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Newcastle Investment Corp. (NYSE:NCT)

Q1 2010 Earnings Call Transcript

May 7, 2010 1:00 pm ET

Executives

Nadean Finke – IR

Ken Riis – President and CEO

Brian Sigman – CFO

Analysts

Matthew Howlett – Macquarie

Operator

Good afternoon. My name is Brooke and I will be your conference operator today. At this time, I would like to welcome everyone to the Newcastle first quarter earnings conference call.

(Operator instructions) Thank you. Ms Nadean Finke, you may begin your conference.

Nadean Finke

Thank you, Brooke and good afternoon everyone. I would like to welcome all of you today, May 07, 2010 to Newcastle’s first 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 of the company’s control. So you should not place undue reliance on any of these statements.

I would encourage you to review the forward-looking statements disclaimer in our earnings press release, including our recommendation to review the risk factors contained in our annual and quarterly reports filed with the SEC.

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

Ken Riis

Thanks Nitty. Good afternoon everyone and thank you for joining our first quarter 2010 earnings call. The first quarter was very active as credit markets continued to stabilize. As expected, credit spreads tightened as investors readjusted the pricing of risk. The events of the last few days may change investors’ perception of risk, but the general view is the markets will improve as liquidity improves.

That said, there are still a lot of great investment opportunities in the pipeline. Companies with cash to invest should be able to structure attractive investments with high returns, generating investment multiples of two to three times, you just have to work hard to find them.

The commercial real estate markets continued to struggle with increased delinquencies and maturity defaults. The potential restructuring of the $110 billion of commercial debt maturing over the next two years will be a big opportunity for us. We will look to purchase existing debt cheaply and restructure with borrowers willing to invest capital in the properties.

As it relates to Newcastle, we have been very busy and have accomplished a lot in the first part of 2010. We completed four major transactions that deleveraged our balance sheet and reduced operating expenses. First, we closed our preferred exchange offer. In the exchange, we issued 9 million shares of common stock and used $16 million of cash to buy back 60% of our preferred stock. The result is we retired $91 million of preferred stock and eliminated $8 million of annual dividends. Second, we repurchased $52 million of our junior subordinated notes eliminating 50% of these outstanding notes saving $4 million of annual interest expense. Third, we were able to buy back $56 million of CDO debt for $7.5 million or a price of $0.13. There is currently other debt for sale and I anticipate an increase in this activity over the next couple of quarters. Finally, we repaid $76 million of recourse debt basically eliminating all of our short-term recourse debt obligations.

These events greatly simply our balance sheet and are highly accretive to our common shareholders. We eliminate a significant amount of debt and equity senior to our common stock at deep discounts, and reduced annual interest and dividend expenses by approximately $13 million.

The results of the first quarter were very positive, today we are positioned for growth. We no longer have to retain cash in our balance sheet to repay recourse debt. This frees us up to invest our current (inaudible) restricted cash and grow. We currently have $25 million of unrestricted cash and $160 million of CDO cash to invest. We will continue to focus on highly accretive investments and transactions that build shareholder value.

Now, I want to turn it over to Brian Sigman, our CFO, to discuss our first quarter results in more detail. Brian?

Brian Sigman

Thanks Ken and good afternoon everyone. Based on Ken’s broader view of Newcastle and the markets, I will drill down on our liquidity, financial results for the quarter and finish with some key points.

As Ken said currently, we have $25 million of unrestricted cash and $160 million of restricted cash for reinvestment in our CDOs, primarily all of which is held in CDOs VIII, IX, and X. Adding to our liquidity was $13 million of cash flow received in the first quarter from our CDOs, pretty much unchanged from the prior quarter. We continue to pass the respective cash flow tests in CDOs VIII. IX, X and continued to receive senior management fees on our other deals.

In April, we repaid the remaining $13 million of our repurchase agreement and therefore now only have $6 million of short-term recourse financing, which we expect to repay in the next quarter or so. In the first quarter, we also terminated the last four derivatives that we held outside of our non-recourse financing.

Now, on to our financial results for the quarter, we had GAAP income of $3.36 per share with the following components; our net interest income, less our expenses and net of accrued preferred dividends resulted in income of $13 million or $0.24 per share, basically the same as last quarter. Additionally, we had other income of $1.86 per share during the quarter due to the following four items; one, a gain of $0.90 per share on the repurchase of $56 million of our own CDO debt at an average price of $0.13 on the dollar with a current average rating of DD, originally the debt was rated AA+; two, a gain of $0.80 per share on preferred stock exchange; three, a net gain of $0.24 per share on the sale of $193 million face of assets; and four, a net loss of $0.08 per share primarily due to the termination of our remaining derivatives.

