Newcastle Investment Corp. (NYSE:NCT)
Q1 2008 Earnings Call
May 12, 2008, 1:00 pm ET
Lily Donohue - Director of Investor Relation
Wesley Edens - Chairman
Ken Riis - Chief Executive Officer and President
Debra Hess - Chief Financial Officer
Bose George - KBW
Edmond Safra - M. Safra & Co.
David Fick - Stifel Nicolaus
Matthew Howlett - Fox Pitt Kelton
Jeremy Banker - Citi
Good afternoon. My name is Dennis and I will be your conference operator today. At this time, I would like to welcome everyone to the Newcastle First Quarter 2008 Earnings 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).
I will now turn the call over to Ms. Lilly Donohue, please go ahead ma’am.
Lily Donohue – Director of Investor Relation
Thanks, Dennis. Good afternoon, everyone. I’d like to welcome you all to Newcastle’s First Quarter 2008 Earnings Conference Call. Joining us today is Wes Edens, our Chairman; Ken Riis, our CEO and President and Debra Hess, our Chief Financial Officer.
Before I turn the call over to Wes, as the operator mentioned, this call is being recorded and the replay number is 800-642-1687 from within the United States, outside of the United States, is 706-645-9291, access code is 447298044. The call is also be available on our website newcastleinv.com.
I’d also like to point out that statements today which are not historical facts may be forward-looking statements. Our actual results may differ materially the estimates or expectations and 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 also encourage you to review the forward-looking statement disclaimer in our press release and also reviewing the risk factors contained in our annual and quarterly reports that are filed with the SEC also available on our website. And with that I would like to turn the call Wes Edens. Wes?
Wesley R. Edens – Chairman
Great, thanks Lilly and welcome everyone, and welcome to our 2008 first quarter earnings calls. The first few months of the year have continued to be very volatile, obviously. Now, since the Feds action to mid March the market has stabilized its significant extent, and our primary focus at New Castle during these truculent times has been to rebalance the portfolio, increase as much liquidity as possible. I am happy to report that thus far we’ve accomplished a great deal this year, we still have work to do, but we’ve made great progress.
In the long term, our objective in New Castle is the weakest stewards for our shareholders capital. We’ve been focused mainly on from liquidity and financing and we expect to complete the bulk of what we’ve focused in this regard in the first half of the year. Now our focus can shift. So looking to aggressively seek to investment liquidity we’ve generated in the best risk adjusted investments available. This is something we have already started to focus on and they should only accelerate in the second half of this year.
In total since the beginning of the year, we’ve reduced our recourse borrowings by just over a billion dollars from approximately 1.8 billion at year-end, down to about $765 million currently. We’ve reduced the CDO financings by $348 million, increased cash on hand from 29 million and cash at year end to nearly a $125 million today, and now have a much more liquid balance with substantial amount of cash, greatly reduce to recourse, non-recourse borrowings and a couple of hundred million dollars on assets that are on leverage, so far, so good.
We still have a number of initiatives that we believe we will continue to add to our liquidity, as long as we’re successful on executing it on them, but just recently we turned our attention to looking at a variety of investment alternatives that are in front of us.
There are basically two types of investment alternatives that we focused on, the first it simply to look for investment opportunity that exist in the market for various types of debt. If the target reach environment for debt these days, there should be good news in this front in coming.
Second of all, we continue to look to acquire elements of our outstanding capital structure at attractive prices. We’ve made some modest investments this quarter that Kenny in just a sec and the debt is issued by some of our CDOs. In addition, we are looking closely at the company’s equity securities. We have not purchased any thus far, how we have authorization to do itself from the board and this something which we are continuing to evaluate and monitor closely.
All in all this is good first quarter for the company and we continue to have good success thus far in the second quarter and achieving the objective that we created first in the year. Our hope is that continue good of execution as well to maximize the shareholder equity and delivering the opportunities that exists in this market.
Now to talk specifically about our activities, I would like to turn the call over to Ken. Ken?
Ken Riis – Chief Executive Officer and President
Thanks Wes. As we mentioned we have had a very active first quarter. With the focus on raising cash and reducing recourse debt we sold $1.3 billion of assets, reduced total debt by $1.4 billion, and more importantly reduced recourse debt by about a billion dollars in the quarter. Today we have a $123 million of unrestricted cash on our balance sheet and $62 million of restricted cash in our CDOs.
