Colleen Banse - IR
Tim Conway - Chairman and CEO
John Kirby Bray - CFO
Sameer Gokhale - Keefe, Bruyette & Woods
NewStar Financial, Inc. (NEWS) Q1 2010 Earnings Call May 5, 2010 10:00 AM ET
Welcome to the NewStar Financial Q1 2010 earnings call. (Operator Instructions)
And now your host for today's conference, Colleen Banse, please begin.
Thanks everyone for joining us for our earnings conference call where we will be discussing our first quarter 2010 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, www.newstarfin.com. 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 a recording of the call will be available beginning at approximately 1:00 p.m. Eastern Time today. Our press release and website provide details on accessing the archived call.
Also before we begin, I must inform you that statements in this earnings call, which are not historical facts, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All forward-looking statements, including statements regarding future financial operating results, 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. More detailed information about these risk factors can be found in our press release issued this morning and in the Risk Factors section as updated on 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 where required by law. NewStar plans to file its Form 10-Q with the SEC on or before May 10 and urges its shareholders to refer to that document for a more complete information concerning the company's financial results.
Now I'd like to turn the call over to NewStar's Chairman and Chief Executive Officer, Tim Conway.
Thanks, Colleen, and thanks for joining the call today. As you are all aware, 2009 was a challenging year and we spent most of our time managing credit, reserving liquidity and reducing expenses. We made significant progress against each of these objectives in 2009 and further reduced the company's risk profile by increasing reserves, paying down short-term debt, renewing two credit facilities, adding $75 million of liquidity and executing a new CLO.
Although the economic environment is still volatile, these accomplishments have enabled us to shift our focus to providing more capital to our customers and executing on growth initiatives and generating profits.
I'm pleased to report that the company's financial results improved in the first quarter and that our outlook remains positive. Credit performed as expected and loan demand has begun to rebound. I'm also pleased to see that our progress against these objectives has provided a catalyst for the stock price, which has increased 30% since the last call.
Although still relatively modest, the loan volume improved significantly in the quarter. We originated 10 loans totaling $62 million in the quarter compared to 13 loans totaling $115 million for all of 2009. Activity has picked up noticeably in the last month, and we expect the origination volume to continue to build during the year.
Margins were negatively affected in large part by several non-recurring items or also by the higher cost of the recent CLO and the liquidity line. The non-recurring items were due to the acceleration of deferred financing fees in connection with the early retirement of debt and the reduction in the size of our credit facility with Citibank.
We expect margins to return to more normal levels in the second quarter, and John will discuss that in more detail. Before we close, I will provide some color on the yields we're seeing on new business and the implications for our margins going forward.
On our last call, I indicated that the credit outlook had improved and that we believed provision for loan loss is going to peak in the fourth quarter. We still believe that credit provisions peaked in the fourth quarter. The addition of new specific reserves, our primary measure of credit performance, declined by $18 million or 44% during the quarter and we forecast another meaningful decline next quarter.
Although we continue to operate in a challenging environment with elevated levels of non-performing assets, we expect these positive trends to continue through the year as our borrowers benefit from a rebound in the economy.
If this trend continues as expected, we would return to profitability in the second quarter and generate earnings for the full year as credit costs declined and origination volumes increased.
Our results in the first quarter reinforced our confidence in that outlook. Our credit forecast is based on the financial forecast of our borrowers and developed through detailed reviews of each name in the portfolio as well as our own view of how changes in economic conditions and industry trends may impact them. This analysis gives us confidence that our credit performance through the cycle will continue to compare favorably to peers and to recognize market benchmarks.
Summarizing our view of the middle market, we believe that while benefits of the economic recovery are uneven across industry sectors, the performance of most of our weakest middle market borrowers has largely stabilized and in certain cases begun to improve, while the performance of our middle market portfolio overall is clearly improving.
Moving to the commercial real estate segment of the portfolio, it continues to lag the economic recovery or making meaningful progress in reducing the risks in that portfolio.
Since many of you have asked for more detail on this segment of our business, even though it represents only 16% of our portfolio, I'd like to focus on that explicitly on this call.
Outstandings in our real estate portfolio have been reduced from $450 million to $320 million, a reduction of about 30%. We continue to make good progress working the portfolio down, and we have several additional properties under contract to sell.
As you can see on slide six and seven, the commercial real estate portfolio comprises 34 loans totaling $320 million and in every case is secured by the first mortgage on the property, and two deals totaling $18 million arrear secured by subordinated interest in the first mortgage.
