AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 23, 2002
REGISTRATION NO. 333-90578
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 4
TO
FORM S-11
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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NEWCASTLE INVESTMENT CORP.
(Exact name of registrant as specified in its governing instruments)
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1251 AVENUE OF THE AMERICAS
NEW YORK, NY 10020
(212) 798-6100
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
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RANDAL A. NARDONE
SECRETARY
NEWCASTLE INVESTMENT CORP.
C/O FORTRESS INVESTMENT GROUP LLC
1251 AVENUE OF THE AMERICAS
NEW YORK, NY 10020
(212) 798-6100
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
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COPIES TO:
DAVID J. GOLDSCHMIDT J. GERARD CUMMINS
SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP JAMES O'CONNOR
4 TIMES SQUARE SIDLEY AUSTIN BROWN & WOOD LLP
NEW YORK, NEW YORK 10036-6522 787 SEVENTH AVENUE
(212) 735-3000 NEW YORK, NEW YORK 10019
(212) 839-5300
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this registration statement becomes effective.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] ----------
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ----------
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ----------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
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TITLE OF SECURITIES PROPOSED MAXIMUM AGGREGATE AMOUNT OF
BEING REGISTERED OFFERING PRICE(1)(2) REGISTRATION FEE(2)(3)
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Common stock, par value $0.01 per share..... $124,775,000 $11,479.30
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(1) Includes shares that may be purchased pursuant to an over-allotment option
granted to the underwriters.
(2) Estimated based on a bona fide estimate of the maximum aggregate offering
price solely for the purposes of calculating the registration fee pursuant
to Rule 457(o) of the Securities Act of 1933.
(3) $123,408.76 was previously paid in connection with the registration
statement (no. 333-63061) filed by Newcastle Investment Holdings Corp.
(formerly Fortress Investment Corp.), the parent corporation of the issuer,
which was withdrawn.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION ACTING,
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED SEPTEMBER 23, 2002
PROSPECTUS
7,000,000 SHARES
NEWCASTLE INVESTMENT CORP.
(NEWCASTLE LOGO) COMMON STOCK
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This is the initial public offering of Newcastle Investment Corp. No public
market currently exists for our common stock. Substantially all of our
outstanding common stock is currently owned by Newcastle Investment Holdings
Corp. After this offering, new investors will own 28.9% of our common stock and
Newcastle Investment Holdings Corp. will own 68.2% of our common stock, assuming
exercise of all outstanding options.
We currently anticipate the initial public offering price of our common
stock to be between $14.50 and $15.50 per share. We have applied for listing of
the shares on the New York Stock Exchange under the symbol "NCT."
We are externally managed by Fortress Investment Group LLC, our manager. At
June 30, 2002, Fortress Investment Group and its principals owned approximately
16.4% of the equity of Newcastle Investment Holdings (25.8% upon exercise of
outstanding options). In connection with this offering, we will grant to our
manager an option to purchase 700,000 shares of our common stock, representing
10% of the number of shares being offered hereby, and subject to adjustment if
the underwriters' over-allotment option is exercised, at the offering price of
our shares in this offering. As a result, upon completion of this offering, our
manager and its principals will beneficially own approximately 20.5% of our
common stock, taking into account interests in Newcastle Investment Holdings and
assuming exercise of all of their options. The manager option shares will not be
registered in connection with this offering. We have no ownership interest in
Fortress Investment Group. We pay Fortress Investment Group an annual base
management fee and may pay incentive compensation based on certain performance
criteria. Fortress Investment Group also manages and invests in other entities,
including Newcastle Investment Holdings, that invest in real estate assets.
We are organized and conduct our operations to qualify as a real estate
investment trust (a REIT) for federal income tax purposes. To assist us in
complying with certain federal income tax requirements applicable to REITs, our
charter and bylaws contain certain restrictions relating to the ownership and
transfer of our common stock, including an 8.0% ownership limit.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING
ON PAGE 14 FOR A DISCUSSION OF THESE RISKS, INCLUDING, AMONG OTHERS:
- We are dependent upon our manager and may not find a suitable replacement
if our manager terminates the management agreement.
- Our manager manages and invests in other real estate-related vehicles,
including Newcastle Investment Holdings, and our chairman and chief
executive officer and some of our other officers also serve as officers
and/or directors of these other entities, which may result in decisions
made that are not in our best interest.
- We were organized in June 2002 and have not operated separately from
Newcastle Investment Holdings and may not operate successfully as a
separate business.
- We may change our investment strategy without stockholder consent, which
could result in investments that are different, and possibly more risky,
than our current investments.
- Many of our investments are illiquid and we may not be able to respond to
changes in market conditions.
- We invest in subordinated securities, which have a greater risk of loss
than more senior securities.
- We may leverage up to 90% of the value of our assets, which may result in
losses.
- Interest rate fluctuations may reduce our net income.
- If we fail to qualify as a REIT, we will be subject to income tax at
regular corporate rates, which would reduce the amount of cash available
for distribution to our stockholders.
- Newcastle Investment Holdings may make a distribution to its stockholders
of shares of our common stock, subject to its lock-up agreement with Bear,
Stearns & Co. Inc. pursuant to which Newcastle Investment Holdings will
agree not to transfer any shares for a period of 180 days after the date
of this prospectus, and substantial sales of these shares may adversely
affect the market price of our common stock.
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UNDERWRITING
PRICE DISCOUNTS AND PROCEEDS
TO PUBLIC COMMISSIONS TO US
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Per Share................................................... $ $ $
Total....................................................... $ $ $
We have granted the underwriters a 30-day option to purchase up to 1,050,000
additional shares to cover any over-allotments.
Delivery of the shares will be made on or about , 2002.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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BEAR, STEARNS & CO. INC. LEHMAN BROTHERS
BANC OF AMERICA SECURITIES LLC
The date of this prospectus is , 2002
YOU MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NEITHER
WE NOR THE UNDERWRITERS HAVE AUTHORIZED ANYONE TO PROVIDE YOU WITH DIFFERENT OR
ADDITIONAL INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT
SEEKING AN OFFER TO BUY COMMON STOCK IN ANY JURISDICTION WHERE THE OFFER OR SALE
IS NOT PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY
AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF COMMON STOCK.
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TABLE OF CONTENTS
PAGE
----
PROSPECTUS SUMMARY.......................................... 1
RISK FACTORS................................................ 14
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS... 26
USE OF PROCEEDS............................................. 27
DISTRIBUTION POLICY......................................... 27
CAPITALIZATION.............................................. 28
DILUTION.................................................... 29
SELECTED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION....... 30
SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION OF
NEWCASTLE INVESTMENT HOLDINGS CORP. ...................... 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PRO FORMA FINANCIAL
CONDITION AND RESULTS OF OPERATIONS....................... 37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF HISTORICAL FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF NEWCASTLE
INVESTMENT HOLDINGS CORP. ................................ 47
NEWCASTLE INVESTMENT CORP................................... 60
OUR MANAGER AND THE MANAGEMENT AGREEMENT.................... 76
MANAGEMENT.................................................. 85
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS........ 87
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 90
DESCRIPTION OF CAPITAL STOCK................................ 92
SHARES ELIGIBLE FOR FUTURE SALE............................. 97
IMPORTANT PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER AND
BYLAWS.................................................... 99
FEDERAL INCOME TAX CONSIDERATIONS........................... 102
ERISA CONSIDERATIONS........................................ 118
UNDERWRITING................................................ 121
LEGAL MATTERS............................................... 125
EXPERTS..................................................... 125
WHERE YOU CAN FIND MORE INFORMATION......................... 125
INDEX TO FINANCIAL STATEMENTS............................... F-1
PROSPECTUS SUMMARY
This summary highlights information more fully described elsewhere in this
prospectus. This summary is not complete and does not contain all the
information you should consider before buying shares of our common stock. You
should read this entire prospectus carefully, including "Risk Factors" and our
consolidated historical and pro forma financial statements and the related notes
included in this prospectus, before deciding to invest in shares of our common
stock.
As of July 12, 2002, Newcastle Investment Holdings Corp. had contributed to
us the following assets, which represented approximately seventy percent of the
total assets of Newcastle Investment Holdings (100% of the real estate
securities and approximately 25% of the real properties, in each case, based on
book value as of June 30, 2002) and related liabilities, in exchange for all of
our outstanding common stock:
- Real estate securities (CBO I and CBO II);
- Credit leased real estate (Bell Canada portfolio and LIV portfolio); and
- Other assets.
In this prospectus we refer to our formation and this transfer of assets
and liabilities as the "initial transactions." We describe each of these assets
and related liabilities in this prospectus under "Newcastle Investment
Corp. -- Our Investments." Unless otherwise noted, all financial and statistical
data that we provide with respect to our investments assumes that the initial
transactions had been completed as of the date such information is given.
NEWCASTLE INVESTMENT CORP.
We invest in real estate securities and other real estate-related assets.
We seek to finance these investments primarily using match-funded financing
structures. Match-funded financing structures match assets and liabilities with
respect to interest rates and maturities. Our objective is to maximize the
difference between the yield on our investments and the cost of financing these
investments while hedging our positions. We are organized and conduct our
operations to qualify as a real estate investment trust (REIT) for federal
income tax purposes.
Newcastle Investment Holdings Corp. currently owns substantially all of our
outstanding common stock. Newcastle Investment Holdings was formed in May 1998.
We were formed in June 2002 for the purpose of separating the real estate
securities and credit leased real estate businesses, our two operating segments,
from Newcastle Investment Holdings. We believe that separating these businesses
from Newcastle Investment Holdings provides an opportunity for achieving more
stable earnings. In connection with our formation, Newcastle Investment Holdings
changed its name from Newcastle Investment Corp. Immediately upon completion of
this offering, Newcastle Investment Holdings will own 68.2% of our common stock
and new investors in this offering will own 28.9% of our common stock, assuming
exercise of all outstanding options.
As a result of the initial transactions, we own a diversified portfolio of
credit sensitive real estate securities, including commercial and residential
mortgage backed securities and unsecured REIT debt, rated primarily BBB (BBB- is
the lowest investment grade rating) and BB (BB+ is the highest non-investment
grade rating). Mortgage backed securities are interests in or obligations
secured by pools of commercial or residential mortgage loans. We also own credit
leased real estate in Canada and Belgium, which we refer to in this prospectus
as the "Bell Canada portfolio" and the "LIV portfolio," respectively. We
consider credit leased real estate to be real estate that is leased primarily to
tenants with, or whose major tenant has, investment grade credit ratings. After
giving effect to the initial transactions as if they had been completed as of
the dates below:
- our portfolio consisted of approximately $1.2 billion of assets at June
30, 2002;
- our portfolio was encumbered by approximately $1.0 billion of debt at
June 30, 2002;
1
- for the year ended December 31, 2001, we had revenues of approximately
$77.4 million, expenses of approximately $50.3 million and income from
continuing operations of approximately $27.1 million;
- for the six months ended June 30, 2002, we had revenues of approximately
$46.7 million, expenses of approximately $28.9 million and income from
continuing operations of approximately $17.8 million; and
- our income from continuing operations per common share was $1.60 for 2001
and $1.05 for the six months ended June 30, 2002.
As of and for the six months ended June 30, 2002, 89% of our total assets
was comprised of real estate securities and 11% was comprised of credit leased
real estate, and 77% of our total revenue was derived from interest and gains on
settlement of investments from our real estate securities and 23% was derived
from rental and escalation income from our credit leased real estate.
We have entered into an agreement with EMC Mortgage Corporation, an
affiliate of Bear, Stearns & Co. Inc., that provides us with an option to
purchase up to $235 million principal amount of mortgage loans. For more
information, including a description of these assets and related financing, see
"Use of Proceeds" and "Newcastle Investment Corp. -- Our Investments."
We intend to focus on increasing our holdings in credit sensitive real
estate securities, including mortgage backed securities and REIT debt
securities, and to continue to invest in other real estate related investments,
including credit leased real estate and mortgage loans. We expect to finance our
real estate securities investments through the issuance of debt securities in
the form of collateralized bond obligations, known as CBOs, which are
obligations issued in multiple classes secured by an underlying portfolio of
securities. CBO transactions offer us structural flexibility to buy and sell
certain investment positions to manage risk and, subject to certain limitations,
to optimize returns.
The annual gross return on our weighted average equity investment of $92.3
million in our first CBO transaction issued in July 1999, which we refer to as
CBO I, was approximately 22.3% from inception through June 30, 2002. On April
25, 2002 we closed our second CBO transaction, which we refer to as CBO II. As
of June 30, 2002, the aggregate dollar amount of the collateral in CBO I and CBO
II is approximately $1.0 billion. The weighted average credit rating of the
collateral in CBO I and CBO II is BBB-. Pursuant to an agreement entered into in
July 2002, Bear, Stearns International Limited, an affiliate of Bear, Stearns &
Co. Inc., will provide financing to purchase securities for, and Bear, Stearns &
Co. Inc. will act as placement agent in connection with, our third CBO
transaction.
OUR INVESTMENT STRATEGY
The keys to our investment strategy are:
- to actively manage our investment portfolio to minimize credit risk;
- to use match-funded financing structures, such as CBOs, to minimize
exposure to interest rate fluctuations and to take advantage of the
structural flexibility offered by CBO transactions to buy and sell
investment positions; and
- to take advantage of our manager's significant existing business
relationships, its expertise in real estate investing and financing,
capital markets, transaction structuring and resolution of distressed
assets, its operational and risk management systems and the economies of
scale associated with its current business operation.
2
OUR COMPETITIVE STRENGTHS
Our competitive strengths include:
- our diversified portfolio, by asset type, industry, location and issuer;
- our match-funding discipline, whereby we seek to match our assets and
liabilities with respect to interest rates and maturities to finance our
investments with like-kind debt;
- our creative financing strategies, in particular, CBOs and lease
securitizations; and
- our experienced management.
OUR MANAGER
We are externally managed and advised by Fortress Investment Group LLC. At
June 30, 2002, Fortress Investment Group and its principals owned approximately
16.4% of the equity of Newcastle Investment Holdings (25.8% upon exercise of
outstanding options). In connection with this offering, we will grant to our
manager an option to purchase 700,000 shares of our common stock, representing
10% of the number of shares being offered hereby, and subject to adjustment if
the underwriters' over-allotment option is exercised, at the offering price of
our shares in this offering. As a result, upon completion of this offering, our
manager and its principals will beneficially own approximately 20.5% of our
common stock, taking into account interests in Newcastle Investment Holdings and
assuming exercise of all of their options. We have no ownership interest in our
manager. Fortress Investment Holdings LLC is the sole member of the manager. The
beneficial owners of Fortress Investment Holdings LLC are Messrs. Wesley R.
Edens, Robert I. Kauffman, Randal A. Nardone and Erik P. Nygaard.
Our chairman and chief executive officer and each of our executive officers
also serve as officers of our manager. Our manager is entitled to receive a base
management fee from us and may receive incentive compensation based on certain
performance criteria.
As required by our management agreement, our manager provides a dedicated
management team to us, including a President, Chief Financial Officer and Chief
Operating Officer, whose primary responsibility is to manage us.
Our manager also serves as manager of Newcastle Investment Holdings. In
addition, our manager also manages other real estate-related assets and intends
to engage in additional management and investment opportunities and investment
vehicles in the future. However, our manager has agreed not to raise or sponsor
any new investment vehicle that targets, as its primary investment category,
investment in credit sensitive real estate securities, although these entities,
and other entities managed by our manager, are not prohibited from investing in
credit sensitive real estate securities.
3
The following chart shows our corporate structure and equity ownership
after giving effect to the initial transactions and this offering. The
percentage ownership information in the chart assumes full exercise of all
outstanding options to purchase shares of our common stock and all outstanding
options to purchase shares of Newcastle Investment Holdings.
[Post-Initial Public Offering Graphic]
SUMMARY RISK FACTORS
An investment in shares of our common stock involves various material
risks. You should consider carefully the risks discussed below and under "Risk
Factors" before purchasing our common stock.
- We are dependent upon our manager and may not find a suitable replacement
if our manager terminates the management agreement.
- We are subject to potential conflicts of interest arising out of our
relationships with our manager, which may result in decisions made that
are not in our best interest.
- Our manager and certain of our officers will devote substantial time to
activities outside of our business, including the management of other
real estate-related vehicles.
- We are subject to potential conflicts of interest arising out of our
relationship with Newcastle Investment Holdings, which may result in
decisions made that are not in our best interest. Our manager manages and
also has an equity interest in both us and in Newcastle Investment
Holdings, which may give rise to conflicts that may result in decisions
that are not in our best interest.
- We were organized in June 2002 and have not operated separately from
Newcastle Investment Holdings and may not operate successfully as a
separate business.
- We pay our manager substantial base management fees regardless of the
performance of our portfolio and may pay incentive compensation based on
our portfolio's performance, which may lead
4
our manager to place emphasis on the maximization of revenues which could
result in increased risk to the value of the invested portfolio.
- We may change our investment strategy at any time without the consent of
our stockholders, which could result in our making investments that are
different from, and possibly riskier than, the investments described in
this prospectus.
- Our ability to vary our portfolio in response to changes in economic and
other conditions may be relatively limited because our real estate assets
are generally illiquid and our real estate securities are unregistered
and may have restrictions on transfer.
- We leverage our assets, which can compound losses and reduce the cash
available for distribution to our stockholders.
- The assets we invest in are subject to the credit risk of the underlying
assets and in the event of default of such assets and the exhaustion of
any underlying credit support, we may not recover our full investment.
- The yield on our investments may be sensitive to changes in prevailing
interest rates and changes in prepayment rates, which may result in a
mismatch between our asset yields and borrowing rates and consequently
reduce or eliminate income derived from our investments.
- We are exposed to credit risk from our tenant, Bell Canada. If the credit
quality of this tenant is downgraded, or if it is unable or unwilling to
timely pay rent, the value of our Bell Canada portfolio would decline.
- If we fail to qualify as a REIT, we will be subject to income tax at
regular corporate rates, which will reduce the cash available for
distribution to our stockholders.
- The REIT qualification rules impose limitations on the types of
investments and activities which we may undertake, including limitations
on our use of hedging transactions and derivatives, and these limitations
may, in some cases, preclude us from pursuing the most economically
beneficial investment alternatives.
- Newcastle Investment Holdings may make a distribution to its stockholders
of shares of our common stock, subject to its lock-up agreement with
Bear, Stearns & Co. Inc. pursuant to which Newcastle Investment Holdings
will agree not to transfer any shares for a period of 180 days after the
date of this prospectus, and substantial sales of these shares may
adversely affect the market price of our common stock.
Newcastle Investment Holdings was incorporated in the State of Maryland in
May 1998. We were incorporated in the State of Maryland in June 2002. Our
principal executive offices are located at 1251 Avenue of the Americas, New
York, New York 10020. Our telephone number is (212) 798-6100.
5
THE OFFERING
The following information assumes that the underwriters do not exercise
their over-allotment option to purchase additional shares in this offering.
Common stock we are offering........ 7,000,000 shares
Common stock to be outstanding after
the offering........................ 23,488,517 shares
Use of proceeds..................... Proceeds will be used to purchase
mortgage loans. See "Use of Proceeds."
Proposed NYSE symbol................ NCT
The number of shares of common stock that will be outstanding after the
offering is based on the number of shares outstanding as of June 30, 2002, and
excludes 700,000 options to be granted to our manager in connection with this
offering, representing 10% of the number of shares being offered hereby, subject
to adjustment if the underwriters' over-allotment option is exercised.
RESTRICTIONS ON OWNERSHIP OF STOCK
Due to limitations on the concentration of ownership of a REIT imposed by
the Internal Revenue Code of 1986, as amended, our charter prohibits any
stockholder from directly or indirectly owning more than 8.0% of the aggregate
value of the outstanding shares of any class or series of our stock, referred to
in this prospectus as the stock ownership limit. Notwithstanding the foregoing,
our board of directors has exercised its right under our charter to exempt
Newcastle Investment Holdings, our manager and certain of its affiliates and
executive officers from such limitation. Our board of directors has also granted
a limited exemption to Wallace R. Weitz & Company, a third party group of funds,
from such limitation.
DISTRIBUTION POLICY
We generally need to distribute at least 90% of our net taxable income each
year (subject to certain adjustments) so as to qualify as a REIT under the
Internal Revenue Code. We may, under certain circumstances, make a distribution
of capital or of assets. Distributions will be made at the discretion of our
board of directors.
6
SUMMARY SELECTED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Newcastle Investment Holdings contributed to us certain assets and related
liabilities in exchange for all of our shares of common stock. However, as
presented in the following table, for accounting purposes this transaction is
presented as a reverse spin-off. Under a reverse spin-off, Newcastle Investment
Corp. is treated as the continuing entity and the assets to be retained by
Newcastle Investment Holdings are accounted for as if they were distributed
through a spin-off to Newcastle Investment Holdings.
As of July 12, 2002, for accounting purposes, we distributed to Newcastle
Investment Holdings assets which represented approximately thirty percent of our
total assets (100% of our real estate loans, our investment in Fortress
Investment Fund (the Fund), and approximately 75% of our real properties, in
each case based on book value as of June 30, 2002) and related liabilities. The
following assets were retained by us:
- Real estate securities (CBO I and CBO II);
- Credit leased real estate (Bell Canada portfolio and LIV portfolio); and
- Other assets.
The following table sets forth certain summary selected financial and
operating information on a pro forma basis.
The summary selected unaudited pro forma consolidated statements of income
are presented as if the distribution had been consummated on January 1, 2002 or
2001, as applicable. The historical results of operations of the assets and
liabilities distributed to Newcastle Investment Holdings have been presented as
discontinued operations for those operations that constitute a component of an
entity. A component of an entity must have cash flows that are clearly
distinguished operationally and for financial reporting purposes from the rest
of the entity. Of the assets distributed to Newcastle Investment Holdings, the
GSA portfolio and the mortgage loans qualify as a component of an entity. The
remaining operations related to the other assets and liabilities distributed to
Newcastle Investment Holdings which are not a component of an entity have been
eliminated.
The summary selected unaudited pro forma consolidated balance sheet is
presented as if the distribution had been consummated on June 30, 2002.
The summary selected unaudited pro forma consolidated financial statements
are presented for comparative purposes only, and are not necessarily indicative
of what our actual financial position or our consolidated results of operations
would have been at the date or for the periods presented, nor do they purport to
represent the results of any future periods. In the opinion of management, all
adjustments necessary to present fairly the unaudited pro forma financial
information have been made. The summary selected pro forma consolidated
financial information set forth below as of June 30, 2002 and for the year ended
December 31, 2001 and the six month periods ended June 30, 2002 and 2001 have
been derived from our unaudited pro forma financial statements.
The information below should be read in conjunction with "Management's
Discussion and Analysis of Pro Forma Financial Condition and Results of
Operations" and the financial statements and notes thereto included in this
prospectus.
7
SUMMARY SELECTED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED
JUNE 30, YEAR ENDED
------------------ DECEMBER 31,
2002 2001 2001
------- ------- ------------
OPERATING DATA
Revenues
Interest and dividend income.............................. $30,861 $24,216 $47,711
Rental and escalation income.............................. 10,788 11,484 22,289
Gain on settlement of investments......................... 5,030 6,390 7,405
Other income.............................................. 9 9 43
------- ------- -------
46,688 42,099 77,448
Expenses
Interest expense.......................................... 19,173 16,842 32,659
Property operating expense................................ 4,761 5,225 9,830
Loan servicing and REO expense............................ 201 116 243
General and administrative expense........................ 1,480 467 1,283
Management fees to affiliates............................. 1,823 1,503 3,642
Depreciation and amortization............................. 1,431 1,321 2,690
------- ------- -------
28,869 25,474 50,347
------- ------- -------
Income from continuing operations........................... $17,819 $16,625 $27,101
======= ======= =======
Income from discontinued operations......................... $ 686 $ 3,407 $ 4,988
======= ======= =======
Income from continuing operations per common share, basic
and diluted............................................... $ 1.05 $ 0.98 $ 1.60
======= ======= =======
Weighted average number of common shares outstanding, basic
and diluted............................................... 16,969 16,977 16,973
======= ======= =======
JUNE 30,
2002
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BALANCE SHEET DATA
CBO collateral, net......................................... $1,006,882
Operating real estate, net.................................. $ 118,233
Cash and cash equivalents................................... $ 1,155
Total assets................................................ $1,165,029
Debt........................................................ $ 958,824
Stockholders' equity........................................ $ 170,962
8
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
------------------- ------------
2002 2001 2001
--------- ------- ------------
OTHER DATA
Cash flow from continuing operations provided by (used in):
Operating activities..................................... $ 14,803 $11,443 $17,483
Investing activities..................................... $(452,404) $(3,359) $(6,973)
Financing activities..................................... $ 408,794 $ 5,318 $16,294
Funds from Operations (FFO) from continuing
operations(A)............................................ $ 19,151 $17,923 $29,738
- ---------------
(A) We believe funds from operations (FFO) is one appropriate measure of the
performance of real estate companies because it provides investors with an
understanding of our ability to incur and service debt and make capital
expenditures. Funds from operations (FFO), for our purposes, represents net
income available for common stockholders (computed in accordance with
accounting principles generally accepted in the United States (GAAP)),
excluding extraordinary items, plus real estate depreciation and
amortization, and after adjustments for unconsolidated subsidiaries, if any.
We consider gains and losses on resolution of our investments to be a normal
part of our recurring operations and, therefore, do not exclude such gains
and losses when arriving at funds from operations (FFO). Adjustments for
unconsolidated subsidiaries, if any, are calculated to reflect funds from
operations (FFO) on the same basis. Funds from operations (FFO) does not
represent cash generated from operating activities in accordance with GAAP
and therefore should not be considered an alternative to net income as an
indicator of our operating performance or as an alternative to cash flow as
a measure of liquidity and is not necessarily indicative of cash available
to fund cash needs.
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
----------------- ------------
2002 2001 2001
------- ------- ------------
CALCULATION OF FUNDS FROM OPERATIONS (FFO)
Income from continuing operations........................... $17,819 $16,625 $27,101
Real estate depreciation and amortization................... 1,332 1,298 2,637
------- ------- -------
Funds from Operations (FFO) from continuing operations...... $19,151 $17,923 $29,738
======= ======= =======
9
SUMMARY SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
OF NEWCASTLE INVESTMENT HOLDINGS CORP.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table sets forth certain summary selected financial and
operating information on a historical consolidated basis.
The historical summary selected consolidated financial information set
forth below as of December 31, 2001, 2000, 1999 and 1998 and for the years ended
December 31, 2001, 2000 and 1999 and for the period from May 11, 1998 to
December 31, 1998 have been derived from Newcastle Investment Holdings' audited
historical consolidated financial statements. The summary selected historical
financial information set forth below as of June 30, 2002 and for the six month
periods ended June 30, 2002 and 2001 have been derived from Newcastle Investment
Holdings' unaudited historical financial statements.
The information below should be read in conjunction with "Management's
Discussion and Analysis of Historical Financial Condition and Results of
Operations" and the financial statements and notes thereto included in this
prospectus.
SIX MONTHS ENDED YEAR ENDED PERIOD
JUNE 30, DECEMBER 31, FROM MAY 11,
-------------------------- ------------------------------------------ 1998 TO
2002 2001 2001 2000 1999 DEC 31, 1998
----------- ------------ ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
OPERATING DATA
Revenues
Interest and dividend
income.................... $ 31,100 $28,370 $ 53,434 $ 65,389 $ 50,245 $19,675
Rental and escalation
income.................... 37,532 38,015 75,979 75,293 64,822 23,143
Gain (loss) on settlement of
investments............... 5,108 8,941 10,386 21,763 (1,526) 2,584
Management fee from
affiliates................ 4,470 4,470 8,941 8,941 944 --
Incentive income (loss) from
affiliates................ (1,218) -- 28,709 -- -- --
Other income................ 12 22 146 1,006 462 369
-------- ------- -------- -------- -------- -------
77,004 79,818 177,595 172,392 114,947 45,771
Expenses
Interest expense............ 32,769 31,949 61,332 66,411 46,529 12,693
Property operating
expense................... 14,276 14,359 28,822 28,264 23,169 7,027
Loan servicing and REO
expense................... 423 511 965 2,325 3,122 1,291
General and administrative
expense................... 1,838 757 2,399 3,988 3,516 2,751
Management fees to
affiliates................ 7,168 7,221 14,687 15,587 8,351 6,751
Incentive return to
affiliates................ 827 -- 17,188 -- -- --
Depreciation and
amortization.............. 6,802 6,383 13,049 12,244 10,383 4,165
-------- ------- -------- -------- -------- -------
64,103 61,180 138,442 128,819 95,070 34,678
-------- ------- -------- -------- -------- -------
Income (loss) before equity in
earnings of unconsolidated
subsidiaries and minority
interest.................... 12,901 18,638 39,153 43,573 19,877 11,093
Equity in earnings (losses) of
unconsolidated
subsidiaries................ 362 1,125 2,807 (980) (3,615) 117
Minority interest in (income)
loss of consolidated
subsidiaries................ (13) (208) 83 (748) (1,258) (570)
-------- ------- -------- -------- -------- -------
10
SIX MONTHS ENDED YEAR ENDED PERIOD
JUNE 30, DECEMBER 31, FROM MAY 11,
-------------------------- ------------------------------------------ 1998 TO
2002 2001 2001 2000 1999 DEC 31, 1998
----------- ------------ ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
Income from continuing
operations.................. 13,250 19,555 42,043 41,845 15,004 10,640
Discontinued operations....... 1,009 682 1,628 1,015 149 --
Extraordinary item -- loss on
extinguishment of debt...... -- -- -- -- (2,341) --
-------- ------- -------- -------- -------- -------
Income before change in
accounting principle........ 14,259 20,237 43,671 42,860 12,812 10,640
Cumulative effect of change in
accounting
principle -- write off of
organizational costs........ -- -- -- -- (513) --
-------- ------- -------- -------- -------- -------
Net Income.................... 14,259 20,237 43,671 42,860 12,299 10,640
Preferred dividends and
related accretion........... (1,162) (1,264) (2,540) (2,084) -- --
-------- ------- -------- -------- -------- -------
Income available for common
shareholders................ $ 13,097 $18,973 $ 41,131 $ 40,776 $ 12,299 $10,640
======== ======= ======== ======== ======== =======
Net Income per Common Share,
basic and diluted........... $ 0.79 $ 1.15 $ 2.49 $ 2.16 $ 0.59 $ 0.51
======== ======= ======== ======== ======== =======
Income from continuing
operations per common share,
after preferred dividends
and related accretion, basic
and diluted................. $ 0.73 $ 1.11 $ 2.39 $ 2.11 $ 0.72 $ 0.51
======== ======= ======== ======== ======== =======
Income from discontinued
operations per common share,
basic and diluted........... $ 0.06 $ 0.04 $ 0.10 $ 0.05 $ -- $ --
======== ======= ======== ======== ======== =======
Effect of extraordinary item
per common share, basic and
diluted..................... $ -- $ -- $ -- $ -- $ (0.11) $ --
======== ======= ======== ======== ======== =======
Effect of change in accounting
principle per common share,
basic and diluted........... $ -- $ -- $ -- $ -- $ (0.02) $ --
======== ======= ======== ======== ======== =======
Weighted average number of
common shares outstanding,
basic and diluted........... 16,489 16,497 16,493 18,892 20,917 20,862
======== ======= ======== ======== ======== =======
Dividends declared per common
share....................... $ 1.20 $ 1.00 $ 2.00 $ 1.50 $ 2.04 $ 0.55
======== ======= ======== ======== ======== =======
DECEMBER 31,
JUNE 30, ---------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
BALANCE SHEET DATA
CBO collateral, net.......... $1,006,882 $ 522,258 $ 509,729 $ 504,669 $ --
Operating real estate, net... $ 487,628 $ 524,834 $ 540,539 $ 558,849 $383,073
Cash and cash equivalents.... $ 13,578 $ 31,360 $ 10,575 $ 14,345 $ 75,596
Total assets................. $1,681,102 $1,262,119 $1,331,086 $1,381,600 $765,650
Debt......................... $1,309,727 $ 897,390 $ 975,656 $ 971,260 $336,845
Stockholders' equity......... $ 318,224 $ 310,545 $ 300,655 $ 354,673 $384,924
11
SIX MONTHS ENDED PERIOD
JUNE 30, YEAR ENDED DECEMBER 31, FROM MAY 11,
--------------------------- ------------------------------------------ 1998 TO
2002 2001 2001 2000 1999 DEC 31, 1998
------------ ------------ ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
OTHER DATA
Cash flow provided by
(used in):
Operating activities... $ 18,452 $ 13,274 $ 34,448 $ 24,823 $ 32,834 $ (7,230)
Investing activities... $(393,124) $ 66,279 $ 106,053 $ 151,632 $(683,420) $(638,844)
Financing activities... $ 356,890 $(85,254) $(119,716) $(180,225) $ 589,335 $ 721,670
Funds from Operations
(FFO)(A)............... $ 19,470 $ 25,946 $ 48,264 $ 53,523 $ 24,707 $ 14,337
- ---------------
(A) We believe funds from operations (FFO) is one appropriate measure of the
performance of real estate companies because it provides investors with an
understanding of our ability to incur and service debt and make capital
expenditures. Funds from operations (FFO), for our purposes, represents net
income available for common stockholders (computed in accordance with GAAP),
excluding extraordinary items, plus real estate depreciation and
amortization, and after adjustments for unconsolidated subsidiaries. We
consider gains and losses on resolution of our investments to be a normal
part of our recurring operations and, therefore, do not exclude such gains
and losses when arriving at funds from operations (FFO). In addition, we
exclude accrued incentive income (loss) from Fortress Investment Fund (the
Fund or FIF) and include incentive income distributed or distributable from
the Fund in accordance with the operating agreement of the Fund since this
more accurately reflects cash distributed or distributable to us from the
Fund, while our accrued incentive income is based upon the fair value of the
Fund's net assets, which is subject to fluctuation in future periods.
Adjustments for unconsolidated subsidiaries are calculated to reflect funds
from operations (FFO) on the same basis. Funds from operations (FFO) does
not represent cash generated from operating activities in accordance with
GAAP and therefore should not be considered an alternative to net income as
an indicator of our operating performance or as an alternative to cash flow
as a measure of liquidity and is not necessarily indicative of cash
available to fund cash needs.
SIX MONTHS ENDED PERIOD
JUNE 30, YEAR ENDED DECEMBER 31, FROM MAY 11,
-------------------------- ------------------------------------------ 1998 TO
2002 2001 2001 2000 1999 DEC 31, 1998
----------- ------------ ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
CALCULATION OF FUNDS FROM
OPERATIONS (FFO):
Income available for common
shareholders............... $13,097 $18,973 $ 41,131 $40,776 $12,299 $10,640
Extraordinary item -- loss on
extinguishment of debt..... -- -- -- -- 2,341 --
Real estate depreciation and
amortization............... 6,591 6,363 12,909 12,621 9,927 3,697
Accumulated depreciation on
real estate sold........... (2,371) -- -- -- -- --
Real estate depreciation and
amortization -- unconsolidated
subsidiaries............... 1,614 610 2,564 126 140 --
Incentive (income) loss
accrued from FIF(A)........ 609 -- (14,354) -- -- --
Equity in incentive return
accrued by FIF............. (70) -- 1,645 -- -- --
Distributable incentive
income from FIF(B)......... -- -- 4,369 -- -- --
------- ------- -------- ------- ------- -------
Funds from Operations (FFO).. $19,470 $25,946 $ 48,264 $53,523 $24,707 $14,337
======= ======= ======== ======= ======= =======
12
- ---------------
(A) Represents our 50% interest in the incentive income as follows:
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 2002 DECEMBER 31, 2001
---------------- -----------------
(UNAUDITED)
Total incentive income
(loss)..................... $(1,218) $ 28,709
Manager portion.............. $ 609 $(14,355)
------- --------
Our incentive income
(loss).................. $ (609) $ 14,354
======= ========
(B) Represents our 50% interest in the distributable incentive income:
Total distributable incentive income.................. $ 8,738
Distributable incentive income due Manager............ $(4,369)
-------
Our distributable incentive income.................. $ 4,369
=======
13
RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should carefully consider the following information, together with the other
information contained in this prospectus, before buying shares of our common
stock. In connection with the forward-looking statements that appear in this
prospectus, you should also carefully review the cautionary statement referred
to under "Cautionary Statement Regarding Forward-Looking Statements."
RISKS RELATING TO OUR MANAGEMENT
WE ARE DEPENDENT ON OUR MANAGER AND MAY NOT FIND A SUITABLE REPLACEMENT IF OUR
MANAGER TERMINATES THE MANAGEMENT AGREEMENT.
We have no employees. Our officers are employees of our manager. We have no
separate facilities and are completely reliant on our manager, which has
significant discretion as to the implementation of our operating policies and
strategies. We are subject to the risk that our manager will terminate the
management agreement and that no suitable replacement will be found to manage
us. We believe that our success depends to a significant extent upon the
experience of the manager's executive officers, whose continued service is not
guaranteed.
THERE ARE CONFLICTS OF INTEREST IN OUR RELATIONSHIP WITH OUR MANAGER.
Our chairman and chief executive officer and each of our executive officers
also serve as officers of our manager. As a result, the management agreement was
not negotiated at arm's-length and its terms, including fees payable, may not be
as favorable to us as if it had been negotiated with an unaffiliated third
party.
Our manager also manages and invests in other real estate-related
investment vehicles, including Newcastle Investment Holdings, and our chairman
and chief executive officer and some of our other officers also serve as
officers and/or directors of these other entities. As a result, they may not be
able to devote sufficient time to the management of our business operations. For
example, our manager manages Fortress Investment Fund, which has a substantial
investment in Capstead Mortgage Corporation, a publicly traded mortgage REIT.
Our chairman and chief executive officer, who is also an officer of our manager,
also serves as chairman and chief executive officer of Capstead. Capstead's
portfolio consists primarily of adjustable-rate residential mortgage backed
securities issued by Fannie Mae, Freddie Mac and Ginnie Mae. However, Capstead
has a broader investment mandate, which could lead to a future conflict with our
business. Certain investments appropriate for us may also be appropriate for one
or more of these other investment vehicles and our manager may decide to make a
particular investment through another investment vehicle rather than through us.
Our manager also intends to engage in additional real estate-related management
and investment opportunities in the future which may also compete with us for
investments.
Our management agreement with our manager generally does not limit or
restrict our manager from engaging in any business or managing any other vehicle
that invests generally in real estate securities. The ability of our manager and
its officers and employees to engage in these other business activities will
reduce the time our manager spends managing us. The manager is required to seek
the approval of the independent members of our board of directors before we
engage in a material transaction with another entity managed by our manager.
The management compensation structure that we have agreed to with our
manager may cause our manager to invest in high risk investments. In addition to
its management fee, our manager is entitled to receive incentive compensation
based in part upon our achievement of targeted levels of funds from operations.
In evaluating investments and other management strategies, the opportunity to
earn incentive compensation based on funds from operations may lead our manager
to place undue emphasis on the maximization of funds from operations at the
expense of other criteria, such as preservation of capital, in
14
order to achieve higher incentive compensation. Investments with higher yield
potential are generally riskier or more speculative. This could result in
increased risk to the value of our invested portfolio.
Termination of the management agreement with our manager is difficult and
costly. The management agreement may only be terminated annually upon the
affirmative vote of at least two-thirds of our independent directors, or by a
vote of the holders of a majority of the outstanding shares of our common stock,
based upon (1) unsatisfactory performance by our manager that is materially
detrimental to us or (2) a determination that the compensation to our manager is
not fair, subject to our manager's right to prevent such a compensation
termination by accepting a mutually acceptable reduction of fees. Our manager
will be provided 60 days' prior notice of any termination and will be paid a
termination fee equal to the amount of the management fee earned by the manager
during the twelve-month period preceding such termination. In addition,
following any termination of the management agreement, the manager may require
us to purchase its right to receive incentive compensation at a price determined
as if our assets were sold for their fair market value (as determined by an
appraisal, taking into account, among other things, the expected future value of
the underlying investments) or otherwise we may continue to pay the incentive
compensation to our manager. These provisions may increase the effective cost to
us of terminating the management agreement, thereby adversely affecting our
ability to terminate our manager without cause.
THERE ARE CONFLICTS OF INTEREST IN OUR RELATIONSHIP WITH NEWCASTLE INVESTMENT
HOLDINGS.
Our chairman and chief executive officer also serves as chairman and chief
executive officer of Newcastle Investment Holdings and, at the time the initial
transactions and other organizational matters were approved for us, Newcastle
Investment Holdings was our sole stockholder. As a result, these matters were
not approved at arm's length and the terms of the transfer may not be as
favorable to us as if the transfer was with an unaffiliated third party. Our
manager also manages and has an equity interest in both us and in Newcastle
Investment Holdings. In addition, we may enter into transactions in the future
with Newcastle Investment Holdings with the approval of the independent members
of our board.
WE HAVE NO SEPARATE OPERATING HISTORY FROM NEWCASTLE INVESTMENT HOLDINGS AND MAY
NOT OPERATE SUCCESSFULLY AS A SEPARATE BUSINESS.
Newcastle Investment Holdings was organized in May 1998. We were organized
in June 2002, our investments we describe in this prospectus were contributed to
us in July 2002 and we have not operated separately from Newcastle Investment
Holdings. The results of our operations will depend on many factors, including
the availability of opportunities for the acquisition of assets, the level and
volatility of interest rates, readily accessible short and long term funding,
alternative conditions in the financial markets and economic conditions, and we
may not operate successfully as a separate business. We will face substantial
competition in acquiring suitable investments, which could increase our costs.
OUR DIRECTORS HAVE APPROVED VERY BROAD INVESTMENT GUIDELINES FOR OUR MANAGER AND
DO NOT APPROVE EACH INVESTMENT DECISION MADE BY OUR MANAGER.
Our manager is authorized to follow very broad investment guidelines. Our
directors will periodically review our investment guidelines and our investment
portfolio. However, our board does not review each proposed investment. In
addition, in conducting periodic reviews, the directors rely primarily on
information provided to them by our manager. Furthermore, transactions entered
into by our manager may be difficult or impossible to unwind by the time they
are reviewed by the directors. Our manager has great latitude within the broad
investment guidelines in determining the types of assets it may decide are
proper investments for us.
15
WE MAY CHANGE OUR INVESTMENT STRATEGY WITHOUT STOCKHOLDER CONSENT WHICH MAY
RESULT IN RISKIER INVESTMENTS THAN OUR CURRENT INVESTMENTS.
We may change our investment strategy at any time without the consent of
our stockholders, which could result in our making investments that are
different from, and possibly riskier than, the investments described in this
prospectus. A change in our investment strategy may increase our exposure to
interest rate and real estate market fluctuations.
RISKS RELATING TO OUR BUSINESS
WE ARE SUBJECT TO SIGNIFICANT COMPETITION AND WE MAY NOT COMPETE SUCCESSFULLY.
We are subject to significant competition in seeking investments. We
compete with several other companies, including other REITs, insurance companies
and other investors, including funds and companies affiliated with our manager.
Some of our competitors have greater resources than us and we may not be able to
compete successfully for investments.
WE LEVERAGE OUR PORTFOLIO, WHICH MAY ADVERSELY AFFECT OUR RETURN ON OUR
INVESTMENTS AND MAY REDUCE CASH AVAILABLE FOR DISTRIBUTION.
We leverage our portfolio through borrowings, generally through the use of
bank credit facilities, repurchase agreements, mortgage loans on real estate,
securitizations, including the issuance of CBOs, and other borrowings. The
percentage of leverage varies depending on our ability to obtain credit
facilities and the lender's estimate of the stability of the portfolio's cash
flow. We currently have a policy limiting the use of leverage up to 90% of the
value of our assets on an aggregate basis. Our return on our investments and
cash available for distribution to our stockholders may be reduced to the extent
that changes in market conditions cause the cost of our financing to increase
relative to the income that can be derived from the assets acquired.
Our debt service payments reduce the net income available for distributions
to stockholders. After giving effect to the initial transactions as if they
occurred as of that date, for the year ended December 31, 2001, our debt service
payments were $1.1 million and $35.0 million of principal and interest payments,
respectively, and for the six months ended June 30, 2002, our debt service
payments were $1.0 million and $15.1 million of principal and interest payments,
respectively, excluding debt repayments from the proceeds of asset sales and
refinancings. We may not be able to meet our debt service obligations and, to
the extent that we cannot, we risk the loss of some or all of our assets to
foreclosure or sale to satisfy our debt obligations.
We may leverage certain of our investments through repurchase agreements. A
decrease in the value of the assets may lead to margin calls which we will have
to satisfy. We may not have the funds available to satisfy any such margin
calls.
THE MORTGAGE LOANS WE MAY INVEST IN AND THE MORTGAGE LOANS UNDERLYING THE
MORTGAGE BACKED SECURITIES WE INVEST IN ARE SUBJECT TO DELINQUENCY, FORECLOSURE
AND LOSS, WHICH COULD RESULT IN LOSSES TO US.
Commercial mortgage loans are secured by multifamily or commercial property
and are subject to risks of delinquency and foreclosure, and risks of loss that
are greater than similar risks associated with loans made on the security of
single-family residential property. The ability of a borrower to repay a loan
secured by an income-producing property typically is dependent primarily upon
the successful operation of such property rather than upon the existence of
independent income or assets of the borrower. If the net operating income of the
property is reduced, the borrower's ability to repay the loan may be impaired.
Net operating income of an income-producing property can be affected by, among
other things: tenant mix, success of tenant businesses, property management
decisions, property location and condition, competition from comparable types of
properties, changes in laws that increase operating expense or limit rents that
may be charged, any need to address environmental contamination at the property,
the occurrence of any uninsured casualty at the property, changes in national,
regional or local economic conditions and/or
16
specific industry segments, declines in regional or local real estate values,
declines in regional or local rental or occupancy rates, increases in interest
rates, real estate tax rates and other operating expenses, changes in
governmental rules, regulations and fiscal policies, including environmental
legislation, acts of God, terrorism, social unrest and civil disturbances.
Residential mortgage loans are secured by single-family residential
property and are subject to risks of delinquency and foreclosure, and risks of
loss. The ability of a borrower to repay a loan secured by a residential
property is dependent upon the income or assets of the borrower. A number of
factors, including a general economic downturn, acts of God, terrorism, social
unrest and civil disturbances, may impair borrowers' abilities to repay their
loans.
In the event of any default under a mortgage loan held directly by us, we
will bear a risk of loss of principal to the extent of any deficiency between
the value of the collateral and the principal and accrued interest of the
mortgage loan, which could have a material adverse effect on our cash flow from
operations. In the event of the bankruptcy of a mortgage loan borrower, the
mortgage loan to such borrower will be deemed to be secured only to the extent
of the value of the underlying collateral at the time of bankruptcy (as
determined by the bankruptcy court), and the lien securing the mortgage loan
will be subject to the avoidance powers of the bankruptcy trustee or
debtor-in-possession to the extent the lien is unenforceable under state law.
Foreclosure of a mortgage loan can be an expensive and lengthy process which
could have a substantial negative effect on our anticipated return on the
foreclosed mortgage loan.
Residential mortgage backed securities evidence interests in or are secured
by pools of residential mortgage loans and commercial mortgage backed securities
evidence interests in or are secured by a single commercial mortgage loan or a
pool of commercial mortgage loans. Accordingly, the mortgage backed securities
we invest in are subject to all of the risks of the underlying mortgage loans.
OUR INVESTMENTS IN SUBORDINATED MORTGAGE BACKED SECURITIES ARE SUBJECT TO
LOSSES.
In general, losses on an asset securing a mortgage loan included in a
securitization will be borne first by the equity holder of the property, then by
a cash reserve fund or letter of credit, if any, and then by the "first loss"
subordinated security holder. In the event of default and the exhaustion of any
equity support, reserve fund, letter of credit and any classes of securities
junior to those in which we invest, we will not be able to recover all of our
investment in the securities we purchase. In addition, if the underlying
mortgage portfolio has been overvalued by the originator, or if the values
subsequently decline and, as a result, less collateral is available to satisfy
interest and principal payments due on the related mortgage backed securities,
the securities in which we invest may effectively become the "first loss"
position behind the more senior securities, which may result in significant
losses to us.
The prices of lower credit quality securities are generally less sensitive
to interest rate changes than more highly rated investments, but more sensitive
to adverse economic downturns or individual issuer developments. A projection of
an economic downturn, for example, could cause a decline in the price of lower
credit quality securities because the ability of obligors of mortgages
underlying mortgage backed securities to make principal and interest payments
may be impaired. In such event, existing credit support in the securitization
structure may be insufficient to protect us against loss of our principal on
these securities.
OUR INVESTMENTS IN REIT DEBT SECURITIES ARE SUBJECT TO SPECIFIC RISKS RELATING
TO THE PARTICULAR REIT ISSUER OF THE SECURITIES AND TO THE GENERAL RISKS OF
INVESTING IN SUBORDINATED REAL ESTATE SECURITIES, WHICH MAY RESULT IN LOSSES TO
US.
Our investments in REIT debt securities involve special risks. REITs
generally are required to substantially invest in real estate or real
estate-related assets and are subject to the inherent risks associated with real
estate-related investments discussed in this prospectus. Our investments in REIT
debt securities are subject to the risks described above with respect to
mortgage loans and mortgage backed securities and similar risks, including (i)
risks of delinquency and foreclosure, and risks of loss in the event thereof,
(ii) the dependence upon the successful operation of and net income from real
property, (iii) risks
17
generally incident to interests in real property, and (iv) risks that may be
presented by the type and use of a particular commercial property.
REIT debt securities are generally unsecured and may also be subordinated
to other obligations of the issuer. We may also invest in REIT debt securities
that are rated below investment grade. As a result, investments in REIT debt
securities are also subject to risks of: (i) limited liquidity in the secondary
trading market, (ii) substantial market price volatility resulting from changes
in prevailing interest rates, (iii) subordination to the prior claims of banks
and other senior lenders to the issuer, (iv) the operation of mandatory sinking
fund or call/redemption provisions during periods of declining interest rates
that could cause the issuer to reinvest premature redemption proceeds in lower
yielding assets, (v) the possibility that earnings of the REIT debt security
issuer may be insufficient to meet its debt service and (vi) the declining
creditworthiness and potential for insolvency of the issuer of such REIT debt
securities during periods of rising interest rates and economic downturn. These
risks may adversely affect the value of outstanding REIT debt securities and the
ability of the issuers thereof to repay principal and interest.
THE B NOTES WE INVEST IN MAY BE SUBJECT TO ADDITIONAL RISKS RELATING TO THE
PRIVATELY NEGOTIATED STRUCTURE AND TERMS OF THE TRANSACTION, WHICH MAY RESULT IN
LOSSES TO US.
We intend to invest in one or more "B Notes." A "B Note" is a mortgage loan
typically (a) secured by a first mortgage on a single large commercial property
or group of related properties and (b) subordinated to an "A Note" secured by
the same first mortgage on the same collateral. As a result, if an issuer
defaults, there may not be sufficient funds remaining for B Note holders. B
Notes reflect similar credit risks to comparably rated commercial mortgage
backed securities. However, since each transaction is privately negotiated, B
Notes can vary in their structural characteristics and risks. For example, the
rights of holders of B Notes to control the process following a borrower default
may vary from transaction to transaction. Further, B Notes typically are secured
by a single property, and so reflect the risks associated with significant
concentration. B Notes also are less liquid than commercial mortgage backed
securities.
OUR INSURANCE ON OUR REAL ESTATE AND INSURANCE ON OUR REAL ESTATE COLLATERAL MAY
NOT COVER ALL LOSSES.
There are certain types of losses, generally of a catastrophic nature, such
as earthquakes, floods, hurricanes, terrorism or acts of war, that may be
uninsurable or not economically insurable. Inflation, changes in building codes
and ordinances, environmental considerations, and other factors, including
terrorism or acts of war, also might make the insurance proceeds insufficient to
repair or replace a property if it is damaged or destroyed. Under such
circumstances, the insurance proceeds received might not be adequate to restore
our economic position with respect to the affected real property.
As a result of the events of September 11, 2001, insurance companies are
limiting and/or excluding coverage for acts of terrorism in insurance policies.
As a result, we may suffer losses from acts of terrorism that are not covered by
insurance. In addition, the mortgage loans which are secured by certain of our
properties contain customary covenants, including covenants that require us to
maintain property insurance in an amount equal to the replacement cost of the
properties. There can be no assurance that the lenders under our mortgage loans
will not take the position that exclusions from our coverage for losses due to
terrorist acts is a breach of a covenant which, if uncured, could allow the
lenders to declare an event of default and accelerate repayment of the mortgage
loans.
ENVIRONMENTAL COMPLIANCE COSTS AND LIABILITIES WITH RESPECT TO OUR REAL ESTATE
MAY AFFECT OUR RESULTS OF OPERATIONS.
Our operating costs may be affected by our obligation to pay for the cost
of complying with existing environmental laws, ordinances and regulations, as
well as the cost of complying with future legislation with respect to the
assets, or loans secured by assets, with environmental problems that materially
impair the value of the assets. Under various federal, state and local
environmental laws, ordinances and regulations, a current or previous owner or
operator of real property may be liable for the costs of removal or remediation
of hazardous or toxic substances on, under, or in such property. Such laws often
impose
18
liability whether or not the owner or operator knew of, or was responsible for,
the presence of such hazardous or toxic substances. In addition, the presence of
hazardous or toxic substances, or the failure to remediate properly, may
adversely affect the owner's ability to borrow by using such real property as
collateral. Certain environmental laws and common law principles could be used
to impose liability for releases of hazardous materials, including
asbestos-containing materials into the environment, and third parties may seek
recovery from owners or operators of real properties for personal injury
associated with exposure to released asbestos-containing materials or other
hazardous materials. Environmental laws may also impose restrictions on the
manner in which a property may be used or transferred or in which businesses may
be operated, and these restrictions may require expenditures. In connection with
the ownership and operation of properties, we may be potentially liable for any
such costs. The cost of defending against claims of liability or remediating
contaminated property and the cost of complying with environmental laws could
materially adversely affect our results of operations and financial condition.
MANY OF OUR INVESTMENTS ARE ILLIQUID AND WE MAY NOT BE ABLE TO VARY OUR
PORTFOLIO IN RESPONSE TO CHANGES IN ECONOMIC AND OTHER CONDITIONS.
Real estate and real estate-related assets are generally illiquid. In
addition, the real estate securities that we purchase in connection with
privately negotiated transactions are not registered under the relevant
securities laws, resulting in a prohibition against their transfer, sale, pledge
or other disposition except in a transaction that is exempt from the
registration requirements of, or is otherwise in accordance with, those laws. A
majority of the mortgage backed securities and REIT debt securities, and all of
the B Notes, that we purchase are purchased in private, unregistered
transactions and are therefore subject to restrictions on resale or otherwise
have no established trading market. As a result, our ability to vary our
portfolio in response to changes in economic and other conditions may be
relatively limited.
INTEREST RATE FLUCTUATIONS MAY CAUSE LOSSES.
Our primary interest rate exposures relate to our loans, mortgage backed
securities and variable-rate debt, as well as our interest rate swaps and caps
that we primarily utilize for hedging purposes. Changes in interest rates can
affect our net interest income, which is the difference between the interest
income we earn on our interest-earning investments and the interest expense we
incur in financing these investments. Changes in the level of interest rates
also can affect our ability to originate and acquire assets, the value of our
assets and our ability to realize gains from the settlement of such assets.
In a period of rising interest rates, our interest expense could increase
while the interest we earn on our fixed-rate mortgage backed securities would
not change. This would adversely affect our profitability.
Our operating results will depend in large part on differences between the
income from our assets, net of credit losses, and our financing costs. We
anticipate that, in most cases, for any period during which our assets are not
match-funded, the income from such assets will respond more slowly to interest
rate fluctuations than the cost of our borrowings. Consequently, changes in
interest rates, particularly short-term interest rates, may significantly
influence our net income. Increases in these rates will tend to decrease our net
income and market value of our assets. Interest rate fluctuations resulting in
our interest expense exceeding interest income would result in operating losses
for us.
OUR HEDGING TRANSACTIONS MAY LIMIT OUR GAINS OR RESULT IN LOSSES.
We use derivatives to hedge our liabilities and this has certain risks,
including the risk that losses on a hedge position will reduce the cash
available for distribution to stockholders and that such losses may exceed the
amount invested in such instruments. Our board of directors has adopted a
general policy with respect to the use of derivatives, which generally allows us
to use derivatives where appropriate, but does not set forth specific policies
and procedures. We use derivative instruments, including forwards, futures,
swaps and options, in our risk management strategy to limit the effects of
changes in interest rates on our operations. A hedge may not be effective in
eliminating all of the risks inherent in any particular position. Our
profitability may be adversely affected during any period as a result of the use
of derivatives.
19
WE MAY NOT BE ABLE TO ACQUIRE ELIGIBLE SECURITIES FOR A CBO ISSUANCE, OR MAY NOT
BE ABLE TO ISSUE CBO SECURITIES ON ATTRACTIVE TERMS, WHICH MAY REQUIRE US TO
SEEK MORE COSTLY FINANCING FOR OUR INVESTMENTS OR TO LIQUIDATE ASSETS.
We acquire real estate securities and finance them on a long-term basis,
such as through the issuance of collateralized bond obligations. During the
period that we are acquiring these assets, we finance our purchases through
relatively short-term credit facilities. We use these warehouse lines of credit
to finance the acquisition of real estate securities until a sufficient quantity
of securities is accumulated at which time we may refinance these lines through
a securitization, such as a CBO issuance, or other long-term financing. As a
result, we are subject to the risk that we will not be able to acquire, during
the period that our warehouse facility is available, a sufficient amount of
eligible securities to maximize the efficiency of a collateralized bond
obligation issuance. In addition, conditions in the capital markets may make the
issuance of a collateralized bond obligation less attractive to us when we do
have a sufficient pool of collateral. If we are unable to issue a collateralized
bond obligation to finance these assets, we may be required to seek such other
forms of potentially less attractive financing or otherwise to liquidate the
assets.
PREPAYMENT RATES CAN INCREASE, ADVERSELY AFFECTING YIELDS ON OUR INVESTMENTS.
The value of our assets may be affected by prepayment rates on mortgage
loans. Prepayment rates on mortgage loans are influenced by changes in current
interest rates and a variety of economic, geographic and other factors beyond
our control, and consequently, such prepayment rates cannot be predicted with
certainty. In periods of declining mortgage interest rates, prepayments on
mortgage loans generally increase. If general interest rates decline as well,
the proceeds of such prepayments received during such periods are likely to be
reinvested by us in assets yielding less than the yields on the assets that were
prepaid. In addition, the market value of the mortgage assets may, because of
the risk of prepayment, benefit less than other fixed-income securities from
declining interest rates. Conversely, in periods of rising interest rates,
prepayments on mortgage loans generally decrease, in which case we would not
have the prepayment proceeds available to invest in assets with higher yields.
Under certain interest rate and prepayment scenarios we may fail to recoup fully
our cost of acquisition of certain investments.
OUR INTERNATIONAL INVESTMENTS ARE SUBJECT TO CURRENCY RATE EXPOSURE AND THE
UNCERTAINTY OF FOREIGN LAWS AND MARKETS.
We own real estate located in Canada and in Belgium, which in addition to
all the risks inherent in the investment in real estate generally discussed in
this prospectus are also subject to fluctuations in foreign currency exchange
rates, unexpected changes in regulatory requirements, political and economic
instability in certain geographic locations, difficulties in managing
international operations, potentially adverse tax consequences, enhanced
accounting and control expenses and the burden of complying with a wide variety
of foreign laws. A change in foreign currency exchange rates may adversely
impact returns on our non-dollar denominated investments. Our principal currency
exposures are to the Euro and the Canadian Dollar. Changes in the currency rates
can adversely impact the fair values and earnings streams of our international
holdings. We generally do not directly hedge our foreign currency risk through
the use of derivatives, due to, among other things, REIT income qualification
issues.
WE ARE EXPOSED TO CREDIT RISK FROM BELL CANADA.
After giving effect to the initial transactions as if they occurred as of
such date, approximately 5.9% of our total assets at December 31, 2001 and 5.2%
of our total assets at June 30, 2002 consisted of properties leased to Bell
Canada. If the credit quality of this tenant is downgraded, or if it is unable
or unwilling to timely pay rent, the value of our Bell Canada portfolio would
decline.
20
RISKS RELATED TO OUR COMPANY
OUR FAILURE TO QUALIFY AS A REIT WOULD RESULT IN HIGHER TAXES AND REDUCED CASH
AVAILABLE FOR STOCKHOLDERS.
We intend to operate in a manner so as to qualify as a REIT for federal
income tax purposes. Although we do not intend to request a ruling from the
Internal Revenue Service (the IRS) as to our REIT status, we will receive the
opinion of Skadden, Arps, Slate, Meagher & Flom LLP with respect to our
qualification as a REIT. This opinion will be issued in connection with this
offering of common stock. Investors should be aware, however, that opinions of
counsel are not binding on the IRS or any court. The opinion of Skadden, Arps,
Slate, Meagher & Flom LLP will represent only the view of our counsel based on
our counsel's review and analysis of existing law and on certain representations
as to factual matters and covenants made by us and our manager, including
representations relating to the values of our assets and the sources of our
income. The opinion of Skadden, Arps, Slate, Meagher & Flom LLP also relies on
various legal opinions issued by other counsel for Newcastle and its
predecessors with respect to certain issues and transactions. The opinions,
copies of which are filed as an exhibit to the registration statement of which
this prospectus is a part, are expressed as of the date issued, and do not cover
subsequent periods. Counsel will have no obligation to advise us or the holders
of our common stock of any subsequent change in the matters stated, represented
or assumed, or of any subsequent change in applicable law. Furthermore, both the
validity of the opinion of Skadden, Arps, Slate, Meagher & Flom LLP, and our
continued qualification as a REIT will depend on our satisfaction of certain
asset, income, organizational, distribution, stockholder ownership and other
requirements on a continuing basis, the results of which will not be monitored
by Skadden, Arps, Slate, Meagher & Flom LLP. Our ability to satisfy the asset
tests depends upon our analysis of the fair market values of our assets, some of
which are not susceptible to a precise determination, and for which we will not
obtain independent appraisals. Our compliance with the REIT income and quarterly
asset requirements also depends upon our ability to successfully manage the
composition of our income and assets on an ongoing basis. Moreover, the proper
classification of an instrument as debt or equity for federal income tax
purposes may be uncertain in some circumstances, which could affect the
application of the REIT qualification requirements as described below.
Accordingly, there can be no assurance that the IRS will not contend that our
interests in subsidiaries or other issuers will not cause a violation of the
REIT requirements. If we were to fail to qualify as a REIT in any taxable year,
we would be subject to federal income tax, including any applicable alternative
minimum tax, on our taxable income at regular corporate rates, and distributions
to stockholders would not be deductible by us in computing our taxable income.
Any such corporate tax liability could be substantial and would reduce the
amount of cash available for distribution to our stockholders, which in turn
could have an adverse impact on the value of, and trading prices for, our common
stock. Unless entitled to relief under certain Internal Revenue Code provisions,
we also would be disqualified from taxation as a REIT for the four taxable years
following the year during which we ceased to qualify as a REIT. The rule against
re-electing REIT status following a loss of such status would also apply to us
if Newcastle Investment Holdings fails to qualify as a REIT, and we are treated
as a successor to Newcastle Investment Holdings for federal income tax purposes.
See "Federal Income Tax Considerations" for a discussion of material federal
income tax consequences relating to us and our common stock.
REIT DISTRIBUTION REQUIREMENTS COULD ADVERSELY AFFECT OUR LIQUIDITY.
We generally must distribute annually at least 90% of our net taxable
income, excluding any net capital gain, in order for corporate income tax not to
apply to earnings that we distribute. We intend to make distributions to our
stockholders to comply with the requirements of the Internal Revenue Code.
