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Newcastle Investment Corporation (NYSE:NCT)

Q2 2011 Earnings Call

August 5, 2011 11:00 AM ET

Executives

Ivy Hernandez – IR

Ken Riis – President and CEO

Brian Sigman – CFO

Analysts

Joshua Barber – Stifel Nicolaus

Matthew Howlett – Macquarie

Operator

Good morning my name is Melissa and I will be conference operator today. At this time I would like to welcome everyone to the Newcastle Second Quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question and answer session [Operator Instructions] Thank you I would now like to turn the conference over to Ivy Hernandez.

Ivy Hernandez

Thank you Melissa and good morning everyone I would like to welcome all of you today August 5th 2011 to Newcastle’s second quarter 2011 earnings conference call. Joining us today are Ken Riis, our CEO and President and Brian Sigman our CFO. I would also like to point out that certain statements made today maybe forward looking statements. Forward looking statements are not statements of fact instead these statements represent the company’s current belief regarding events that by their nature are uncertain and outside of the company’s control. The company’s actual result may differ materially from the estimates or expectations expressed in any forward looking statements therefore you should not place undue reliance on any forward looking statements. I encourage you to review the disclaimer in our earnings release regarding forward looking statements and to review the risk factors contained in our annual and quarterly report filed with the SEC.

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

Ken Riis

Thanks Ivy, good morning and thank you for joining our second quarter 2011 earnings conference call. In the second quarter global volatility and market uncertainty caused credit spreads to widen and prices to decline for the first time in more than 12 months. Recent events have reinforced the need to maintain a balance sheet with little or no debt maturity risk and have an opportunity platform that’s generating a lot of cash flow. We are positioned well in both areas excluding the financing of our agency securities we don’t have any near term debt maturities.

We are generating strong operating cash flow and we are focused on new investments to grow at a time when markets are offering high yielding investment opportunities. On the call today I want to highlight three things relating to our second quarter, first our operating results second our investment activity and third our common stock dividend. We had a successful and productivity second quarter Brian will review the financial results in more detail in a minute. But I want to highlight the operating metrics that we focus on on a quarterly basis, these are net operating income and cash flow generated that can be used to pay a dividend.

In the second quarter we generated $30 million or $0.37 per share of GAAP operating earnings. This is a solid result given the amount of cash we had on our balance sheet and the late timing of new investments in the second quarter. Next cash flow from operations increased to $15 million in the quarter in addition we received $48 million of unrestricted cash from principal repayments on CDOs that were purchased at material discount, in this case 74% at par. These 26 points or $12 million of discount earned in the quarter along with $15 million of operating cash flow is money that can be used to pay a dividend.

Now moving on to our investment activity we saw some great investment in the quarter the timing of our March 29th capital raise turned out to be good as we had ample cash to invest just as asset prices started to weaken. We entered the second quarter with a $160 million of unrestricted cash, in the quarter we invested a $121 million of unrestricted cash at an expected return of 19%. Our biggest investment was $86 million to repurchase Newcastle CDO bonds. We repurchased $119 million of Newcastle CDO debt at an average price of 72.

We expect these investments will recover at par and generate a 16% annual return. In addition we resourced investment in non-Newcastle CDO bonds managed by a third party. We purchased 31 million at $0.50 we expect this investment to recover at par and generate a 26% annual return. This is a good example of us leveraging our CDO expertise to source investments with higher returns. Finally I want to discuss our dividend on June 17th we reinstated our common stock dividend and announced a $0.10 per share dividend. This $8 million cash payment is well covered as it only represents a portion of the cash generated in the quarter.

This was our first dividend payment in three years and we concluded it was important to reinstate the dividend for really three reasons first we have successfully stabilized the company and are consistently improving results second the volatility of our stock price didn’t reflect the stability of our operations. Paying a dividend demonstrates operating strength and gives more transparency to common stock holders. And third we made good new investment progress in the second quarter, we invested at very high returns and that was another impetus for looking at turning the dividend back on.

I’m happy that we are back in position to pay a dividend and we can now focus on dividend growth. Today we still have 85 million of unrestricted cash to invest and we are very excited about the opportunities in front of us. Over the last two years we have repurchased about $1 billion of Newcastle CDO debt at big discounts. There is another 2.8 billion of outstanding Newcastle CDO bonds that we can potentially buyback. I believe selling pressures will increase in the third and fourth quarter and this will continue to represent a good investment opportunity for us. In addition our investment pipeline is expanding not contracting; our affiliation with Fortress gives us a great platform to source a wide range of investments for Newcastle. We are well positioned and I look forward to updating you on our progress over the next few months. Now I will hand it over to Brian Sigman our Chief Financial Officer to review our financial results in more detail.

