Newcastle Investment Corp. Q4 2007 Earnings Call Transcript

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Newcastle Investment Corp. (NCT) Q4 2007 Earnings Call February 27, 2008 1:00 PM ET


Wesley Edens – Chairman

Kenneth Riis – Chief Executive Officer and President

Debra Hess – Chief Financial Officer

Philip Evanski – Chief Investment Officer

Lilly Donohue – Director of Investor Relations


Matthew Howlett - Fox-Pitt Kelton

Don Fandetti - Citigroup

Bose George - KBW


Good afternoon. My name is Ashley and I will be your conference operator today. At this time I would like to welcome everyone to the Newcastle Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions).

Miss Donohue, you may begin your conference.

Lilly H. Donohue

Thanks, Ashley. Good afternoon, everyone. I’d like to welcome you all to Newcastle’s Fourth Quarter and 2007 Year-End Earnings Conference Call. Joining us today is Wes Edens, our Chairman; Ken Riis, our CEO and President; Debra Hess, our Chief Financial Officer; and Phil Evanski, our Chief Investment 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 and outside of the United States, it’s 706-645-9291, access code is 3405948. The call will also be available on our website which is

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 from our estimates and expectations in our forward-looking statements.

These statements represent the company’s beliefs regarding events that, by their nature, are uncertain and outside of the company’s control. So you should not place undue reliance on any of these statements.

I would also encourage you to review the forward-looking statement disclaimer in our quarterly earnings release, including the recommendation to review the risk factors contained in our annual and quarterly reports that are filed with the SEC.

Now I’d like to turn the call over to Wes Edens.

Wesley R. Edens

Thanks Lilly. Welcome, everyone. I’ll give a bit of an overview and then I’ll turn the call over to Ken and Debra to go through some of the specifics. The fourth quarter recently competed was a challenging but highly productive quarter for the company.

The credit markets in the United States continued to deteriorate throughout the quarter going into the year-end. And in fact, the prices of debt securities have continued to under-perform thus far the first two months of this year.

While that has created a host of issues for us, and of course every other credit investor in the United States, it’s also created an investment market with a tremendous amount of potential.

The price gap between perceived credit risk and what we believe to be the actual credit risk is as wide as any time I’ve ever seen, including going back all the way to the RTC days, and should result in some excellent investment opportunities for us.

Given market conditions, our view was that the first order of priority was to create as much liquidity as possible in the company. This is necessary both to create a liquidity cushion for the company as well as to provide liquidity to pursue new investment opportunities. I’m happy to say we’ve been very successful in doing so.

We increased cash on hand to approximately $120 million currently, up from $29 million at year-end; reduced recourse borrowings from $1.8 billion to just over $900 million, about half of which is repo against agency securities. So the actual recourse level of debt on the balance sheet is down dramatically.

Holding aside our agency securities, our balance sheet today has $120 million in cash; approximately $239 million in assets held with no financing against them; approximately $700 million in credit assets with about $470 million in term financing; and then about $5 billion of assets held in our various CDOs which have about $4.5 billion in term non-recourse financing.

Overall, a very healthy financial profile and one that I’m very happy to have in this market at this time. Getting here has been a lot of work. Both Ken and Debra will detail some of our specific activity. But overall this puts us in a great position to consider the next things for us to do.

There’s obviously been a little bit of cost in doing so but I’m confident that we’ve done the right things to ensure both the financial stability for the company as well as to give us the opportunity to take advantage of what we think will be exceptional market opportunities.

The core operating results for the company are good, but those are likely to come down in the near term as a result of the cash build-up that we’ve had. Overall, we’ve increased liquidity by about $100 million. In simple terms, for a fully-invested equity was earning around 15%, and cash on hand earns a lofty 3% or so, our run-rate until we invest the excess cash will come down.

Obviously, we’re in the process of reviewing what impact this will have on the dividend prior to our next announced dividend date of March 14. But, again, our focus, my focus is what to do in terms of the investments in the balance sheet on a go-forward basis.

