Newcastle Investment Corp's CEO Discusses Q3 2012 Results - Earnings Call Transcript

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Newcastle Investment Corp (NCT) Q3 2012 Earnings Call October 25, 2012 8:00 AM ET


Sarah Waterson – IR

Wes Edens – Chairman

Ken Riis – CEO, President

Brian Sigman – CFO

Greg Finck – Portfolio Manager


Bose George – KBW

Douglas Harter – Credit Suisse

Jasper Burch – Macquarie

Joshua Barber – Stifel Nicolaus

Henry Coffee – Sterne Agee

Josh Bederman – Pyrrho Capital

John Evans – Edmons

David Haas – Moore Capital


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 Investment Corporation third quarter 2012 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)

It is now my pleasure to hand the program over to Ms. Sarah Waterson. Please go ahead.

Sarah Waterson

Thank you and good morning. I'd like to welcome you today, October 25, 2012, to Newcastle's third quarter 2012 earnings call. Joining us today are Wes Edens, Chairman of the Board of Directors; Ken Riis, our CEO and President; 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 estimates or expectations expressed in any forward-looking statements, so you should not place undue reliance on any forward-looking statements.

I encourage you to view the disclaimer in our earnings release regarding forward-looking statements and expected returns and 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

Thanks, Sarah, and welcome, everybody. I'll go through a few of the highlights both financially and transactionally and then turn it over to Ken to talk about some of the business.

The quarter that we just finished was an exceptional one for us. Obviously net income, $1.63, extraordinary. There was a collapse of one of our commercial loans (inaudible) securitizations that Ken will talk about that resulted in a very big (inaudible) event for us, generated a lot of cash flow, a lot of good investable assets.

Other core measures of the company also had a very good quarter, so core earnings $0.26, cash for distribution $0.21. We paid a common dividend that we increased to $0.22 for the quarter, so all very good financial metrics.

We still had a fair bit of dry powder on the balance sheet, so average uninvested cash $157 million, also a lot of unleveraged assets on the balance sheet, so the net of it was with the full investment of the capital on the balance sheet would have been another $0.04 or $0.05 for the quarter.

So even with a lot of dry powder we had a very good financial result for the quarter. So the transactional highlights, again, talked about the (CDL) that we collapsed. Ken will give some detail on that.

But we purchased $130 million (inaudible). We purchased eight securities and loans onto the balance sheet for $50 million and we expect a lot of profitability from them and then we deconsolidated and simplified the balance sheet. So this is something that we're very focused on.

We had five financial transactions in this sector on the balance sheet this time last quarter. We now have four and it is something that we are focused on continually to chip away at.

MSRs, the performance of the portfolio I'll get to in a few minutes but it had a very, very good quarter very much in line with our expectations, so our cash flow return of just a shade under 20%, so very good returns on the MSR book.

We made one new MSR commitment for the quarter, a $15 billion pool of Ginnie Mae servicing that we expect to close on in November. The LOI was executed back in September but it will show up in our financials this quarter. Lots and lots going on in that sector and I'll talk about that in a few minutes.

The non-agency RMBS book that Greg Finck will speak to had an active quarter brought $140 million in securities, again, very focused on securities that are serviced by (Nation Star) for a lot of good and obvious reasons but we'll talk about that in a second.

And then lastly, we mentioned this last quarter we made our first investment in the commercial part of our balance sheet in the senior housing sector, invested $65 million in equity. That investment has been off to a very good start, so (inaudible) that.

So with that, Ken, do you want to talk about the commercial business?

Ken Riis

Sure, thanks, Wes. Today, the commercial real estate debt business is really made up of our legacy portfolio. It's currently $2.8 billion face amount of assets financed with $1.9 billion face amount of primarily non-recourse debt.

As Wes mentioned, one of the big transactions in the quarter was collapsing CDO 10 and selling our interest to our senior note holder to generate a lot of cash flow for us.

If you think about this portfolio, one of the big things we've been doing over the last couple of years has been buying back a lot of the debt at material discounts and generating a lot of investment activity that way and profits for the company.

