Newcastle Investment CEO Discusses Q3 2010 Results - Earnings Call Transcript

Nov. 9.10 | About: Newcastle Investment (NCT)

Newcastle Investment Corp. (NYSE:NCT)

Q3 2010 Earnings Call

November 9, 2010 11:00 am ET


Nadean Novogratz - VP of IR

Ken Riis - CEO and President

Brian Sigman - CFO


Matthew Howlett - Macquarie

Joshua Barber - Stifel Nicolaus


At this time, I would like to welcome everyone to the Newcastle third quarter earnings call. (Operator Instructions) Thank you. Ms. Novogratz, you may begin your conference.

Nadean Novogratz

Thank you, Cynthia, and good morning, everyone. I'd like to welcome all of you today, November 9, 2010 to Newcastle's third 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 statement disclaimer in our earnings press release, including the 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 morning, everyone, and thank you for joining our third quarter 2010 earnings conference call. The third quarter was very productive and towing for us. Our financial metrics are improving, cash for new investment is growing, and the value of our portfolio is increasing.

First, let's talk about our financial results. Operating income increased $0.12 to $0.48 per share and cash flow from our CDOs increased over $1 million to $17 million versus the second quarter. A key highlight relating to our CDOs is we increased the over-collateralization cushion in CDOs VIII, IX and X by $59 million despite $194 million of asset downgrades. As a very productive result for us and highlights our ability to successfully manage these portfolios and source new investments at discount dollar prices.

Today of the three, CDO X is the most challenged, as it has the largest amount of assets on downgrade watch and the lowest OC cushion at $44 million. On the contrary, CDOs VIII and IX have over $100 million of cushion, and the cash flow generated from these two portfolios is more reliable.

Now, moving on to cash for new investments. Since we last spoke to you in August, our cash has grown by $76 million to $239 million. This is comprised of $63 million of on balance sheet cash and $176 million of cash in our CDOs. During the quarter we've purchased $148 million of assets at a price of $0.70 on the dollar, generating a 30% unleveraged return. We also repurchased $48 million of CDO debt for $105 million.

We see our CDO debt as the best opportunity to deploy capital and increase shareholder value. We still have $3.4 billion of debt owned by third parties, which may offer good value depending on the price. We expect selling pressure to intensify going into year end and spread should widen. We are currently seeing a lot of good investment opportunities and we are well positioned with cash on hand to take advantage of these opportunities.

Finally, I would like to highlight the performance of our portfolio. Our current investment portfolio totals $4.7 billion of assets, financed with $3.7 billion of non-recourse debt. We actively managed our portfolio with the focus on maximizing values and the recovery of principal and interest.

We are starting to see the results of our efforts reflected in the price of our portfolio. In the quarter, the value increased 6% or by $178 million. For the nine months of 2010, the value increased 20% or over $500 million. As a benchmark over the same nine-month period, the BBB CMBS indices are up about 13%.

I am proud of our performance year-to-date and have a positive outlook regarding the future performance of our portfolio.

With that, I'll now hand it over to Brian Sigman, our Chief Financial Officer to review the quarter in more detail. Brain?

Brian Sigman

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

Our liquidity, as Ken mentioned, we currently have $63 million of unrestricted cash and $176 million of restricted cash for reinvestment in our CDOs, all of which is held in CDOs VIII, IX and X. Adding to our liquidity was $17 million of cash flow received in the third quarter from our CDOs, which is approximately $1 million higher than the prior quarter. We continue to pass the respective cash flow tests in CDOs VIII, IX and X and in September we once again passed the quarterly test for CDO V, which had previously failed in the fourth quarter '09 and first quarter 2010.

We continue to receive senior management fees on all of our other deals. Early this quarter, last quarter and the third quarter we repaid the last remaining fees of our short-term recourse financing. And as stated previously, we don't have any funding commitment, corporate margin exposure or any recourse financings expect for our junior subordinate notes, which are due in 2035.

Now on to the financial results for the quarter. We had GAAP income of $2.61 per share with the following components. Our net interest income, lesser expenses and net of preferred dividends resulted in income of $30 million or $0.48 per share. This is up from the $22 million in the second quarter. The $8 million increase is primarily a result of investing our CDO cash, some prepayment penalties received and the cash flow plus interest on securities that were non-accrual status, and had been paid off subsequent to quarter end.

Additionally we had other income of $0.60 per share, which was primarily due to a gain of $0.75 per share on the repurchase of $48 million of our own CDO debt at an average price of $0.03 on the dollar for the current average rating of B+. This gain was offset by a loss of $0.15 per share, resulting from the decrease in value of some of our economic hedges that were deemed ineffective per GAAP.

