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Executives

Cameron McDougall – Company Representative

Ken Riis - CEO and President

Wes Edens – Chairman

Brian Sigman - CFO

Analysts

Douglas Harter – Credit Suisse

Joshua Barber - Stifel Nicolaus

Jasper Burch - Macquarie

Bose George - KBW

Jason Stewart - Compass Point

Newcastle Investment Corp (NCT) Q2 2012 Earnings Call August 9, 2012 8:00 AM ET

Operator

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 second quarter 2012 conference call. (Operator Instructions).

Mr. Cameron McDougall, you may now begin.

Cameron McDougall

Thanks, and good morning. I'd like to welcome you today, August 9th, 2012, to Newcastle's second quarter 2012 earnings conference call. Joining us today are Ken Riis, our CEO and President, Wes Edens, the Chairman of our Board of Directors, and Brian Sigman, our CFO.

Before I turn the call over to Wes, I'd like to point out certain statements made today may be forward-looking statements. Forward-looking statements are not statements of fact. Instead, these statements describe the company's current beliefs regarding events that by their nature are uncertain and outside the company's control. The company's actual results may differ materially from the estimates or expectations expressed in any forward-looking statements so you do not place undue reliance on any forward-looking statements.

I encourage you to review the disclaimers in our earnings release regarding forward-looking statements and expected returns. And 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 Wes.

Wes Edens

Great, thanks Cam. Welcome everyone.

I'm going to give you a few kind of general remarks. And then we'll jump into it.

The quarter that was recently concluded was in many respects the busiest and most productive quarter the company has had in many, many years. Lots of investment activity, lots of new and interesting things that are going on in the sectors that we are closely involved in with the mortgage servicing rights. And also the non-agency residential securities market had very busy and active periods and a lot of activity to report there. We made new investments in a sector that we think has a lot of promise, the senior housing sector. And our core real estate debt business also had a very good quarter. So all and all, a good and productive period of time for us.

Just to start with financial results, the numbers that we look at, core earnings for the quarter, $39 million or $0.29 per share. Cash available for distribution, which is our measure of availability to pay sustainable and growing dividends, $22 million, which is about $0.16 a share. And the common dividend we paid was $0.20 a share.

Results for the quarter were definitely hampered to the extent that we had committed capital on transactions that did not get invested during the quarter. On balance for the quarter, we had $240 million on un-invested capital. All of that capital subsequent to the quarter and by the end of the quarter, was fully invested. The impact of our earnings was about $.07 per share. So in general terms, if you could take the earnings numbers that we had and just add $.06 to $.07 to get the impact of a full quarter of activity, it will give you a truer sense of the run rates. So third quarter results based upon that are off to a very strong start.

For the quarter, we invested $283 million in cash to purchase excess MSRs non-agency RMBS. And then subsequent to quarter, we made our first investment in the senior housing sector.

So investment activity, $220 million of the $283 that we invested was in excess mortgage servicing rights. Four different pools predominately the pools that we had agreed to purchase earlier in the year from Aurora. Aurora was the servicing operation of the bankrupt Lehman Brothers estate we committed to back in February. We had anticipated originally that transaction closing in May. It ended up closing close to the end of June. That was the big chunk of the un-invested capital. We expect the rate of return on this portfolio to be mid-teens, specifically 17.5%. We expect total cash flows from the portfolio to be about two times what we paid for it, $445 million and average life over the next six years.

In addition to the mortgage servicing rights, we invested $64 million in non-agency RMBS. Greg Sukenik is the portfolio manager for the RMBS portfolios. So I will have him go through what we're up there in a second. But this is a scenario that we think has a lot of promise.

In May of the quarter, we committed to invest up to $450 million with an expected amount between $150 and $300 million to buy a 65% interest in the excess MSRs from the ResCap transaction. ResCap is the mortgage servicing operation. It's a subsidiary of Allied Bank. It filed for bankruptcy on May 13th. Nationstar was named the stocking horse bidder. I know there will be a lot of questions about that, so I'll hold any further comments on that. But the net of it is that after a little bit of back and forth, we ended being confirmed as the stocking horse for that transaction. That auction is scheduled to take place in October. I think right now October 19th is the date folks have to be certified as bidders. And October 23rd is the expected bid date. So there is a lot of activity going on behind the scenes in that between ourselves and Nationstar as well. But I'll talk about that a little bit later.