The collapse of CDO 10 was a big deal for us. In the quarter, we generated over $170 million of total cash flow, $130 million coming from the collapse of CDO 10 and $40 million coming from core interest and principle receipts.

If you look at our portfolio today, $2.8 million of assets with $1.9 billion of face amount of debt, that $900 million difference represents a total principle that Newcastle would recover over time if all the assets and liabilities paid at that part and we did nothing.

The collapse of CDO 10 sort of highlights incremental value that we can extract out of the portfolio by not being passive or being very active. Today, of the $925 million face amount of difference between our assets and liabilities, we expect to generate $700 million to $750 million of principle over time, again, if we did nothing.

But our plan isn't to do nothing. We will continue to look at buying back debt collapsing deals and generating material incremental cash flows for the company. As Wes mentioned, this transaction derisked the company because the proceeds that we received from the collapse of CDO 10 will be reinvested on an unlevered basis and potentially at higher returns, so really stabilizing our core operations.

Finally, we made a new investment in senior living properties. We invested $65 million in the quarter and the portfolio is starting out better than expected. It generated $1.6 million of cash flow, $400,000 more than we underwrote and our levered return for the quarter was roughly 12%. And as we move forward, we think we'll get to our projected levered return of over 20% in a year or so. So that portfolio is setting up very well.

Now I'll hand it back to Wes.

Wes Edens

Great, thanks. On the residential side of the ledger let's talk first about the equity and then (inaudible). Obviously, lots of activity in the space. There was a notable auction in there yesterday of the ResCap asset that had we decided to pay or buy those assets, we would have been (inaudible) here at Newcastle. It's something that we did not end up doing.

But away from that there is a tremendous pipeline of MSR and MSR-related activities. I think you're going to see a lot of investable capital coming on this side of the balance sheet for us.

In the supplement we lay out each of the pools that we have invested thus far. There are five. There are soon to be six with this latest transaction, which I mentioned, all performing very well.

If you look at the supplement, you see that IRR since its inception has been run down the list of 24%, 18%, 19%, 20%, 17%. The weighted average of all of this is just a shade under 20%, so very consistent across the board.

So we capture rates – and speaking on the pools that have been on the books for some time, we've got enough time to get our recapture mechanics in place have been also affected, so the other pools, 34%, 35% doing very well.

So the $262 million in capital we invested thus far generating 19% plus returns and we do this by (put) a lot of capital to work on this. It's very much a process of finding things that we want to invest in both on the balance sheet here as well as good situations for Nationstar.

I'm optimistic that there will be a lot of activity here as we go into the fourth quarter at year-end. So we do have a lot of draw power. There's $157 million of capital on balance sheet.

It really understates it a bit because we do have a lot of the investments that could generate a little bit more capital for the (inaudible). And so it's a very good situation for us. (Inaudible), Greg?

Greg Finck

Thanks, Wes. As Wes mentioned earlier, we purchased $140 million current base in non-agency RMBS this quarter, an average price of 57% of (inaudible), investing approximately $80 million.

We received $8.6 million of principle interest cash flow during the quarter. We closed the quarter with an RMBS portfolio totaling $390 million current base and approximately $200 million market value.

We have roughly $60 million debt against the portfolio for a net investment of roughly $140 million. The slight (depreciation) in cash flow is received. Our RMBS investments returned over 8% during the quarter.

We expect these RMBS investments to generate 6% to 8% annualized returns on unlevered basis which shows (within) a 15% to 20% returns on a levered basis.

We have primarily invested in current base, subprime and Alt-A RMBS service by Nationstar. We believe Nationstar has been very effective at carrying delinquent loans, thus reducing the (inaudible).

We also believe they have proven their effectiveness at accelerating principle cash flows. Additionally, just as we collapsed the CDO during the quarter, we also think some RMBS (inaudible) may be collapsible as well. We intend to work with Nationstar to explore the RMBS collapse option.

Nationstar owns call rights on over $100 billion RMBS transactions and I think this could be a very good opportunity going into the fourth quarter of next year.

RMBS prices (rise) significantly in the quarter. We remain positive on current valuations given the fundamental improvements in the (inaudible) and (inaudible) markets. Home prices appear to have hit bottom during the first quarter and have increased each in the last six months and up roughly 8% from the lows.