In the quarter, we also booked income of $1.78 per share from the reversal of prior loss allowances on our held for sale loans, offset by $0.52 per share of additional impairments charge in our securities. Adding these components of $0.24, $1.86, $1.78 and subtracting the $0.52 gets us to our GAAP income for the quarter of $3.36 per share.

Lastly some key points. As we discussed in our 8-K filing, we completed a securitization in April to refinance our first manufactured housing loan pool. The old financing had matured in January of 2009 and all cash flows were being diverted away from us to pay down the debt. As a result of the securitization, we repaid the old debt, received $14 million of unrestricted cash, and retained the residual interest in the securitization on our balance sheet.

During the quarter, we invested $99 million of restricted cash in our CDOs purchasing $127 million face of new assets at an average unlevered deal close to 10% with a single A rating. Further with the adoption of FASB 167, on January 1, we deconsolidated CDO VII from our financial statements. The deconsolidation reduced our assets by $149 million and our liabilities by $438 million resulting in an increase to GAAP book value of $4.65 per share. The increase to book value is due to us having written down CDO VII to assets in excess of its non-recourse financing.

Lastly, I would like to point out some of the new information to look for in our 10-Q that we are filing, which I think will be helpful. On our balance sheet and in the fair value table, we have broken out assets and liabilities between what is owned in our non-recourse financing structures and what is owned outside of them. In our CDO table, we added the fair value of our assets within the portfolio of composition section, and lastly we added a table that details our CDO bonds by class and lists whether they are owned by third parties or by us. As we buy back our CDO debt, this table will show the specific classes of the capital structure that we are invested in.

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

Thanks for taking my question. Guys, first I want to congratulate you on a lot of hard work and success in turning around the company. It is good to hear you talk about growth now that the deleveraging and then the recapitalization stages are over. The first question relates to CDO VIII, IX, and X, are you at a point where you can declare victory in terms of keeping those structures in compliance until the exploration of the reinvestment period. I think the first one is November 2011. I say that with regards that the OC levels are up year over year, deterioration appears to have slowed, and the restricted cash about $160 million at all-time high.

Ken Riis

Thanks Mat. I cannot really say that we can ever declare victory within the CDOs. We have worked very hard to monitor and maintain the cash flows in these three deals. If there is one that is at more risk than others, I would say it is CDO X, (inaudible) a lot of securities in the financing and there is a fair amount on negative lots. So we really cannot declare victory on those three but we have worked very hard and are working very hard to maintain the cash flows coming to Newcastle.

Matthew Howlett – Macquarie

The CDO X has the most restricted cash in it, am I correct?

Ken Riis

Could you break out the amount of cash in it.

Brian Sigman

Yes I will. CDO VIII has 60, CDO IX has 38 and CDO X has 60. You also have it on the Q.

Matthew Howlett – Macquarie

Got you, I will look for that. I guess, am I thinking right, if you are fully invested on the $170 million, is there a way to look at where the OC targets would go, obviously assuming no other deterioration or more importantly, what would be the impact to cash distribution in the quarter if we assume a margin of let us say 4% and a leverage of say four or five times, could we assume an additional $4 million to $5 million per quarter would come out of those CDOs when they are fully invested?

Brian Sigman

So it is $160 million, I think the math is – that is why we break out what we purchased and obviously it could change, but in the past quarter we were buying things anywhere from 75 to 90 and coupon probably like you said of around 4% to 5%.

Matthew Howlett – Macquarie

Got you. Okay, great, there is a lot of details [ph] out there, we can do the math but certainly it looks like directionally the cash flows should be in the increase as you deploy cash. I notice one of the CDOs bought manufactured housing securitization that you did that presumably would help it get fully deployed.

I guess the next question is also when are you going to start – the adjusted book, I know you put it on the queue, when you mark the liability to market presumably we will see that in the Q, what is that number, you continue to show negative GAAP book with the way the GAAP accounting works?

Brian Sigman

Yes, if you look at the fair value table when we filed the Q, you will have it – I think it comes out to be about $16 per share.

Matthew Howlett – Macquarie

Okay.

Brian Sigman

Just to put some context around that, if we were able to purchase all their CDO debt at the prices that we have them marked out.

Matthew Howlett – Macquarie

Right, got you, great, that is helpful. And then last question related to the second MH pool, when is that callable and would you consider doing a resecuritization as well?

Brian Sigman

The financing matures next summer in August 2011. We control the assets so if we chose we could do something now, but the maturity is not till next summer.

Matthew Howlett – Macquarie

Great, thanks guys.

Ken Riis

Yes.

Brian Sigman

Yes.

Operator

At this time, there are no further questions. Presenters, do you have any closing remarks?

Nadean Finke

Thanks again everyone for joining us today. We really appreciate it and look forward to speaking to you next quarter. Thank you.

Operator

Thank you. This concludes the conference. You may now disconnect.

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