Subsequent to the end of the quarter, we invested an additional $82 million with cash. $64 million of that was to purchase eight senior housing assets that we financed with $88 million in non-recourse debt. I'll talk about our senior housing exposure in a second. But it's something we are very, very bullish on.

$18 million to purchase $29 million of RMBS. So I'll have Greg talk about that in a second.

Our business lines today are very clearly being defined into two significant components, one being the residential business, which is residential servicing and the residential securities and related assets. The second being the legacy business of the real estate debt and other assets. We're excited to be adding to that business through the purchase of our senior housing business. But I'll let Kenny talk about that in just a second.

Page five in our supplement, the excess MSR, this is disclosure that we filed last night. And we'll update it with July numbers here shortly. But the performance of the servicing portfolio continues to be very strong. Pool One, the first investment we made, the pool was just under $10 billion in mortgage servicing. It had another very strong month. The prepayment fees of that portfolio is well below what our forecast was. The recapture rate, which is the way we kind of see the prepayment exposure continues to increase. So from the first day when we owned this portfolio, our recapture rate on loans that were refinanced was zero. Last month, it is now up to 40%. So we averaged the last three months is 36% of the loans that have refinanced, we have recaptured. Since conception, it's 28%, so that's a very strong performance on the part of Nationstar and really good news for us.

The rest of the portfolio is really too early to see any real significant trends except to say that the prepayment speeds in the first month were all materially below what our forecasts were when we made it.

So with that, let me turn it over the call to Greg and have him walk through the non-agency portfolio. Greg.

Greg Sukenik

Thanks, Wes.

When we began investing in residential mortgage back in April, to date, we've purchased $192 million of face and average price of about $.66 to the $1. We've been targeting what we believe are under-valued securities that are serviced by Nationstar. We believe Nationstar's actions can help improve the performance of these securities. Some of the securities have been with Nationstar for a while. Some have been recently acquired for the Aurora transaction.

We believe these securities produce a return, yields rather in the high single digits. And with a relatively low degree of leverage can produce levered returns in the mid to high teens. These return projections are more or less based on sort of status quo performance. Any material improvements in the housing market or the mortgage market are in general contribute to have a significant impact on improving the performance of these securities. We think this market remains under-valued. And represents a number of good investment opportunities.

Ken Riis

Sure, I'm going to talk about the real estate debt business. We have about $3.9 billion face amount in securities on our balance sheet financed with $2.9 billion of debt. So the way we think about it is we have about $1 billion of face amount of direct holdings on our balance sheet at Newcastle.

The portfolio has performed very well this quarter. This segment generated $35 million of total cash flow in the quarter, the same as the first quarter, so very stable results.

In the quarter, we purchased $97 million of assets in CMBS and ABS securities at an average price of 92% of par. And an average unleveraged yield of 8%. So very productive there in purchasing and investing the restricted cash in our CDOs.

As of July, the reinvestment period for CDO 10 expired. But prior to that, we invested all cash that was unrestricted or restricted cash in the CDO. So we're fully invested prior to the end of the reinvestment period. And looking forward to continue to generate stable cash flows from really all three of our CDOs that are generating cash flow to us.

The other thing I want to highlight as it relates to those three CDOs, in the quarter, the over-collateralization of those deals increased materially to $307 million. So since we talked last time in our disclosure, from April to July, the over-collateralization increased $74 million. So what that means is we're well positioned going forward with these portfolios. And will continue to generate good cash flows to us to pay our dividends from this core portfolio.

With that, I'll hand it over to Brian. Oh, yes, do you want to talk about senior living?

Wes Edens

Yes, let me talk about that before Brian goes. So by way of background, when you think of the businesses that we are invested in right now, the residential business, which is a lot of activity that really kind of caught fire about this time last year, just to put it all in context, the market in the U.S. appears to us by virtue of every measure to certainly has stopped going down in many cases to a bottom drawer. It's actually doing modestly better.

The size of the residential market is about $17 trillion. There's about $10 trillion in debt and related servicing rights that exist. And so when we look at the business as we try and identify significant areas of focus and investment activity, in mortgage servicing is the first element of that that we made our investments in.