Additionally, the (shallow) inventory of delinquent loans has been shrinking as related new delinquencies ebb and flows (inaudible) the past couple years. At current valuations, we believe now you can see RMBS still offer an attractive value and (make it further offset).

Brian Sigman

Thanks, Greg. Now I'll go through the financial results for the quarter. In the quarter we had GAAP income of $1.63 per share. This included core earnings of $0.26 and the remainder is primarily out gain on sales from the CDO collapse.

We generated $35 million of cash available for distribution, or CAD, in the quarter, which is an increase of 65% over Q2. In September, we increased our dividend to $0.22 per share, which is also an increase of 10% from the second quarter.

Our third quarter financial results were effected by having $150 million of average uninvested capital in the quarter, including $80 million of proceeds from the CDO 10 liquidation.

As we continue to invest this capital, our earnings and total cash flow will continue to grow.

As Ken mentioned, we are pleased with the execution of the CDO 10 collapse. CDO 10 was consolidated on our books and this transaction materially simplified our balance sheet by reducing assets by $1.1 billion and reducing liabilities by $1.2 billion.

As we do with all of our consolidated CDO, we mark our assets to fair value but carry the debt at safe. In the previous quarter, CDO 10 was contributing a negative $80 million of GAAP book value even though the debt was fully nonrecourse.

Combining this meant $80 million of negative book value with $130 million of proceeds that gets us to the $210 million of increase to our GAAP book value. Additionally, this transaction resulted in our consolidated debt-to-equity ratio decreasing from 3.8 times to 2.2 times.

As you can see from our disclosures, we have been breaking out our results by our two business lines. This quarter we continue to see growth in the residential servicing and securities business. And while it only generated 40% of our total cash flow, we expect it to grow to approximately 50% with a full quarter of our recent investment and even further as we deploy our cash on hand.

We currently have $184 million of unrestricted cash to invest and, as Wes mentioned, we're seeing a lot of opportunities to invest the capital.

In early July, we entered into the financing of $59 million on some of our non-agency RMBS positions. This modest amount of leverage brought us to an overall portfolio leverage of only 30% and increased our leverage returns to low teens.

We continue to have the ability to finance the remaining securities if we need the capital, which would also increase our returns on this portfolio even further.

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

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Bose George – KBW.

Bose George – KBW

In your presentation, the slides, you note that CDO 4 passed the OC test in September. Any commentary on what could get that to start cash flowing in terms of what we could think of in terms of potential cash that could come out of that?

Unidentified Corporate Participant

We passed the over prioritization trigger in the third quarter. It didn't generate any cash flow to us in the third quarter. But going forward, assuming we continue to pass the over prioritization triggers, we would expect to generate roughly $300,000 to $400,000 of cash flow per quarter if we continue to pass, so look forward to that in the quarters to come.

Bose George – KBW

Then actually switching to the Ginnie Mae servicing that you guys are going to get, is the economics about similar to the (GOC) stuff and in terms of the repurchase obligations to be on the delinquent loans, is that done by Nationstar or is that going to end up with you guys or how does that work?

Wes Edens

No, ours is always the case. The servicing obligations are going to stay with Nationstar including the repurchase obligations for that servicing. This will be the first significant block of Ginnie Mae servicing that we have brought on. We think that there is a tremendous amount of value in effect.

It's got some different characteristics, as you know, especially on the VA portions of those loans. There is both some elements of credit exposure, modest amounts of credit exposure but there is also some very significant reperforming and new origination opportunities.

From a servicing standpoint on balance, we think that that's an exciting portion of it. And then the refinancing activities, these new streamlined refinancing guidelines on the Ginnie Mae side, we think the recapture opportunities in that space are very, very significant.

We've gone through the process. It's take us a bit of time with Ginnie Mae but we've gotten the same structure, a similar structure to what we have for Ginnie Mae. Freddie Mac, which is a big (inaudible) for us and it's the kind of thing I think you could see a (inaudible).