In the quarter, we also booked income of $1.69 per share from the reversal of prior loss allowances on our held-for-sale loan. And this was offset by $0.16 per share of additional impairment charges that we took on some of our securities. Adding these components of $0.48, $0.60, $1.69 and subtracting the $0.16 per gets us to our GAAP income for the quarter of $2.61 per share. To be clear, this is not comparable to taxable income of which our dividend requirements are based on.

And lastly, I'll finish with some key points. As you read, we must distribute annually at least 90% of our REIT taxable income. And we want to note that as of December 31, 2009, we had a net operating loss carry forward of $549 million and a net capital loss carry forward of $359 million. These carry forward losses can generally be used to offset ordinary taxable income and taxable gains in future years.

Due to these losses, we currently do not think we will have any distributional requirements for 2010. As detailed in our press release, we've purchased $148 million face of assets during the quarter. These purchases were primarily made in our CDOs. However, I would like to point out that one of the investments was made using $6 million of unrestricted cash, used to purchase $17 million additional face in a whole loan that we already had a large position in.

That ends our prepared remarks section. We'll now take your questions. Operator?

Question-and-Answer Session


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

Matthew Howlett - Macquarie

Now I understand you have to make traditional risk statements in regards to the CDO's specifically VIII, IX and X. But is it fair to say that that these are going to probably be cash bearing for the foreseeable future. I know you mentioned X as the most challenged, but doesn't that have the longest reinvestment period and the most excess cash of the CDO's.

Ken Riis

We really don't like to project out what the cash flows will be in the CDO's. Although, I will say, we've make good progress. And you're right, CDO X has the longest reinvestment period. So I think we've become very skilled at managing the portfolios. And as I said in my comments, the CDO's VIII and IX had a point where the cash flows are more reliable to us. And I think that's about as far as I want to go.

Matthew Howlett - Macquarie

Let me ask you this way, do you think over the last year with all the downgrades you've been through, what's sort of the shocking off from the (inaudible). We've seen a dramatic decline in the rate of your portfolio or the downgrades to deterioration. Do you think that will be less? And the prepayments occurring, initial cash, are they higher than they were a year ago? I mean all else being equal, you should be able to see those improve, should they not going forward?

Ken Riis

We're seeing good asset prepayments higher than our projections, although, we don't really publicly say what they are. They are coming in higher than what we had anticipated. So that's a good thing, because we can reinvest in discounts and build over- collateralization that way, which we have done. In terms of downgrade, it's really hard to project. I think we're pretty conservative as it relates to our projections regarding rating agency actions. But we weathered the storm, and who knows that the rating agency would do in the future. But we've done a good job to date and this is where we are now.

And some of the stats for the CDO X, it does have the longest reinvestment. It had about $43 million of cash available, but there are obviously other tools in the deal where we can sell assets to build up that cash if we need to. And we did disclose this $340 million of assets on negative downgrade watch, which was really increased. And I think that's a result of new deals kind of unexpectedly going back and putting a lot of the CMBS conduits back…


…resulted in Moody's kind of unexpectedly going back and putting a lot of the CMBS conduits its back on watch. The $340 million that we disclosed, that is a true assets on negative watch number, and that doesn't justify the risk that we have because there are assets within there that can be rated by an agency that's not on that specific deal.

So, I don't think $340 million is the right number but that is still a significant amount. I think the way we look at CDO X is probably around $100 million or so that has specific risk to that deal. And then in terms of paydowns, it's a great point that Ken said in we've actually received $335 million of paydowns through the first three quarters of 2010 and it was specifically $123 million in the third quarter.

Matthew Howlett - Macquarie

The CDOs are just performing great. I just can't imagine CDO X falling out of compliance and issues, but we'll certainly watch that on a quarterly basis. But as regards to other tools, I've noticed some CDO managers beginning to cancel debt again. If you could address that, I know you've done it in the past.

And also, on CDO V, and none of us ever expected that to come back in compliance. It is. Should we just look at that month to month? Any guidance you can give on that? It's pretty seasoned.

Brian Sigman

I would say CDO V, it's a quarterly pay deal, so it's a quarter-by-quarter battle. But I am happy that they have been on the last two quarters, and we just continue to manage the portfolio and keep it on, but it's fairly thin in terms of its OC cushion. So it's hard to predict where that would go.

Ken Riis

I did notice that some other collateral managers were allowed. And there's still, as we disclosed in our Q, there's actually no update to where we stand, but still haven't tried and there is still that court case that's going on with Aurora trustees. But it is a good point to note that we have cancelled over $200 million to date.

So I think we were ahead of the game as compared to some of the other collateral managers that are starting to do it now.