The short-term impact of that, I think, will be whatever it is. But we’ll obviously be mindful about that when we set dividends and talk to you about that or relate that to the markets in a couple of weeks.

So, with that as an overview, let me turn it over to Ken and Debra.

Kenneth M. Riis

Okay. Thanks, Wes. It has been a busy first two months of the year. As Wes mentioned, we’ve been focused on increasing cash and decreasing recourse debt. The good news is we’ve made a lot of progress in both areas. So I want to spend a few minutes reviewing the activities over the past two months.

As Wes mentioned, today we have about $120 million of cash available to invest and our recourse debt has declined by about $880 million. We primarily achieved this through the sale of $1.3 billion of assets, at an average price of 100.1%, resulting in a net loss of $14.2 million.

$770 million or 60% of the assets sold were Fannie Mae and Freddie Mac agency securities which are highly liquid. $547 million or about 40% of the assets sold were real estate securities and loans, with the majority being CMBS and REIT debt having a relatively short average life and limited price upside.

So what does that mean for the liability side of our balance sheet and how does it look today? We have $5.8 billion of total debt of which $4.9 billion is non-recoursed to Newcastle and $918 million has recourse.

First I want to focus on the recourse financings. About half, or $447 million is related to the financing of our remaining portfolio of Fannie Mae and Freddie Mac agency securities. Again, these assets are highly liquid, and I’m not worried about our ability to finance these securities on an on-going basis.

So our main focus is the remaining $471 million of recourse debt which represents about 8% of the total debt of the company and is related to the financing of $709 million face amount of commercial real estate B notes, mezzanine loans, senior secured bank loans and other securities.

These assets have interest rates that adjust over LIBOR and have a relatively short duration of about 2.7 years. In these markets, our main focus has been to reduce the debt financing on these types of assets as they are less liquid. In the past two months, we have reduced debt on these types of assets by $130 million, from $600 million at year-end to $470 million today.

Now I want to talk about our non-recourse financings, which I think have tremendous value to the company, specifically the seven individual CDOs. Our total CDO debt is about $4.5 billion today.

Just to review and so you could understand what these are, these liabilities are non-recourse to the company which means that we are not required to post additional cash or sell assets as the market value of the underlying securities change.

Our capital at risk is only the initial invested equity in each portfolio net of our debt that we’ve issued. Each CDO is a discreet portfolio of assets and we can actively manage those assets. That is, we can buy and sell the assets without any change in the terms of the debt.

Our average funding spread is very attractive at LIBOR plus 40 basis points. And the average life is relatively long at 6.3 years. Our CDO financings provide a lot of opportunity and flexibility to the company as well as stability to our cash flows.

In summary, in the short term we will remain focused on maintaining a strong balance sheet. The markets continue to be challenging but I think we are better positioned today to again focus on new market opportunities.

Now I want to turn it over to Debra Hess, our CFO, to review our fourth quarter and full-year financial results.

Debra A. Hess

Thank you, Ken. Good afternoon. I just wanted to highlight some of the financial results. FSO excluding charges was $0.70 per diluted share for the fourth quarter and $2.86 for the year. The net charge for the quarter of $143 million, or $2.71, primarily related to impairment, and let me just highlight some of the largest contributors:

$59 million related to a write-down on the rest of our 2006 vintage KBS, bringing our basis to a $14 price. We basically wrote down the principal to a negligible amount.

$26 million related to our retained bonds and residual from our two sub-prime hold unfolds. While we are currently out-performing our original assumptions, we updated our assumptions going forward to be more conservative in light of the current market condition.

$11 million related to a CDO investment that we wrote down to a $4 price and this was and is our only CDO position.

In terms of our book value, we believe the right way to look at it is our adjusted book value which was 16.39 at year-end versus 15.59 at September 30. The GAAP book value only reflects market value changes for securities and derivatives.