But the net of it is and the direct answer is that we think the returns are very consistent in the Ginnie Maes as they are with the Fannie, Freddie and other payouts.


Your next question comes from the line of Douglas Harter – Credit Suisse.

Douglas Harter – Credit Suisse

Tell us how much capital you'll be putting to work on that Ginnie Mae portfolio.

Wes Edens

It's going to be about $30 million to $35 million I think.

Douglas Harter – Credit Suisse

And then just with the remainder of the cash, how are you thinking about putting it to work more quickly in non-agency side versus keeping some powder dry for some of the opportunities on the MSR side that you referenced.

Wes Edens

Well, I think that the balance of the two groups, the investing activity and the residential side, gives us a lot of opportunities on both elements of it. The work that Greg and others have done on the RMBS portfolio, we're very happy about that.

We do think that the long-term technicals (inaudible) are very positive and continue to improve and by focusing on securities that we, our affiliate has, the servicing (floor), we've heard about their servicing abilities to develop those.

As Greg said, we do think there's going to be some opportunities to generate some windfall profits if we can collapse in those deals. And I do think – when you look at the RMBS market, broadly speaking, there's about $1 trillion still outstanding in that sector, so we service roughly 10% of it today when we started, so there's more of that, obviously.

But that's a big chunk of it. It's $100 billion. You could take all the securities that existed as if it was one – the average price is about $0.70. If you could look at all the collateral that fits behind it, that collateral – I can give you some very general numbers – is worth about $0.90.

So there's a very significant gap between the price of the securities and the value of the assets. It's not easy to get at that, obviously. But in the aggregate, 20 points on $1 trillion is $200 billion. That's a bit notional amount of opportunity to go after.

And so we're going to continue to chip away on the RMBS side and be very thoughtful about what we're looking at there.

On the MSR side, it's a little bit more episodic, right. Have we bought the (inaudible) deal? You can see a big chunk of capital come out of it then. There are a handful of other large transactions that could be very substantial our could be more along the lines of what we're reporting here on the Ginnie Mae portfolio.

But I think that having the two allows us to carry a balance of cash along and we can keep ourselves available for larger transactions but still stay in the investing business. So I like the mix of the two.

I think that the fourth quarter is going to be a busy quarter. It feels that way already. There's a lot going on and so I'm optimistic we'll have some good investment activity.


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

Jasper Burch – Macquarie

Just staying off of – I think obviously it's a good thing that you're diversifying your income streams. I think a lot of people were worried about (Trinity Star) kicking in and ramping up.

Drilling into the senior living portion of the book, looking at what your projections are and how you can really reap the rewards of that asset, it's really more in terms of the operational side increasing the revenue and the occupancy and then, two, on the leverage side.

I was wondering if you could give us a little bit more color on both of those I guess first and how you are going to increase the basic returns on the asset and then also what type of leverage you're looking at applying.

Ken Riis

Yes, that portfolio – the way we're going to drive incremental returns is to increase occupancy and rent in the portfolio. So along with that, obviously, we're increase cash flows and increase returns.

In the quarter we generated a leverage return of about 12%. But as we drive revenues higher, we think we'll get it up to about 20% return on equity by the end of the year and stabilize in the mid 25% to 30% return over the next couple of years.

So a quick ramp up due to good active management in portfolio and we're optimistic we'll get to the 20% plus return over – by the end of the year, over the next 12 months.

Jasper Burch – Macquarie

And in terms of leverage, is the leverage that you're going to apply, is that already in place or are you going to take on additional financing?

Ken Riis

There's current leverage in place and the unique thing about the financing is as the value increases we can actually increase the leverage over time as cash flows increase.

Jasper Burch – Macquarie

And then I guess operation on the MSR side, the broader market we've seen obviously one large competitor take down a large portfolio yesterday that you were also bidding on.

I was just wondering if you could speak to what you see in terms of competition for bidding on these assets and what the differences in terms of the availability in capital that you and Nationstar have versus some of your competitors and whether there's differences in valuing different types of MSR assets just to get an idea of really what we can expect for any call in terms of the investment piece or your propensity to compete.