Historically, that was the business that was dominated by the banks. They made mortgages. They sold mortgages and kept the servicing rights. So roughly 90% of all mortgage servicing in the U.S. was with the banking system dominated by the top five that collectively had more than 50% of the marketplace. The clear and obvious trim line there is that the banks are sellers and are discontinuing their activity to a significant extent in the business. And that's resulted in a lot of the portfolio transactions that you've seen, a number of which we've been a participant here in the last number of months.

In addition to the sales and the portfolio sales and servicing, I think that the next thing that you will see from us is likely to be flow arrangements. There's a number of different situations that we're looking at right now. I think that Nationstar will speak to some of their activities here on their earnings call in the next few days. But I think that just the term structure of the servicing business in the U.S. is one where it's going from the regulated banking environment to the non-bank, non-regulated financial services companies. And we think that the architecture of the relationship between the ownership of the asset, which is primarily Newcastle as well as the servicing and ownership in part of it with Nationstar is the right architecture. And we think it's the right way for us to approach the business. And we're very happy with how it has transpired over the last year or so.

The next lay of that really is the non-agency market itself. With the closing of the Aurora transaction, Nationstar now is the master servicer on approximately $117 billion in securities. That's just over 10% of the overall market. Pro forma the ResCap transaction, that would go to north of 20% of the market. So it's a significant amount of the market that exists.

Why that's relevant is that we think that investing in securities where we've got a partner that we are confident in their abilities and confident in the results they can achieve is the right thing. So Greg who is a very, very experienced investor in the securities market in general has really taken the lead of us to develop a portfolio that we think will deliver terrific results for the company. And so you'll see the, if you look at the exposure, you'll see first, the first supplement that lays that out, I'll think hopefully you'll see a lot of activity from us in the coming months and quarters. And it will reflect positively to the results.

On the commercial side, we've got $3.9 billion in assets, $2.9 billion in debt. There has been lots of investment activity over the last number of years. The company has been productive. Ken has done a great job in identifying situations to buy back our debt when we thought it was under-valued and also make good investments. Those two things together have produced a lot of good results for us. We bought back about $1 billion of our debt at a substantial discount. That's been a good source of investment activity. We've also been on the lookout for what we think are other long term investment opportunities that are similar in nature to the MSR opportunity. Situations that we think that there's long secular trends that we can be a participant in and generate good results.

As a firm, Fortress has been invested in the senior housing business since 1999. So we've been in the business, or 1999, 2009, 2001, so we've been an investor in the business for over a decade. We've got a handful of large investments.

One of the things that's interesting about the sector is that you had tremendous growth in the healthcare industry over the past ten years. As they've gotten bigger and bigger, a section of the market that we think is very under-appreciated are some of the smaller transactions. In particular, the ones that are serviced by people that are as we think of as kind of mom and pop operators. About 75% of the senior housing in the U.S. is operated by people who operate 15 or fewer properties. So with that, there's a great opportunity to buy assets that are under managed, leverage them modestly, and generate good returns.

On the supplement, we lay out the details of the first portfolio that we bought. Total assets of $151 million with $88 million in non-recourse debt at a cost of 3.45%. Equity is $63 million. It's about a 7% unleveraged yield in the portfolio. So it's a leverage in place that generates an immediate cash-on-cash return of about 11%. And we think through just growth and occupancy and an increase in rates to market levels, we can increase that 11% to high teens, low 20's over the course of the next couple years. So given the dynamics of the business, we think that's just a terrific opportunity. So it's one example of what we think are some good opportunities in the sector and hope you will see more activity from us in the coming months.

So with that, let me turn it over to Brian.

Brian Sigman

Thanks, Wes.

In the quarter, we had GAAP income of $.21 per share. This included core earnings of $.29. We generated $21 million of cash available for distribution or CAD in the quarter, an increase of 10% over Q1. And in June, we declared a second quarter dividend of $.20 per share of $29 million.

Our financial results were affected by having $240 million of average un-invested capital in the quarter. This capital was primarily invested in June with the closing of the two MSR deals in which we invested $220 million.

In the quarter, the two deals did not contribute any CAD and only one month of earnings. And in Q3, we'll see the full effects of these investments in addition to the effects of investing the range of the capital in early July.

As Wes described, we have been breaking out our results by our two business lines. This quarter, we continued to see growth in the residential servicing and securities business. And while it only generated 20% of our total cash flow, we expect it to grow to approximately 45% with a full quarter of our recent investments. And even further as we deploy the capital from our recent rates.