The loans were typically structured with an initial maturity of three years with extension options available to borrowers if it takes longer than expected for the property to reach stabilization or be refinanced.
The fully extended maturity profile of the portfolio provided on the same page indicates that more than 60% of the portfolio does not mature until 2012 or later. Therefore, the risk of the form of that maturity in the current environment of severely depressed value is in a weak, but clearly improving refinancing market, is somewhat mitigated.
On page six, we also provided a breakdown of the portfolio by geography and property type. You can see that there are no land or construction loans in the portfolio. We also avoid hotel loans and we have limited exposure to the California and Florida markets and no exposure in Nevada. 16 loans or 55% of the portfolio is secured by office properties, 20% by multifamily, 13% by industrial and 8% by retail.
On page seven, we broke the portfolio down according to our credit performance categories. Approximately $245 million or 76% of the CRE portfolio is performing and unimpaired. We have reserves of approximately $18 million or 7% against this segment of the portfolio. That translates into a net carrying value of 93% on the performing loans.
We also have poor performing loans totaling about $47 million classified as impaired and have incurred $2 million of charge-offs on our specific reserves of $10.6 million. That represents a net carrying value of approximately $34 million or $0.73 on the dollar.
Remaining four loans totaling $35 million are classified as non-performing. They have been written down by $4.3 million and have another $9.4 million of specific reserves, which implies a carrying value of $0.61 on the dollar. This level is consistent with our recovery experience on resolved loans for impaired loans to date. One of the big loans in office building in Tacoma is under contract to be sold at level consistent with where we carried the loan.
The balance of our commercial real estate exposure is comprised of the two properties with original loan amounts of $17.9 million, which we'll classify as OREO at the end of the first quarter. They're carried at fair value estimate of $9.2 million or 51% of the current loan. One of the two is under contract at a price consistent with our carrying value.
On page seven, we have included a top-down estimate of total credit costs in real estate. We started with estimated ranges of declines in property values based on credit category. The midpoint estimate for decline in value is 40%, which I believe is roughly consistent with published indices to track CRE values.
Assuming a 75% loan-to-value when we made the loans, which is one of our primary underwriting guidelines, after factoring in a 40% decline in property values, the net carrying value of the loans in the portfolio would be approximately $15 million higher than the estimated current property values. That's a hypothetical example based on the assumptions I outlined, but I think is helpful. As I said earlier, we calculate our reserves on a loan-by-loan bottoms-up basis, and we believe that we are appropriately reserved against this portfolio at this time.
Now I'll turn it over to John to discuss our financials in more detail, and I'll wrap it up, and we'll take some questions.
Thank you, Tim. I'll begin with a summary of our Q1 2010 financial results. I'll be following the presentation we posted on the website which is starting on page nine with my presentation.
The adjusted net loss was $9.2 million for the quarter, which is a GAAP net loss excluding after-tax non-cash compensation expense for approximately $700,000 related to equity grants made in connection with our initial public offering. This resulted in an adjusted basic and diluted loss per share of $0.19 for the quarter. On a GAAP basis, the net loss was $9.9 million or $0.20 a share per diluted share for the quarter.
Our share count on the weighted average basis was $49.9 million from the quarter. At the end of Q1, we had 49.9 million shares outstanding. Under our stock repurchase program, we bought back 29,000 shares during the quarter.
If you turn to the next slide, funding platform, I'd like to start out with the slides. As we mentioned last quarter, we completed a $275 million CLO and $75 million of revolving credit notes. We used the proceeds from the CLO to payoff our term debt facility with Deutsche Bank.
Additionally, we amended our credit facility with Citi, reducing the commitment amount to $75 million from $150 million. This facility has a balance of approximately $41 million at quarter-end. By decreasing the commitment amount, we reduced the unused fees, which would have been incurred, and will save as approximately $1 million over the life of the Citi facility.
As a result of the Citi amendment and the Deutsche Bank payoff, we accelerated the amortization of deferred financing costs and wrote-off $3.4 million of costs above our normal run rate, which is reflected in interest expense for the quarter.
We had $18 million of unrestricted cash at March 31, down from $40 million at the end of 2009. The primary driver of this decrease was our use of cash to purchase impaired assets from our 2007 CLO in order to preserve the flow of management fees. We did an analysis on the net present value made sense to, but to purchase these assets out.
Although we have not drawn on the credit facility with Fortress, the decrease in unrestricted cash is evidence of how this facility provides us a buffer, which will allow us to manage cash effectively on locked cash trapped in funding vehicles and optimize recoveries on our impaired assets. The liquidity available under the line provides us insurance policy that gives us the flexibility to deliver maximum value to our shareholders.