Wes Edens

There's no question there's more competition in the sector today than there was this time last year. This is very much of a still (fledge) in the asset class a year ago and what a difference a year makes both in terms of our own activity as well as the activity of others.

The other day, yesterday, when you look at that transaction, it's a big public transaction and it was one that had a lot of people looking at it. In the end, it was only one firm that stepped forward to be a competitor.

So I think that that's proof positive of, A, there's a lot of interest in the sector but, B, it's reasonably hard to be big and effective competitor in this space. In fact, in order to compete in that transaction, you had the two firms actually join forces because they – I think that (inaudible).

Not only is it this stuff in particular, I think (Walter) was (certainly on the same). He had to stop and measure how the rest of it was split up. But I think it's a big space with a lot of activity.

And when you look at the returns of that portfolio, which we've made very transparent, (inaudible) unleveraged cash flows in a market of zero interest rates is obviously a very, very (inaudible) investment story.

The challenge is to get from here to there. You have to be a good servicer. You have to have lots of capital. You have to be in good standing with GSEs. There's a lot of things that have to come to play in order to be effective about it.

And so I think bottom line is there certainly is a lot of activity that we see now and I think it's prospectively going to result in investments. And while there is competition, I think that the barriers to entry are high and are going to stay fairly high.

One other thing to note is when you looked at the – so the transaction yesterday was about a $3 billion purchase price. The bulk of that purchase price were for the advances obviously. (Inaudible) the combined bid to the – the (inaudible) fee was $700. The apples, the eventual price that that traded out was north of $1 billion, too, so obviously a very substantial increase over the (inaudible) last spring.

Without a lot of context, it's hard to know where people – kind of what that means on returns other than returns are somewhat complexed by that. Also, I think in order to really be an effective bidder for these kind of assets you have to place a lot of enterprise value on your ability to originate loans, which is a problem with part of the general ancillary income.

So again, all of this is to say if you're going to be competitive today in where the business is going to, you have to have a full spectrum of capabilities in order to take advantage of all those things and I think that there are a handful of very capable and competent firms that are out there and then it's a pretty big gap down to the next level.

Jasper Burch – Macquarie

I guess as one last thing, do you guys provide the metrics on the non-agency book, the delinquency rates, the discount, the par that you bought it out? Is that (move) slide presentation in queue?

Wes Edens

On the securities portfolio or the MSR?

Jasper Burch – Macquarie

The non-agency RMBS, securities.

Ken Riis

Limited details that are provided in the queue as well, yes, including prepayment rates, default rates, delinquency rates, loss of (inaudible), et cetera.


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

Joshua Barber – Stifel Nicolaus

What you're targeting on the MSR side today, would that be more non-agency versus agency and are you seeing more competition on one of those versus the other?

Wes Edens

We're not really focused on one element over the other. I think that with this latest Ginnie Mae, our portfolio will have every major food group represented in the portfolio, so (PLS) and Ginnie Mae, and Fannie Mae and Freddie Mac.

I think when you look at the universe of servicing, if there is just over $10 trillion in mortgage servicing in total, about $6 trillion of that is Fannie Mae and Freddie Mac, about $1 trillion of it is non-agency (inaudible) and the other $3 trillion are loans on the balance sheets of different financial institutes.

So you'd think proportionately over time you'd have more to do with Freddie, Fannie, Ginnie than you would in the non-agency stuff. You've seen a lot of non-agency security servicing operations be sold by the financial institutions, which is why I think it's been a disproportionate representation of the overall sector in terms of the activity to date.

I would expect the next year and the year after, for example, and that's going to transfer. You'll get (inaudible) something, which is much more representative of the overall market statistics and see a lot of that Fannie, Freddie, Ginnie stuff.

But at the end of the day, they've all got somewhat different characteristics. The Fannie Mae programs in particular, those portfolios that have a lot of (hard) (inaudible) are going to see a lot of refinancing activity but those are also great portfolios to recapture loans.

In some of the new MSRs that are out there, very high quality dollars, that's great from a credit standpoint. It's less great in terms of your ability to control that dollar because they have more options.

There's lots of nuances to them. You have to really pay attention to what the underlying credit worthiness is and did you predict how those things are going to perform and how are you going to be able to recapture loans.