We currently have $173 million of unrestricted cash and are seeing a lot of opportunity to invest the capital. In early July, we entered into a financing of $59 million in our non-agency RMBS portfolio for an overall portfolio leverage of 48%. This modest amounts of leverage brings our levered returns to the mid-teens. And allows us to increase our leverage if we need the capital.

Lastly, we are pleased to have a new research analyst from Credit Suisse to pick up the coverage in July. We now have six research analysts that are covering NCT. And combined with our posted supplemental information, investors can access some great information to learn more about the company. The contact information for all our research analysts can be found on the website under the investor relations section.

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

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from the line of Douglas Harter with Credit Suisse.

Douglas Harter – Credit Suisse

I was hoping you could give us some thoughts about the timing of the deployment of that 170 million of cash and maybe what areas are looking the most opportune right now.

Wes Edens

The timing of the deployment, we expect to be primarily in the quarter. So the – our estimate of the dilution of having that cash on hand is substantially less than it was last quarter. I think our guess is really a penny or so a share is kind of the net of this. So we’ve already started making some investments with the capital and I’m, you know, confident that we’re going to actually have a quarter of investing as well.

The two areas that we’re focused on with that case in particular are the continued purchase of MSRs, there’s a robust pipeline of transactions in addition to the bigger ones which I’ve highlighted as well as continued building on the non-agency RMBS portfolio as well as some other smaller portfolios on the senior house side. So kind of across the board there’s a fair array of investments that we’re looking at right now.

Douglas Harter – Credit Suisse

Great. And then on the MSR pools, can you talk about, you know, the MSRs obviously are – I’m sorry, the CPRs are significantly below your expectations. Is that a function of that sort of still being on a ramp phase or is that just, you know, that they’re performing better? Is there any sort of time related – anything time related with that?

Wes Edens

No, I think that our expectation is that the government’s latest attempt to encourage refinancing activity is likely to be successful, or more successful than a number of the programs in the past. So in anticipation of the – the views, I think are appropriate conservative numbers with respect to prepayments. Those prepayments have not yet manifested themselves. It’s not so much of a ramp period because the actual mortgages underline these are quite seasoned, on average, you’re talking loans that are 5, 6, 7 years old. So there are loans that had many, many opportunities to refinance. I think the primary reason they have not is some form of credit impairment, either their loan to value is too high or they’ve had credit problems, or maybe a combination of both of them has kept people out of the refinancing market. So the government’s made a whole series of attempts with HARP, HAMP, you know, et cetera, et cetera to try to be more successful in helping those people refinance. And we do think at some point they’re going to have some impact on it. So I think you’ll see some higher repayment fees. That’s why the additional element of recapturing becomes so important. You know, when you’re recapturing four of every ten loans that’s refinancing, not only are you increasing the base returns of those investments by 7 or 8 or 900 basis points, which is significant, but you’re also mitigating to a very significant extent the real tail risk of something really dramatically happening as interest rates goes a lot higher.

So we just had the one portfolio that we had a lot of experience. We tried very hard to make this as transparent and clear to investors as possible and hopefully you got it. I think that that’s the case. You’ll now see the one month of the investments that we made in June and soon you’ll have two months, so we’ll double the amount of exposure on that side. But I’m optimistic that our projects will prove to be conservative. You’ll see them play out month by month.

Douglas Harter – Credit Suisse

Great. Thank you, Wes.

Wes Edens

You bet.

Operator

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

Joshua Barber - Stifel Nicolaus

Good morning. I’m wondering if you guys could talk a little bit more about – maybe not – maybe file drift is the wrong word, but your investments I guess have been in some new platforms over the last couple of quarters. Can you talk a little bit more about potential new areas and places that you might be going, or do you think the portfolio today pretty much stays with the CDOs, the senior living facilities and MSRs and the RMBS?

Wes Edens

Well, the residential business, I think it’s appropriate to take a bit of context and look at the broad spectrum of things that could be available on it. That’s why, you know, we’ve got, obviously, a huge amount of infrastructure on this as a firm between our investments in Nationstar and the emphasis on Newcastle and other parts of the firm. So we see a lot of different things and I think I’m very happy with the results of the – of the MSRs we’ve invested in and I think that given Nationstar’s non-agency servicing portfolio, master servicing portfolio, it’s the appropriate time to look at the non-agency market as well because I think what we’re looking to do is make investments in things where we can incrementally influence returns, either individually or collectively as opposed to making just truly passive investments. I think when you look at the three types of investments we’ve made over the last year, the MSR investments obviously we think we’re buying in at good prices, but then the recapture element of it I think is a significant enhancement to the return profile.