However, differences in timing between the recognition of taxable income and the
actual receipt of cash could require us to sell assets or borrow funds on a
short-term or long-term basis to meet the 90% distribution requirement of the
Internal Revenue Code. Certain of our assets generate substantial mismatches
between taxable income and available cash. Such assets include (a) rental real
estate that has been financed through financing structures which require some or
all of available cash flows to be used to service borrowings and (b) mortgage
backed securities we hold that have been issued at a discount and require the
accrual of taxable economic interest in advance of receipt in cash. As a result,
the requirement to distribute a substantial portion of our net taxable income
could cause us to: (a) sell assets in adverse
21
market conditions, (b) borrow on unfavorable terms or (c) distribute amounts
that would otherwise be invested in future acquisitions, capital expenditures or
repayment of debt in order to comply with REIT requirements.
Further, amounts distributed will not be available to fund investment
activities. Newcastle Investment Holdings has historically funded its
investments, initially, by raising capital in a private equity offering and,
subsequently, through borrowings from financial institutions, along with
securitization financings. We expect to finance our investments this way. If we
fail to obtain debt or equity capital in the future, it could limit our ability
to grow, which could have a material adverse effect on the value of our common
stock.
MAINTENANCE OF OUR INVESTMENT COMPANY ACT EXEMPTION IMPOSES LIMITS ON OUR
OPERATIONS.
We conduct our operations so as not to become regulated as an investment
company under the Investment Company Act of 1940, as amended. We believe that
there are a number of exemptions under the Investment Company Act that may be
applicable to us. The assets that we may acquire, therefore, are limited by the
provisions of the Investment Company Act and the rules and regulations
promulgated under the Investment Company Act. In addition, we could, among other
things, be required either (a) to change the manner in which we conduct our
operations to avoid being required to register as an investment company or (b)
to register as an investment company, either of which could have an adverse
effect on us and the market price for our common stock.
ERISA MAY RESTRICT INVESTMENTS BY PLANS IN OUR COMMON STOCK.
A plan fiduciary considering an investment in our common stock should
consider, among other things, whether such an investment might constitute or
give rise to a prohibited transaction under ERISA, the Internal Revenue Code or
any substantially similar federal, state or local law and whether an exemption
from such prohibited transaction rules is available. See "ERISA Considerations."
THE STOCK OWNERSHIP LIMIT IMPOSED BY THE INTERNAL REVENUE CODE FOR REITS AND OUR
CHARTER MAY INHIBIT MARKET ACTIVITY IN OUR STOCK AND MAY RESTRICT OUR BUSINESS
COMBINATION OPPORTUNITIES.
In order for us to maintain our qualification as a REIT under the Internal
Revenue Code, not more than 50% in value of our outstanding stock may be owned,
directly or indirectly, by five or fewer individuals (as defined in the Internal
Revenue Code to include certain entities) at any time during the last half of
each taxable year. Our charter, with certain exceptions, authorizes our
directors to take such actions as are necessary and desirable to preserve our
qualification as a REIT. Unless exempted by our board of directors, no person,
other than Newcastle Investment Holdings, our manager and certain of its
affiliates and executive officers, each of which have been exempted by our
board, may own more than 8.0% of the aggregate value of the outstanding shares
of any class or series of our stock. Our board of directors has also granted a
limited exemption to Wallace R. Weitz & Company, a third party group of funds,
from such limitation. Our board may grant such an exemption in its sole
discretion, subject to such conditions, representations and undertakings as it
may determine. These ownership limits could delay or prevent a transaction or a
change in our control that might involve a premium price for our common stock or
otherwise be in the best interest of our stockholders.
MARYLAND TAKEOVER STATUTES MAY PREVENT A CHANGE OF OUR CONTROL. THIS COULD
DEPRESS OUR STOCK PRICE.
Under Maryland law, "business combinations" between a Maryland corporation
and an interested stockholder or an affiliate of an interested stockholder are
prohibited for five years after the most recent date on which the interested
stockholder becomes an interested stockholder. These business combinations
22
include a merger, consolidation, share exchange, or, in circumstances specified
in the statute, an asset transfer or issuance or reclassification of equity
securities. An interested stockholder is defined as:
- any person who beneficially owns 10% or more of the voting power of the
corporation's shares; or
- an affiliate or associate of the corporation who, at any time within the
two-year period prior to the date in question, was the beneficial owner
of 10% or more of the voting power of the then outstanding voting stock
of the corporation.
A person is not an interested stockholder under the statute if the board of
directors approved in advance the transaction by which he otherwise would have
become an interested stockholder.
After the five-year prohibition, any business combination between the
Maryland corporation and an interested stockholder generally must be recommended
by the board of directors of the corporation and approved by the affirmative
vote of at least:
- 80% of the votes entitled to be cast by holders of outstanding shares of
voting stock of the corporation; and
- two-thirds of the votes entitled to be cast by holders of voting stock of
the corporation other than shares held by the interested stockholder with
whom or with whose affiliate the business combination is to be effected
or held by an affiliate or associate of the interested stockholder.
The business combination statute may discourage others from trying to
acquire control of us and increase the difficulty of consummating any offer,
including potential acquisitions that might involve a premium price for our
common stock or otherwise be in the best interest of our stockholders. See
"Important Provisions of Maryland Law and of Our Charter and Bylaws -- Business
Combinations" and "-- Control Share Acquisitions."
OUR AUTHORIZED BUT UNISSUED COMMON AND PREFERRED STOCK MAY PREVENT A CHANGE IN
OUR CONTROL.
Our charter authorizes us to issue additional authorized but unissued
shares of our common stock or preferred stock. In addition, our board of
directors may classify or reclassify any unissued shares of common stock or
preferred stock and may set the preferences, rights and other terms of the
classified or reclassified shares. As a result, our board may establish a series
of preferred stock that could delay or prevent a transaction or a change in
control that might involve a premium price for our common stock or otherwise be
in the best interest of our stockholders.
OUR STOCKHOLDER RIGHTS PLAN COULD INHIBIT A CHANGE IN OUR CONTROL.
We have adopted a stockholder rights agreement. Under the terms of the
rights agreement, in general, if a person or group acquires more than 15% of the
outstanding shares of our common stock, all of our other stockholders will have
the right to purchase securities from us at a discount to such securities' fair
market value, thus causing substantial dilution to the acquiring person. The
rights agreement may have the effect of inhibiting or impeding a change in
control not approved by our board of directors and, therefore, could adversely
affect our stockholders' ability to realize a premium over the then-prevailing
market price for our common stock in connection with such a transaction. In
addition, since our board of directors can prevent the rights agreement from
operating, in the event our board approves of an acquiring person, the rights
agreement gives our board of directors significant discretion over whether a
potential acquiror's efforts to acquire a large interest in us will be
successful. Because the rights agreement contains provisions that are designed
to assure that the executive officers, our manager and its affiliates will
never, alone, be considered a group that is an acquiring person, the rights
agreement provides the executive officers, our manager and its affiliates with
certain advantages under the rights agreement that are not available to other
stockholders. See "Description of Capital Stock -- Stockholder Rights Plan."
23
OUR STAGGERED BOARD AND OTHER PROVISIONS OF OUR CHARTER AND BYLAWS MAY PREVENT A
CHANGE IN OUR CONTROL.
Our board of directors is divided into three classes of directors. The
current terms of the Class I, Class II and Class III directors will expire in
2003, 2004 and 2005, respectively. Directors of each class are chosen for
three-year terms upon the expiration of their current terms, and each year one
class of directors is elected by the stockholders. The staggered terms of our
directors may reduce the possibility of a tender offer or an attempt at a change
in control, even though a tender offer or change in control might be in the best
interest of our stockholders. In addition, our charter and bylaws also contain
other provisions that may delay or prevent a transaction or a change in control
that might involve a premium price for our common stock or otherwise be in the
best interest of our stockholders.
RISKS RELATED TO THIS OFFERING
YOU WILL EXPERIENCE IMMEDIATE AND SIGNIFICANT DILUTION IN THE BOOK VALUE PER
SHARE.
The initial public offering price of our common stock is substantially
higher than the book value per share of our outstanding common stock will be
immediately after this offering. If you purchase our common stock in this
offering, you will incur immediate dilution of approximately $2.08 in the book
value per share of common stock from the price you pay for our common stock in
this offering.
THE MARKET PRICE FOR OUR COMMON STOCK AFTER THIS OFFERING MAY BE LOWER THAN THE
OFFERING PRICE AND OUR STOCK PRICE MAY BE VOLATILE.
Prior to this offering, there has been no public market for the shares of
our common stock. The initial public offering price will be determined by
negotiations between us and representatives of the underwriters. The price at
which the shares of our common stock may sell in the public market after this
offering may be lower than the price at which they are sold by the underwriters.
The stock market in general has recently experienced extreme price
fluctuations. Fluctuations in our stock price may not be correlated in a
predictable way to our performance or operating results. Our stock price may
fluctuate as a result of factors that are beyond our control or unrelated to our
operating results.
FUTURE SALES OF SHARES OF OUR COMMON STOCK, INCLUDING SHARES OF COMMON STOCK AS
A RESULT OF ANY DISTRIBUTION BY NEWCASTLE INVESTMENT HOLDINGS, MAY DEPRESS THE
PRICE OF OUR SHARES.
Any sales of a substantial number of our shares in the public market, or
the perception that such sales might occur, may cause the market price of our
shares to decline. Upon completion of this offering, all shares we are offering
will be freely tradable without restriction, unless the shares are owned by one
of our affiliates. Newcastle Investment Holdings has informed us that it may
make a distribution to its stockholders of its holdings of our common stock.
Newcastle Investment Holdings has agreed with Bear Stearns not to distribute our
common stock to its stockholders earlier than 180 days after the date of this
prospectus. Upon any such distribution, assuming the distribution is made pro
rata to all holders and for no consideration, all of those shares of our common
stock that are not owned by our affiliates (representing approximately 75% of
the shares of our common stock that may be distributed by Newcastle Investment
Holdings) would be eligible for immediate resale in the public market. None of
these shares are being registered in connection with this offering. We are
unable to predict whether significant numbers of shares will be sold in the open
market in anticipation of or following a distribution.
Newcastle Investment Holdings is a guarantor under a credit facility
entered into by a subsidiary of Newcastle Investment Holdings with Fleet
National Bank, as administrative agent and lender. In connection with an
amendment to this credit facility which will be entered into in September 2002,
Newcastle Investment Holdings will agree to pledge as collateral all of the
shares of our common stock held by it.
24
BEAR STEARNS WILL RECEIVE BENEFITS IN ADDITION TO ITS UNDERWRITING DISCOUNTS AND
COMMISSIONS.
Bear Stearns, an underwriter of this offering, and its affiliate, EMC
Mortgage Corporation (EMC), will receive benefits from this offering in addition
to underwriting discounts and commissions. The net proceeds of this offering
will be used to purchase a portfolio of mortgage loans through EMC. See "Use of
Proceeds" and "Underwriting."
25
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains certain forward-looking statements which are
subject to various risks and uncertainties, including without limitation,
statements relating to the operating performance of our investments and
financing needs. Forward-looking statements are generally identifiable by use of
forward-looking terminology such as "may," "will," "should," "potential,"
"intend," "expect," "endeavor," "seek," "anticipate," "estimate,"
"overestimate," "underestimate," "believe," "could," "project," "predict,"
"continue" or other similar words or expressions. Forward-looking statements are
based on certain assumptions, discuss future expectations, describe future plans
and strategies, contain projections of results of operations or of financial
condition or state other forward-looking information. Our ability to predict
results or the actual effect of future plans or strategies is inherently
uncertain. Although we believe that the expectations reflected in such
forward-looking statements are based on reasonable assumptions, our actual
results and performance could differ materially from those set forth in the
forward-looking statements. Factors which could have a material adverse effect
on our operations and future prospects include, but are not limited to, changes
in economic conditions generally and the real estate and bond markets
specifically, legislative/regulatory changes (including changes to laws
governing the taxation of real estate investment trusts), availability of
capital, interest rates and interest rate spreads, generally accepted accounting
principles and policies and rules applicable to REITs. When considering forward-
looking statements, you should keep in mind the risk factors and other
cautionary statements in this prospectus. Readers are cautioned not to place
undue reliance on any of these forward-looking statements, which reflect our
management's views as of the date of this prospectus. The "Risk Factors" and
other factors noted throughout this prospectus could cause our actual results to
differ significantly from those contained in any forward-looking statement. For
a discussion of our critical accounting policies see "Management's Discussion
and Analysis of Pro Forma Financial Condition and Results of Operations --
Critical Accounting Policies."
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We are under no duty to update any of the
forward-looking statements after the date of this prospectus to conform these
statements to actual results.
26
USE OF PROCEEDS
We estimate that the net proceeds to us from the sale of the 7,000,000
shares of common stock will be approximately $94.5 million, or approximately
$109.1 million if the underwriters exercise their over-allotment option in full,
based upon an assumed public offering price of $15.00 per share (the midpoint of
the offering price range set forth on the cover page of this prospectus), after
deducting assumed underwriting discounts and estimated offering expenses.
We intend to use the net proceeds of this offering to pay a portion of the
$239.7 million purchase price for a portfolio of $235 million principal amount
of mortgage loans. We intend to initially finance approximately $145.2 million
of the purchase price for such mortgage loans. The mortgage loans and related
financing are to be obtained from affiliates of Bear Stearns. The financing will
be secured by the mortgage loans and will bear interest at LIBOR plus 0.75%, or
2.53% based on LIBOR of 1.78% on August 12, 2002. The financing will permit us
to further borrow up to an additional $70.5 million (which amount, when added to
$145.2 million, will not exceed 90% of the purchase price of the mortgage
loans). We intend to utilize borrowings under the additional financing to
purchase additional real estate securities, including collateral for the CBO III
transaction, and for general corporate purposes.
DISTRIBUTION POLICY
In order for corporate income tax not to apply to the earnings that we
distribute, we must distribute to our stockholders an amount at least equal to
(i) 90% of our REIT taxable income (determined before the deduction for
dividends paid and excluding any net capital gain) plus (ii) 90% of the excess
of our net income from foreclosure property (as defined in Section 856 of the
Internal Revenue Code) over the tax imposed on such income by the Internal
Revenue Code less (iii) any excess non-cash income (as determined under the
Internal Revenue Code). See "Federal Income Tax Considerations." We anticipate,
based on historical results, that the primary differences between reported
income and REIT taxable income will be the following: (a) straight-line rent,
which affects reported income but not REIT taxable income, (b) foreign currency
translation, which affects REIT taxable income currently based on Section 987 of
the Internal Revenue Code, but does not affect reported income until the
disposition of the related asset, and (c) amortization of the cost of interest
rate cap agreements, which affects REIT taxable income but not reported income.
The actual amount and timing of distributions, however, will be at the
discretion of our board of directors and will depend upon our financial
condition in addition to the requirements of the Internal Revenue Code.
Subject to the distribution requirements referred to in the immediately
preceding paragraph, we intend, to the extent practicable, to invest
substantially all of the proceeds from repayments, sales and refinancings of our
assets in real estate-related assets and other assets. We may, however, under
certain circumstances, make a distribution of capital or of assets. Such
distributions, if any, will be made at the discretion of our board of directors.
Distributions will be made in cash to extent that cash is available for
distribution.
It is anticipated that distributions generally will be taxable as ordinary
income to our non-exempt stockholders, although a portion of such distributions
may be designated by us as long-term capital gain or may constitute a return of
capital. We will furnish annually to each of our stockholders a statement
setting forth distributions paid during the preceding year and their federal
income tax status. For a discussion of the federal income tax treatment of
distributions by us, see "Federal Income Tax Considerations -- Taxation of
Newcastle" and "-- Taxation of Stockholders."
Subsequent to the offering, we intend to make regular quarterly
distributions to the holders of our common stock. Prior to the consummation of
the offering, it is anticipated that our board of directors will declare a
distribution of $0. per share to Newcastle Investment Holdings, which owns
substantially all of our common stock, and to our manager, which owns a de
minimis number of shares of our common stock, for the period ending September
30, 2002. In addition, it is anticipated that our board of directors will
declare a distribution of $0. per share to such shareholders for the period
commencing on October 1, 2002 and ending on the date of the closing of this
offering. We anticipate paying these dividends so that holders of common stock
prior to the offering will receive a distribution for the period prior to the
offering. These distributions will be funded from cash flow provided by
operations. Purchasers of shares of our common stock in this offering will not
be entitled to these distributions.
27
CAPITALIZATION
The following table sets forth our consolidated capitalization as of June 30,
2002:
(i) on a pro forma basis to give effect to the initial transactions;
(ii) on a pro forma basis, as adjusted for the sale to Bear Stearns for $37.9
million of an aggregate of $62.3 million face amount of bonds we held that
were issued by the various affiliates of Newcastle Investment Holdings
that hold indirectly the GSA portfolio; and
(iii) on a pro forma as adjusted basis as described in clause (ii), as further
adjusted to give effect to the sale of 7,000,000 shares of our common
stock offered by us in this offering at an assumed initial public offering
price of $15.00, after deducting assumed underwriting discounts and
estimated offering expenses payable by us, and the use of the proceeds as
described under "Use of Proceeds."
JUNE 30, 2002
----------------------------------------------
PRO FORMA PRO FORMA
PRO FORMA AS ADJUSTED AS FURTHER ADJUSTED
---------- ----------- -------------------
(DOLLARS IN THOUSANDS)
Debt................................................ $ 958,824 $ 958,824 $1,104,024
Stockholders' equity:
Preferred stock, $0.01 par value: 100,000,000
shares authorized; no shares issued and
outstanding on a pro forma basis; no shares
issued and outstanding on a pro forma as
adjusted basis; no shares issued and
outstanding on a pro forma as further adjusted
basis.......................................... -- -- --
Common stock, $0.01 par value: 500,000,000 shares
authorized; 16,488,517 shares issued and
outstanding on a pro forma basis; 16,488,517
shares issued and outstanding on a pro forma as
adjusted basis; 23,488,517 shares issued and
outstanding on a pro forma as further adjusted
basis.......................................... 165 165 235
Additional paid-in capital.......................... 158,713 196,640 291,070
Retained earnings................................... -- -- --
Accumulated other comprehensive income.............. 12,084 12,084 12,084
---------- ---------- ----------
Total stockholders' equity(A)....................... 170,962 208,889 303,389
---------- ---------- ----------
Total capitalization........................... $1,129,786 $1,167,713 $1,407,413
========== ========== ==========
- ---------------
(A) Total stockholders' equity is subject to change based on the mark-to-market
value of our assets.
28
DILUTION
The information below assumes that the initial transactions were completed
as of June 30, 2002.
Our pro forma book value attributable to common stockholders on June 30,
2002, as adjusted for the subsequent transaction described in clause (ii) to the
introduction to the table under "Capitalization," was approximately $208.9
million, or $12.67 per common share.
After giving effect to this offering, our pro forma book value attributable
to common stockholders on June 30, 2002 would have been $303.4 million, or
$12.92 per common share. The adjustments made to determine pro forma book value
per share are the following:
- increasing total assets to reflect the estimated net proceeds of the
offering as described under "Use of Proceeds" at an assumed initial
public offering price of $15.00 per share; and
- adding the number of common shares offered by this prospectus to the
number of common shares outstanding.
The following table illustrates the pro forma increase in book value of
$0.25 per common share and the dilution (the difference between the offering
price per common share and book value per common share) to new investors:
Initial public offering price per share of common stock..... $15.00
Book value per share of common stock prior to the
offering.................................................. $12.67
Increase in book value per share of common stock
attributable to investors in the offering................. 0.25
------
Pro forma book value per common share, after the offering... 12.92
------
Dilution to new investors................................... $ 2.08
======
The following table shows the difference between Newcastle Investment
Holdings, which owns substantially all of our common stock, as of June 30, 2002
and new investors with respect to the number of shares purchased, the total
consideration paid and the average price paid per common share. We have used an
assumed initial public offering price of $15.00 per share.
SHARES PURCHASED TOTAL CONSIDERATION
-------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ------------ ------- -------------
Newcastle Investment
Holdings.................. 16,488,517 70.2% $208,889,000 66.5% $12.67
New investors............... 7,000,000 29.8% $105,000,000 33.5% $15.00
---------- ------ ------------ ------
Total....................... 23,488,517 100.0% $313,889,000 100.0%
========== ====== ============ ======
In the discussion and tables above, we assume no exercise of any
outstanding options.
29
SELECTED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
Newcastle Investment Holdings contributed to us certain assets and related
liabilities in exchange for all of our shares of common stock. However, as
presented in the following table, for accounting purposes this transaction is
presented as a reverse spin-off. Under a reverse spin-off, Newcastle Investment
Corp. is treated as the continuing entity and the assets to be retained by
Newcastle Investment Holdings are accounted for as if they were distributed at
historical book basis through a spin-off to Newcastle Investment Holdings.
As of July 12, 2002, for accounting purposes, we distributed to Newcastle
Investment Holdings assets which represented approximately thirty percent of our
total assets (100% of our real estate loans, our investment in the Fund, and
approximately 75% of our real properties, in each case based on book value as of
June 30, 2002), and related liabilities. The following assets were retained by
us:
- Real estate securities (CBO I and CBO II);
- Credit leased real estate (Bell Canada portfolio and LIV portfolio); and
- Other assets.
The following table sets forth certain selected financial and operating
information on a pro forma basis.
The selected unaudited pro forma consolidated statements of income are
presented as if the distribution had been consummated on January 1, 2002 or
2001, as applicable. The historical results of operations of the assets and
liabilities distributed to Newcastle Investment Holdings have been presented as
discontinued operations for those operations that constitute a component of an
entity. A component of an entity must have cash flows that are clearly
distinguished operationally and for financial reporting purposes from the rest
of the entity. Of the assets distributed to Newcastle Investment Holdings, the
GSA portfolio and the mortgage loans qualify as a component of an entity. The
remaining operations related to the other assets and liabilities distributed to
Newcastle Investment Holdings which are not a component of an entity have been
eliminated.
The selected unaudited pro forma consolidated balance sheet is presented as
if the distribution had been consummated on June 30, 2002.
The selected unaudited pro forma consolidated financial statements are
presented for comparative purposes only, and are not necessarily indicative of
what our actual financial position or our consolidated results of operations
would have been at the date or for the periods presented, nor do they purport to
represent the results of any future periods. In the opinion of management, all
adjustments necessary to present fairly the unaudited pro forma financial
information have been made. The selected pro forma financial information set
forth below as of June 30, 2002 and for the year ended December 31, 2001 and the
six month periods ended June 30, 2002 and 2001 have been derived from our
unaudited pro forma financial statements.
The information below should be read in conjunction with "Management's
Discussion and Analysis of Pro Forma Financial Condition and Results of
Operations" and the financial statements and notes thereto included in this
prospectus.
30
SELECTED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED
JUNE 30, YEAR ENDED
----------------- DECEMBER 31,
2002 2001 2001
------- ------- ------------
OPERATING DATA
Revenues
Interest and dividend income.............................. $30,861 $24,216 $47,711
Rental and escalation income.............................. 10,788 11,484 22,289
Gain on settlement of investments......................... 5,030 6,390 7,405
Other income.............................................. 9 9 43
------- ------- -------
46,688 42,099 77,448
Expenses
Interest expense.......................................... 19,173 16,842 32,659
Property operating expense................................ 4,761 5,225 9,830
Loan servicing and REO expense............................ 201 116 243
General and administrative expense........................ 1,480 467 1,283
Management fees to affiliates............................. 1,823 1,503 3,642
Depreciation and amortization............................. 1,431 1,321 2,690
------- ------- -------
28,869 25,474 50,347
------- ------- -------
Income from continuing operations........................... $17,819 $16,625 $27,101
======= ======= =======
Income from discontinued operations......................... $ 686 $ 3,407 $ 4,988
======= ======= =======
Income from continuing operations per common share, basic
and diluted............................................... $ 1.05 $ 0.98 $ 1.60
======= ======= =======
Weighted average number of common shares outstanding, basic
and diluted............................................... 16,969 16,977 16,973
======= ======= =======
JUNE 30,
2002
----------
BALANCE SHEET DATA
CBO collateral, net........................................ $1,006,882
Operating real estate, net................................. $ 118,233
Cash and cash equivalents.................................. $ 1,155
Total assets............................................... $1,165,029
Debt....................................................... $ 958,824
Stockholders' equity....................................... $ 170,962
31
SIX MONTHS ENDED
JUNE 30, YEAR ENDED
------------------- DECEMBER 31,
2002 2001 2001
--------- ------- ------------
OTHER DATA
Cash flow from continuing operations provided by (used in):
Operating activities..................................... $ 14,803 $11,443 $17,483
Investing activities..................................... $(452,404) $(3,359) $(6,973)
Financing activities..................................... $ 408,794 $ 5,318 $16,294
Funds from Operations (FFO) from continuing
operations(A)............................................ $ 19,151 $17,923 $29,738
- ---------------
(A) We believe funds from operations (FFO) is one appropriate measure of the
performance of real estate companies because it provides investors with an
understanding of our ability to incur and service debt and make capital
expenditures. Funds from operations (FFO), for our purposes, represents net
income available for common stockholders (computed in accordance with
accounting principles generally accepted in the United States ("GAAP")),
excluding extraordinary items, plus real estate depreciation and
amortization, and after adjustments for unconsolidated subsidiaries, if any.
We consider gains and losses on resolution of our investments to be a normal
part of our recurring operations and, therefore, do not exclude such gains
and losses when arriving at funds from operations (FFO). Adjustments for
unconsolidated subsidiaries, if any, are calculated to reflect funds from
operations (FFO) on the same basis. Funds from operations (FFO) does not
represent cash generated from operating activities in accordance with GAAP
and therefore should not be considered an alternative to net income as an
indicator of our operating performance or as an alternative to cash flow as
a measure of liquidity and is not necessarily indicative of cash available
to fund cash needs.
SIX MONTHS ENDED
JUNE 30, YEAR ENDED
----------------- DECEMBER 31,
2002 2001 2001
------- ------- ------------
CALCULATION OF FUNDS FROM OPERATIONS
Income from continuing operations........................... $17,819 $16,625 $27,101
Real estate depreciation and amortization................... 1,332 1,298 2,637
------- ------- -------
Funds from Operations (FFO) from continuing operations...... $19,151 $17,923 $29,738
======= ======= =======
32
SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
OF NEWCASTLE INVESTMENT HOLDINGS CORP.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table sets forth certain selected financial and operating
information on a historical consolidated basis.
The selected historical consolidated financial information set forth below
as of December 31, 2001, 2000, 1999 and 1998 and for the years ended December
31, 2001, 2000 and 1999 and for the period from May 11, 1998 to December 31,
1998 have been derived from Newcastle Investment Holdings' audited historical
consolidated financial statements. The selected historical financial information
set forth below as of June 30, 2002 and for the six month periods ended June 30,
2002 and 2001 have been derived from Newcastle Investment Holdings' unaudited
historical financial statements.
The information below should be read in conjunction with "Management's
Discussion and Analysis of Historical Financial Condition and Results of
Operations" and the financial statements and notes thereto included in this
prospectus.
SIX MONTHS ENDED YEAR ENDED PERIOD
JUNE 30, DECEMBER 31, FROM MAY 11,
-------------------------- ------------------------------------------ 1998 TO
2002 2001 2001 2000 1999 DEC. 31, 1998
----------- ------------ ------------ ------------ ------------ -------------
(UNAUDITED) (UNAUDITED)
OPERATING DATA
Revenues
Interest and dividend
income.................... $ 31,100 $28,370 $ 53,434 $ 65,389 $ 50,245 $19,675
Rental and escalation
income.................... 37,532 38,015 75,979 75,293 64,822 23,143
Gain (loss) on settlement of
investments............... 5,108 8,941 10,386 21,763 (1,526) 2,584
Management fee from
affiliates................ 4,470 4,470 8,941 8,941 944 --
Incentive income from
affiliates................ (1,218) -- 28,709 -- -- --
Other income................ 12 22 146 1,006 462 369
-------- ------- -------- -------- -------- -------
77,004 79,818 177,595 172,392 114,947 45,771
Expenses
Interest expense............ 32,769 31,949 61,332 66,411 46,529 12,693
Property operating
expense................... 14,276 14,359 28,822 28,264 23,169 7,027
Loan servicing and REO
expense................... 423 511 965 2,325 3,122 1,291
General and administrative
expense................... 1,838 757 2,399 3,988 3,516 2,751
Management fees to
affiliates................ 7,168 7,221 14,687 15,587 8,351 6,751
Incentive return to
affiliates................ 827 -- 17,188 -- -- --
Depreciation and
amortization.............. 6,802 6,383 13,049 12,244 10,383 4,165
-------- ------- -------- -------- -------- -------
64,103 61,180 138,442 128,819 95,070 34,678
-------- ------- -------- -------- -------- -------
Income (loss) before equity in
earnings of unconsolidated
subsidiaries and minority
interest.................... 12,901 18,638 39,153 43,573 19,877 11,093
Equity in earnings (losses) of
unconsolidated
subsidiaries................ 362 1,125 2,807 (980) (3,615) 117
Minority interest in (income)
loss of consolidated
subsidiaries................ (13) (208) 83 (748) (1,258) (570)
-------- ------- -------- -------- -------- -------
Income from continuing
operations.................. 13,250 19,555 42,043 41,845 15,004 10,640
Discontinued operations....... 1,009 682 1,628 1,015 149 --
Extraordinary item -- loss on
extinguishment of debt...... -- -- -- -- (2,341) --
-------- ------- -------- -------- -------- -------
33
SIX MONTHS ENDED YEAR ENDED PERIOD
JUNE 30, DECEMBER 31, FROM MAY 11,
-------------------------- ------------------------------------------ 1998 TO
2002 2001 2001 2000 1999 DEC. 31, 1998
----------- ------------ ------------ ------------ ------------ -------------
(UNAUDITED) (UNAUDITED)
Income before change in
accounting principle........ 14,259 20,237 43,671 42,860 12,812 10,640
Cumulative effect of change in
accounting
principle -- write off of
organizational costs........ -- -- -- -- (513) --
-------- ------- -------- -------- -------- -------
Net Income.................... 14,259 20,237 43,671 42,860 12,299 10,640
Preferred dividends and
related accretion........... (1,162) (1,264) (2,540) (2,084) -- --
-------- ------- -------- -------- -------- -------
Income available for common
shareholders................ $ 13,097 $18,973 $ 41,131 $ 40,776 $ 12,299 $10,640
======== ======= ======== ======== ======== =======
Net Income per Common Share,
basic and diluted........... $ 0.79 $ 1.15 $ 2.49 $ 2.16 $ 0.59 $ 0.51
======== ======= ======== ======== ======== =======
Income from continuing
operations per common share,
after preferred dividends
and related accretion, basic
and diluted................. $ 0.73 $ 1.11 $ 2.39 $ 2.11 $ 0.72 $ 0.51
======== ======= ======== ======== ======== =======
Income from discontinued
operations per common share,
basic and diluted........... $ 0.06 $ 0.04 $ 0.10 $ 0.05 $ -- $ --
======== ======= ======== ======== ======== =======
Effect of extraordinary item
per common share, basic and
diluted..................... $ -- $ -- $ -- $ -- $ (0.11) $ --
======== ======= ======== ======== ======== =======
Effect of change in accounting
principle per common share,
basic and diluted........... $ -- $ -- $ -- $ -- $ (0.02) $ --
======== ======= ======== ======== ======== =======
Weighted average number of
common shares outstanding,
basic and diluted........... 16,489 16,497 16,493 18,892 20,917 20,862
======== ======= ======== ======== ======== =======
Dividends declared per common
share....................... $ 1.20 $ 1.00 $ 2.00 $ 1.50 $ 2.04 $ 0.55
======== ======= ======== ======== ======== =======
DECEMBER 31,
JUNE 30, ---------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
BALANCE SHEET DATA
CBO collateral, net.......... $1,006,882 $ 522,258 $ 509,729 $ 504,669 $ --
Operating real estate, net... $ 487,628 $ 524,834 $ 540,539 $ 558,849 $383,073
Cash and cash equivalents.... $ 13,578 $ 31,360 $ 10,575 $ 14,345 $ 75,596
Total assets................. $1,681,102 $1,262,119 $1,331,086 $1,381,600 $765,650
Debt......................... $1,309,727 $ 897,390 $ 975,656 $ 971,260 $336,845
Stockholders' equity......... $ 318,224 $ 310,545 $ 300,655 $ 354,673 $384,924
34
SIX MONTHS ENDED PERIOD
JUNE 30, YEAR ENDED DECEMBER 31, FROM MAY 11,
--------------------------- ------------------------------------------ 1998 TO
2002 2001 2001 2000 1999 DEC 31, 1998
------------ ------------ ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
OTHER DATA
Cash flow provided by
(used in):
Operating activities... $ 18,452 $ 13,274 $ 34,448 $ 24,823 $ 32,834 $ (7,230)
Investing activities... $(393,124) 66,279 $ 106,053 $ 151,632 $(683,420) $(638,844)
Financing activities... $ 356,890 $(85,254) $(119,716) $(180,225) $ 589,335 $ 721,670
Funds from Operations
(FFO)(A)............... $ 19,470 $ 25,946 $ 48,264 $ 53,523 $ 24,707 $ 14,337
- ---------------
(A) We believe funds from operations (FFO) is one appropriate measure of the
performance of real estate companies because it provides investors with an
understanding of our ability to incur and service debt and make capital
expenditures. Funds from operations (FFO), for our purposes, represents net
income available for common stockholders (computed in accordance with GAAP),
excluding extraordinary items, plus real estate depreciation and
amortization, and after adjustments for unconsolidated subsidiaries. We
consider gains and losses on resolution of our investments to be a normal
part of our recurring operations and, therefore, do not exclude such gains
and losses when arriving at funds from operations (FFO). In addition, we
exclude accrued incentive income from Fortress Investment Fund (the Fund or
FIF) and include incentive income distributed or distributable from FIF in
accordance with the operating agreement of the Fund since this more
accurately reflects cash distributed or distributable to us from the Fund,
while our accrued incentive income is based upon the fair value of the
Fund's net assets, which is subject to fluctuation in future periods.
Adjustments for unconsolidated subsidiaries are calculated to reflect funds
from operations (FFO) on the same basis. Funds from operations (FFO) does
not represent cash generated from operating activities in accordance with
GAAP and therefore should not be considered an alternative to net income as
an indicator of our operating performance or as an alternative to cash flow
as a measure of liquidity and is not necessarily indicative of cash
available to fund cash needs.
SIX MONTHS ENDED PERIOD
JUNE 30, YEAR ENDED DECEMBER 31, FROM MAY 11,
------------------------- --------------------------- 1998 TO
2002 2001 2001 2000 1999 DEC 31, 1998
----------- ----------- ------- ------- ------- ------------
(UNAUDITED) (UNAUDITED)
CALCULATION OF FUNDS FROM
OPERATIONS (FFO):
Income available for common
shareholders................... $13,097 $18,973 $41,131 $40,776 $12,299 $10,640
Extraordinary item -- loss on
extinguishment of debt......... -- -- -- -- 2,341 --
Real estate depreciation and
amortization................... 6,591 6,363 12,909 12,621 9,927 3,697
Accumulated depreciation on real
estate sold.................... (2,371) -- -- -- -- --
Real estate depreciation and
amortization -- unconsolidated
subsidiaries................... 1,614 610 2,564 126 140 --
Incentive (income) loss accrued
from FIF (A)................... 609 -- (14,354) -- -- --
Equity in incentive return
accrued by FIF................. (70) -- 1,645 -- -- --
Distributable incentive income
from FIF (B)................... -- -- 4,369 -- -- --
------- ------- ------- ------- ------- -------
Funds from Operations (FFO)...... $19,470 $25,946 $48,264 $53,523 $24,707 $14,337
======= ======= ======= ======= ======= =======
35
- ---------------
(A) Represents our 50% interest in the incentive income as follows:
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 2002 DECEMBER 31, 2001
---------------- -----------------
(UNAUDITED)
Total incentive income
(loss)..................... $(1,218) $ 28,709
Manager portion.............. $ 609 $(14,355)
------- --------
Our incentive income
(loss)..................... $ (609) $ 14,354
======= ========
(B) Represents our 50% interest in the distributable incentive income:
Total distributable incentive income.................. $ 8,738
Distributable incentive income due Manager............ $(4,369)
-------
Our distributable incentive income.................... $ 4,369
=======
36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PRO FORMA FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following should be read in conjunction with our Unaudited Pro Forma
Consolidated Financial Statements and Notes thereto included herein.
Management's discussion for the years ended December 31, 2000 and 1999 is based
on the table set forth below, which adjusts the Unaudited Pro Forma Consolidated
Financial Statements to reflect the elimination of the historical results of
operations of the assets and liabilities distributed to Newcastle Investment
Holdings, which have not been treated as discontinued operations. Such
adjustments, which are detailed below, also include allocations of general and
administrative expense and management fees, pro rata based on equity, between us
and Newcastle Investment Holdings. The Unaudited Pro Forma Consolidated
Financial Statements included herein for the year ended December 31, 2001 and
the six months ended June 30, 2001 and 2002 already reflect the elimination of
such amounts.
SIX MONTHS PRO FORMA PRO FORMA
ENDED FOR THE YEAR ENDED FOR THE
JUNE 30, YEAR ENDED YEAR ENDED DECEMBER 31, YEAR ENDED
----------------- DECEMBER 31, DECEMBER 31, 2000 DECEMBER 31,
2002 2001 2001 2000 ADJUSTMENTS AS ADJUSTED 1999
------- ------- ------------ ------------ ----------- ------------ ------------
Revenues
Interest and dividend income.......... $30,861 $24,216 $47,711 $50,989 $ (3,954) $47,035 $30,288
Rental and escalation income.......... 10,788 11,484 22,289 22,726 -- 22,726 17,087
Gain (loss) on settlement of
investments.......................... 5,030 6,390 7,405 20,836 (20,821) 15 1,765
Management fee from affiliates........ -- -- -- 8,941 (8,941) -- 944
Other income.......................... 9 9 43 728 (674) 54 69
------- ------- ------- ------- -------- ------- -------
46,688 42,099 77,448 104,220 (34,390) 69,830 50,153
------- ------- ------- ------- -------- ------- -------
Expenses
Interest expense...................... 19,173 16,842 32,659 36,897 (1,757) 35,140 19,741
Property operating expense............ 4,761 5,225 9,830 10,148 -- 10,148 8,428
Loan servicing and REO expense........ 201 116 243 265 -- 265 112
General and administrative expense.... 1,480 467 1,283 3,310 (1,101) 2,209 3,083
Management fees to affiliates......... 1,823 1,503 3,642 15,587 (11,912) 3,675 8,331
Depreciation and amortization......... 1,431 1,321 2,690 3,054 (515) 2,539 1,819
------- ------- ------- ------- -------- ------- -------
28,869 25,474 50,347 69,261 (15,285) 53,976 41,514
------- ------- ------- ------- -------- ------- -------
Equity in earnings (losses) of
unconsolidated subsidiaries.......... -- -- -- (980) 980 -- (3,615)
------- ------- ------- ------- -------- ------- -------
Income from continuing operations..... $17,819 $16,625 $27,101 $33,979 $(18,125) $15,854 $ 5,024
======= ======= ======= ======= ======== ======= =======
Income from discontinued operations... $ 686 $ 3,407 $ 4,988 $ 7,866 $ -- $ 7,866 $ 9,980
======= ======= ======= ======= ======== ======= =======
Income from continuing operations per
common share, basic and diluted...... $ 1.05 $ 0.98 $ 1.60 $ 1.80 $ (0.96) $ 0.84 $ 0.24
======= ======= ======= ======= ======== ======= =======
Income from discontinued operations
per common share, basic and
diluted.............................. $ 0.04 $ 0.20 $ 0.29 $ 0.42 $ -- $ 0.42 $ 0.48
======= ======= ======= ======= ======== ======= =======
Weighted average number of common
shares outstanding, basic and
diluted.............................. 16,969 16,972 16,973 18,892 18,892 18,892 20,917
======= ======= ======= ======= ======== ======= =======
YEAR ENDED
DECEMBER 31,
1999
ADJUSTMENTS AS ADJUSTED
----------- ------------
Revenues
Interest and dividend income.......... $(4,827) $25,461
Rental and escalation income.......... -- 17,087
Gain (loss) on settlement of
investments.......................... 1,143 2,908
Management fee from affiliates........ (944) --
Other income.......................... (62) 7
------- -------
(4,690) 45,463
------- -------
Expenses
Interest expense...................... (242) 19,499
Property operating expense............ -- 8,428
Loan servicing and REO expense........ -- 112
General and administrative expense.... (1,258) 1,825
Management fees to affiliates......... (4,235) 4,096
Depreciation and amortization......... (461) 1,358
------- -------
(6,196) 35,318
------- -------
Equity in earnings (losses) of
unconsolidated subsidiaries.......... 3,615 --
------- -------
Income from continuing operations..... $ 5,121 $10,145
======= =======
Income from discontinued operations... $ -- $ 9,980
======= =======
Income from continuing operations per
common share, basic and diluted...... $ 0.25 $ 0.49
======= =======
Income from discontinued operations
per common share, basic and
diluted.............................. $ -- $ 0.48
======= =======
Weighted average number of common
shares outstanding, basic and
diluted.............................. 20,917 20,917
======= =======
37
GENERAL
We were formed in June 2002 as a wholly owned subsidiary of Newcastle
Investment Holdings Corp. for the purpose of separating the real estate
securities and credit leased real estate businesses from Newcastle Investment
Holdings' other investments. In July 2002 Newcastle Investment Holdings
contributed to us certain assets and liabilities in exchange for shares of our
common stock. However, as presented in this section, for accounting purposes
this transaction is presented as a reverse spin-off. Under a reverse spin-off,
Newcastle Investment Corp. is treated as the continuing entity and the assets to
be retained by Newcastle Investment Holdings are accounted for as if they were
distributed at historical book basis through a spin-off to Newcastle Investment
Holdings.
We are organized and conduct our operations to qualify as a REIT for
federal income tax purposes. As such, we will generally not be subject to
federal income tax on that portion of our income that is distributed to
shareholders if we distribute at least 90% of our REIT taxable income to our
shareholders by the due date of our federal income tax return and comply with
various other requirements.
We conduct our business through two primary segments: (i) real estate
securities and (ii) revenue-producing real estate, primarily credit leased real
estate. Revenues attributable to each segment are disclosed below (unaudited)
(in thousands).
REAL
REAL ESTATE UN-
ESTATE SECURITIES ALLOCATED TOTAL
---------- -------------- --------- -------
For the six months
ended June 30, 2002................... $10,799 $35,221 $ 668 $46,688
For the year ended
December 31, 2001..................... $22,487 $53,095 $1,866 $77,448
Certain activities described herein occurred prior to our formation and
were consummated by Newcastle Investment Holdings Corp.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
We have classified our real estate securities as available for sale. As
such, they are carried at market value with net unrealized gains or losses
reported as a component of accumulated other comprehensive income. Market value
is based primarily upon multiple broker quotations, which provide valuation
estimates based upon reasonable market order indications or a good faith
estimate thereof. These quotations are subject to significant variability based
on market conditions, such as interest rates and spreads. Changes in market
conditions, as well as changes in the assumptions or methodology used to
determine market value, could result in a significant increase or decrease in
our book equity.
Similarly, our derivative instruments, held for hedging purposes, are
carried at market value pursuant to Statement of Financial Accounting Standards
("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities,"
as amended. Market value is based on counterparty quotations. To the extent they
qualify as hedges under SFAS No. 133, net unrealized gains or losses are
reported as a component of accumulated other comprehensive income; otherwise,
they are reported as a component of current income. Market values of such
derivatives are subject to significant variability based on many of the same
factors as the securities discussed above. The results of such variability could
be a significant increase or decrease in our book equity and/or earnings.
38
RESULTS OF OPERATIONS
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED JUNE
30, 2001 ON A PRO FORMA BASIS
Interest and dividend income increased by $6.7 million or 27.4%, from $24.2
million to $30.9 million. This increase is primarily the result of the interest
earned on the CBO II deposit of $2.5 million and the CBO II collateral of $5.7
million.
Rental and escalation income decreased by $0.7 million or 6.1%, from $11.5
million to $10.8 million. This decrease is primarily the result of foreign
currency fluctuations related to our Bell Canada portfolio. Escalation income
represents contractual increases in rental income to offset increases in
expenses or general price increases over a base amount.
Gain on settlement of investments decreased by $1.4 million, from $6.4
million to $5.0 million, primarily as a result of a reduction in the volume of
sales of certain CBO I securities. Sales of CBO securities are based on a number
of factors including credit, asset type and industry and can be expected to
increase or decrease from time to time. Periodic fluctuations in the volume of
sales of securities is dependent upon, among other things, management's
assessment of credit risk, asset concentration, portfolio balance and other
factors. The reduced volume of sales of securities during this period reflects
management's determination that the portfolio required less adjustment than in
prior periods.
Interest expense increased by $2.4 million or 13.8%, from $16.8 million to
$19.2 million. This increase is primarily the result of interest on the CBO II
securitization ($5.0 million), partially offset by lower interest rates being
paid on the variable rate CBO I securities classes.
Property operating expense decreased by $0.4 million or 8.9%, from $5.2
million to $4.8 million, primarily as the result of foreign currency
fluctuations related to our Bell Canada portfolio.
Loan servicing expense increased by $0.1 million, from $0.1 million to $0.2
million, primarily as a result of the acquisition of the CBO II collateral.
General and administrative expense increased by $1.0 million, from $0.5
million to $1.5 million, primarily as a result of increased insurance expense.
Management fee expense increased by $0.3 million, from $1.5 million to $1.8
million. The calculation of the management fee is more fully discussed under
"Our Manager and The Management Agreement -- Management Fees" in this
prospectus.
Depreciation and amortization increased by $0.1 million or 8.3%, from $1.3
million to $1.4 million, primarily as the result of depreciation on the capital
expenditures we made with respect to our real estate assets.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED DECEMBER 31,
2000 ON A PRO FORMA BASIS
Interest and dividend income increased by $0.7 million or 1.4%, from $47.0
million to $47.7 million. This increase is primarily the result of interest on
securities acquired in late 2000 ($1.2 million) offset by decreased interest
earned on the CBO I collateral securities ($0.7 million).
Rental and escalation income decreased by $0.4 million or 1.9%, from $22.7
million to $22.3 million. This decrease is primarily the result of foreign
currency fluctuations related to our Bell Canada portfolio.
Gain on settlement of investments increased by $7.4 million, primarily as a
result of gains on the sale of certain CBO I collateral securities in 2001.
Interest expense decreased by $2.4 million or 7.1%, from $35.1 million to
$32.7 million. This decrease is primarily the result of lower interest rates
being paid on the variable rate CBO I securities classes.
Property operating expense decreased by $0.3 million or 3.1%, from $10.1
million to $9.8 million, primarily as the result of foreign currency
fluctuations related to our Bell Canada portfolio.
39
Loan servicing expense remained at approximately $0.2 million.
General and administrative expense decreased by $0.9 million or 41.6%, from
$2.2 million to $1.3 million, primarily as a result of a decrease in
professional fees.
Management fee expense decreased $0.1 million, from $3.7 million to $3.6
million. The calculation of the management fee is more fully discussed under
"Our Manager and The Management Agreement -- Management Fees" in this
prospectus.
Depreciation and amortization increased by $0.2 million or 5.9%, from $2.5
million to $2.7 million, primarily as the result of depreciation on the capital
expenditures we made with respect to our real estate assets.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED DECEMBER 31,
1999 ON A PRO FORMA BASIS
Interest and dividend income increased by $21.5 million or 84.7%, from
$25.5 million to $47.0 million. This increase is primarily the result of our CBO
investments during 1999.
Rental and escalation income increased by $5.6 million or 33.0%, from $17.1
million to $22.7 million. This increase is primarily the result of the
acquisition of our LIV portfolio in November 1999.
Gain on settlement of investments decreased by $2.9 million, primarily as a
result of a reduction in the volume of sales of certain CBO I collateral
securities.
Interest expense increased by $15.6 million or 80.2%, from $19.5 million to
$35.1 million. This increase is primarily the result of the CBO securitization,
the Bell Canada mortgage and the LIV mortgage, which were entered into in 1999,
net of interest on various notes payable which were repaid with the proceeds
thereof.
Property operating expense increased by $1.7 million or 20.4%, from $8.4
million to $10.1 million, primarily as the result of the acquisition of our LIV
portfolio in November 1999.
Loan servicing expense increased $0.2 million, from $0.1 million to $0.3
million as a result of the CBO I securitization.
General and administrative expense increased by $0.4 million or 21.0%, from
$1.8 million to $2.2 million, primarily as a result of an increase in
professional fees.
Management fee expense decreased $0.4 million, from $4.1 million to $3.7
million. The calculation of the management fee is more fully discussed under
"Our Manager and The Management Agreement -- Management Fees" in this
prospectus.
Depreciation and amortization increased by $1.1 million or 87.0%, from $1.4
million to $2.5 million, primarily as the result of the acquisition of our LIV
portfolio in November 1999.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measurement of our ability to meet potential cash
requirements, including ongoing commitments to repay borrowings, fund and
maintain investments, and other general business needs. Additionally, to
maintain our status as a REIT under the Internal Revenue Code, we must
distribute annually at least 90% of our taxable income. Our primary sources of
funds for liquidity, in addition to this offering, consist of net cash provided
by operating activities, borrowings under loans and the issuance of debt
securities.
Our ability to execute our business strategy, particularly the growth of
our investment portfolio, depends to a significant degree on our ability to
obtain additional capital. Our CBO strategy is dependent upon our ability to
place the match funded debt we create in the market at spreads that provide a
positive arbitrage. If spreads for CBO liabilities widen or if demand for such
liabilities ceases to exist, then our ability to execute future CBO transactions
will be severely restricted.
40
We expect to meet our short-term liquidity requirements generally through
our cash flow provided by operations, as well as investment specific borrowings
and secured or unsecured lines of credit. Our real estate investments are
financed long-term and primarily leased to credit tenants with long-term leases
and are therefore expected to generate generally stable cash flows. Our real
estate securities are also financed long-term and their credit status is
continuously monitored; therefore, these investments are also expected to
generate a generally stable return, subject to interest rate fluctuations. See
"-- Quantitative and Qualitative Disclosures About Market Risk -- Interest Rate
Exposure" below. We consider our ability to generate cash to be adequate and
expect it to continue to be adequate to meet operating requirements both in the
short- and long-terms.
We expect to meet our long-term liquidity requirements, specifically the
repayment of our debt and our investment funding needs, through additional
borrowings, the issuance of debt and/or equity securities and the liquidation or
refinancing of our assets at maturity. We believe that the value of these assets
is, and will continue to be, sufficient to repay our debt at maturity under
either scenario.
We expect that our cash flow provided by operations, our financing from
Bear Stearns Mortgage Capital Corporation relating to our purchase of a mortgage
loan portfolio and our financing from Bear, Stearns International Limited in
connection with our purchase of securities for our third CBO transaction and our
subsequent CBO issuance will satisfy our liquidity needs for our business plan
over the next twelve months.
With respect to our real estate assets, we expect to incur approximately
$1.4 million of tenant improvements in connection with the inception of leases
and capital expenditures during the eighteen months ending December 31, 2003.
Our long-term debt existing at June 30, 2002 (gross of $15.3 million of
discounts) is expected to mature as follows: $3.9 million during the period from
July 1, 2002 through December 31, 2002, $3.3 million in 2003, $3.3 million in
2004, $3.3 million in 2005, $3.3 million in 2006, $3.3 million in 2007, and
$953.7 million thereafter.
In July 1999, we completed our first CBO securitization, CBO I, whereby the
CBO I collateral was contributed to a consolidated subsidiary which issued
$437.5 million face amount of investment grade senior securities and $62.5
million face amount of non-investment grade subordinated securities in a private
placement. As a result of the CBO I securitization, the existing short-term
repurchase agreement on the CBO I collateral was repaid. At June 30, 2002, the
subordinated securities were retained by us, except for the Class E Note as
described below, and the senior securities (all of which are still outstanding),
which bore interest at a weighted average effective rate, including discount and
cost amortization, of 4.32%, had an expected weighted average life of
approximately 5.9 years. Two classes of the senior securities bear floating
interest rates. We have obtained an interest rate swap and cap in order to hedge
our exposure to the risk of changes in market interest rates with respect to
these securities, at an initial cost of approximately $14.3 million. In
addition, in connection with the sale of two classes of securities, we entered
into two interest rate swaps and three interest rate cap agreements that do not
qualify for hedge accounting.
In March 1999, we obtained the Bell Canada mortgage secured by the Bell
Canada properties. In April 2002, we refinanced the Bell Canada properties
through a securitization transaction by issuing approximately $37.6 million of
investment grade debt securities in a private placement. The issued securities,
which bore interest at a weighted average effective rate, including discount and
cost amortization, of approximately 6.70% at closing, had an expected weighted
average life of approximately 5.1 years at closing. We have retained one class
of the issued securities. The proceeds from the issued securities were used, in
part, to repay the Bell Canada mortgage.
In November 1999, we obtained the LIV mortgage, which had an outstanding
balance of $51.6 million and bore interest at 4.79% as of June 30, 2002, and is
due in November 2016. We hedged our exposure to the risk of changes in market
interest rates with respect to the LIV mortgage by obtaining an interest rate
cap.
41
We utilize repurchase agreements for short-term financings of investments.
As of June 30, 2002 we had a $1.5 million repurchase agreement outstanding,
bearing interest at approximately 3.19% with a short-term maturity.
In October 2001, we entered into an agreement with Morgan Stanley & Co.
whereby we had the right to purchase up to $400 million, plus our deposit, of
commercial mortgage backed securities, unsecured REIT debt and asset backed
securities, which we refer to as the CBO II collateral, which were specifically
designated for our second CBO transaction, the CBO II securitization. In April
2002, we completed the CBO II securitization whereby a consolidated subsidiary
of ours issued $444.0 million face amount of investment grade senior securities
and $56.0 million face amount of non-investment grade subordinated securities,
collectively referred to as the CBO II securities, in a private placement. The
senior securities were issued for net proceeds of $438.8 million after issue
costs. The subordinated securities have been retained by us. The CBO II
securities are collateralized by a portfolio of CMBS, unsecured REIT debt,
asset-backed securities, and a limited amount of other securities and restricted
cash, pending its use for investment in securities (collectively, the CBO II
collateral), which was acquired with the proceeds from the CBO II securities and
with the deposit we made on such securities. The senior securities, which bore
interest at a weighted average effective rate, including discount and cost
amortization, of approximately 3.69% at closing, had an expected weighted
average life of approximately 8.04 years at closing. One class of the senior
securities bears a floating interest rate. We obtained an interest rate swap and
cap in order to hedge our exposure to the changes in market interest rates with
respect to this security, at an initial cost of $1.2 million.
In November 2001, we sold the retained subordinated $17.5 million Class E
Note from our CBO I to a third party for approximately $18.5 million. The Class
E Note bore interest at a fixed rate of 8.0% and had a stated maturity of June
2038. The sale of the Class E Note represented an issuance of debt and was
recorded as additional CBO bonds payable. In April 2002, a wholly owned
subsidiary of ours repurchased the Class E Note. The repurchase of the Class E
Note represents a repayment of debt and was recorded as a reduction of CBO bonds
payable. The Class E Note is included in the CBO II collateral. The Class E Note
is eliminated in consolidation.
In June 2002, we entered into a financing arrangement with an affiliate of
Bear Stearns. We will use this financing to fund an approximate $145.2 million
portion of the $239.7 million purchase price for a portfolio of $235 million
principal amount of mortgage loans. The financing will be secured by the
mortgage loans and will bear interest at LIBOR plus 0.75%. The financing will
permit us to further borrow up to an additional $70.5 million (which amount,
when added to $145.2 million, will not exceed 90% of the purchase price of the
mortgage loans). We intend to utilize borrowings under the additional financing
to purchase additional real estate securities, including collateral for the CBO
III transaction, and for general corporate purposes.
Pursuant to an agreement entered into in July 2002, Bear, Stearns
International Limited (BSIL) will purchase up to $450 million of commercial
mortgage backed securities, REIT debt, real estate loans and asset backed
securities (the CBO III collateral), subject to our right to purchase such
securities from BSIL. The CBO III collateral is expected to be included in a
securitization transaction in which we would acquire the equity interest (the
CBO III transaction). Pursuant to the agreement, Bear, Stearns & Co. Inc. also
has been engaged to structure and serve as lead manager for the CBO III
transaction for which it will receive customary fees. As of August 14, 2002,
approximately $87 million of the $450 million has been accumulated. If the CBO
III transaction is not consummated as a result of our failure to acquire the
equity interest or otherwise as a result of our gross negligence or willful
misconduct, we would be required to either purchase the CBO III collateral from
BSIL or pay BSIL the difference between the price it paid for the CBO III
collateral and the price at which it sold the CBO III collateral to a third-
party (a collateral loss). If the CBO III transaction fails to close for any
other reason, other than as a result of BSIL's gross negligence or willful
misconduct, we would be required to either purchase the CBO III collateral from
BSIL or pay BSIL the lesser of $15 million and the collateral loss or, if we
have paid a deposit on the CBO III collateral in exchange for a portion of the
interest payments on the securities, the lesser of the collateral loss and any
such deposit. Although we currently anticipate
42
completing the CBO III transaction during the fourth quarter of 2002, there is
no assurance that the CBO III transaction will be consummated. As of August 12,
2002, we estimate that the fair value of the securities purchased by BSIL is in
excess of the purchase price paid by BSIL.
In September, 2002, we sold to Bear Stearns for $37.9 million an aggregate
of $62.3 million face amount of bonds we held that were issued by the various
affiliates of Newcastle Investment Holdings that hold indirectly the GSA
portfolio.
INFLATION
Substantially all of our office leases provide for separate escalations of
real estate taxes and operating expenses over a base amount, and/or increases in
the base rent based on changes in the Consumer Price Index ("CPI"). We believe
that inflationary increases in expenses will generally be offset by the expense
reimbursements and contractual rent increases described above.
We believe that our risk of increases in the market interest rates on our
floating rate debt as a result of inflation is largely offset by our use of
match funding and hedging instruments as described above. See "-- Quantitative
and Qualitative Disclosure About Market Risk -- Interest Rate Exposure" below.
PRO FORMA FUNDS FROM OPERATIONS
We believe Funds from Operations (FFO) is one appropriate measure of the
performance of real estate companies because it provides investors with an
understanding of our ability to incur and service debt and make capital
expenditures. Funds from Operations (FFO), for our purposes, represents net
income available for common shareholders (computed in accordance with accounting
principles generally accepted in the United States ("GAAP")), excluding
extraordinary items, plus real estate depreciation and amortization, and after
adjustments for unconsolidated subsidiaries, if any. We consider gains and
losses on resolution of our investments to be a normal part of our recurring
operations and therefore do not exclude such gains and losses when arriving at
FFO. Adjustments for unconsolidated subsidiaries, if any, are calculated to
reflect FFO on the same basis. FFO does not represent cash generated from
operating activities in accordance with GAAP and therefore should not be
considered an alternative to net income as an indicator of our operating
performance or as an alternative to cash flow as a measure of liquidity and is
not necessarily indicative of cash available to fund cash needs.
Funds from Operations (FFO), on a pro forma basis after giving effect to
the initial transactions, is calculated as follows (unaudited) (in thousands):
FOR THE SIX MONTHS ENDED
JUNE 30, FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2001 2000(A) 1999(A)
-------------- -------------- ------------- ---------------- ----------------
Income from continuing
operations.............. $17,819 $16,625 $27,101 $15,854 $10,145
Real estate depreciation
and amortization........ 1,332 1,298 2,637 2,518 1,358
------- ------- ------- ------- -------
Funds from Operations
(FFO) from continuing
operations.............. $19,151 $17,923 $29,738 $18,372 $11,503
======= ======= ======= ======= =======
(A) Adjusted as described in the introduction to "Management's Discussion
and Analysis of Pro Forma Financial Condition and Results of
Operations."
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risks that we are exposed to are interest rate risk and foreign
currency exchange rate risk. Interest rate risk and foreign currency exchange
rate risk are highly sensitive to many factors, including governmental monetary
and tax policies, domestic and
43
international economic and political considerations and other factors beyond our
control. All of our market risk sensitive assets, liabilities and related
derivative positions are for non-trading purposes only.
Interest Rate Exposure
Our primary interest rate exposures relate to our loans, mortgage backed
securities and variable-rate debt, as well as our interest rate swaps and caps.
Changes in the general level of interest rates can effect our net interest
income, which is the difference between the interest income earned on
interest-earning assets and the interest expense incurred in connection with our
interest-bearing liabilities. Changes in the level of interest rates also can
effect, among other things, our ability to originate and acquire loans and
securities, the value of our loans and mortgage backed securities, and our
ability to realize gains from the settlement of such assets. We utilize interest
rate swaps, caps and match-funded financings in order to limit the effects of
interest rates on our operations. As of June 30, 2002, a 100 basis point change
in short-term interest rates would affect our earnings by no more than $2.2
million per annum.
Currency Rate Exposure
Our primary foreign currency exchange rate exposures relate to our real
estate leases and assets. Our principal direct currency exposures are to the
Euro and the Canadian Dollar. Changes in the currency rates can adversely impact
the fair values and earnings streams of our international holdings. We have
attempted to mitigate this impact in part by utilizing local
currency-denominated financing on our foreign investments to partially hedge, in
effect, these assets.
We have material investments in a portfolio of Belgian properties, the LIV
portfolio, and a portfolio of Canadian properties, the Bell Canada portfolio.
These properties are financed utilizing debt instruments denominated in their
respective local currencies (the Euro and the Canadian Dollar). The net equity
invested in these portfolios, approximately $18.1 million and $20.9 million,
respectively, at June 30, 2002, is exposed to foreign currency exchange risk.
Fair Values
For certain of our financial instruments, fair values are not readily
available since there are no active trading markets as characterized by current
exchanges between willing parties. Accordingly, fair values can only be derived
or estimated for these investments using various valuation techniques, such as
computing the present value of estimated future cash flows using discount rates
commensurate with the risks involved. However, the determination of estimated
future cash flows is inherently subjective and imprecise. We note that minor
changes in assumptions or estimation methodologies can have a material effect on
these derived or estimated fair values, and that the fair values reflected below
are indicative of the interest rate and currency rate environments as of June
30, 2002 and do not take into consideration the effects of subsequent interest
rate or currency rate fluctuations.
44
We held the following interest rate risk sensitive instruments at June 30,
2002 on a pro forma basis after giving effect to the initial transactions
(unaudited) (dollars in thousands):
PRINCIPAL WEIGHTED
BALANCE OR AVERAGE
CARRYING NOTIONAL EFFECTIVE MATURITY
AMOUNT AMOUNT INTEREST RATE DATE OTHER TERMS FAIR VALUE
---------- ---------- ------------- ---------- ------------------------- ----------
Assets:
CBO collateral,
net(A)............... $1,006,882 $1,015,896 7.31% Various Various (mixed floating $1,006,882
and fixed rates,
amortizing and interest
only)
Marketable securities,
available for
sale(B).............. 7,184 19,326 N/A (B) (B) 7,184
Interest rate caps,
treated as hedges,
net(C)............... 7,418 184,493 N/A (C) (C) 7,418
Liabilities:
CBO bonds payable(D)... 867,058 881,500 4.32% (D) Amortizes principal based 887,160
on collateral payments,
subject to reinvestment
Other bonds
payable(E)........... 38,739 39,544 6.33% Apr-12 Interest only 38,269
Notes payable(E)....... 51,570 51,570 4.79% Nov-16 Amortizes principal with 51,570
a balloon payment at
maturity
Repurchase
agreement(E)......... 1,457 1,457 3.19% Short-term Interest only 1,457
Interest rate swaps,
treated as hedges,
net(F)............... 26,421 466,007 N/A (F) (F) 26,421
Non-hedge derivative
obligations(G)....... 156 (G) N/A (G) (G) 156
- ---------------
(A) The fair value of these securities is estimated by obtaining third party
independent broker quotations.
