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Newcastle Investment Corp. (NYSE:NCT)

Q1 2011 Earnings Call

May 6, 2011 11:00 AM ET

Executive

Nadean Novogratz – Investor Relations

Ken Riis – President and Chief Executive Officer

Brian Sigman – Chief Financial Officer

Analyst

Matthew Howlett – Macquarie

Joshua Barber – Stifel Nicolaus

Operator

Good morning, my name is [Christie], 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. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to hand the call over to Nadean Novogratz. Please go ahead.

Nadean Novogratz

Thank you, Christie. And good morning, everyone. I like to welcome all of you today, May 6, 2011 to Newcastle's first quarter 2011 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 our 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 the recommendation to review the risk factors contained in our annual and quarterly reports filed with the SEC.

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

Ken Riis

Thanks, Nadean. Good morning. And thank you for joining our first quarter 2011 earnings conference call. We continue to see stabilization in commercial real estate values and that market is experiencing a strong recovery. Lending is expanding, but leverage is much lower. Borrowers need access to both debt and equity to refinance maturing debt and the availability of capital is growing. This is beneficial to Newcastle in two ways.

First the expansion in lending should reduce maturity defaults in our portfolio. Second, is creating good investment opportunities for us in the new debt. We are seeing a lot of activity in our portfolio. Borrowers are getting new loans, paying us off at par and reinvesting a new debt at lower leverage and higher returns.

I see this trend continuing and it should help us grow our earnings going forward. Now on to the first quarter results. It was a good quarter for us; we earned $1.73 of GAAP income and $0.41 of operating income. In the first quarter, we generated $17 million of operating cash flow, compared to $12 million in the fourth quarter, 2010.

Our $4.2 billion portfolio continues to perform well. The credit profile is getting better and the value continues to increase. In the first quarter, the value increased $162 million to a total value of $3.2 billion and an average price of 77% of par. As a comparison, the value in the first quarter 2010 was 64% of par.

So over the last 12 months the value of our portfolio has increased 13 points or 20%, a pretty good move. As our portfolio improves the cash flows received from the CDOs debt finance become more reliable. At year-end, CDOs eight, nine, and 10 had $145 million of assets on negative watch by the rating agencies.

In the first quarter the rating agencies completed their review of a lot of the assets they had on negative watch and as a result, the over collateralization cushion in our CDOs was reduced somewhat.

Today, we have only $20 million of assets on negative watch in these three CDOs with $143 million of over collateralization. Going forward, we are well-positioned, we will continue to look for ways to build overseas and I am confident that we will continue to receive cash flows from these three CDOs going forward.

Now, on March 29th we closed on the sale of $17.3 million shares of common stock, raising $98 million of new cash. This is our first equity offering in four years and I am very pleased with our timing. We are seeing good investment opportunities and we have been very busy putting capital to work.

In the 30 days since, we raised the new money, we have invested or committed to invest, $63 million of unrestricted cash at a 20% return and $228 million of restricted CDO cash at an average return of 8%. We have a strong deal pipeline and my goal is to have all of our unrestricted and restricted cash invested by the end of the second quarter.

In addition, I would like to highlight a very positive event that just occurred this week. Two days ago, we closed a new financing of our second manufactured housing loan portfolio. We have owned this portfolio for five years. The current principal plan is $200 million and it has a high average net coupon to us of 8.7%.

The loans have performed very well from a credit perspective. Today only 2% of the loans are delinquent. I am pleased that we were able to issue new debt at a very low cost and term finance this portfolio through the issuance of a new securitization.

In new securitization we sold $160 million of fixed rate investment grade debt at an average funding cost of 3.7%. After investing new capital, we were able to terminate the relevant interest rate swap and pay off $164 million of existing debt, which had an average funding cost of 5.3%.

So net-net we invested new capital and reduced our funding costs by 160 basis points. The new capital should earn a 30% loss adjusted return, as we continue to benefit from the stable cash flows generated from this portfolio. This is a very good result for us.