The non-agency securities we’re focused on are securities where, you know, we feel like we’ve got, you know, a very good partner and something we have great confidence in in terms of their ability to influence the results of those – the performance of securities. That’s why we focus on things at Nationstar. And I think you’ll – there’s lots of interesting things that could come out of that that as they start to play out, I think we’ll have some interesting things to talk about there.

On the senior housing side, not only are we going to make investments in assets that we think are good, but we’re actually the manager of those. We actually bought the manager and management [inaudible]. So the theme of looking for investments that we think offer excellent risk adjusted returns, where we can also be active managers and try to drive additional results, that’s the theme that I think you’ll see that we’re very focused on.

So on the commercial side, you know, we have, as Ken said, you know, you’ve got $3.9 billion in assets, we see lots and lots of different elements of the commercial real estate business that exists. The one that we have been focused on for the past year in particular has been senior housing and I’ very happy that’s the first portfolio that we bought. We certainly will look for other asset classes within that sector that we think are interesting. There’s no in particular that are notable for us to talk about right now, but I think that we’re in the investment business and our job is to generate good returns and so we’re definitely focused on the next opportunity.

But I think – this is a long answer to a very short question, but I think that that the net of it is we look at the three sectors, if they were, that we’re invested in right now, they all have the hallmark of being very, very substantial and large sectors so we can be very, very specific and very targeted in our investments and still see lots of good opportunities.

Joshua Barber - Stifel Nicolaus

Okay. That’s helpful. When you think about financing those portfolios, especially, you know, just given the amount of deal flow that you’re seeing today, is your posture changing, you know, going forward, especially given the cash reg, could you rather time offerings or deals to culture match fund deals or prefund them? How are you guys thinking about that today?

Wes Edens

You know, that’s a good question and it’s a constant challenge on our part because on the one hadn you need to have the capital on hand to make the investments. On the other hand you can see in the quarter, having $240 million sitting in cash sitting around earns basically zero while you’re waiting for committed investments to fund is a drag on earnings. That is the unity hang of it.

In the case of the MSRs, we think that the returns are substantial enough that they don’t need financing to generation additional returns, so we own them on an unleveraged basis. On the RMBS side, the amount of leverage that we use has been modest. I think the average leverage this far is roughly 50% right now so far, Greg, and I think that the peak leverage for that would be kind of two to one, so call 55% leverage.

On the senior housing side, obviously when you make the investments, you commit financing on it at the time of the investment. You know, 3.45% non-recourse, interest only, seven-year debt is very, very good debt and it enhances returns and so that’s what we did.

Now, I think, you know, one thing that does give me a lot of comfort in terms of managing the balance sheet though is that with a large amount of unleveraged assets, in particular, the MSRs where we could leverage them if we needed to, that gives us more flexibility to commit to larger transactions like ResCap and know that we can cover that commitment in the event that the markets weren’t good markets for us to raise equity and what not. But I think that the financing part of the profile of this is something that as we described is exactly how we think it’s going to play out. So unleveraged on the MSR side, modest leverage on the non-agency RMBS and committed term financing on the housing side.

Joshua Barber - Stifel Nicolaus

Okay. When you’re looking at the MSR investing landscape today, I mean, it looks like the excess fees have actually gone down fairly sharply and I get that some of that is, you know, different between private label versus GSE, but even on the GSE side, it seemed to have gone down pretty sharply over the last 8, 9 months. What are pricing trends there today and is that market just gotten a lot more competitive in the last year than it was?

Wes Edens

Yeah, actually, I don’t think that the [inaudible] has gone down too much. They tend to very idiosyncratic and are specifically related to the quality of the portfolio. In particular, if you see a portfolio that’s got a lot of delinquencies, you’re going to have higher base fees because it’s more expensive to service those portfolios. So I wouldn’t necessarily draw that the base fees have moved that much.