Matthew Howlett - Macquarie

Well, that's certainly another tool. And then just moving on towards the excess cash deployment, Ken you mentioned there could be CDOs selling at the year end, and you're certainly buying stuff at, looks like tremendous prices? But there is a lot of opportunity out there, we know there's a lot of debt, but when you look at how Newcastle is going to look a few years from now, you're trying to get two times earnings, you're not getting any credit for a good new business strategy.

Can you speak to sort of investments that you'll make outside of the CDOs other than just buy the debt back, and could we see mezz lending? Could you even talk about the possibility where you are with some lenders and reestablishing credit lines? Are you seeing that sort of pop up among the commercial REITs? Anything just sort of setting the signal here that you're more than just a REIT and run up by bad debt?

Ken Riis

Well, I highlighted the REIT debt is something that's very accretive for shareholders. We are looking at everything. There is a lot of opportunity out there. CDO debt is just one of the opportunities that we've highlighted and looking at to invest to build shareholder value that's accretive. There are other investments out there that generate very good returns that I hope to deploy over the next few months.

I don't really want to be specific as to exactly what it's going to be, because I can't really tell you today where we are going to end up two months from now. But we are highly focused on creating shareholder value, finding assets to invest that are most accretive to shareholders. And we have a lot of cash on hand, $239 million is a lot, and that's where we are focused right now.

Matthew Howlett - Macquarie

Going forward, do you foresee your capital building of portfolio outside of the CDOs? I guess given that sort of model, that structure, seems like its on hold for now. Could you see building a portfolio outside the CDOs at some point in time?

Ken Riis

That's a potential. Yes, we are always looking at different opportunities, and that is one of them.


Your next question comes from the line of Joshua Barber with Stifel Nicolaus.

Joshua Barber - Stifel Nicolaus

Just trying to continue a little bit with the question that Matt was asking. Looking forward, I guess at what price point and at what point do you look at your current portfolio and say, we are willing to go ahead and move forward and start raising some new capital to go out on often, because it sounds like you are able to find some good opportunities with your cash today. But at what point do you feel secure enough in your current portfolio that you want to go ahead and bring some capital outside the existing non-recourse structure?

Brian Sigman

We are really focused right now on investing the cash we have on hand. We are always looking our stock price and is it time and opportunities and is it time to go out and raise new capital for investments. So, trust me, we are always looking at that. But right now, if it's accretive to shareholders and we've run out of cash on our balance sheet then we may look at it but only if it's accretive and only if we have great opportunities to put money to work. So today, we are focused on the $230 million to invest and that's sort of where we are.

Joshua Barber - Stifel Nicolaus

Okay, keeping that in mind, how do you think about the preferred dividend going forward?

Ken Riis

I think we have been pretty consistent with what we've said. But that obviously is not a huge amount; it's about $1.5 million, $1.25 million. As I stated, we do have a lot of taxable losses. So I don't want to say that's the primary factor that goes into it, but every quarter we meet with the Board and management, and the Board taking consideration of the losses. And there is no need from a redistribution point of view to pay it.

We do look at liquidity, and although we do have a strong position, obviously keeping that dividend and being able to reinvest in our own CDO debt is highly attractive to us. So I think again, it's a quarterly decision and the Boards and our last decision was not pay it and we'll revisit that in December.

Joshua Barber - Stifel Nicolaus

I may have missed this before, but can you just tell us what the restricted cash is for CDOs VIII, IX and X?

Brian Sigman

Its $68 million for CDO VIII; $65 million for CDO IX; and $43 million for CDO X.

Joshua Barber - Stifel Nicolaus

And one last question, I know that you discussed the cash flow that was coming from the CDOs. Can you talk about the cash flow that you are getting from any other assets, from the unlevered, from the manufactured housing portfolio, re-securitization, anything else that you're getting, and give us an idea of what the quarterly cash flow looks like from that portfolio.

Brian Sigman

We don't actually disclose what the cash flow from those segments are. We have to, in our plans be very careful of using non-GAAP measures, and as much as cash seems pretty obvious to be allowed to, we haven't been able to get comfortable with putting a lot of that information in the 10Q. And this is something we do think about.

So we usually, kind of the way we look at it here is those assets are pretty close to your net spread per GAAP. And between our debt table and our segments table you can estimate what the amount this cash is, since there is no really cash trap features because it's unlevered and in the second (image) pool all the cash flow is flowing to us. And I think you can easily estimate what those numbers are using those tools.


At this time, there are no further questions. I would like to turn the call back to management for closing remarks.

Nadean Novogratz

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


Ladies and gentlemen, this concludes today's conference. You may now disconnect.

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