So to conclude, we have been very busy. In the near term, we will continue to focus on investing our cash on hand. We are very existed about the investment opportunities in front of us and the prospectus of growing our net operating earnings and cash flows.

Now I'll hand it over to Brian Sigman, our Chief Financial Officer to review our financial results in more detail. Brian?

Brian Sigman

Thanks, Ken. And good morning, everyone. Based on Ken's broad review of Newcastle and the markets I will drill down on our liquidity and financial results for the quarter.

Our liquidity. We currently have $129 million of unrestricted cash and $152 million of restricted cash for reinvestment in CDO, eight, nine and 10. We have a $17 million repurchase agreement that is financing $41 million of our CDO's six senior bonds that we purchased in December. Although the facility does require margin to reposted, the recourse of the company is limited to 25% of the outstanding balance of the repurchase facility which was $4 million at quarter end.

We also have $106 million repurchase agreement that is financing $112 million of Fannie Mae and Freddy Mac one-year ARM securities. We use this type of investment and related financing for compliance purposes with the Investment Company Act of 1940.

Now on to our financial results for the quarter. We had GAAP income of $1.73 per share with the following components. Our net interest income, less our expenses and net our preferred dividends, resulted in income of $26 million or $0.41 per share.

Additionally, we had other income of $0.72 per share primarily due to a net gain of $0.54 per share on the settlement of investments through pay downs and sales and a gain of $0.18 per share on the repurchase of $12 million of our own CDO debt at an average price of $0.09 on the dollar.

In the quarter, we also booked income of $0.66 per share from the reversal of prior loss allowances on our held-for-sale loans. This was offset by $0.06 per share of additional impairment charges on our securities, adding these components of $0.41, $0.72, $0.66 and then subtracting the $0.06, gets us to or GAAP income for the quarter of $1.73 per share.

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

Nadean Novogratz

Operator? We can begin taking questions.

Question-and-Answer Session

Operator

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

Matthew Howlett – Macquarie

Hi, guys. Thank for taking my question. Ken, this is the first time in a while you have been able to really say that the free cash flows from the three CDOs are going to remain in compliance for the foreseeable future. Is that just a function of the assets coming down -- on watch coming down to a level where you just feel comfortable that CDO X, particularly, is going to continue cash flowing?

Ken Riis

Yeah. I think we've gone through the majority of the rating actions in the near term. And it gives me a lot more confidence that we can manage the portfolio, manage our over collateralization cushions and continue to receive cash flows in -- not only that one but all three of them.

Matthew Howlett – Macquarie

Great. That's certainly a big victory for you guys. Congrats on getting through that. I know it has been a long time in the making. Just on CDO IV, that's still out of compliance but it looks like toward its de-leveraging, it's working back in -- it threw off some cash, a little more than expected. What can you say about that one? Could that come back on?

Ken Riis

We continue to work on all of our CDOs, but -- and that one has a chance of coming on. We’re not -- we don't have it in our financial modeling, probably you shouldn't either. But there is a chance that it could come back, but I would -- it is just hard to predict, going forward.

Matthew Howlett – Macquarie

Right. Okay. We'll watch for that one. And then, just one in term if that get real busy April, a lot of assets are spoken for, a good time to be buying with the widening that has gone on. What’s -- you look at buying back debt, you bought back a little bit of debt in the first quarter, a little bit more in the second quarter thus far; I guess, what are you seeing in terms of the repurchase of CDO debt? You had (inaudible) you had it marked at roughly $0.61, $0.62 on the dollar at the end of the quarter. What has happened to that debt recently? And what are you seeing in terms of potential repurchases, beyond what you have already disclosed?

Ken Riis

A little bit hard to comment on that, because we're working on a lot of transactions or trying to pull them out from sellers. But I would say that I would expect to continue to see some good progress there going forward. We'll work -- it's a very -- it's a high priority for us and we'll see how it goes but we have done a good job to-date and we can expect that to continue.