(B) These two securities with carrying amounts of $3.9 million and $3.2
million, respectively, mature in November 2007 and August 2030,
respectively, and represent subordinate and residual interests in
securitizations. The fair values of these securities, for which quoted
market prices are not readily available, are estimated by means of a
price/yield analysis based on our expected disposition strategies for such
assets.
(C) These two agreements have notional balances of $166.5 million and $18.0
million, respectively, mature in March 2009 and October 2015, respectively,
and cap 1-month LIBOR at 6.50% and 3-month LIBOR at 8.00%, respectively.
The fair value of these agreements is estimated by obtaining counterparty
quotations.
(D) For those bonds bearing floating rates at spreads over market indices,
representing approximately $709.8 million of the carrying amount of the CBO
bonds payable, we believe that for similar financial instruments with
comparable credit risks, the effective rates at June 30, 2002 approximate
market rates. Accordingly, the carrying amount outstanding on these bonds
is believed to approximate fair value. For those bonds bearing fixed
interest rates, values were obtained by discounting expected future
payments by a rate calculated by imputing a spread over a market index on
the date of borrowing. The weighted average stated maturity of the CBO
bonds payable is September 2035.
(E) We believe that for similar financial instruments with comparable credit
risks, the stated interest rates at June 30, 2002 (all of which are
floating rates at spreads over market indices) approximate market rates,
with the exception of the Bell Canada securitization which bears interest
at a fixed rate. The Bell Canada securitization was valued by discounting
expected future payments by a rate calculated by imputing a spread over a
market index on the date of borrowing.
(F) These two agreements have notional balances of $176.0 million and $290.0
million, respectively, mature in July 2005 and April 2011, respectively,
and swap 1-month LIBOR for 6.1755% and
45
3-month LIBOR for 5.93%, respectively. The fair value of these agreements
is estimated by obtaining counterparty quotations.
(G) These are two essentially offsetting interest rate caps and two essentially
offsetting interest rate swaps, each with notional amounts of $32.5 million
as of June 30, 2002, an interest rate cap with a notional balance of $17.5
million as of June 30, 2002, and an interest rate cap with a notional
balance of approximately $59.8 million as of June 30, 2002. The maturity
date of the purchased swap is July 2009; the maturity date of the sold swap
is July 2014, the maturity date of the $32.5 million caps is July 2038, the
maturity date of the $17.5 million cap is July 2009, and the maturity date
of the $59.8 million cap is August 2004. They have been valued by reference
to counterparty quotations.
We held the following currency rate risk sensitive balances at June 30,
2002 on a pro forma basis after giving effect to the initial transactions
(unaudited):
CURRENT EFFECT OF A 5% EFFECT OF A 5%
EXCHANGE NEGATIVE NEGATIVE
CARRYING LOCAL RATE TO CHANGE IN CHANGE IN
AMOUNT CURRENCY USD EURO RATE CAD RATE
-------- --------- -------- -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT EXCHANGE RATES)
Assets:
LIV portfolio..................... $64,923 Euro 1.00867 $(3,246) N/A
Bell Canada portfolio............. 53,310 CAD 1.51730 N/A $(2,666)
LIV other, net.................... 4,793 Euro 1.00867 (240) N/A
Bell Canada other, net............ 6,318 CAD 1.51730 N/A (316)
Liabilities:
LIV mortgage...................... 51,570 Euro 1.00867 2,579 N/A
Bell Canada bonds................. 38,739 CAD 1.51730 N/A 1,937
------- -------
Total............................. $ (907) $(1,045)
======= =======
- ---------------
USD refers to U.S. dollars; CAD refers to Canadian dollars.
46
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF HISTORICAL FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OF NEWCASTLE INVESTMENT HOLDINGS CORP.
The following should be read in conjunction with the Historical
Consolidated Financial Statements and Notes thereto included herein.
GENERAL
Newcastle Investment Holdings was incorporated on May 11, 1998 and was
initially capitalized through the sale of 50 shares of common stock for $1,000.
In June 1998, Newcastle Investment Holdings completed a private offering,
including an over-allotment option, for the sale of 20,912,401 shares of common
stock for proceeds of approximately $384.5 million, net of expenses. In
addition, in July 1998, certain employees of Fortress Investment Group LLC
purchased an aggregate of 4,288 shares of the common stock of Newcastle
Investment Holdings resulting in additional proceeds of approximately $0.1
million. In 2000 and 2001, Newcastle Investment Holdings repurchased an
aggregate of 4,428,222 shares of its common stock for $32.4 million of cash and
$46.3 million of newly issued shares of its Series A Cumulative Convertible
Preferred Stock (the "Series A Preferred"). At June 30, 2002, Newcastle
Investment Holdings had 16,488,517 shares of its common stock outstanding. The
Series A Preferred was fully redeemed by June 14, 2002.
Newcastle Investment Holdings has elected to be taxed as a REIT under the
Internal Revenue Code. As such, it will generally not be subject to federal
income tax on that portion of its income that is distributed to shareholders if
it distributes at least 90% of its REIT taxable income to its shareholders by
the due date of its federal income tax return and complies with various other
requirements.
Newcastle Investment Holdings conducts its business through four primary
segments: (1) real estate securities, (2) revenue-producing real estate,
primarily credit leased real estate, (3) its investment in Fortress Investment
Fund LLC (the "Fund") and (4) real estate loans. Revenues attributable to each
segment are disclosed below. For a further discussion of Newcastle Investment
Holdings' operating segments, please see the audited Historical Consolidated
Financial Statements included herein. As discussed in this prospectus, in
connection with the initial transactions, Newcastle Investment Holdings'
investments in real estate securities and a portion of its investments in
revenue-producing real estate were contributed to us. All of Newcastle
Investment Holdings' historical operations are considered below, including those
contributed to us. See "Management's Discussion and Analysis of Pro Forma
Financial Condition and Results of Operations" for a separate discussion of the
operations contributed to us on a stand alone basis.
REAL REAL FORTRESS
REAL ESTATE ESTATE INVESTMENT UN-
ESTATE SECURITIES LOANS FUND ALLOCATED TOTAL
------- ---------- ------ ---------- --------- --------
(UNAUDITED) (IN THOUSANDS)
FOR THE SIX MONTHS ENDED JUNE 30,
2002:
Revenues........................... $37,535 $35,221 $ 128 $(1,183) $ 5,303 $ 77,004
FOR THE YEAR ENDED DECEMBER 31,
2001:
Revenues........................... 76,452 53,095 6,270 29,356 12,422 177,595
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Newcastle Investment Holdings has classified its real estate securities,
which have been contributed to us, as available for sale. As such, they are
carried at market value with net unrealized gains or losses reported as a
component of accumulated other comprehensive income. Market value is based
primarily upon multiple broker quotations, which provide valuation estimates
based upon reasonable market order indications or a good faith estimate thereof.
Such quotations are subject to significant variability based on market
conditions, such as interest rates and spreads. Changes in market conditions, as
well as changes in
47
the assumptions or methodology used to determine market value, could result in a
significant increase or decrease in the book equity of Newcastle Investment
Holdings.
Similarly, Newcastle Investment Holdings' derivative instruments, held for
hedging purposes, are carried at market value pursuant to Statement of Financial
Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and
Hedging Activities," as amended. Such derivative instruments were primarily
contributed to us. Market value is based on counterparty quotations. To the
extent they qualify as hedges under SFAS No. 133, net unrealized gains or losses
are reported as a component of accumulated other comprehensive income;
otherwise, they are reported as a component of current income. Market values of
such derivatives are subject to significant variability based on many of the
same factors as the securities discussed above. The results of such variability
could be a significant increase or decrease in Newcastle Investment Holdings'
book equity and/or earnings.
The investment in the Fund was retained by Newcastle Investment Holdings.
The managing member of the Fund is Fortress Fund MM LLC (the "Managing Member"),
which is owned jointly, through subsidiaries, by Newcastle Investment Holdings,
approximately 94%, and the Manager, approximately 6%. The Managing Member is
entitled to an incentive return (the "Fund Incentive Return") generally equal to
20% of the Fund's returns, as defined, subject to: (1) a 10% preferred return
payable to the Investors and (2) a clawback provision which requires amounts
previously distributed as Fund Incentive Return to be returned to the Fund if,
upon liquidation of the Fund, the amounts ultimately distributed to each
Investor do not meet a 10% preferred return to the Investors. The Fund is
managed by the Manager pursuant to the Managing Member's operating agreement and
a management agreement between the Manager and the Managing Member. In
accordance with those documents, (1) the Manager is entitled to 100% of the
management fee payable by the Fund, (2) the Manager is entitled to 50% of the
Fund Incentive Return payable by the Fund, (3) Newcastle Investment Holdings is
entitled to 50% of the Fund Incentive Return payable by the Fund and (4)
Newcastle Investment Holdings is entitled to receive 100% of the investment
income or loss attributable to the capital invested in the Fund by the Managing
Member. The Manager of the Fund also manages Newcastle Investment Holdings.
Newcastle Investment Holdings consolidates the financial results of the Managing
Member because it owns substantially all of the voting interest in the Managing
Member. As a result, the financial statements of Newcastle Investment Holdings
reflect all of the Fund Incentive Return payable to the Managing Member,
including the 50% portion payable to the Manager which is treated as Incentive
Return to Affiliates.
The Fund Incentive Return is payable on an asset-by-asset basis, as
realized. Accordingly, a Fund Incentive Return may be paid to the Managing
Member in connection with a particular Fund investment if and when such
investment generates proceeds to the Fund in excess of the capital called with
respect to such investment, plus a 10% preferred return thereon. If, upon
liquidation of the Fund, the aggregate amount paid to the Managing Member as the
Fund Incentive Return exceeds the amount actually due to the Managing Member
(that is, amounts that should instead have been paid to Investors) after taking
into account the aggregate return to Investors, the excess is required to be
returned by the Managing Member (that is "clawed back") to the Fund. Newcastle
Investment Holdings receives a credit against management fees otherwise payable
under the Management Agreement with the Manager for management fees and any Fund
Incentive Return paid to the Manager by the Fund in connection with Newcastle
Investment Holdings' investment in the Fund.
Newcastle Investment Holdings has adopted Method 2 of Emerging Issues Task
Force Topic D-96 which specifies that companies with management arrangements
that contain a performance based incentive return that is not finalized until
the end of a period of time specified in the contract may record such return as
revenue in the amount that would be due under the formula at any point in time
as if the incentive return arrangement was terminated at that date.
Newcastle Investment Holdings records as incentive income the amount that
would be due based on the fair value of the assets in the Fund exceeding the
required return at a specific point in time as if the management arrangement was
terminated on that date. Based on this methodology, the net income of Newcastle
Investment Holdings in each reporting period will reflect changes in the fair
value of the assets
48
in the Fund which may be significant. The fair value of the assets in the Fund
is determined by the Managing Member pursuant to guidelines established by the
Fund's board of directors. Due to the inherent uncertainty of valuations of
investments without a public market, the estimates of value may differ from the
values that are ultimately realized by the Fund, and the differences could be
material. Such estimates of fair value can fluctuate from quarter to quarter,
which can result in material fluctuations in the amount of Fund Incentive Return
recorded by Newcastle Investment Holdings. Fund Incentive Return recorded in
prior periods may be reversed in future periods if value estimates decrease.
This could result in material fluctuations, positive or negative, in Newcastle
Investment Holdings' earnings from quarter to quarter.
RESULTS OF OPERATIONS
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED JUNE
30, 2001
Interest and dividend income increased by $2.7 million or 9.6%, from $28.4
million to $31.1 million. This increase is primarily the result of interest
earned on the CBO II deposit and CBO II collateral, offset by a decrease in
interest earned on loan and mortgage pool investments as a result of the
settlement of a substantial portion of such investments in 2001.
Rental and escalation income decreased by $0.5 million or 1.3%, from $38.0
million to $37.5 million. This decrease is primarily the result of foreign
currency fluctuations related to the Bell Canada portfolio.
Gain on settlement of investments decreased by $3.8 million, from $8.9
million to $5.1 million, primarily as a result of a reduction in the volume of
sales of certain CBO collateral securities. Sales of CBO securities are based on
a number of factors including credit, asset type and industry and can be
expected to increase or decrease from time to time. Periodic fluctuations in the
volume of sales of securities is dependent upon, among other things,
management's assessment of credit risk, asset concentration, portfolio balance
and other factors. The reduced volume of sales of securities during this period
reflects management's determination that the portfolio required less adjustment
than in prior periods.
Equity in earnings of unconsolidated subsidiaries decreased $0.7 million,
from $1.1 million to $0.4 million, as a result of a reduction of Newcastle
Investment Holdings' income from its investment in Fortress Investment Fund LLC
(a $2.6 million reduction in income) offset by the elimination of prior loss
recognition from Newcastle Investment Holdings' investment in Austin Holdings
Corporation due to the winding-up of its activities ($1.9 million).
Fund Incentive Return from Newcastle Investment Holdings' investment in
Fortress Investment Fund LLC of $1.2 million of loss was recorded during the
period. Newcastle Investment Holdings records as Fund Incentive Return the
amount that would be due based on the fair value of the assets in the Fund
exceeding the required return as if the management arrangement was terminated.
During the period, the amount previously recognized as Fund Incentive Return in
2001 was reduced due to losses incurred in the Fund. The calculation of
incentive income is more fully discussed above.
Management fee income from the Fund, all of which is payable to the Manager
and is therefore included in management fee expense, has no net effect on
Newcastle Investment Holdings' operations.
Minority interest increased by $0.2 million primarily due to prior period
losses on mortgage pool investments which had minority interests.
Interest expense increased by $0.9 million or 2.6%, from $31.9 million to
$32.8 million. This increase is primarily the result of interest on the CBO II
securitization ($5.0 million), offset by the repayment of debt associated with
the settlement of certain of Newcastle Investment Holdings' loan and mortgage
pool investments during these periods ($1.8 million), as well as lower interest
rates being paid on the variable rate CBO securities classes ($2.3 million).
Property operating expense decreased by $0.1 million or 0.6%, from $14.4
million to $14.3 million, primarily as the result of foreign currency
fluctuations related to the Canadian properties.
49
Loan servicing and REO expense decreased by $0.1 million from $0.5 million
to $0.4 million primarily as the result of the settlement of a substantial
portion of our loan and mortgage pool investments in 2001, offset by an increase
related to the CBO II transaction. REO expense represents expenses related to
maintaining foreclosed property and preparing it for sale.
General and administrative expense increased by $1.0 million, from $0.8
million to $1.8 million, primarily as a result of increased insurance costs and
increased state and local taxes.
Management fee expense remained at approximately $7.2 million. The
calculation of our management fee is more fully discussed under "Our Manager and
The Management Agreement -- Management Fees" in this prospectus. Management fee
expense includes management fees related to Fortress Investment Fund ($4.5
million) which are directly offset by management fee income.
Incentive return increased by $0.8 million as a result of Newcastle
Investment Holdings and Fortress Investment Fund reaching the incentive return
threshold in late 2001. The calculation of our incentive return is more fully
discussed under "Our Manager and The Management Agreement -- Management Fees" in
this prospectus.
Depreciation and amortization increased by $0.4 million or 6.6%, from $6.4
million to $6.8 million, primarily as the result of depreciation on the capital
expenditures we made with respect to our real estate assets.
Preferred dividends and related accretion decreased $0.1 million from $1.3
million to $1.2 million as a result of the redemption of such stock in June
2002.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED DECEMBER 31,
2000
Interest and dividend income decreased by $12.0 million or 18.3%, from
$65.4 million to $53.4 million. This decrease is primarily the result of a
decrease in interest earned on loan and mortgage pool investments as the result
of the settlement of a substantial portion of such investments during 2001 ($9.8
million) and a decrease in interest earned on cash balances due to Newcastle
Investment Holdings being more fully invested in 2001.
Rental and escalation income increased by $0.7 million or 0.9%, from $75.3
million to $76.0 million. This increase is primarily the result of increased
escalations related to the GSA properties.
Gain on settlement of investments decreased by $11.4 million, from $21.8
million to $10.4 million, primarily as a result of the gains on the sale of
various securities we acquired in connection with our acquisition of Impac
Commercial Holdings, Inc. in 2000 ($21.3 million) offset by gains on the sale of
certain CBO collateral securities ($7.4 million) and notes receivable ($3.0
million) in 2001.
Equity in earnings (losses) of unconsolidated subsidiaries increased $3.8
million, from a $1.0 million loss to a $2.8 million gain, primarily as a result
of the recognition of Newcastle Investment Holdings' share of increased income
from its investment in Fortress Investment Fund LLC.
Fund Incentive Return from Newcastle Investment Holdings' Fortress
Investment Fund LLC investment of $28.7 million was recorded during the year
ended December 31, 2001. Newcastle Investment Holdings records as incentive
income the amount that would be due based on the fair value of the assets in the
Fund exceeding the required return as if the management arrangement was
terminated. The calculation of incentive income is more fully discussed above.
Management fee income from the Fund, all of which is payable to the Manager
and is therefore included in management fee expense, has no net effect on
Newcastle Investment Holdings' operations.
Minority interest increased by $0.8 million primarily due to prior year
losses on mortgage pool investments which had minority interests.
Interest expense decreased by $5.1 million or 7.6%, from $66.4 million to
$61.3 million. This decrease is primarily the result of the repayment of debt
associated with the settlement of certain loan and mortgage pool investments
during these periods ($3.4 million) and lower interest rates being paid on the
variable rate CBO securities classes ($2.9 million).
50
Property operating expense increased by $0.5 million or 2.0%, from $28.3
million to $28.8 million, primarily as the result of increased expenses at the
GSA properties, which is offset by increased escalation income (see above).
Loan servicing and REO expense decreased by $1.3 million or 58.5%, from
$2.3 million to $1.0 million. This decrease is primarily the result of the
settlement of a substantial portion of Newcastle Investment Holdings' mortgage
pool investments during these periods.
General and administrative expense decreased by $1.6 million or 39.2%, from
$4.0 million to $2.4 million, primarily as a result of decreases in insurance
expense ($0.4 million) and professional fees ($1.1 million).
Management fee expense decreased $0.9 million from $15.6 million to $14.7
million. The calculation of our management fee is more fully discussed under
"Our Manager and The Management Agreement -- Management Fees" in this
prospectus. Management fee expense includes management fees related to Fortress
Investment Fund ($8.9 million) which are directly offset by management fee
income.
Incentive return increased by $17.2 million as a result of Newcastle
Investment Holdings and Fortress Investment Fund reaching the incentive return
threshold in late 2001. The calculation of our incentive return is more fully
discussed under "Our Manager and The Management Agreement -- Management Fees" in
this prospectus.
Depreciation and amortization increased by $0.8 million or 6.6%, from $12.2
million to $13.0 million, primarily as the result of depreciation on the capital
expenditures made with respect to real estate assets.
Preferred dividends and related accretion increased by $0.4 million from
$2.1 million to $2.5 million as a result of the contractual increase in dividend
rate effective July 1, 2001.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED DECEMBER 31,
1999
Rental and escalation income increased by $10.5 million, from $64.8 million
to $75.3 million. This increase was primarily the result of the acquisition of
two GSA properties during 1999 ($4.9 million) and the acquisition of the Belgian
real estate portfolio in November 1999 ($6.2 million).
Interest and dividend income increased by $15.2 million, from $50.2 million
to $65.4 million. This increase was primarily the result of CBO investments
during 1999 ($20.8 million), offset by a decrease in interest earned on mortgage
pool investments as the result of the settlement of a substantial portion of
such investments during 1999 and 2000 ($4.2 million) as well as a decrease in
interest earned on cash balances due to Newcastle Investment Holdings being more
fully invested in 2000.
Gain (loss) on settlement of investments improved $23.3 million, from a
loss of $1.5 million to a gain of $21.8 million, primarily as a result of the
gains on the sale of various securities acquired in the ICH transaction in
November and December 2000 ($21.3 million), as well as improved net gains on the
settlement of a substantial portion of Newcastle Investment Holdings' mortgage
pool investments ($4.4 million), offset by a reduction in gains on the sale of
CBO collateral subsequent to the securitization of such collateral in July 1999
(after which trading of such securities was reduced substantially) ($2.9
million).
Management fee income from the Fund, all of which is payable to the Manager
and is therefore included in management fee expense, has no net effect on
Newcastle Investment Holdings' operations.
Equity in earnings (losses) of unconsolidated subsidiaries improved $2.6
million, from a loss of $3.6 million to a loss of $1.0 million, primarily as a
result of losses associated with certain joint ventures, including Ascend
Residential Holdings, Inc., whose primary business is the acquisition,
rehabilitation and sale of single-family residential properties, which were
recorded in 1999.
Interest expense increased by $19.9 million, from $46.5 million to $66.4
million. This increase is primarily the result of interest on the GSA
securitization, the CBO securitization, the LIV mortgage, and the Bell Canada
mortgage which were funded in 1999 and Newcastle Investment Holdings' credit
facility which was entered in July 2000, net of interest on various notes
payable which were repaid with the proceeds thereof.
51
Property operating expense increased by $5.1 million, from $23.2 million to
$28.3 million, primarily as the result of the same factors described under
"rental and escalation income" above.
Loan servicing and REO expense decreased by $0.8 million, from $3.1 million
to $2.3 million. This decrease is primarily the result of the settlement of a
substantial portion of Newcastle Investment Holdings' mortgage pool investments
during 1999 and 2000.
General and administrative expense increased by $0.5 million, from $3.5
million to $4.0 million, primarily as a result of increased costs associated
with Newcastle Investment Holdings being more fully invested.
Management fee expense increased by $7.2 million, from $8.4 million to
$15.6 million primarily as a result of management fees related to Fortress
Investment Fund which are directly offset by management fee income. The
calculation of our management fee is more fully discussed under "Our Manager and
The Management Agreement -- Management Fees" in this prospectus.
Depreciation and amortization increased by $1.8 million, from $10.4 million
to $12.2 million, primarily as the result of the same factors described under
"rental and escalation income" above.
Preferred dividends and related accretion increased by $2.1 million as a
result of the issuance of the Series A Preferred in June 2000.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measurement of the ability to meet potential cash
requirements, including ongoing commitments to repay borrowings, fund and
maintain investments, and other general business needs. Additionally, to
maintain its status as a REIT under the Internal Revenue Code, Newcastle
Investment Holdings must distribute annually at least 90% of its taxable income.
Newcastle Investment Holdings' primary sources of funds for liquidity,
subsequent to its private equity offering in 1998, have consisted of net cash
provided by operating activities, borrowings under loans, the issuance of debt
securities and the settlement of investments.
At this time, Newcastle Investment Holdings does not expect to materially
grow its separate investment portfolio in the future, except for its required
contributions to the Fund.
Newcastle Investment Holdings expects to meet its short-term liquidity
requirements generally through its cash flow provided by operations, as well as
investment specific borrowings and secured or unsecured lines of credit. Its
real estate investments, a portion of which have been contributed to us, are
financed long-term and primarily leased to credit tenants with long-term leases
and are therefore expected to generate generally stable cash flows. Its real
estate securities, which were contributed to us, are also financed long-term and
their credit status is continuously monitored; therefore, these investments are
also expected to generate a generally stable return, subject to interest rate
fluctuations. See "- Interest Rate Exposure" below. Returns on Newcastle
Investment Holdings' investment in the Fund, which has been retained by
Newcastle Investment Holdings, are subject to significant variability. However,
this asset is unleveraged. Newcastle Investment Holdings considers its ability
to generate cash to be adequate and expects it to continue to be adequate to
meet operating requirements both in the short- and long-terms.
Newcastle Investment Holdings expects to meet its long-term liquidity
requirements, specifically the repayment of its debt and its investment funding
needs, through additional borrowings, the issuance of debt and/or equity
securities and the liquidation or refinancing of its assets at maturity.
Newcastle Investment Holdings believes that the value of these assets is, and
will continue to be, sufficient to repay its debt at maturity under either
scenario.
Newcastle Investment Holdings has certain investments in, and commitments
to, two unconsolidated subsidiaries as described below. Both of these
investments, and the related commitments, were retained by Newcastle Investment
Holdings.
52
Newcastle Investment Holdings has committed to contribute approximately
$100 million to Fortress Investment Fund LLC, along with other major
institutional investors who, together with Newcastle Investment Holdings and its
affiliates, have committed approximately $872.8 million over the three years
ending April 28, 2003. Approximately $635.5 million, net, of this amount had
been funded through June 30, 2002. The portion of the expenses payable by
Newcastle Investment Holdings in connection with raising the Fund, including
placement agent fees, printing costs and legal fees, is approximately $9.8
million, of which approximately $4.0 million has been paid through June 30,
2002.
In 1998, Newcastle Investment Holdings and Fortress Principal Investment
Group LLC ("FPIG"), an affiliate of our manager, formed Austin Holdings
Corporation ("Austin"). FPIG contributed cash and Newcastle Investment Holdings
contributed its interest in entities that owned certain assets, primarily non-
performing loans and foreclosed real estate intended for sale, which it
originally acquired as part of a loan pool acquisition. The assets Newcastle
Investment Holdings contributed, and any income generated from them, are not
well suited to be held by a REIT because of the following reasons. If the assets
were treated as inventory held for sale in the ordinary course of business, any
gain from the sale of these assets would be subject to a 100% excise tax in the
hands of a REIT. By holding these assets indirectly through Austin, a corporate
entity, Newcastle Investment Holdings instead receives dividend income from the
corporation, which is not subject to the 100% excise tax, and is treated as
qualifying income for purposes of the REIT 95% income test. Newcastle Investment
Holdings holds non-voting preferred stock of Austin. Newcastle Investment
Holdings' preferred stock in Austin represents a 95% economic ownership interest
in Austin and has a liquidation preference over the common stockholders.
Newcastle Investment Holdings' interest in Austin is accounted for under the
equity method. As of June 30, 2002, Newcastle Investment Holdings had no
outstanding obligations to Austin. Newcastle Investment Holdings acquired stock
that is non-voting in order to comply with the rule that REITs generally may not
hold more than 10% of the voting stock of any corporation. FPIG is the holder of
all of the common stock, which represents 100% of the vote and 5% of the
economic ownership interest in Austin. Austin also owns 100% of the common stock
of Ascend Residential Holdings, Inc. ("Ascend"). Ascend's primary business is
the acquisition, rehabilitation and sale of single-family residential
properties. As of June 30, 2002, Newcastle Investment Holdings' gross investment
in Austin is $9.2 million, Austin has no debt outstanding, and Austin is in the
process of disposing of its remaining assets.
With respect to its real estate assets, Newcastle Investment Holdings
expects to incur approximately $1.4 million and $5.6 million, related to the
assets held by us and Newcastle Investment Holdings, after the initial
transactions, respectively, of tenant improvements in connection with the
inception of leases and capital expenditures during the eighteen months ending
December 31, 2003. Subsequent to the initial transactions, we bear the costs,
including all capital expenditures and tenant improvements, related to the
assets we own.
Newcastle Investment Holdings' long-term debt existing at June 30, 2002
(gross of $54.5 million of discounts) is expected to mature as follows: $19.7
million during the period from July 1, 2002 through December 31, 2002, $51.0
million in 2003, $22.4 million in 2004, $24.0 million in 2005, $25.6 million in
2006, $26.4 million in 2007, and $1,195.1 million thereafter. Newcastle
Investment Holdings' debt contains various customary loan covenants.
In August 1998, Newcastle Investment Holdings closed on the $234.2 million
GSA mortgage. In March 1999, it closed on the $18.6 million GSA San Diego
mortgage. In May 1999, it repaid these two mortgages with proceeds from the
$399.1 million GSA Securitization, of which $351.9 million (gross of discounts)
was outstanding on June 30 2002. The GSA securitization matures in May 2011 and
has a weighted average effective interest rate, including discount and cost
amortization, of approximately 7.04%. The GSA securitization, and related
assets, were retained by Newcastle Investment Holdings.
In July 1999, Newcastle Investment Holdings completed its first CBO
securitization whereby the CBO collateral was contributed to a consolidated
subsidiary of Newcastle Investment Holdings which issued $437.5 million of
investment grade senior securities and $62.5 million of non-investment grade
subordinated securities in a private placement. As a result of the CBO
securitization, the existing short-
53
term repurchase agreement on the CBO collateral was repaid. At June 30, 2002,
the subordinated securities were retained by Newcastle Investment Holdings, and
the senior securities (all of which are still outstanding), which bore interest
at a weighted average effective rate, including discount and cost amortization,
of 4.32%, had an expected weighted average life of approximately 5.9 years. Two
classes of the senior securities bear floating interest rates. Newcastle
Investment Holdings has obtained an interest rate swap and cap in order to hedge
its exposure to the risk of changes in market interest rates with respect to
these securities, at an initial cost of approximately $14.3 million. In
addition, in connection with the sale of two classes of securities, Newcastle
Investment Holdings entered into two interest rate swaps and three interest rate
cap agreements that do not qualify for hedge accounting. The CBO securitization,
and related assets, were contributed to us.
In November 1999, Newcastle Investment Holdings securitized a U.S.
commercial mortgage loan by issuing $55.6 million of bonds. The bonds were also
secured by a $15.0 million letter of credit. These obligations were repaid in
December 2001.
In March 1999, Newcastle Investment Holdings obtained the Bell Canada
mortgage secured by the Bell Canada properties. In April 2002, Newcastle
Investment Holdings refinanced the Bell Canada properties by issuing
approximately $37.6 million of investment grade debt securities in a private
placement. The issued securities, which bore interest at a weighted average
effective rate, including discount and cost amortization, of approximately 6.70%
at closing, had an expected weighted average life of approximately 5.1 years at
closing. Newcastle Investment Holdings has retained one class of the issued
securities. The proceeds from the issued securities were used, in part, to repay
the Bell Canada mortgage. In November 1999, Newcastle Investment Holdings
obtained the LIV mortgage, which had an outstanding balance of $51.6 million and
bore interest at 4.79% as of June 30, 2002, and is due in November 2016. In
November 1999, Newcastle Investment Holdings obtained the $24.8 million GSA
Kansas City mortgage, which was repaid in May 2002 upon sale of the related
asset. Newcastle Investment Holdings hedged its exposure to the risk of changes
in market interest rates with respect to the LIV mortgage and the GSA Kansas
City mortgage by obtaining interest rate caps. The Bell Canada mortgage, LIV
mortgage, and related assets, were contributed to us.
In July 2000, Newcastle Investment Holdings entered into a $40 million
revolving credit agreement, which had an outstanding balance of $38.3 million
and bore interest at 6.10% as of June 30, 2002, and is due in July 2003.
Newcastle Investment Holdings hedged its exposure to the risk of changes in
market interest rates with respect to the credit agreement by obtaining an
interest rate swap. This credit agreement was retained by Newcastle Investment
Holdings.
Newcastle Investment Holdings utilizes repurchase agreements for short-term
financings of mortgage pools and of investments prior to securitizations. As of
June 30, 2002 Newcastle Investment Holdings had a $1.5 million repurchase
agreement outstanding, bearing interest at approximately 3.19% with a short-
term maturity. This agreement, and the related asset, was contributed to us.
In October 2001, Newcastle Investment Holdings entered into an agreement
with Morgan Stanley & Co. Incorporated whereby it had the right to purchase up
to $400 million, plus our deposit, of commercial mortgage backed securities,
unsecured REIT debt and asset backed securities, which we refer to as the CBO II
collateral, which were specifically designated for a securitization transaction,
the CBO II transaction. In April 2002, Newcastle Investment Holdings completed
the CBO II transaction whereby a consolidated subsidiary of Newcastle Investment
Holdings issued $444.0 million face amount of investment grade senior securities
and $56.0 million face amount of non-investment grade subordinated securities,
collectively referred to as the CBO II securities, in a private placement. The
senior securities were issued for net proceeds of $438.8 million after issue
costs. The subordinated securities were retained by Newcastle Investment
Holdings. The CBO II securities are collateralized by a portfolio of CMBS,
unsecured REIT debt, asset-backed securities, and a limited amount of other
securities and restricted cash, pending its use for investment in securities
(collectively, the CBO II collateral), which was acquired with the proceeds from
the CBO II securities and with the deposit Newcastle Investment Holdings had
made on such securities. The senior securities, which bore interest at a
weighted average effective rate, including discount
54
and cost amortization, of approximately 3.69% at closing, had an expected
weighted average life of approximately 8.04 years at closing. One class of the
senior securities bears a floating interest rate. Newcastle Investment Holdings
obtained an interest rate swap and cap in order to hedge its exposure to the
changes in market interest rates with respect to this security, at an initial
cost of $1.2 million. The CBO II collateral and retained CBO II securities were
contributed to us.
In November 2001, Newcastle Investment Holdings sold the retained
subordinated $17.5 million Class E Note (the "Note") from CBO I, issued by
Fortress CBO Investments I, Ltd., for approximately $18.5 million. The Note bore
interest at a fixed rate of 8.0% and had a stated maturity of June 2038. The
sale of the Note represented an issuance of debt and was recorded as additional
CBO bonds payable. In April 2002, a wholly owned subsidiary of Newcastle
Investment Holdings repurchased the Note. The repurchase of the Note represents
a repayment of debt and will be recorded as a reduction of CBO bonds payable.
The Note is included in the CBO II collateral which was purchased in connection
with the CBO II transaction. The Note will be eliminated in consolidation.
The net cash flow provided by operating activities increased from $24.8
million for the year ended December 31, 2000 to $34.4 million for the year ended
December 31, 2001 and decreased from $32.8 million for the year ended December
31, 1999 to $24.8 million for the year ended December 31, 2000. It increased
from $13.3 million for the six months ended June 30, 2001 to $18.5 million for
the six months ended June 30, 2002. These changes generally resulted from the
acquisition and settlement of Newcastle Investment Holdings' investments as
described above.
Investing activities provided (used) $106.1 million, $151.6 million and
($683.4 million) during the years ended December 31, 2001, 2000 and 1999,
respectively. They provided (used) ($393.1 million) and $66.3 million during the
six months ended June 30, 2002 and 2001, respectively. Investing activities
consisted primarily of the acquisition and improvement of properties and the
investments made in certain loans, mortgage pools, and equity securities, as
well as debt instruments used as the CBO collateral, net of proceeds from the
settlement of such debt and equity investments (no properties have been sold
through June 30, 2002).
Financing activities provided (used) ($119.7 million), ($180.2 million) and
$589.3 million during the years ended December 31, 2001, 2000 and 1999,
respectively. They provided (used) $356.9 million and ($85.3 million) during the
six months ended June 30, 2002 and 2001, respectively. The borrowings and debt
issuances described above, as well as the issuance of the Series A Preferred and
certain short-term repurchase agreements and other borrowings, served as the
primary sources of cash flow from financing activities. Offsetting uses included
the payment of related deferred financing costs (including the purchase of
hedging instruments), the payment of dividends and the repayment of debt and
repurchase of common shares as described above.
See the Historical Consolidated Statements of Cash Flows included in our
Historical Consolidated Financial Statements included herein for a
reconciliation of Newcastle Investment Holdings' cash position for the periods
described herein.
INFLATION
Substantially all of the office leases of Newcastle Investment Holdings
provide for separate escalations of real estate taxes and operating expenses
over a base amount, and/or increases in the base rent based on changes in the
Consumer Price Index ("CPI"). Newcastle Investment Holdings' management believes
that inflationary increases in expenses will generally be offset by the expense
reimbursements and contractual rent increases described above.
The management of Newcastle Investment Holdings believes that its risk of
increases in the market interest rates on its floating rate debt as a result of
inflation is largely offset by its use of match funding and hedging instruments
as described above. See "-- Quantitative and Qualitative Disclosures About
Market Risk -- Interest Rate Exposure" below.
55
FUNDS FROM OPERATIONS
Newcastle Investment Holdings believes Funds from Operations (FFO) is one
appropriate measure of the performance of real estate companies because it
provides investors with an understanding of Newcastle Investment Holdings'
ability to incur and service debt and make capital expenditures. Funds from
Operations (FFO), for its purposes, represents net income available for common
shareholders (computed in accordance with accounting principles generally
accepted in the United States (GAAP)), excluding extraordinary items, plus real
estate depreciation and amortization, and after adjustments for unconsolidated
subsidiaries. Newcastle Investment Holdings considers gains and losses on
resolution of its investments to be a normal part of its recurring operations
and therefore does not exclude such gains and losses when arriving at Funds from
Operations (FFO). In addition, Newcastle Investment Holdings excludes accrued
incentive income from Fortress Investment Fund LLC (the Fund or FIF) and
includes incentive income distributed or distributable from FIF in accordance
with the operating agreement of the Fund since this reflects cash distributed or
distributable to Newcastle Investment Holdings from the Fund, while its accrued
incentive income is based upon the fair value of the Fund's net assets, which is
subject to fluctuation in future periods. Adjustments for unconsolidated
subsidiaries are calculated to reflect Funds from Operations (FFO) on the same
basis. Funds from Operations (FFO) does not represent cash generated from
operating activities in accordance with GAAP and therefore should not be
considered an alternative to net income as an indicator of the operating
performance of Newcastle Investment Holdings or as an alternative to cash flow
as a measure of liquidity and is not necessarily indicative of cash available to
fund cash needs.
Funds from Operations for Newcastle Investment Holdings is calculated as
follows (unaudited) (in thousands):
FOR THE SIX MONTHS
ENDED JUNE 30, FOR THE YEAR ENDED DECEMBER 31,
------------------ ---------------------------------
2002 2001 2001 2000 1999
------- ------- --------- -------- --------
Income available for common
shareholders........................... $13,097 $18,973 $ 41,131 $40,776 $12,299
Extraordinary item -- loss on
extinguishment of debt................. -- -- -- -- 2,341
Real estate depreciation and
amortization........................... 6,591 6,363 12,909 12,621 9,927
Accumulated depreciation on real estate
sold................................... (2,371) -- -- -- --
Real estate depreciation and
amortization -- unconsolidated
subsidiaries........................... 1,614 610 2,564 126 140
Incentive income accrued from Fortress
Investment Fund(A)..................... 609 -- (14,354) -- --
Equity in incentive return accrued by
Fortress Investment Fund............... (70) -- 1,645 -- --
Distributable incentive income from
Fortress Investment Fund(B)............ -- -- 4,369 -- --
------- ------- -------- ------- -------
Funds from Operations (FFO).............. $19,470 $25,946 $ 48,264 $53,523 $24,707
======= ======= ======== ======= =======
- ---------------
(A) Represents our 50% interest in the incentive income as follows:
Total incentive income............. $(1,218) $ 28,709
Manager portion.................... $ 609 $(14,355)
------- --------
Our incentive income............... $ (609) $ 14,354
======= ========
(B) Represents our 50% interest in the distributable incentive income:
Total distributable incentive income................... $ 8,738
Distributable incentive income due Manager............. $ (4,369)
--------
Our distributable incentive income..................... $ 4,369
========
56
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risks that Newcastle Investment Holdings is exposed to are
interest rate risk and foreign currency exchange rate risk. Interest rate risk
and foreign currency exchange rate risk are highly sensitive to many factors,
including governmental monetary and tax policies, domestic and international
economic and political considerations and other factors beyond its control. All
of its market risk sensitive assets, liabilities and related derivative
positions are for non-trading purposes only.
Interest Rate Exposure
Newcastle Investment Holdings' primary interest rate exposures relate to
its loans, mortgage pools, mortgage backed securities and variable-rate debt, as
well as its interest rate swaps and caps. Changes in the general level of
interest rates can effect its net interest income, which is the difference
between the interest income earned on interest-earning assets and the interest
expense incurred in connection with its interest-bearing liabilities. Changes in
the level of interest rates also can effect, among other things, its ability to
originate and acquire loans and securities, the value of its loans, mortgage
pools and mortgage backed securities, and its ability to realize gains from the
settlement of such assets. Newcastle Investment Holdings utilizes interest rate
swaps, caps and match-funded financings in order to limit the effects of
interest rates on its operations. As of June 30, 2002, a 100 basis point change
in short-term interest rates would affect its earnings from its real estate
securities, credit leased real estate portfolio and mortgage loans, which
represents 95% of its assets based on book value, by no more than $2.2 million
per annum.
Currency Rate Exposure
Newcastle Investment Holdings' primary foreign currency exchange rate
exposures relate to its real estate leases and assets and one of its mortgage
pools, as well as a portion of its investment in Fortress Investment Fund LLC.
Newcastle Investment Holdings' principal direct currency exposures are to the
Euro and the Canadian Dollar. Changes in the currency rates can adversely impact
the fair values and earnings streams of its international holdings. Newcastle
Investment Holdings has attempted to mitigate this impact in part by utilizing
local currency-denominated financing on its foreign investments to partially
hedge, in effect, these assets.
Newcastle Investment Holdings has material investments in a portfolio of
Belgian properties and a portfolio of Canadian properties. These properties are
financed utilizing debt instruments denominated in their respective local
currencies (the Euro and the Canadian Dollar). The net equity invested in these
portfolios, approximately $18.1 million and $20.9 million, respectively, at June
30, 2002, is exposed to foreign currency exchange risk. These assets were
contributed to us in connection with the initial transactions.
Fair Values
For the majority of Newcastle Investment Holdings' financial instruments,
principally loans and certain securities, fair values are not readily available
since there are no active trading markets as characterized by current exchanges
between willing parties. Accordingly, fair values can only be derived or
estimated using various valuation techniques, such as computing the present
value of estimated future cash flows using discount rates commensurate with the
risks involved. However, the determination of estimated future cash flows is
inherently subjective and imprecise. Newcastle Investment Holdings' notes that
minor changes in assumptions or estimation methodologies can have a material
effect on these derived or estimated fair values, and that the fair values
reflected below are indicative of the interest rate and currency rate
environments as of June 30, 2002 and do not take into consideration the effects
of subsequent interest rate or currency rate fluctuations.
57
Newcastle Investment Holdings held the following interest rate risk
sensitive instruments at June 30, 2002 (unaudited) (dollars in thousands):
PRINCIPAL WEIGHTED
BALANCE OR AVERAGE
CARRYING NOTIONAL EFFECTIVE MATURITY
AMOUNT AMOUNT INTEREST RATE DATE OTHER TERMS FAIR VALUE
-------- ---------- ------------- -------- ----------- ----------
Assets:
CBO collateral,
net(A)............. $1,006,882 $1,015,896 7.20% Various Various (mixed floating $1,006,882
and fixed rates,
amortizing and interest
only)
Marketable
securities,
available for
sale(B)............ 21,776 461,000 N/A (B) (B) 21,776
Interest rate caps,
treated as hedges,
net(C)............. 7,418 184,493 N/A (C) (C) 7,418
Liabilities:
CBO bonds
payable(D)......... 867,058 881,500 4.32% (D) Amortizes principal 887,160
based on collateral
payments, subject to
reinvestment
Other bonds
payable(D)......... 351,392 391,422 6.96% (D) Amortizes principal 416,549
with a balloon payment
Notes payable(E)..... 51,570 51,570 4.79% Nov-16 Amortizes principal 51,570
with a balloon payment
Repurchase
agreement(E)....... 1,457 1,457 3.19% Short-term Interest only 1,457
Credit facility(E)... 38,250 38,250 6.10% Jul-03 Interest only 38,250
Interest rate swaps,
treated as hedges,
net(F)............. 28,119 504,007 N/A (F) (F) 28,119
Non-hedge derivative
obligations(G)..... 156 (G) N/A (G) (G) 156
- ---------------
(A) The fair value of these securities is estimated by obtaining third party
independent broker quotations. These securities were contributed to us in
connection with the initial transactions.
(B) These four securities with carrying amounts of $3.9 million, $3.2 million,
$7.7 million and $6.9 million, respectively, mature in November 2007,
August 2030, August 2018 and July 2016, respectively, and represent
subordinate and residual interests in securitizations and an interest-only
strip security. The fair values of these securities, for which quoted
market prices are not readily available, are estimated by means of a
price/yield analysis based on our expected disposition strategies for such
assets. The former two of these securities were contributed to us in
connection with the initial transactions.
(C) These two agreements have notional balances of $166.5 million and $18.0
million, respectively, mature in March 2009 and October 2015, respectively,
and cap 1-month LIBOR at 6.50% and 3-month LIBOR at 8.00%, respectively.
The fair value of these agreements is estimated by obtaining counterparty
quotations. These agreements were contributed to us in connection with the
initial transactions.
(D) For those bonds bearing floating rates at spreads over market indices,
representing approximately $709.8 million of the carrying amount of the CBO
bonds payable, Newcastle Investment Holdings believes that for similar
financial instruments with comparable credit risks, the effective rates at
June 30, 2002 approximate market rates. Accordingly, the carrying amount
outstanding on these bonds is believed to approximate fair value. For those
bonds bearing fixed interest rates, values were obtained by discounting
expected future payments by a rate calculated by imputing a spread over a
market index on the date of borrowing. These bonds were contributed to us in
connection with the initial transactions. The weighted average stated
maturity of the CBO bonds payable is September 2035. The weighted average
stated maturity of the other bonds payable is June 2009.
58
(E) Newcastle Investment Holdings believes that for similar financial
instruments with comparable credit risks, the stated interest rates at June
30, 2002 (all of which are floating rates at spreads over market indices)
approximate market rates. Accordingly, the carrying amount outstanding is
believed to approximate fair value for these notes. This debt, except for a
$38.3 million note, was contributed to us in connection with the initial
transactions.
(F) These three agreements have notional balances of $176.0 million, 290.0
million and $38.0 million, respectively, mature in July 2005, April 2011
and July 2003, respectively, and swap 1-month LIBOR for 6.1755%, 3-month
LIBOR for 5.93% and 1-month LIBOR for 7.18%, respectively. The fair value
of these agreements is estimated by obtaining counterparty quotations. The
former two agreements were contributed to us in connection with the initial
transactions.
(G) These are two essentially offsetting interest rate caps and two essentially
offsetting interest rate swaps, each with notional amounts of $32.5 million
as of June 30, 2002, an interest rate cap with a notional balance of $17.5
million as of June 30, 2002, and an interest rate cap with a notional
balance of approximately $59.8 million as of June 30, 2002. The maturity
date of the purchased swap is July 2009; the maturity date of the sold swap
is July 2014, the maturity date of the $32.5 million caps is July 2038, the
maturity date of $17.5 million cap is July 2009, and the maturity date of
the $59.8 million cap is August 2004. They have been valued by reference to
current counterparty quotations. These agreements were contributed to us in
connection with the initial transactions.
Newcastle Investment Holdings held the following currency rate risk
sensitive balances at June 30, 2002 (unaudited) (dollars in thousands, except
exchange rates):
EFFECT OF A EFFECT OF A
CURRENT EFFECT OF A 5% NEGATIVE 5% NEGATIVE
EXCHANGE 5% NEGATIVE CHANGE IN CHANGE IN
CARRYING LOCAL RATE TO CHANGE IN CAD GBP
AMOUNT CURRENCY(C) USD(C) EURO RATE RATE(C) RATE(C)
-------- ----------- -------- ----------- ----------- -----------
Assets Contributed to us:
LIV portfolio................ $64,923 Euro 1.00867 $(3,246) N/A N/A
Bell Canada portfolio........ 53,310 CAD 1.51730 N/A $(2,666) N/A
LIV other, net............... 4,793 Euro 1.00867 (240) N/A N/A
Bell Canada other, net....... 6,318 CAD 1.51730 N/A (316) N/A
Liabilities Contributed to
us:
LIV mortgage................. 51,570 Euro 1.00867 2,579 N/A N/A
Bell Canada bonds............ 38,739 CAD 1.51730 N/A 1,937 N/A
------- ------- -----
Net Operations Contributed
to us...................... (907) (1,045) N/A
Assets retained by Newcastle
Investment Holdings
Austin Holdings Corp.(A)..... 4,513 Euro 1.00867 (226) N/A N/A
Bell Canada mortgage loan
pool....................... 59 CAD 1.51730 N/A (3) N/A
Fortress Investment Fund
LLC(B)..................... 34,865 Various Various (1,052) N/A $(691)
------- ------- -----
Net Operations retained by
Newcastle Investment
Holdings................... (1,278) (3) (691)
------- ------- -----
Total........................ $(2,185) $(1,048) $(691)
======= ======= =====
- ---------------
(A) Represents foreign portion only.
(B) Represents foreign portion only. Excludes the affect of hedging at the
Fortress Investment Fund LLC level.
(C) USD refers to U.S. dollars; CAD refers to Canadian dollars; and GBP refers
to the Great Britain Pound.
59
NEWCASTLE INVESTMENT CORP.
We invest in real estate securities and other real estate-related assets.
We seek to finance these investments primarily using match-funded financing
structures. Match-funded financing structures match assets and liabilities with
respect to interest rates and maturities. Our objective is to maximize the
difference between the yield on our investments and the cost of financing these
investments while hedging our positions. We are organized and conduct our
operations to qualify as a real estate investment trust (REIT) for federal
income tax purposes.
Newcastle Investment Holdings Corp. currently owns substantially all of our
outstanding common stock. Newcastle Investment Holdings was formed in May 1998.
We were formed in June 2002 for the purpose of separating the real estate
securities and credit leased real estate businesses from Newcastle Investment
Holdings. We believe that separating these businesses from Newcastle Investment
Holdings provides an opportunity for achieving more stable earnings. The
remaining assets in Newcastle Investment Holdings that were not contributed to
us have historically had and may continue to have either unpredictable or low
current returns. For example, the GSA portfolio, which constituted approximately
75% of Newcastle Investment Holdings' investments in credit leased real estate,
was not contributed to us because it does not generate any cash flow on a
current basis since all of the cash flow on the portfolio is used to service and
reduce debt and to fund capital expenditures on these properties, which are
obligations of Newcastle Investment Holdings. In connection with our formation,
Newcastle Investment Holdings changed its name from Newcastle Investment Corp.
Immediately upon completion of this offering, Newcastle Investment Holdings will
own 68.2% of our common stock and new investors in this offering will own 28.9%
of our common stock, assuming exercise of all outstanding options.
Newcastle Investment Holdings contributed to us certain assets and related
liabilities in exchange for all of our shares of common stock. However, as
presented in the unaudited pro forma statements, for accounting purposes this
transaction is presented as a reverse spin-off. Under a reverse spin-off,
Newcastle Investment Corp. is treated as the continuing entity and the assets to
be retained by Newcastle Investment Holdings are accounted for as if they were
distributed at historical book basis through a spin-off to Newcastle Investment
Holdings.
In July 2002, Newcastle Investment Holdings contributed to us certain
assets and liabilities in exchange for all of our shares of our common stock. We
describe each of these assets and liabilities below under "-- Our Investments."
As a result of the initial transactions, we own a diversified portfolio of
credit sensitive real estate securities, including commercial and residential
mortgage backed securities and unsecured REIT debt, rated primarily BBB (BBB- is
the lowest investment grade rating) and BB (BB+ is the highest non-investment
grade rating). Mortgage backed securities are interests in or obligations
secured by pools of commercial or residential mortgage loans. We will also own
credit leased real estate in Canada and Belgium. We consider credit leased real
estate to be real estate that is leased primarily to tenants with, or whose
major tenant has, investment grade credit ratings. After giving effect to the
initial transactions as if they had been completed as of the dates below:
- our portfolio consisted of approximately $1.2 billion of assets at June
30, 2002;
- our portfolio was encumbered by approximately $1.0 billion of debt at
June 30, 2002;
- for the year ended December 31, 2001, we had revenues of approximately
$77.4 million, expenses of approximately $50.3 million and income from
continuing operations of approximately $27.1 million;
- for the six months ended June 30, 2002, we had revenues of approximately
$46.7 million, expenses of approximately $28.9 million and income from
continuing operations of approximately $17.8 million; and
- our income from continuing operations per common share was $1.60 for 2001
and $1.05 for the six months ended June 30, 2002.
60
As of and for the six months ended June 30, 2002, 89% of our total assets
was comprised of real estate securities and 11% was comprised of credit leased
real estate, and 77% of our total revenue was derived from interest and dividend
income and gains on settlement of investments from our real estate securities
and 23% was derived from rental and escalation income from our credit leased
real estate.
We have also entered into an agreement with an affiliate of Bear Stearns
that provides us with an option to purchase up to $235 million principal amount
of mortgage loans, which we intend to purchase with the proceeds of this
offering. For more information, including a description of these assets and
related financing, see "Newcastle Investment Corp. -- Our Investments."
We are externally managed and advised by Fortress Investment Group LLC. Our
chairman and chief executive officer and each of our executive officers also
serve as officers of our manager. We have no ownership interest in our manager.
We have chosen to be externally managed by Fortress Investment Group to take
advantage of the existing business relationships, operational and risk
management systems, expertise and economies of scale associated with our
manager's current business operation. At June 30, 2002, our manager and its
principals owned approximately 16.4% of the equity of Newcastle Investment
Holdings (25.8% upon exercise of outstanding options to purchase shares of
Newcastle Investment Holdings). In connection with this offering, we will grant
to our manager an option to purchase 700,000 shares of our common stock,
representing 10% of the number of shares being offered hereby, and subject to
adjustment if the underwriters' over-allotment option is exercised, at the
offering price of our shares in this offering. Fortress Investment Group and its
principals would have a total beneficial ownership in our common stock of
approximately 20.5%, taking into account interests in Newcastle Investment
Holdings and exercise of all of their options. We pay Fortress Investment Group
an annual base management fee and may pay incentive compensation based on
certain performance criteria. Fortress Investment Group also manages and invests
in other entities, including Newcastle Investment Holdings, that invest in real
estate assets.
Newcastle Investment Holdings was formed in 1998 by Messrs. Wesley R.
Edens, Robert I. Kauffman, Randal A. Nardone and Erik P. Nygaard. In June 2002,
we were organized under the laws of the State of Maryland. For information
regarding each of these individuals, including the positions and offices they
hold, see "Our Manager and the Management Agreement -- Officers of Our Manager."
We may form an operating partnership, of which we will be the sole general
partner, through which we may make certain of our investments in the future.
OUR STRATEGY
We intend to focus on increasing our holdings in credit sensitive real
estate securities, including mortgage backed securities and REIT debt
securities, and to continue to invest in other real estate related investments,
including credit leased real estate and mortgage loans. The mortgage backed
securities we intend to invest in will generally be junior in right of payment
of interest and principal to one or more senior classes, but will benefit from
the support of one or more subordinate classes of securities or other form of
credit support within a securitization transaction. The REIT debt securities we
intend to invest in will reflect comparable credit risk. We believe that these
securities offer attractive risk-adjusted returns with long-term principal
protection under a variety of default and loss scenarios. While the expected
yield on these securities is sensitive to the performance of the underlying
assets, the more subordinated securities or other features of the securitization
transaction, in the case of mortgage backed securities, and the issuer's
underlying equity and subordinated debt, in the case of REIT debt, are designed
to bear the first risk of default and loss. We intend to further minimize credit
risk through active management of our portfolio.
Returns on these investments can be sensitive to interest rate volatility.
We intend to minimize exposure to interest rate fluctuation through the use of
match-funded financing structures. In particular, we expect to finance our real
estate securities investments through the issuance of debt securities in the
form of CBOs to take advantage of the structural flexibility offered by CBO
transactions to buy and sell certain investment positions to manage risk and,
subject to certain limitations, to optimize returns.
61
We actively monitor our investment portfolio and the underlying credit
quality of our holdings and, where appropriate, reposition our investments to
upgrade the credit quality and yield on our investments. We selectively pursue
special investment situations where we believe cash flows have been mispriced,
including discounted securities purchases in sectors or jurisdictions which have
fallen out of favor due to economic pressures, regulatory issues or illiquidity.
We will draw on our manager's expertise and significant business relationships
with participants in the real estate securities industry to enhance our access
to these investments, which may not be broadly marketed.
We intend to broadly diversify our portfolio by asset type, industry,
location and issuer. We expect that diversification will minimize the risk of
capital loss, and will also enhance the terms of our financing structures.
Our investments may be made directly or indirectly, such as in the form of
an investment in a vehicle created to hold such assets. We do not intend that
our investment in securities of other issuers will require us to register as an
"investment company" under the Investment Company Act of 1940, as amended, and
we would divest securities before any such registration would be required.
OUR COMPETITIVE STRENGTHS
Asset Quality and Diversification
Our portfolio is diversified by asset type, industry, location and issuer.
We expect that diversification will minimize the risk of capital loss, and will
also enhance the terms of our financing structures.
Our CBO collateral, which consists primarily of real estate securities, has
an overall weighted average credit rating of BBB-, and approximately 67% of
these securities have an investment grade rating (BBB- or higher). As of June
30, 2002, 80% of the square footage of our credit leased real estate was
occupied by tenants having investment grade credit ratings. For a detailed
description of the ratings assigned by Standard and Poor's and Moody's, see
"Newcastle Investment Corp. -- Ratings." The credit ratings of our tenants and
our real estate securities do not represent a rating of the securities offered
in this prospectus.
Match-Funding Discipline
Generally, we seek to "match fund" our assets and liabilities with respect
to interest rates and maturities. Our objective is to finance our investments
with like-kind debt (i.e., floating-rate assets are financed with floating-rate
debt and fixed-rate assets are financed with fixed-rate debt), directly or
through the use of hedges such as interest rate swaps, caps and other financial
instruments, subject to limitations on the ability to utilize these instruments
pursuant to the tax rules applicable to REITs. In addition, we attempt to match
the maturities of our investments with the maturities of our financial
obligations. This allows us to reduce the impact of changing interest rates on
our earnings and net asset value. As of June 30, 2002, a 100 basis point change
in short-term interest rates would affect our earnings by no more than $2.2
million per annum.
Creative Financing Strategies
We seek to enhance returns to stockholders through the use of leverage. We
finance our investments in real estate securities by issuing debt securities, in
particular, CBOs, to take advantage of the structural flexibility offered by CBO
transactions. Unlike typical securitization structures, the assets underlying
the CBOs may be sold, subject to certain limitations, without a corresponding
pay-down of the CBO, provided the proceeds are reinvested in qualifying assets.
As a result, CBOs enable us to actively manage, subject to certain limitations,
the pool of assets. We have also employed lease securitizations to finance
certain of our credit leased real estate. We intend to use short term financing,
in the form of repurchase agreements, bridge financings and bank warehousing
facilities, prior to implementing optimal match-funded financing.
62
Experienced Management
The principal executives of our manager have an average of more than 17
years of experience in the fields of real estate investing and finance, private
equity investment, capital markets, transaction structuring and risk management
with respect to both dollar and non-dollar denominated investments, providing us
with significant expertise in key areas of our business. Over the last six years
alone, the founders of our manager have managed the acquisition of over $20
billion of real estate-related assets and the issuance of over $11 billion of
real estate securities.
OUR INVESTMENT GUIDELINES
Our board of directors has adopted general guidelines for our investments
and borrowings to the effect that:
- no investment shall be made which would cause us to fail to qualify as a
REIT;
- no investment shall be made which would cause us to be regulated as an
investment company;
- no more than 20% of our equity, determined as of the date of such
investment, shall be invested in any single asset;
- our leverage shall not exceed 90% of the value of our assets; and
- we shall not co-invest with the manager or any of its affiliates unless
(i) our co-investment is otherwise in accordance with these guidelines
and (ii) the terms of such co-investment are at least as favorable to us
as to the manager or such affiliate (as applicable) making such
co-investment.
Our manager is required to seek the approval of the independent members of
our board of directors before we engage in a material transaction with another
entity managed by our manager. These investment guidelines may be changed by our
board of directors without the approval of our stockholders.
OUR TARGETED INVESTMENTS
COMMERCIAL MORTGAGE BACKED SECURITIES. We intend to invest in commercial
mortgage backed securities (CMBS), which are secured by or evidence ownership
interests in a single commercial mortgage loan or a pool of mortgage loans
secured by commercial properties. These securities may be senior, subordinate,
investment grade or non-investment grade securities. We expect the majority of
our CMBS investments to be rated by at least one nationally recognized rating
agency. The majority of our investments in CMBS will consist of securities that
are part of a capital structure or securitization where the rights of such class
to receive principal and interest are subordinate to senior classes but senior
to the rights of lower rated classes of securities. We intend to seek to invest
in CMBS that will yield high current interest income and where we consider the
return of principal to be likely. We intend to acquire CMBS from private
originators of, or investors in, mortgage loans, including savings and loan
associations, mortgage bankers, commercial banks, finance companies, investment
banks and other entities.
The yield on CMBS depends on the timely payment of interest and principal
due on the underlying mortgage loans and defaults by the borrowers on such loans
may ultimately result in deficiencies and defaults on the CMBS. In the event of
a default, the trustee for the benefit of the holders of CMBS has recourse only
to the underlying pool of mortgage loans and, if a loan is in default, to the
mortgaged property securing such mortgage loan. After the trustee has exercised
all of the rights of a lender under a defaulted mortgage loan and the related
mortgaged property has been liquidated, no further remedy will be available.
However, holders of relatively senior classes of CMBS will be protected to a
certain degree by the structural features of the securitization transaction
within which such CMBS were issued, such as the subordination of the relatively
more junior classes of the CMBS.
The credit quality of CMBS depends primarily on the credit quality of the
underlying mortgage loans. Among the factors determining credit quality of a
mortgage loan are (i) the purpose of the mortgage loan (e.g. refinancing or new
purchase), (ii) the principal amount of the mortgage loan relative to the value
of
63
the related mortgaged property at origination and at maturity, (iii) the
mortgage loan terms (e.g. amortization, balloon amounts, reserves, prepayment
terms), (iv) the geographic location of the mortgaged property securing the
mortgage loan, and (v) the creditworthiness of tenants occupying the underlying
properties.
In considering whether to acquire a CMBS, we perform due diligence to
assess the credit quality of the mortgage loans as discussed above, as well as
(i) the capabilities of the master and special servicer servicing the mortgage
loans, (ii) the CMBS structure including subordination levels, (iii) the
prepayment and default history of the other mortgage loans previously originated
by lenders, (iv) cash flow analyses under various prepayment and interest rate
scenarios (including sensitivity analyses), and (v) an analysis of various
default scenarios.
B NOTES. We intend to invest in one or more "B Notes" rated by at least
one nationally recognized rating agency. A "B Note" is typically a privately
negotiated loan (a) secured by a first mortgage on a single large commercial
property or group of related properties and (b) subordinated to an "A Note"
secured by the same first mortgage on the same property. The subordination of a
B Note is typically evidenced by an inter-creditor agreement with the holder of
the related A Note.
B Notes share certain credit characteristics with subordinated CMBS, in
that both reflect an interest in a first mortgage and are subject to more credit
risk with respect to the underlying mortgage collateral than the corresponding
senior securities or the A Notes, as the case may be. As opposed to a typical
CMBS secured by a large pool of mortgage loans, B Notes typically are secured by
a single property, and the associated credit risk is concentrated in that single
property. B Notes also share certain credit characteristics with second
mortgages, in that both are subject to more credit risk with respect to the
underlying mortgage collateral than the corresponding first mortgage or the A
Note, as the case may be. We will acquire B Notes in negotiated transactions
with the originators, as well as in the secondary market.
The yield on a B Note depends on the timely payment by the borrower of
interest and principal. Default by the borrower may, depending on the
transaction structure, result in the immediate interruption of current cash flow
and may ultimately result in the loss of principal of the B Note. In the event
of such a default, the rights of the B Note holders to foreclose on the mortgage
collateral are typically subject to the prior right of the holder of the
corresponding A Note. As a result, the rights of the holder of a B Note to
mitigate losses in the event of a borrower default may be impaired.
The credit quality of a B Note depends on (i) the borrower under the
underlying mortgage, (ii) the value of the underlying collateral and the extent
to which it secures the obligation owed to the B Note holder, (iii) the rights
under the mortgage loan documents (e.g. personal guarantees, additional
collateral, default covenants, remedies), (iv) the B Note holder's rights under
an inter-creditor agreement with the A Note holders, (v) the level and stability
of cash flow from the property available to service the mortgage debt, and (vi)
the availability of capital for refinancing by the borrower if the mortgage loan
does not fully amortize.
We perform extensive due diligence and credit analysis including (i)
borrower credit underwriting, (ii) property review (e.g. appraisal,
environmental, structural), (iii) mortgage loan and B Note documentation review,
(iv) property cash flow analysis, and (v) analysis of the eligibility of each
mortgage loan for inclusion as collateral in a future securitization or
appropriateness for other forms of financing or sale.