You know, on the market for the MSRs, when we started making these investments a year ago, I don’t think it was the mainstream investment. It was not really talked about broadly by any other folks and I think that that has changed a lot. You know, we did a capital raise last September and I want around and spoke to a lot of investors about it and I started to say that [inaudible] MSR. It’s not an asset class that was in their stream of conscious and they just didn’t focus on it. That has changed dramatically, you see a number of other folks that either have made the investments or are talking about it and there’s a lot of interest, I think, in investing in it and I think that that interest is well founded, the mid-teens and mid-20s on average returns in the zero interest rate environment are obviously very, very attractive investments.

That said, to successfully execute the strategy is not that easy. You need to have a great servicer partner that is not only a servicer in my view, but obviously an originator as well, that’s a significant element to the strategy. They also have to be very well capitalized because you want them to be a big holder of the asset alongside of you. And so those are – there’s a handful of people that fit that classification but it’s not dozens of people. So – and I think that you know, on balance, you have a – you still have a buyer’s market of investment opportunities and there’s a lot of big things that are out there and so while I think there’s clearly going to be more competition and frankly the disclosure that we provide to investors and analysts also we provide to competitors and so there’s probably a plus and a minus to that, on balance we think it’s obviously the right decision to be very forthcoming about the information, but with that, I think that we’re certainly going to do our share.

Joshua Barber - Stifel Nicolaus

Okay. I have one last maintenance question. I’m sorry. On the – when you talk about the recapture rate, is that number of loans that repay or is that percentage of UPB?

Wes Edens

Percentage of UPB.

Joshua Barber - Stifel Nicolaus

Great. Thank you very much.

Operator

Your next question comes from the line of Jasper Burch – Macquarie.

Jasper Burch – Macquarie

Good morning, gentlemen and thank you for taking my question. I guess just starting out with, on your asset allocation, if you could reshuffle your portfolio. Now I know that you’re putting money where there’s the opportunities. But what would you ideal asset allocation be, and is that something that the diversification of the portfolio – I mean, is that something that you’re actively focusing on?

Ken Riis

We are, we focused on diversifications of investments. I think that the balance of the portfolio right now where we’ve got a substantial amount of capital invested in MSRs, and we have an increased amount of capital invested in the non-agency RBF, so I think that those two investments are good compliments to each other. And I say that, you know, the investment in MSRs tend to be fairly episodic, transactions happen when they happen, and it’s hard to predict the timing of them, and they can be lumpy. The balance of the RMBs is that there’s lots of smaller opportunities, so there’s many different transactions. Just lock the door so in case it should happen there. So, those two things together forming the kind of the base or our investment active on the residential side we think is a good mix. And I think what that balance is over time will be somewhat of function what the opportunities that is.

On the commercial side, we got the legacy of CDO business that, again I think these guys have done a terrific job in managing the opportunities that have come up there to buyback and kind of harvest the existing investments. We have been looking for, and continue to look for incremental investment and activity on that side, that’s a big part of our business. And so, the senior housing part of it is a new investment for us, what the size and dimension of that part of the portfolio will be, is again going to be somewhat a function of what the opportunities that avails themselves are.

So, there’s not, unfortunately a programatic or charismatic calculation I can give you about portfolio composition, other than say, a handful of big robust sectors where we have lots of investment opportunities, those are the things that yield good risk adjusted returns, and that’s where our focus is.

Jasper Burch – Macquarie

Okay, and then on – I mean, you guys have been growing a lot, and obviously you have no solid pipeline. Can you just talk a little bit about financing that gross? I mean, you mentioned the potential “take no leverage” on the MSRs, I mean is that something that you expect to do to continue to finance growth there, or what other avenues, you know, are you looking at. And do you think they’re most likely?

Ken Riis

We don’t intend to finance the MSRs, I think it’s a good example of how do the balance sheet flexibility allows us to manage our capital and growth appropriately. But it’s more of a safeguard then it is a primary financing activity. So, no we don’t anticipate financing it, but it’s good to have a lot of unleveraged investments, so if you need to finance it to provide capital for some incremental transaction you’ve got it.

Jasper Burch – Macquarie

So, essentially you continue financing through measure capital raises?

Ken Riis

That’s right. Okay, that’s helpful. And then I guess just lastly, just a little bit of accounting on the MSRs. I mean, we saw higher CPRs across the agency markets in August. Can you give me a little collar on – will that impact the accrual on those, or is it really based on long term expectations and sort of month-to-month correlated quarter changes in prepayment rates aren’t as impactful?