In addition, we have income tax receivable of $10 million, which we have already received $2 million refund. The remaining $8 million will be converted into cash over the next few quarters or applied to this future estimate in federal and state tax payments. We renewed our credit facility with NATIXIS yesterday on more favorable terms, and details will be included in an 8-K that we plan to file later today.
In addition to the ramp-up the new CLO we just put in place, we continue to have reinvestment capacity and two existing CLOs at attractive locked-in spreads. If you assume a 19% prepayment rate, the rate at which we are presently running at, we would have a capacity to originate approximately $400 million of loans during the remainder of 2010. Our funding profile shows that substantially all of our outstanding debt is classified as either long-term or medium-term.
If you turn to the next slides, which deal with our securitization summary, it shows how the company funds its loan portfolio and lending operations through a combination of CLOs, medium-term debt in large banks, warehouse lines of credit and equity.
78% percent of our loans are funded through securitization of attractive locked-in spreads. The CLOs represent a stable source of funding, which are designed with the flexibility to reserve of non-performing assets. If there is deterioration in an asset held in the CLO, we have the option, but not the obligation to repurchase the asset and substitute collateral.
If we choose not to repurchase, the CLO will trap cash in an account sufficient to pay down the debt. Having impaired assets and CLOs can be an effective liquidity strategy, because it allows us to take advantage of the excess cash flow that is generated in the CLOs and not use balance sheet cash.
If you turn to slide 12, this slides shows that we have reduced our short-term debt by 39% since December 31, 2008. We have net asset position of approximately $153 million, including our CLOs term debt and approximately 80% of our CRE loans or term funded.
If you turn to the next slide, the key takeaway here is that we have $75 million revolving credit facility, which provides the management with the available liquidity that supports our operating flexibility.
We have also actively supported our warehouses and CLOs by repurchasing more than $100 million during the cycle. By repurchasing the credit impaired loans from the warehouse facilities, the company has avoided the need to sell loans at depressed prices and preserve the value of residual interest in the loan portfolios.
The next slide 14, the managed loan portfolio shows that the managed loan portfolio was roughly $2.5 billion, down slightly from levels over recent quarters, while adjusted revenue decreased to $20.6 million. Net interest income decreased to $16.1 million from $24.1 million in the fourth quarter. I'll explain the factors affecting the net interest income and the net interest margin in greater detail later.
Non-interest income was $4.6 million in the first quarter, reflecting a $2.9 million gain from the repurchase of our CLO debt. We continue to be opportunistic. We purchased our CLO debt as current market prices reflect a discount to par resulting in strong returns to our shareholders.
The next slide, originated new loans funded by the CLOs and NCOF, describes the amount and composition of the first quarter originations and related revenue that that origination line drives. Originations totaled $62 million. $33 million was retained on NewStar's balance sheet and $29 million was booked for the NewStar Credit Opportunities Fund. Origination by the end of the quarter remained light when compared to what we are planning to originate for the coming year.
Credit spreads and amortizing fees on new loans originated in the first quarter were roughly 550 basis points over LIBOR. We continue to get LIBOR floors on our new transactions and approximately 44% of our portfolio now includes them.
The floors give us a natural heads against our equity funded loans if interest rates moved downwards. If rates move upward, the asset yield should not move as quickly as liability, since at different levels before they're still in place. But this has been a great trade and has resulted in increased interest spread.
The next slide, the net interest margin, will highlight that the net interest margin was 3.03% for the quarter, down from the last quarter's 4.31%. Interest expense included an additional $3.1 million of accelerated amortization of deferred financing fees related to our Citi facility and the Deutsche facility.
The acceleration of the amortization negatively impacted the margin by 65 basis points. Also, negatively impacting the margin this quarter was a higher cost of funds associated with the new CLO of 32 basis points as well as an unused fee on our revolving facility with Fortress. Increased non-performing assets were 5 basis points detrimental to the margin. The total cost of our NPA portfolio is approximately 52 basis points.
During the quarter, we benefited by approximately 7 basis points from re-pricing in new loans. As I mentioned last quarter, we incurred additional fees and higher cost of funds associated with the new Fortress debt and the new CLO. We made that trade to ensure we had adequate liquidity. We gave up a little margin to ensure that we have proper liquidity levels for the environment we are in. We expect our net interest margin will run just under 4% until we are able to take more loans or if non-accrual originate higher yielding assets.