The benefit to our adjusted book value is that it marked all of our financial assets and liabilities to fair value, and also would be equivalent to our GAAP book value if we elected to mark all of these assets and liabilities under FAS 159.

Next I’d like to turn it over to the operator for any questions.

Question-and-Answer Session


(Operator Instructions). Our first question comes from the line of Bose George - KBW.

Bose George - KBW

We had a question on the increase in your adjusted book value over the last quarter. Can you just walk through the changes in your adjusted book value between 3Q and 4Q? And also on a related note, are you planning to adopt FAS 159 in the first quarter?

Debra Hess

To answer your first question, the increase in the adjusted book value is primarily related to our CDL liabilities, which was $12.15. We are not anticipating adopting 159 through the GAAP due to the volatility of our income statement but our goal is to report our adjusted book value as if we did. So you’d get to the same place.

Bose George - KBW

Great, thanks a lot.


Our next question comes from the line of Don Fandetti - Citigroup.

Don Fandetti - Citigroup

Wes, I wanted to know if you have any cash flow triggers on any of your securitizations that could be a risk to your cash flow?

Wesley Edens

There are credit tests on each of the CBOs. None of them are market triggers so it’s not a matter of being forced to liquidate any of the positions. The nature of the financing we put in place is quite stable and given times like this, you can see the benefit of doing so.

There are no triggers in any of the individual transactions that are currently been triggered or are on the verge of being triggered. Obviously future performances will dictate how that all turns out, but for the immediate term we don’t see any issues there.

Don Fandetti - Citigroup

And do you have those triggers on your sub-prime securitizations?

Wesley Edens


Kenneth Riis


Don Fandetti - Citigroup

Okay. And then obviously, you sold some of your agency assets. Does that somehow impact your exemption from the ‘40 Act or are you comfortable? And how are you making up for that?

Debra Hess

We are passing the test.

Don Fandetti - Citigroup

Okay, you are passing the test?

Debra Hess

We have no issues.

Wesley Edens

Yes, we’re comfortable with that.

Don Fandetti - Citigroup

Okay. And then this question is for Wes. There’s a lot of concern in the marketplace about commercial real estate and where it’s headed with CMBS spreads being very wide. What is your take? Could you handicap where the market might be going over the next six to twelve months?

Wesley Edens

It’s a pretty path-dependent question by virtue of what you expect is going to happen is what’s going to dictate the performance of those securities. Since the end of the year, the indices and the cash markets have gone down a fair bit on the commercial side, really for the first time in sympathy to the residential markets.

The big difference being in the residential markets you’ve actually seen very substantial rises in delinquencies and foreclosures. On the commercial side, at least empirically right now that has not been the case.

So, it has everything to do with how severe you think the recession is going to be, if indeed there is a recession. The commercial stuff in general has, I think, more consistent underwriting standards, and I think it has more integrity in terms of the capital structures than some of the residential stuff did.

There’s reason to be optimistic on that front but it has 100% to do with how bad you think it’s going to be regionally and on a deal-by-deal basis. I’m not particularly negative about it because I don’t have a horribly pessimistic view, although there are lots of folks that do. We’ll just have to wait and see.

Don Fandetti - Citigroup

Okay, and then just lastly, Debra, can you confirm how much you wrote your CMBS portfolio down this quarter?

Debra Hess

Wrote it down in OCI or through impairment?

Don Fandetti - Citigroup


Debra Hess

Yes, we wrote it down $2.60 per share in the aggregate.

Don Fandetti - Citigroup

Okay, all right. Thank you.


Our next question comes from the line of Matthew Howlett - Fox-Pitt Kelton.

Matthew Howlett - Fox-Pitt Kelton

Thanks for taking my question. I’m still trying to work through the difference between the reported GAAP-book value versus the core book value, i.e., FAS 159. The question is, is the true or fair market value of the assets close to $16 compared to $5?

In other words, if you were to sell those assets today could you get $16 per share? And, if you could, why wouldn’t you buy back stock, eliminate the dividend, buy back stock, if you could buy it back at 60% of the fair market value?