Brian Sigman

It’s a long term view, and we’re accruing to the yield that we’re expectin, but we do update them every month based on how the markets are performing, and as Wes mentioned on our Pools, they’ve actually been prepaying a lot slower than we thought, and we’ve been recapturing higher. That’s actually led to an increased yield and an increased mark on the first Pool.

Jasper Burch – Macquarie

But when it prepays slower than you expected, is that incremental sort of earnings? How does that come through that, it just comes through a sort of a higher yield in that quarter?

Brian Sigman

Yes it does. It comes through prospectively at a higher yield.

Jasper Burch – Macquarie

Okay, that makes sense, all right, thank you.

Brian Sigman

To date, actually on the first Pool we expected it to return, I think about 19-20%, and we’ve actually booked 23-24% on that Pool.

Jasper Burch – Macquarie

Okay, that’s useful. Thank you guys, nice job in the quarter.

Operator

Your next question comes from the line of Bose George – KBW.

Bose George – KBW

Good morning. Actually I had a follow-up question on the MSR. You guys had a positive mark on the MSR in the quarter, and I was wondering, 1) Is that part of “core” earning, and does that affect the yield going forward. I mean, the fact that there was a positive mark?

Ken Riis

Yes, it was on the first portfolio as we’ve been saying it’s just performed so well. So we marked it up by $3.5 million. It does not go to “core” earnings. We view it as kind of evaluation change like our other non-cash market-to-market changes. But it does reflect the performance of the Pool, and it shows how we’ve been booking a higher yield on that Pool, since we’ve purchased it.

Bose George – KBW

Okay. And just in terms of the runoff of the MSR, the amortization does that when you booked the interest income, is that part of the accrual? Is that how that runs off?

Brian Sigman

Yes it is. When the capital comes in, we allocate a portion to CAD and that’s really what we look to pay our dividend out. The other portion is a return of capital that we look to reinvest in other assets.

Bose George – KBW

Okay great. And then switching over to ResCap, I was curious, are there any other milestones, you know, before the auction or just do we wait till the auction and just see who wins it at that point? Just curious like how that’s going play out.

Ken Riis

Yes, there’s really no significant milestones. The company filed bankruptcy in May, the hearing was in June. That is typically a fairly low key event. In this case it ended up being a little bit more drama, as another bidder that was attempting to become a stocking horse showed up. And so, again the just back and forth. The Nation Star, Newcastle bid was the one that was awarded the stocking horse position. The perspective bidders for that, in addition to Nation Star are in the process of doing due diligence, and in the process of getting vetted by the agency, (inaudible) and I don’t have any collar on that process at all, on the activity that’s going on there. It’s a lot of work to become a qualified bidder, so there’s certainly (inaudible) part of my summer vacation I suspect. We too both at Newcastle and Nation Star are working hard on an incremental plots about the portfolio, because we’re trying to be prepared for, you know, to put the best number on the table if that’s necessary, because we fully intend to be the winner in October. But the next specific milestone that you are going to see will be on October 19th when they announce who are the qualified bidders. And then the auction is scheduled to begin on the 23rd of October and be concluded no later than the 26th, so it will be an interesting end of October for sure.

Bose George – KBW

Yes that would be. Then on the pipeline, can you just comment on the pipeline, you know, excluding ResCap?

Ken Riis

You know it’s a combination of two types of investments. There’s a lot of activity on the flow bases. This is something I think will become part of the architecture of mortgage origination servicing on a go forward basis. I think you’ve seen the number of large corespondents in the sector go down dramatically. You know, the one that has been most prominently active is Wells Fargo, so I don’t know what their second quarter numbers were. In the first quarter they made something like one out of every three mortgages in the U.S. So they’ve taken an extremely aggressive, and I think productive chunk of their market, but there’s a huge market out there for the origination side. We think that you’re going see a lot of flow-based transactions, and I think the Nations Star guys will talk about that next week.

In addition to that though, there are a number of large portfolios. ResCap is obviously one of the most prominent, but there are literally thousands of prospective transactions, and hard to predict the outcome on any one of them. Other than I would say that when you see that much activity in the pipeline, it’s quite likely you’re going to get some of it to flow through the bottom lines. So, it’s a competitive landscape, but it’s very much of a buyers’ market still at this point.