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. With respect to our liquidity we currently have 84 million of unrestricted cash and 99 million of restricted cash for reinvestment in CDO 8, 9 and 10. We have a $14 million repurchase agreement that is financing 35 million of our CDO 6 senior bond that we purchased back in December. But the recourse of the company is only limited to 25% of the outstanding balance of the repurchase facility which was only 3.5 million at quarter end. We also have 2.5 million of repurchase agreement that are financing 206 million shares of Fannie Mae and Freddie Mac one year ARM securities.

We use these type of investment and related financing for compliance purpose with the Investment Company Act of 1940. Now I will announce our financial results for the quarter, with GAAP income of $1.23 per share representing three main components first our net interest income less our expenses net of preferred dividends resulted in income of $30 million or $0.37 per share. Second we have other income of $0.75 per share which was primarily due to a net gain of $0.45 per share on the settlement of investment through payout and sales and again a $0.42 per share on the repurchase of our own CDO debt. These gains were offset by a loss of $0.14 per share primarily resulting from a mark to market loss on an interest rate swap in connection with the repurchase of CDO bond.

Third we booked income of $0.11 per share of net impairment reversal on our portfolio. Adding these components of $0.37, $0.75 and $0.11 gets us to our GAAP income for the quarter of $1.23 per share. Lastly I would like to touch on some key points in April we completed a securitization to refinance our second manufactured housing loan pool with financing was set to mature this month. As a result of the securitization we termed out our financing to match the underlying asset, reduced our financing cost by 160 basis point to 5.3% and we invested 20 million of unrestricted cash to retain the below investment grade notes and residual interest in the securitization on our balance sheet.

In June we did reconsolidate CDO 5 from our financial statements although the deconsolidation had no material economic effect on our operations. It did increase our GAAP book value by $0.70 per share, the increase to GAAP book value is because CDO 5 assets were written down to their fair value which was lower than its non-recourse financing. The deconsolidation was the result of the failure of a collateral manager trigger in CDO 5 which allowed the controlling class to remove us as collateral manager although we have not being removed today. Finally I like to point out the new information to look for in our second quarter 10Q that I think will be helpful in our segment table we further broke out our non-recourse finance investments by face, carrying value and type of investments. That ends our prepared remarks we will now take your questions. Operator

Question-and-Answer Session

Operator

[Operator Instructions] your first question comes from Joshua Barber of Stifel Nicolaus.

Joshua Barber – Stifel Nicolaus

Hi good morning. Can you just confirm whether or not the third party CDO bonds that you buyback had to anything with – were there one from the Seabass [ph] deals.

Ken Riis

No it was from another third party manger.

Joshua Barber – Stifel Nicolaus

A number of the investments that you made this quarter seem to have duration somewhere between three and four years which would seem to me that your CDO cash flow is not going to last for much more than 3 or 4 years just given the duration the overall duration of the assets and what they were at the end of the quarter. Have you guys thought about trying to maybe sacrifice some yield for longer duration in terms of those facilities given the long term nature of them.

Ken Riis

We are targeting returns that generate good near term cash flow to us so we are really focused on buying assets and again generate a lot of cash flow to us in the near term and that’s what we are focused on. So we are targeting you know assets that have high current coupon and the average life you know we can buy things that are longer we will but right now in the market place I think our investment activity represents I’m sorry what’s typical out there for us to buy right now.

Brian Sigman

And actually in the press release we focused on breaking out our investment between unrestricted and the restricted CDO cash and the 293 million of restricted CDO cash was actually at a 4.7 year average life so almost five years so little better than the unrestricted the – little longer than the three years of the unrestricted.

Joshua Barber – Stifel Nicolaus

Okay that’s fair, can I ask you – you guys have the new liability show up on your balance sheet there are the payable to brokers. Can you clarify exactly what that is please?

Ken Riis

Unfortunately we had a trade that we traded on June 30th but didn’t settle till July 2nd so for GAAP the asset come under book on June 30th but the repurchase agreement for the agency securities that we brought don’t come on till July so for those three days we have a trade payable to brokers. So it’s in essence it just turns into the repurchase agreement.

Joshua Barber – Stifel Nicolaus

Okay so that’s just a basic Repo agreement.

Ken Riis

Yes really it’s just GAAP.

Joshua Barber – Stifel Nicolaus

I know there has been a lot of talk in the last few weeks about repo haircuts and everything that’s been happening there in the agency and not agency market. Can you discuss what your potential exposure is there invested capital and what you have been seeing in terms of collateral requirements?

Ken Riis

Yes the great news is you know beside away from the agency we really don’t have any repurchase advantage they have the small 14 million on the CDO 6 which is only 25% recourse. It’s really just a non-agency and we are I think a little different than some of the agency rates they have I think they only have mostly 3% haircut. We actually have a 5% haircut so we haven’t really heard of anybody calling; nobody called us up so that’s going to change.