Debra Hess

The book value only really takes into consideration two of the three pieces of our match-funding strategy. We have securities, and loans for that matter; we have derivatives and we have debt. The way the GAAP-book value works, it only marks the securities and the derivative and does not take into consideration our debt.

Our CBO liabilities have also widened dramatically so therefore when you mark that as well, the $16.39 is more reflective of what our GAAP-book value is, based on market values.

Matthew Howlett - Fox-Pitt Kelton

Okay, but if you put your assets out to a market, would presumably they be worth in sum $16 per share? In other words, why wouldn’t you just buy back stock if that was really the true NAV of the company down here?

Wesley Edens

Maybe I could just step in. The book value really reflects what would be the value if you just sold off the assets. If you did sell all the assets of the company, you’d have a book value that is, in this case, as Debra just reported.

What it does not take into account is the fact you then have $5 billion, or $4.5 billion of liabilities that have an average cost of liabilities of about 40 basis points, where the true market value for those, if you were to issue new liabilities today, would be considerably wider than that. I know it’s a little bit through a looking glass but in effect those liabilities are themselves an asset.

The easiest way to understand, or at least for me to get my head around it is, we can go buy back in the marketplace, and have from time to time, those liabilities at considerable discounts.

So as the underlying assets have traded down in value, so too have the liabilities to the extent that you retire those liabilities, and sold all of your assets at market, then the combination of those two would result in the adjusted book value. It’s the number that Debra reports.

Matthew Howlett - Fox-Pitt Kelton

Okay, fair enough. And with the buyback in place, it doesn’t look like you’ve repurchased any shares in the fourth quarter. And that may be a good thing as you get your liquidity back into position. Are you looking now at potentially buying back shares today given where the stock price is?

Wesley Edens

It’s a really good question. I think that over the course of the next couple weeks, when we run through our analysis in terms of the dividend and use of cash flow and whatnot, the alternatives are, pay out cash in dividend; it’s retire obligations of the company be they common equity, preferred equity, or debt outstanding, or make new investments.

And, yes, I suspect that there’s a good case to be made for doing all those things. I’m a big fan of a balanced approach to things, so I doubt that we will do something which is really dramatic on one side or the other. But all those things are things that we need to consider and what we do is, we think, in the best interest of the company.

Matthew Howlett - Fox-Pitt Kelton

Great, West, the last question for you. Could you just maybe give us the background on how committed Fortress is to the Castles? And would you step up potentially if Newcastle had a liquidity problem or if it needed to repurchase a bond out of a CDO that could hit triggers? Could Fortress provide some type of financing to do that?

Wesley Edens

We are very committed to all of the invested vehicles we sponsor for Fortress. We’re big investors in them. Frequently we’re the largest investors. I don’t know if I’m the largest investor in Newcastle, but I may well be. And I’m very committed to it.

It’s an important business to us. It’s one that can have its typical highs and lows if it trades in sympathy with the overall debt markets. These are difficult times to be a borrower; they’re difficult times to be involved in the debt market. That’s the bad news.

The good news is the opportunities that are created by those difficulties. Historical context has given rise to great investment opportunities. So we’re very committed to the vehicles and the top priority is really to generate the highest returns on shareholder capital of which we’re one of the shareholders. But presumably so are a lot of the other people that are on the phone here today.

With regards to anything that we would do in terms of specifically supporting the vehicles, we’ve got no arrangements to do so. If and when those circumstances ever arose, I certainly would like to start doing a whole host of things, but there’s nothing specific that’s outstanding, nor is there a definitive commitment for obvious reasons.

Matthew Howlett - Fox-Pitt Kelton

Great. Thank you.


And there are no questions at this time.

Debra A. Hess

Thank you, everyone, and we will talk to you next quarter. Thanks again.


This concludes today’s Newcastle fourth quarter earnings conference call. You may now disconnect.

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