Bose George – KBW

Okay, great. And then one last one. Can you just discuss your plans, you’d mentioned when you did the capital raise about potentially splitting the company? Is it too early to go into any specifics there?

Ken Riis

Yes, it’s something that we have talked about with folks really for some time. As the businesses have become clearly defined in the past year, and there’s a very robust residential business, which I think we’re very happy with the results thus far, and we think the prospects they’ll continue to grow that business (inaudible) are great.

And the Legacy Commercial business, not just the CDO business, but now the senior housing, we think there’s a lot of opportunities that. I think in the long run if both of those businesses continue to grow and are robust, it will make a lot of sense to continue to consider that. The gaining factor from my personal perspective is, I don’t want to split a company that is now getting some scale, getting some (inaudible) in the stock, into two small companies. So, I think the company needs to be a little bit bigger to try to get to the right place in both those sides. So, the time to do it in my opinion is not now. But as we continue to grow the company and continue to have good results in the investment side, I think it becomes a more reasonable likelihood, so.

Bose George – KBW

Okay, thanks a lot.

Operator

(Operator Instructions). Your next question comes from the line of Jason Stewart with Compass Point.

Jason Stewart - Compass Point

Hi, good morning. Brian, you started to touch on this, the CAD number and the dividend. I’m just wondering if you could provide a little bit more color on what primary metrics you’re looking at when you evaluate the dividend?

Brian Sigman

We take into account CAD and we also definitely look at core and core earnings was $0.29 and our dividend was 65% roughly of that. The CAD is a great way for us to really look at what cash we’re generating on a quarterly basis, but here with the board, we definitely take into consideration both amounts when we try and set the event.

Jason Stewart - Compass Point

Okay, and on the non-agency portfolio, when you lay out the expected return, is that based on improvement and some of the fundamentals when Nationstar takes over as servicer or is that – are expectations on a go-forward basis? I mean, what – I guess my question is, what factors are you looking at and putting into those return expectations?

Brian Sigman

Base-case projects are more or less based on current performance currently, status quo type performance. We are hopeful and optimistic that, you know, especially if Nationstar takes over some of the award transactions, they could have a meaningful improvement to the [inaudible] security. And also, potentially, any improvements in the broader economy and [inaudible]. But our performance results are really based on kind of more of a status quo with what we believe is a significant upside.

Ken Riis

In particular, any material change in prepayment fees on the end of the line, securities, would have a profound impact on a lot of these security drives.

Brian Sigman

Increase in prepayment fees, they decline [inaudible] defaulting loans, either one of those would have a significant impact on these sort of discounted bonds. Any way you can further consolidate the cash flows, it will boost the return profile.

Jason Stewart - Compass Point

Okay, great. And then when I look at that, the capital that you have invested there, it’s obviously not at your leveraged target. When we factor that into your overall liquidity, understanding that the excess MSR investments are lump and do take some time to close, is there a cash number that you have in mind that you want to keep, either on balance sheet or available to take out of securities that’s specific or is it – is it more general as you’ve talked already on this call? I understand you’ve [inaudible]?

Ken Riis

It really is more general. We’ve got, you know, we try to be very disciplined in terms of raising capital and only raise it when we invested, you know, fully the capital we’ve got on balance sheet so that hopefully that we’re investing capital and doing these sort of returns, we’re doing [inaudible] and kind of growing the earnings of the company and growing the dividend of the company. So it’s obviously a balance and there’s not a precise science to it, but – and we just did raise some capital here recently, you know, Greg has been active in the MSR business and in the housing stuff we’re active. So there’s a number of things that we’re looking at and as that capital is invested, we’re earning, then we can look to consider additional equity offerings, but it’s – there’s not a catch on hand. The one thing we are mindful though is managing kind of future commitments in the [inaudible] of material, obviously, it’s ResCap, that’s where the ability to leverage up the portfolio of you needed to is something that’s meaningful and important to us.

Jason Stewart - Compass Point

Great. Very helpful. Thank you for taking the questions.

Operator

Thank you. That concludes our question-and-answer session for today. I would like to hand the program back over to Mr. Wes Edens.

Wes Edens

Great. Well, thank you very much for your time and your questions this morning and we look forward to seeing you folks soon.

Operator

That concludes our conference today. You may now disconnect.

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