REIT DEBT SECURITIES. We intend to invest in investment grade and
non-investment grade debt securities issued by other REITs. REIT debt securities
are generally unsecured corporate obligations of REITs. We expect the majority
of these REIT debt securities to be rated by at least one nationally recognized
rating agency. We will seek to invest in REIT debt securities that will yield
high current interest income and where we consider the return of principal to be
likely. We intend to acquire REIT debt from companies representing a variety of
property types.
64
The credit quality of REIT debt is directly dependent on the financial
condition and business outlook of the issuer. Factors determining the financial
condition and outlook include (i) portfolio credit quality (e.g. diversity, type
of asset and stability of cash flow), (ii) availability of capital, (iii)
leverage and leverage trends, (iv) size of portfolio, (v) competition, and (vi)
quality of the REIT's management team.
In analyzing these debt securities, we consider, among other factors, the
credit quality factors described above as well as unencumbered and encumbered
cash flow coverage, capital structure, refinancing risks, and covenants of the
issuer's outstanding debt.
RESIDENTIAL MORTGAGE SECURITIES. We intend to invest in residential
mortgage backed securities (RMBS), which are secured by or evidence ownership
interests in pools of mortgage loans secured by single family residential
properties. We will invest in securities with credit quality and subordination
levels similar to those described above for our CMBS investments.
We will seek to invest in RMBS that will yield high current interest income
and where we consider the return of principal to be likely. We intend to acquire
RMBS from private originators of, or investors in, mortgage loans, including
savings and loan associations, mortgage bankers, commercial banks, finance
companies, investment banks and other entities.
Like CMBS, the yield on RMBS depends on the timely payment of interest and
principal due on the underlying mortgage loans by the borrowers under such
mortgage loans and defaults by such borrowers may ultimately result in
deficiencies and defaults on the RMBS. In the event of a default, the trustee
for the benefit of the holders of RMBS has rights similar to corresponding
rights of a CMBS trustee.
Like CMBS, the credit quality of RMBS depends on the credit quality of the
underlying mortgage loans, which is a function of factors such as (i) the
purpose of the mortgage loans (e.g. refinancing or new purchase), (ii) the
principal amount of the mortgage loans relative to the value of the related
mortgaged properties, (iii) the mortgage loan terms (e.g. amortization), (iv)
the geographic location of the properties securing the mortgage loans, and (v)
the creditworthiness of the borrowers.
In considering whether to acquire an RMBS, we will perform due diligence to
assess the credit quality of the mortgage loans as discussed above for CMBS, as
well as the likelihood of prepayment, which residential borrowers are generally
permitted to do without penalty. For RMBS, credit quality may also depend on the
extent of any government or agency guarantee of the mortgage loans securing the
mortgage loans.
MORTGAGE LOANS. We may invest in portfolios of mortgage loans from various
sellers, including life insurance companies, banks and other owners, generally
secured by commercial or residential properties in the U.S. Among the factors
determining credit quality of a mortgage loan are (i) the purpose of the
mortgage loan (e.g. refinancing or new purchase), (ii) the principal amount of
the mortgage loan relative to the value of the related mortgaged property at
origination and at maturity, (iii) the mortgage loan terms (e.g. amortization,
balloon amounts, reserves, prepayment terms), (iv) the geographic location of
the mortgaged property securing the mortgage loan, and (v) the creditworthiness
of tenants or borrowers occupying the underlying property.
We intend to use the net proceeds of this offering to pay a portion of the
purchase price for a portfolio of mortgage loans. We have entered into an
agreement with an affiliate of Bear Stearns that provides us with an option to
purchase up to $235 million principal amount of mortgage loans. We have also
entered into a financing arrangement with an affiliate of Bear Stearns to fund
the balance of the purchase price for the mortgage loans. This financing
arrangement will permit us to further borrow up to an additional $70.5 million
(which amount, when added to $145.2 million of initial financing, will not
exceed 90% of the purchase price of the mortgage loans) at a rate of LIBOR plus
0.75%. We intend to utilize borrowings under the financing to purchase
additional real estate securities, including collateral for the CBO III
transaction, and for general corporate purposes.
65
OTHER REAL ESTATE-RELATED INVESTMENTS. We may also make investments in
other types of commercial real estate assets as well as in non-mortgage backed
securities. In particular, we may invest in credit leased real property similar
to our current credit leased real estate portfolio.
Although we intend to invest in the investments described above, our
business decisions will depend on changing market conditions. As a result, we
cannot predict with any certainty the percentage of our assets that will be
invested in each category. We may change our investment strategy and policies
without a vote of stockholders. We may acquire assets from our manager or its
affiliates, including securities issued by our manager or its affiliates. There
are no limitations on such transactions, except that they must comply with our
general investment guidelines and our management agreement with our manager.
OUR FINANCING STRATEGY
We will seek to enhance returns to stockholders through the use of
leverage. Our financing strategy focuses on the use of match-funded financing
structures. This means that we seek to match the maturities of our financial
obligations with the maturities of our investments to minimize the risk that we
have to refinance our liabilities prior to the maturities of our assets, and to
reduce the impact of changing interest rates on earnings. In addition, we match
fund interest rates with like-kind debt (i.e., fixed-rate assets are financed
with fixed-rate debt, and floating-rate assets are financed with floating-rate
debt), through the use of hedges such as interest rate swaps, caps, or through a
combination of these strategies. This allows us to reduce the impact of changing
interest rates on our earnings. In this regard, we intend to utilize
securitization structures, particularly collateralized bond obligations,
otherwise known as CBOs, as well as other match-funded financing structures.
CBOs are multiple class debt securities, or bonds, secured by pools of assets,
such as mortgage backed securities, B Notes and REIT debt. Like typical
securitization structures, in a CBO (a) the assets are pledged to a trustee for
the benefit of the holders of the bonds, (b) one or more classes of the bonds
are rated by one or more rating agencies, and (c) one or more classes of the
bonds are marketed to a wide variety of fixed income investors, which enables
the CBO sponsor to achieve a relatively low cost of long-term financing. Unlike
typical securitization structures, the underlying assets may be sold, subject to
certain limitations, without a corresponding pay-down of the CBO, provided the
proceeds are reinvested in qualifying assets. As a result, CBOs enable the
sponsor to actively manage, subject to certain limitations, the pool of assets.
We believe that CBO financing structures are an appropriate financing vehicle
for our targeted asset classes, because they will enable us to lock in a
long-term cost of funds and minimize the risk that we have to refinance our
liabilities prior to the maturities of our investments while giving us the
flexibility to manage credit risk and, subject to certain limitations, to take
advantage of profit opportunities.
We may also use short term financing, in the form of repurchase agreements,
bridge financings and bank warehousing facilities, as an intermediary step prior
to the implementation of optimal match-funded financing. We utilize leverage for
the sole purpose of financing our portfolio and not for the purpose of
speculating on changes in interest rates. As of June 30, 2002, a 100 basis point
change in short-term interest rates would affect our earnings by no more than
$2.2 million per annum.
OUR HEDGING ACTIVITIES
We intend to enter into hedging transactions to protect our positions from
interest rate fluctuations and other changes in market conditions. These
transactions may include interest rate swaps, the purchase or sale of interest
rate collars, caps or floors, options, mortgage derivatives and other hedging
instruments. These instruments may be used to hedge as much of the interest rate
risk as our manager determines is in the best interest of our stockholders,
given the cost of such hedges and the need to maintain our status as a REIT. Our
manager may elect to have us bear a level of interest rate risk that could
otherwise be hedged when our manager believes, based on all relevant facts, that
bearing such risks is advisable. Our manager has extensive experience in hedging
real estate positions with these types of instruments. Our manager engages in
hedging for the sole purpose of protecting against interest rate risk and not
for the purpose of speculating on changes in interest rates.
66
OUR INVESTMENTS
As a result of the initial transactions, we own a diversified portfolio of
credit sensitive real estate securities, including commercial mortgage backed
securities and unsecured REIT debt rated primarily BBB (the lowest investment
grade rating) and BB (one level below investment grade). We also own certain
credit leased real estate in Canada and Europe. Newcastle Investment Holdings
contributed these assets and liabilities to us and retained its investment and
interest in, among other things, Fortress Investment Fund, a private equity fund
managed by our manager, and a portfolio of credit leased real estate leased to
the Government Services Administration of the United States government. The
retained assets produce less predictable current cash flows than the transferred
assets. Accordingly, these assets were not contributed to us.
As of June 30, 2002, our assets, after giving effect to the initial
transactions, based on the book value of our operating segments, were 89% in
real estate securities and 11% in credit leased real estate. The following is a
description of our investment assets as of June 30, 2002. For an explanation of
the ratings assigned by Standard & Poor's and Moody's Investor Services, see
"-- Ratings."
REAL ESTATE SECURITIES
CBO I: In July 1999, Fortress CBO Investments I, Limited and Fortress CBO
Investments I Corp. issued approximately $500 million face amount of
collateralized bond obligations (CBOs) and other securities in transactions
exempt from the registration requirements of the Securities Act pursuant to Rule
144A and Regulation S thereunder. As of June 30, 2002, the underlying securities
securing CBO I consist of:
- $344.9 million face amount in commercial mortgage backed securities
(CMBS) with a weighted average coupon of 6.30%, a weighted average rating
of approximately Ba2 and a weighted average term to maturity of 7.41
years at June 30, 2002. Retail, multifamily and office properties
comprise 48%, 16% and 28%, respectively, of the underlying collateral.
- $240.1 million face amount in unsecured REIT debt securities with a
weighted average coupon of 7.44%, a weighted average rating of
approximately Baa3 and a weighted average remaining term to maturity of
5.88 years at June 30, 2002. Office, retail, industrial and residential
REIT industries comprise 17%, 28%, 19% and 13%, respectively, of the
debt.
$437.5 million of Senior CBO I Securities were sold to third parties and we
own $62.5 million of the Subordinated CBO I Securities. The table below sets
forth further information with respect to the CBO I structure.
MOODY'S/S&P EXPECTED
CLASS RATINGS FACE AMOUNT COUPON MATURITY
--------- ----------- ------------ ----------- --------
Senior CBO I Securities..... A Aaa/AAA $322,500,000 LIBOR +0.65% July-04
B Aa2/AA $ 20,000,000 LIBOR +0.80% July-04
C A2/NR $ 62,500,000 7.85% July-09
D Baa2/NR $ 32,500,000 8.60% July-09
------------
TOTAL.................. $437,500,000
============
Subordinate CBO I
Securities................ E Ba2 $ 17,500,000 9.00% July-09
Preferred B2 $ 17,500,000 9.00% July-09
Common I $ 26,400,000 N/A N/A
Common II $ 1,100,000 N/A N/A
------------
TOTAL.................. $ 62,500,000
============
We act as collateral manager for CBO I and are paid a monthly fee of 0.5%
per annum of the principal balance of the CBO I collateral. We have the
discretion to buy and sell up to 15% of the
67
outstanding face of the collateral annually, and to sell defaulted and credit
risk securities on an unlimited basis. Until 2004, we are obligated to reinvest
principal received from the collateral. In 2004, we intend to refinance the
Class A and B Senior CBO I securities, provided it would not result in a
downgrade of any rated classes of securities. Failure to so refinance on the
scheduled date in 2004 will result in an additional allocation of cash flows
from certain of the Subordinate CBO I securities to the Class A and B Senior CBO
I securities. To better match the collateral cash flow to the debt service on
the CBO I Securities, we entered into interest rate swap and cap agreements.
CBO II: On April 25, 2002, Newcastle CDO I Limited and Newcastle CDO I
Corp. issued $500 million face amount of collateralized bond obligations and
other securities in our second CBO transaction. As of June 30, 2002, the
proceeds had been 96% invested. We expect to be 100% invested by August 2002
with a portfolio composed of approximately 63% CMBS, 28% REIT debt securities
and 9% Asset Backed Securities and other securities. More specifically, at June
30, 2002 the second CBO, which we refer to as CBO II, consisted of:
- $314 million face amount in CMBS with a weighted average coupon of 6.23%,
a weighted average rating of approximately Ba1 and a weighted average
term to maturity of 8.0 years. Retail, multifamily and office properties
comprise 39%, 16% and 28%, respectively, of the underlying collateral.
- $132 million face amount in unsecured REIT debt securities with a
weighted average coupon of 7.51%, a weighted average rating of
approximately Baa3 and a weighted average remaining term to maturity of
8.4 years. Office, retail, industrial and residential REIT industries
comprise 34%, 36%, 4% and 13% respectively, of the debt.
- $32 million face amount in asset backed securities with a weighted
average coupon of 7.69% and a weighted average term to maturity of 8.7
years.
$444 million face amount of Senior CBO II securities were sold to third
parties and we own $56 million of the Subordinated CBO II securities. The table
below sets for the further information with respect to the structure of CBO II.
MOODY'S/S&P EXPECTED
CLASS RATINGS FACE AMOUNT COUPON MATURITY
--------- ----------- ------------ ---------- --------
Senior CBO II Securities...... Class I Aaa/AAA $372,000,000 LIBOR+0.55% April-32
Class II A3/A- $ 38,000,000 7.59% April-37
Class III Baa2/BBB $ 34,000,000 8.37% April-37
------------
TOTAL.................... $444,000,000
============
Subordinate CBO II
Securities.................. Class IV Ba2/BB $ 19,000,000 7.50% April-37
Preferred NR $ 37,000,000 N/A April-37
------------
TOTAL.................... $ 56,000,000
============
We act as collateral manager for CBO II and are paid a quarterly fee of
1/4 of 0.35% of the principal balance of the CBO II collateral. We have the
discretion to buy and sell up to 15% of the outstanding face of the collateral
annually, and to sell defaulted and credit risk securities on an unlimited
basis. Until 2007, we are obligated to reinvest principal received from the
collateral. To better match the collateral cash flow to the debt service on the
CBO II securities, we entered into interest rate swap and cap agreements.
CBO III: Pursuant to an agreement entered into in July 2002 Bear, Stearns
International Limited will purchase up to $450 million of commercial mortgage
backed securities, REIT debt, real estate loans and asset backed securities (the
CBO III Collateral), subject to our right to purchase such securities from Bear,
Stearns International Limited. The CBO III Collateral is expected to be included
in a securitization transaction in which we would acquire the equity interest
(the CBO III Transaction). Pursuant to the agreement, Bear, Stearns & Co. Inc.
also has been engaged to structure and serve as lead manager for the CBO III
Transaction for which it will receive customary fees. As of August 14, 2002,
approximately
68
$87 million of the $450 million has been accumulated. If the CBO III Transaction
is not consummated as a result of our failure to acquire the equity interest or
otherwise as a result of our gross negligence or willful misconduct, we would be
required to either purchase the CBO III Collateral from Bear, Stearns
International Limited or pay Bear, Stearns International Limited the difference
between the price it paid for the CBO III Collateral and the price at which it
sold the CBO III Collateral to a third-party (a Collateral Loss). If the CBO III
Transaction fails to close for any other reason, other than as a result of Bear,
Stearns International Limited's gross negligence or willful misconduct, we would
be required to either purchase the CBO III Collateral from Bear, Stearns
International Limited or pay Bear, Stearns International Limited the lesser of
$15 million and the Collateral Loss or, if we have paid a deposit on the CBO III
Collateral in exchange for a portion of the interest payments on the securities,
the lesser of the Collateral Loss and any such deposit. Although we currently
anticipate completing the CBO III Transaction during the fourth quarter of 2002,
there is no assurance that the CBO III transaction will be consummated.
CREDIT LEASED REAL ESTATE
Bell Canada Portfolio. We own four office properties and an industrial
property in Canada leased primarily to Bell Canada. In this prospectus, we refer
to these properties as the Bell Canada Portfolio. The total net rentable area is
approximately 1.3 million square feet and the current annual rent as of June 30,
2002 is approximately $6.0 million. We believe that these properties are
adequately covered by insurance against potential loss.
To more effectively monetize lease cash flows and the anticipated value of
the properties in the Bell Canada Portfolio, in April 2002, we issued
approximately $70 million face amount of securities secured by the lease
payments and by the five Bell Canada properties in a transaction exempt from the
registration requirements of both Canadian and U.S. securities laws. The Series
A and B Notes were sold to third parties and the Series C Notes were retained by
us.
The table below sets forth further information on the securities issued:
S&P EXPECTED
SERIES RATINGS FACE COUPON MATURITY
- ------ ----------- ----------- ------------ ----------
Series A Class I Notes..... AAA $18,000,000 6.150% April-2012
Series A Class II Notes.... AA $ 6,000,000 6.150% April-2012
Series A Class III Notes... A+ $30,000,000 6.150% April-2012
Series B Notes............. A $ 6,000,000 7.675% April-2012
Series C Notes............. BBB $10,000,000 11.000% April-2012
-----------
TOTAL...................... $70,000,000
===========
The following table sets forth certain information with respect to the Bell
Canada Portfolio as of June 30, 2002:
69
BELL CANADA PORTFOLIO
NET
RENTABLE YEAR
STATE/ SQUARE BUILT/ OWNERSHIP
PROPERTY ADDRESS CITY/SUBMARKET(1) PROVINCE FEET RENOVATED % USE
- ---------------- -------------------- -------- --------- --------- --------- ------------
20-40 Norelco Drive, Toronto/North York ON 624,786 1963/ 100% Industrial/
83 Signet Drive 1971/ Distribution
1979
2 Fieldway Road Etobicoke (Toronto)/ ON 177,214 1972/ 100% Office
Metro West expanded
1978
100 Dundas Street London/CBD ON 325,764 1980 100% Office
449 Princess Street Kingston/CBD ON 45,691 1981 100% Office
66 Bay Street South Hamilton/CBD ON 118,787 1974 100% Office
---------
Total/Average 1,292,242
% OF TENANT
TOTAL NET
SQUARE RENTABLE LEASE LEASE TENANT
FOOTAGE SQUARE START EXP CREDIT
PROPERTY ADDRESS TENANT LEASED FEET DATE DATE RATING
- ---------------- ------------------------- ------- --------- ------- -------- ------
20-40 Norelco Drive, Bell Canada-Office 98.48% 615,274 3/26/98 3/31/07 A
83 Signet Drive Bell Canada-Cafeteria 0.73% 4,559 3/26/98 3/31/07 A
Bell Canada-Storage 0.47% 2,960 3/26/98 3/31/07 A
Bell Canada-O&Y 0.32% 1,993 3/26/98 3/31/07
2 Fieldway Road Bell Canada-Office 94.1% 166,753 3/26/98 3/31/04 A
Bell Canada-Cafeteria 4.25% 7,533 3/26/98 3/31/04 A
Bell Canada-Storage 0.91% 1,619 3/26/98 3/31/04 A
Bell Canada-Mgmt 0.65% 1,153 3/26/98 3/31/04 A
Hosnya Elshaarawy 0.09% 156 4/1/01 3/31/06
100 Dundas Street Bell Canada-Office 89.24% 290,706 3/26/98 3/31/06 A
Bell Canada-Cafeteria 3.96% 12,890 3/26/98 3/31/06 A
Bell Canada-Storage 0.52% 1,686 3/26/98 3/31/47 A
Bell Canada-Mgmt 0.45% 1,478 3/26/98 3/31/06 A
ComTech 0.03% 96 1/01/00 12/31/05
MacTel 0.47% 1,536 6/1/00 5/31/03
MacTel 0.21% 673 4/1/01 5/31/03
Tony & Fay Gardner 0.14% 460 9/1/99 8/31/02
Pointts Limited 0.61% 1,989 8/15/97 7/31/02
Palmieri's Fine Food Inc 0.58% 1,884 10/1/00 9/30/10
449 Princess Street Bell Canada-Office 99.41% 45,422 3/26/98 3/31/03 A
Bell Canada-Storage 0.59% 269 3/26/98 3/31/03 A
66 Bay Street South Bell Canada-Office 92.94% 110,400 3/26/98 3/31/03 A
Bell Canada-Cafeteria 6.42% 7,621 3/26/98 3/31/03 A
Bell Canada-Storage 0.41% 492 3/26/98 3/31/03 A
Bell Canada-Mgmt 0.23% 274 3/26/98 3/31/03 A
----- ---------
Total/Average 99.04% 1,279,876
CURRENT
RENT ANNUAL
PER REAL LEASE
ANNUAL SQUARE ESTATE RENEWAL
PROPERTY ADDRESS RENT(2) FOOT TAXES OPTION
- ---------------- ---------- ------- ---------- ----------
20-40 Norelco Drive, $2,838,541 $ 4.61 $1,111,858 One 5 Year
83 Signet Drive $ 30,047 $ 6.59
$ 9,754 $ 3.30
$ 9,195 $ 4.61
2 Fieldway Road $ 769,308 $ 4.61 $ 617,012 One 5 Year
$ 49,647 $ 6.59
$ 5,335 $ 3.30
$ 7,559 $ 6.59
$ 720 $ 4.61
100 Dundas Street $1,341,160 $ 4.61 $1,073,465 One 5 Year
$ 42,477 $ 3.30 One 5 Year
$ 22,224 $13.18 None
$ 10,228 $ 6.92
$ 506 $ 5.27
$ 8,099 $ 5.27 One 2 Year
$ 3,548 $ 5.27 One 2 Year
$ 2,729 $ 5.93 None
$ 19,663 $ 9.89 One 5 Year
$ 32,284 $17.14 One 5 Year
449 Princess Street $ 209,552 $ 4.61 $ 60,596 One 5 Year
$ 886 $ 3.30 One 5 Year
66 Bay Street South $ 509,326 $ 4.61 $ 312,642 One 5 Year
$ 50,227 $ 6.59 One 5 Year
$ 1,621 $ 3.30 One 5 Year
$ 1,265 $ 4.61
---------- ----------
Total/Average $5,975,901 $3,175,573
- ---------------
(1) CBD means central business district.
(2) Certain operating expenses are reimbursed by tenants at rates ranging up to
15% above actual cost
All monetary amounts are in U.S. dollars based on the June 28, 2002 Canadian
dollar to U.S. dollar exchange rate of 1.5173.
70
The following schedule represents the leases expiring over the next 10
years for the Bell Canada portfolio as of June 30, 2002.
SCHEDULE OF LEASE EXPIRATIONS
BELL CANADA PORTFOLIO
% OF GROSS ANNUAL
NUMBER OF TENANTS SQUARE FEET OF ANNUAL RENT OF RENT REPRESENTED
YEAR LEASE EXPIRING EXPIRING LEASES EXPIRING LEASES* BY EXPIRING LEASES
- ---- ----------------- --------------- ---------------- ------------------
2002 2 2,449 $ 22,392 0.37%
2003 8 166,687 $ 784,524 13.13%
2004 4 177,058 $ 831,889 13.92%
2005 1 96 $ 506 0.01%
2006 4 305,230 $1,394,584 23.34%
2007 4 624,786 $2,887,537 48.32%
2008 0 0 $ 0 0.00%
2009 0 0 $ 0 0.00%
2010 1 1,884 $ 32,284 0.54%
2047 1 1,686 $ 22,224 0.37%
- ---------------
* Monetary amount is in U.S. dollars based on a Canadian dollar to U.S. dollar
exchange rate of 1.5173 as of June 28, 2002.
LIV Portfolio. As of June 30, 2002, we own eight office and industrial
properties in Belgium leased primarily to government or quasi-governmental
entities, referred to in this prospectus as the LIV portfolio. The total net
rentable area of the portfolio is approximately 456,000 square feet and the
current annual rent is approximately $5.8 million.
The LIV portfolio is financed with a loan from a commercial bank in
Belgium, $51.6 million of which was outstanding as of June 30, 2002. The loan
bears interest at a rate equal to EURIBOR + 1.49%. In order to mitigate the
interest rate risk related to the financing, we are party to an interest rate
cap agreement with a commercial bank in Belgium. Pursuant to the interest rate
cap agreement, the hedge counterparty pays the excess, if any, between the
strike rate (4.75%) and the three-month EURIBOR rate as of the payment date. The
cap has a notional balance of $53.3 million and matures in August 2004.
The following table sets forth certain information with respect to the LIV
portfolio as of June 30, 2002:
71
LIV PORTFOLIO
NET
STATE/ RENTABLE YEAR BUILT/ OWNERSHIP
PROPERTY ADDRESS CITY/ SUBMARKET PROVINCE SQUARE FEET RENOVATED % USE
- ---------------- ---------------- -------- ----------- -------------- --------- ---------
54 Gossetlaan Groot-Bijgaarden Belgium 81,763 1994 100% Office
325 Leuvensesteenweg Zaventum Belgium 65,175 1975/1990 100% Office
15-17 Rue Belliard Brussels Belgium 28,180 1974/1996 100% Office
159 Dreve Richelle Waterloo Belgium 46,231 1930/1990 100% Office
4 Rue de la Science Brussels Belgium 26,651 1952/1993/1998 100% Office
4-6 Rue Belliard Brussels Belgium 32,206 1987/2001 100% Office
5 Hoge Wei Zaventum Belgium 55,606 1986 100% Warehouse
10 Rue Guimard Brussels Belgium 119,781 1973/1995 100% Office
-------
Total/Average 455,593
% OF
TOTAL
SQUARE TENANT NET LEASE LEASE
FOOTAGE RENTABLE START EXP
PROPERTY ADDRESS TENANT LEASED SQUARE FEET DATE DATE
- ---------------- ---------------------------- ------- ----------- -------- --------
54 Gossetlaan Ascend/Lucent Tech 9.56% 7,815 12/1/98 11/30/02
Wella 14.96% 12,228 1/1/99 12/31/07
Lucent Tech 6.92% 5,662 10/1/00 11/30/07
Media Genix 17.58% 14,370 3/1/00 2/28/08
United Biscuits 18.04% 14,746 3/1/99 2/28/08
Job @ 10.02% 8,191 7/1/00 6/30/09
325 Leuvensesteenweg Express Road 9.27% 6,039 9/1/91 8/31/02
Space Applic. Services 7.27% 4,736 8/15/93 8/14/11
K & L 4.38% 2,852 10/1/97 9/30/06
Integri 12.48% 8,137 4/1/98 3/31/07
Integri 2.44% 1,593 9/1/01 3/31/07
Euro Business 2.89% 1,884 6/1/99 5/31/08
Elsevier 23.52% 15,199 6/1/99 5/31/08
Elsevier 15.82% 10,312 12/1/99 11/30/08
Aprico 7.27% 4,736 3/1/00 2/28/09
Secproof 1.90% 1,238 1/1/01 12/31/09
Quality Infor 4.57% 2,982 3/1/01 2/28/10
15-17 Rue Belliard Foratom 18.87% 5,318 6/1/97 5/31/06
Foratom 10.73% 3,025 6/1/99 5/31/08
Alliance for Beverages 10.73% 3,025 2/1/00 1/31/09
Agenzia Erogazioni 10.73% 3,025 10/1/00 9/30/09
Agricoltura
Czech Trade Promotioa Agency 4.39% 1,238 12/1/00 11/30/09
C.V.N. 10.73% 3,025 9/1/01 8/31/10
159 Dreve Richelle CBC Banque 4.66% 2,153 11/1/93 10/31/11
Battersby Chung 1.70% 786 7/1/96 6/30/05
Europay 91.01% 42,076 1/1/00 12/31/07
Lunch Time 2.63% 1,217 5/1/00 4/30/09
4 Rue de la Science Swedish & Finnish Ass. 13.81% 3,681 8/15/95 8/14/04
Vedior Interim 8.24% 2,196 6/1/96 5/31/05
Vedior Interim 2.79% 743 12/1/97 5/31/05
Local Government 19.91% 5,307 1/1/00 12/31/08
Denmark
Government of Belgium 55.25% 14,724 4/1/01 03/31/10
4-6 Rue Belliard Nouvelle Entreprise Stragier 28.7% 9,235 04/01/02 03/31/11
5 Hoge Wei Unidata Noortman Belgium 100% 55,606 7/1/00 6/30/09
10 Rue Guimard European Commission 100% 119,782 10/1/95 9/30/07
------ -------
Total/Average 87.55% 398,882
ANNUAL
CURRENT REAL
ANNUAL RENT PER ESTATE
PROPERTY ADDRESS RENT SQUARE FOOT TAXES
- ---------------- ---------- ----------- --------
54 Gossetlaan $ 108,205 $13.85 $ 47,584
$ 163,882 $13.40
$ 80,201 $14.16
$ 180,834 $12.58
$ 197,494 $13.39
$ 97,495 $11.90
325 Leuvensesteenweg $ 33,120 $ 5.48 $ 27,631
$ 54,913 $11.59
$ 28,182 $ 9.88
$ 80,463 $ 9.89
$ 16,602 $10.42
$ 21,360 $11.34
$ 145,129 $ 9.55
$ 24,815 $ 2.41
$ 50,383 $10.64
$ 13,057 $10.55
$ 28,934 $ 9.70
15-17 Rue Belliard $ 64,295 $12.09 $ 65,828
$ 35,325 $11.68
$ 34,863 $11.53
$ 36,183 $11.96
$ 16,113 $13.02
$ 32,805 $10.85
159 Dreve Richelle $ 37,699 $17.51 $ 48,967
$ 9,278 $11.80
$ 521,071 $12.38
$ 26,830 $22.05
4 Rue de la Science $ 57,147 $15.52 $ 55,647
$ 22,469 $10.23
$ 8,045 $10.83
$ 69,321 $13.06
$ 213,971 $14.53
4-6 Rue Belliard $ 99,806 $10.81 $ 75,772
5 Hoge Wei $ 263,800 $ 4.74 $ 15,004
10 Rue Guimard $2,952,015 $24.64 $356,865
---------- --------
Total/Average $5,826,105 $693,298
- ---------------
All monetary amounts are in U.S. dollars based on the June 28, 2002 Euro to U.S.
dollars exchange rate of 1.0086.
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The following schedule represents the leases expiring over the next 10
years for the LIV portfolio as of June 30, 2002.
SCHEDULE OF LEASE EXPIRATIONS
LIV PORTFOLIO
% OF GROSS ANNUAL
NUMBER OF TENANTS SQUARE FEET OF ANNUAL RENT OF RENT REPRESENTED
YEAR LEASE EXPIRING EXPIRING LEASES EXPIRING LEASES* BY EXPIRING LEASES
- ---- ----------------- --------------- ---------------- ------------------
2002 2 13,854 $ 141,325 2.43%
2003 0 0 $ 0 0.00%
2004 1 3,681 $ 57,147 0.98%
2005 3 3,725 $ 39,792 0.68%
2006 2 8,170 $ 92,477 1.59%
2007 6 189,478 $3,814,234 65.47%
2008 7 64,842 $ 674,278 11.57%
2009 8 78,276 $ 538,724 9.25%
2010 3 20,731 $ 275,710 4.73%
2011 3 16,124 $ 192,418 3.30%
- ---------------
* Monetary amount is in U.S. dollars based on Euro to U.S. dollars exchange rate
of 1.0086 as of June 28, 2002.
RATINGS
The following are the explanations of the ratings provided by Standard and
Poor's and Moody's. Ratings of BBB- and Baa3 and above are considered investment
grade.
STANDARD AND POOR'S RATINGS:
AAA: The highest rating assigned by Standard & Poor's. The obligor's
capacity to meet its financial commitment on the obligation is extremely strong.
AA: Differs from the highest rated obligations only in small degree. The
obligor's capacity to meet its financial commitment on the obligation is very
strong.
A: Somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than obligations in higher rated
categories. However, the obligor's capacity to meet its financial commitment on
the obligation is still strong.
BBB: Exhibits adequate protection parameters. However, adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity of the obligor to meet its financial commitment on the obligation.
BB: Less vulnerable to nonpayment than other speculative issues. However,
it faces major ongoing uncertainties or exposure to adverse business, financial,
or economic conditions which could lead to the obligor's inadequate capacity to
meet its financial commitment on the obligation.
PLUS (+) OR MINUS (-): Shows relative standing within the major rating
categories.
MOODY'S RATINGS:
AAA: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
73
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
AA: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risk appear somewhat larger than the Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the future.
BAA: Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA: Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from Aa through Caa. The modifier 1 indicates that the obligation
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranging; and the modifier 3 indicates a ranking in the lower end of
that generic rating category.
POLICIES WITH RESPECT TO CERTAIN OTHER ACTIVITIES
If our board of directors determines that additional funding is required,
we may raise such funds through additional equity offerings, debt financing,
retention of cash flow (subject to provisions in the Internal Revenue Code
concerning taxability of undistributed REIT taxable income) or a combination of
these methods.
In the event that our board of directors determines to raise additional
equity capital, it has the authority, without stockholder approval, to issue
additional common stock or preferred stock in any manner and on such terms and
for such consideration it deems appropriate, including in exchange for property.
Borrowings may be in the form of bank borrowings, secured or unsecured, and
publicly or privately placed debt instruments, purchase money obligations to the
sellers of assets, long-term, tax-exempt bonds or other publicly or privately
placed debt instruments, financing from banks, institutional investors or other
lenders, securitizations, including CBOs, any of which indebtedness may be
unsecured or may be secured by mortgages or other interests in the asset. Such
indebtedness may be recourse to all or any part of our assets or may be limited
to the particular asset to which the indebtedness relates.
We have authority to offer our common stock or other equity or debt
securities in exchange for property and to repurchase or otherwise reacquire our
shares or any other securities and may engage in such activities in the future.
Similarly, we may offer additional interests in our operating partnership that
are exchangeable into common shares or, at our option, cash, in exchange for
property. We also may make loans to our subsidiaries.
74
Subject to the percentage of ownership limitations and gross income and
asset tests necessary for REIT qualification, we may invest in securities of
other REITs, other entities engaged in real estate activities or securities of
other issuers, including for the purpose of exercising control over such
entities.
We may engage in the purchase and sale of investments. We do not underwrite
the securities of other issuers.
Our officers and directors may change any of these policies without a vote
of our stockholders.
COMPETITION
We are subject to significant competition in seeking investments. We
compete with several other companies for investments, including other REITs,
insurance companies and other investors. Some of our competitors have greater
resources than we do and we may not be able to compete successfully for
investments.
COMPLIANCE WITH THE AMERICANS WITH DISABILITIES ACT OF 1990
Our properties are required to meet federal requirements related to access
and use by disabled persons as a result of the Americans with Disabilities Act
of 1990. In addition, a number of additional federal, state and local laws may
require modifications to any properties we purchase, or may restrict further
renovations thereof, with respect to access by disabled persons. Noncompliance
with these laws or regulations could result in the imposition of fines or an
award of damages to private litigants. Additional legislation could impose
additional financial obligations or restrictions with respect to access by
disabled persons. If required changes involve greater expenditures than we
currently anticipate, or if the changes must be made on a more accelerated
basis, our ability to make expected distributions could be adversely affected.
COMPLIANCE WITH FEDERAL, STATE AND LOCAL ENVIRONMENTAL LAWS
Our properties are subject to various federal, state and local
environmental laws, ordinances and regulations. Under these laws, ordinances and
regulations, a current or previous owner of real estate (including, in certain
circumstances, a secured lender that succeeds to ownership or control of a
property) may become liable for the costs of removal or remediation of certain
hazardous or toxic substances or petroleum product releases at, on, under or in
its property. These laws typically impose cleanup responsibility and liability
without regard to whether the owner or control party knew of or was responsible
for the release or presence of the hazardous or toxic substances. The costs of
investigation, remediation or removal of these substances may be substantial and
could exceed the value of the property. An owner or control party of a site may
be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from a site. Certain
environmental laws also impose liability in connection with the handling of or
exposure to asbestos-containing materials, pursuant to which third parties may
seek recovery from owners of real properties for personal injuries associated
with asbestos-containing materials. Our operating costs and values of these
assets may be adversely affected by the obligation to pay for the cost of
complying with existing environmental laws, ordinances and regulations, as well
as the cost of complying with future legislation, and our income and ability to
make distributions to our stockholders could be affected adversely by the
existence of an environmental liability with respect to our properties. We will
endeavor to ensure our properties will be in compliance in all material respects
with all Federal, state and local laws, ordinances and regulations regarding
hazardous or toxic substances or petroleum products.
LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
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OUR MANAGER AND THE MANAGEMENT AGREEMENT
FORTRESS INVESTMENT GROUP LLC
Our manager, Fortress Investment Group, was founded in 1998 by Messrs.
Wesley R. Edens, Robert I. Kauffman, Randal A. Nardone and Erik P. Nygaard.
Our manager employs 15 professionals and has offices in New York, London
and Rome. Our manager's principal executives have an average of more than 17
years of experience in the fields of real estate investing and finance, private
equity investment, capital markets, transaction structuring and risk management
with respect to both dollar and non-dollar denominated investments. Over the
last six years alone, the founders of our manager have managed the acquisition
of over $20 billion of real estate-related assets and the issuance of over $11
billion of real estate securities. At June 30, 2002, our manager and its
principals owned approximately 16.4% of the equity of Newcastle Investment
Holdings (25.8% upon exercise of outstanding options to purchase shares of
Newcastle Investment Holdings). In addition, in connection with this offering,
we will grant to our manager an option to purchase 700,000 shares of our common
stock, representing 10% of the number of shares being offered hereby, and
subject to adjustment if the underwriters' over-allotment option is exercised,
at the offering price of our shares in this offering. Fortress Investment Group
and its principals would have a total beneficial ownership in our common stock
of approximately 20.5%, taking into account interests in Newcastle Investment
Holdings and exercise of all of their options. Our manager is entitled to
receive an annual base management fee from us and may receive incentive
compensation based on certain performance criteria.
Our manager continues to manage Newcastle Investment Holdings and also
manages and invests in other entities that invest in real estate and other
assets.
The executive offices of Fortress Investment Group are located at 1251
Avenue of the Americas, New York, New York 10020 and the telephone number of its
executive offices is (212) 798-6100.
OFFICERS OF OUR MANAGER
The following table sets forth certain information with respect to the
senior officers of our manager. Each of our executive officers is also a senior
officer of our manager.
NAME AGE POSITION WITH OUR MANAGER
- ---- --- -------------------------
Wesley R. Edens........................ 40 Chief Executive Officer
Robert I. Kauffman..................... 38 President
Randal A. Nardone...................... 47 Chief Operating Officer
Erik P. Nygaard........................ 42 Chief Information Officer
Jeffrey R. Rosenthal................... 51 Chief Financial Officer and Treasurer
WESLEY R. EDENS has been our Chief Executive Officer and the Chairman of
our board of directors since inception. Mr. Edens co-founded our manager with
Messrs. Kauffman, Nardone and Nygaard and is its Chief Executive Officer. Mr.
Edens was previously a Managing Director of Union Bank of Switzerland from May
1997 to May 1998. Prior to joining Union Bank of Switzerland, Mr. Edens was a
partner and Managing Director of BlackRock Financial Management, Inc. In
addition, Mr. Edens was formerly a partner and Managing Director of Lehman
Brothers, where he was head of the Non-Agency Mortgage Trading Desk. Mr. Edens
received a B.S. degree in Business Administration from Oregon State University.
Mr. Edens has been Chief Executive Officer, President and Chairman of the board
of directors of Capstead Mortgage Corporation since April 2000.
ROBERT I. KAUFFMAN has been President of our manager since inception. Mr.
Kauffman co-founded our manager with Messrs. Edens, Nardone and Nygaard. Mr.
Kauffman was previously a Managing Director of Union Bank of Switzerland from
May 1997 to May 1998. Prior to joining Union Bank of Switzerland in 1997, Mr.
Kauffman was a principal of BlackRock Financial Management, Inc. Prior to
joining BlackRock, Mr. Kauffman was an Executive Director of Lehman Brothers
International in London from
76
December 1992. Mr. Kauffman received a B.S. degree in Business Administration
from Northeastern University.
RANDAL A. NARDONE has been our Secretary since inception. Mr. Nardone
co-founded our manager with Messrs. Edens, Kauffman and Nygaard and has been
Chief Operating Officer of our manager since inception. Mr. Nardone was
previously a Managing Director of Union Bank of Switzerland from May 1997 to May
1998. Prior to joining Union Bank of Switzerland in 1997, Mr. Nardone was a
principal of BlackRock Financial Management, Inc. Prior to joining BlackRock,
Mr. Nardone was a partner and a member of the executive committee at the law
firm of Thacher Proffitt & Wood. Mr. Nardone joined Thacher Proffitt & Wood in
1980 and became head of its structured finance group in 1993. Mr. Nardone
received a B.A. degree in English and Biology from the University of Connecticut
and a J.D. degree from the Boston University School of Law.
ERIK P. NYGAARD has been our Chief Information Officer since our inception
and Chief Information Officer of our manager since inception. Mr. Nygaard
co-founded our manager with Messrs. Edens, Kauffman and Nardone. Mr. Nygaard was
previously a Managing Director of Union Bank of Switzerland from May 1997 to May
1998. Prior to joining Union Bank of Switzerland, Mr. Nygaard was a principal of
BlackRock Financial Management, Inc. From April 1990 to July 1994, Mr. Nygaard
was a Director at Nomura Securities International. Mr. Nygaard received a B.S.
degree in Electrical Engineering and Computer Science from the Massachusetts
Institute of Technology.
JEFFREY R. ROSENTHAL has been our manager's Chief Financial Officer since
June 2002. Mr. Rosenthal was previously Executive Vice President and Chief
Operating Officer of Starwood Capital Group, a real estate equity fund manager,
from April 1997 to June 2002. In addition, he was a member of Starwood's
Executive and Investment Committees. Mr. Rosenthal previously held the positions
of Chief Financial Officer of JMB Realty Corporation from December 1987 to
February 1996, Chief Financial Officer of Reyes Holdings from February 1996 to
April 1997, and was a partner in the public accounting firm of KPMG Peat Marwick
from December 1972 to December 1987. Mr. Rosenthal is also a Director of Baird &
Warner, Inc., the largest independent real estate brokerage firm in the Chicago
area. Mr. Rosenthal received a B.S. in Accounting from The University of
Illinois in Chicago and is a Certified Public Accountant.
OTHER KEY PROFESSIONALS OF OUR MANAGER
KENNETH M. RIIS has been our President since inception and a Managing
Director of our manager since December 2001. From November 1996 to December
2001, Mr. Riis was an independent consultant for our manager as well as other
financial companies. From 1989 to 1996, Mr. Riis was a Principal and Managing
Director of the real estate finance group at Donaldson, Lufkin & Jenrette. Mr.
Riis received a B.S. degree in Finance and Business Management from San Jose
State University.
MICHAEL I. WIRTH has been our Chief Financial Officer since our formation
and joined our manager in May 2002. From August 2000 to May 2002, Mr. Wirth was
the Senior Vice President and Chief Financial Officer of three public companies:
Charter Municipal Mortgage Acceptance Company, American Mortgage Acceptance
Company and Aegis Realty Inc. He was also a Senior Vice President of Related
Capital Company which externally managed these companies. Prior to joining
Related Capital in August 2000, Mr. Wirth was a Vice President at CGA Investment
Management. From 1988-1997, Mr. Wirth was a Senior Manager with the Estate
Consulting Practice of Deloitte & Touche, where he specialized in real estate
capital markets and the financial services industry. From 1986-1988, Mr. Wirth
was the Chief Financial Officer for Cochran Properties, Inc., an Atlanta,
Georgia commercial real estate development company and from 1983-1986 was a
Senior Accountant with Deloitte Haskins & Sells. Mr. Wirth holds a Bachelor of
Business Administration from Georgia State University and is a member of the
American Institute of Certified Public Accountants.
JONATHAN ASHLEY has been our Chief Operating Officer since our formation
and a Managing Director of our manager since its formation in May 1998. Mr.
Ashley previously worked for Union Bank of Switzerland from May 1997 to May
1998. Prior to joining Union Bank of Switzerland, Mr. Ashley worked
77
for an affiliate of BlackRock Financial Management, Inc. from April 1996 to May
1997. Prior to joining BlackRock, Mr. Ashley worked at Morgan Stanley, Inc. in
its Real Estate Investment Banking Group. Prior to joining Morgan Stanley, Mr.
Ashley was in the Structured Finance Group at the law firm of Skadden, Arps,
Slate, Meagher & Flom LLP. Mr. Ashley received a B.A. degree in History from
Tufts University and a J.D. degree from the University of Pennsylvania Law
School.
JONATHAN BROWN joined our manager in October 1999 and is a Vice President
and Corporate Controller. Prior to joining our manager, Mr. Brown worked at
Wellsford Real Properties, Inc., a real estate merchant banking firm, as
corporate controller. From 1994 to 1997, Mr. Brown served as the controller of
Wellsford Residential Property Trust, a public real estate investment trust.
Prior to that, Mr. Brown was an audit manager with Kenneth Leventhal & Company,
a public accounting firm specializing in real estate and financial services. Mr.
Brown received a B.S. in accounting from New York University and is a Certified
Public Accountant.
WILLIAM DONIGER joined our manager in May 1998 as a Managing Director. Mr.
Doniger previously worked for Union Bank of Switzerland from January 1998 to May
1998. Prior to joining Union Bank of Switzerland, Mr. Doniger worked for an
affiliate of BlackRock Financial Management, Inc. from January 1996 through
December 1997. Prior to that, Mr. Doniger was in the structured finance group of
the law firm of Thacher Proffitt & Wood. Mr. Doniger graduated from Princeton
University with an A.B. degree in History and received a J.D. degree from
American University.
LILLY H. DONOHUE joined our manager in May 1998 and is a Vice President in
the investor relations and capital raising area. Ms. Donohue is responsible for
client service and reporting as well as public relations. Prior to joining our
manager, Ms. Donohue worked at Union Bank of Switzerland and, before that, at
BlackRock from 1992 to 1998, where she focused on structured finance and the
small balance commercial loan business. Ms. Donohue received a B.S.B.A. in
Finance from Boston University.
MARSHALL L. GLICK joined our manager in February 2002 and is presently
serving as our Senior Credit Officer. Mr. Glick previously was a Vice President
and Senior CMBS analyst in the Fixed Income Division at Alliance Capital
Management L.P from April 1996 to February 2002. Prior to joining Alliance, Mr.
Glick was an Associate Director in the Structured Finance Ratings Group at
Standard & Poor's Rating Services. Prior to joining Standard & Poor's, Mr. Glick
was a Real Estate Associate with National Westminster Bank in New York. Mr.
Glick received an M.B.A. from the Graduate School of Business Administration at
Fordham University with a concentration in finance and a Bachelor of Science
Degree from the School of Business at the State University of New York in
Albany.
ALLISON THRUSH joined our manager in March 2001 as Director of Investor
Relations. From 1996 to 2001, Ms. Thrush was with The New York State Common
Retirement Fund, most recently as Senior Investment Officer. Ms. Thrush received
a B.S. degree in Economics from the University of California, Berkeley, and an
M.P.P. degree from Harvard University's Kennedy School of Government.
THE MANAGEMENT AGREEMENT
We are party to a management agreement with Fortress Investment Group,
dated as of , 2002, pursuant to which Fortress Investment Group, our
manager, provides for the day-to-day management of our operations.
The management agreement requires our manager to manage our business
affairs in conformity with the policies and the investment guidelines that are
approved and monitored by our board of directors. Our manager's management is
under the direction of our board of directors. The manager is responsible for
(i) the purchase and sale of real estate securities and other real
estate-related assets, (ii) management of our real estate, including arranging
for purchases, sales, leases, maintenance and insurance, (iii) the purchase,
sale and servicing of mortgages for us, and (iv) investment advisory services.
Our manager is responsible for our day-to-day operations and performs (or causes
to be performed) such services and
78
activities relating to our assets and operations as may be appropriate,
including, without limitation, the following:
(i) serving as our consultant with respect to the periodic review of
the investment criteria and parameters for our investments, borrowings and
operations for the approval of our board of directors;
(ii) investigating, analyzing and selecting possible investment
opportunities;
(iii) conducting negotiations with real estate brokers, sellers and
purchasers and their agents and representatives, investment bankers and
owners of privately and publicly held real estate companies;
(iv) engaging and supervising, on our behalf and at our expense,
independent contractors which provide real estate brokerage, investment
banking and leasing services, mortgage brokerage, securities brokerage and
other financial services and such other services as may be required
relating to our investments;
(v) negotiating on our behalf for the sale, exchange or other
disposition of any of our investments;
(vi) coordinating and managing operations of any joint venture or
co-investment interests held by us and conducting all matters with any
joint venture or co-investment partners;
(vii) coordinating and supervising, on our behalf and at our expense,
all property managers, leasing agents and developers for the
administration, leasing, management and/or development of any of our
investments;
(viii) providing executive and administrative personnel, office space
and office services required in rendering services to us;
(ix) administering our day-to-day operations and performing and
supervising the performance of such other administrative functions
necessary to our management as may be agreed upon by our manager and the
board of directors, including the collection of revenues and the payment of
our debts and obligations and maintenance of appropriate computer services
to perform such administrative functions;
(x) communicating on our behalf with the holders of any of our equity
or debt securities as required to satisfy the reporting and other
requirements of any governmental bodies or agencies or trading markets and
to maintain effective relations with such holders;
(xi) counseling us in connection with policy decisions to be made by
our board of directors;
(xii) evaluating and recommending to our board of directors
modifications to the hedging strategies in effect and engaging in overall
hedging strategies, engaging in hedging activities on our behalf,
consistent with our status as a REIT and with the investment guidelines;
(xiii) counseling us regarding the maintenance of our status as a REIT
and monitoring compliance with the various REIT qualification tests and
other rules set out in the Internal Revenue Code and Treasury Regulations
thereunder;
(xiv) counseling us regarding the maintenance of our exemption from
the Investment Company Act and monitoring compliance with the requirements
for maintaining an exemption from that Act;
(xv) assisting us in developing criteria for asset purchase
commitments that are specifically tailored to our investment objectives and
making available to us its knowledge and experience with respect to
mortgage loans, real estate, real estate securities and other real
estate-related assets;
(xvi) representing and making recommendations to us in connection with
the purchase and finance and commitment to purchase and finance of mortgage
loans (including on a portfolio basis), real estate, real estate securities
and other real estate-related assets, and the sale and commitment to sell
such assets;
79
(xvii) monitoring the operating performance of our investments and
providing periodic reports with respect thereto to our board of directors,
including comparative information with respect to such operating
performance and budgeted or projected operating results;
(xviii) investing or reinvesting any money of ours (including
investing in short-term investments pending investment in long-term asset
investments, payment of fees, costs and expenses, or payments of dividends
or distributions to our stockholders and partners), and advising us as to
our capital structure and capital raising;
(xix) causing us to retain qualified accountants and legal counsel, as
applicable, to assist in developing appropriate accounting procedures,
compliance procedures and testing systems with respect to financial
reporting obligations and compliance with the REIT provisions of the
Internal Revenue Code and to conduct quarterly compliance reviews with
respect thereto;
(xx) causing us to qualify to do business in all applicable
jurisdictions and to obtain and maintain all appropriate licenses;
(xxi) assisting us in complying with all regulatory requirements
applicable to us in respect of our business activities, including preparing
or causing to be prepared all financial statements required under
applicable regulations and contractual undertakings and all reports and
documents, if any, required under the Exchange Act;
(xxii) taking all necessary actions to enable us to make required tax
filings and reports, including soliciting stockholders for required
information to the extent provided by the REIT provisions of the Internal
Revenue Code;
(xxiii) handling and resolving all claims, disputes or controversies
(including all litigation, arbitration, settlement or other proceedings or
negotiations) in which we may be involved or to which we may be subject
arising out of our day-to-day operations, subject to such limitations or
parameters as may be imposed from time to time by our board of directors;
(xxiv) using commercially reasonable efforts to cause expenses
incurred by or on behalf of us to be reasonable or customary and within any
budgeted parameters or expense guidelines set by our board of directors
from time to time;
(xxv) performing such other services as may be required from time to
time for management and other activities relating to our assets as our
board of directors shall reasonably request or our manager shall deem
appropriate under the particular circumstances; and
(xxvi) using commercially reasonable efforts to cause us to comply
with all applicable laws.
Pursuant to the management agreement, our manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of our board of directors in following or
declining to follow its advice or recommendations. Our manager, its directors
and its officers will not be liable to us, any subsidiary of ours, our
directors, our stockholders or any subsidiary's stockholders for acts performed
in accordance with and pursuant to the management agreement, except by reason of
acts constituting bad faith, willful misconduct, gross negligence, or reckless
disregard of their duties under the management agreement. We have agreed to
indemnify our manager, its directors and its officers with respect to all
expenses, losses, damages, liabilities, demands, charges and claims arising from
acts of our manager not constituting bad faith, willful misconduct, gross
negligence, or reckless disregard of duties, performed in good faith in
accordance with and pursuant to the management agreement. Our manager has agreed
to indemnify us, our directors and officers with respect to all expenses,
losses, damages, liabilities, demands, charges and claims arising from acts of
our manager constituting bad faith, willful misconduct, gross negligence or
reckless disregard of its duties under the management agreement. Our manager
carries errors and omissions and other customary insurance.
Pursuant to the terms of the management agreement, the manager is required
to provide a dedicated management team, including a President, Chief Financial
Officer and Chief Operating Officer, to provide
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the management services to be provided by the manager to us, the members of
which team shall have as their primary responsibility the management of us and
shall devote such of their time to the management of us as our board of
directors reasonably deems necessary and appropriate, commensurate with our
level of activity from time to time.
The management agreement provides for automatic one-year extensions from
and after , 2003. Our independent directors review our manager's
performance annually and the management agreement may be terminated annually
upon the affirmative vote of at least two-thirds of our independent directors,
or by a vote of the holders of a majority of the outstanding shares of our
common stock, based upon unsatisfactory performance that is materially
detrimental to us or a determination by our independent directors that the
compensation to our manager is not fair, subject to our manager's right to
prevent such a compensation termination by accepting a mutually acceptable
reduction of fees. Our manager will be provided with 60 days' prior notice of
any such termination and will be paid a termination fee equal to the amount of
the management fee earned by our manager during the twelve-month period
preceding such termination which may make it more difficult for us to terminate
the management agreement. Following any termination of the management agreement,
we shall be entitled to purchase the portion of our manager's incentive return,
as described below, at a price determined as if our assets were sold for cash at
their then current fair market value (as determined by an appraisal, taking into
account, among other things, the expected future value of the underlying
investments) or otherwise we may continue to pay the incentive return to our
manager. In addition, if we do not elect to so purchase our manager's incentive
return, our manager will have the right to require us to purchase the same at
the price discussed above. In addition, the management agreement may be
terminated by us at any time for cause, which is defined as fraud,
misappropriation of funds, willful violation of the management agreement, or
gross negligence, without payment of the termination fee. Our manager may at any
time assign certain duties under the management agreement to any affiliate of
our manager provided that certain officers of the manager also jointly manage
and supervise the day-to-day business and operations of such affiliate and
provided, further, that our manager shall be fully responsible to us for all
errors or omissions of such assignee.
MANAGEMENT FEES AND INCENTIVE COMPENSATION
We do not maintain an office or employ personnel. Instead we rely on the
facilities and resources of our manager to conduct our operations. Expense
reimbursements to our manager are made monthly. The management fee and any other
expenses are payable on the first business day of each calendar month.
To date, we have not paid any fees to our manager. Below is a summary of
the fees and other amounts due from Newcastle Investment Holdings to the manager
since the inception of Newcastle Investment Holdings.
SIX MONTHS
MAY - DECEMBER ENDED
1998 1999 2000 2001 JUNE 30, 2002
---------------- ------------ ------------ ------------ -------------
Management Fee.......... $6.0 million $5.6 million $5.1 million $4.8 million $2.4 million
Reimbursement of
Expenses.............. $1.2 million $1.8 million $1.6 million $0.9 million $0.3 million
Management Incentive
Return................ -- -- -- $2.8 million $1.4 million
Manager options......... 2,091,673 shares -- -- -- --
Management Fee. We pay our manager an annual management fee equal to 1.5%
of our gross equity, as defined in the management agreement. Our manager uses
the proceeds from its management fee in part to pay compensation to its officers
and employees who, notwithstanding that certain of them also are our officers,
receive no cash compensation directly from us.
Reimbursement of Expenses. Because our manager's employees perform certain
legal, accounting, due diligence tasks and other services that outside
professionals or outside consultants otherwise would perform, our manager is
paid or reimbursed for the cost of performing such tasks, provided that such
costs
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and reimbursements are no greater than those which would be paid to outside
professionals or consultants on an arm's-length basis; and provided, further
that such costs shall not be reimbursed in excess of $500,000 per annum. In
addition, our manager will be reimbursed for any expenses incurred in
contracting with third parties, including affiliates of our manager, for the
special servicing of our assets.
We also pay all operating expenses, except those specifically required to
be borne by our manager under the management agreement. Our manager is
responsible for all costs incident to the performance of its duties under the
management agreement, including compensation of our manager's employees, rent
for facilities and other "overhead" expenses. The expenses required to be paid
by us include, but are not limited to, issuance and transaction costs incident
to the acquisition, disposition and financing of our investments, legal and
auditing fees and expenses, the compensation and expenses of our independent
directors, the costs associated with the establishment and maintenance of any
credit facilities and other indebtedness of ours (including commitment fees,
legal fees, closing costs, etc.), expenses associated with other securities
offerings of ours, the costs of printing and mailing proxies and reports to our
stockholders, costs incurred by employees of our manager for travel on our
behalf, costs associated with any computer software or hardware that is used
solely for us, costs to obtain liability insurance to indemnify our directors
and officers and the compensation and expenses of our transfer agent.
Incentive Compensation. Our manager is entitled to receive annual
incentive compensation pursuant to the terms of the management agreement with
us. The purpose of the incentive compensation is to provide an additional
incentive for our manager to achieve targeted levels of funds from operations
(including gains and losses) and to increase our stockholder value. This
incentive compensation, which is calculated on a cumulative, but not
compounding, basis is an amount equal to the product of:
(A) 25% of the dollar amount by which
(1)(a) the funds from operations before the incentive return per
share of common stock, plus (b) gains (or losses) from debt
restructuring and gains (or losses) from sales of property and other
assets per share of common stock (subsequent to the initial
transactions),
exceed
(2) an amount equal to (a) the weighted average of the book value
per share of the net assets transferred to us in the initial
transactions and the prices per share of our common stock in any
offerings by us (adjusted for prior capital dividends or capital
distributions) multiplied by (b) a simple interest rate of 10% per annum
multiplied by
(B) the weighted average number of shares of common stock outstanding.
"Funds from operations" means net income (computed in accordance with GAAP),
excluding gains (losses) from debt restructuring and gains (or losses) from
sales of property, plus depreciation and amortization on real estate assets, and
after adjustments for unconsolidated partnerships and joint ventures. Funds from
operations does not represent cash generated from operating activities in
accordance with GAAP and should not be considered as an alternative to net
income as an indication of our performance or to cash flows as a measure of
liquidity or ability to make distributions.
Upon any termination of the management agreement by either party, we shall
be entitled to purchase the manager's right to receive incentive compensation
from our manager for a cash purchase price equal to the amount that would be
distributed to our manager if all of our assets were sold for cash at their then
current fair market value (taking into account, among other things, expected
future performance of the underlying investments) or otherwise continue to pay
the incentive compensation to our manager. In addition, if we do not elect to so
purchase our manager's right to receive incentive compensation, our manager will
have the right to require us to purchase the same at the price described above.
In either case, such fair market value shall be determined by independent
appraisal to be conducted by a nationally recognized appraisal firm mutually
agreed upon by us and our manager.
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Our board of directors may request that our manager accept all or a portion
of its incentive compensation in shares of our common stock, and our manager may
elect, in its discretion, to accept such payment in the form of shares, subject
to limitations that may be imposed by the rules of the New York Stock Exchange
or otherwise.
Manager Options. In connection with this offering, we will grant to our
manager options representing the right to acquire 10% of the number of shares
offered and sold in this offering at an exercise price per share equal to the
initial public offering price per share of the shares in this offering. The
options are exercisable as to 1/30 of the shares subject to the option on the
first day of each of the 30 calendar months following the date of grant. The
manager options provide a means of performance-based compensation in order to
provide an additional incentive for our manager to enhance the value of our
common stock.
CONFLICTS OF INTEREST IN OUR RELATIONSHIP WITH OUR MANAGER
Our chairman and chief executive officer and each of our executive officers
also serve as officers of our manager. As a result, the management agreement was
not negotiated at arm's-length and its terms, including fees payable, may not be
as favorable to us as if it had been negotiated with an unaffiliated third
party.
Our manager also manages and invests in other real estate-related
investment vehicles, including Newcastle Investment Holdings, and our chairman
and chief executive officer and some of our other officers also serve as
officers and/or directors of these other entities. For example, our manager
manages Fortress Investment Fund, which has a substantial investment in Capstead
Mortgage Corporation, a publicly traded mortgage REIT. Our chairman and chief
executive officer, who is an officer of our manager, also serves as chairman and
chief executive officer of Capstead. Capstead's portfolio consists primarily of
adjustable-rate and short-maturity assets, including residential mortgage backed
securities issued by Fannie Mae, Freddie Mac and Ginnie Mae. However, Capstead
has a broader investment mandate, which could lead to a future conflict. Certain
investments appropriate for us may also be appropriate for one or more of these
other investment vehicles and our manager may decide to make a particular
investment through another investment vehicle rather than through us. Our
manager also intends to engage in additional real estate-related management and
investment opportunities in the future which may also compete with us for
investments.
Our management agreement with our manager generally does not limit or
restrict our manager from engaging in any business or managing any other vehicle
that invests generally in real estate securities. However, the terms of the
management agreement prohibit our manager and any entity controlled by or under
common control with our manager from raising or sponsoring any new investment
fund, company or vehicle whose investment policies, guidelines or plan targets
as its primary investment category investment in credit sensitive real estate
securities, but no such fund, company or vehicle shall be prohibited from
investing in credit sensitive real estate securities. Our manager is also
required to seek the approval of our independent directors before we engage in a
material transaction with another unrelated entity managed by our manager. The
ability of our manager and its officers and employees to engage in these other
business activities will reduce the time our manager spends managing us.
The management compensation structure that we have agreed to with our
manager may cause our manager to invest in high risk investments. In addition to
its management fee, our manager may receive an incentive return based in part
upon our achievement of targeted levels of funds from operations. In evaluating
investments and other management strategies, the opportunity to earn incentive
return based on funds from operations may lead our manager to place undue
emphasis on the maximization of funds from operations at the expense of other
criteria, such as preservation of capital, in order to achieve a higher
incentive return. Investments with higher yield potential are generally riskier
or more speculative. This could result in increased risk to the value of our
invested portfolio.
Termination of the management agreement with our manager is difficult and
costly. The management agreement may only be terminated annually upon the
affirmative vote of at least two-thirds of our
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independent directors, or by a vote of the holders of a majority of the
outstanding shares of our common stock, based upon (1) unsatisfactory
performance by our manager that is materially detrimental to us or (2) a
determination that the compensation to our manager is not fair, subject to our
manager's right to prevent such a compensation termination by accepting a
mutually acceptable reduction of fees. Our manager will be provided 60 days'
prior notice of any such termination and will be paid a termination fee equal to
the amount of the management fee earned by the manager during the twelve-month
period preceding such termination. In addition, following any termination of the
management agreement, the manager may require us to purchase its incentive
return at a price determined as if our assets were sold for their fair market
value (as determined by an appraisal, taking into account, among other things,
the expected future value of the underlying investments) or we may otherwise
continue to pay the incentive return to our manager. These provisions may
increase the effective cost to us of terminating the management agreement,
thereby adversely affecting our ability to terminate our manager without cause.
Our manager is authorized to follow very broad investment guidelines. Our
directors periodically review our investment guidelines and our investment
portfolio. However, our board does not review each proposed investment. In
addition, in conducting periodic reviews, the directors rely primarily on
information provided to them by our manager. Furthermore, transactions entered
into by our manager may be difficult or impossible to unwind by the time they
are reviewed by the directors. Our manager has great latitude within the broad
guidelines of the investment guidelines in determining the types of assets it
may decide are proper investments for us.