The next slide just continues to show the diversification of our portfolio. And as again, you'll see it is very diversified and senior focused. The next slide following that is our credit performance. The outlook for credit continues to improve, although we increased our allowance for credit losses to 604 basis on period-end loans compared to 568 basis points in December 31, the provision for credit loss is applying to 31%, and new specific positions declined 44% from the last quarter. Also, our non-performing loans declined 4% to $156 million.
Other real estate owned consisted two properties totaling $9.5 million as of March 31. Our annualized charge-off rate increased slightly to 5.4% of period-end loans. These charge-offs were related to loans previously identified as impaired. While we believe the decline in specifics is a good signal of the improvement in credit environment, we expect levels of charge-offs and NPAs to remain elevated for several quarter.
The next slide gives a breakdown of our non-performing assets. By industry, it shows that non-performing assets decreased 4% from Q4 2009. On average, we're carrying our non-performing assets at 49% of face value.
Now I'd like to get into the income statement on the next slide. This slide highlights our income statement. As I mentioned earlier, adjusted net loss was $9.2 million for the quarter and GAAP net loss was $9.9 million. Net interest income was $16.1 million for the first quarter compared to $24.4 million in the fourth quarter. The net interest margin, as I mentioned, was 3.03%, down from 4.31%.
Provision decreased in the first quarter from $39 million in the fourth quarter to $27 million in the first quarter. Non-interest income increased slightly to 4.6. Our asset management fees were pretty much flat quarter-to-quarter. Expenses increased slightly to $9.8 million from the first quarter of $9.6 million primarily due to higher loan workout costs. Our headcount for the firm was 59 people at the end of the quarter.
On the balance sheet, which is the next slide, you start to look at equity was $538 million and the book value per share came in at $10.79.
Now I'll turn it back to Tim.
Thanks, John. So in summary, we've achieved our objectives to stabilize liquidity and preserve book value per share, and our financial results are improving as a result of better credit performance.
One of the last thing impacts of the credit crisis is that we're seeing fewer lenders with less capacity to lend. Despite that lending capacity, it has exceeded demands for loans in recent quarters, which has put downward pressure on pricing. However, we believe that conditions in our market will remain favorable for an extended period, as loan demand rebound faster than lending capacity and the capabilities of many banks.
On page 24 of the slide presentation, we outlined the return profile on new loans that we're making in the market. We're seeing lending opportunities with spreads in the LIBOR plus 550 range to 2 points upfront and approximately 1.75% LIBOR floor, which adds about 150 basis points of spread in generation all-in yield of about 7.75%. Our actual all-in cost of funding in Q1 was 2.3%, resulting in a margin on new loans of 586 basis points.
Since we executed our CLO, several others have been done, and the pipeline is building, leading us to believe that quarter one debt to equity leverage is an appropriate and achievable leverage target for NewStar.
As shown on page 24, returns on the new middle market loans with those margins and leverage ratios remain very attractive with pretax ROEs approaching 20%. So it shifted from defense to offense, and we're pleased to be in a position to provide more capital to our clients. Our goals for 2010 are to continue to increase lending activity, begin to re-lever the balance sheet and add accretive businesses or platforms.
With that, I'll open it up for questions.
(Operator Instructions) Our first question is from Sameer Gokhale.
Sameer Gokhale - Keefe, Bruyette & Woods
The first question I had was, on slide 16, you mentioned that you expect the margin to widen in Q2 as discrete interest expense items roll off. I might have missed it. I know one of the items was clearly the accelerated amortization of some fees. But were there any other discrete interest expense items that you expect to roll off or is that more a function of the new loans coming on at higher yields? Could help clarify that?
Sure. The majority of it is the new loans rolling off, which is about $3.8 million when you factor in what comes off.
Sameer Gokhale - Keefe, Bruyette & Woods
You mean the $3.8 million, was that the accelerate amortization?
Sameer Gokhale - Keefe, Bruyette & Woods
And then it looks like, John, during the quarter, it didn't seem like you bought back any shares, right? What is your thinking, yours and Tim's, as far as share buybacks, given the value that the stock prices had? Do you expect to hold off on that for the foreseeable future or at one point would you ramp that up?
The plan is still in place. We did buy some shares. And actually right around the time we put the plan in place and announced it, we announced a number of other things that we executed on the stock was moving up, and it was more volume than we had seen. Now frankly, we just didn't want to get in the market and push it anymore than it was already moving. So we've got it move up naturally.
We did plan to buy some more shares. We still have the plan in place. And I can't really disclose what exactly we'll do, but we still think this value in the stock at these levels certainly compare to book value. And so the plan is in place, and we'll consider to use it. On the daily basis, we'll look at it and figure it out going forward.