The $1.3 billion of assets sold in the first quarter, $760 million Fannie Mae and Freddie Mac securities, $300 million were commercial real estate securities and loans, and $273 million was mostly a weak debt. If we focused on the liability side of our balance sheet which is where we’ve been focused in the last four month, at quarter end, we had $5.7 billion of total debt, $4.9 billion of non-recourse and about $787 million of recourse debt.
Our main focus has been to reduce our recourse debt exposure, so let’s focus on that first. Currently when I look at it and we have two forms of debt, we have financing to reduce this debt by $250 million over the last four month. We will continue to focus on this part of our balance sheet, but I feel very good about where we are today.
Next I want to talk about the larger part of our liability side of our balance sheet which is our non-recourse borrowings. It totals $4.9 billion and $4.5 billion as recourse is non-recourse CDO debt. Our CDO liabilities are non-recourse. This means that our capital at risk is limited to our investments and the assets net of debt that has already been issued against those assets. We currently have $4.9 billion of assets financed with $4.5 billion of debt in our CDOs. The average funding spread on these liabilities is very attractive, currently about LIBOR plus 40 basis points, and the average LIFO liabilities at six years.
Today the CDO’s offer great value to the company, we can only do two things, we can continue to use these financings to fund our portfolio and generate a good positive spread. OA end also buy new assets at high yields as asset prepay in the CDOs and generate higher returns on equity. And also, given the current marketplace we are able to theistically repurchase CDO liability that distress prices and generate gains for the company.
In the quarter we bought that $19 million as CDO liabilities at an average price of $0.39 on the dollar generating a $11.5 million gain.
In summary our balance sheet is in good shape and we will remain focused on utilizing our liquidity to take advantage of our current market opportunity. The buying back of some of our debt in the quarter is just the beginning for us and there are lots of opportunities like these in the marketplace today.
Our short term focus is position the company to take greater advantage of all these market opportunities. Now, I will turn it over to Debra Hess, our CFO to review our first quarter financial results. Debra?
Debra Hess - Chief Financial Officer
Thank you Ken and good afternoon. I wanted to highlight our results and focus on two key financial metrics, recurring income and book value. Recurring income or FFO scoring net charges was $0.56 per diluted share for the first quarter.
We talk about recurring income every quarter. So to make it easier to calculate we reformatted our income statement, we added a new caption called non-recurring income and expense that now summarize all of those net charges from the past. We also added a line item called operating income which if you net off the preferred dividend is the equivalent of recurring income before these other item.
Net charges for the quarter were roughly $74 million or a $1.40 per share and is principally comprise of impairment of $70 million. Impairment included 46 million related to AVS securities, 19 million related to loan, and 3.5 million related to the future sell of our real estate. Other income and expense item for the quarter related to sales, the repurchase of CDO debt and unrealized losses and total returns loss.
Next is our book value. Our GAAP book value only reflects market value changes for securities and derivatives and does not mark our loan investments or debt. Given the dramatic spread widening in the quarter for instance, BBB CMBS widened approximately 900 basis points. Our GAAP book value was a negative $4.12 per share.
The two largest contributed to the unrealized loss for CMBS of 302 million or $5.73 per share and interest rate swap used as hedges of 160 million or $2.19 per share.
However, this number in no way represents our two economic book values. We believe a better metric is adjusted book value which marks all of our financial assets and liabilities to fair value. Our adjusted book value equals $16.28 per share at March 31st. This measure may be easier to understand as it is an equivalent to FAS 159. However, by presenting the adjusted book value we avoid all of the accounting noise in the income statement from electing fair value under FAS 159.
Another way to think about GAAP book value and why it's a not useful measure is because of how we finance ourselves. Our securities portfolio is predominantly financed with CBOs that are not affected by unrealized changes in value.
Hardly under US GAAP we have negative equity in all but one of our CBOs. However, given that they are non-recourse financings we could never loose more than our equity interest. Just adding back the negative GAAP CBO equity would increase our GAAP book value by 650 million and bring it to $8.20 a share.