But really, again, it all depends on the seller, what price they want to sell at and what pressures they have to sell, either for capital purposes or risk weighting purposes at banks who own some of the senior bonds. It's really going to rely on that but my guess is that, overtime, a lot of these assets will be for sale and we really should be one of the best bidders for them.

Matthew Howlett – Macquarie

Yeah. It's a huge opportunity for you guys. Is it fair to say that the marks haven't changed that much from where you had them at the end of December, I mean, you had it at $0.62 on the dollar, is it fair to say that it's still a very dislocated market and you can still buy stuff -- you bought stuff at, I think it was $0.50 on the dollar -- I'm assuming that was the below senior tranche, but is there still a big opportunity in that in terms of buying stuff at deep discounts there?

Ken Riis

Yeah. I don't think the value of the -- of our liabilities has changed much since the end of the year. It may be up slight a little bit but not materially. So yes, I do think that there’s an opportunity to buy back the debt at a discount.

Matthew Howlett – Macquarie

Great. And just last question, what is the company's -- after all of the assets that you have disclosed, you had $129 million of unrestricted cash as of May; does that include all of the assets that you have spoken for that are going to close and what is, I guess, the unencumbered excess cash -- unrestricted cash position the company that we can look towards to making new investment from -- on top of what you have already disclosed?

Brian Sigman

Well, I would just say the unrestricted cash that we disclosed, the reason I said, we committed to invest, because we have committed $25 million that hasn't closed yet. So if you take the $128 less the $25, we're about a -- we still have about $100 million of unrestricted cash to invest. My goal is to have that invested by the end of this quarter or the second quarter.

Matthew Howlett – Macquarie

That's great. Thanks guys, congratulations.

Ken Riis

Thank you.

Operator

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

Joshua Barber – Stifel Nicolaus

Hi, good morning. I know you are still in the process of closing on a couple of investments, but can you give us a little bit more insight on the $210 million of mezzanine loans that you're purchasing? It looks like it adds about a 7.6% coupon and not a lot of par value discounts. Can you speak to what the relative attractiveness of those assets are?

Ken Riis

Those are actually -- fit well into our CDOs, they -- most of them are floating rate. They float at LIBOR on average, LIBOR plus 600 basis points with a 1% floor. So it fits well, from a spread perspective, in our current CDOs. And the majority of the investments are senior mezzanine loans on newly originated loans backed by commercial real estate.

Joshua Barber – Stifel Nicolaus

Okay. Would you plan on giving further disclosure, maybe once the investments close, on what exactly is collateralizing those loans?

Ken Riis

Yeah. We're thinking about that right now, actually. And once they close, looking in at the next press release, maybe we could look -- add a little bit more disclosure about what we're buying and so forth. And we plan on doing that.

Joshua Barber – Stifel Nicolaus

Yeah. I think that would be great. One last question, can you talk about the restricted cash at each of the CDOs, please?

Brian Sigman

Sure, I have that. And this is to tie into the OC, this is $55 million was at CDO VIII at the end of the quarter $65 million -- I'm sorry, May 4th, $65 million on CDO IX and $32 million on CDO X.

Joshua Barber – Stifel Nicolaus

Okay. And that $32 million that's still remaining or at least once that has been invested into some of those new loans, you’re pretty confident that the OC will be okay, now that those watch list assets are gone?

Brian Sigman

Yeah. Like, I -- Ken did say that. But also keep in mind that sometimes when we buy these mez debt at par, we can put them in CDOs VIII and IX they sit very well into the loan deals and those two deals have a lot of OC cushion. They are not as sensitive to buying things at discount.

Joshua Barber – Stifel Nicolaus

Great. Thanks very much.

Brian Sigman

No problem.

Operator

There are no further questions at this time. I hand the program back over to management for any further comments or closing remarks.

Nadean Novogratz

Thanks, again, everyone for joining us today. We really appreciate it. And 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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