Sameer Gokhale - Keefe, Bruyette & Woods
And just my last question. As far as your access to funding, you've done CLO transaction recently and you were one of the first companies to execute on that. But as far as potentially accessing the unsecured market, do you have any plans there? You've spoken to the rating agencies. Obviously, your balance sheet is pretty under-levered at this point. And I would anticipate your credit losses improve at some point and perhaps significantly. But is there or are there any plans? Are you in discussions with the rating agencies about accessing that market? That's question number one.
And the second thing is as we've seen your charge-off rate rise now to these levels, you're still outperforming the industry by a pretty significant margin. But are there any lessons learned from this last cycle and the cycle you're going through now that you would apply in the future, so that your charge-off rates you expect to be may be a much tighter band and a much lower band. So those are like a two-part question there.
So the unsecured market, we're looking at every way that you might imagine in terms of how we would re-lever in a cost-effective basis the balance sheet. The unsecured market has been very, very high-yield market in general, very attractive, less so for financial companies, but still an attractive market.
And we do spend a lot of time with the rating agencies, and we have a sense based on our plans as to what level we'd like to be in terms of rating in order to tap the unsecured market. But we do believe that the more conventional debt capital markets will be open to us, and that's something that we will be following very closely, targeting the rating agencies on a regular basis. And we'll consider doing if we think there is an opportunity.
I would also say that the banks have been much more aggressive recently in terms of coming back and looking at providing longer-term facilities at what we think are pretty attractive levels. And that's another area where we think we can efficiently put some leverage on the balance sheet.
And we did the one deal with the hold or own notes which is an attractive deal for us as well. (inaudible) credit cycle, I agree that we've performed very well and I think we performed very well, because a couple of things. One is we start to (inaudible) and did senior debt. We held swap positions in the deals. We will diversify industry. I think our direct origination has enabled us to do our own due diligence on the companies we underwrote.
I think we avoided some of the sectors that got hit hard, and we've paid a lot of attention to where we thought the market was going and guided our bankers to focus on certain sectors versus other sectors.
In every cycle I've been through, more than I would like to remember, we have lessons that we've learned. In this cycle, I think number one, you always realize in retrospect that you underwrote some deals that you shouldn't have, because they had an obvious credit issue that you had missed somehow with respect to customer concentration or something along those lines.
I think the sector this time, media clearly was one that was an issue for us in the first quarter. Media broadcasting, publishing was really a more than just a cycle. There was a shift I think in that marketplace, and that was one that we didn't anticipate. And take anytime we've done anything like a dividend recap where we put more leverage on company with less equity and there's a problem, it's more difficult to fix it than that scenario where we had a couple of issues.
But by and large, we said 50% senior loan to value and what we found was the value underneath us was in many cases people who own the companies, because they had value to support those companies and hence improved our credit performance relative to peers.
Sameer Gokhale - Keefe, Bruyette & Woods
I guess it's my last question. I've seen this for many different types of specialty finance companies. There is a company called Financial Federal, which I think you're familiar with, that was sold. It is also pretty under-levered. It's a different business mix. They had also very, very low credit losses. And seems like actions to these funding markets, I guess, especially unsecured is partly a function of credit losses and balance sheet strength as well.
But for a company like yours, it seems like longer term the value there in order to avoid it as much for growth as you are for consecutive underwriting, so it seems like to the extent that you can bring those credit losses in even with low leverage, that should help your valuation.
So along those lines, at what point would you decide pursuing a sale of the company? Are you thinking along those lines currently? Is that something on the table or is that something you're not contemplating at this point?
Well, at 1.6 times book value like Financial Federal, so we might consider that opportunity. We think that the returns in the business, as we re-lever and you look at the market, are attractive and generate better returns, and we're coming out of the credit cycle. I think we've built a greater platform as valuable and on standalone basis clearly is valuable with deposit funding or other funding as well.
So our plan is to growing that shareholder value. I still think we're significantly undervalued and we're coming out of a very difficult environment. And our plan is to execute now on continuing to build the platform, continuing to generate attractive portfolio. And we're always going to be thinking strategically of all the ways to shareholder value. So we will over time consider all the things that you would expect us to consider to generate that value for shareholders.
(Operator Instructions) And I'm showing no further questions or comments at this time. Mr. Banse?
Thanks everyone for joining our first quarter earnings call today. And we'll conclude our remarks. Thanks and have a great day.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect and have a wonderful day.
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