So it's a idiosyncratic analysis but it's one that I think at the end of the day all of the sectors I think offer a lot of interesting values and you just have to pay attention to what it is that really drives the returns (inaudible).

Joshua Barber – Stifel Nicolaus

Looking at the senior living business, would you guys expect that to be a bigger source of growth in the next few months, that you're continuing to see deals there that make sense or seem to have some opportunity?

Wes Edens

Well, I think that we talked about this last time. You look at the senior housing, which is something you've been invested as a firm for the last dozen years or so, so we've been in this for a long time – it is very much of a market that's dominated by true (inaudible) operators.

I think roughly 75% of the market is managed by people that manage 15 or fewer properties, so there's a lot of small operators out there. It's a business that creates benefits from scale of operations and kind of (professional) operations.

So this first portfolio we think is a good example of something exactly like that. You say, well, (narrow) to the 12% run rate on return of equity now and we aspire to be north of 20% in the next year or so.

There are other small portfolios that we think that we can find. They are very much under the radar of the big REIDs. The REIDs in that sector have done exceptionally well but they're very large companies.

So for them the relevance of buying a $50 million, $25 million even a $100 million portfolio is just not – it just doesn't make that big of a dent when they've got the gigantic market caps that they have.

So it's a robust amount of activity in a very big market that's being executed in fairly small amounts. And so I think you'll see small incremental investments likely to crop up as we find the opportunities there.


Your next question comes from the line of Henry Coffee – Sterne Agee.

Henry Coffee – Sterne Agee

As you look at your pipeline – and maybe this may be asking for too much information – but as you look at your pipeline, (Alli) owns about $1 billion in MSRs, which we think is backed by about $160 billion in servicing assets.

Did that opportunity go away with the sale of ResCap or is that still an open opportunity for Newcastle?

Wes Edens

(Alli) did not sell their MSRs as part of the transaction. Those loans, as you speak correctly, Henry, they're subserviced by the ResCap estate and thus are going to be subserviced by the (affluent) slash (inaudible).

That MSR, a month ago they talked about selling it in conjunction with the estate or contributing that there was a bunch of different conversations about that. None of that came to pass.

But today as we sit here, that MSR is still owned by (Alli) and what their intentions are with it, you'd have to ask them. They could sell it, they could keep it, they could grow it, they could do a lot of different things.

But it really is independent from the transaction that happened yesterday and there's nothing about that transaction that happened yesterday that would hinder their abilities to sell it freely if they chose to do so.

Henry Coffee – Sterne Agee

And they keep saying they're getting out of mortgage, so this would be part of that – that door hasn't closed for anybody is what you're saying.

Wes Edens

I think that MSR ownership by financial institutions is on the decline. That's an easy, broad statement to make. And what that'll translate into for (Alli) bank or any other bank for that matter is something you have to talk to the manager in those places because that's not my point of view.

But I do think that as an asset class I would expect these guys to own a lot less of it by this time next year.


Your next question comes from the line of Josh Bederman – Pyrrho Capital.

Josh Bederman – Pyrrho Capital

I'm wondering if you could talk a little bit more about the senior living portion of the book. Obviously a little bit of activity there. It looks like their terms are pretty good. You talked a little bit about the dynamic in the space from an acquisition salvation side.

Can you talk a little bit about what you're seeing there on the fundamental side? Is there anything that's changed in the sector that's caused you to get back involved or is it just you're starting to see more opportunities?

Wes Edens

What drives that business I think in the end is just the broad demographics of the aging population in the US. I think that the cohort of people over the age of 65 that would be eligible for this property is north of 26 million.

It's the fastest growing cohort of individuals that exist and I think broadly speaking the pace of construction activity and particularly during the crisis in the last five years has underperformed relative to the number of people that need it.

So we think that the broad metrics through the industry are very good and are going to continue to get better, so there's a great fundamental underpinning to the sector.

One thing we have learned about in this sector in the last dozen years is that it seems superficial like a (inaudible) business. You basically build something that's a lot like an apartment house. You rent it out to seniors, provide some basic services and charge two X the rent you could for them to just be living there.