Joshua Barber – Stifel Nicolaus

Great thank you very much.

Operator

Your next question comes from Matthew Howlett of Macquarie.

Matthew Howlett – Macquarie

Okay guys thanks for taking my question, another solid quarter. What can we expect in terms of the cash you are getting from the your own CDO debt repurchased third party CDOs I mean what can we expect – where should we be modeling or can we expect that going forward. I mean there was obviously still a discount left on that but I will it its function of prepayment, what can we expect from sort of that piece of portfolio going forward.

Ken Riis

You know as you know the return of principle really depends on the performance of the underlying collateral in the CDO so the timing of that is a little bit hard to predict so it really doesn’t make sense to predict every forward what each quarter will be. I will say that the amount of principal received in this quarter the 48 million was probably a little bit higher than what you can assume going forward. But you know I do think that every quarter will have you know a good portion of principal coming back, we purchase these securities at a discount so part of our do I look at it, part of our operating earnings is a normal cash flow from operations plus the recovery of discount on these investments that we’ve made.

It’s really hard to project exactly quarter by quarter what that will be

Matthew Howlett – Macquarie

How much I know it might be hard what’s the total on the discount that you can tell us of what you repurchased that’s left to be amortized.

Ken Riis

It’s similar to what we had in the first quarter about 74% at par. In the second quarter sorry.

Matthew Howlett – Macquarie

Got you great. Okay and just on the CDO when the three remaining cash flowing CDO you will see levels all improved or at least flat I mean what can you downgrade the assets on what are down. Can you tell us about those deals are they just cranking along are you taking advantage of the spread wining that’s gone in the CMBS market to put more cash to work. Anything on CDO 4 just any color on those CDO it seem like they are in really good shape.

Ken Riis

Yes CDO 8, 9 and 10 which generates a lot of cash flow for us are performing well. We stabilize them we work very hard on keeping the OC levels you know keeping a good OC cushion in those deals every month. And I feel good about our cash flow generation from those three deals and the amount of cash flow we will continue to receive so you know I feel good about that.

Matthew Howlett – Macquarie

Got you, I know you are still focused on buying the senior debt with all pieces that back at some point. Do you think there is going to be more selling as you mentioned in your prepared remarks going forward I mean. Can you tell us of any negotiation I mean things take a while they get ramped up, have price come down with recent [inaudible] are you more encouraged about getting more stuff in house.

Brian Sigman

We are encouraged by the recent market moves and the decline in asset values because basically our whole portfolio is term finance so the change in prices on the asset that we own today don’t really impact our earnings and operations and cash flow that we generate on a quarterly basis. We are very excited about the new investment opportunities that we are seeing today you know this volatility creates better opportunities for us and we have a lot of cash to invest. So we feel really good about that.

Matthew Howlett – Macquarie

Great thanks guys.

Brian Sigman

Thanks.

Operator

Your next question is a follow from Joshua Barber from Stifel Nicolaus.

Joshua Barber – Stifel Nicolaus

Just had a quick follow up your foot notes noted that you had a lot more seeming assets on for the July remittance about I am sorry which assets are on watch list now especially on CDO 10. Was there more assets in that CDO that were put on downgrade or did that just reflect things that you want there in that quarter.

Ken Riis

The assets on negative watch assets.

Joshua Barber – Stifel Nicolaus

Yes, the negative watch assets particularly in CDO 10.

Brian Sigman

Those went up I would say that the assets on negative we show that as sort of a metric but in terms its impact on our over collateralization in each CDO I think that is just one of many factors that can affect over collateralization. And I think it’s over time it hasn’t been a great metric for people to look at in terms of whether our OC level will increase or decrease over time. But assets on negative watch did increase in CDO 10 I don’t think it has a material impact on our ability to receive cash from that in the near term.

Joshua Barber – Stifel Nicolaus

Thanks, last question, in your CDO cash flow for the quarter you excluded the senior management fees from CDO 5 is that correct.

Brian Sigman

Yes we did.

Joshua Barber – Stifel Nicolaus

What’s the quarterly queue on that?

Brian Sigman

What you said?

Joshua Barber – Stifel Nicolaus

I’m sorry what is the quarter fee on that?

Ken Riis

It’s about a 150,000 a quarter but we are still receiving it.

Joshua Barber – Stifel Nicolaus

Right. Okay great. Thank you.

Operator

Thank you I will now turn the conference back to Ivy Hernandez for closing remarks.

Ivy Hernandez

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

Operator

Thank you for participating in today’s conference call, you may now disconnect.

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