Our manager manages and also has an equity interest in both us and in
Newcastle Investment Holdings, which may result in decisions that are not in our
best interest.
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MANAGEMENT
OUR DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information about our directors and
executive officers upon completion of the offering.
NAME AGE POSITION WITH US
- ---- --- ----------------
Wesley R. Edens............................ 40 Chief Executive Officer and Chairman of the
Board of Directors (Class III)
David J. Grain............................. 39 Independent Director (Class II)
Stuart A. McFarland........................ 54 Independent Director (Class I)
Kenneth M. Riis............................ 42 President
Jonathan Ashley............................ 35 Chief Operating Officer
Michael I. Wirth........................... 44 Chief Financial Officer and Treasurer
Erik P. Nygaard............................ 42 Chief Information Officer
Randal A. Nardone.......................... 47 Secretary
Pursuant to our charter, the board of directors is divided into three
classes of directors. The current terms of the Class I, Class II and Class III
directors will expire in 2003, 2004 and 2005, respectively. Directors of each
class will be chosen for three-year terms upon the expiration of their current
terms and each year one class of directors will be elected by the stockholders.
All officers serve at the discretion of our board of directors. We expect to
have at least a 5 person board of directors. We will have two qualified audit
committee members in place within three months of the consummation of this
offering and a third qualified member in place within twelve months of the
consummation of this offering. Our Bylaws provide that a majority of the entire
board of directors may establish, increase or decrease the number of directors,
provided that the number of directors shall never be less than the minimum
number required by the Maryland General Corporation Law, which is one, nor more
than 15.
Information for each of our independent directors is set forth below. For
biographical information on Messrs. Edens, Riis, Ashley, Wirth, Nygaard and
Nardone see "Our Manager and the Management Agreement -- Officers of Our
Manager."
DAVID J. GRAIN has agreed to become a member of our board of directors upon
completion of this offering. Mr. Grain has been a director of Newcastle
Investment Holdings since January 2002. Mr. Grain currently serves as Senior
Vice President for AT&T Broadband's Northeast Region. He is the senior executive
responsible for providing cable television, high speed internet, and digital
telephone service to AT&T Broadband's New England Region. Prior to joining AT&T
in June 2000, Mr. Grain was a Principal at the New York investment banking firm
of Morgan Stanley from 1992 to June 2000. Mr. Grain is currently a member of the
Board of Directors of New England Cable News, Fox Sports New England, the New
England Cable Television Association and the Greater Boston Chamber of Commerce.
Mr. Grain is also a Director and member of the Investment Committee of the
Pension Reserves Investment Management (PRIM) Board of Massachusetts and is a
Trustee of the AT&T Foundation. Mr. Grain earned a B.A. degree in English from
the College of the Holy Cross and an M.B.A. degree from the Amos Tuck School at
Dartmouth College.
STUART A. MCFARLAND has agreed to become a member of our board of directors
upon completion of this offering. Mr. McFarland has been a director of Newcastle
Investment Holdings since May 1998. Mr. McFarland is Managing Partner of Federal
City Capital Advisors, a strategic advisory and corporate financial services
firm located in Washington, D.C. Previously, Mr. McFarland was President and
Chief Executive Officer of Pedestal Inc., an internet secondary mortgage market
trading exchange for the trading of spot and pooled mortgage loans. Mr.
McFarland was Executive Vice President and General Manager of GE Capital
Mortgage Services and President and CEO of GE Capital Asset Management
Corporation from 1990 to 1995 where he ran GE Capital's mortgage business. Prior
to GE Capital, Mr. McFarland
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was President and CEO of Skyline Financial Services Corp., where he was the U.S.
Bankruptcy Court appointed asset manager for the EPIC Bankruptcy. Before joining
Skyline, Mr. McFarland was President and CEO of National Permanent Federal
Savings Bank in Washington, D.C. Prior to this, Mr. McFarland was Executive Vice
President and Chief Financial Officer with Fannie Mae (Federal National Mortgage
Association). From 1972 to 1981, he was also President and Director of Ticor
Mortgage Insurance Company in Los Angeles, California. Mr. McFarland currently
serves as a Director of the Brandywine Funds, as a Director and Member of the
Executive Committee of the Center for Housing Policy, is a Trustee of the
National Building Museum and a Member of the Board of Trustees of the Brookings
Greater Washington Research Program. Mr. McFarland attended Lafayette College in
Easton, Pennsylvania, where he earned an A.B. degree in Government and Law in
1970.
We pay an annual director's fee to each independent director equal to
$20,000, with no additional fee to be paid for the first four meetings of our
board of directors each year. After the first four meetings, each independent
director will be paid a fee of $1,000 for each additional meeting of our board
of directors attended in person by such independent director. All members of our
board of directors are reimbursed for their costs and expenses in attending all
meetings of our board of directors. In addition, an annual fee of $1,000 will be
paid to the chair of any committee of our board of directors. Affiliated
directors, however, will not be separately compensated by us. Fees to the
independent directors may be made by issuance of common stock, based on the
value of such common stock at the date of issuance, rather than in cash.
In addition, the option plan provides for the automatic grant of 2,000
options to each of our independent directors on the first business day after
each annual meeting of our board of directors each year during which the option
plan is effective. These options will have an exercise price equal to 100% of
the fair market value of our common stock on the date of grant, subject to
adjustment as necessary to preserve the value of such options in connection with
the occurrence of certain events.
EXECUTIVE COMPENSATION
Because our management agreement provides that our manager will assume
principal responsibility for managing our affairs, our officers, in their
capacities as such, will not receive compensation from us. However, in their
capacities as officers or employees of our manager, or its affiliates, they will
devote such portion of their time to our affairs as is required for the
performance of the duties of our manager under the management agreement. Our
manager has informed us that, because the services performed by its officers or
employees in their capacities as such are not performed exclusively for us, it
cannot segregate and identify that portion of the compensation awarded to,
earned by or paid to our named executive officers by the manager that relates
solely to their services to us. For the year ended December 31, 2001, pursuant
to the management agreement between Newcastle Investment Holdings and the
manager, Newcastle Investment Holdings paid the manager a management fee of $4.8
million and an incentive return of $2.8 million and reimbursed the manager for
$0.9 million in expenses. See "Our Manager and the Management
Agreement -- Management Fees" and "Management -- Stock Options."
STOCK OPTIONS
We have adopted the Newcastle Investment Corp. Nonqualified Stock Option
and Incentive Award Plan, referred to in this prospectus as the option plan, to
provide incentives to attract and retain the highest qualified directors,
officers, employees, advisors, consultants and other personnel. The option plan
is currently administered by our full board of directors. We expect to create a
committee, a majority of whose members will be independent directors, which will
administer our option plan subsequent to the offering. The maximum number of
shares of our common stock reserved and available for issuance each year under
the option plan is that number of shares equal to 15% of the number of our
outstanding equity interests but in no event more than 10,000,000 shares in the
aggregate over the term of the plan.
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Stock Options
The option plan permits the granting of options to purchase common stock
that do not qualify as incentive stock options under section 422 of the Internal
Revenue Code ("Non-Qualified Options"). The option exercise price of each option
will be determined by the committee and may be less than 100% of the fair market
value of our common stock subject to such option on the date of grant.
The terms of each option will be fixed by the committee. The committee will
determine at what time or times each option may be exercised and, subject to the
provisions of the option plan, the period of time, if any, after retirement,
death, disability or termination of employment during which options may be
exercised. Options become vested and exercisable in installments, and the
exercisability of options may be accelerated by the committee. Upon exercise of
options, the option exercise price must be paid in full either in cash or by
certified or bank check or other instrument acceptable to the committee or, if
the committee so permits, by delivery of shares of common stock already owned by
the optionee or delivery of a promissory note. The exercise price may also be
delivered to us by a broker pursuant to irrevocable instructions to the broker
from the optionee.
At the discretion of the committee, stock options granted under the option
plan may include a "re-load" feature pursuant to which an optionee exercising an
option by the delivery of shares of common stock would automatically be granted
an additional stock option (with an exercise price equal to the fair market
value of the common stock on the date the additional stock option is granted) to
purchase that number of shares of common stock equal to the number delivered to
exercise the original stock option. The purpose of this feature is to enable
participants to exercise options using previously owned shares of common stock
while continuing to maintain their previous level of equity ownership in us.
The committee may also grant stock appreciation rights, restricted stock,
performance awards, tandem awards and other stock and non-stock-based awards
under the option plan. These awards will be subject to such conditions and
restrictions as the committee may determine, which may include the achievement
of certain performance goals or continued employment with us through a specific
period.
Stock Option Grants
In connection with this offering, we will grant to our manager an option to
purchase 700,000 shares of our common stock, representing 10% of the number of
shares being offered hereby, and subject to adjustment if the underwriters'
over-allotment option is exercised, at an exercise price equal to the offering
price of the shares in this offering. These options expire in 2012. These
options will have an exercise price equal to 100% of the fair market value of
our common stock on the date of grant, subject to adjustment as necessary to
preserve the value of such options in connection with the occurrence of certain
events.
LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
Maryland law permits a Maryland corporation to include in its charter a
provision limiting the liability of its directors and officers to the
corporation and its stockholders for money damages except for liability
resulting from (a) actual receipt of an improper benefit or profit in money,
property or services or (b) active and deliberate dishonesty established by a
final judgment and which is material to the cause of action. Our charter
contains such a provision which eliminates directors' and officers' liability to
the maximum extent permitted by Maryland law.
Our charter authorizes us, to the maximum extent permitted by Maryland law,
to indemnify any present or former director or officer or any individual who,
while our director and at our request, serves or has served another corporation,
real estate investment trust, partnership, joint venture, trust, employee
benefit plan or other enterprise as a director, officer, partner or trustee,
from and against any claim or liability to which that person may become subject
or which that person may incur by reason of his or her status as a present or
former director or officer of ours and to pay or reimburse their reasonable
expenses in advance of final disposition of a proceeding. Our bylaws obligate
us, to the maximum extent permitted by Maryland law, to indemnify any present or
former director or officer or any individual who, while our
87
director and at our request, serves or has served another corporation, real
estate investment trust, partnership, joint venture, trust, employee benefit
plan or other enterprise as a director, officer, partner or trustee and who is
made a party to the proceeding by reason of his service in that capacity from
and against any claim or liability to which that person may become subject or
which that person may incur by reason of his or her status as a present or
former director or officer of ours and to pay or reimburse their reasonable
expenses in advance of final disposition of a proceeding. The charter and bylaws
also permit us to indemnify and advance expenses to any person who served a
predecessor of ours in any of the capacities described above and any employee or
agent of ours or a predecessor of ours.
Maryland law requires a corporation (unless its charter provides otherwise,
which our charter does not) to indemnify a director or officer who has been
successful in the defense of any proceeding to which he is made a party by
reason of his service in that capacity. Maryland law permits a corporation to
indemnify its present and former directors and officers, among others, against
judgments, penalties, fines, settlements and reasonable expenses actually
incurred by them in connection with any proceeding to which they may be made a
party by reason of their service in those or other capacities unless it is
established that (a) the act or omission of the director or officer was material
to the matter giving rise to the proceeding and (i) was committed in bad faith
or (ii) was the result of active and deliberate dishonesty, (b) the director or
officer actually received an improper personal benefit in money, property or
services or (c) in the case of any criminal proceeding, the director or officer
had reasonable cause to believe that the act or omission was unlawful. However,
under Maryland law, a Maryland corporation may not indemnify for an adverse
judgment in a suit by or in the right of the corporation or for a judgment of
liability on the basis that personal benefit was improperly received, unless in
either case a court orders indemnification and then only for expenses. In
addition, Maryland law permits a corporation to advance reasonable expenses to a
director or officer upon the corporation's receipt of (a) a written affirmation
by the director or officer of his good faith belief that he has met the standard
of conduct necessary for indemnification by the corporation and (b) a written
undertaking by him or on his behalf to repay the amount paid or reimbursed by
the corporation if it is ultimately determined that the standard of conduct was
not met.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, the registrant has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.
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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
In July 2002, Newcastle Investment Holdings contributed certain assets and
liabilities to us in exchange for all of the shares of our common stock. Our
chairman and chief executive officer also serves as chairman and chief executive
officer of Newcastle Investment Holdings and, at the time the transfer of assets
and liabilities from Newcastle Investment Holdings to us was approved and other
organizational matters were approved for us, Newcastle Investment Holdings was
our sole stockholder. As a result, these matters were not approved at arm's
length and the terms of the transfer may not be as favorable to us as if the
transfer was with an unaffiliated third party. We may enter into future
transactions with Newcastle Investment Holdings with the approval of our
independent directors.
Our chairman and chief executive officer and all of our executive officers
also serve as officers of our manager. As a result, the management agreement
between us and our manager was not negotiated at arm's-length and its terms,
including fees payable, may not be as favorable to us as if it had been
negotiated with an unaffiliated third party. See "Our Manager and the Management
Agreement -- Conflicts of Interest in Our Relationship with Our Manager."
Our manager also manages Newcastle Investment Holdings and may become
subject to conflicts of interest with respect to managing our interests and the
interests of Newcastle Investment Holdings.
We have not entered into any other transactions in which any other director
or officer or stockholder of ours or of our manager had any material interest.
Newcastle Investment Holdings currently owns substantially all of our
outstanding stock less a de minimis number of shares that Newcastle Investment
Holdings subsequently sold to our manager for tax purposes. Newcastle Investment
Holdings was formed in May 1998. We were formed in June 2002 for the purpose of
separating the core real estate securities business from Newcastle Investment
Holdings' other investments. Immediately upon completion of this offering,
Newcastle Investment Holdings will own 68.2% of our common stock and new
investors in this offering will own 28.9% of our common stock, assuming exercise
of all outstanding options. At June 30, 2002, our manager, Fortress Investment
Group and its principals owned approximately 16.4% of the equity of Newcastle
Investment Holdings (25.8% upon exercise of outstanding options). In connection
with this offering, we will grant to our manager an option to purchase 700,000
shares of our common stock, representing 10% of the number of shares being
offered hereby, and subject to adjustment if the underwriters' over-allotment
option is exercised, at the offering price of our shares in this offering. As a
result, upon completion of this offering, our manager and its principals will
beneficially own approximately 20.5% of our common stock, taking into account
interests in Newcastle Investment Holdings and assuming exercise of all of their
options.
Fortress Investment Holdings LLC is the sole member of Fortress Investment
Group LLC, our manager. The beneficial owners of Fortress Investment Holdings
are Messrs. Edens, Kauffman, Nardone and Nygaard. The beneficial owners of
Fortress Principal Investment Holdings are the same as the holders of Fortress
Investment Holdings (Messrs. Edens, Kauffman, Nardone and Nygaard).
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SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Substantially all shares of our outstanding common stock are owned by
Newcastle Investment Holdings Corp. The following table sets forth, as of August
31, 2002, the total number of shares of our common stock beneficially owned, and
the percent so owned, by (i) each person known by us to own more than 5% of our
common stock, (ii) each of our directors and executive officers and (iii) all
directors and executive officers as a group.
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP(1)
----------------------------------------------------------
PERCENT
NUMBER OF BEFORE PERCENT AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES OFFERING OFFERING(6)
- ------------------------------------ ------------------------- ----------- --------------
Newcastle Investment Holdings Corp.(2)(3)(4)........... 16,486,339 100% 70.2%
Fortress Principal Investment Holdings LLC(2)(3)(5).... 4,254,032(7) 25.8% 18.3%(9)
Wesley R. Edens(2)..................................... 4,254,032(8) 25.8% 18.3%(9)
David J. Grain(2)...................................... -- -- *
Stuart A. McFarland(2)................................. -- -- *
Jonathan Ashley(2)..................................... -- -- *
Randal A. Nardone(2)................................... 4,254,032(8) 25.8% 18.3%(9)
Erik P. Nygaard(2)..................................... 4,254,032(8) 25.8% 18.3%(9)
Kenneth M. Riis(2)..................................... -- -- --
Michael I. Wirth(2).................................... -- -- --
All directors and executive officers as a group
(8 persons)............................................ 4,254,032 25.8% 18.3%(9)
- ---------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of common stock subject
to options or warrants currently exercisable, or exercisable within 60 days
of the date hereof, are deemed outstanding for computing the percentage of
the person holding such options or warrants but are not deemed outstanding
for computing the percentage of any other person.
(2) The address of Newcastle Investment Holdings Corp., Fortress Principal
Investment Holdings LLC and all officers and directors listed above are in
care of Fortress Investment Group, 1251 Avenue of the Americas, New York, NY
10020.
(3) Certain beneficial ownership information with respect to each owner of more
than 5% of the common stock of Newcastle Investment Holdings Corp. is as
follows:
(4) All of the shares held by Newcastle Investment Holdings will be pledged by
Newcastle Investment Holdings as collateral to Fleet National Bank in
connection with an amendment to a credit facility between a subsidiary of
Newcastle Investment Holdings and Fleet National Bank.
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP
----------------------
NUMBER OF
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES PERCENT
- ------------------------------------ --------- --------
Fortress Principal Investment Holdings LLC(a)............... 4,791,862(c) 25.8%(c)
Wallace R. Weitz & Company(b)............................... 2,975,142 18.0%
- ---------------
(a) For the beneficial owners of Fortress Principal Investment Holdings
LLC, see footnote 5.
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(b) The address for Wallace R. Weitz & Company ("Weitz") is 1125 South
103rd Street, Omaha, NE 68124. The beneficial owners are Weitz Partners
III, Weitz Value Fund, Weitz Partners Value and Weitz Hickory Fund.
(c) Includes 2,091,673 shares underlying stock options, all of which are
fully vested and exercisable.
(5) The beneficial owners of Fortress Principal Investment Holdings LLC are
Messrs. Edens, Kauffman, Nardone and Nygaard. Fortress Investment Holdings
LLC is the sole member of the manager. The beneficial owners of Fortress
Investment Holdings LLC are also Messrs. Edens, Kauffman, Nardone and
Nygaard.
(6) Percentage amount assumes the exercise by such persons of all options to
acquire shares of common stock and no exercise by any other person.
(7) Includes 2,178 shares beneficially owned directly in us and 4,251,854 shares
beneficially owned as a result of the ownership of shares in Newcastle
Investment Holdings.
(8) All shares are held by Fortress Principal Investment Holdings LLC or
Fortress Principal Investment Group LLC, in which Messrs. Edens, Kauffman,
Nardone and Nygaard own all of the beneficial interests.
(9) Includes options to acquire 46,667 shares of common stock, which represents
the portion of 700,000 options that are exercisable within 60 days of the
date hereof. Upon completion of this offering, our manager, through Fortress
Principal Investment Holdings LLC, will beneficially own approximately 20.5%
of our common stock, taking into account its interest in Newcastle
Investment Holdings and assuming exercise of all its outstanding options to
purchase 700,000 shares of our common stock and 2,091,673 shares of common
stock of Newcastle Investment Holdings.
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DESCRIPTION OF CAPITAL STOCK
The following description of the terms of our stock is only a summary. For
a complete description, we refer you to the Maryland General Corporation Law,
our charter and our bylaws. We have filed our charter and bylaws as exhibits to
this registration statement.
GENERAL
Our charter provides that we may issue up to 500,000,000 shares of common
stock, $.01 par value per share, and up to 100,000,000 shares of preferred
stock, $.01 par value per share. Upon completion of this offering, 23,488,517
shares of common stock, and no shares of preferred stock will be issued and
outstanding. Under Maryland law, our stockholders generally are not liable for
our debts or obligations.
COMMON STOCK
All shares of common stock offered by this prospectus will be duly
authorized, fully paid and nonassessable. Holders of our common stock are
entitled to receive dividends when authorized by our board of directors out of
assets legally available for the payment of dividends. They are also entitled to
share ratably in our assets legally available for distribution to our
stockholders in the event of our liquidation, dissolution or winding up, after
payment of or adequate provision for all of our known debts and liabilities.
These rights are subject to the preferential rights of any other class or series
of our stock and to the provisions of our charter regarding restrictions on
transfer of our stock.
Subject to our charter restrictions on transfer of our stock, each
outstanding share of common stock entitles the holder to one vote on all matters
submitted to a vote of stockholders, including the election of directors. Except
as provided with respect to any other class or series of stock, the holders of
our common stock will possess the exclusive voting power. There is no cumulative
voting in the election of directors, which means that the holders of a majority
of the outstanding shares of common stock can elect all of the directors then
standing for election, and the holders of the remaining shares will not be able
to elect any directors.
Holders of our common stock have no preference, conversion, exchange,
sinking fund, redemption or appraisal rights and have no preemptive rights to
subscribe for any of our securities. Subject to our charter restrictions on
transfer of stock, all shares of common stock will have equal dividend,
liquidation and other rights.
Under Maryland law, a Maryland corporation generally cannot dissolve, amend
its charter, merge, sell all or substantially all of its assets, engage in a
share exchange or engage in similar transactions outside the ordinary course of
business, unless approved by the affirmative vote of stockholders holding at
least two thirds of the shares entitled to vote on the matter. However, a
Maryland corporation may provide in its charter for approval of these matters by
a lesser percentage, but not less than a majority of all of the votes entitled
to be cast on the matter. Our charter provides that these matters may be
approved by a majority of all of the votes entitled to be cast on the matter.
POWER TO RECLASSIFY UNISSUED SHARES OF OUR STOCK
Our charter authorizes our board of directors to classify and reclassify
any unissued shares of our common stock or preferred stock into other classes or
series of stock. Prior to issuance of shares of each class or series, our board
is required by Maryland law and by our charter to set, subject to our charter
restrictions on transfer of stock, the terms, preferences, conversion or other
rights, voting powers, restrictions, limitations as to dividends or other
distributions, qualifications and terms or conditions of redemption for each
class or series. Therefore, our board could authorize the issuance of shares of
preferred stock with terms and conditions which could have the effect of
delaying, deferring or preventing a transaction or a change in control that
might involve a premium price for holders of our common stock or otherwise be in
their best interest. No shares of our preferred stock are presently outstanding
and we have no present plans to issue any preferred stock.
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POWER TO ISSUE ADDITIONAL SHARES OF COMMON STOCK AND PREFERRED STOCK
We believe that the power to issue additional shares of common stock or
preferred stock and to classify or reclassify unissued shares of common stock or
preferred stock and thereafter to issue the classified or reclassified shares
provides us with increased flexibility in structuring possible future financings
and acquisitions and in meeting other needs which might arise. These actions can
be taken without stockholder approval, unless stockholder approval is required
by applicable law or the rules of any stock exchange or automated quotation
system on which our securities may be listed or traded. Although we have no
present intention of doing so, we could issue a class or series of stock that
could delay, defer or prevent a transaction or a change in control of us that
might involve a premium price for holders of common stock or otherwise be in
their best interest.
STOCKHOLDER RIGHTS PLAN
Our board of directors has adopted a stockholder rights agreement. The
adoption of the stockholder rights agreement could make it more difficult for a
third party to acquire, or could discourage a third party from acquiring, us or
a large block of our common stock.
Pursuant to the terms of the stockholder rights agreement, our board of
directors declared a dividend distribution of one preferred stock purchase right
for each outstanding share of common stock to stockholders of record at the
close of business on . In addition, one preferred stock purchase right
will automatically attach to each share of common stock issued between the
record date and the distribution date. Each preferred stock purchase right
entitles the registered holder to purchase from us a unit consisting of one
one-hundredth of a share, each a rights unit, of Series A Junior Participating
Preferred Stock, par value $0.01 per share, the Series A Preferred Stock, at a
purchase price of $70 per rights unit, the purchase price, subject to
adjustment. Each share offered hereby will be entitled to a preferred stock
purchase right when distributed.
Initially, the preferred stock purchase rights are not exercisable and are
attached to and transfer and trade with, the outstanding shares of common stock.
The preferred stock purchase rights will separate from the common stock and will
become exercisable upon the earliest of (i) the close of business on the tenth
business day following the first public announcement that an acquiring person
has acquired beneficial ownership of 15% or more of the sum of the outstanding
shares of common stock, subject to certain exceptions, the date of said
announcement being referred to as the stock acquisition date, or (ii) the close
of business on the tenth business day (or such later date as our board of
directors may determine) following the commencement of a tender offer or
exchange offer that would result upon its consummation in a person or group
becoming an acquiring person, the earlier of such dates being the distribution
date. For these purposes, a person will not be deemed to beneficially own shares
of common stock which may be issued in exchange for rights units. The
stockholder rights agreement contains provisions that are designed to ensure
that the manager and its affiliates will never, alone, be considered a group
that is an acquiring person.
Until the distribution date (or earlier redemption, exchange or expiration
of rights), (a) the rights will be evidenced by the common stock certificates
and will be transferred with and only with such common stock certificates, (b)
new common stock certificates issued after the record date will contain a
notation incorporating the stockholder rights agreement by reference, and (c)
the surrender for transfer of any certificates for common stock outstanding will
also constitute the transfer of the rights associated with common stock
represented by such certificate.
The rights are not exercisable until the distribution date and will expire
ten years after the issuance thereof, on , unless such date is
extended or the rights are earlier redeemed or exchanged by us as described
below.
As soon as practicable after the distribution date, rights certificates
will be mailed to holders of record of common stock as of the close of business
on the distribution date and, thereafter, the separate rights
93
certificates alone will represent the rights. Except as otherwise determined by
our board of directors, only shares of common stock issued prior to the
distribution date will be issued with rights.
In the event that a person becomes an acquiring person, except pursuant to
an offer for all outstanding shares of common stock which the independent
directors determine to be fair to, not inadequate and to otherwise be in our
best interests and the best interest of our stockholders, after receiving advice
from one or more investment banking firms, a qualified offer, each holder of a
right will thereafter have the right to receive, upon exercise, common stock
(or, in certain circumstances, cash, property or other securities of ours)
having a value equal to two times the exercise price of the right. The exercise
price is the purchase price times the number of rights units associated with
each right. Notwithstanding any of the foregoing, following the occurrence of
the event set forth in this paragraph, all rights that are, or (under certain
circumstances specified in the rights agreement) were, beneficially owned by any
acquiring person will be null and void. However, rights are not exercisable
following the occurrence of the event set forth above until such time as the
rights are no longer redeemable by us as set forth below.
In the event that, at any time following the stock acquisition date, (i) we
engage in a merger or other business combination transaction in which we are not
the surviving corporation (other than with an entity which acquired the shares
pursuant to a qualified offer), (ii) we engage in a merger or other business
combination transaction in which we are the surviving corporation and our common
stock changed or exchanged, or (iii) 50% or more of our assets, cash flow or
earning power is sold or transferred, each holder of a right (except rights
which have previously been voided as set forth above) shall thereafter have the
right to receive, upon exercise, common stock of the acquiring company having a
value equal to two times the exercise price of the right. The events set forth
in this paragraph and in the preceding paragraph are referred to as the
"triggering events."
At any time after a person becomes an acquiring person and prior to the
acquisition by such person or group of fifty percent (50%) or more of the
outstanding common stock, our board may exchange the rights (other than rights
owned by such person or group which have become void), in whole or in part, at
an exchange ratio of one share of common stock, or one one-hundredth of a share
of preferred stock (or of a share of a class or series of our preferred stock
having equivalent rights, preferences and privileges), per right (subject to
adjustment).
We may redeem the rights in whole, but not in part, at a price of $0.01 per
right (payable in cash, common stock or other consideration deemed appropriate
by our board of directors) at any time until the earlier of (i) the close of
business on the tenth business day after the stock acquisition date, or (ii) the
expiration date of the rights agreement. Immediately upon the action of our
board of directors ordering redemption of the rights, the rights will terminate
and thereafter the only right of the holders of rights will be to receive the
redemption price.
The rights agreement may be amended by our board of directors in its sole
discretion at any time prior to the distribution date. After the distribution
date, subject to certain limitations set forth in the rights agreement, our
board of directors may amend the rights agreement only to cure any ambiguity,
defect or inconsistency, to shorten or lengthen any time period, or to make
changes that do not adversely affect the interests of rights holders (excluding
the interests of an acquiring person or its associates or affiliates). The
foregoing notwithstanding, no amendment may be made at such time as the rights
are not redeemable.
Until a right is exercised, the holder thereof, as such, will have no
rights as our stockholder, including, without limitation, the right to vote or
to receive dividends. While the distribution of the rights will not be taxable
to stockholders or to us, stockholders may, depending upon the circumstances,
recognize taxable income in the event that the rights become exercisable for
common stock, other securities of ours, other consideration or for common stock
of an acquiring company or in the event of the redemption of the rights as set
forth above.
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A copy of the rights agreement is available from us upon written request.
The foregoing description of the rights does not purport to be complete and is
qualified in its entirety by reference to the rights agreement, which is filed
as an exhibit to the registration statement of which this prospectus is a part.
DIVIDEND REINVESTMENT PLAN
We may implement a dividend reinvestment plan whereby stockholders may
automatically reinvest their dividends in our common stock. Details about any
such plan would be sent to our stockholders following adoption thereof by our
board of directors.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is American Stock
Transfer & Trust Company, New York, New York.
TRANSFER RESTRICTIONS
Our charter contains restrictions on the number of shares of our stock that
a person may own. No person may acquire or hold, directly or indirectly, in
excess of 8.0% of the aggregate value of the outstanding shares of any class or
series of our stock.
Our charter further prohibits (a) any person from owning shares of our
stock that would result in our being "closely held" under Section 856(h) of the
Internal Revenue Code or otherwise cause us to fail to qualify as a REIT and (b)
any person from transferring shares of our stock if the transfer would result in
our stock being owned by fewer than 100 persons. Any person who acquires or
intends to acquire shares of our stock that may violate any of these
restrictions, or who is the intended transferee of shares of our stock which are
transferred to the Trust, as defined below, is required to give us immediate
written notice and provide us with such information as we may request in order
to determine the effect of the transfer on our status as a REIT. The above
restrictions will not apply if our board of directors determines that it is no
longer in our best interests to continue to qualify as a REIT.
Our board of directors, in its sole discretion, may exempt a person from
these limits, subject to such terms, conditions, representations and
undertakings as it may determine. The above ownership limits do not apply to the
common stock owned, directly or indirectly, by Newcastle Investment Holdings
Corp., Fortress Principal Investment Group LLC, Fortress Principal Investment
Holdings LLC, Fortress Investment Group LLC, Wallace R. Weitz & Company and
certain of their officers. Our board of directors may require a ruling from the
Internal Revenue Service or an opinion of counsel in order to determine or
ensure our status as a REIT.
Any attempted transfer of our stock which, if effective, would result in
violation of the above limitations, will cause the number of shares causing the
violation (rounded to the nearest whole share) to be automatically transferred
to a trust ("Trust") for the exclusive benefit of one or more charitable
beneficiaries ("Charitable Beneficiary"), and the proposed transferee will not
acquire any rights in the shares. The automatic transfer will be deemed to be
effective as of the close of business on the business day (as defined in our
charter) prior to the date of the transfer. The shares transferred to the Trust
will generally be so as to minimize the aggregate value of shares transferred to
the Trust. Shares of our stock held in the Trust will be issued and outstanding
shares. The proposed transferee will not benefit economically from ownership of
any shares of stock held in the Trust, will have no rights to dividends and no
rights to vote or other rights attributable to the shares of stock held in the
Trust. The trustee of the Trust will have all voting rights and rights to
dividends or other distributions with respect to shares held in the Trust. These
rights will be exercised for the exclusive benefit of the Charitable
Beneficiary. Any dividend or other distribution paid prior to our discovery that
shares of stock have been transferred to the Trust will be paid by the recipient
to the Trustee upon demand. Any dividend or other distribution authorized but
unpaid will be paid when due to the Trustee. Any dividend or distribution paid
to the Trustee will be held in trust for the Charitable Beneficiary. Subject to
Maryland law, the Trustee will have the authority (i) to rescind as void any
vote cast by the proposed transferee prior to our discovery that the shares have
been transferred to the Trust and (ii) to recast the vote in accordance with the
desires of the
95
Trustee acting for the benefit of the Charitable Beneficiary. However, if we
have already taken irreversible corporate action, then the Trustee will not have
the authority to rescind and recast the vote. If necessary to protect our status
as a REIT, we may establish additional Trusts with distinct Trustees and
Charitable Beneficiaries to which shares may be transferred.
Within 20 days of receiving notice from us that shares of our stock have
been transferred to the Trust, the Trustee will sell the shares to a person
designated by the Trustee, whose ownership of the shares will not violate the
above ownership limitations. Upon the sale, the interest of the Charitable
Beneficiary in the shares sold will terminate and the Trustee will distribute
the net proceeds of the sale to the proposed transferee and to the Charitable
Beneficiary as follows. The proposed transferee will receive the lesser of (i)
the price paid by the proposed transferee for the shares or, if the proposed
transferee did not give value for the shares in connection with the event
causing the shares to be held in the Trust (e.g., a gift, devise or other
similar transaction), the Market Price (as defined in our charter) of the shares
on the day of the event causing the shares to be held in the Trust and (ii) the
price received by the Trustee from the sale or other disposition of the shares.
Any net sale proceeds in excess of the amount payable to the proposed transferee
will be paid immediately to the Charitable Beneficiary. If, prior to our
discovery that shares of our stock have been transferred to the Trust, the
shares are sold by the proposed transferee, then (i) the shares shall be deemed
to have been sold on behalf of the Trust and (ii) to the extent that the
proposed transferee received an amount for the shares that exceeds the amount he
was entitled to receive, the excess shall be paid to the Trustee upon demand.
In addition, shares of our stock held in the Trust will be deemed to have
been offered for sale to us, or our designee, at a price per share equal to the
lesser of (i) the price per share in the transaction that resulted in the
transfer to the Trust (or, in the case of a devise or gift, the Market Price at
the time of the devise or gift) and (ii) the Market Price on the date we, or our
designee, accept the offer. We will have the right to accept the offer until the
Trustee has sold the shares. Upon a sale to us, the interest of the Charitable
Beneficiary in the shares sold will terminate and the Trustee will distribute
the net proceeds of the sale to the proposed transferee.
Our charter further provides that, prior to the date the common stock
qualifies as a class of "publicly offered securities" (within the meaning of
Department of Labor Regulation Section 2510.3-101(a)(2)), (a) no plan investor
may acquire shares of our stock without our prior written consent; and (b) any
transfers to plan investors that would increase the aggregate plan investors,
ownership of shares of our stock to a level that meets or exceeds 25% or more of
the value of any class of our stock will be void ab initio. If any transfer of
shares of our stock to plan investors occurs which, if effective, would result
in plan investors beneficially or constructively owning, in the aggregate,
shares of our stock in excess or in violation of the above transfer or ownership
limitations, then that number of shares of our stock, the beneficial or
constructive ownership of which otherwise would cause such plan investors to
violate such limitations shall be automatically transferred to the Trust (as
defined above) to be held, subject to certain adjustments, in accordance with
the provisions detailed above.
All certificates representing shares of our stock will bear a legend
referring to the restrictions described above.
Every owner of more than 5% (or such lower percentage as required by the
Internal Revenue Code or the regulations promulgated thereunder) of our stock,
within 30 days after the end of each taxable year, is required to give us
written notice, stating his name and address, the number of shares of each class
and series of our stock which he beneficially owns and a description of the
manner in which the shares are held. Each such owner shall provide us with such
additional information as we may request in order to determine the effect, if
any, of his beneficial ownership on our status as a REIT and to ensure
compliance with the ownership limits. In addition, each stockholder shall upon
demand be required to provide us with such information as we may request in good
faith in order to determine our status as a REIT and to comply with the
requirements of any taxing authority or governmental authority or to determine
such compliance.
These ownership limits could delay, defer or prevent a transaction or a
change in control that might involve a premium price for the common stock or
otherwise be in the best interest of the stockholders.
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SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for our common stock.
Future sales in the public markets of substantial amounts of common stock could
adversely affect the market prices prevailing from time to time for the common
stock. It could also impair our ability to raise capital through future sales of
equity securities.
Newcastle Investment Holdings Corp. currently owns substantially all of our
outstanding common stock. We were formed in June 2002 for the purpose of
separating the real estate securities and credit leased real estate businesses
from Newcastle Investment Holdings. We believe that separating these businesses
from Newcastle Investment Holdings provides an opportunity for achieving more
stable earnings. The remaining assets in Newcastle Investment Holdings that were
not contributed to us have historically had and may continue to have
unpredictable returns. In connection with our formation, Newcastle Investment
Holdings changed its name from Newcastle Investment Corp. Immediately upon
completion of this offering, Newcastle Investment Holdings will own 68.2% of our
common stock and new investors in this offering will own 28.9% of our common
stock, assuming exercise of all outstanding options. At June 30, 2002, Fortress
Investment Group and its principals owned approximately 16.4% of the equity of
Newcastle Investment Holdings (25.8% upon exercise of outstanding options).
After completion of this offering, we will have 23,488,517 shares of common
stock outstanding, assuming no exercise of the underwriters' over-allotment
option and no exercise of outstanding options held by our manager. All of the
7,000,000 shares of common stock sold in this offering will be freely
transferable without restriction or further registration under the Securities
Act, except for any of the shares that are acquired by affiliates as that term
is defined in Rule 144 under the Securities Act.
The shares of common stock held by our manager and our officers and
directors are restricted securities as that term is defined in Rule 144 under
the Securities Act. Restricted securities may be sold in the public market only
if registered or if they qualify for an exemption from registration under Rule
144, which is summarized below.
Newcastle Investment Holdings has agreed with Bear Stearns not to
distribute our common stock to its stockholders earlier than 180 days after the
date of this prospectus. However, assuming the distribution is made pro rata to
all holders and for no consideration, upon any such distribution all of the
shares of our common stock that are not owned by our affiliates (representing
approximately 75% of the shares of our common stock that may be distributed by
Newcastle Investment Holdings) would be eligible for immediate resale in the
public market.
In connection with this offering, we will grant to our manager an option to
purchase 700,000 shares of our common stock, representing 10% of the number of
shares being offered hereby, and subject to adjustment if the underwriters'
over-allotment option is exercised, at the offering price of our shares in this
offering, which will result in beneficial ownership by our manager and its
principals of approximately 20.5% of our equity upon exercise of all options,
including their beneficial interests in Newcastle Investment Holdings. The
option shares are not registered in connection with this offering.
LOCK-UP
We have agreed that, subject to specified exceptions (including issuances
of shares of common stock in connection with acquisitions), without the consent
of Bear Stearns, we will not, directly or indirectly, offer, sell or otherwise
dispose of any shares of our common stock or any securities that may be
converted into or exchanged for any shares of our common stock for a period of
180 days from the date of this prospectus. Our manager, including its directors
and executive officers, our executive officers and our directors have agreed
under lock-up agreements with Bear Stearns that, without the prior written
consent of Bear Stearns, they will not, directly or indirectly, offer for sale,
sell, pledge, enter into any swap or other derivatives transaction that
transfers to another any of the economic benefits or risks of ownership of our
common stock, or otherwise dispose of any shares of our common stock or any
securities that may be converted into or exchanged for any shares of common
stock (collectively, "Transfer") for a period ending
97
365 days after the date of this prospectus or pursuant to an earlier release as
provided in the lock-up agreements. Newcastle Investment Holdings has agreed
under a lock-up agreement with Bear Stearns that, without the prior written
consent of Bear Stearns, it will not, directly or indirectly, offer for sale,
sell, pledge, enter into any swap or other derivatives transaction that
transfers to another any of the economic benefits or risks of ownership of our
common stock, or otherwise dispose of any shares of our common stock or any
securities that may be converted into or exchanged for any shares of common
stock (collectively, "Transfer") for a period ending 180 days after the date of
this prospectus or pursuant to an earlier release as provided in the lock-up
agreement.
Newcastle Investment Holdings is a guarantor under a credit facility
entered into by a subsidiary of Newcastle Investment Holdings with Fleet
National Bank. In connection with an amendment to the credit facility which will
be entered into in September 2002, that, among other things, allows for
Newcastle Investment Holdings' contribution of assets to us in connection with
the initial transactions, Newcastle Investment Holdings will pledge as
collateral to Fleet all of the shares of our common stock held by Newcastle
Investment Holdings. In the event of a default under the credit facility, Fleet
could foreclose on the pledged shares. In connection with this offering, Fleet
will agree with Bear Stearns, subject to certain exceptions, that in the event
of a foreclosure, Fleet will not transfer any of the pledged shares for a period
of 180 days after the date of this prospectus without the prior written consent
of Bear Stearns.
RULE 144
In general, Rule 144 provides that a person who is not an affiliate and has
not been an affiliate in the prior 90 days who has beneficially owned shares of
our common stock for at least one year would be entitled to sell within any
three month period a number of shares that does not exceed the greater of:
- 1% of the total number of shares of common stock then outstanding; or
- the average weekly trading volume of the common stock on the New York
Stock Exchange during the four calendar weeks preceding the filing of
notice on Form 144 with respect to the sale.
Sales under Rule 144 are also subject to manner of sale provisions and
notice requirements and to the availability of current public information about
us.
RULE 144(K)
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner which was not an affiliate, is
entitled to sell the shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
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IMPORTANT PROVISIONS OF MARYLAND LAW AND
OF OUR CHARTER AND BYLAWS
The following description of the terms of our stock and of certain
provisions of Maryland law is only a summary. For a complete description, we
refer you to the Maryland General Corporation Law, our charter and our bylaws.
We have filed our charter and bylaws as exhibits to this registration statement.
CLASSIFICATION OF OUR BOARD OF DIRECTORS
Our bylaws provide that the number of our directors may be established by
our board of directors but may not be fewer than the minimum required by the
MGCL (which is currently one) nor more than fifteen. Any vacancy will be filled,
at any regular meeting or at any special meeting called for that purpose, by a
majority of the remaining directors, except that a vacancy resulting from an
increase in the number of directors must be filled by a majority of the entire
board of directors.
Pursuant to our charter, the board of directors is divided into three
classes of directors. The current terms of the Class I, Class II and Class III
directors will expire in 2003, 2004 and 2005, respectively. Directors of each
class will be chosen for three-year terms upon the expiration of their current
terms and each year one class of directors will be elected by the stockholders.
We believe that classification of the board of directors will help to assure the
continuity and stability of our business strategies and policies as determined
by the board of directors. Holders of shares of our common stock will have no
right to cumulative voting in the election of directors. Consequently, at each
annual meeting of stockholders, the holders of a majority of the shares of our
common stock will be able to elect all of the successors of the class of
directors whose terms expire at that meeting.
The classified board provision could have the effect of making the
replacement of incumbent directors more time-consuming and difficult. At least
two annual meetings of stockholders, instead of one, will generally be required
to effect a change in a majority of our board of directors. Thus, the classified
board provision could increase the likelihood that incumbent directors will
retain their positions. The staggered terms of directors may delay, defer or
prevent a tender offer or an attempt to change the control of us, even though
the tender offer or change in control might be in the best interest of our
stockholders.
REMOVAL OF DIRECTORS
Our charter provides that a director may be removed only for cause (as
defined in the charter) and only by the affirmative vote of at least two-thirds
of the votes entitled to be cast in the election of directors. This provision,
when coupled with the provision in our bylaws authorizing our board of directors
to fill vacant directorships, precludes stockholders from removing incumbent
directors except for cause and by a substantial affirmative vote and filling the
vacancies created by the removal with their own nominees.
BUSINESS COMBINATIONS
Under Maryland law, "business combinations" between a Maryland corporation
and an interested stockholder or an affiliate of an interested stockholder are
prohibited for five years after the most recent date on which the interested
stockholder becomes an interested stockholder. These business combinations
include a merger, consolidation, share exchange, or, in circumstances specified
in the statute, an asset transfer or issuance or reclassification of equity
securities. An interested stockholder is defined as:
- any person who beneficially owns 10% or more of the voting power of the
corporation's shares; or
- an affiliate or associate of the corporation who, at any time within the
two-year period prior to the date in question, was the beneficial owner
of 10% or more of the voting power of the then outstanding voting stock
of the corporation.
A person is not an interested stockholder under the statute if the board of
directors approved in advance the transaction by which he otherwise would have
become an interested stockholder. However, in
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approving a transaction, the board of directors may provide that its approval is
subject to compliance, at or after the time of approval, with any terms and
conditions determined by the board.
After the five-year prohibition, any business combination between the
Maryland corporation and an interested stockholder generally must be recommended
by the board of directors of the corporation and approved by the affirmative
vote of at least:
- 80% of the votes entitled to be cast by holders of outstanding shares of
voting stock of the corporation; and
- two-thirds of the votes entitled to be cast by holders of voting stock of
the corporation other than shares held by the interested stockholder with
whom or with whose affiliate the business combination is to be effected
or held by an affiliate or associate of the interested stockholder.
These super-majority vote requirements do not apply if the corporation's
common stockholders receive a minimum price, as defined under Maryland law, for
their shares in the form of cash or other consideration in the same form as
previously paid by the interested stockholder for its shares.
The statute permits various exemptions from its provisions, including
business combinations that are exempted by the board of directors before the
time that the interested stockholder becomes an interested stockholder. Pursuant
to the statute, our board of directors has exempted any business combinations
(a) between us and Fortress Investment Group LLC or any of its affiliates, (b)
between us and Newcastle Investment Holdings, or any of its affiliates and (c)
between us and any interested stockholder, provided that any such business
combination is first approved by our board of directors (including a majority of
our directors who are not affiliates or associates of such interested
stockholder). Consequently, the five-year prohibition and the super-majority
vote requirements will not apply to business combinations between us and any of
them. As a result, such parties may be able to enter into business combinations
with us that may not be in the best interest of our stockholders, without
compliance with the super-majority vote requirements and the other provisions of
the statute.
The business combination statute may discourage others from trying to
acquire control of us and increase the difficulty of consummating any offer.
CONTROL SHARE ACQUISITIONS
Maryland law provides that control shares of a Maryland corporation
acquired in a control share acquisition have no voting rights except to the
extent approved by a vote of two-thirds of the votes entitled to be cast on the
matter. Shares owned by the acquiror, by officers or by directors who are
employees of the corporation are excluded from shares entitled to vote on the
matter. Control shares are voting shares of stock which, if aggregated with all
other shares of stock owned by the acquiror or in respect of which the acquiror
is able to exercise or direct the exercise of voting power (except solely by
virtue of a revocable proxy), would entitle the acquiror to exercise voting
power in electing directors within one of the following ranges of voting power:
- one-tenth or more but less than one-third,
- one-third or more but less than a majority, or
- a majority or more of all voting power.
Control shares do not include shares the acquiring person is then entitled
to vote as a result of having previously obtained stockholder approval. A
control share acquisition means the acquisition of control shares, subject to
certain exceptions.
A person who has made or proposes to make a control share acquisition may
compel the board of directors of the corporation to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. The right to compel the calling of a special meeting is subject
to the satisfaction of certain conditions, including an undertaking to pay the
expenses of the meeting. If no request for a meeting is made, the corporation
may itself present the question at any stockholders meeting.
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If voting rights are not approved at the meeting or if the acquiring person
does not deliver an acquiring person statement as required by the statute, then
the corporation may redeem for fair value any or all of the control shares,
except those for which voting rights have previously been approved. The right of
the corporation to redeem control shares is subject to certain conditions and
limitations. Fair value is determined, without regard to the absence of voting
rights for the control shares, as of the date of the last control share
acquisition by the acquiror or of any meeting of stockholders at which the
voting rights of the shares are considered and not approved. If voting rights
for control shares are approved at a stockholders meeting and the acquiror
becomes entitled to vote a majority of the shares entitled to vote, all other
stockholders may exercise appraisal rights. The fair value of the shares as
determined for purposes of appraisal rights may not be less than the highest
price per share paid by the acquiror in the control share acquisition.
The control share acquisition statute does not apply (a) to shares acquired
in a merger, consolidation or share exchange if the corporation is a party to
the transaction, or (b) to acquisitions approved or exempted by the charter or
bylaws of the corporation.
Our bylaws contain a provision exempting from the control share acquisition
statute any and all acquisitions by any person of shares of our stock. This
provision may be amended or eliminated at any time in the future.
AMENDMENT TO OUR CHARTER
Our charter, including its provisions on classification of our board of
directors and removal of directors, may be amended only by the affirmative vote
of the holders of not less than a majority of all of the votes entitled to be
cast on the matter.
ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS
Our bylaws provide that with respect to an annual meeting of stockholders,
nominations of persons for election to our board of directors and the proposal
of business to be considered by stockholders may be made only (i) pursuant to
our notice of the meeting, (ii) by our board of directors or (iii) by a
stockholder of record who is entitled to vote at the meeting and who has
complied with the advance notice procedures of our bylaws. With respect to
special meetings of stockholders, only the business specified in our notice of
the meeting may be brought before the meeting. Nominations of persons for
election to our board of directors at a special meeting may be made only (i)
pursuant to our notice of the meeting, (ii) by the board of directors, or (iii)
provided that the board of directors has determined that directors will be
elected at the meeting, by a stockholder who is entitled to vote at the meeting
and who has complied with the advance notice provisions of our bylaws.
ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER
AND BYLAWS
The business combination provisions and, if the applicable provision in our
bylaws is rescinded, the control share acquisition provisions of Maryland law,
the provisions of our charter on classification of our board of directors and
removal of directors and the advance notice provisions of our bylaws could
delay, defer or prevent a transaction or a change in the control of us that
might involve a premium price for holders of our common stock or otherwise be in
their best interest.
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FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material federal income tax consequences
relating to the acquisition, holding, and disposition of our common stock. For
purposes of this section under the heading "Federal Income Tax Considerations",
references to Newcastle mean only Newcastle Investment Corp. and not its
subsidiaries, except as otherwise indicated. This summary is based upon the
Internal Revenue Code of 1986, as amended (the Internal Revenue Code), the
regulations promulgated by the U.S. Treasury Department, rulings and other
administrative pronouncements issued by the IRS, and judicial decisions, all as
currently in effect, and all of which are subject to differing interpretations
or to change, possibly with retroactive effect. No assurance can be given that
the IRS would not assert, or that a court would not sustain, a position contrary
to any of the tax consequences described below. No advance ruling has been or
will be sought from the IRS regarding any matter discussed in this prospectus.
The summary is also based upon the assumption that the operation of Newcastle
and its subsidiaries and affiliated entities will be in accordance with its
applicable organizational documents or partnership agreement. This summary is
for general information only, and does not purport to discuss all aspects of
federal income taxation that may be important to a particular investor in light
of its investment or tax circumstances, or to investors subject to special tax
rules, such as:
- financial institutions;
- insurance companies;
- broker-dealers;
- regulated investment companies;
- holders who receive Newcastle common stock through the exercise of
employee stock options or otherwise as compensation;
- persons holding Newcastle common stock as part of a "straddle," "hedge,"
"conversion transaction," "synthetic security" or other integrated
investment;
and, except to the extent discussed below:
- tax-exempt organizations; and
- foreign investors.
This summary assumes that investors will hold their common stock of ours as
capital assets, which generally means as property held for investment.
THE FEDERAL INCOME TAX TREATMENT OF HOLDERS OF NEWCASTLE COMMON STOCK
DEPENDS IN SOME INSTANCES ON DETERMINATIONS OF FACT AND INTERPRETATIONS OF
COMPLEX PROVISIONS OF FEDERAL INCOME TAX LAW FOR WHICH NO CLEAR PRECEDENT OR
AUTHORITY MAY BE AVAILABLE. IN ADDITION, THE TAX CONSEQUENCES OF HOLDING
NEWCASTLE COMMON STOCK TO ANY PARTICULAR STOCKHOLDER WILL DEPEND ON THE
STOCKHOLDER'S PARTICULAR TAX CIRCUMSTANCES. YOU ARE URGED TO CONSULT YOUR TAX
ADVISOR REGARDING THE FEDERAL, STATE, LOCAL, AND FOREIGN INCOME AND OTHER TAX
CONSEQUENCES TO YOU IN LIGHT OF YOUR PARTICULAR INVESTMENT OR TAX CIRCUMSTANCES
OF ACQUIRING, HOLDING, EXCHANGING, OR OTHERWISE DISPOSING OF NEWCASTLE COMMON
STOCK.
TAXATION OF NEWCASTLE
Newcastle will elect to be taxed as a REIT, commencing with its initial
taxable year ending December 31, 2002, upon the filing of its federal income tax
return for that year. Newcastle believes that it was organized and has operated
in such a manner as to qualify for taxation as a REIT, and intends to continue
to operate in such a manner.
The law firm of Skadden, Arps, Slate, Meagher & Flom LLP has acted as our
tax counsel in connection with our election to be taxed as a REIT. Newcastle
expects to receive the opinion of Skadden, Arps, Slate, Meagher & Flom LLP to
the effect that Newcastle was organized in conformity with the requirements for
qualification as a REIT under the Internal Revenue Code, and that its actual
method of
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operation has enabled, and its proposed method of operation will enable, it to
meet the requirements for qualification and taxation as a REIT. It must be
emphasized that the opinion of Skadden, Arps, Slate, Meagher & Flom LLP is based
on various assumptions relating to the organization and operation of Newcastle,
and is conditioned upon representations and covenants made by the management of
Newcastle regarding its organization, assets and the past, present and future
conduct of its business operations. While Newcastle intends to operate so that
it will qualify as a REIT, given the highly complex nature of the rules
governing REITs, the ongoing importance of factual determinations, and the
possibility of future changes in the circumstances of Newcastle, no assurance
can be given by Skadden, Arps, Slate, Meagher & Flom LLP or Newcastle that
Newcastle will so qualify for any particular year. The opinion of Skadden, Arps,
Slate, Meagher & Flom LLP also relies on various legal opinions issued by other
counsel for Newcastle and its predecessors, including Sidley Austin Brown & Wood
LLP and Thacher Proffitt & Wood, with respect to certain issues and
transactions. The opinions, copies of which are filed as an exhibit to the
registration statement of which this prospectus is a part, are expressed as of
the date issued, and do not cover subsequent periods. Counsel will have no
obligation to advise Newcastle or the holders of Newcastle common stock of any
subsequent change in the matters stated, represented or assumed, or of any
subsequent change in the applicable law. You should be aware that opinions of
counsel are not binding on the IRS, and no assurance can be given that the IRS
will not challenge the conclusions set forth in such opinions.
Qualification and taxation as a REIT depends on the ability of Newcastle to
meet on a continuing basis, through actual operating results, distribution
levels, and diversity of stock ownership, various qualification requirements
imposed upon REITs by the Internal Revenue Code, the compliance with which will
not be reviewed by Skadden, Arps, Slate, Meagher & Flom LLP. In addition,
Newcastle's ability to qualify as a REIT depends in part upon the operating
results, organizational structure and entity classification for federal income
tax purposes of certain affiliated entities, including affiliates that have made
elections to be taxed as REITs, the status of which may not have been reviewed
by Skadden, Arps, Slate, Meagher & Flom LLP. Newcastle's ability to qualify as a
REIT also requires that it satisfies certain asset tests, some of which depend
upon the fair market values of assets directly or indirectly owned by Newcastle.
Such values may not be susceptible to a precise determination. Accordingly, no
assurance can be given that the actual results of Newcastle's operations for any
taxable year satisfy such requirements for qualification and taxation as a REIT.
TAXATION OF REITS IN GENERAL
As indicated above, qualification and taxation as a REIT depends upon the
ability of Newcastle to meet, on a continuing basis, various qualification
requirements imposed upon REITs by the Internal Revenue Code. The material
qualification requirements are summarized below under "-- Requirements for
Qualification -- General." While Newcastle intends to operate so that it
qualifies as a REIT, no assurance can be given that the IRS will not challenge
its qualification, or that it will be able to operate in accordance with the
REIT requirements in the future. See "-- Failure to Qualify."
Provided that Newcastle qualifies as a REIT, it will generally be entitled
to a deduction for dividends that it pays and therefore will not be subject to
federal corporate income tax on its net income that is currently distributed to
its stockholders. This treatment substantially eliminates the "double taxation"
at the corporate and stockholder levels that generally results from investment
in a corporation. Rather, income generated by a REIT generally is taxed only at
the stockholder level upon a distribution of dividends by the REIT. Net
operating losses, foreign tax credits and other tax attributes of a REIT
generally do not pass through to the stockholders of the REIT, subject to
special rules for certain items such as capital gains recognized by REITs. See
"Taxation of Stockholders."
If Newcastle qualifies as a REIT, it will nonetheless be subject to federal
tax in the following circumstances:
- Newcastle will be taxed at regular corporate rates on any undistributed
income, including undistributed net capital gains.
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- Newcastle may be subject to the "alternative minimum tax" on its items of
tax preference, including any deductions of net operating losses.
- If Newcastle has net income from prohibited transactions, which are, in
general, sales or other dispositions of property held primarily for sale
to customers in the ordinary course of business, other than foreclosure
property, such income will be subject to a 100% excise tax. See
"-- Prohibited Transactions", and "-- Foreclosure Property", below.
- If Newcastle elects to treat property that it acquires in connection with
a foreclosure of a mortgage loan or certain leasehold terminations as
"foreclosure property", it may thereby avoid the 100% excise tax on gain
from a resale of that property (if the sale would otherwise constitute a
prohibited transaction), but the income from the sale or operation of the
property may be subject to corporate income tax at the highest applicable
rate (currently 35%).
- If Newcastle should fail to satisfy the 75% gross income test or the 95%
gross income test, as discussed below, but nonetheless maintains its
qualification as a REIT because other requirements are met, it will be
subject to a 100% tax on an amount equal to (a) the greater of the amount
by which Newcastle fails the 75% or the 95% gross income test, as the
case may be, multiplied by (b) a fraction intended to reflect the
profitability of Newcastle.
- If Newcastle should fail to distribute during each calendar year at least
the sum of (a) 85% of its REIT ordinary income for such year, (b) 95% of
its REIT capital gain net income for such year, and (c) any undistributed
taxable income from prior periods, Newcastle would be subject to a 4%
excise tax on the excess of the required distribution over the sum of (i)
the amounts actually distributed, plus (ii) retained amounts on which
income tax is paid at the corporate level.
- Newcastle may be required to pay monetary penalties to the IRS in certain
circumstances, including if it fails to meet record keeping requirements
intended to monitor its compliance with rules relating to the composition
of a REIT's stockholders, as described below in "-- Requirements for
Qualification -- General."
- A 100% excise tax may be imposed on some items of income and expense that
are directly or constructively paid between a REIT and a taxable REIT
subsidiary (as described below) if and to the extent that the IRS
successfully adjusts the reported amounts of these items.
- If Newcastle acquires assets from a corporation that is not a REIT (i.e.,
a corporation taxable under subchapter C of the Internal Revenue Code),
in a transaction in which the adjusted tax basis of the assets in the
hands of Newcastle is determined by reference to the adjusted tax basis
of the assets in the hands of the subchapter C corporation, under
Temporary Treasury Regulations the subchapter C corporation would
generally be required to recognize any net built-in gain that would have
been realized if it had liquidated on the day before the date of the
transfer (i.e., as if it had sold its assets in a taxable transaction).
The regulations provide, however, that in lieu of taxation of the
transferor subchapter C corporation as described immediately above, a
REIT that acquires the assets may elect to be subject to tax at the
highest corporate income tax rate then applicable if it subsequently
recognizes the built-in gain on a disposition of any such assets during
the ten-year period following their acquisition from the subchapter C
corporation.
- Certain of Newcastle's subsidiaries may be subchapter C corporations, the
earnings of which would subject to federal corporate income tax.
In addition, Newcastle and its subsidiaries may be subject to a variety of
taxes, including payroll taxes and state, local, and foreign income, property
and other taxes on their assets and operations. Newcastle could also be subject
to tax in situations and on transactions not presently contemplated.
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REQUIREMENTS FOR QUALIFICATION -- GENERAL
The Internal Revenue Code defines a REIT as a corporation, trust or
association:
(1) that is managed by one or more trustees or directors;
(2) the beneficial ownership of which is evidenced by transferable
shares, or by transferable certificates of beneficial interest;
(3) which would be taxable as a domestic corporation but for the
special Internal Revenue Code provisions applicable to REITs;
(4) that is neither a financial institution nor an insurance company
subject to specific provisions of the Internal Revenue Code;
(5) the beneficial ownership of which is held by 100 or more persons;
(6) in which, during the last half of each taxable year, not more than
50% in value of the outstanding stock is owned, directly or indirectly, by
five or fewer "individuals" (as defined in the Internal Revenue Code to
include specified entities); and
(7) which meets other tests described below, including with respect to
the nature of its income and assets.
The Internal Revenue Code provides that conditions (1) through (4) must be
met during the entire taxable year, and that condition (5) must be met during at
least 335 days of a taxable year of 12 months, or during a proportionate part of
a shorter taxable year. Newcastle's charter provides restrictions regarding
transfers of its shares, which are intended to assist Newcastle in satisfying
the share ownership requirements described in conditions (5) and (6) above.
To monitor compliance with the share ownership requirements, Newcastle is
generally required to maintain records regarding the actual ownership of its
shares. To do so, Newcastle must demand written statements each year from the
record holders of significant percentages of its stock in which the record
holders are to disclose the actual owners of the shares, i.e., the persons
required to include in gross income the dividends paid by Newcastle. A list of
those persons failing or refusing to comply with this demand must be maintained
as part of the records of Newcastle. Failure by Newcastle to comply with these
record keeping requirements could subject it to monetary penalties. A
stockholder that fails or refuses to comply with the demand is required by
Treasury regulations to submit a statement with its tax return disclosing the
actual ownership of the shares and other information.
In addition, a corporation generally may not elect to become a REIT unless
its taxable year is the calendar year. Newcastle satisfies this requirement.
EFFECT OF SUBSIDIARY ENTITIES
Ownership of Partnership Interests. In the case of a REIT that is a
partner in a partnership, Treasury regulations provide that the REIT is deemed
to own its proportionate share of the partnership's assets, and to earn its
proportionate share of the partnership's income, for purposes of the asset and
gross income tests applicable to REITs as described below. In addition, the
assets and gross income of the partnership are deemed to retain the same
character in the hands of the REIT. Thus, Newcastle's proportionate share of the
assets and items of income of its subsidiary partnerships are treated as assets
and items of income of Newcastle for purposes of applying the REIT requirements
described below. A summary of certain rules governing the federal income
taxation of partnerships and their partners is provided below in "Tax Aspects of
Investments in Affiliated Entities -- Partnerships."
Disregarded Subsidiaries. If a REIT owns a corporate subsidiary that is a
"qualified REIT subsidiary", that subsidiary is disregarded for federal income
tax purposes, and all assets, liabilities and items of income, deduction and
credit of the subsidiary are treated as assets, liabilities and items of income,
deduction and credit of the REIT itself, including for purposes of the gross
income and asset tests
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applicable to REITs as summarized below. A qualified REIT subsidiary is any
corporation, other than a "taxable REIT subsidiary" as described below, that is
wholly-owned by a REIT, or by other disregarded subsidiaries, or by a
combination of the two. Newcastle has several qualified REIT subsidiaries. Other
entities wholly-owned by Newcastle, including single member limited liability
companies, are also generally disregarded as a separate entities for federal
income tax purposes, including for purposes of the REIT income and asset tests.
Disregarded subsidiaries, along with subsidiary partnerships of Newcastle, are
sometimes referred to in this prospectus as "pass-through subsidiaries."
In the event that a disregarded subsidiary of Newcastle ceases to be
wholly-owned -- for example, if any equity interest in the subsidiary is
acquired by a person other than Newcastle or another disregarded subsidiary of
Newcastle -- the subsidiary's separate existence would no longer be disregarded
for federal income tax purposes. Instead, it would have multiple owners and
would be treated as either a partnership or a taxable corporation. Such an event
could, depending on the circumstances, adversely affect Newcastle's ability to
satisfy the various asset and gross income requirements applicable to REITs,
including the requirement that REITs generally may not own, directly or
indirectly, more than 10% of the securities of another corporation. See
"-- Asset Tests" and "-- Income Tests."
Taxable Subsidiaries. Effective in 2001, a REIT, in general, may jointly
elect with subsidiary corporations, whether or not wholly-owned, to treat the
subsidiary corporation as a taxable REIT subsidiary ("TRS"). The separate
existence of a TRS or other taxable corporation, unlike a disregarded subsidiary
as discussed above, is not ignored for federal income tax purposes. Accordingly,
such an entity would generally be subject to corporate income tax on its
earnings, which may reduce the cash flow generated by Newcastle and its
subsidiaries in the aggregate, and Newcastle's ability to make distributions to
its stockholders.