That sounds really great. Then all the seniors show up and all the issues of dealing with the management and whatnot of them.

So it's a complicated operating business and, again, we have found is that there are very significant benefits to scale in terms of things like per (unit) of food and insurance and services and whatnot.

And so I do think that there's a very substantial opportunity to roll up enough of these small operations. Also, the prices of the assets in the larger portfolios have been higher than what we have seen on a one-by-one case.

So as Ken mentioned, we've got a return in that portfolio of about 12% in the current basis. Probably the leveraged return of assets on the books would be senior housing are substantially south of that.

So there's a big gap between the two. If we're able to continue to add to the portfolio and add an improvement rate where the performance is still, I think you could get at some point a very significant revaluation between the portfolio that we assemble versus where the market might buy that.

So we're excited about it. It's not something that you can jump out and go do a lot of. That would be the way to make a bunch of poor investments. But I think one by one is that we've got a robust pipeline of activity where you see a lot of smaller things crop up and we'll report on them as they show up.

I'm trying to get great transparency on this portion of the portfolio (inaudible) and not agency (stats). So hopefully you'll see it. But it's, again, it's $55 million of equity out of $1 billion for market cap, so it's still a relatively small part of our activity and but it is something that we do think has some promises. So hopefully we'll have a good next year on it.

Josh Bederman – Pyrrho Capital

One, the returns that you're seeing in the recent deal, should we expect that for what you're going to be acquiring going forward? And two, are there any markets that you guys are seeing more opportunities or specifically targeting or is this going to be a national type of thing?

Wes Edens

The returns are what we hoped for. (We're responding to) very much consistent to what we've gotten here, so low double digits on the returns in the early phase of the investment and really shooting for high teens, 20% returns in the portfolio over time. So that profile is very much (inaudible) what we're trying to do.

One thing – it's less picking markets specifically than it is looking for clustering of assets. Again, it's very helpful to be in a market and have half a dozen assets rather than just one asset in terms of your ability to manage it (to keep moving) services forward.

So I think that the things that we have looked at and we will do over time as the portfolio gets bigger is look for clustering of assets in different markets, much like you'll see in the apartment sectors, frankly, as opposed to picking a good sector versus bad sector.


(Operator Instructions) Your next question comes from the line of John Evans – Edmonds.

John Evans – Edmons

Can you just help me understand? So we've been shareholders for three years. You guys have done a fabulous job. But here is what I’m curious is how big do you have to get to before you split the company into two where you have the healthcare and you have the MSR?

And then what do you think you need to do or need to show to the market because you trade at a significant discount on a yield basis to – on the MSR side like HLSS and then obviously on the healthcare REIDs they trade a 6% yield?

So what do you think you need to do and help us understand how big you have to get the two pieces before you split the company?

Wes Edens

I think we do think there are two clearly delineated business plans here and we do think that the businesses would be valued better on their own standings, so I think that that's right.

When you look at our MSR portfolio and we're returning roughly 20% and you look at (inaudible) yields in the single digits, you think a two time or 2.5 time multiple and in terms of the value of that portion's capital the business could easily be in the (cards) for us if and when we split that out.

I'm very mindful of not trying to do this prematurely and thus end up with having picking a company that has had, as you said, a very good run the last number of years, has gotten to an institutional size of a company that's growth and its market cap and splitting it up into two companies that no longer fit that bill.

So there's no hard and fast rule to it. I do think that we are one significant investment or one material capital raise away from being able to do something like that, so in my mind, given what we're trying to accomplish in the quarter, that could be something that happens here early next year if we do what I expect to.

But I do think we want to get a little bit bigger and I think that my view is exactly what you mentioned, which is that I think that we'll get the visibility and purity of the vehicles. I think you'll then have people be able to value them more readily and I'm hoping that some of the (inaudible) substantially greater than it is right now because I do agree.

I think that an $0.80 dividend return when you look at the attributes (in our) businesses that's a very significant discount to where a number of the other competitors are and I think that we should do better.