However, this analysis does not take into consideration all of the expected future cash flows which in the first quarter we generated 22 million of income cash flows on our CDOs as well.
Next I will turn it over to the operator for questions.
(Operator Instructions). Your first question is from the line of Bose George with KBW.
Hey good afternoon. Had a couple of questions. One, your quarter-end spread was up by 33 basis points over Q4 and does that primarily reflect the fact that assets are marked down further?
It's actually two pieces. We actually sold 1.3 billion of assets in the first quarter over 700 of which were agency RMBS, which just happens to have a lower net spread to it, that’s the largest contributor.
Okay. And second just switching to the – I just wanted to try and figure out the capital that you had invested in your sub prime securities and just in terms of the total exposure that you guys have?
Well the assets that most of assets – most of the assets-backeds aren't sitting in our CBO's. We have them marked on the basis of say the overall '06 of vintage for instance with that $0.14 at the end of year and currently it is at $0.06.
So when in term - when I think of our total exposure its really its what that is marked on to plus - is the calculation of your exposure in your residuals separate?
It is. When you go to the table in the press release we actually break out the third party sub prime securities separately from the sub prime retained interest and the retained bonds. And you…
Yes so it’s the – and then I just take the $0.06 of this and then add there on the residuals as well.
You can add it all up.
Okay great thanks.
(Operator Instructions). The next question comes from the line of Edmond Safra with M. Safra & Co.
Hi. Can you just give us a little bit of an idea of how the B notes portfolio is doing and are there non-marked-to-market assets. So you had a couple charges related to that you know, the bulk of our portfolio is performing very well, we have very low leverage on our mezzanine loans and B notes, and the underlying assets are performing inline with expectations. So, no real issues there. The charges we took were on a bank loan that we had and also a residential loan which was a loan lands in Arizona. So those are the two charges we took in the quarter. So it was isolated the bulk of portfolio is performing very well or better than expected.
Your next question comes from the line of David Fick with Stifel Nicolaus.
Good morning. I just want to be clear you recently announced like 159 equivalent income statement and then over your adjustment through scholarship?
That is correct.
Okay. Can you walk us through your loss covered by asset type and as reserve you have now on your commercial loan, your residential loans and your bank loans?
Well, we don’t really have reserves on our securities, right, what we do there where we taken an impairment we’ve just reduced our basis down. Aside from that, we don’t have any reserve. The number that are actually different on the adult side, the loans that we have, in our 10-Q we actually disclosed what our loan loss coverage is that for instance, on our commercial real estate related loans again, we have some results that came through the form of the impairment that we took in the first quarter. And then on the residential loans, prime loans and MH loans, of the total portfolio of 621 million, we have 11.5 million of delinquent loan, and on that we have 8.6 million of reserves against that.
Okay, that’s clear thanks. What are your thoughts on the order $787 million of recourse debt especially the Fannie’s and Freddie’s, what’s your problem on that?
Well we are on those for compliance purposes and if that decides where we need to be. So, our plan here is to continue to own those in finance and it will be actually expanded financing counterparties in the quarter with investments banks that will finance those assets for us. So, from my point of view it’s really not an issue that where it’s liquid and easy to finance, but we do need to own the current size or compliance, re-compliance purposes.
We all like your repurchase of the CDO debt from you or how does it offer to you? And at what level you bought it? And how much more you think the liabilities is?
We bought at $19.39 million on the dollar. So the way it was offered to us came on a bid list that we bought in competition and another one, the buyer came back to us directly to purchase at renegotiated price. You know, there is more opportunity out there to do these types of acquisition but you know we are going to look out on a case by case basis.
What level of cost did you get and what level would you interested in?
I am sorry, what is the question?
At what level you would have buy them in terms of the credit level?
Oh, I am sorry, it was singly rated.
And how down would you go?
We would go depending on price, we would go down, its all of function of price.
Got it. Okay thank you.
Our next question comes from the line of Matthew Howlett with Fox Pitt Kelton.
Thanks for taking my question. If you could just give us an update on what the CDO triggers are, specifically the par value test. Would it a table a Q like you had in the K in terms its par value test is you know, you had little bit mega ratings migrating on the corporate I know there was some operating migration on the CMBS side. But first, what is – where do they stand today and sort of what’s the outlook if things continue to get downgraded the second half of the year?
