I’d like to move to the slide to talks about our capital liquidity position, which we highlighted on the slide 24 and provide some perspective on our outlook for the funding markets. We continue to maintain a strong capital base with common equity equals 24% of total assets at December 31st.

During the fourth quarter, we amended a leverage finance credit facility with Wells Fargo to increase the commitment amount by $100 million to $275 million. We amended the commercial real-estate credit facility in the quarter to extend it by one year while providing additional $25.5 million of advances for existing assets and a $15 million to fund an additional commercial mortgage loan and we’ve reached $41 million of previously trapped restricted cash. We called at par the outstanding notes of our CLO we completed in 2005. At the end of the fourth quarter, we had approximately $51 million of liquidity comprised of $43 million of unrestricted cash, $8 million of undrawn collateral availability under our warehouse facilities in the CLOs.

Substantially, all of our outstanding debt is classified either as medium or long-term. At the end of Q4, we had $27 million of capacity in our 2013 CLO, $31 million of capacity in our 2012 CLO, $43 million of capacity in our ABL facility with DZ Bank, $16 million of capacity in our ABL facility with Wells Fargo, $67 million of capacity in our Wells Fargo leasing facility and $92 million in our Wells Fargo leverage financed facility. As demonstrated by our 2013-1 CLO, we remained very confident about our ability to access additional funding and plan to continue to be programmatic issuer of CLOs.

If you now turn to the next page, our consolidated balance sheet, highlighted couple of line items of change. Restricted cash decreased primarily due to the timing difference in settlement dates of CLO trusts and other non-recourse financing. Consolidated loans grew approximately $2.3 billion. Term debt declined $90 million due to the retirement of the 2005 CLO. Loans managed the benefit of the Arlington fund in the consolidated NewStar results were $173 million as of December 31st. Borrowings under the funds, warehouse credit facility were approximately $120 million and the funds membership interest was $29 million as of December 31st. Our book equity value at the end of the quarter was approximately $617 million and we continue to add the book value per share, which increased to $12.68 at December 31 reflecting Q4 earnings.

The next two slides present our income statement for the quarter in the full year. As I mentioned, consolidated net income was $6.4 million for the quarter in $24.6 million for the year and consolidated net interest income was $21 million for the quarter and $87 million for the year, which I covered earlier. Expenses increased in the quarter is $12.2 million in the quarter and were $49.5 million for the year primarily the expense increase was due to slightly higher compensation G&A expense. The net results of the Arlington fund included NewStar’s financial statements as consolidated were 600,000 for the quarter and $1.2 million for the year. The tax rate for the quarter was just under 39%. We expect the tax rate to be around 40.5% for 2014. Net income excluding the VIE economic impact on NewStar’s net income if we do not consolidate the entire financial results of Arlington would have resulted non-GAAP net interest income of $6.2 million for the quarter and $24.3 million for the full year.

I’ll now turn it back to Tim.

Tim Conway - Chairman and Chief Executive Officer

Thanks, John. So summarizing as we said, we had a very good fourth quarter highlighted by significant increase in originations volume. As we head into 2014, I am optimistic about our prospects. Our outlook for the year reflects an expectation that the macroeconomic environment will continue its pattern of slow improvement, which will be supportive of continued favorable credit trends. While M&A activity is difficult to forecast, we believe the environment will become more supportive of deal activity as confidence continues to improve. We expect the rate environment to evolve with a steepening yield curve as long rates trend upward for short-terms top rates trend upward but short-terms rates remain low.

You can see on Page 29 of our slide presentation, we are providing guidance for key metrics for the business consistent with past practice. We expect loan volume to grow by up to 15% in 2014 reflecting a combination of higher loan demand from increased sponsor driven M&A activity. Loan yields were under pressure in 2013 as our average yield decreased by approximately 85 basis points. We now expect yields in our markets to remain stable in 2014. Our range for new loan yields is 5.75% to 6.25%, which is consistent with last year.