A parent REIT is not treated as holding the assets of a taxable subsidiary
corporation or as receiving any income that the subsidiary earns. Rather, the
stock issued by the subsidiary is an asset in the hands of the parent REIT, and
the REIT recognizes as income, the dividends, if any, that it receives from the
subsidiary. This treatment can affect the income and asset test calculations
that apply to the REIT, as described below. Because a parent REIT does not
include the assets and income of such subsidiary corporations in determining the
parent's compliance with the REIT requirements, such entities may be used by the
parent REIT to indirectly undertake activities that the REIT rules might
otherwise preclude it from doing directly or through pass-through subsidiaries
(for example, activities that give rise to certain categories of income such as
management fees or foreign currency gains).
INCOME TESTS
In order to maintain qualification as a REIT, Newcastle annually must
satisfy two gross income requirements. First, at least 75% of Newcastle's gross
income for each taxable year, excluding gross income from sales of inventory or
dealer property in "prohibited transactions", must be derived from investments
relating to real property or mortgages on real property, including "rents from
real property," dividends received from other REITs, interest income derived
from mortgage loans secured by real property (including certain types of
mortgage backed securities), and gains from the sale of real estate assets, as
well as income from some kinds of temporary investments. Second, at least 95% of
Newcastle's gross income in each taxable year, excluding gross income from
prohibited transactions, must be derived from some combination of such income
from investments in real property (i.e., income that qualifies under the 75%
income test described above), as well as other dividends, interest, and gain
from the sale or disposition of stock or securities, which need not have any
relation to real property.
Rents received by Newcastle will qualify as "rents from real property" in
satisfying the gross income requirements described above, only if several
conditions are met, including the following. If rent is partly attributable to
personal property leased in connection with a lease of real property, the
portion of the total rent that is attributable to the personal property will not
qualify as "rents from real property" unless it constitutes 15% or less of the
total rent received under the lease. Moreover, for rents received to qualify as
"rents from real property," the REIT generally must not operate or manage the
property or furnish or
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render services to the tenants of such property, other than through an
"independent contractor" from which the REIT derives no revenue. Newcastle and
its affiliates are permitted, however, to perform services that are "usually or
customarily rendered" in connection with the rental of space for occupancy only
and are not otherwise considered rendered to the occupant of the property. In
addition, Newcastle and its affiliates may directly or indirectly provide
non-customary services to tenants of its properties without disqualifying all of
the rent from the property if the payment for such services does not exceed 1%
of the total gross income from the property. For purposes of this test, the
income received from such non-customary services is deemed to be at least 150%
of the direct cost of providing the services. Moreover, Newcastle is permitted
to provide services to tenants or others through a TRS without disqualifying the
rental income received from tenants for purposes of the REIT income
requirements. Also, rental income will qualify as rents from real property only
to the extent that Newcastle does not directly or constructively hold a 10% or
greater interest, as measured by vote or value, in the lessee's equity.
To the extent that a REIT derives interest income from a mortgage loan or
income from the rental of real property where all or a portion of the amount of
interest or rental income payable is contingent, such income generally will
qualify for purposes of the gross income tests only if it is based upon the
gross receipts or sales, and not the net income or profits, of the borrower or
lessee. This limitation does not apply, however, where the borrower or lessee
leases substantially all of its interest in the property to tenants or
subtenants, to the extent that the rental income derived by the borrower or
lessee, as the case may be, would qualify as rents from real property had it
been earned directly by a REIT.
To the extent that the terms of a loan provide for contingent interest that
is based on the cash proceeds realized upon the sale of the property securing
the loan (a "shared appreciation provision"), income attributable to the
participation feature will be treated as gain from sale of the underlying
property, which generally will be qualifying income for purposes of both the 75%
and 95% gross income tests.
Interest income constitutes qualifying mortgage interest for purposes of
the 75% income test (as described above) to the extent that the obligation is
secured by a mortgage on real property. If Newcastle receives interest income
with respect to a mortgage loan that is secured by both real property and other
property, and the highest principal amount of the loan outstanding during a
taxable year exceeds the fair market value of the real property on the date that
Newcastle acquired or originated the mortgage loan, the interest income will be
apportioned between the real property and the other collateral, and Newcastle's
income from the arrangement will qualify for purposes of the 75% income test
only to the extent that the interest is allocable to the real property. Even if
a loan is not secured by real property, or is undersecured, the income that it
generates may nonetheless qualify for purposes of the 95% income test.
Newcastle may indirectly receive distributions from TRSs or other
corporations that are not REITs or qualified REIT subsidiaries. These
distributions will be classified as dividend income to the extent of the
earnings and profits of the distributing corporation. Such distributions will
generally constitute qualifying income for purposes of the 95% gross income
test, but not under the 75% gross income test. Any dividends received by
Newcastle from a REIT will be qualifying income in Newcastle's hands for
purposes of both the 95% and 75% income tests.
If Newcastle fails to satisfy one or both of the 75% or 95% gross income
tests for any taxable year, it may still qualify as a REIT for the year if it is
entitled to relief under applicable provisions of the Internal Revenue Code.
These relief provisions will be generally available if the failure of Newcastle
to meet these tests was due to reasonable cause and not due to willful neglect,
Newcastle attaches to its tax return a schedule of the sources of its income,
and any incorrect information on the schedule was not due to fraud with intent
to evade tax. It is not possible to state whether Newcastle would be entitled to
the benefit of these relief provisions in all circumstances. If these relief
provisions are inapplicable to a particular set of circumstances involving
Newcastle, Newcastle will not qualify as a REIT. As discussed above under
"-- Taxation of REITs in General," even where these relief provisions apply, a
tax would be imposed upon the amount by which Newcastle fails to satisfy the
particular gross income test.
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ASSET TESTS
Newcastle, at the close of each calendar quarter, must also satisfy four
tests relating to the nature of its assets. First, at least 75% of the value of
the total assets of Newcastle must be represented by some combination of "real
estate assets", cash, cash items, U.S. government securities, and, under some
circumstances, stock or debt instruments purchased with new capital. For this
purpose, real estate assets include interests in real property, such as land,
buildings, leasehold interests in real property, stock of other corporations
that qualify as REITs, and some kinds of mortgage backed securities and mortgage
loans. Newcastle Investment Holdings has held and currently holds stock of
subsidiary entities that have made elections to be taxed as REITs. If any of
these entities were to fail to qualify as a REIT, it could adversely affect
Newcastle's compliance with the REIT qualification requirements described in
this prospectus. Assets that do not qualify for purposes of the 75% test are
subject to the additional asset tests described below.
The second asset test is that the value of any one issuer's securities
owned by Newcastle may not exceed 5% of the value of Newcastle's total assets.
Third, Newcastle may not own more than 10% of any one issuer's outstanding
securities, as measured by either voting power or value. The 5% and 10% asset
tests do not apply to securities of TRSs, and the 10% value test does not apply
to "straight debt" having specified characteristics. Fourth, the aggregate value
of all securities of TRSs held by a REIT may not exceed 20% of the value of the
REIT's total assets.
Notwithstanding the general rule, as noted above, that for purposes of the
REIT income and asset tests, a REIT is treated as owning its share of the
underlying assets of a subsidiary partnership, if a REIT holds indebtedness
issued by a partnership, the indebtedness will be subject to, and may cause a
violation of the asset tests, unless it is a qualifying mortgage asset or
otherwise satisfies the rules for "straight debt". Similarly, although stock of
another REIT is a qualifying asset for purposes of the REIT asset tests, non-
mortgage debt held by Newcastle that is issued by another REIT may not so
qualify.
Interests held by Newcastle in a real estate mortgage investment conduit,
or "REMIC," are generally treated as qualifying real estate assets, and income
derived by Newcastle from interests in REMICs is generally treated as qualifying
income for purposes of the REIT income tests described above. If less than 95%
of the assets of a REMIC are real estate assets, however, then only a
proportionate part of Newcastle's interest in the REMIC, and its income derived
from the interest, qualifies for purposes of the REIT asset and income tests.
Newcastle believes that its holdings of securities and other assets comply,
and will continue to comply, with the foregoing REIT asset requirements, and it
intends to monitor compliance on an ongoing basis. No independent appraisals
have been obtained, however, to support Newcastle's conclusions as to the value
of its total assets, or the value of any particular security or securities.
Moreover, values of some assets, including instruments issued in securitization
transactions, may not be susceptible to a precise determination, and values are
subject to change in the future. Furthermore, the proper classification of an
instrument as debt or equity for federal income tax purposes may be uncertain in
some circumstances, which could affect the application of the REIT asset
requirements. Accordingly, there can be no assurance that the IRS will not
contend that Newcastle's interests in its subsidiaries or in the securities of
other issuers will not cause a violation of the REIT asset requirements.
ANNUAL DISTRIBUTION REQUIREMENTS
In order to qualify as a REIT, Newcastle is required to distribute
dividends, other than capital gain dividends, to its stockholders in an amount
at least equal to:
(a) the sum of
(1) 90% of the "REIT taxable income" of Newcastle (computed without
regard to the deduction for dividends paid and net capital gains of
Newcastle), and
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(2) 90% of the net income, if any, (after tax) from foreclosure
property (as described below), minus
(b) the sum of specified items of noncash income.
These distributions must be paid in the taxable year to which they relate,
or in the following taxable year if declared before Newcastle timely files its
tax return for the year and if paid with or before the first regular dividend
payment after such declaration. In order for distributions to be counted for
this purpose, and to give rise to a tax deduction by Newcastle, they must not be
"preferential dividends". A dividend is not a preferential dividend if it is pro
rata among all outstanding shares of stock within a particular class, and is in
accordance with the preferences among different classes of stock as set forth in
Newcastle organizational documents.
To the extent that Newcastle distributes at least 90%, but less than 100%,
of its "REIT taxable income," as adjusted, it will be subject to tax at ordinary
corporate tax rates on the retained portion. Newcastle may elect to retain,
rather than distribute, its net long-term capital gains and pay tax on such
gains. In this case, Newcastle could elect to have its stockholders include
their proportionate share of such undistributed long-term capital gains in
income, and to receive a corresponding credit for their share of the tax paid by
Newcastle. Stockholders of Newcastle would then increase the adjusted basis of
their Newcastle common stock by the difference between the designated amounts
included in their long-term capital gains and the tax deemed paid with respect
to their shares.
To the extent that a REIT has available net operating losses carried
forward from prior tax years, such losses may reduce the amount of distributions
that it must make in order to comply with the REIT distribution requirements.
Such losses, however, will generally not affect the character, in the hands of
stockholders, of any distributions that are actually made by the REIT, which are
generally taxable to stockholders to the extent that the REIT has current or
accumulated earnings and profits. See "-- Taxation of Stockholders -- Taxation
of Taxable Domestic Stockholders -- Distributions."
If Newcastle should fail to distribute during each calendar year at least
the sum of (a) 85% of its REIT ordinary income for such year, (b) 95% of its
REIT capital gain net income for such year, and (c) any undistributed taxable
income from prior periods, Newcastle would be subject to a 4% excise tax on the
excess of such required distribution over the sum of (x) the amounts actually
distributed and (y) the amounts of income retained on which it has paid
corporate income tax. Newcastle intends to make timely distributions so that it
is not subject to the 4% excise tax.
It is possible that Newcastle, from time to time, may not have sufficient
cash to meet the distribution requirements due to timing differences between (a)
the actual receipt of cash, including receipt of distributions from its
subsidiaries, and (b) the inclusion of items in income by Newcastle for federal
income tax purposes. See, for example, the discussion below of excess inclusion
income under "-- Taxable Mortgage Pools." Other sources of non-cash taxable
income include real estate and securities that have been financed through
securitization structures, such as the CBO structure (as described above under
"Newcastle Investment Corp. -- Our Investments"), which require some or all of
available cash flows to be used to service borrowings, loans or mortgage backed
securities we hold that have been issued at a discount and require the accrual
of taxable economic interest in advance of its receipt in cash, and distressed
loans on which we may be required to accrue taxable interest income even though
the borrower is unable to make current servicing payments in cash. In the event
that such timing differences occur, in order to meet the distribution
requirements, it might be necessary to arrange for short-term, or possibly
long-term, borrowings, or to pay dividends in the form of taxable in-kind
distributions of property.
Newcastle may be able to rectify a failure to meet the distribution
requirements for a year by paying "deficiency dividends" to stockholders in a
later year, which may be included in Newcastle's deduction for dividends paid
for the earlier year. In this case, Newcastle may be able to avoid losing its
REIT status or being taxed on amounts distributed as deficiency dividends.
However, Newcastle will be required to pay interest and a penalty based on the
amount of any deduction taken for deficiency dividends.
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FAILURE TO QUALIFY
If Newcastle fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, Newcastle would be subject to tax,
including any applicable alternative minimum tax, on its taxable income at
regular corporate rates. Distributions to stockholders in any year in which
Newcastle is not a REIT would not be deductible by Newcastle, nor would they be
required to be made. In this situation, to the extent of current and accumulated
earnings and profits, all distributions to stockholders will be taxable as
ordinary income, and, subject to limitations of the Internal Revenue Code,
corporate distributees may be eligible for the dividends received deduction.
Unless Newcastle is entitled to relief under specific statutory provisions,
Newcastle would also be disqualified from re-electing to be taxed as a REIT for
the four taxable years following the year during which qualification was lost.
It is not possible to state whether, in all circumstances, Newcastle would be
entitled to this statutory relief. The rule against re-electing REIT status
following a loss of such status would also apply to Newcastle if Newcastle
Investment Holdings fails to qualify as a REIT, and Newcastle is treated as a
successor to Newcastle Investment Holdings for federal income tax purposes.
PROHIBITED TRANSACTIONS
Net income derived from a prohibited transaction is subject to a 100%
excise tax. The term "prohibited transaction" generally includes a sale or other
disposition of property (other than foreclosure property) that is held primarily
for sale to customers in the ordinary course of a trade or business. Newcastle
intends to conduct its operations so that no asset owned by Newcastle or its
pass-through subsidiaries will be held for sale to customers, and that a sale of
any such asset will not be in the ordinary course of Newcastle's business.
Whether property is held "primarily for sale to customers in the ordinary course
of a trade or business" depends, however, on the particular facts and
circumstances. No assurance can be given that any property sold by Newcastle
will not be treated as property held for sale to customers, or that Newcastle
can comply with certain safe-harbor provisions of the Internal Revenue Code that
would prevent such treatment.
FORECLOSURE PROPERTY
Foreclosure property is real property and any personal property incident to
such real property (i) that is acquired by a REIT as the result of the REIT
having bid in the property at foreclosure, or having otherwise reduced the
property to ownership or possession by agreement or process of law, after there
was a default (or default was imminent) on a lease of the property or a mortgage
loan held by the REIT and secured by the property, (ii) for which the related
loan or lease was acquired by the REIT at a time when default was not imminent
or anticipated, and (iii) for which such REIT makes a proper election to treat
the property as foreclosure property. REITs generally are subject to tax at the
maximum corporate rate (currently 35%) on any net income from foreclosure
property, including any gain from the disposition of the foreclosure property,
other than income that would otherwise be qualifying income for purposes of the
75% gross income test. Any gain from the sale of property for which a
foreclosure property election has been made will not be subject to the 100%
excise tax on gains from prohibited transactions described above, even if the
property would otherwise constitute inventory or dealer property in the hands of
the selling REIT. Newcastle does not anticipate that it will receive any income
from foreclosure property that is not qualifying income for purposes of the 75%
gross income test, but, if Newcastle does receive any such income, it intends to
make an election to treat the related property as foreclosure property.
FOREIGN INVESTMENTS
Newcastle and its subsidiaries currently hold and may acquire additional
investments and, accordingly pay taxes, in foreign countries. Taxes paid by
Newcastle in foreign jurisdictions may not be passed-through to, or used by, its
stockholders as a foreign tax credit or otherwise. Newcastle's foreign
investments may also generate foreign currency gains and losses. Foreign
currency gains are treated as income that does not qualify under the 95% or 75%
income tests, unless certain technical requirements are met. No assurance can be
given that these technical requirements will be met in the case of any foreign
currency gains
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recognized by Newcastle directly or through pass-through subsidiaries, and will
not adversely affect Newcastle's ability to satisfy the REIT qualification
requirements.
DERIVATIVES AND HEDGING TRANSACTIONS
Newcastle and its subsidiaries have, from time to time, and may in the
future enter into hedging transactions with respect to interest rate exposure on
one or more of their assets or liabilities. Any such hedging transactions could
take a variety of forms, including the use of derivative instruments such as
interest rate swap contracts, interest rate cap or floor contracts, futures or
forward contracts, and options. To the extent that Newcastle or a pass-through
subsidiary enters into such a contract to reduce interest rate risk on
indebtedness incurred to acquire or carry real estate assets, any periodic
income from the instrument, or gain from the disposition of it, would be
qualifying income for purposes of the REIT 95% gross income test, but not for
the 75% gross income test. To the extent that Newcastle hedges with other types
of financial instruments or in other situations (for example, hedges against
fluctuations in the value of foreign currencies), the resultant income will be
treated as income that does not qualify under the 95% or 75% income tests unless
certain technical requirements are met. Newcastle intends to structure any
hedging transactions in a manner that does not jeopardize its status as a REIT.
Newcastle may conduct some or all of its hedging activities (including hedging
activities relating to currency risk) through a TRS or other corporate entity,
the income from which may be subject to federal income tax, rather than
participating in the arrangements directly or through pass-through subsidiaries.
No assurance can be given, however, that Newcastle's hedging activities will not
give rise to income that does not qualify for purposes of either or both of the
REIT income tests, and will not adversely affect Newcastle's ability to satisfy
the REIT qualification requirements.
TAXABLE MORTGAGE POOLS
An entity, or a portion of an entity, may be classified as a taxable
mortgage pool ("TMP") under the Internal Revenue Code if (1) substantially all
of its assets consist of debt obligations or interests in debt obligations, (2)
more than 50% of those debt obligations are real estate mortgages or interests
in real estate mortgages as of specified testing dates, (3) the entity has
issued debt obligations (liabilities) that have two or more maturities, and (4)
the payments required to be made by the entity on its debt obligations
(liabilities) "bear a relationship" to the payments to be received by the entity
on the debt obligations that it holds as assets. Under regulations issued by the
U.S. Treasury Department, if less than 80% of the assets of an entity (or a
portion of an entity) consist of debt obligations, these debt obligations are
considered not to comprise "substantially all" of its assets, and therefore the
entity would not be treated as a TMP. Newcastle currently holds an interest in
two TMPs, and its future financing and securitization arrangements may give rise
to other TMPs, with the consequences as described in the next paragraph.
Where an entity, or a portion of an entity, is classified as a TMP, it is
generally treated as a taxable corporation for federal income tax purposes. In
the case of a REIT, or a portion of a REIT, or a disregarded subsidiary of a
REIT, that is a TMP, however, special rules apply. The TMP is not treated as a
corporation that is subject to corporate income tax, and the TMP classification
does not directly affect the tax status of the REIT. Rather, the consequences of
the TMP classification would, in general, except as described below, be limited
to the stockholders of the REIT. The Treasury Department has not yet issued
regulations to govern the treatment of stockholders as described below. A
portion of the REIT's income from the TMP arrangement, which might be non-cash
accrued income, could be treated as "excess inclusion income". This income would
nonetheless be subject to the distribution requirements that apply to the REIT,
and could therefore adversely affect its liquidity. See "-- Annual Distribution
Requirements". Moreover, the REIT's excess inclusion income would be allocated
among its stockholders. A stockholder's share of excess inclusion income (i)
would not be allowed to be offset by any net operating losses otherwise
available to the stockholder, (ii) would be subject to tax as unrelated business
taxable income in the hands of most types of stockholders that are otherwise
generally exempt from federal income tax, and (iii) would result in the
application of U.S. federal income tax withholding at the
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maximum rate (30%), without reduction for any otherwise applicable income tax
treaty, to the extent allocable to most types of foreign stockholders. See
"Taxation of Stockholders". To the extent that excess inclusion income is
allocated to a tax-exempt stockholder of a REIT that is not subject to unrelated
business income tax (such as government entities), the REIT would be taxable on
this income at the highest applicable corporate tax rate (currently 35%).
Tax-exempt investors, foreign investors and taxpayers with net operating losses
should carefully consider the tax consequences described above and are urged to
consult their tax advisors.
If a subsidiary partnership of Newcastle were a TMP, the foregoing rules
would not apply. Rather, the partnership that is a TMP would be treated as a
corporation for federal income tax purposes, and would potentially be subject to
corporate income tax. In addition, this characterization would alter Newcastle's
REIT income and asset test calculations, and could adversely affect its
compliance with those requirements. Newcastle believes that it has no subsidiary
partnerships that are or will become TMPs, and intends to monitor the structure
of any TMPs in which it has an interest to ensure that they will not adversely
affect its status as a REIT.
TAX ASPECTS OF INVESTMENTS IN AFFILIATED ENTITIES
PARTNERSHIPS
General. Newcastle may hold investments through entities that are
classified as partnerships for federal income tax purposes. In general,
partnerships are "pass-through" entities that are not subject to federal income
tax. Rather, partners are allocated their proportionate shares of the items of
income, gain, loss, deduction and credit of a partnership, and are potentially
subject to tax on these items, without regard to whether the partners receive a
distribution from the partnership. Newcastle will include in its income its
proportionate share of these partnership items for purposes of the various REIT
income tests and in the computation of its REIT taxable income. Moreover, for
purposes of the REIT asset tests, Newcastle will include its proportionate share
of assets held by subsidiary partnerships. See "Taxation of Newcastle -- Effect
of Subsidiary Entities -- Ownership of Partnership Interests."
Entity Classification. The investment by Newcastle in partnerships
involves special tax considerations, including the possibility of a challenge by
the IRS of the status of any of Newcastle's subsidiary partnerships as a
partnership, as opposed to an association taxable as a corporation, for federal
income tax purposes (for example, if the IRS were to assert that a subsidiary
partnership is a TMP). See "Taxation of Newcastle -- Taxable Mortgage Pools". If
any of these entities were treated as an association for federal income tax
purposes, it would be taxable as a corporation and therefore could be subject to
an entity-level tax on its income. In such a situation, the character of the
assets of Newcastle and items of gross income of Newcastle would change and
could preclude Newcastle from satisfying the REIT asset tests or the gross
income tests as discussed in "Taxation of Newcastle -- Asset Tests" and
"-- Income Tests," and in turn could prevent Newcastle from qualifying as a
REIT. See "Taxation of Newcastle -- Failure to Qualify," above, for a discussion
of the effect of the failure of Newcastle to meet these tests for a taxable
year. In addition, any change in the status of any of Newcastle's subsidiary
partnerships for tax purposes might be treated as a taxable event, in which case
Newcastle could have taxable income that is subject to the REIT distribution
requirements without receiving any cash.
Tax Allocations with Respect to Partnership Properties. Under the Internal
Revenue Code and the Treasury regulations, income, gain, loss and deduction
attributable to appreciated or depreciated property that is contributed to a
partnership in exchange for an interest in the partnership must be allocated for
tax purposes in a manner such that the contributing partner is charged with, or
benefits from, the unrealized gain or unrealized loss associated with the
property at the time of the contribution. The amount of the unrealized gain or
unrealized loss is generally equal to the difference between the fair market
value of the contributed property at the time of contribution, and the adjusted
tax basis of such property at the time of contribution (a "book-tax
difference"). Such allocations are solely for federal income tax purposes and do
not affect the book capital accounts or other economic or legal arrangements
among the partners.
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To the extent that any subsidiary partnership of Newcastle acquires
appreciated (or depreciated) properties by way of capital contributions from its
partners, allocations would need to be made in a manner consistent with these
requirements. Where a partner contributes cash to a partnership at a time that
the partnership holds appreciated (or depreciated) property, the Treasury
regulations provide for a similar allocation of these items to the other (i.e.
non-contributing) partners. These rules may apply to the contribution by
Newcastle to any subsidiary partnerships of the cash proceeds received in
offerings of its stock. As a result, partners, including Newcastle, in
subsidiary partnerships, could be allocated greater or lesser amounts of
depreciation and taxable income in respect of a partnership's properties than
would be the case if all of the partnership's assets (including any contributed
assets) had a tax basis equal to their fair market values at the time of any
contributions to that partnership. This could cause Newcastle to recognize, over
a period of time, taxable income in excess of cash flow from the partnership,
which might adversely affect Newcastle's ability to comply with the REIT
distribution requirements discussed above.
TAXATION OF STOCKHOLDERS
TAXATION OF TAXABLE DOMESTIC STOCKHOLDERS
Distributions. Provided that Newcastle qualifies as a REIT, distributions
made to its taxable domestic stockholders out of current or accumulated earnings
and profits, and not designated as capital gain dividends, will be taken into
account by them as ordinary income and will not be eligible for the dividends
received deduction for corporations. Distributions that are designated as
capital gain dividends will be taxed to stockholders as long-term capital gains,
to the extent that they do not exceed the actual net capital gain of Newcastle
for the taxable year, without regard to the period for which the stockholder has
held its stock. A similar treatment will apply to long-term capital gains
retained by Newcastle, to the extent that Newcastle elects the application of
provisions of the Internal Revenue Code that treat stockholders of a REIT as
having received, for federal income tax purposes, undistributed capital gains of
the REIT, while passing through to stockholders a corresponding credit for taxes
paid by the REIT on such retained capital gains. Corporate stockholders may be
required to treat up to 20% of some capital gain dividends as ordinary income.
Long-term capital gains are generally taxable at maximum federal rates of 20% in
the case of stockholders who are individuals, and 35% for corporations. Capital
gains attributable to the sale of depreciable real property held for more than
12 months are subject to a 25% maximum federal income tax rate for taxpayers who
are individuals, to the extent of previously claimed depreciation deductions.
Distributions in excess of current and accumulated earnings and profits
will not be taxable to a stockholder to the extent that they do not exceed the
adjusted basis of the stockholder's shares in respect of which the distributions
were made, but rather, will reduce the adjusted basis of these shares. To the
extent that such distributions exceed the adjusted basis of a stockholder's
shares, they will be included in income as long-term capital gain, or short-term
capital gain if the shares have been held for one year or less. In addition, any
dividend declared by Newcastle in October, November or December of any year and
payable to a stockholder of record on a specified date in any such month will be
treated as both paid by Newcastle and received by the stockholder on December 31
of such year, provided that the dividend is actually paid by Newcastle before
the end of January of the following calendar year.
To the extent that a REIT has available net operating losses and capital
losses carried forward from prior tax years, such losses may reduce the amount
of distributions that must be made in order to comply with the REIT distribution
requirements. See "Taxation of Newcastle -- Annual Distribution Requirements."
Such losses, however, are not passed through to stockholders and do not offset
income of stockholders from other sources, nor would they affect the character
of any distributions that are actually made by a REIT, which are generally
subject to tax in the hands of stockholders to the extent that the REIT has
current or accumulated earnings and profits.
If excess inclusion income from a taxable mortgage pool is allocated to any
Newcastle stockholder, that income will be taxable in the hands of the
stockholder and would not be offset by any net operating
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losses of the stockholder that would otherwise be available. See "Taxation of
Newcastle -- Taxable Mortgage Pools."
Dispositions of Newcastle Stock. In general, capital gains recognized by
individuals and other non-corporate stockholders upon the sale or disposition of
shares of Newcastle stock will be subject to a maximum federal income tax rate
of 20% if the Newcastle stock is held for more than 12 months, and will be taxed
at ordinary income rates of up to 39.6% if the Newcastle stock is held for 12
months or less. Gains recognized by stockholders that are corporations are
subject to federal income tax at a maximum rate of 35%, whether or not
classified as long-term capital gains. Capital losses recognized by a
stockholder upon the disposition of Newcastle stock held for more than one year
at the time of disposition will be considered long-term capital losses, and are
generally available only to offset capital gain income of the stockholder but
not ordinary income (except in the case of individuals, who may offset up to
$3,000 of ordinary income each year). In addition, any loss upon a sale or
exchange of shares of Newcastle stock by a stockholder who has held the shares
for six months or less, after applying holding period rules, will be treated as
a long-term capital loss to the extent of distributions received from Newcastle
that are required to be treated by the stockholder as long-term capital gain.
TAXATION OF FOREIGN STOCKHOLDERS
The following is a summary of certain United States federal income and
estate tax consequences of the ownership and disposition of Newcastle stock
applicable to non-U.S. holders of Newcastle stock. A "non-U.S. holder" is any
person other than:
(a) a citizen or resident of the United States,
(b) a corporation or partnership created or organized in the United
States or under the laws of the United States, or of any state thereof, or
the District of Columbia,
(c) an estate, the income of which is includable in gross income for
U.S. federal income tax purposes regardless of its source, or
(d) a trust if a United States court is able to exercise primary
supervision over the administration of such trust and one or more United
States fiduciaries have the authority to control all substantial decisions
of the trust. The discussion is based on current law and is for general
information only. The discussion addresses only selective and not all
aspects of United States federal income and estate taxation.
Ordinary Dividends. The portion of dividends received by non-U.S. holders
payable out of the earnings and profits of Newcastle which are not attributable
to capital gains of Newcastle and which are not effectively connected with a
U.S. trade or business of the non-U.S. holder will be subject to U.S.
withholding tax at the rate of 30%, unless reduced by treaty. Reduced treaty
rates are not available to the extent that income is excess inclusion income
allocated to the foreign stockholder. See "Taxation of Newcastle -- Taxable
Mortgage Pools".
In general, non-U.S. holders will not be considered to be engaged in a U.S.
trade or business solely as a result of their ownership of Newcastle common
stock. In cases where the dividend income from a non-U.S. holder's investment in
Newcastle stock is, or is treated as, effectively connected with the non-U.S.
holder's conduct of a U.S. trade or business, the non-U.S. holder generally will
be subject to U.S. tax at graduated rates, in the same manner as domestic
stockholders are taxed with respect to such dividends, and may also be subject
to the 30% branch profits tax in the case of a non-U.S. holder that is a
corporation.
Non-Dividend Distributions. Unless Newcastle stock constitutes a U.S. real
property interest (a "USRPI"), distributions by Newcastle which are not
dividends out of the earnings and profits of Newcastle will not be subject to
U.S. income tax. If it cannot be determined at the time at which a distribution
is made whether or not the distribution will exceed current and accumulated
earnings and profits, the distribution will be subject to withholding at the
rate applicable to dividends. However, the
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non-U.S. holder may seek a refund from the IRS of any amounts withheld if it is
subsequently determined that the distribution was, in fact, in excess of
Newcastle's current and accumulated earnings and profits. If Newcastle stock
constitutes a USRPI, as described below, distributions by Newcastle in excess of
the sum of its earnings and profits plus the stockholder's basis in its
Newcastle stock will be taxed under the Foreign Investment in Real Property Tax
Act of 1980 ("FIRPTA") at the rate of tax, including any applicable capital
gains rates, that would apply to a domestic stockholder of the same type (e.g.,
an individual or a corporation, as the case may be), and the collection of the
tax will be enforced by a refundable withholding at a rate of 10% of the amount
by which the distribution exceeds the stockholder's share of Newcastle's
earnings and profits.
Capital Gain Dividends. Under FIRPTA, a distribution made by Newcastle to
a non-U.S. holder, to the extent attributable to gains from dispositions of
USRPIs held by Newcastle directly or through pass-through subsidiaries ("USRPI
capital gains"), will be considered effectively connected with a U.S. trade or
business of the non-U.S. holder and will be subject to U.S. income tax at the
rates applicable to U.S. individuals or corporations, without regard to whether
the distribution is designated as a capital gain dividend. In addition,
Newcastle will be required to withhold tax equal to 35% of the amount of
dividends to the extent the dividends constitute USRPI capital gains.
Distributions subject to FIRPTA may also be subject to a 30% branch profits tax
in the hands of a non-U.S. holder that is a corporation.
Dispositions of Newcastle Stock. Unless Newcastle stock constitutes a
USRPI, a sale of the stock by a non-U.S. holder generally will not be subject to
U.S. taxation under FIRPTA. The stock will not be treated as a USRPI if less
than 50% of Newcastle's assets throughout a prescribed testing period consist of
interests in real property located within the United States, excluding, for this
purpose, interests in real property solely in a capacity as a creditor.
Even if the foregoing test is not met, Newcastle stock nonetheless will not
constitute a USRPI if Newcastle is a "domestically-controlled REIT." A
domestically-controlled REIT is a REIT in which, at all times during a specified
testing period, less than 50% in value of its shares is held directly or
indirectly by non-U.S. holders. Newcastle believes that it is, and it expects to
continue to be, a domestically-controlled REIT and, therefore, the sale of
Newcastle stock should not be subject to taxation under FIRPTA. Because
Newcastle common stock will be publicly traded, however, no assurance can be
given that Newcastle will be a domestically-controlled REIT.
In the event that Newcastle does not constitute a domestically-controlled
REIT, a non-U.S. holder's sale of stock nonetheless will generally not be
subject to tax under FIRPTA as a sale of a USRPI, provided that (a) the stock is
"regularly traded," as defined by applicable Treasury Department regulations, on
an established securities market, and (b) the selling non-U.S. holder held 5% or
less of Newcastle's outstanding stock at all times during a specified testing
period.
If gain on the sale of stock of Newcastle were subject to taxation under
FIRPTA, the non-U.S. holder would be subject to the same treatment as a U.S.
stockholder with respect to such gain, subject to applicable alternative minimum
tax and a special alternative minimum tax in the case of non-resident alien
individuals, and the purchaser of the stock could be required to withhold 10% of
the purchase price and remit such amount to the IRS.
Gain from the sale of Newcastle stock that would not otherwise be subject
to FIRPTA will nonetheless be taxable in the United States to a non-U.S. holder
in two cases: (a) if the non-U.S. holder's investment in the Newcastle stock is
effectively connected with a U.S. trade or business conducted by such non-U.S.
holder, the non-U.S. holder will be subject to the same treatment as a U.S.
stockholder with respect to such gain, or (b) if the non-U.S. holder is a
nonresident alien individual who was present in the United States for 183 days
or more during the taxable year and has a "tax home" in the United States, the
nonresident alien individual will be subject to a 30% tax on the individual's
capital gain.
Estate Tax. Newcastle stock owned or treated as owned by an individual who
is not a citizen or resident (as specially defined for U.S. federal estate tax
purposes) of the United States at the time of
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death will be includable in the individual's gross estate for U.S. federal
estate tax purposes, unless an applicable estate tax treaty provides otherwise,
and may therefore be subject to U.S. federal estate tax.
TAXATION OF TAX-EXEMPT STOCKHOLDERS
Tax-exempt entities, including qualified employee pension and profit
sharing trusts and individual retirement accounts, generally are exempt from
federal income taxation. However, they are subject to taxation on their
unrelated business taxable income ("UBTI"). While many investments in real
estate generate UBTI, the IRS has ruled that dividend distributions from a REIT
to a tax-exempt entity do not constitute UBTI. Based on that ruling, and
provided that (1) a tax-exempt stockholder has not held its Newcastle common
stock as "debt financed property" within the meaning of the Internal Revenue
Code (i.e. where the acquisition or holding of the property is financed through
a borrowing by the tax-exempt stockholder), and (2) the Newcastle common stock
is not otherwise used in an unrelated trade or business, distributions from
Newcastle and income from the sale of the Newcastle common stock should not give
rise to UBTI to a tax-exempt stockholder. To the extent, however, that Newcastle
(or a part of Newcastle, or a disregarded subsidiary of Newcastle) is a TMP, or
if Newcastle holds residual interests in a REMIC, a portion of the dividends
paid to a tax-exempt stockholder that is allocable to excess inclusion income
may be subject to tax as UBTI. See "Taxation of Newcastle -- Taxable Mortgage
Pools".
Tax-exempt stockholders that are social clubs, voluntary employee benefit
associations, supplemental unemployment benefit trusts, and qualified group
legal services plans exempt from federal income taxation under sections
501(c)(7), (c)(9), (c)(17) and (c)(20) of the Internal Revenue Code,
respectively, are subject to different UBTI rules, which generally will require
them to characterize distributions from Newcastle as UBTI.
In certain circumstances, a pension trust that owns more than 10% of
Newcastle's stock could required to treat a percentage of the dividends from
Newcastle as UBTI, if Newcastle is a "pension-held REIT". Newcastle will not be
a pension-held REIT unless either (A) one pension trust owns more than 25% of
the value of Newcastle's stock, or (B) a group of pension trusts, each
individually holding more than 10% of the value of Newcastle's stock,
collectively owns more than 50% of the such stock. The restrictions on ownership
and transfer of Newcastle's stock as discussed above should prevent a tax-exempt
entity from owning more than 10% of the value of Newcastle's stock, or Newcastle
from becoming a pension-held REIT.
TAX-EXEMPT STOCKHOLDERS ARE URGED TO CONSULT THEIR TAX ADVISOR REGARDING
THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF AN INVESTMENT IN
NEWCASTLE.
OTHER TAX CONSIDERATIONS
DIVIDEND REINVESTMENT PLAN
To the extent that a stockholder receives shares of Newcastle stock
pursuant to a dividend reinvestment plan, the federal income tax treatment of
the stockholder and Newcastle will generally be the same as if the distribution
had been made in cash. See "Taxation of Stockholders" and "Taxation of
Newcastle -- Annual Distribution Requirements."
LEGISLATIVE OR OTHER ACTIONS AFFECTING REITS
The rules dealing with federal income taxation are constantly under review
by persons involved in the legislative process and by the IRS and the Treasury
Department. Changes to the federal tax laws and interpretations of federal tax
laws could adversely affect an investment in Newcastle.
STATE, LOCAL AND FOREIGN TAXES
Newcastle and its subsidiaries and stockholders may be subject to state,
local or foreign taxation in various jurisdictions, including those in which it
or they transact business, own property or reside. Newcastle owns properties
located in a number of jurisdictions, and may be required to file tax returns in
116
some or all of those jurisdictions. The state, local or foreign tax treatment of
Newcastle and its stockholders may not conform to the federal income tax
treatment discussed above. Newcastle will pay foreign property taxes, and
dispositions of foreign property or operations involving, or investments in,
foreign property may give rise to foreign income or other tax liability.
Consequently, prospective investors should consult their tax advisors regarding
the application and effect of state, local and foreign income and other tax laws
on an investment in Newcastle common stock.
117
ERISA CONSIDERATIONS
A plan fiduciary considering an investment in the securities should
consider, among other things, whether such an investment might constitute or
give rise to a prohibited transaction under ERISA, the tax Internal Revenue Code
or any substantially similar federal, state or local law. ERISA and the Internal
Revenue Code impose restrictions on:
- employee benefit plans as defined in Section 3(3) of ERISA,
- plans described in Section 4975(e)(1) of the Internal Revenue Code,
including retirement accounts and Keogh Plans,
- entities whose underlying assets include plan assets by reason of a
plan's investment in such entities, and
- persons who have certain specified relationships to a plan described as
"parties in interest" under ERISA and "disqualified persons" under the
tax code.
REGULATION UNDER ERISA AND THE TAX CODE
ERISA imposes certain duties on persons who are fiduciaries of a plan.
Under ERISA, any person who exercises any authority or control over the
management or disposition of a plan's assets is considered to be a fiduciary of
that plan. Both ERISA and the tax code prohibit certain transactions involving
"plan assets" between a plan and parties in interest or disqualified persons.
Violations of these rules may result in the imposition of an excise tax or
penalty
The term "plan assets" is not defined by ERISA or the tax code. However, a
plan's assets may be deemed to include an interest in the underlying assets of
an entity if the plan acquires an "equity interest" in such an entity such as
the shares. In that event, the operations of such an entity could result in a
prohibited transaction under ERISA and the tax code.
REGULATION ISSUED BY THE DEPARTMENT OF LABOR
The Department of Labor issued a regulation that provides exceptions to
this rule. Under this regulation, if a plan acquires a "publicly-offered
security," the issuer of the security is not deemed to hold plan assets. A
publicly-offered security is a security that:
- is freely transferable,
- is part of a class of securities that is owned by 100 or more investors
independent of the issuer and of one another, and
- is either:
(i) part of a class of securities registered under Section 12(b) or
12(g) of the Exchange Act, or
(ii) sold to the plan as part of an offering of securities to the
public pursuant to an effective registration statement under the Securities
Act and the class of securities of which such security is part is
registered under the Exchange Act within the requisite time.
THE SHARES OF COMMON STOCK AS "PUBLICLY-OFFERED SECURITIES'
It is anticipated that the shares of common stock being offered here will
meet the criteria of publicly-offered securities. Although no assurances can be
given, the Underwriters expect that:
- there will be no restrictions imposed on the transfer of interests in the
shares of common stock,
- shares of common stock will be held by at least 100 independent investors
at the conclusion of the offering, and
118
- the shares of common stock will be sold as part of an offering pursuant
to an effective registration statement under the Securities Act and then
will be timely registered under the Exchange Act.
OTHER EXCEPTIONS IN THE REGULATIONS
In addition, the regulation provides another exception for Plan investments
in a "venture capital operating company" or a "real estate operating company."
To be a "venture capital operating company," an entity must have at least 50% of
its assets (other than short term investments pending long-term commitment or
distribution to investors), valued at cost, invested in "venture capital
investments," which are defined as companies in the business of selling goods or
services (other than the investment of capital) with respect to which the entity
has or obtains management rights. To be a "real estate operating company," an
entity must have at least 50% of its assets (other than short term investments
pending long-term commitment or distribution to investors), valued at cost,
invested in real estate that is managed or developed and with respect to which
such entity has the right to substantially participate directly in the
management and development. We believe that we constitute either a "venture
capital operating company" or a "real estate operating company" for purposes of
the regulations.
EXEMPTIONS TO PROHIBITED TRANSACTIONS
If the shares of common stock fail to meet the criteria of publicly-offered
securities, or we fail to be a venture capital operating company or a real
estate operating company, our assets may be deemed to include assets of plans
that are stockholders. In that event, transactions involving our assets and
parties in interest or disqualified persons with respect to such plans might be
prohibited under ERISA and the tax code unless a statutory or administrative
exemption exist and the plan satisfies all conditions for such exemptive relief.
There are five class exemptions issued by the Department of Labor that
could apply in the event of a prohibited transaction. These Department of Labor
Prohibited Transaction Class Exemptions apply to:
- plan asset transactions determined by independent qualified professional
asset managers (PTE 84-14),
- certain transactions involving bank collective investment funds (PTE
91-38),
- certain transactions involving insurance company pooled separate accounts
(PTE 90-1),
- certain transactions involving insurance company general accounts (PTE
95-60), and
- plan asset transactions determined by in-house asset manager (PTE 96-23).
However, there is no assurance that these exemptions or any other exemption
will apply, even if all of the conditions specified are satisfied.
SPECIAL CONSIDERATIONS FOR INSURANCE COMPANIES
An insurance company considering an investment should consider whether its
general account may be deemed to include assets of the plans investing in the
general account, for example, through the purchase of an annuity contract. In
John Hancock Mutual Life Insurance Co. v. Harris Trust and Savings Bank, 510
U.S. 86 (1993), the United States Supreme Court held that assets held in an
insurance company's general account may be deemed to be plan assets under
certain circumstances In that event, the insurance company might be treated as a
party in interest under such plans. However, PTE 95-60 may exempt some or all of
the transactions that could occur as the result of the acquisition of the common
stock by an insurance company general account. Therefore, insurance company
investors should analyze whether John Hancock and PTE 95-60 or any other
exemption may have an impact with respect to their purchase of the common stock.
In addition, regulations were issued pursuant to Section 401(c) of ERISA
relating to the status of the assets of insurance company general accounts under
ERISA and Section 4975 of the tax code with respect
119
to insurance policies issued on or before December 31, 1998 that are supported
by an insurer's general account. As a result of these regulations, assets of an
insurance company general account will not be treated as "plan assets" for
purposes of the fiduciary responsibility provisions of ERISA and Section 4975 of
the Internal Revenue Code to the extent such assets relate to contracts issued
to employee benefit plans on or before December 31, 1998 and the insurer
satisfies various conditions. The plan asset status of insurance company
separate accounts is unaffected by new Section 401(c) of ERISA, and separate
account assets continue to be treated as the plan assets of any such plan
invested in a separate account.
GENERAL INVESTMENT CONSIDERATIONS
Prospective fiduciaries of a plan considering the purchase of common stock
should consult with their legal advisors concerning the impact of ERISA and the
tax code and the potential consequences of making an investment in the
certificates with respect to their specific circumstances. Each plan fiduciary
should take into account, among other considerations:
- whether the fiduciary has the authority to make the investment,
- the composition of the plan's portfolio with respect to diversification
by type of asset,
- the plan's funding objectives,
- the tax effects of the investment,
- whether the assets of the trust which are represented by such interests
would be considered plan assets, and
- whether, under the general fiduciary standards of investment prudence and
diversification an investment in certificates of any series is
appropriate for the plan taking into account the overall investment
policy of the plan and the composition of the plan's investment
portfolio.
Certain employee benefit plans, such as governmental plans and certain
church plans are not subject to the provisions of Title I of ERISA and Section
4975 of the tax code. Accordingly, assets of such plans may be invested in the
common stock without regard to the ERISA considerations described here, subject
to the provisions of any other applicable federal and state law. It should be
noted that any such plan that is qualified and exempt from taxation under the
tax code is subject to the prohibited transaction rules set forth in the tax
code.
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UNDERWRITING
We intend to offer the shares of common stock being sold in this offering
through the underwriters. Bear, Stearns & Co. Inc., Lehman Brothers Inc. and
Banc of America Securities LLC are acting as representatives of the underwriters
named below. Subject to the terms and conditions described in a underwriting
agreement among us and the underwriters, we have agreed to sell to the
underwriters, and the underwriters severally have agreed to purchase from us,
the number of shares listed opposite their names below.
UNDERWRITER NUMBER OF SHARES
- ----------- ----------------
Bear, Stearns & Co. Inc. ...................................
Lehman Brothers Inc. .......................................
Banc of America Securities LLC..............................
---------
Total.................................................. 7,000,000
=========
The underwriters have agreed to purchase all of the shares sold under the
underwriting agreement if any of these shares are purchased. If any underwriter
defaults, the underwriting agreement provides that the purchase commitments of
the nondefaulting underwriters may be increased or the underwriting agreement
may be terminated.
We have agreed to indemnify the underwriters against various liabilities,
including liabilities under the Securities Act, or to contribute to payments the
underwriters may be required to make in respect of those liabilities.
The underwriters are offering the shares, subject to prior sale, when, as
and if issued to and accepted by them, subject to approval of legal matters by
their counsel, including the validity of the shares, and other conditions
contained in the underwriting agreement, such as the receipt by the underwriters
of officer's certificates and legal opinions. The underwriters reserve the right
to withdraw, cancel or modify offers to the public and to reject orders in whole
or in part.
The underwriters have reserved for sale, at the initial public offering
price, up to 100,000 shares of common stock for our officers and directors,
officers and employees of the manager and their families, and other persons
associated with us who express an interest in purchasing these shares of common
stock in this offering. The number of shares available for sale to the general
public in the offering will be reduced to the extent these persons purchase
reserved shares. Any reserved shares not purchased by these persons will be
offered by the underwriters to the general public on the same terms as the other
shares offered in this offering.
COMMISSIONS AND DISCOUNTS
The representatives have advised us that the underwriters initially propose
to offer the shares to the public at the initial public offering price on the
cover page of this prospectus and to dealers at that price less a concession not
in excess of $ per share. The underwriters may allow, and the dealers may
reallow, a discount not in excess of $ per share to other dealers. After
this offering, the public offering price, concession and discount may be
changed.
The following table shows the public offering price, underwriting discount
and proceeds before expenses to us. The information assumes either no exercise
or full exercise by the underwriters of the overallotment option.
PER SHARE WITHOUT OPTION WITH OPTION
--------- -------------- -----------
Public offering price...................
Underwriting discount...................
Proceeds, before expenses, to us........
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The expenses of the offering, not including the underwriting discount, are
estimated at $3,150,000 and are payable by us.
OVERALLOTMENT OPTION
We have granted an option to the underwriters to purchase up to 1,050,000
additional shares at the public offering price less the underwriting discount.
The underwriters may exercise this option for 30 days from the date of this
prospectus solely to cover any overallotments. If the underwriters exercise this
option, each will be obligated, subject to conditions contained in the
underwriting agreement, to purchase a number of additional shares proportionate
to that underwriter's initial amount reflected in the above table.
NO SALES OF SIMILAR SECURITIES
We have agreed that, subject to specified exceptions (including issuances
of shares of common stock in connection with acquisitions), without the consent
of Bear Stearns, we will not, directly or indirectly, offer, sell or otherwise
dispose of any shares of our common stock or any securities that may be
converted into or exchanged for any shares of our common stock for a period of
180 days from the date of this prospectus. Our manager (including its executive
officers and directors), our executive officers and our directors have agreed
under lock-up agreements with Bear Stearns that, subject to specified exceptions
(including existing pledges and refinancing thereof and transfers for charitable
and estate planning purposes), without the prior written consent of Bear
Stearns, they will not, directly or indirectly, offer for sale, sell, pledge,
enter into any swap or other derivatives transaction that transfers to another
any of the economic benefits or risks of ownership of our common stock, or
otherwise dispose of any shares of our common stock or any securities that may
be converted into or exchanged for any shares of common stock (collectively,
"Transfer") for a period ending 365 days after the date of this prospectus or
pursuant to an earlier release as provided in the lock-up agreements and as
described under the heading "Shares Eligible For Future Sale -- Lock-up" in this
prospectus. In addition, Newcastle Investment Holdings has agreed under a
lock-up agreement with Bear Stearns that, subject to specified exceptions
(including existing pledges and refinancings thereof), without the prior written
consent of Bear Stearns, it will not, directly or indirectly, offer for sale,
sell, pledge, enter into any swap or other derivatives transaction that
transfers to another any of the economic benefits or risks of ownership of our
common stock, or otherwise dispose of any shares of our common stock or any
securities that may be converted into or exchanged for any shares of common
stock (collectively, "Transfer") for a period ending 180 days after the date of
this prospectus or pursuant to an earlier release as provided in the lock-up
agreement and as described under the heading "Shares Eligible For Future
Sale -- Lock-up" in this prospectus.
Newcastle Investment Holdings is a guarantor under a credit facility
entered into by a subsidiary of Newcastle Investment Holdings with Fleet
National Bank. In connection with an amendment to the credit facility which will
be entered into in September 2002, that, among other things, allows for
Newcastle Investment Holdings' contribution of assets to us in connection with
the initial transactions, Newcastle Investment Holdings will pledge as
collateral to Fleet all of the shares of our common stock held by Newcastle
Investment Holdings. In the event of a default under the credit facility, Fleet
could foreclose on the pledged shares. In connection with this offering, Fleet
will agree with Bear Stearns, subject to certain exceptions, that in the event
of a foreclosure, Fleet will not transfer any of the pledged shares for a period
of 180 days after the date of this prospectus without the prior written consent
of Bear Stearns.
In connection with this offering, we will grant to our manager an option to
purchase 700,000 shares of our common stock, representing 10% of the number of
shares being offered hereby, and subject to adjustment if the underwriters'
over-allotment option is exercised, at the offering price of our shares in this
offering, which will result in beneficial ownership by our manager and its
principals of approximately 20.5% of our equity upon exercise of all options,
including their beneficial interests in Newcastle Investment Holdings. The
option shares are not registered in connection with this offering.
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NEW YORK STOCK EXCHANGE LISTING
We have applied for listing on the New York Stock Exchange under the symbol
"NCT." In order to meet the requirements for listing on the NYSE, the
underwriters have undertaken that the shares will be sold to ensure that the
NYSE distribution standards are met.
Prior to this offering, there has been no public market for the shares of
our common stock. The initial public offering price has been negotiated between
the representatives and us. The material factors considered in determining the
initial public offering price of our common stock, in addition to prevailing
market conditions, were:
- our historical performance and capital structure;
- estimates of our business potential and earning prospects;
- an overall assessment of our management; and
- the above factors in relation to market valuation of companies in related
businesses.
An active trading market for the shares may not develop. It is also
possible that after the offering, the shares of our common stock will not trade
in the public market at or above the initial public offering price.
The underwriters do not expect to sell more than 5% of the shares of our
common stock in the aggregate to accounts over which they exercise discretionary
authority.
PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
Until the distribution of the shares is completed, SEC rules may limit
underwriters and selling group members from bidding for and purchasing our
common stock. However, the representatives may engage in transactions that
stabilize the price of the common stock, such as bids or purchases to peg, fix
or maintain that price.
If the underwriters create a short position in our common stock in
connection with this offering that is, if they sell more shares than are listed
on the cover of this prospectus, the representatives may reduce that short
position by purchasing shares in the open market. The representatives may also
elect to reduce any short position by exercising all or part of the
overallotment option described above. Purchases of our common stock to stabilize
its price or to reduce a short position may cause the price of our common stock
to be higher than it might be in the absence of those purchases.
The representatives may also impose a penalty bid on underwriters and
selling group members. This means that if the representatives purchase shares in
the open market to reduce the underwriters' short position or to stabilize the
price of those shares, they may reclaim the amount of the selling concession
from the underwriters and selling group members who sold those shares. The
imposition of a penalty bid may also affect the price of the shares in that it
discourages resales of those shares.
Neither we nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of our common stock. In addition, neither
we nor any of the underwriters makes any representation that the representatives
or the lead managers will engage in these transactions or that these
transactions, once commenced, will not be discontinued without notice.
OTHER RELATIONSHIPS
Some of the underwriters and their affiliates have engaged in, and may in
the future engage in, investment banking and other commercial dealings in the
ordinary course of business with us and our affiliates. They have received
customary fees and commissions for these transactions. We intend to use the net
proceeds of this offering to purchase a portfolio of mortgage loans from EMC
Mortgage Corporation ("EMC"), an affiliate of Bear Stearns. We have also entered
into a financing arrangement with an affiliate of Bear Stearns. See "Use of
Proceeds." In addition, in July 2002, we entered into an agreement with
123
Bear Stearns in connection with our proposed third CBO issuance for which Bear
Stearns will receive customary fees. See "Newcastle Investment Corp. -- Our
Investments." Bear Stearns Private Equity Opportunity Fund II, LP has committed
to invest $10 million in Fortress Investment Fund. Atlantic Equity Corporation,
an affiliate of Banc of America Securities LLC, has committed to invest $10
million in Fortress Investment Fund and owns 536,193 shares of common stock of
Newcastle Investment Holdings Corp. In September 2002, we sold to Bear Stearns
for $37.9 million an aggregate of $62.3 million face amount of bonds that we
held that were issued by the various affiliates of Newcastle Investment Holdings
that hold indirectly the GSA portfolio.
124
LEGAL MATTERS
Certain legal matters will be passed upon for us by Skadden, Arps, Slate,
Meagher & Flom LLP, New York, New York, and Piper Rudnick LLP, Baltimore,
Maryland and for the underwriters by Sidley Austin Brown & Wood LLP, New York,
New York. Sidley Austin Brown & Wood LLP has represented us in the past and
continues to represent us on a regular basis on a variety of matters.
EXPERTS
The consolidated financial statements of Newcastle Investment Holdings
Corp. (formerly Newcastle Investment Corp. and prior to that Fortress Investment
Corp.) and subsidiaries at December 31, 2001 and 2000, and for each of the three
years in the period ended December 31, 2001, appearing in this prospectus and
registration statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such reports given on the authority of such firm
as experts in accounting and auditing.
The balance sheet of Newcastle Investment Corp. at June 6, 2002 appearing
in this prospectus and registration statement has been audited by Ernst & Young
LLP, independent auditors, as set forth in their report thereon appearing
elsewhere herein, and is included in reliance upon such report given on the
authority of such firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement, of which this prospectus is a part,
on Form S-11 with the Securities and Exchange Commission (the "Commission")
relating to this offering. This prospectus does not contain all of the
information in the registration statement and the exhibits and financial
statements included with the registration statement. References in this
prospectus to any of our contracts, agreements or other documents are not
necessarily complete, and you should refer to the exhibits attached to the
registration statement for copies of the actual contracts, agreements or
documents. You may read and copy the registration statement, the related
exhibits and other material we file with the Commission at the Commission's
public reference room in Washington, D.C. at Room 1024, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C. 20549. You can also request copies of those
documents, upon payment of a duplicating fee, by writing to the Commission.
Please call the Commission at 1-800-SEC-0330 for further information on the
operation of the public reference rooms. The Commission also maintains an
internet site that contains reports, proxy and information statements and other
information regarding issuers that file with the Commission. The website address
is http://www.sec.gov. You may also request a copy of these filings, at no cost,
by writing or telephoning us as follows: Newcastle Investment Corp., c/o
Fortress Investment Group, 1251 Avenue of the Americas, New York, NY 10020,
Attention: Secretary or (212) 798-6100.
Upon the effectiveness of the registration statement, we will be subject to
the informational requirements of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and, in accordance with the Exchange Act, will
file reports, proxy and information statements and other information with the
Commission. Such annual, quarterly and special reports, proxy and information
statements and other information can be inspected and copied at the locations
set forth above. We will report our financial statements on a year ended
December 31. We intend to furnish our stockholders with annual reports
containing consolidated financial statements audited by our independent
certified public accountants and with quarterly reports containing unaudited
consolidated financial statements for each of the first three quarters of each
fiscal year.
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INDEX TO FINANCIAL STATEMENTS
TABLE OF CONTENTS
PAGE
----
NEWCASTLE INVESTMENT CORP.
HISTORICAL FINANCIAL STATEMENT
Report of Independent Auditors.............................. F-2
Balance Sheet at June 6, 2002............................... F-3
Notes to Balance Sheet at June 6, 2002...................... F-4
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Pro Forma Balance Sheet at June 30, 2002
(unaudited)............................................... F-6
Notes to Consolidated Pro Forma Balance Sheet at June 30,
2002 (unaudited).......................................... F-7
Consolidated Pro Forma Statement of Income for the Six
Months Ended June 30, 2002 (unaudited).................... F-8
Notes to Consolidated Pro Forma Statement of Income for the
Six Months Ended June 30, 2002 (unaudited)................ F-9
Consolidated Pro Forma Statement of Income for the Year
Ended December 31, 2001 (unaudited)....................... F-10
Notes to Consolidated Pro Forma Statement of Income for the
Year Ended December 31, 2001 (unaudited).................. F-11
Consolidated Pro Forma Statement of Income for the Six
Months Ended June 30, 2001 (unaudited).................... F-12
Notes to Consolidated Pro Forma Statement of Income for the
Six Months Ended June 30, 2001 (unaudited)................ F-13
Consolidated Pro Forma Statement of Income for the Year
Ended December 31, 2000 (unaudited)....................... F-14
Notes to Consolidated Pro Forma Statement of Income for the
Year Ended December 31, 2000 (unaudited).................. F-15
Consolidated Pro Forma Statement of Income for the Year
Ended December 31, 1999 (unaudited)....................... F-16
Notes to Consolidated Pro Forma Statement of Income for the
Year Ended December 31, 1999(unaudited)................... F-17
NEWCASTLE INVESTMENT HOLDINGS CORP.
HISTORICAL CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors.............................. F-18
Consolidated Balance Sheets at December 31, 2001 and 2000... F-19
Consolidated Statements of Income For The Years Ended
December 31, 2001, 2000 and 1999.......................... F-20
Consolidated Statements of Stockholders' Equity and
Redeemable Preferred Stock For The Years Ended December
31, 2001, 2000 and 1999................................... F-21
Consolidated Statements of Cash Flows For The Years Ended
December 31, 2001, 2000 and 1999.......................... F-22
Notes to Consolidated Financial Statements For The Years
Ended December 31, 2001, 2000 and 1999.................... F-23
Consolidated Balance Sheets at June 30, 2002 (unaudited) and
December 31, 2001......................................... F-52
Consolidated Statements of Income for the Six Months Ended
June 30, 2002 and 2001 (unaudited)........................ F-53
Consolidated Statements of Stockholders' Equity and
Redeemable Preferred Stock for the Six Months Ended June
30, 2002 and 2001 (unaudited)............................. F-54
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2002 and 2001 (unaudited).................. F-55
Notes to Consolidated Financial Statements for the Six
Months Ended June 30, 2002 and 2001 (unaudited)........... F-56
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Newcastle Investment Corp.
We have audited the accompanying balance sheet of Newcastle Investment
Corp. (the "Company") as of June 6, 2002. This balance sheet is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this balance sheet based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the balance sheet is free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the balance sheet. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall balance sheet presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material respects, the financial position of Newcastle Investment Corp. as of
June 6, 2002, in conformity with accounting principles generally accepted in the
United States.
/s/ ERNST & YOUNG LLP
New York, New York
June 10, 2002
F-2
NEWCASTLE INVESTMENT CORP.
BALANCE SHEET
JUNE 6, 2002
--------------
(IN THOUSANDS)
ASSETS
Total assets................................................ $ 0.00
======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities................................................. $ 0.00
Stockholders' equity:
Common stock, $.01 par value, 500,000,000 shares authorized
1 share issued and outstanding............................ 0.01
Additional paid in capital.................................. 0.99
Subscriptions receivable.................................... (1.00)
------
Total stockholders' equity.................................. 0.00
Total liabilities and stockholders' equity.................. $ 0.00
======
See accompanying note to balance sheet.
F-3
NEWCASTLE INVESTMENT CORP.
NOTE TO BALANCE SHEET
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
Newcastle Investment Corp. (the "Company") was incorporated in the state of
Maryland on June 6, 2002. The Company was formed for the purpose of separating
the real estate securities and credit leased real estate businesses from
Newcastle Investment Holdings Corp. Upon completion of the separation
transaction, the Company expects to invest in real estate securities and other
real estate assets. Other than its formation, the Company has not conducted any
activities.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amount reported in the balance sheet.
F-4
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Newcastle Investment Holdings contributed to us certain assets and related
liabilities in exchange for all of our shares of our common stock. However, for
accounting purposes and throughout these financial statements, this transaction
is presented as a reverse spin-off. Under a reverse spin-off, Newcastle
Investment Corp. is treated as the continuing entity and the assets to be
retained by Newcastle Investment Holdings are accounted for as if they were
distributed at historical book basis through a spin-off to Newcastle Investment
Holdings.
As of July 12, 2002, for accounting purposes, we distributed to Newcastle
Investment Holdings Corp. assets which represented approximately thirty percent
of our total assets (100% of our real estate loans, our investment in the Fund,
and approximately 75% of our real properties, in each case based on book value
as of June 30, 2002), and related liabilities. The following assets were
retained by us:
- Real estate securities (CBO I and CBO II);
- Credit leased real estate (Bell Canada portfolio and LIV portfolio); and
- Other assets.
The unaudited pro forma consolidated statements of income are presented as
if the distribution had been consummated on January 1, 2002, 2001 or 2000, as
applicable. The historical results of operations of the assets and liabilities
distributed to Newcastle Investment Holdings for the six months ended June 30,
2002 and 2001 and the year ended December 31, 2001 have been presented as
discontinued operations, for those operations that constitute a component of an
entity. A component of an entity must have cash flows that are clearly
distinguished operationally and for financial reporting purposes from the rest
of the entity. Of the assets distributed to Newcastle Investment Holdings, the
GSA portfolio and the mortgage loans qualify as a component of an entity. The
remaining operations related to the other assets and liabilities distributed to
Newcastle Investment Holdings which are not a component of an entity have been
eliminated in these periods. The historical results of operations for the GSA
portfolio and the mortgage loans have also been presented as discontinued
operations for the years ended December 31, 2000 and 1999; the historical
results of operations for the other assets and liabilities distributed to
Newcastle Investment Holdings have not been eliminated for these periods. The
unaudited pro forma consolidated statements of income after discontinued
operations but before eliminations, represent the presentation of our operations
which will appear in our future financial statements for comparative periods
which occurred prior to the initial transactions.