Actually we will have the same table on our Q which will filed this afternoon and we are passing all triggers. Ken to you?
Yeah, the outlook is we actually feel very good about our triggers there because the ratings on your portfolios are investment grade in general. Really what you have issues for OC triggers is if you get downgraded below triple-C. So we don't anticipate any of those securities being downgraded below triple-C, so we don't anticipate any OC issues
When you say any of those securities, you mean CMBS? Because some of the subprime is below triple-C?
No, I know, but any other securities.
Okay. Great, thanks. And then Wes, maybe you can answer this one for me. With the securitization markets shut down this year, your CDO market looks like it's not going to come back this year and expectations are for the subprime markets, securitization markets to be on hold. Does Newcastle need to reinvent itself going forward? I mean, this is going to be a different business model down the road? Or is there going to be sort of -- is it going to start transforming to this distressed CMBS buyer of assets funded a different way?
Well, I think certainly the capital structure is going to be different for the foreseeable future. I don't think the securitization markets are dead by any means for a whole array of different asset classes; but neither do I think they are in any danger of reopening for financings of the type and the levels we have been able to get them done in the past. So, really the financings are not what really drives the bus, though. Really what we're focused on are the types of investments we can make. As I said, this is a target-rich environment. There is a lot of things that are out there. Risk-adjusted spreads in our view on debt assets, broadly speaking, are about as attractive today as they have ever been. You know, I would say the gap between the perception in the market of the risks of many instruments and actual risks are kind of the exact opposite of where they were at this time last year. So we think there is going to be lots of interesting things to do. The first thing we had to do is make sure that the Company's finances and liquidity were in good shape and it’s been a lot of hard work to get us to where we are, but we feel great about that. The alternative -- to not be in great shape -- we know lots of those stories from the first quarter, so we don't need to repeat that, and we were never really in danger of being that impaired. But in these kinds of turbulent markets, you want to be in a good position to be offensive, and we are in a good place to do so.
Would you be willing -- so are you looking to buy things sort of unlevered now? I know returns are great in the subordinate market. Or is there some way you could create some type of term financing outside the CDO market to lever some of this stuff up?
Yes, I think it is probably a combination of those two. As you know, exactly as you said, when the financing markets dry up the yield -- the difference between unleveraged returns and leveraged returns tends to converge and that might not be great for asset prices, but it's good for buying opportunities, and that is exactly what has been happening. Also, you might find situations that sellers are willing to provide term financing. It is just that the key is really to not put yourself in a place where you have a bunch of assets that you are long and a bunch of financing that is short term that is callable in nature. That is obviously what we are very, very focused on. We didn't have a lot of that proportionally when we started this whole credit retrenchment. We have an awful lot less of it now, so we are in a good place.
Great, thanks a lot.
Your next question comes from the line of Jeremy Banker with Citi.
Hi, how are you doing? I was wondering if you could give your general overall outlook on the residential market. Do you think that we might be nearing a bottom here?
You know, I think this is something we spent a lot of time with at Fortress and in many different parts of the firm. We have a lot of exposure to the residential markets, and I do think it is an extremely attractive part of the debt markets. You know, for what is a fairly simple asset, just a residential mortgage; the market has created very complex capital structures to stuff them into. So it takes a lot of work to sort through and figure out which ones you like more and which ones you really like less. But I think that there is a lot of value in that market. You know, we do have a service that we own in one of the private equity funds – or two of the private equity funds, actually. It certainly seems to us that the pace of delinquencies, the pace of some of the market downturns has abated in recent months, and I think it is still way too early to call the bottom of a market. But it seems like it may be more getting more regionalized, which I think is a -- would be a healthy step if in fact that is what is happening. So I think that the credit problems are going to take some time to work out; but as Kenny said, it is really about the prices that you can acquire these assets at, and what the risk-adjusted returns are as a result. And the bottom we do feel like its attractive.
Ladies and gentlemen we have reached the end of the allotted time for questions and answers. Are they any additional remarks?
Well thank everyone for joining us and we will talk to you next quarter. Thanks everyone.
Ladies and gentlemen this does conclude the Newcastle's first quarter 2008 earnings call. You may now disconnect.