Run off in 2013 was exceptionally high at 40%. We expect this trend to abate as much of that activity has occurred and the rate environment does not provide further refinancing incentives. As a result we believe the prepayments will slow to between 30% and 40%, which will rollout for net loan growth ranging from 5% to 15% for the year. The cost of funds is expected to increase to a range of 3% to 3.25%, which reflects the impact of higher cost debt replacing lower cost legacy CLO debt that is amortizing down.

Marginal all-in interest rates on CLO financing is expected to be in the LIBOR plus 2.50 area. As a result we forecasted modest pressure on the net interest margin, which we estimated between 3.25% and 3.50%. Continued increases in leverage levels also factor into that. We expect to fund planned growth with additional debt as we continue to relever the balance sheet, as a result leverage is expected to increase to as much as 3.5 times.

Non-interest income is expected to remain in the range of 50 basis points to 75 basis points, provision expense of 50 basis points to 75 basis points on average loans reflects a favorable credit environment but as always it could be vulnerable event risk. Expenses continue to trend favorably and reflect the operating leverage in the business. We expect expenses to be less than 2% of average assets for the year. So overall, we expect the business to continue growing scale and profitability. We operate in attractive markets and we will continue to work hard to enhance the value of the franchise.

With that, we would open it up to any question you might have.

Question-and-Answer Session


Thank you. (Operator Instructions) And our first question comes from Steven Kwok from KBW. Your line is open, please go ahead.

Tai DiMaio - KBW

Hi, this is actually Tai DiMaio filling in for Steven. Thanks for taking my question. I guess first on your guidance on the new loan yields side, it assumes stable pricing with some slight improvements. Could you talk about this in the context of the general industry and I guess what you are seeing competitively right now?

Tim Conway

Yes, I would say for the last quarter, maybe a little longer we have seen there is still some pressure, downward pressure on spreads. But we have seen stabilization of rates in our market. And as I said in the fourth quarter, we put on a direct – direct originated leverage loans at around just above 6%. What we are seeing right now in our pipeline is in that range. I think if volumes pickup – which actually we are seeing pretty good volumes in the first quarter so far this year. We think they actually could be a little better. Thanks. As I mentioned we are getting some pressure from regulators and we have seen a little less activity from the banks. So I think there is the range of – I am comfortable with the range of 5.75 to 6.25 and to me it’s really a function to be driven more by the level of private equity, M&A activity more than anything else for us.

Tai DiMaio - KBW

Great. And I guess switching to prepayments, I mean you guys mentioned that they are a little bit elevated during the quarter, but your guidance kind of assumes lower level, what is sort of giving you guys the confidence on the outlook for this year?

Tim Conway

I just think so much of the deals that we think would have refinanced have refinanced, and so I think in a bigger percentage I’d say gradually into the end of last year, bigger percentage of the business we were doing was new money transaction as opposed to refinancing. And I think as rates creep up, that will naturally slowdown refinancing activity as well.

Tai DiMaio - KBW

And I guess so lastly on the non-accruals, are there any other loans that you’re currently tracking that might have some difficulties or would this sort, I know the non-accruals this quarter were impaired so was this sort of like an anomaly during the quarter?

Tim Conway

Well, I think it was – I think it’s a function of as I said and I don’t think it’s an indication of any trend in any way, I think it’s a function of the way we manage our NPAs, we’ve got some legacy loans that we continue to work out. We’ve made great progress against them, we take reserves against them and at some point you get to a level of reserve on a loan where you make the decision to call at an NPA and I think that’s where we were with these three loans, we also took one loan off of NPA status. So, the number is, of NPAs we have is manageable. We think they are reserved right and I think we – it’s really a function of the way we do this, which is we worked them out as opposed to selling them. There is nothing in the portfolio that I’m aware of that would make me concerned about any kind of significant increase in NPAs going forward.

Tai DiMaio - KBW

Great, thanks.

Tim Conway

Thank you.


Thank you. (Operator Instructions) And I’m showing no one else in the queue at this time, sir. I’d like to hand the conference back over for closing remarks.

Tim Conway - Chairman and Chief Executive Officer

I’d like to thank everybody for joining our call. That will conclude our remarks.


Thank you. And ladies and gentlemen thank you for participating in today’s conference. This concludes our program. You may all disconnect and have a wonderful day.

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