The unaudited pro forma consolidated balance sheet is presented as if the
distribution had been consummated on June 30, 2002.
The unaudited pro forma consolidated financial statements are presented for
comparative purposes only, and are not necessarily indicative of what our actual
financial position or our consolidated results of operations would have been for
the periods presented, nor do they purport to represent the results of any
future periods. In the opinion of management, all adjustments necessary to
present fairly the unaudited pro forma financial information have been made.
The information below should be read in conjunction with "Management's
Discussion and Analysis of Pro Forma Financial Condition and Results of
Operations" and the financial statements and notes thereto included in this
prospectus.
F-5
NEWCASTLE INVESTMENT CORP.
CONSOLIDATED PRO FORMA BALANCE SHEET
JUNE 30, 2002
(UNAUDITED)
(IN THOUSANDS)
DISTRIBUTED TO
NEWCASTLE
INVESTMENT DISTRIBUTED TO
HOLDINGS NEWCASTLE
-------------- PRO FORMA INVESTMENT
AFTER HOLDINGS
DISCONTINUED DISCONTINUED --------------
HISTORICAL(A) OPERATIONS(B) OPERATIONS OTHER PRO FORMA
------------- -------------- ------------ -------------- ----------
ASSETS
CBO collateral, net............................. $1,006,882 $ -- $1,006,882 $ -- $1,006,882
Operating real estate, net...................... 487,628 (369,395) 118,233 -- 118,233
Loans and mortgage pools receivable, net........ 45 (45) -- -- --
Marketable securities, available for sale....... 21,776 -- 21,776 (14,592)(C) 7,184
Investments in unconsolidated subsidiaries...... 86,406 -- 86,406 (86,406)(C) --
Cash and cash equivalents....................... 13,578 (1,681) 11,897 (10,742)(C) 1,155
Restricted cash................................. 10,337 (4,029) 6,308 -- 6,308
Due from (to) affiliates........................ 12,957 -- 12,957 (12,957)(C) --
Deferred costs, net............................. 15,435 (4,864) 10,571 (985)(C) 9,586
Receivables and other assets.................... 26,058 (10,315) 15,743 (62)(C) 15,681
---------- --------- ---------- --------- ----------
$1,681,102 $(390,329) $1,290,773 $(125,744) $1,165,029
========== ========= ========== ========= ==========
LIABILITIES, MINORITY INTEREST, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS'
EQUITY
LIABILITIES
CBO bonds payable............................... $ 867,058 $ -- $ 867,058 -- $ 867,058
Other bonds payable............................. 351,392 (312,653) 38,739 -- 38,739
Notes payable................................... 51,570 -- 51,570 -- 51,570
Repurchase agreements........................... 1,457 -- 1,457 -- 1,457
Credit facility................................. 38,250 -- 38,250 (38,250)(C) --
Derivative liabilities.......................... 30,510 -- 30,510 (1,698)(C) 28,812
Dividends payable............................... 9,893 -- 9,893 (9,893)(C) --
Accrued expenses and other liabilities.......... 12,645 (5,729) 6,916 (485)(C) 6,431
---------- --------- ---------- --------- ----------
1,362,775 (318,382) 1,044,393 (50,326) 994,067
---------- --------- ---------- --------- ----------
Commitments and contingencies
MINORITY INTEREST............................... 103 (103) -- -- --
STOCKHOLDERS' EQUITY
Common stock.................................... 165 -- 165 -- 165
Additional paid-in capital...................... 309,356 (68,771) 240,585 (81,872)(C) 158,713
Dividends in excess of earnings................. (14,457) -- (14,457) 14,457(C) --
Accumulated other comprehensive income.......... 23,160 (3,073) 20,087 (8,003)(C) 12,084
---------- --------- ---------- --------- ----------
318,224 (71,844) 246,380 (75,418) 170,962
---------- --------- ---------- --------- ----------
$1,681,102 $(390,329) $1,290,773 $(125,744) $1,165,029
========== ========= ========== ========= ==========
F-6
NEWCASTLE INVESTMENT CORP.
NOTES TO CONSOLIDATED PRO FORMA BALANCE SHEET
JUNE 30, 2002
(UNAUDITED)
(A) Historical amounts were derived from our unaudited historical consolidated
financial statements as of and for the six months ended June 30, 2002.
(B) Adjustments represent historical balances of assets and liabilities related
to investments distributed to Newcastle Investment Holdings which have been
treated as discontinued operations, specifically the GSA portfolio and the
mortgage loans.
(C) Adjustments represent historical balances related to other investments
distributed to Newcastle Investment Holdings, which have been eliminated, as
they will have no continuing impact on our operations.
F-7
NEWCASTLE INVESTMENT CORP.
CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
DISTRIBUTED TO
NEWCASTLE
INVESTMENT DISTRIBUTED TO
HOLDINGS NEWCASTLE
-------------- PRO FORMA INVESTMENT
AFTER HOLDINGS
DISCONTINUED DISCONTINUED --------------
HISTORICAL(A) OPERATIONS(B) OPERATIONS OTHER PRO FORMA
------------- -------------- ------------- -------------- ---------
REVENUES
Interest and dividend income.................... $31,100 $ (65) $31,035 $ (174)(C) $30,861
Rental and escalation income.................... 37,532 (26,744) 10,788 -- 10,788
Gain (loss) on settlement of investments........ 5,108 (107) 5,001 29(C) 5,030
Management fee from affiliates.................. 4,470 -- 4,470 (4,470)(C) --
Incentive income from affiliates................ (1,218) -- (1,218) 1,218(C) --
Other income.................................... 12 -- 12 (3)(C) 9
------- -------- ------- ------- -------
77,004 (26,916) 50,088 (3,400) 46,688
------- -------- ------- ------- -------
EXPENSES
Interest expense................................ 32,769 (11,281) 21,488 (2,315)(C) 19,173
Property operating expense...................... 14,276 (9,515) 4,761 -- 4,761
Loan servicing and REO expense.................. 423 (222) 201 -- 201
General and administrative expense.............. 1,838 (258) 1,580 (100)(C) 1,480
Management fees to affiliates................... 7,168 -- 7,168 (5,345)(D) 1,823
Incentive return to affiliates.................. 827 -- 827 (827)(D) --
Depreciation and amortization................... 6,802 (4,941) 1,861 (430)(C) 1,431
------- -------- ------- ------- -------
64,103 (26,217) 37,886 (9,017) 28,869
------- -------- ------- ------- -------
INCOME BEFORE EQUITY IN EARNINGS OF
UNCONSOLIDATED SUBSIDIARIES AND MINORITY
INTEREST...................................... 12,901 (699) 12,202 5,617 17,819
Equity in earnings (losses) of unconsolidated
subsidiaries.................................. 362 -- 362 (362)(C) --
Minority interest in income of consolidated
subsidiaries.................................. (13) 13 -- -- --
------- -------- ------- ------- -------
INCOME FROM CONTINUING OPERATIONS............... $13,250 $ (686) $12,564 $ 5,255 $17,819
======= ======== ======= ======= =======
Income from continuing operations per common
share, basic and diluted...................... $ 0.80 $ 0.76 $ 1.05
======= ======= =======
Weighted average number of common shares
outstanding, basic and diluted................ 16,489 16,489 16,969(E)
======= ======= =======
F-8
NEWCASTLE INVESTMENT CORP.
NOTES TO CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
(A) Historical amounts were derived from our unaudited historical consolidated
financial statements as of and for the six months ended June 30, 2002.
(B) Adjustments represent historical results of operations related to
investments distributed to Newcastle Investment Holdings which have been
treated as discontinued operations, specifically the GSA portfolio and the
mortgage loans.
(C) Adjustments represent historical results of operations related to other
investments distributed to Newcastle Investment Holdings, which have been
eliminated, as they will have no continuing impact on our operations, as
follows:
RELATED INVESTMENT
------------------------------------------
FORTRESS
AUSTIN INVESTMENT
CAPTION HOLDINGS FUND ICH(I) CORPORATE TOTAL
- ------- -------- ---------- ------ --------- -------
Interest and dividend income............................ $ -- $ (35) $-- $ (139) $ (174)
Gain on settlement of investments....................... -- -- 29 -- 29
Management fee from affiliates.......................... -- -- -- (4,470)(ii) (4,470)
Incentive income from affiliates........................ -- 1,218 -- -- 1,218
Other income............................................ -- -- -- (3) (3)
Interest expense........................................ -- -- -- (2,315)(iii) (2,315)
General and administrative expense...................... -- -- -- (100)(iv) (100)
Depreciation and amortization........................... -- (329) -- (101)(v) (430)
Equity in earnings of unconsolidated subsidiaries....... (59) (303) -- -- (362)
- ---------------
(i) Relates to assets acquired in the ICH transaction which were sold prior
to the initial transactions.
(ii) Represents the management fee received by the Managing Member related
to Fortress Investment Fund which is paid directly to the Manager and
will have no continuing impact on our operations.
(iii) Represents interest on Newcastle Investment Holdings' line of credit.
(iv) Represents data processing expenses, state and local taxes, and
professional fees related directly to entities and assets distributed
to Newcastle Investment Holdings.
(v) Represents depreciation of furniture, fixtures and equipment
distributed to Newcastle Investment Holdings.
(D) Management fees related to the Managing Member's agreement with Fortress
Investment Fund ($4.5 million) have been eliminated as they will have no
continuing impact on our operations. Management fees related to our
management agreement with the Manager have been allocated pro rata between
continuing operations and operations related to assets distributed to
Newcastle Investment Holdings, based on pro forma equity; incentive return
has been allocated based on the investments which generated such return. We
note that we will not be responsible for management fees or incentive return
related to the investments or equity distributed to Newcastle Investment
Holdings. The actual management fee charged to us is based upon actual
equity, as defined. Accordingly, management fees have been allocated between
the operations distributed to Newcastle Investment Holdings and our
continuing operations based upon the same methodology. The incentive return
has been allocated to the investments which generated such return.
(E) Includes 0.5 million shares deemed to be issued for pro forma statement of
income purposes only, which would generate incremental proceeds sufficient
to offset Newcastle Investment Holdings' dividends in excess of earnings for
the six months ended June 30, 2002 of $6.7 million.
F-9
NEWCASTLE INVESTMENT CORP.
CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2001
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
DISTRIBUTED TO
NEWCASTLE
INVESTMENT DISTRIBUTED TO
HOLDINGS NEWCASTLE
-------------- PRO FORMA INVESTMENT
AFTER HOLDINGS
DISCONTINUED DISCONTINUED --------------
HISTORICAL(A) OPERATIONS(B) OPERATIONS OTHER PRO FORMA
------------- -------------- ------------ -------------- ---------
REVENUES
Interest and dividend income................... $ 53,434 $ (4,491) $ 48,943 $ (1,232)(C) $47,711
Rental and escalation income................... 75,979 (53,690) 22,289 -- 22,289
Gain (loss) on settlement of investments....... 10,386 (1,948) 8,438 (1,033)(C) 7,405
Management fee from affiliates................. 8,941 -- 8,941 (8,941)(C) --
Incentive income from affiliates............... 28,709 -- 28,709 (28,709)(C) --
Other income................................... 146 (78) 68 (25)(C) 43
-------- -------- -------- -------- -------
177,595 (60,207) 117,388 (39,940) 77,448
-------- -------- -------- -------- -------
EXPENSES
Interest expense............................... 61,332 (25,469) 35,863 (3,204)(C) 32,659
Property operating expense..................... 28,822 (18,992) 9,830 -- 9,830
Loan servicing and REO expense................. 965 (711) 254 (11)(C) 243
General and administrative expense............. 2,399 (778) 1,621 (338)(C) 1,283
Management fees to affiliates.................. 14,687 -- 14,687 (11,045)(D) 3,642
Incentive return to affiliates................. 17,188 -- 17,188 (17,188)(D) --
Depreciation and amortization.................. 13,049 (9,352) 3,697 (1,007)(C) 2,690
-------- -------- -------- -------- -------
138,442 (55,302) 83,140 (32,793) 50,347
-------- -------- -------- -------- -------
INCOME BEFORE EQUITY IN EARNINGS OF
UNCONSOLIDATED SUBSIDIARIES AND MINORITY
INTEREST..................................... 39,153 (4,905) 34,248 (7,147) 27,101
Equity in earnings (losses) of unconsolidated
subsidiaries................................. 2,807 -- 2,807 (2,807)(C) --
Minority interest in income of consolidated
subsidiaries................................. 83 (83) -- -- --
-------- -------- -------- -------- -------
INCOME FROM CONTINUING OPERATIONS.............. $ 42,043 $ (4,988) $ 37,055 $ (9,954) $27,101
======== ======== ======== ======== =======
Income from continuing operations per common
share, basic and diluted..................... $ 2.55 $ 2.25 $ 1.60
======== ======== =======
Weighted average number of common shares
outstanding, basic and diluted............... 16,493 16,493 16,973(E)
======== ======== =======
F-10
NEWCASTLE INVESTMENT CORP.
NOTES TO CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2001
(UNAUDITED)
(A) Historical amounts were derived from our audited historical consolidated
financial statements as of and for the year ended December 31, 2001.
(B) Adjustments represent historical results of operations related to
investments distributed to Newcastle Investment Holdings which have been
treated as discontinued operations, specifically the GSA portfolio and the
mortgage loans.
(C) Adjustments represent historical results of operations related to other
investments distributed to Newcastle Investment Holdings, which have been
eliminated, as they will have no continuing impact on our operations, as
follows:
RELATED INVESTMENT
-------------------------------------------
FORTRESS
AUSTIN INVESTMENT
CAPTION HOLDINGS FUND ICH(I) CORPORATE TOTAL
- ------- -------- ---------- ------- --------- --------
Interest and dividend income........................... $ -- $ (647) $ (260) $ (325)(ii) $ (1,232)
Gain on sale of investments............................ -- -- (1,984) 951(iii) (1,033)
Management fee from affiliates......................... -- -- -- (8,941)(iv) (8,941)
Incentive income from affiliates....................... -- (28,709) -- -- (28,709)
Other income........................................... -- -- -- (25) (25)
Interest expense....................................... -- -- -- (3,204)(v) (3,204)
Loan servicing and REO expense......................... -- -- (11) -- (11)
General and administrative expense..................... -- -- (74) (264)(vi) (338)
Depreciation and amortization.......................... -- (560) -- (447)(vii) (1,007)
Equity in earnings of unconsolidated subsidiaries...... 2,553 (5,360) -- -- (2,807)
- ---------------
(i) Relates to assets acquired in the ICH transaction which were sold prior
to the initial transactions.
(ii) Represents interest on corporate cash balances distributed to
Newcastle Investment Holdings as part of the initial transactions.
(iii) Represents the loss on the sale of a stock investment sold by
Newcastle Investment Holdings prior to the initial transactions.
(iv) Represents the management fee received by the Managing Member related
to Fortress Investment Fund which is paid directly to the Manager and
will have no continuing impact on our operations.
(v) Represents interest on Newcastle Investment Holdings' line of credit.
(vi) Represents data processing expenses, state and local taxes, and
professional fees related directly to entities and assets distributed
to Newcastle Investment Holdings.
(vii) Represents depreciation of furniture, fixtures and equipment
distributed to Newcastle Investment Holdings.
(D) Management fees related to the Managing Member's agreement with Fortress
Investment Fund ($8.9 million) have been eliminated as they will have no
continuing impact on our operations. Management fees related to our
management agreement with the Manager have been allocated pro rata between
continuing operations and operations related to assets distributed to
Newcastle Investment Holdings, based on pro forma equity; incentive return
has been allocated based on the investments which generated such return. We
note that we will not be responsible for management fees or incentive return
related to the investments or equity distributed to Newcastle Investment
Holdings. The actual management fee charged to us is based upon actual
equity, as defined. Accordingly, management fees have been allocated between
the operations distributed to Newcastle Investment Holdings and our
continuing operations based upon the same methodology. The incentive return
has been allocated to the investments which generated such return.
(E) Includes 0.5 million shares deemed to be issued for pro forma statement of
income purposes only, which would generate incremental proceeds sufficient
to offset Newcastle Investment Holdings' dividends in excess of earnings for
the six months ended June 30, 2002 of $6.7 million.
F-11
NEWCASTLE INVESTMENT CORP.
CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
DISTRIBUTED TO
NEWCASTLE
INVESTMENT DISTRIBUTED TO
HOLDINGS NEWCASTLE
-------------- PRO FORMA INVESTMENT
AFTER HOLDINGS
DISCONTINUED DISCONTINUED --------------
HISTORICAL(A) OPERATIONS(B) OPERATIONS OTHER PRO FORMA
------------- -------------- ------------ -------------- ---------
REVENUES
Interest and dividend income................... $28,370 $ (3,261) $25,109 $ (893)(C) $24,216
Rental and escalation income................... 38,015 (26,540) 11,475 9 (C) 11,484
Gain (loss) on settlement of investments....... 8,941 (1,520) 7,421 (1,031)(C) 6,390
Management fee from affiliates................. 4,470 -- 4,470 (4,470)(C) --
Other income................................... 22 (4) 18 (9)(C) 9
------- -------- ------- ------- -------
79,818 (31,325) 48,493 (6,394) 42,099
------- -------- ------- ------- -------
EXPENSES
Interest expense............................... 31,949 (13,435) 18,514 (1,672)(C) 16,842
Property operating expense..................... 14,359 (9,134) 5,225 -- 5,225
Loan servicing and REO expense................. 511 (395) 116 -- 116
General and administrative expense............. 757 (142) 615 (148)(C) 467
Management fees to affiliates.................. 7,221 -- 7,221 (5,718)(D) 1,503
Depreciation and amortization.................. 6,383 (4,604) 1,779 (458)(C) 1,321
------- -------- ------- ------- -------
61,180 (27,710) 33,470 (7,996) 25,474
------- -------- ------- ------- -------
INCOME BEFORE EQUITY IN EARNINGS OF
UNCONSOLIDATED SUBSIDIARIES AND MINORITY
INTEREST..................................... 18,638 (3,615) 15,023 1,602 16,625
Equity in earnings (losses) of unconsolidated
subsidiaries................................. 1,125 -- 1,125 (1,125)(C) --
Minority interest in income of consolidated
subsidiaries................................. (208) 208 -- -- --
------- -------- ------- ------- -------
INCOME FROM CONTINUING OPERATIONS.............. $19,555 $ (3,407) $16,148 $ 477 $16,625
======= ======== ======= ======= =======
Income from continuing operations per common
share, basic and diluted..................... $ 1.19 $ 0.98 $ 0.98
======= ======= =======
Weighted average number of common shares
outstanding, basic and diluted............... 16,497 16,497 16,977(E)
======= ======= =======
F-12
NEWCASTLE INVESTMENT CORP.
NOTES TO CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(UNAUDITED)
(A) Historical amounts were derived from our unaudited historical consolidated
financial statements as of and for the six months ended June 30, 2001.
(B) Adjustments represent historical results of operations related to
investments distributed to Newcastle Investment Holdings which have been
treated as discontinued operations, specifically the GSA portfolio and the
mortgage loans.
(C) Adjustments represent historical results of operations related to other
investments distributed to Newcastle Investment Holdings, which have been
eliminated, as they will have no continuing impact on our operations, as
follows:
RELATED INVESTMENT
---------------------------------------------
FORTRESS
AUSTIN INVESTMENT
CAPTION HOLDINGS FUND ICH(I) CORPORATE TOTAL
------- -------- ---------- ------- --------- -------
Interest and dividend income.......................... $ -- $ (434) $ -- $ (459)(ii) $ (893)
Rental and escalation income.......................... -- -- -- 9 9
Gain on sale of investments........................... -- -- (1,982) 951(iii) (1,031)
Management fee from affiliates........................ -- -- -- (4,470)(iv) (4,470)
Other income.......................................... -- -- -- (9) (9)
Interest expense...................................... -- -- -- (1,672)(v) (1,672)
General and administrative expense.................... -- -- (15) (133)(vi) (148)
Depreciation and amortization......................... -- (231) -- (227)(vii) (458)
Equity in earnings of unconsolidated subsidiaries..... 1,785 (2,910) -- -- (1,125)
- ---------------
(i) Relates to assets acquired in the ICH transaction which were sold prior
to the initial transactions.
(ii) Represents interest on corporate cash balances distributed to
Newcastle Investment Holdings as part of the initial transactions.
(iii) Represents the loss on the sale of a stock investment sold by
Newcastle Investment Holdings prior to the initial transactions.
(iv) Represents the management fee received by the Managing Member related
to Fortress Investment Fund which is paid directly to the Manager and
will have no continuing impact on our operations.
(v) Represents interest on Newcastle Investment Holdings' line of credit.
(vi) Represents data processing expenses, state and local taxes, and
professional fees related directly to entities and assets distributed
to Newcastle Investment Holdings.
(vii) Represents depreciation of furniture, fixtures and equipment
distributed to Newcastle Investment Holdings.
(D) Management fees related to the Managing Member's agreement with Fortress
Investment Fund ($4.5 million) have been eliminated as they will have no
continuing impact on our operations. Management fees related to our
management agreement with the Manager have been allocated pro rata between
continuing operations and operations related to assets distributed to
Newcastle Investment Holdings, based on pro forma equity. We note that we
will not be responsible for management fees related to the investments or
equity distributed to Newcastle Investment Holdings. The actual management
fee charged to us is based upon actual equity, as defined. Accordingly,
management fees have been allocated between the operations distributed to
Newcastle Investment Holdings and our continuing operations based upon the
same methodology.
(E) Includes 0.5 million shares deemed to be issued for pro forma statement of
income purposes only, which would generate incremental proceeds sufficient
to offset Newcastle Investment Holdings' dividends in excess of earnings for
the six months ended June 30, 2002 of $6.7 million.
F-13
NEWCASTLE INVESTMENT CORP.
CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2000
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
DISTRIBUTED TO
NEWCASTLE
INVESTMENT
HOLDINGS
--------------
DISCONTINUED
HISTORICAL(A) OPERATIONS(B) PRO FORMA
------------- -------------- ---------
REVENUES
Interest and dividend income................................ $ 65,389 $(14,400) $ 50,989
Rental and escalation income................................ 75,293 (52,567) 22,726
Gain (loss) on settlement of investments.................... 21,763 (927) 20,836
Management fee from affiliates.............................. 8,941 -- 8,941
Other income................................................ 1,006 (278) 728
-------- -------- --------
172,392 (68,172) 104,220
-------- -------- --------
EXPENSES
Interest expense............................................ 66,411 (29,514) 36,897
Property operating expense.................................. 28,264 (18,116) 10,148
Loan servicing and REO expense.............................. 2,325 (2,060) 265
General and administrative expense.......................... 3,988 (678) 3,310
Management fees to affiliates............................... 15,587 -- 15,587
Depreciation and amortization............................... 12,244 (9,190) 3,054
-------- -------- --------
128,819 (59,558) 69,261
-------- -------- --------
INCOME BEFORE EQUITY IN EARNINGS OF UNCONSOLIDATED
SUBSIDIARIES AND MINORITY INTEREST........................ 43,573 (8,614) 34,959
Equity in earnings (losses) of unconsolidated
subsidiaries.............................................. (980) -- (980)
Minority interest in income of consolidated subsidiaries.... (748) 748 --
-------- -------- --------
INCOME FROM CONTINUING OPERATIONS........................... $ 41,845 $ (7,866) $ 33,979
======== ======== ========
Income from continuing operations per common share, basic
and diluted............................................... $ 2.21 $ 1.80
======== ========
Weighted average number of common shares outstanding, basic
and diluted............................................... 18,892 18,892
======== ========
F-14
NEWCASTLE INVESTMENT CORP.
NOTES TO CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2000
(UNAUDITED)
(A) Historical amounts were derived from our audited historical consolidated
financial statements as of and for the year ended December 31, 2000.
(B) Adjustments represent historical results of operations related to
investments distributed to Newcastle Investment Holdings which are treated
as discontinued operations, specifically the GSA portfolio and the mortgage
loans.
F-15
NEWCASTLE INVESTMENT CORP.
CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1999
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
DISTRIBUTED TO
NEWCASTLE
INVESTMENT
HOLDINGS
--------------
DISCONTINUED
HISTORICAL(A) OPERATIONS(B) PRO FORMA
------------- -------------- ---------
REVENUES
Interest and dividend income................................ $ 50,245 $(19,957) $30,288
Rental and escalation income................................ 64,822 (47,735) 17,087
Gain (loss) on settlement of investments.................... (1,526) 3,291 1,765
Management fee from affiliates.............................. 944 -- 944
Other income................................................ 462 (393) 69
-------- -------- -------
114,947 (64,794) 50,153
-------- -------- -------
EXPENSES
Interest expense............................................ 46,529 (26,788) 19,741
Property operating expense.................................. 23,169 (14,741) 8,428
Loan servicing and REO expense.............................. 3,122 (3,010) 112
General and administrative expense.......................... 3,516 (433) 3,083
Management fees to affiliates............................... 8,351 (20) 8,331
Depreciation and amortization............................... 10,383 (8,564) 1,819
-------- -------- -------
95,070 (53,556) 41,514
-------- -------- -------
INCOME BEFORE EQUITY IN EARNINGS OF UNCONSOLIDATED
SUBSIDIARIES AND MINORITY INTEREST........................ 19,877 (11,238) 8,639
Equity in earnings (losses) of unconsolidated
subsidiaries.............................................. (3,615) -- (3,615)
Minority interest in income of consolidated subsidiaries.... (1,258) 1,258 --
-------- -------- -------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY
ITEM...................................................... 15,004 $ (9,980) $ 5,024
======== =======
Income from discontinued operations......................... 149
Extraordinary item -- loss on extinguishment of debt........ (2,341)
--------
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE................ 12,812
Cumulative effect of change in accounting principle -- write
off of organizational costs............................... (513)
--------
NET INCOME.................................................. $ 12,299
========
Net Income per Common Share, basic and diluted.............. $ 0.59
========
Income from continuing operations per common share, basic
and diluted............................................... $ 0.72 $ 0.24
======== =======
Income before extraordinary item per common share, basic and
diluted................................................... $ 0.72
========
Effect of extraordinary item per common share, basic and
diluted................................................... $ (0.11)
========
Effect of change in accounting principle per common share,
basic and diluted......................................... $ (0.02)
========
Weighted average number of common shares outstanding, basic
and diluted............................................... 20,917 20,917
======== =======
F-16
NEWCASTLE INVESTMENT CORP.
NOTES TO CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1999
(UNAUDITED)
(A) Historical amounts were derived from our audited historical consolidated
financial statements as of and for the year ended December 31, 1999.
(B) Adjustments represent historical results of operations related to
investments distributed to Newcastle Investment Holdings which are treated
as discontinued operations, specifically the GSA portfolio and the mortgage
loans.
F-17
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Newcastle Investment Holdings Corp.
We have audited the accompanying consolidated balance sheets of Newcastle
Investment Holdings Corp. (formerly Newcastle Investment Corp. and prior to that
Fortress Investment Corp.) and subsidiaries (the "Company") as of December 31,
2001 and 2000, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the consolidated financial position of the Company at December 31,
2001 and 2000, and the consolidated results of its operations and its cash flows
for each of the three years in the period ended December 31, 2001 in conformity
with general accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1999
the Company adopted Statement of Position 98-5, "Reporting on the Costs of
Start-up Activities" which required the expensing of unamortized organization
costs.
As discussed in Note 2 to the consolidated financial statements, in 2001
the Company adopted Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
Statement of Financial Accounting Standards No. 138, "Accounting for Derivative
Instruments and Certain Hedging Activities."
/s/ ERNST & YOUNG LLP
New York, New York
March 15, 2002, except for note 16 as to
which the date is August 14, 2002
F-18
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DEC. 31, 2001 DEC. 31, 2000
------------- -------------
(IN THOUSANDS)
ASSETS
Operating real estate, net -- Note 4........................ $ 524,834 $ 540,539
CBO collateral, net -- Note 5............................... 522,258 509,729
Loans and mortgage pools receivable, net -- Note 3.......... 10,675 106,957
Marketable securities, available for sale................... 14,467 40,491
Investments in unconsolidated subsidiaries -- Note 6........ 73,208 63,427
Cash and cash equivalents................................... 31,360 10,575
Restricted cash............................................. 34,508 12,453
Due from (to) affiliates -- Note 12......................... 11,334 (328)
Deferred costs, net......................................... 17,988 23,541
Receivables and other assets................................ 21,487 23,702
---------- ----------
$1,262,119 $1,331,086
========== ==========
LIABILITIES, MINORITY INTEREST, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
LIABILITIES
CBO bonds payable -- Note 10.............................. $ 445,514 $ 424,972
Other bonds payable -- Note 10............................ 319,303 380,663
Notes payable -- Note 9................................... 111,116 120,727
Repurchase agreements -- Note 8........................... 1,457 16,294
Credit facility -- Note 9................................. 20,000 33,000
Derivative liabilities.................................... 11,732 14,399
Dividends payable......................................... 8,882 149
Accrued expenses and other liabilities.................... 10,633 12,134
---------- ----------
928,637 1,002,338
---------- ----------
Commitments and contingencies -- Note 13
MINORITY INTEREST........................................... 2,527 7,926
Redeemable preferred stock, par value $.01 per share,
100,000,000 shares authorized; 1,020,517 shares issued and
outstanding at December 31, 2001 and 2000................. 20,410 20,167
STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 500,000,000 shares authorized;
16,488,517 and 16,499,765 shares issued and outstanding at
December 31, 2001 and 2000, respectively.................. 165 165
Additional paid-in capital.................................. 309,356 309,551
Dividends in excess of earnings............................. (7,767) (7,666)
Accumulated other comprehensive income (loss)............... 8,791 (1,395)
---------- ----------
310,545 300,655
---------- ----------
$1,262,119 $1,331,086
========== ==========
See notes to consolidated financial statements
F-19
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, 2001 DEC. 31, 2000 DEC. 31, 1999
------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES:
Rental and escalation income........................ $ 75,979 $ 75,293 $ 64,822
Interest and dividend income........................ 53,434 65,389 50,245
Gain (loss) on settlement of investments............ 10,386 21,763 (1,526)
Management fee from affiliates -- Note 6............ 8,941 8,941 944
Incentive income from affiliates -- Note 6.......... 28,709 -- --
Other income........................................ 146 1,006 462
------------- ------------- -------------
177,595 172,392 114,947
------------- ------------- -------------
EXPENSES:
Interest expense.................................... 61,332 66,411 46,529
Property operating expense.......................... 28,822 28,264 23,169
Loan servicing and REO expense...................... 965 2,325 3,122
General and administrative expense.................. 2,399 3,988 3,516
Management fee to affiliates -- Note 6 and 12....... 14,687 15,587 8,351
Incentive return to affiliates -- Note 12........... 17,188 -- --
Depreciation and amortization....................... 13,049 12,244 10,383
------------- ------------- -------------
138,442 128,819 95,070
------------- ------------- -------------
INCOME BEFORE EQUITY IN EARNINGS OF UNCONSOLIDATED
SUBSIDIARIES AND MINORITY INTEREST.................. 39,153 43,573 19,877
Equity in earnings (losses) of unconsolidated
subsidiaries........................................ 2,807 (980) (3,615)
Minority interest in income of consolidated
subsidiaries........................................ 83 (748) (1,258)
------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS..................... 42,043 41,845 15,004
Income from discontinued operations................... 1,628 1,015 149
Extraordinary item-loss on extinguishment of
debt -- Note 9...................................... -- -- (2,341)
------------- ------------- -------------
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE.......... 43,671 42,860 12,812
Cumulative effect of change in accounting
principle-write off of organizational costs......... -- -- (513)
------------- ------------- -------------
NET INCOME............................................ 43,671 42,860 12,299
Preferred dividends and related accretion............. (2,540) (2,084) --
------------- ------------- -------------
INCOME AVAILABLE FOR COMMON SHAREHOLDERS.............. $ 41,131 $ 40,776 $ 12,299
============= ============= =============
NET INCOME PER COMMON SHARE, BASIC AND DILUTED........ $ 2.49 $ 2.16 $ 0.59
============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING,
BASIC AND DILUTED................................... 16,492,708 18,892,232 20,916,739
============= ============= =============
Income from continuing operations per common share,
after preferred dividends and related accretion,
basic and diluted................................... $ 2.39 $ 2.11 $ 0.72
============= ============= =============
Income from discontinued operations per common share,
basic and diluted................................... $ 0.10 $ 0.05 $ 0.00
============= ============= =============
Effect of extraordinary item per common share, basic
and diluted......................................... $ -- $ -- $ (0.11)
============= ============= =============
Effect of change in accounting principle per common
share, basic and diluted............................ $ -- $ -- $ (0.02)
============= ============= =============
See notes to consolidated financial statements
F-20
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
REDEEMABLE
PREFERRED STOCK COMMON STOCK DIV'S IN TOTAL
-------------------- ------------------- ADDITIONAL EXCESS OF ACCUM. OTHER STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT PD. IN CAP. EARNINGS COMP. INCOME EQUITY
---------- ------- ---------- ------ ----------- --------- ------------ -------------
(DOLLARS IN THOUSANDS)
Stockholders'
equity -- December 31,
1998...................... -- $ -- 20,916,739 $209 $388,045 $ (864) $ (2,466) $384,924
---------- ------- ---------- ---- -------- -------- -------- --------
Dividends declared.......... -- -- -- -- -- (42,671) -- (42,671)
Comprehensive income
Net income................ -- -- -- -- -- 12,299 -- 12,299
Unrealized loss on
securities:
reclassification
adjustment.............. -- -- -- -- -- -- 1,886 1,886
Unrealized loss on
securities.............. -- -- -- -- -- -- (1,981) (1,981)
Foreign currency
translation............. -- -- -- -- -- -- 216 216
--------
Total comprehensive
income.................. 12,420
---------- ------- ---------- ---- -------- -------- -------- --------
Stockholders'
equity -- December 31,
1999...................... -- -- 20,916,739 209 388,045 (31,236) (2,345) 354,673
---------- ------- ---------- ---- -------- -------- -------- --------
Redemption of common
shares.................... -- -- (2,210,540) (22) (32,204) -- -- (32,226)
Exchange of redeemable
preferred stock for common
shares.................... 2,370,516 46,312 (2,206,434) (22) (46,290) -- -- (46,312)
Redemption of redeemable
preferred stock........... (1,349,999) (26,999) -- -- -- -- -- --
Dividends declared.......... -- -- -- -- -- (18,436) -- (18,436)
Accretion of redeemable
preferred stock........... -- 854 -- -- -- (854) -- (854)
Comprehensive income:
Net income................ -- -- -- -- -- 42,860 -- 42,860
Unrealized loss on
securities:
reclassification
adjustment.............. -- -- -- -- -- -- 509 509
Unrealized gain on
securities.............. -- -- -- -- -- -- 2,828 2,828
Foreign currency
translation:
reclassification
adjustment.............. -- -- -- -- -- -- 257 257
Foreign currency
translation............. -- -- -- -- -- -- (2,644) (2,644)
--------
Total comprehensive
income.................. 43,810
---------- ------- ---------- ---- -------- -------- -------- --------
Stockholders'
equity -- December 31,
2000...................... 1,020,517 20,167 16,499,765 165 309,551 (7,666) (1,395) 300,655
---------- ------- ---------- ---- -------- -------- -------- --------
Redemption of common
shares.................... -- -- (11,248) -- (195) -- -- (195)
Dividends declared.......... -- -- -- -- -- (43,529) -- (43,529)
Accretion of redeemable
preferred stock........... -- 243 -- -- -- (243) -- (243)
Translation
adjustment -- deferred
hedge gains and losses.... -- -- -- -- -- -- 4,064 4,064
Comprehensive income:
Net income................ -- -- -- -- -- 43,671 -- 43,671
Unrealized loss on
securities:
reclassification
adjustment.............. -- -- -- -- -- -- 954 954
Unrealized gain on
securities.............. -- -- -- -- -- -- 19,695 19,695
Foreign currency
translation:
reclassification
adjustment.............. -- -- -- -- -- -- 29 29
Foreign currency
translation............. -- -- -- -- -- -- (3,198) (3,198)
Unrealized loss on
derivatives designated
as cash flow hedges:
reclassification
adjustment.............. -- -- -- -- -- -- 205 205
Unrealized loss on
derivatives designated
as cash flow hedges..... -- -- -- -- -- -- (11,563) (11,563)
--------
Total comprehensive
income.................. 49,793
---------- ------- ---------- ---- -------- -------- -------- --------
Stockholders'
equity -- December 31,
2001...................... 1,020,517 $20,410 16,488,517 $165 $309,356 $ (7,767) $ 8,791 $310,545
========== ======= ========== ==== ======== ======== ======== ========
See notes to consolidated financial statements.
F-21
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, 2001 DEC. 31, 2000 DEC. 31, 1999
------------- ------------- -------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 43,671 $ 42,860 $ 12,299
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 13,996 13,183 10,474
Accretion of discount and other amortization............ (3,284) (2,739) (2,193)
Equity in (earning) loss of unconsolidated
subsidiaries........................................... (2,807) 980 3,615
Accrued incentive income from affiliates................ (11,715) -- --
Minority interest....................................... (83) 748 1,258
Deferred rent........................................... (1,964) (2,544) (2,763)
(Gain)/loss on settlement of investments................ (10,386) (21,763) 1,526
Write off of organizational costs....................... -- -- 513
Loss on extinguishment of debt.......................... -- -- 2,341
Change in:
Restricted cash......................................... 1,308 537 8,373
Receivables and other assets............................ 2,687 (627) (3,474)
Accrued expenses and other liabilities.................. (555) (5,582) 2,090
Due from affiliates..................................... 3,580 (230) (1,225)
--------- --------- ---------
Net cash provided by operating activities............. 34,448 24,823 32,834
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase and improvement of operating real estate......... (4,495) (1,520) (172,522)
Acquisitions of and advances on loans..................... -- (33,770) (86,217)
Repayments of loan principal.............................. 75,324 62,891 66,610
Proceeds from settlement of loans and foreclosed real
estate.................................................. 29,069 22,239 87,782
Contributions to unconsolidated subsidiaries.............. (25,829) (57,042) (39,457)
Distributions from unconsolidated subsidiaries............ 25,814 11,170 29,845
Purchase of CBO collateral................................ (73,365) (10,799) (543,141)
Proceeds from sale of CBO collateral...................... 105,722 10,543 43,410
Deposit on CBO collateral................................. (23,631) -- --
Payment of deferred transaction costs..................... (5,150) (1,319) (5,126)
Settlement of foreign exchange future contracts........... -- (137) (3,184)
Purchase of marketable securities......................... (7,680) (29,935) (67,399)
Proceeds from sale of marketable securities............... 10,274 179,311 5,979
--------- --------- ---------
Net cash provided by (used in) investing activities... 106,053 151,632 (683,420)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under repurchase agreements.................... 10,000 -- 406,884
Repayments of repurchase agreements....................... (24,837) (104,314) (484,081)
Borrowings under notes payable............................ -- -- 143,361
Repayments of notes payable............................... (4,157) (541) (252,776)
Issuance of CBO bonds payable............................. 18,418 -- 422,396
Issuance of other bonds payable........................... -- -- 411,192
Repayment of other bonds payable.......................... (64,175) (17,899) (12,655)
Draws under credit facility............................... 21,000 74,000 --
Repayments of credit facility............................. (34,000) (41,000) --
Redemption of common stock................................ (195) (32,226) --
Redemption of redeemable preferred stock.................. -- (27,000) --
Minority interest contributions (distributions)........... (5,090) (1,485) 3,065
Dividends paid............................................ (34,796) (28,893) (38,488)
Payment of deferred financing costs....................... (1,884) (867) (23,859)
Settlement of hedges of anticipated financings............ -- -- 13,563
Purchase of non-hedge derivatives......................... -- -- (3,022)
Sale of non-hedge derivatives............................. -- -- 3,755
--------- --------- ---------
Net cash provided by (used in) financing activities... (119,716) (180,225) 589,335
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 20,785 (3,770) (61,251)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 10,575 14,345 75,596
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 31,360 $ 10,575 $ 14,345
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest expense............ $ 61,640 $ 66,141 $ 45,772
========= ========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Loan foreclosures......................................... $ -- $ (5,169) $ (945)
========= ========= =========
Common stock dividends declared but not paid.............. $ 8,244 $ -- $ 10,458
========= ========= =========
Redeemable preferred stock dividends declared but not
paid.................................................... $ 638 $ 149 $ --
========= ========= =========
Deposits used in purchases of operating real estate....... $ -- $ -- $ 11,105
========= ========= =========
Issuance of redeemable preferred stock in exchange for
common stock............................................ $ -- $ (46,312) $ --
========= ========= =========
Repurchase agreements assumed............................. $ -- $ 94,776 $ --
========= ========= =========
Transfer of interest in unconsolidated subsidiary......... $ -- $ 5,169 $ --
========= ========= =========
See notes to consolidated financial statements.
F-22
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
(DOLLAR AMOUNTS IN TABLES SHOWN IN THOUSANDS, EXCEPT PER SHARE DATA)
1. ORGANIZATION
Newcastle Investment Holdings Corp. (formerly Newcastle Investment Corp.
and prior to that Fortress Investment Corp.) ("Newcastle Holdings") is a
Maryland corporation that invests in real estate-related assets on a global
basis. Its primary businesses are (1) investing in marketable real
estate-related debt securities, (2) investing in commercial properties leased to
third parties, (3) investing in Fortress Investment Fund LLC (the "Fund"), and
(4) investing in distressed, sub-performing and performing residential and
commercial mortgage loans, or portfolios thereof, and related properties
acquired in foreclosure or by deed-in-lieu of foreclosure.
The consolidated financial statements include the accounts of Newcastle
Holdings and its controlled subsidiaries, which include Fortress Partners, L.P.
(the "Operating Partnership"), its primary investment subsidiary.
Newcastle Holdings was incorporated on May 11, 1998 and was initially
capitalized through the sale of 50 shares of common stock for $1,000. In June
1998, Newcastle Holdings completed a private offering for the sale of 20,912,401
shares of common stock (the "Private Offering"), including an over-allotment
option, for proceeds of approximately $384.5 million, net of expenses. In
addition, in July 1998, certain employees of Fortress Investment Group LLC (the
"Manager") purchased 4,288 shares of common stock resulting in additional
proceeds of approximately $0.1 million. In 2000 and 2001, Newcastle Holdings
repurchased 4,416,974 and 11,248 shares of common stock, respectively, for an
aggregate of $32.4 million of cash and $46.3 million of Series A Cumulative
Convertible Preferred Stock (the "Series A Preferred"). At December 31, 2001,
Newcastle Holdings had 16,488,517 common shares issued and outstanding.
The Series A Preferred has a $20 liquidation preference and pays dividends
of $2.00 per share for the year ended June 30, 2001, $2.50 per share for the
year ending June 30, 2002, and $3.00 per share each year thereafter. The Series
A Preferred is convertible during the period from June 30, 2002 through December
27, 2002 at a price of $17 per common share and can also be redeemed by the
holder at the liquidation preference amount at any time after June 30, 2002.
Newcastle Holdings can redeem the Series A Preferred at $20 per share at any
time. Approximately $20.4 million of the Series A Preferred remained outstanding
at December 31, 2001.
Newcastle Holdings has elected to be taxed as a real estate investment
trust ("REIT") under the Internal Revenue Code of 1986 (the "Code"). As such,
Newcastle Holdings will generally not be subject to federal income tax on that
portion of its income that is distributed to shareholders if it distributes at
least 90% of its REIT taxable income to its shareholders by the due date of its
federal income tax return and complies with various other requirements.
Newcastle Holdings has entered into a management agreement (the "Management
Agreement," further described in Note 12) with the Manager under which the
Manager advises Newcastle Holdings on various aspects of its business and
manages its day-to-day operations, subject to the supervision of Newcastle
Holdings' board of directors. For its services, the Manager receives an annual
management fee, as defined in the Management Agreement. In addition, an
affiliate of the Manager holds a nominal (less than 0.1%) equity interest in the
Operating Partnership, designated a Special Limited Partnership interest, which
provides for an Incentive Return (Note 12).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING -- The accompanying consolidated financial statements
are prepared in accordance with accounting principles generally accepted in the
United States ("GAAP") and include the accounts of Newcastle Holdings, the
Operating Partnership, and their consolidated subsidiaries. All
F-23
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
significant intercompany transactions and balances have been eliminated.
Newcastle Holdings consolidates those entities in which it has an investment of
50% or more and has control over significant operating, financial and investing
decisions of the entity. For entities over which Newcastle Holdings exercises
significant influence, but which do not meet the requirements for consolidation,
Newcastle Holdings uses the equity method of accounting. Minority interest
represents the ownership in certain consolidated subsidiaries held by entities
other than Newcastle Holdings.
Newcastle Holdings records incentive income from the Fund, which is one of
its unconsolidated subsidiaries accounted for under the equity method. For a
discussion of Newcastle Holdings' policy for recognition of such incentive
income, see Note 6.
Certain prior year amounts have been reclassified to conform to the current
year presentation.
RISKS AND UNCERTAINTIES -- In the normal course of business, Newcastle
Holdings encounters primarily two significant types of economic risk: credit and
market. Credit risk is the risk of default on Newcastle Holdings' securities,
leases, and loans that results from a borrower's, lessee's or derivative
counterparty's inability or unwillingness to make contractually required
payments. Market risk reflects changes in the value of investments in
securities, loans and real estate or in derivatives due to changes in interest
rates or other market factors, including the value of the collateral underlying
loans and securities and the valuation of real estate held by Newcastle
Holdings. Concentrations of risks include the leasing of a substantial portion
of Newcastle Holdings' operating real estate to two tenants as described in Note
4. Management believes that the carrying values of its investments are
reasonable taking into consideration these risks along with estimated collateral
values, payment histories, and other borrower information.
Newcastle Holdings also invests in real estate, or mortgage loans secured
by real estate, located outside of the United States. Newcastle Holdings'
international operations are subject to the same risks associated with its
United States operations as well as additional risks, such as fluctuations in
foreign currency exchange rates, unexpected changes in regulatory requirements,
heightened risk of political and economic instability, potential adverse tax
consequences and the burden of complying with a wide variety of foreign laws.
Additionally, Newcastle Holdings is subject to significant tax risks. If
Newcastle Holdings were to fail to qualify as a REIT in any taxable year,
Newcastle Holdings would be subject to federal income tax on its taxable income
at regular corporate rates, which could be material. Unless entitled to relief
under certain provisions of the Code, Newcastle Holdings could also be
disqualified from taxation as a REIT for the four taxable years following the
year during which it failed to qualify as a REIT.
USE OF ESTIMATES -- The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual results could differ
from those estimates.
FEDERAL INCOME TAXES -- Newcastle Holdings expects to qualify as a REIT
under the Code. A REIT will generally not be subject to federal income taxation
on that portion of its income that is distributed to shareholders if it
distributes at least 90% (95% prior to 2001) of its REIT taxable income by the
due date of its federal income tax return and complies with certain other
requirements. Since Newcastle Holdings distributed 100% of its 2001, 2000 and
1999 taxable income, no provision has been made for federal income taxes in the
accompanying consolidated financial statements.
F-24
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Distributions relating to 1999, 2000 and 2001 were taxable as follows:
DIVIDENDS ORDINARY CAPITAL
PER SHARE INCOME GAINS RETURN OF CAPITAL
--------- -------- ------- -----------------
1999....................................... $1.50 48.56% --% 51.44%
2000....................................... $1.50 61.93% --% 38.07%
2001....................................... $2.00 71.82% 28.18% --%
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH -- Newcastle Holdings
considers all highly liquid short-term investments with maturities of 90 days or
less when purchased to be cash equivalents. Restricted cash consisted of amounts
held by third parties in margin accounts of $1.6 million and $1.5 million at
December 31, 2001 and 2000, respectively, related to certain derivative hedge
agreements, restricted property operating accounts of $8.4 million and $8.4
million at December 31, 2001 and 2000, respectively, cash held by trustees
related to certain of Newcastle Holdings' investments of $0.9 million and $2.6
million at December 31, 2001 and 2000, respectively, and cash held as a deposit
on the CBO II Collateral (Note 5) of $23.6 million at December 31, 2001.
Substantially all amounts on deposit with major financial institutions exceed
insured limits.
INVESTMENT IN MARKETABLE SECURITIES -- Newcastle Holdings has classified
its investment in marketable securities as available for sale. Securities
available for sale are carried at market value with the net unrealized gains or
losses reported as a separate component of accumulated other comprehensive
income. At disposition, the net realized gain or loss is determined on the basis
of the cost of the specific investments and is included in earnings. Unrealized
losses on securities are charged to earnings if they reflect a decline in value
that is other than temporary.
Newcastle Holdings held the following investments classified as marketable
securities available for sale:
UNREALIZED
COST BASIS FAIR VALUE HOLDING LOSSES
------------------- ------------------- -------------------
TYPE 12/31/01 12/31/00 12/31/01 12/31/00 12/31/01 12/31/00
- ---- -------- -------- -------- -------- -------- --------
REIT#1 common equity
securities(a)..................... $ -- $ 3,035 $ -- $ 2,080 $-- $955
CMBS#1(b)........................... 3,940 4,787 3,940 4,787 -- --
CMBS#2(b)........................... -- 6,504 -- 6,504 -- --
CMBS#3(b)........................... 3,137 27,120 3,137 27,120 -- --
I/O security(c)..................... 7,430 -- 7,390 -- 40 --
------- ------- ------- ------- --- ----
$14,507 $41,446 $14,467 $40,491 $40 $955
======= ======= ======= ======= === ====
- ---------------
(a) During 2000, Newcastle Holdings sold 55,900 shares of REIT #1 for net
proceeds of approximately $1.1 million at a loss of approximately $0.5
million. In January 2001, Newcastle Holdings sold the remaining 105,675
shares of REIT #1 for net proceeds of approximately $2.1 million at a loss
of approximately $1.0 million.
(b) Acquired from ICH (Note 6). CMBS #1 is encumbered by a $1.5 million
repurchase agreement at December 31, 2001. CMBS #1 has a maturity of
November 2007, CMBS #2 was sold in May 2001 at a gain of $1.4 million, and
CMBS #3 has a maturity of August 2030. CMBS #3 was restructured in April
2001 and a $23.7 million portion was transferred into the CBO securitization
(Note 5).
(c) The I/O security matures in August 2018.
LOANS AND MORTGAGE POOLS RECEIVABLE AND CBO COLLATERAL -- Newcastle
Holdings invests in performing, sub-performing, and non-performing individual
loans, loan portfolios, and securities secured by
F-25
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
loans or loan portfolios for prices generally at or below face value. Loans and
mortgage pools receivable are presented in the consolidated balance sheet net of
any unamortized discount and an allowance for loan losses. Discounts are
accreted into interest income based upon a comparison of actual collections and
expected collections. Income is not accrued on non-performing loans; cash
received on such loans is treated as income to the extent of interest previously
accrued. Interest income with respect to non-discounted loans is recognized on
an accrual basis. Deferred fees and costs are recognized as interest income over
the terms of the loans using the interest method. Upon settlement of loans, the
excess (or deficiency) of net proceeds over the net carrying value of the loan
is recognized as a gain (or loss) in the period of settlement.
ALLOWANCE FOR LOAN AND MORTGAGE POOL LOSSES -- Newcastle Holdings
periodically evaluates loans for impairment. Commercial and residential real
estate loans are considered to be impaired, for financial reporting purposes,
when it is probable that Newcastle Holdings will be unable to collect all
principal or interest when due according to the contractual terms of the
original loan agreements, or, for loans purchased at a discount for credit
losses, when Newcastle Holdings determines that it is probable that it would be
unable to collect as anticipated. Upon determination of impairment, Newcastle
Holdings establishes specific valuation allowances, through provisions for
losses, based on the estimated fair value of the underlying real estate
collateral using a discounted cash flow analysis (see Note 7). The allowance for
each loan pool is maintained at a level believed adequate by management to
absorb probable losses. It is Newcastle Holdings' policy to establish an
allowance for uncollectible interest on performing loans that are past due more
than 90 days or sooner when, in the judgment of management, the probability of
collection of interest is deemed to be insufficient to warrant further accrual.
Upon such a determination, those loans are placed on non-accrual status and
deemed to be non-performing. Actual losses may differ from Newcastle Holdings'
estimates.
RENTAL AND ESCALATION INCOME -- Contractual minimum rental income is
recognized on a straight-line basis over the terms of the related operating
leases. The excess of straight-line rents above contractual amounts was $2.0
million, $2.5 million and $2.8 million during 2001, 2000 and 1999, respectively.
Expense recoveries are included in rental and escalation income.
INVESTMENT IN REAL ESTATE -- Investment in real estate is recorded at cost
less accumulated depreciation. Depreciation is computed on a straight-line
basis. Buildings are depreciated over 40 years. Major improvements are
capitalized and depreciated over their estimated useful lives. Fees and costs
incurred in the successful negotiation of leases are deferred and amortized on a
straight-line basis over the terms of the respective leases. Expenditures for
repairs and maintenance are expensed as incurred. Foreclosed real estate, held
for sale, is recorded in Receivables and Other Assets at the lower of its cost
or fair value less cost to sell and is not depreciated. Newcastle Holdings
reviews its real estate assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. No material impairment was recorded during 2001, 2000 or 1999. In
August 2001, Statement of Financial Accounting Standards ("SFAS") No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" was issued, and
will be effective in 2002. Newcastle Holdings does not expect the adoption of
SFAS No. 144 to have a material effect on its financial position or results of
operations.
DEFERRED COSTS -- Deferred costs consist primarily of costs incurred in
obtaining financing (amortized over the term of such financing using the
interest method) and external costs related to probable acquisitions and $0.8
million related to a potential public offering of shares (Note 13). During 2001,
2000 and 1999, approximately $1.9 million, $2.5 million and $0.9 million of
financing costs were amortized into interest expense, respectively.
NET INCOME PER COMMON SHARE -- Net income per common share is calculated
using net income available for common shareholders, on the basis of the weighted
average number of common shares
F-26
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outstanding plus the additional dilutive effect of common stock equivalents
during each period. Newcastle Holdings did not have any dilutive common stock
equivalents during 2001, 2000 or 1999. Net income available for common
shareholders is equal to net income less preferred dividends and accretion of
the discount on the Series A Preferred.
STOCK OPTIONS -- Newcastle Holdings accounts for stock options granted to
non-employees in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation." The fair value of the options issued as compensation to the
Manager for its efforts in raising capital for Newcastle Holdings was recorded
in 1998 as an increase in stockholders' equity with an offsetting reduction of
capital proceeds received. No options were issued in 2001, 2000 or 1999.
DERIVATIVES AND HEDGING ACTIVITIES -- In January 2001, Newcastle Holdings
adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities." SFAS No. 133, as amended,
establishes accounting and reporting standards for derivative instruments.
Specifically, SFAS No. 133 requires an entity to recognize all derivatives as
either assets or liabilities in the statement of financial position and to
measure those instruments at fair value. Additionally, the fair value
adjustments will affect either stockholders' equity or net income depending on
whether the derivative instrument qualifies as a hedge for accounting purposes
and, if so, the nature of the hedging activity.
For those derivative instruments that are designated and qualify as hedging
instruments, a company must designate the hedging instrument, based upon the
exposure being hedged, as either a cash flow hedge, fair value hedge or a hedge
of a net investment in a foreign operation.
Derivative transactions are entered into by Newcastle Holdings solely for
risk-management purposes. The decision of whether or not a given
transaction/position (or portion thereof) is hedged is made on a case-by-case
basis, based on the risks involved and other factors as determined by senior
management, including restrictions imposed by the Internal Revenue Code among
others. In determining whether to hedge a risk, Newcastle Holdings may consider
whether other assets, liabilities, firm commitments and anticipated transactions
already offset or reduce the risk. All transactions undertaken as hedges are
entered into with a view towards minimizing the potential for economic losses
that could be incurred by Newcastle Holdings. Generally, all derivatives entered
into are intended to qualify as hedges under GAAP, unless specifically stated
otherwise. To this end, terms of hedges are matched closely to the terms of
hedged items.
Description of the risks being hedged:
1) Interest rate risk, existing positions -- Newcastle Holdings
generally hedges the aggregate risk of interest rate fluctuations with
respect to its borrowings, regardless of the form of such borrowings, which
require payments based on a variable interest rate index. Newcastle
Holdings generally intends to hedge only the risk related to changes in the
benchmark interest rate (LIBOR or a Treasury rate).
In order to reduce such risks, Newcastle Holdings may enter into swap
agreements whereby Newcastle Holdings would receive floating rate payments
in exchange for fixed rate payments, effectively converting the borrowing
to fixed rate. Newcastle Holdings may also enter into cap agreements
whereby, in exchange for a fee, Newcastle Holdings would be reimbursed for
interest paid in excess of a certain cap rate.
2) Interest rate risk, anticipated transactions -- Newcastle Holdings
may hedge the aggregate risk of interest rate fluctuations with respect to
anticipated transactions, primarily anticipated borrowings. The primary
risk involved in an anticipated borrowing is that interest rates may
increase between the date the transaction becomes probable and the date of
consummation. Newcastle
F-27
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Holdings generally intends to hedge only the risk related to changes in the
benchmark interest rate (LIBOR or a Treasury rate).
In order to "lock in" the rate on the date of forecast, Newcastle
Holdings may enter into swap agreements whereby Newcastle Holdings would
receive fixed rate payments in exchange for floating rate payments. The
value of such a swap should vary inversely with the expected proceeds of a
given fixed rate borrowing in the future, assuming the terms of the swap
and borrowing are properly matched. At the date the borrowing occurs, the
swap is unwound at a gain or loss which should equal the change in expected
proceeds between the date of forecast and the date of consummation which
result from changes in market interest rates, effectively hedging such
changes. At December 31, 2001, no such derivative transactions were
outstanding.
3) Foreign currency rate risk, net investments -- Newcastle Holdings
may hedge the aggregate risk of fluctuations in the exchange rate between a
foreign currency, in which Newcastle Holdings has made a net investment,
and the U.S. dollar.
In order to reduce the risk, Newcastle Holdings may maintain a short
position in the applicable foreign currency. The amount of the position
would be equal to the anticipated net equity in the foreign investment at a
forward date, as denominated in the foreign currency. This effectively
locks in the current exchange rate on Newcastle Holdings' net equity
position for the period of such position. At December 31, 2001, no such
derivative transactions were outstanding.
Newcastle Holdings has employed interest rate swaps primarily in four ways:
(i) to hedge fluctuations in the fair value of the fixed lease payments
underlying its revenue-producing real estate in Canada, (ii) to hedge the
anticipated GSA Securitization (Note 10), which occurred in May 1999, (iii) to
hedge the anticipated securitization of the CBO Collateral (Note 10), which
occurred in July 1999, and (iv) to hedge its exposure to changes in market
interest rates with respect to its floating rate debt. Approximately, $224.5
million and $216.4 million in principal amount of Newcastle Holdings' floating
rate debt were designated as the hedged items to interest rate swap and cap
agreements at December 31, 2001, respectively.
To qualify for cash flow hedge accounting, interest rate swaps and caps
must meet certain criteria, including (1) the items to be hedged expose
Newcastle Holdings to interest rate risk, (2) the interest rate swaps or caps
are highly effective in reducing Newcastle Holdings' exposure to interest rate
risk, and (3) with respect to an anticipated transaction, such transaction is
probable. Correlation and effectiveness are periodically assessed based upon a
comparison of the relative changes in the fair values or cash flows of the
interest rate swaps and caps and the items being hedged.
For derivative instruments that are designated and qualify as a cash flow
hedge (i.e. hedging the exposure to variability in expected future cash flows
that is attributable to a particular risk), the effective portion of the gain or
loss, and net payments received or made, on the derivative instrument is
reported as a component of other comprehensive income and reclassified into
earnings in the same period or periods during which the hedged transaction
affects earnings. The remaining gain or loss on the derivative instrument in
excess of the cumulative change in the present value of future cash flows of the
hedged item, if any, is recognized in current earnings during the period of
change. No material ineffectiveness was recorded during the year ended December
31, 2001. Prior to the adoption of SFAS No. 133, these hedges were measured at
historical cost which was amortized into interest expense on the interest
method. Periodic net payments received or made on such hedges were also included
in interest expense at such time.
With respect to interest rate swaps which were designated as hedges of the
fair value of lease payments, periodic net payments and any gain or loss from
fluctuations in the fair value of the interest rate swaps were capitalized as
adjustments to deferred rent and are being recognized over the term of the
F-28
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
leases as adjustments to rental income. Pursuant to SFAS No. 133, such net
amounts were reclassified to accumulated other comprehensive income at January
1, 2001. Newcastle Holdings' hedge of such payments was terminated in 1999. As
of December 31, 2001 and 2000, $1.6 million and $1.9 million of such losses were
deferred, net of amortization, respectively.
With respect to interest rate swaps which have been designated as hedges of
anticipated refinancings, periodic net payments were recognized currently as
adjustments to interest expense; any gain or loss from fluctuations in the fair
value of the interest rate swaps was recorded as a deferred hedging gain or loss
and treated as a component of the anticipated transaction at the time of such
transaction. Pursuant to SFAS No. 133, such net amounts were reclassified to
accumulated other comprehensive income at January 1, 2001. In the event the
anticipated refinancing failed to occur as expected, the deferred hedging credit
or charge was recognized currently in income. Newcastle Holdings' hedges of such
refinancings were terminated upon the consummation of such refinancings. As of
December 31, 2001 and 2000, $9.1 million and $13.7 million of such gains were
deferred, net of amortization, respectively.
SFAS No. 133 has resulted in a change in Newcastle Holdings' method of
accounting for interest rate caps and swaps used as hedges. As a result of this
change, Newcastle Holdings recorded a transition gain adjustment to other
comprehensive income of approximately $4.1 million on January 1, 2001. During
the year ended December 31, 2001, Newcastle Holdings recorded an aggregate $11.4
million of loss to other comprehensive income and an aggregate of $4.7 million
of gain to earnings, as an adjustment to interest expense, related to such
hedges. Newcastle Holdings expects to reclassify approximately $0.4 million of
net gain on derivative instruments from accumulated other comprehensive income
to earnings during the next twelve months due to differences in the present
value of net interest payments associated with interest rate swaps and to
changes in fair value associated with interest rate caps.
With respect to interest rate swaps and caps that have not been designated
as hedges, any net payments under, or fluctuations in the fair value of, such
swaps and caps has been recognized currently in income.
Newcastle Holdings' derivative financial instruments contain credit risk to
the extent that its bank counterparties may be unable to meet the terms of the
agreements. Newcastle Holdings minimizes such risk by limiting its
counterparties to major financial institutions with good credit ratings. In
addition, the potential risk of loss with any one party resulting from this type
of credit risk is monitored. Management does not expect any material losses as a
result of default by other parties. Newcastle Holdings does not require
collateral.
FOREIGN CURRENCY OPERATIONS -- Assets and liabilities relating to foreign
operations are translated using exchange rates as of the end of each reporting
period. The results of Newcastle Holdings' foreign operations are translated at
the weighted average exchange rate for each reporting period. Translation
adjustments are included as a component of accumulated other comprehensive
income.
Foreign exchange contracts are, from time to time, used to hedge Newcastle
Holdings' net investments in its foreign operations. Gains and losses on foreign
exchange contracts which qualify as hedges of net investments in foreign
operations as well as changes in the market value of these instruments are
included in accumulated other comprehensive income. Upon sale or liquidation of
its investment in a foreign operation, the related amount in accumulated other
comprehensive income is reclassified to transaction gain or loss in the period
of such liquidation.
Transaction gains and losses that arise from exchange rate fluctuations on
transactions denominated in a currency other than the functional currency,
except those transactions which qualify as a hedge, are included currently in
income.
F-29
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMPREHENSIVE INCOME -- Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances, excluding those resulting from investments by and
distributions to owners. For Newcastle Holdings' purposes, comprehensive income
represents net income, as presented in the statements of operations, adjusted
for net foreign currency translation adjustments and unrealized gains or losses
on marketable securities held for sale and derivatives designated as cash flow
hedges. Accumulated other comprehensive income at December 31, 2001 and 2000
represented $5.6 million and $2.4 million of net foreign currency translation
loss adjustments, respectively, $21.7 million and $1.0 million of net unrealized
gains on marketable securities, respectively, and $7.3 million and $0.0 million
of net unrealized losses on derivatives designated as cash flow hedges,
respectively.