I think it's ironic that – I was talking about a few (inaudible) ResCap thing. I mean, from the fundamental standpoint it should be the opposite. The existing portfolio that we have as reflected is probably being undervalued when you look at where market prices are for a start.

So rather than go down, it should go up. I think it's humorous. But I think in the long term – and we're very focused on the long term – we'll generate great returns and if we give great transparency, that should result in better valuations and to all shareholders and that's what the focus is.

John Evans - Edmons

Just the people that are negative just say that you're a habitual equity raiser. Can you talk a little bit about maybe the capital structure down the road how you see that and how you don't always dilute the equity to buy that next deal?

Wes Edens

Yes, I think the balance between having capital to grow your business and doing so in an accretive fashion is of course the right conversation to always be happening. We aspire to earn 20% plus returns across the board in the businesses.

So the non-agency business as Greg said on the leverage and modest leverage basis is a 15% to 20% business. The MSR business is on an average basis 20%. The senior housing stuff is les than that to begin with. Those are very long duration assets, obviously, and so there's a lot of value if those get to be higher.

It would be great if our cost to capital was less and the prices were higher and the gap was a bigger gap. But even where it is right now it's still very accretive and I think that the results that we have generated over the last couple years, the last year in particular, reflects that we are actually very careful about that.

And I've been called a lot of things directly. Habitual capital raiser is not one of them. But I think it's – it's a legitimate conversation in a company that pays out a lot of cash flow and I think that I'm trying to take the steps to get ourselves the best valuation possible to make the gap as wide as possible.

And then you have the opposite. So rather than being a difficult conversation about the gap between the return on your equity and the cost of your capital, if we had a single digit handle on our dividend yield, the gap would be substantial and we would have hugely accretive capital formations.

So I think I'm the biggest shareholder individually. We're very focused on the returns on the equity of the company obviously and we're being, I think, as transparent as we can possible be about what we're trying to accomplish and the steps that we see that are necessary to get there.


Your next question comes from the line of David Haas – Moore Capital.

David Haas – Moore Capital

As you look at the $3 billion bid from (inaudible) for the ResCap assets and you can parse out the (NYSE:MSO), what type of – as you walked away, what type of return, what type of IRRs came from that bid?

Wes Edens

I think – it's what I mentioned before. I think that in order for that to be a good bid, a good acquisition price, you had to place a lot of value onto what we call the E, the enterprise value of the operation because strictly from the MSR standpoint and strictly from the value of those advances, the returns would be very low.

I think you'd end up with a low single digit return IRR on the MSR and that's obviously not the business that we're in or (inaudible) or anybody else is in. And so you have to be generating marginal returns either from some source of activity or the other, whether it's the origination business, which is a very good business right now and a very lucrative one, the ancillary services business that they had done a particularly good job with.

And then I think what could drive us, if you look at the left, is better performance, right, because performing loans are a lot cheaper to service than non-performing loans, and slow up your payment speeds.

Of those two, the bulk of that portfolio, the big chunk of it was the (inaudible) stuff, which already prepays at a very slow rate. There's not a lot of upside from that perspective. In fact, there's a lot of downside than upside in our judgment.

On the performance standpoint, I do think there's a lot of upside. As Greg said, the rate of loans going bad has dropped dramatically. It is a third of what it was a year ago and I think that when you look at the housing market and what we see going on across the different markets, we think that there's a lot of room for optimism about delinquency rates continuing to shrink down and that's a good deal when you're in the servicing business.

It may well be you have to ask the folks who operate them but it may well be they have a very robust view about the prospects for that portion of it because strictly on the basis of where things are today, the pricing is aggressive.

Obviously at the end of the day, our judgment was the price that was offered at the end was higher than what we wanted to pay and that's the difference in option. It doesn't mean that we're right and they're wrong kind of vice versa.

But from our standpoint we thought that there were better risk adjusted returns and they were available in other parts of the business. But time will tell as to what the right (inaudible) was there.


That does conclude our question-and-answer session. I hand the program back over to Mr. Wes Edens for closing remarks.

Wes Edens

Thanks very much, everyone; look forward to talking to you next quarter.


This does conclude today's conference call. You may now disconnect.

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