ORGANIZATION COSTS -- The AICPA has issued Statement of Position ("SOP")
98-5, "Reporting on the Costs of Start-up Activities." This SOP requires costs
of start-up activities and organizational costs to be expensed as incurred and
was effective for financial statements for fiscal years beginning after December
15, 1998. The initial application of this SOP has been recorded by Newcastle
Holdings in 1999 as a cumulative effect of a change in accounting principle.
Newcastle Holdings carried approximately $0.5 million of net deferred
organizational costs on its books as of December 31, 1998 that were written off
in 1999.
3. LOAN PORTFOLIO
Loans and mortgage pools receivable consisted of the following at December
31, 2001 and 2000:
INDIVIDUAL
2001 TOTAL LOAN POOLS LOANS
- ---- -------- ---------- ----------
Residential real estate loans......................... $ 17,002 $ 17,002 $ --
Commercial real estate loans.......................... 8,393 1,833 6,560
-------- -------- ------
Total mortgage loans.................................. 25,395 18,835 6,560
Allowance for loan losses(a).......................... (14,720) (14,720) --
-------- -------- ------
Loans receivable, net................................. $ 10,675 $ 4,115 $6,560
======== ======== ======
- ---------------
(a) During 2001, Newcastle Holdings settled loans which had an aggregate
allowance of approximately $7.3 million on the date of settlement. The total
allowance also increased $0.5 million as a result of foreign currency
fluctuations.
INDIVIDUAL
2000 TOTAL LOAN POOLS LOANS
- ---- -------- ---------- ----------
Residential real estate loans......................... $ 48,596 $ 48,596 $ --
Commercial real estate loans.......................... 81,025 4,412 76,613
-------- -------- -------
Total mortgage loans.................................. 129,621 53,008 76,613
Unaccreted discount................................... (1,095) (1,095) --
Allowance for loan losses(b).......................... (21,569) (21,404) (165)
-------- -------- -------
Loans receivable, net................................. $106,957 $ 30,509 $76,448
======== ======== =======
- ---------------
(b) During 2000, Newcastle Holdings recorded allowances on existing loan
portfolios of approximately $1.2 million (which is included in Gain (Loss)
on Settlement of Investments) and settled and foreclosed loans which had an
aggregate allowance of approximately $5.0 million on the date of settlement.
The total allowance also decreased $1.2 million as a result of foreign
currency fluctuations.
F-30
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The average net balance of Newcastle Holdings' mortgage pools was
approximately $11.8 million and $37.2 million during 2001 and 2000,
respectively, on which Newcastle Holdings earned approximately $1.6 million and
$5.7 million of gross revenues, respectively.
The following table sets forth certain information regarding individual mortgage
loans:
LOAN # COLLATERAL LOCATION INTEREST RATE FINAL MATURITY DATE PAYMENT TERMS
- ------ ---------------------- ---------- ------------- -------------------- -------------
1 Retail Stores 19 States LIBOR + 4.0% Repaid January 2002 Interest Only
2 Residential Properties California 10.75% Repaid June 2001 Interest Only
3 Residential Properties Wisconsin 9.25% Repaid February 2001 Interest Only
FACE AMOUNT CARRYING AMOUNT ENCUMBRANCES
------------------- ------------------- -------------------
LOAN # PRIOR LIENS 12/31/01 12/31/00 12/31/01 12/31/00 12/31/01 12/31/00
- ------ ----------- -------- -------- -------- -------- -------- --------
1 None $6,560 $75,391 $6,560 $75,391 None $48,862
2 None $ -- $ 1,087 $ -- $ 928 None None
3 None $ -- $ 135 $ -- $ 129 None None
The following table sets forth certain additional information regarding mortgage
loan pools:
12/31/2001 PRINCIPAL AMOUNT
--------------------------------------------------------- CARRYING AMOUNT (A) OVER 90 DAYS
RANGE OF LOAN RANGE OF INTEREST RANGE OF FINAL ----------------------- PAST DUE AT
TYPE OF COLLATERAL BALANCES RATES MATURITIES 12/31/2001 12/31/2000 12/31/2001
------------------ --------------------- ----------------- -------------- ---------- ---------- ----------------
Primarily
Residential
Portfolios Under $100 $ -- $12,504 $
$100-$200 (B) (B) 804 8,545 2,148
Over $200 (B) (B) 3,268 8,786 14,855
------ ------- -------
Subtotal 4,072 29,835 17,003
------ ------- -------
Primarily Commercial
Portfolios Under $500 -- 530 --
$500 - $1,000 -- -- --
Over $1,000 (B) (B) 43 144 1,583
------ ------- -------
Subtotal 43 674 1,583
------ ------- -------
Total mortgage
loan pool $4,115 $30,509 $18,586
====== ======= =======
- ---------------
(A) The primary residential portfolios were encumbered by $14.5 million of debt
at December 31, 2000.
(B) These loans have passed their stated maturities and are considered
non-performing loans. Newcastle Holdings is in the process of restructuring
or settling all of these loans and, as such, their stated interest rates are
no longer significant.
F-31
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. OPERATING REAL ESTATE
Investments in operating real estate consisted of the following commercial
properties:
12/31/01 12/31/00
-------- --------
Land.................................................... $ 61,417 $ 62,585
U.S. properties......................................... 395,066 392,154
Canadian properties..................................... 46,206 49,015
Belgian properties...................................... 61,093 63,169
-------- --------
Total................................................... 563,782 566,923
Accumulated depreciation................................ (38,948) (26,384)
Investment in real estate, net.......................... $524,834 $540,539
======== ========
The North American properties are primarily leased on a long-term basis to
the General Services Administration of the U.S. Government ("GSA") (the "GSA
Properties") and Bell Canada, a wholly-owned subsidiary of BCE, Inc. (the "Bell
Canada Properties"). The Belgian properties (the "Belgian Properties") are
leased to a variety of tenants, including the European Commission ("EC") which
has leased approximately 46% of these properties by gross carrying value. For
2001, 2000 and 1999, approximately 71.9%, 67.9% and 66.8% of Newcastle Holdings'
consolidated rental and escalation income was attributable to GSA, respectively,
and approximately 19.4%, 20.6% and 25.0% was attributable to Bell Canada,
respectively. The GSA leases expire over various dates through the year 2018 and
the Bell Canada leases expire over various dates through the year 2007. Each
Bell Canada lease contains one five-year lease renewal option and provides for a
significant payment due upon expiration of the lease. These terminal payments
have been included in the calculation of straight-line rental income assuming
that each lease is renewed once.
In addition to minimum rent, GSA leases generally include an annual rental
escalation based on the increase in the Consumer Price Index ("CPI") applied to
the portion of the base rent attributable to operating expenses, as well as a
provision requiring GSA to pay all increases in taxes over the base year. The
leases to Bell Canada provide for the reimbursement of substantially all
operating expenses and property taxes plus an administrative fee. The leases on
the Belgian Properties provide for annual increases in base rent based on the
change in the Sante Index, as well as payment of increases in operating expenses
and real estate taxes over base year amounts. The following is a schedule by
year of the future minimum rental payments to be received under the
non-cancelable operating leases:
2002............................................. $ 54,552
2003............................................. 49,342
2004............................................. 46,017
2005............................................. 42,895
2006............................................. 41,180
Thereafter....................................... 129,684
--------
$363,670
========
F-32
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
GROSS CARRYING AMOUNT AT 12/31/01
INITIAL COSTS -----------------------------------
---------------------- BLDG.
TYPE OF BLDG. AND COSTS CAP SUBSEQ. AND
PROPERTY LOCATION LAND(A) IMPROV'S.(A) TO ACQ'S(A) LAND IMPROV'S TOTAL(B)
- --------- ------------------ ------- ------------ ----------------- --------- ---------- ----------
(DOLLAR AMOUNTS IN TABLES SHOWN IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Off.
Bldg. Aurora, CO $ 720 $ 12,167 $ 663 $ 720 $ 12,830 $ 13,550
Warehouse Burlington, NJ 4,850 89,390 741 4,850 90,131 94,981
Off.
Bldg. Philadelphia, PA 1,095 12,977 493 1,095 13,470 14,565
Off.
Bldg. Concord, MA 2,100 14,175 115 2,100 14,290 16,390
Off.
Bldg. Huntsville, AL 351 12,180 1,923 351 14,103 14,454
Off.
Bldg. Norfolk, VA 318 5,044 90 318 5,134 5,452
Off.
Bldg. Lakewood, CO 459 5,388 40 459 5,428 5,887
Off.
Bldg. Providence, RI 1,630 16,824 287 1,630 17,111 18,741
Off.
Bldg. Sacramento, CA 8,125 55,687 1,716 8,125 57,403 65,528
Off.
Bldg. Suffolk, VA 924 36,450 441 924 36,891 37,815
Off.
Bldg. Washington, DC 6,482 29,749 477 6,482 30,226 36,708
Off.
Bldg. Houston, TX 2,800 11,092 97 2,800 11,189 13,989
Off.
Bldg. San Diego, CA 1,600 25,254 164 1,600 25,418 27,018
Off.
Bldg. Kansas City, KS 5,679 32,179 25 5,679 32,204 37,883
Off.
Bldg. Kansas City, MO 5,152 29,202 35 5,152 29,237 34,389
Off.
Bldg. Etobicoke, ON 345 8,473 518 345 8,991 9,336
Off.
Bldg. London, ON 759 13,676 186 759 13,862 14,621
Off.
Bldg. Hamilton, ON 458 3,381 -- 458 3,381 3,839
Industrial Toronto, ON 6,768 18,414 94 6,768 18,508 25,276
Off.
Bldg. Kingston, ON 188 1,289 176 188 1,465 1,653
Off.
Bldg. G. Bijgaarden, BEL 1,310 7,088 176 1,310 7,264 8,574
Off.
Bldg. Brussels, BEL 3,531 19,603 10 3,531 19,613 23,144
Off.
Bldg. Brussels, BEL 593 3,298 279 593 3,577 4,170
Off.
Bldg. Brussels, BEL 1,512 8,417 23 1,512 8,440 9,952
Off.
Bldg. Waterloo, BEL 969 5,405 11 969 5,416 6,385
Off.
Bldg. Zaventem, BEL 867 4,835 50 867 4,885 5,752
Off.
Bldg. Brussels, BEL 703 3,940 94 703 4,034 4,737
Warehouse Zaventem, BEL 479 2,673 4 479 2,677 3,156
Off.
Bldg. Brussels, BEL 650 3,657 1,530 650 5,187 5,837
------- -------- ------- ------- -------- --------
TOTALS: $61,417 $491,907 $10,458 $61,417 $502,365 $563,782
======= ======== ======= ======= ======== ========
UNAUDITED
---------------------------
12/31/2001
-------------------------
TYPE OF ACCUM. NET RENTABLE ACQ.
PROPERTY ENCUMB. DEPR. OCC. SQ. FT. DATE
- --------- -------- ------- ---- ------------ -----
(DOLLAR AMOUNTS IN TABLES SHOWN IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 67
Off.
Bldg. $ 9,618 $ 1,101 100% 116,500 7/98
Warehouse 76,928 7,814 100% 1,048,631 7/98
Off.
Bldg. 11,098 1,135 100% 93,552 7/98
Off.
Bldg. 14,217 1,229 100% 104,527 7/98
Off.
Bldg. 10,432 1,171 100% 117,476 7/98
Off.
Bldg. 4,092 459 100% 53,830 7/98
Off.
Bldg. 5,618 478 73% 82,845 7/98
Off.
Bldg. 16,254 1,516 100% 130,600 7/98
Off.
Bldg. 50,207 4,969 78% 323,456 7/98
Off.
Bldg. 27,928 3,242 100% 278,978 7/98
Off.
Bldg. 30,927 2,577 100% 162,038 7/98
Off.
Bldg. 10,451 976 96% 138,000 7/98
Off.
Bldg. 21,318 1,774 100% 144,327 3/99
Off.
Bldg. 30,216 1,981 100% 182,554 7/99
Off.
Bldg. 24,555 1,553 100% 204,607 11/99
Off.
Bldg. 5,153 694 100% 177,212 10/98
Off.
Bldg. 8,436 1,113 96% 325,764 10/98
Off.
Bldg. 2,243 271 100% 118,787 10/98
Industria 14,716 1,480 100% 624,786 10/98
Off.
Bldg. 863 108 100% 45,691 10/98
Off.
Bldg. 7,997 411 77% 81,763 11/99
Off.
Bldg. 21,617 1,043 100% 119,781 11/99
Off.
Bldg. 2,258 237 100% 26,651 11/99
Off.
Bldg. 6,221 451 100% 53,421 11/99
Off.
Bldg. 4,304 291 100% 46,231 11/99
Off.
Bldg. 4,598 278 100% 65,175 11/99
Off.
Bldg. 3,432 227 68% 28,180 11/99
Warehouse 1,427 142 100% 55,606 11/99
Off.
Bldg. 3,295 227 0% 32,206 11/99
-------- ------- --- ------------
$430,419 $38,948 98% 4,983,175
======== ======= === ============
- ---------------
(A) Adjusted for changes in foreign, currency exchange rates, which aggregated
$7.6 million of loss and $7.3 million of loss between land, building and
improvements in 2001 and 2000, respectively.
F-33
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a reconciliation of operating real estate assets and
accumulated depreciation:
ACCUMULATED
GROSS DEPRECIATION NET
-------- ------------ --------
Balance at December 31, 1999........................ $572,664 $(13,815) $558,849
Improvements........................................ 1,520 -- 1,520
Changes in foreign currency exchange rates.......... (7,261) 52 (7,209)
Depreciation........................................ -- (12,621) (12,621)
-------- -------- --------
Balance at December 31, 2000........................ 566,923 (26,384) 540,539
-------- -------- --------
Improvements........................................ 4,495 -- 4,495
Changes in foreign currency exchange rates.......... (7,636) 345 (7,291)
Depreciation........................................ -- (12,909) (12,909)
-------- -------- --------
Balance at December 31, 2001........................ $563,782 $(38,948) $524,834
======== ======== ========
5. REAL ESTATE DEBT SECURITIES
During 1999, Newcastle Holdings purchased various commercial mortgage
backed securities ("CMBS") and unsecured REIT loans (collectively, the "CBO
Collateral"). The CBO Collateral is summarized as follows:
RANGE OF RANGE OF DELINQUENCY
CARRYING AMOUNT PRINCIPAL BALANCE COUPON RATES FINAL MATURITIES STATUS
------------------- ------------------- ------------ ---------------- -----------
12/31/01 12/31/00 12/31/01 12/31/00 12/31/01 12/31/01 12/31/01
-------- -------- -------- -------- ------------ ---------------- -----------
CMBS
Fixed................ $220,211 $216,810 $253,673 $277,011 2.00 - 12.06% 11/07 - 6/32 Current
Floating............. 51,426 55,019 62,384 66,384 6.97 - 7.53% 4/12 - 9/33 Current
Unsecured REIT loans
Fixed................ 225,392 228,050 219,515 234,815 6.70 - 8.88% 2/03 - 3/13 Current
Floating............. -- 9,850 -- 9,850 N/A N/A N/A
Restricted cash(A)..... 25,229 -- -- -- N/A N/A N/A
-------- -------- -------- --------
Total.............. $522,258 $509,729 $535,572 $588,060
======== ======== ======== ========
- ---------------
(A) Represents cash held in a temporary investment account by the trustee for
reinvestment in securities.
The CBO Collateral was initially financed pursuant to a repurchase
agreement, which had a balance of $281.2 million immediately prior to the CBO
securitization (Note 10). This agreement was satisfied with proceeds from the
CBO Securitization.
In May 2000, pursuant to SFAS 115 "Accounting for Certain Investments in
Debt and Equity Securities," as amended, Newcastle Holdings transferred the CBO
Collateral from its securities held to maturity category to its securities
available for sale category. As a result, the CBO Collateral is marked to market
(see Note 7).
In March and April 2001, Newcastle Holdings traded out of 5 collateral
positions in its CBO securitization with an aggregate basis of approximately
$64.5 million in exchange for approximately $23.7 million of privately issued
CMBS from a subsidiary of Newcastle Holdings (representing a portion of the CMBS
#3 securities as described in Note 2), $25.6 million of publicly issued CMBS,
and approximately $12.6 million of unsecured REIT debt securities. As a result
of the trade, Newcastle Holdings received gross proceeds of approximately $71.1
million and recorded a gain on the sale of
F-34
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
approximately $6.4 million, after $0.2 million of accrued interest. Newcastle
Holdings recognized an additional $1.0 million in gains on sales of CBO
Collateral during 2001.
In October 2001, Newcastle Holdings entered into an agreement with a major
investment bank whereby Newcastle Holdings has the right to purchase up to $400
million, plus our deposit, of commercial mortgage backed securities, unsecured
REIT debt and asset backed securities (the "CBO II Collateral"), which are
specifically designated for a securitization transaction (the "CBO II
Transaction"). As of December 31, 2001, $181.2 million of the $400 million had
been accumulated. Should Newcastle Holdings choose not to purchase the CBO II
Collateral, Newcastle Holdings' liability would be limited to the aggregate
market decline in the CBO II Collateral, net of any aggregate gains on swaps
entered into by the investment bank, to the extent of Newcastle Holdings'
deposit. The balance of the deposit, if any, would then be refunded to Newcastle
Holdings. Through December 31, 2001, there has been no material decline in the
value of the collateral in the aggregate. At December 31, 2001, Newcastle
Holdings had a deposit of $23.6 million related to this agreement, which is
recorded in Restricted Cash. Newcastle Holdings plans to finance the purchase of
the CBO II Collateral with a securitization. There is no assurance, however,
that the CBO II Transaction will be consummated.
6. INFORMATION REGARDING BUSINESS SEGMENTS
Newcastle Holdings conducts its business in four primary segments:
revenue-producing real estate, real estate debt securities, real estate loans,
and its investment in the Fund. Details of Newcastle Holdings' real estate debt
securities are shown in Note 5. Details of Newcastle Holdings' real estate
investments are shown in Note 4. Details of Newcastle Holdings' loan investments
are shown in Note 3. The loan investments are secured by real estate or by loans
that are in turn secured by real estate. The loan segment includes foreclosed
property. Since management fees paid by the Fund to the Manager flow through
Newcastle Holdings, the unallocated portion consists primarily of income from
the management fees paid by the Fund (included in gross revenues) fully offset
by a corresponding amount of management fee expense paid to the Manager of the
Fund. Also included in the unallocated portion are interest income on short-term
investments, dividends on equity investments, expenses for professional fees,
overhead, and management fee expense paid by Newcastle Holdings pursuant to its
own Management Agreement with the Manager. Newcastle Holdings has combined two
of its previously reported segments, loan pools and individual loans, into one
segment, real estate loans. Newcastle Holdings' investment in the Fund is now
shown separately, whereas it was previously included in the unallocated caption.
These changes have been made due to the settlement of a significant portion of
the assets in the combined segments and Newcastle Holdings' increasing
investment in the Fund.
F-35
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Summary financial data on Newcastle Holdings' segments is given below,
together with a reconciliation to the same data for Newcastle Holdings as a
whole.
RE DEBT REAL ESTATE
REAL ESTATE SEC'S LOANS FUND UNALLOCATED TOTAL
----------- -------- ----------- -------- ----------- ----------
2001
Gross revenues............ $ 76,452 $ 53,095 $ 6,270 $ 29,356 $ 12,422 $ 177,595
Operating expenses........ (30,083) (253) (938) (14,354) (18,433) (64,061)
-------- -------- -------- -------- -------- ----------
Operating income.......... 46,369 52,842 5,332 15,002 (6,011) 113,534
Interest expense.......... (28,014) (26,793) (3,234) -- (3,291) (61,332)
Depreciation and
amortization............ (12,042) -- -- (560) (447) (13,049)
Equity in earnings of
unconsolidated
subsidiaries............ -- -- -- 5,360 (2,553) 2,807
-------- -------- -------- -------- -------- ----------
Income before minority
interest................ 6,313 26,049 2,098 19,802 (12,302) 41,960
Minority interest......... (10) -- 93 -- -- 83
-------- -------- -------- -------- -------- ----------
Income from continuing
operations.............. 6,303 26,049 2,191 19,802 (12,302) 42,043
Income from discontinued
operations.............. 1,628 -- -- -- -- 1,628
-------- -------- -------- -------- -------- ----------
Net Income................ $ 7,931 $ 26,049 $ 2,191 $ 19,802 $(12,302) $ 43,671
======== ======== ======== ======== ======== ==========
Revenue derived from
non-U.S. sources:
Canada.................. $ 16,092 $ -- $ (17) $ -- $ -- $ 16,075
======== ======== ======== ======== ======== ==========
Belgium................. $ 7,219 $ -- $ -- $ -- $ -- $ 7,219
======== ======== ======== ======== ======== ==========
Italy................... $ -- $ -- $ 764 $ -- $ -- $ 764
======== ======== ======== ======== ======== ==========
Total assets.............. $565,481 $560,155 $ 12,920 $ 97,562 $ 26,001 $1,262,119
======== ======== ======== ======== ======== ==========
Long lived assets outside
the U.S.:
Canada.................. $ 51,060 $ -- $ -- $ -- $ -- $ 51,060
======== ======== ======== ======== ======== ==========
Belgium................. $ 68,399 $ -- $ -- $ -- $ -- $ 68,399
======== ======== ======== ======== ======== ==========
F-36
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RE DEBT REAL ESTATE
REAL ESTATE SEC'S LOANS FUND UNALLOCATED TOTAL
----------- -------- ----------- -------- ----------- ----------
2000
Gross revenues............ $ 75,855 $ 46,222 $ 15,252 $ -- $ 35,063 $ 172,392
Operating expenses........ (29,456) (343) (2,296) -- (18,069) (50,164)
-------- -------- -------- -------- -------- ----------
Operating income.......... 46,399 45,879 12,956 -- 16,994 122,228
Interest expense.......... (28,399) (29,663) (6,583) -- (1,766) (66,411)
Depreciation and
amortization............ (11,729) -- -- -- (515) (12,244)
Equity in earnings
(losses) of
unconsolidated
subsidiaries............ -- -- -- 1,044 (2,024) (980)
-------- -------- -------- -------- -------- ----------
Income before minority
interest................ 6,271 16,216 6,373 1,044 12,689 42,593
Minority interest......... (10) -- (738) -- -- (748)
-------- -------- -------- -------- -------- ----------
Income from continuing
operations.............. 6,261 16,216 5,635 1,044 12,689 41,845
Income from discontinued
operations.............. 1,015 -- -- -- -- 1,015
-------- -------- -------- -------- -------- ----------
Net Income................ $ 7,276 $ 16,216 $ 5,635 $ 1,044 $ 12,689 $ 42,860
======== ======== ======== ======== ======== ==========
Revenue derived from
non-U.S. sources:
Canada.................. $ 16,742 $ -- $ (103) $ -- $ -- $ 16,639
======== ======== ======== ======== ======== ==========
Belgium................. $ 7,022 $ -- $ -- $ -- $ -- $ 7,022
======== ======== ======== ======== ======== ==========
Italy................... $ -- $ -- $ 2,171 $ -- $ -- $ 2,171
======== ======== ======== ======== ======== ==========
Total assets.............. $576,728 $527,989 $112,507 $ 50,694 $ 63,168 $1,331,086
======== ======== ======== ======== ======== ==========
Long lived assets outside
the U.S.:
Canada.................. $ 55,404 $ -- $ -- $ -- $ -- $ 55,404
======== ======== ======== ======== ======== ==========
Belgium................. $ 72,615 $ -- $ -- $ -- $ -- $ 72,615
======== ======== ======== ======== ======== ==========
F-37
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RE DEBT REAL ESTATE
REAL ESTATE SEC'S LOANS FUND UNALLOCATED TOTAL
----------- -------- ----------- -------- ----------- ----------
1999
Gross revenues............ $ 65,701 $ 28,277 $ 16,279 $ -- $ 4,690 $ 114,947
Operating expenses........ (23,742) (152) (3,119) -- (11,145) (38,158)
-------- -------- -------- -------- -------- ----------
Operating income.......... 41,959 28,125 13,160 -- (6,455) 76,789
Interest expense.......... (23,319) (17,342) (5,868) -- -- (46,529)
Depreciation and
amortization............ (9,912) -- (10) -- (461) (10,383)
Equity in earnings
(losses) of
unconsolidated
subsidiaries............ -- -- (3,259) -- (356) (3,615)
-------- -------- -------- -------- -------- ----------
Income before minority
interest................ 8,728 10,783 4,023 -- (7,272) 16,262
Minority interest......... -- -- (1,258) -- -- (1,258)
-------- -------- -------- -------- -------- ----------
Income from continuing
operations.............. 8,728 10,783 2,765 -- (7,272) 15,004
Income from discontinued
operations.............. 149 -- -- -- -- 149
Extraordinary item -- loss
on debt
extinguishment.......... (2,341) -- -- -- -- (2,341)
Cumulative effect of
change in acct.
principle............... -- -- -- -- (513) (513)
-------- -------- -------- -------- -------- ----------
Net Income................ $ 6,536 $ 10,783 $ 2,765 $ -- $ (7,785) $ 12,299
======== ======== ======== ======== ======== ==========
Revenue derived from
non-U.S. sources:
Canada.................. $ 16,579 $ -- $ (2,444) $ -- $ 20 $ 14,155
======== ======== ======== ======== ======== ==========
Belgium................. $ 608 $ -- $ -- $ -- $ -- $ 608
======== ======== ======== ======== ======== ==========
Italy................... $ -- $ -- $ 313 $ -- $ -- $ 313
======== ======== ======== ======== ======== ==========
Total assets.............. $594,248 $523,660 $172,990 $ -- $ 90,702 $1,381,600
======== ======== ======== ======== ======== ==========
Long lived assets outside
the U.S.:
Canada.................. $ 57,954 $ -- $ -- $ -- $ -- $ 57,954
======== ======== ======== ======== ======== ==========
Belgium................. $ 80,835 $ -- $ -- $ -- $ -- $ 80,835
======== ======== ======== ======== ======== ==========
The managing member of the Fund is Fortress Fund MM LLC (the "Managing
Member"), which is owned jointly, through subsidiaries, by Newcastle Holdings,
approximately 94%, and the Manager, approximately 6%, in each case through Class
A membership interests. A separate class of membership interests in the Managing
Member, designated as Class B, reflects the entitlement to the incentive return
payable by the Fund, as described below, which is owned 50% by the Manager and
50% by Newcastle Holdings. Newcastle Holdings and its affiliates, including the
Managing Member, have committed to contribute an aggregate of $100 million, or
approximately 11.5% of the Fund's total committed capital, to the Fund; in the
aggregate, Newcastle Holdings and 21 unaffiliated investors (collectively, the
"Investors") have committed approximately $872.8 million (the "Capital
Commitment") to the Fund over the three years ending April 28, 2003. Newcastle
Holdings has committed to fund 100% of the capital commitments of its
affiliates, including the Managing Member (which has committed $8.7 million or
approximately 1%
F-38
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of the Fund's total committed capital), to the Fund. The Fund, which is a
Delaware limited liability company, is owned through membership interests issued
in direct proportion to capital committed.
The Managing Member of the Fund is entitled to receive an annual management
fee of up to 1.5% (inclusive of an administrative fee of up to 0.5%) of the
Fund's invested capital or total equity commitments. Newcastle Holdings is not
charged management and administrative fees for its investment in the Fund.
Pursuant to an agreement with the Managing Member and the Manager, the Manager
is entitled to 100% of the management fee paid by the Fund to the Managing
Member. Since the management fees paid to the Manager flow through Newcastle
Holdings through its ownership of the Managing Member, they are reflected as
gross amounts in both Management Fee from Affiliates and Management Fee to
Affiliates, although they have no effect on net income.
The Managing Member is entitled to an incentive return (the "Incentive
Return") generally equal to 20% of the Fund's returns, as defined, subject to:
1) a 10% preferred return payable to the Investors and 2) a clawback provision
which requires amounts previously distributed as Incentive Return to be returned
to the Fund if, upon liquidation of the Fund, the amounts ultimately distributed
to each Investor do not meet a 10% preferred return to the Investors. The Fund
is managed by the Manager pursuant to the Managing Member's operating agreement
and a management agreement between the Manager and the Managing Member. In
accordance with those documents, (a) the Manager is entitled to 100% of the
management fee payable by the Fund, (b) the Manager is entitled to 50% of the
Incentive Return payable by the Fund, (c) Newcastle Holdings is entitled to 50%
of the Incentive Return payable by the Fund and (d) Newcastle Holdings is
entitled to receive 100% of the investment income or loss attributable to the
capital invested in the Fund by the Managing Member. The Manager of the Fund
also manages Newcastle Holdings. Newcastle Holdings consolidates the financial
results of the Managing Member because Newcastle Holdings owns substantially all
of the voting interest in the Managing Member. As a result, Newcastle Holdings'
financial statements reflect all of the Incentive Return payable to the Managing
Member, including the 50% portion payable to the Manager which is treated as
Incentive Return to Affiliates.
In January 2000, Newcastle Holdings transferred, in exchange for cash,
approximately $51.2 million of preferred equity securities, acquired in December
1999, to the Fund at their market value, which approximated their book value,
resulting in no gain or loss being recorded. During 2001 and 2000, Newcastle
Holdings invested approximately $21.5 million and $47.2 million, respectively,
in the Fund. During 2001, Newcastle Holdings received $16.3 million of
distributions from the Fund, excluding Incentive Return. Newcastle Holdings
accounts for its investment in the Fund under the equity method. During 2001,
2000 and 1999, the Manager earned $8.9 million, $9.2 million and $0.7 million of
management and administrative fees from the Fund, respectively, through its
agreement with the Managing Member.
The Incentive Return is payable on an asset-by-asset basis, as realized.
Accordingly, an Incentive Return may be paid to the Managing Member in
connection with a particular Fund investment if and when such investment
generates proceeds to the Fund in excess of the capital called with respect to
such investment, plus a 10% preferred return thereon. If upon liquidation of the
Fund the aggregate amount paid to the Managing Member as Incentive Return
exceeds the amount actually due to the Managing Member (that is, amounts that
should instead have been paid to Investors) after taking into account the
aggregate return to Investors, the excess is required to be returned by the
Managing Member (that is "clawed back") to the Fund. Newcastle Holdings is
responsible to pay to the Fund the amount of any excess return to be clawed back
to the extent not funded by the Managing Member. The Manager, in turn, is
responsible for the clawback of any excess return received by it. Newcastle
Holdings believes that the Manager has the ability to meet this obligation.
Newcastle Holdings receives a credit against management fees otherwise payable
by it under the Management Agreement with the Manager for
F-39
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
management fees and any Incentive Return paid to the Manager by the Fund
allocable to Newcastle Holdings' investment in the Fund. This credit is
reflected as increased return to Newcastle Holdings from the Fund, in Equity in
Earnings (Losses) from Unconsolidated Subsidiaries, because: (a) Newcastle
Holdings, unlike the other Fund Investors, does not pay a management fee to the
Fund and its allocation of income from the Fund is calculated gross of any
management fees, and (b) Newcastle Holdings receives payments from the Manager
of amounts paid to the Manager by the Fund representing the Incentive Return
allocable to Newcastle Holdings' investment in the Fund, of which $0.5 million
was received in January 2002.
Newcastle Holdings has adopted Method 2 of Emerging Issues Task Force Topic
D-96 which specifies that companies with management arrangements that contain a
performance based incentive return that is not finalized until the end of a
period of time specified in the contract may record such return as revenue in
the amount that would be due under the formula at any point in time as if the
incentive return arrangement was terminated at that date.
Newcastle Holdings records as incentive income the amount that would be due
based on the fair value of the assets in the Fund exceeding the required return
at a specific point in time as if the management arrangement was terminated on
that date. Based on this methodology, Newcastle Holdings' net income in each
reporting period will reflect changes in the fair value of the assets in the
Fund which may be significant. As such, Newcastle Holdings has accrued $28.7
million of Incentive Return through December 31, 2001. This amount has been
recorded in Incentive Income and Due from Affiliates. The Manager is entitled to
50% of this income which Newcastle Holdings records as Incentive Return to
Affiliates. The Managing Member has received $8.8 million of such income, all of
which is subject to clawback. Newcastle Holdings has received $4.4 million of
such income in cash pertaining to the year ended December 31, 2001, representing
its 50% interest in the Incentive Return paid by the Fund.
Summarized financial information related to Newcastle Holdings'
unconsolidated subsidiaries was as follows:
INCLUDED IN REAL ESTATE LOANS SEGMENT
-------------------------------------------------------------------------------------------
FORTRESS INVESTMENT FUND
AUSTIN HOLDINGS FIC MANAGEMENT INC. LLC(A)
------------------------------ ------------------------------ -------------------------
12/31/01 12/31/00 12/31/99 12/31/01 12/31/00 12/31/99 12/31/01 12/31/00
-------- -------- -------- -------- -------- -------- ----------- -----------
Assets................... $ 7,947 $21,259 $ 31,370 $-- $ -- $5,941 $612,083 $434,009
Liabilities.............. (2,353) (7,207) (17,482) -- -- -- -- --
Minority interest........ (352) (590) (896) -- -- -- -- --
------- ------- -------- -- ----- ------ -------- --------
Equity................... $ 5,242 $13,462 $ 12,992 $-- $ -- $5,941 $612,083 $434,009
======= ======= ======== == ===== ====== ======== ========
Equity held by Newcastle
Holdings(B)............ $ 4,977 $12,733 $ 12,327 $-- $ -- $5,643 $ 68,231 $ 50,694
======= ======= ======== == ===== ====== ======== ========
Revenues................. $(1,370) $ 2,675 $ 2,444 $ 234 $ -- $141,475 $ 21,894
Expenses................. (1,302) (5,001) (6,997) (523) (375) (9,941) (8,941)
Minority interest........ (16) 484 1,123 -- -- -- -- --
------- ------- -------- -- ----- ------ -------- --------
Net income (loss)........ $(2,688) $(1,842) $ (3,430) $-- $(289) $ (375) $131,534 $ 12,953
======= ======= ======== == ===== ====== ======== ========
Newcastle Holdings'
equity in net income
(loss)................. $(2,553) $(1,749) $ (3,259) $-- $(275) $ (356) $ 5,360 $ 1,044
======= ======= ======== == ===== ====== ======== ========
- ---------------
(A) Fortress Investment Fund LLC's summary financial information is presented on
a fair value basis, consistent with its internal basis of accounting, while
Newcastle Holdings' equity is presented on a GAAP basis. Newcastle Holdings'
equity in net income excludes its incentive income.
F-40
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(B) Newcastle Holdings also has a $3.2 million receivable from Austin at
December 31, 2001 as described in Note 12.
The following table summarizes the activity affecting the equity held by
Newcastle Holdings in unconsolidated subsidiaries:
FORTRESS
FIC MANAGEMENT INVESTMENT FUND
AUSTIN HOLDINGS INC. LLC TOTAL
--------------- -------------- --------------- --------
Balance 12/31/99......................... $ 12,327 $ 5,643 $ -- $ 17,970
Contributions to unconsolidated
subsidiaries........................... 13,104 22 43,916 57,042
Contributions to unconsolidated
subsidiaries -- transferred from
prepaid expenses....................... -- -- 3,300 3,300
Distributions from unconsolidated
subsidiaries........................... (10,949) (221) -- (11,170)
Equity in earnings of unconsolidated
subsidiaries........................... (1,749) (275) 1,044 (980)
Equity in OCI of unconsolidated
subsidiaries........................... -- -- 1,933 1,933
Costs incurred related to investment in
the venture............................ -- -- 501 501
Transfer of costs incurred in connection
with the ICH acquisition............... -- (5,169) -- (5,169)
-------- ------- -------- --------
Balance 12/31/00......................... 12,733 -- 50,694 63,427
Contributions to unconsolidated
subsidiaries........................... 5,413 -- 20,416 25,829
Distributions from unconsolidated
subsidiaries........................... (10,616) -- (15,198) (25,814)
Equity in earnings of unconsolidated
subsidiaries........................... (2,553) -- 5,360 2,807
Equity in OCI of unconsolidated
subsidiaries........................... -- -- 7,074 7,074
Transfer of investment in exchange for
notes from Fund co-investors........... -- -- (3,555) (3,555)
Cost incurred related to investment in
the venture............................ -- -- 3,440 3,440
-------- ------- -------- --------
Balance 12/31/01......................... $ 4,977 $ -- $ 68,231 $ 73,208
======== ======= ======== ========
In 1998, Newcastle Holdings and Fortress Principal Investment Group LLC
("FPIG"), an affiliate of the Manager, formed Austin Holdings Corporation
("Austin"). FPIG contributed cash, and Newcastle Holdings contributed its
interest in entities that owned certain assets, primarily non-performing loans
and foreclosed real estate intended for sale, which were originally acquired as
part of loan pool acquisitions. The assets Newcastle Holdings contributed, and
any income generated from them, are not well suited to be held by a REIT because
of the following reasons. If the assets were treated as inventory held for sale
in the ordinary course of business, any gain from the sale of these assets would
be subject to a 100% excise tax in the hands of a REIT. By holding these assets
indirectly through Austin, a corporate entity, Newcastle Holdings instead
receives dividend income from the corporation, which is not subject to the 100%
excise tax, and is treated as qualifying income for purposes of the REIT 95%
income test. Newcastle Holdings holds non-voting preferred stock of Austin.
Newcastle Holdings' preferred stock in Austin represents a 95% economic
ownership interest in Austin, and has a liquidation preference over the common
stockholders. Newcastle Holdings' interest in Austin is accounted for under the
equity method. As of December 31, 2001, Newcastle Holdings has no outstanding
obligations to Austin. Newcastle Holdings and Austin have elected to treat
Austin as a taxable REIT subsidiary ("TRS") as of January 1, 2001 in order
F-41
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to comply with the rule that REITs generally may not hold more than 10% of the
voting securities or 10% of the value of securities of any corporation that is
not a TRS. FPIG is the holder of all of the common stock which represents 100%
of the vote and 5% of the economic ownership interest of Austin. FPIG's
ownership interest was funded in part by a $0.7 million loan from Austin in
2001.
Austin also owns 100% of the common stock of Ascend Residential Holdings,
Inc. ("Ascend"), which has a net book value of $3.9 million at December 31,
2001. Ascend's primary business is the acquisition, rehabilitation and sale of
single-family residential properties.
In May 1999, Newcastle Holdings purchased from Impac Commercial Holdings,
Inc. ("ICH"), a publicly traded mortgage REIT, approximately $12 million of
non-voting Series B Convertible Preferred Stock with a coupon of 8.5%. The
preferred stock was initially convertible into 1,683,635 shares of common stock
of ICH. Subsequently, during 1999 and 2000, Newcastle Holdings purchased 832,400
shares of common stock of ICH. Additionally, FIC Management Inc. ("FICMI"), an
unconsolidated subsidiary of Newcastle Holdings created for this purpose,
purchased the management contract for ICH for $6 million and subcontracted the
management of ICH to the Manager. FICMI was entitled to an incentive fee under
the management agreement, as defined, if certain minimum returns were achieved.
During the third quarter of 2000, FICMI recognized incentive fee income of $0.2
million based on ICH's achievement of such returns. During 2000 and 1999, ICH
reimbursed the Manager for approximately $0.7 million and $1.6 million of
expenses pursuant to such contract, respectively, and reimbursed Newcastle
Holdings for $0.4 million of such expenses in 2000. These investments were
included in the "Unallocated" category. FICMI had substantially the same legal
structure as Austin. Newcastle Holdings and FICMI and Fortress Fund MM, Inc.
(FFMMI) have made elections to treat FICMI and FFMMI as TRS's as of January 1,
2001.
In November 2000 a wholly-owned subsidiary of Newcastle Holdings completed
a tender offer for all of the remaining outstanding common shares of ICH.
Newcastle Holdings' basis in its investment in ICH was approximately $22.1
million at the date of acquisition. In addition, Newcastle Holdings incurred
approximately $44.3 million in connection with its tender offer and assumed
approximately $95.7 million of ICH's liabilities, resulting in total assets
acquired of $162.1 million (including $12.1 million of cash), based on the
"purchase" method of accounting. As part of the transaction, Newcastle Holdings
acquired ICH's net operating loss carry-forwards, subject to applicable tax law
limitations. Subsequent to the acquisition, Newcastle Holdings sold $108.9
million of the former ICH assets during 2000 for net proceeds of approximately
$130.2 million at a gain of approximately $21.3 million, and repaid
approximately $92.8 million of the former ICH liabilities. The remaining,
non-cash ICH assets at December 31, 2001 and 2000 were primarily included in
Marketable Securities Available for Sale (Note 2). Newcastle Holdings'
consolidated financial statements include ICH's results of operations for the
period subsequent to the completion of the tender offer.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
For the majority of Newcastle Holdings' financial instruments, principally
loans, fair values are not readily available since there are no active trading
markets as characterized by current exchanges between willing parties.
Accordingly, fair values can only be derived or estimated using various
valuation techniques, such as computing the present value of estimated future
cash flows using discount rates commensurate with the risks involved. However,
the determination of estimated future cash flows is inherently subjective and
imprecise. It should be noted that minor changes in assumptions or estimation
methodologies can have a material effect on these derived or estimated fair
values, and that the fair values reflected below are indicative of the interest
rate environments as of December 31, 2001 and do not take into consideration the
effects of subsequent interest rate fluctuations.
F-42
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The carrying amounts and estimated fair values of Newcastle Holdings'
financial instruments at December 31, 2001 are as follows:
CARRYING PRINCIPAL BALANCE OR ESTIMATED FAIR
AMOUNT NOTIONAL AMOUNT VALUE
-------- -------------------- --------------
Assets:
Marketable securities, available for sale......... $ 14,467 N/A $ 14,467
CBO Collateral, net............................... 522,258 $ 535,572 522,258
Loans and mortgage pools receivable, net.......... 10,675 25,395 10,864
Interest rate caps, treated as hedges, net(A)..... 10,271 216,365 10,271
Liabilities:
CBO bonds payable................................. 445,514 455,000 466,521
Other bonds payable............................... 319,303 360,029 388,306
Notes payable..................................... 111,116 111,116 111,424
Repurchase agreements............................. 1,457 1,457 1,457
Credit facility................................... 20,000 20,000 20,000
Interest rate swaps, treated as hedges, net(B).... 11,318 244,549 11,318
Non-hedge derivative obligations(B)............... 304 See Below 304
- ---------------
(A) Included in Deferred Costs, Net. The longest cap maturity is March 2009.
(B) Included in Derivative Liabilities. The longest swap maturity is July 2005.
The methodologies used and key assumptions made to estimate fair value are
as follows:
MARKETABLE SECURITIES AVAILABLE FOR SALE -- The fair value of marketable
securities is generally based upon multiple broker quotations, which provide
valuation estimates based upon reasonable market order indications or a good
faith estimate thereof. The related unrealized holding gain or loss is reflected
in accumulated other comprehensive income. The fair value of certain securities
acquired from ICH, for which quoted market prices are not readily available, is
estimated by means of price/yield analyses based on Newcastle Holdings' expected
disposition strategies for such assets. Such assets include Newcastle Holdings'
interest in a securitization executed by ICH (the "CMO Asset"). The CMO Asset
has an estimated value of $3.1 million at December 31, 2001 based on a discount
rate of 20% and estimated credit losses of $5.5 million. Increasing such
estimated discount rate and credit losses to 25% and $7.3 million, respectively,
would decrease the estimated value by $0.6 million and $0.5 million,
respectively. The gross securitized assets underlying the CMO Asset aggregate
$275.9 million (of which $3.5 million is delinquent) at December 31, 2001,
subject to $264.3 million of debt.
CBO COLLATERAL, NET -- The fair value of the REIT unsecured loans and CMBS
is estimated by obtaining broker quotations.
LOANS AND MORTGAGE POOLS RECEIVABLE, NET -- The fair value of floating-rate
loans is estimated at their face amount. The fair value of fixed-rate or
impaired loans is estimated by means of a discounted cash flow analysis,
utilizing expected cash flows and discount rates estimated by management to
approximate those that a willing buyer and seller might use.
INTEREST RATE CAP AND SWAP AGREEMENTS -- The fair value of these agreements
is estimated using current counterparty quotations.
CBO AND OTHER BONDS PAYABLE -- For those bonds bearing floating rates at
spreads over market indices, representing approximately $341.4 million of the
CBO Bonds Payable, management believes that for similar financial instruments
with comparable credit risks, the effective rates at December 31, 2001
F-43
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
approximate market rates. Accordingly, the carrying amount outstanding on these
bonds is believed to approximate fair value. For those bonds bearing fixed
interest rates, values were obtained by discounting expected future payments by
a rate calculated by inferring a spread over a market index on the date of
borrowing.
REPURCHASE AGREEMENTS, NOTES PAYABLE AND CREDIT FACILITY -- Management
believes that for similar financial instruments with comparable credit risks,
the stated interest rates at December 31, 2001 (all of which are floating rates
at a spread over market indices) approximate market rates, with the exception of
the Bell Canada Mortgage which bears interest at a fixed rate. Accordingly, the
carrying amount outstanding is believed to approximate fair value except with
respect to the Bell Canada Mortgage. The Bell Canada Mortgage was valued by
discounting expected future payments by a rate calculated by inferring a spread
over a market index on the date of borrowing.
NON-HEDGE DERIVATIVE OBLIGATIONS -- These obligations are valued by
reference to current counterparty quotations. These obligations represent two
essentially offsetting interest rate caps and two essentially offsetting
interest rate swaps, each with notional amounts of $32.5 million as of December
31, 2001, as well as an interest rate cap with a notional amount of $17.5
million as of December 31, 2001. The longest maturity of these derivatives is
July 2038.
8. REPURCHASE AGREEMENTS
The following table presents certain information regarding Newcastle
Holdings' securities and loan pools (including foreclosed real estate) sold
under agreements to repurchase:
ASSET CARRYING VALUE REPURCHASE OBLIGATION CURRENT
TYPE OF ----------------------- ----------------------- INTEREST CURRENT
MATURITY ASSET 12/31/2001 12/31/2000 12/31/2001 12/31/2000 RATE MATURITY
- -------- -------- ---------- ---------- ---------- ---------- -------- ---------
30 to 90 Mortgage LIBOR
Days loans $3,940 $17,855 $1,457 $ 6,827 +1.35% One-Month
Over 90 Mortgage
Days loans -- 11,575 -- 9,467
------ ------- ------ -------
$3,940 $29,430 $1,457 $16,294
====== ======= ====== =======
The repurchase agreements bore interest at weighted average rates of 3.26%
and 8.94% at December 31, 2001 and 2000, respectively.
F-44
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. NOTES PAYABLE AND CREDIT FACILITY
The following table presents certain information regarding Newcastle
Holdings' notes payable and credit facility:
CARRYING AMOUNT
-----------------------
NOTE MATURITY 12/31/2001 12/31/2000 INTEREST RATE
- ------------------------ ------------- ---------- ---------- ----------------------------
Bell Canada Mortgage April 2002 $ 31,412 $ 34,233 7.25%
Belgian Mortgage November 2016 55,149 61,694 Euribor+1.49%
(4.90% at December 31, 2001)
GSA Kansas City Mortgage November 2002 24,555 24,800 LIBOR+1.40%
(3.34% at December 31, 2001)
-------- --------
$111,116 $120,727
======== ========
Credit Facility July 2003 $ 20,000 $ 33,000 LIBOR+4.25%
(6.38% at December 31, 2001)
Two previously existing mortgages totaling approximately $252.8 million
were repaid in May 1999 with proceeds from the GSA Securitization (Note 10)
resulting in a loss on debt extinguishment of $2.3 million (comprised of a
prepayment penalty of $0.8 million and the write off of deferred financing costs
of $1.5 million) which is classified as an extraordinary item on Newcastle
Holdings' 1999 consolidated statement of operations.
In March 1999, Newcastle Holdings obtained debt financing (the "Bell Canada
Mortgage") secured by the Bell Canada Properties. In November 1999, Newcastle
Holdings obtained debt financing (the "Belgian Mortgage") secured by the Belgian
Properties and a mortgage (the "GSA Kansas City Mortgage") secured by a newly
acquired GSA Property. Newcastle Holdings has hedged its exposure to the risk of
changes in market interest rates with respect to the Belgian Mortgage and the
GSA Kansas City Mortgage by obtaining interest rate caps. In November 2001,
Newcastle Holdings extended the term and modified the rate on the Belgian
Mortgage and obtained a new interest rate cap related thereto.
In July 2000, Newcastle Holdings and Fortress Partners LP, its subsidiary,
entered into a $40 million revolving credit agreement (the "Credit Facility").
Newcastle Holdings has hedged its exposure to the risk of changes in market
interest rates with respect to the Credit Facility by entering into an interest
rate swap.
10. COLLATERALIZED BOND OBLIGATIONS ("CBO") AND BONDS PAYABLE
OUTSTANDING
CARRYING AMOUNT
-------------------
BOND ISSUE FINAL STATED MATURITY 12/31/01 12/31/00
- ---------- --------------------- -------- --------
CBO Securitization........................... July 2038 $445,514 $424,972
======== ========
OTHER BONDS
GSA Securitization........................... May 2011 $319,303 $331,801
Loan Portfolio Securitization................ -- 48,862
-------- --------
$319,303 $380,663
======== ========
In July 1999, Newcastle Holdings completed a transaction (the "CBO
Securitization") whereby the CBO Collateral (Note 5) was contributed to a
consolidated subsidiary of Newcastle Holdings (the "CBO Trust") which issued
$437.5 million of investment grade senior securities and $62.5 million of non-
F-45
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
investment grade subordinated securities (collectively, the "CBO Securities") in
a private placement. As a result of the CBO Securitization, the existing
repurchase agreement on the CBO Collateral (Note 5) was repaid.
In November 2001, Newcastle Holdings sold, through its wholly-owned
subsidiary, the retained subordinated $17.5 million Class E Note (the "Note")
issued by Fortress CBO Investments I, Ltd. for approximately $18.5 million. The
Note bears interest at a fixed rate of 8.0% and has a stated maturity of June
2038. The sale of the Note represents an issuance of debt and has been recorded
as additional CBO Bonds Payable. Newcastle Holdings anticipates that the Note
will become part of the CBO II Collateral (Note 5).
At December 31, 2001, the subordinated securities other than the Note were
retained by Newcastle Holdings. The issued securities, which bore interest at a
weighted average effective rate, including discount and cost amortization, of
4.50%, had an expected weighted average life of approximately 6.3 years at
December 31, 2001. Two classes of the outstanding CBO Securities bear floating
interest rates. Newcastle Holdings has obtained an interest rate swap and cap in
order to hedge its exposure to the risk of changes in market interest rates with
respect to these securities, at an initial cost of approximately $14.3 million.
In addition, in connection with the sale of two classes of the CBO Securities,
Newcastle Holdings entered into two interest rate swaps and three interest rate
cap agreements that do not qualify for hedge accounting. Changes in the values
of these instruments have been recorded currently in income.
In May 1999, Newcastle Holdings executed a securitization (the "GSA
Securitization") to finance fourteen of the GSA Properties (Note 4) on a
long-term basis. The securitization was a two-prong financing pursuant to which
Newcastle Holdings caused the issuance and sale of the following classes of
securities: (1) $223.2 million of "AAA" rated certificates which pay current
interest and principal, amortize over the life of the transaction and are
secured by a portion of the lease cash flows on the properties and (2) $175.9
million of current interest paying certificates which have a bullet principal
payment at maturity, ratings from "AA" to "BBB" and are secured primarily by the
residual value of the properties. The securitization has a weighted average
effective interest rate, including discount and cost amortization, of
approximately 7.04%.
In November 1999, Newcastle Holdings securitized a US commercial mortgage
loan portfolio by issuing $55.6 million of bonds that bear interest at a
weighted average stated rate of LIBOR +1.8%. The bonds were also secured by a
$15.0 million letter of credit, bearing interest at LIBOR +2.5%, with a maturity
date of December 2004, under which no amounts were drawn. These bonds were fully
repaid in December 2001.
Newcastle Holdings' long-term debt, including its repurchase agreements,
notes payable, credit facility, CBO and bonds payable, matures as follows (gross
of discounts of $50.2 million):
2002............................................. $ 80,664
2003............................................. 36,097
2004............................................. 22,058
2005............................................. 23,689
2006............................................. 25,286
Thereafter....................................... 759,808
--------
$947,602
========
F-46
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. STOCK OPTION PLAN
In June 1998, Newcastle Holdings (with the approval of the board of
directors) adopted a non-qualified stock option plan (the "Option Plan") for
non-employee directors and the Manager. The non-employee directors were granted
options in 1998 to acquire an aggregate of 6,000 shares of common stock at a
price of $20 per share, which were fully exercisable upon issuance. The fair
value of such options was not material at the date of grant. For the purpose of
compensating the Manager for its successful efforts in raising capital for
Newcastle Holdings, the Manager was granted options in 1998 representing the
right to acquire 2,091,673 shares of common stock (or, at the election of the
Manager, units in the Operating Partnership) at an exercise price per share of
common stock equal to $20.00 at December 31, 2001, with such price subject to
adjustment as necessary to preserve the value of such options in connection with
the occurrence of certain events (including capital dividends and capital
distributions made by Newcastle Holdings). The 2,091,673 shares represented an
amount equal to 10% of the shares of common stock and units of Newcastle
Holdings outstanding after Newcastle Holdings' stock issuances in 1998.
The options granted to the Manager were fully vested upon issuance and were
exercisable beginning on June 5, 1999. From and after such date, one thirtieth
of the options became exercisable on the first day of each of the following
thirty calendar months, or earlier upon the occurrence of certain events, such
as a change in control of Newcastle Holdings or the termination of the
Management Agreement. The options expire on June 5, 2008.
The fair value of the options granted to the Manager at the date of grant
was approximately $3.6 million. Newcastle Holdings estimated this value by
reference to the volatility and dividend yields of the Morgan Stanley REIT Index
that were approximately 15.4% and 7.1%, respectively, together with an expected
life assumption of 5 years, and a risk-free rate assumption of 4.88%. Since
Newcastle Holdings' common stock was not publicly traded at December 31, 2001
and the Option Plan has characteristics significantly different from those of
traded options, the actual value of the options could vary materially from
management's estimate.
12. MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS
Newcastle Holdings entered into the Management Agreement with the Manager
in June 1998, which provides for an initial term of three years with automatic
one-year extensions, subject to certain termination rights. After the initial
three year term, the Manager's performance will be reviewed annually and the
Management Agreement may be terminated by Newcastle Holdings by payment of a
termination fee, as defined in the Management Agreement, of approximately $5
million upon the affirmative vote of at least two-thirds of the independent
directors, or by a majority vote of the holders of common stock. Pursuant to the
Management Agreement, the Manager, under the supervision of Newcastle Holdings'
board of directors, will formulate investment strategies, arrange for the
acquisition of assets, arrange for financing, monitor the performance of
Newcastle Holdings' assets and provide certain advisory, administrative and
managerial services in connection with the operations of Newcastle Holdings. For
performing these services, Newcastle Holdings will pay the Manager an annual
management fee equal to 1.5% of the gross equity of Newcastle Holdings, as
defined. The management fee incurred in 2001, 2000 and 1999 was $4.8 million,
$5.1 million and $5.6 million, respectively.
An affiliate of the Manager holds units for a nominal percentage of the
Operating Partnership. To provide an incentive for the Manager to enhance the
value of the common stock, the Manager's affiliate is entitled to receive a
quarterly incentive return (the "Incentive Return") on its units on a
cumulative, but not compounding, basis in an amount equal to the product of (A)
25% of the dollar amount by which (1) (a) the Funds from Operations, as defined
(before the Incentive Return) of Newcastle Holdings per share of common stock
and per unit (based on the weighted average number of shares of common stock and
units outstanding) plus (b) gains (or losses) from debt restructuring and from
sales of property and
F-47
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
other assets per share of common stock and per unit (based on the weighted
average number of shares of common stock and units outstanding), exceed (2) an
amount equal to (a) the weighted average of the price per share of common stock
and units in the Private Offering, and in any subsequent offerings by Newcastle
Holdings (adjusted for prior capital dividends or capital distributions)
multiplied by (b) a simple interest rate of 10% per annum (divided by four to
adjust for quarterly calculations) multiplied by (B) the weighted average number
of shares of common stock and units outstanding. No Incentive Return was
incurred for 2000 or 1999. During the year ended December 31, 2001, an Incentive
Return of $2.8 million was accrued. This amount is included in Incentive Return
and Due to Affiliates.
AMOUNTS EARNED
-------------------------------------------------
2001 2000 1999
--------------- -------------- --------------
Management Fee to Manager.............. ($4.8 million) ($5.1 million) ($5.6 million)
Expense Reimbursements to Manager...... ($0.9 million) ($1.6 million) ($1.8 million)
Incentive Return to Manager............ ($2.8 million) -- --
Management Fee from Fund to Managing
Member............................... $8.9 million $8.9 million $0.9 million
Management Fee from Managing Member to
Manager.............................. ($8.9 million) ($8.9 million) ($0.9 million)
Incentive Return from Fund to Managing
Member............................... $28.8 million -- --
Incentive Return from Managing Member
to Manager........................... ($14.4 million) -- --
The Management Agreement provides that Newcastle Holdings will reimburse
the Manager for various expenses incurred by the Manager or its officers,
employees and agents on Newcastle Holdings' behalf, including costs of legal,
accounting, tax, auditing, administrative and other similar services rendered
for Newcastle Holdings by providers retained by the Manager or, if provided by
the Manager's employees, in amounts which are no greater than those which would
be payable to outside professionals or consultants engaged to perform such
services pursuant to agreements negotiated on an arm's-length basis. Newcastle
Holdings incurred $0.9 million, $1.6 million and $1.8 million in 2001, 2000 and
1999, respectively, of reimbursement to the Manager for eligible services
provided by the Manager's employees on behalf of Newcastle Holdings.
Newcastle Holdings has a $68.2 million investment in the Fund and a $5.0
million investment in Austin, which are accounted for under the equity method.
Newcastle Holdings also owns an investment in the Managing Member of the Fund,
which is consolidated. As a result of this investment, Newcastle Holdings is
entitled to an Incentive Return from the Fund. The Manager of Newcastle Holdings
also manages the Fund. Newcastle Holdings receives a credit against management
fees otherwise payable under the Management Agreement with the Manager for
management fees and any Incentive Return paid to the Manager by the Fund in
connection with Newcastle Holdings' investment in the Fund. This credit is
reflected as increased return from the Fund, in Equity in Earnings (Losses) from
Unconsolidated Subsidiaries, because it is structured as a reduced burden on
Newcastle Holdings' return from the Fund as follows: (a) Newcastle Holdings,
unlike the other Fund Investors, does not pay a management fee to the Fund and
its allocation of income from the Fund is calculated gross of any management
fees, and (b) Newcastle Holdings receives payments from the Manager to reimburse
it for its share of Incentive Return paid to the Manager by the Fund, of which
$0.5 million was received in January 2002. For a more complete discussion of
these relationships, see Note 6.
In January 2001, an employee co-investment program was adopted whereby
certain employees of the Manager and of Fortress Registered Investment Trust's
("FRIT") operating subsidiary will have the opportunity to invest in the Fund by
purchasing part of Newcastle Holdings' investment. FRIT is the
F-48
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fund's investment vehicle. The purpose of the program is to align the interests
of FRIT's employees and the employees of the Manager with those of the Fund's
Investors, including Newcastle Holdings, and to enable the Manager and FRIT to
retain such employees and provide them with appropriate incentives and rewards
for their performance. These employees are integral to the success of Newcastle
Holdings and the Fund. Certain of the employees of the Manager are officers of
Newcastle Holdings and the Fund and/or provide management services to Newcastle
Holdings and the Fund. No employees of the Fund are officers of Newcastle
Holdings or provide management services to Newcastle Holdings. Newcastle
Holdings has set aside $10.0 million of its commitment to the Fund for this
program, of which $6.9 million has been allocated, representing 0.8% of the
total commitments to the Fund, and will finance approximately 80% of the
employee investments via non-recourse loans through Austin, which are secured by
such employees' interest in the Fund. The remaining 20% is funded by cash
payments from each of the employees. The loans, which are included in Due from
Affiliates, bear interest at 10%, which is payable currently from distributions
from the Fund, and mature upon liquidation of the Fund. The principal balance
of, and any unpaid interest on, these loans is payable at maturity. At December
31, 2001, Austin was owed $3.2 million of principal and less than $0.1 million
of interest in connection with this financing. The Manager will fund up to $0.1
million of the purchase price of these commitments on behalf of employees.
At December 31, 2001, Due From (To) Affiliates is comprised of $11.7
million of net Incentive Return receivable from the Fund, $3.2 million
receivable from Austin primarily related to the co-investment program, $2.8
million of Incentive Return payable, $0.4 million of management fees payable and
$0.4 million of expense reimbursements payable.
The Fund has an investment in 3.6 million shares of Capstead Mortgage
Corporation, a public company in which Newcastle Holdings' Chairman and Chief
Executive Officer is also Chairman and Chief Executive Officer, which represents
approximately 26% of the outstanding common equity of Capstead.
HOLDINGS OF FORTRESS SECURITIES BY THE MANAGER -- The Manager holds options
to purchase 2,091,673 shares of the common stock of Newcastle Holdings, as more
fully described in Note 11. Additionally, an affiliate of the Manager owns
2,700,189 shares of the common stock of Newcastle Holdings. The principal owners
and executive officers of the Manager also serve as directors and officers of
Newcastle Holdings.
13. COMMITMENTS AND CONTINGENCIES
PRIVATE EQUITY FUND -- Newcastle Holdings and its affiliates have committed
to contribute $100 million to the Fund (see Note 6), along with other major
institutional investors who, together with Newcastle Holdings and its
affiliates, have committed approximately $872.8 million to the Fund over the
three years ending April 28, 2003. The portion of the expenses payable by
Newcastle Holdings in connection with raising the Fund, including placement
agent fees, printing costs and legal fees is approximately $9.8 million, of
which approximately $4.0 million was paid during the year ended December 31,
2001. Such amount was recorded as an adjustment to the basis of Newcastle
Holdings' investment in the Fund and is being amortized over the expected life
of the Fund.
STOCKHOLDER RIGHTS AGREEMENT -- Newcastle Holdings has adopted a
stockholder rights agreement (the "Rights Agreement"). Pursuant to the terms of
the Rights Agreement, Newcastle Holdings will attach to each share of common
stock one preferred stock purchase right (a "Right"). Each Right entitles the
registered holder to purchase from Newcastle Holdings a unit consisting of one
one-hundredth of a share of Series A Junior Participation Preferred Stock, par
value $0.01 per share, at a purchase price of $80 per unit. Initially, the
Rights are not exercisable and are attached to and transfer and trade with the
outstanding shares of common stock. The Rights will separate from the common
stock and will become exercisable upon the acquisition or tender offer to
acquire a 15% beneficial ownership interest by an acquiring person, as defined.
The effect of the Rights Agreement will be to dilute the acquiring party's
F-49
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
beneficial interest. Until a Right is exercised, the holder thereof, as such,
will have no rights as a stockholder of Newcastle Holdings.
REGISTRATION RIGHTS AGREEMENT -- In connection with the Private Offering,
Newcastle Holdings entered into a registration rights agreement which, among
other things, required Newcastle Holdings to (1) file a registration statement
(the "Registration Statement") with respect to the resale of common stock issued
in the Private Offering within 90 days following the First Closing Date, as
defined, of the Private Offering, (2) use its best efforts to cause such
Registration Statement to be declared effective by the Securities and Exchange
Commission (the "Commission"), and (3) use its best efforts to cause such
Registration Statement to remain continuously effective until the second
anniversary of the First Closing Date. Newcastle Holdings filed a registration
statement on Form S-11 in September 1998 and an amendment thereto in April 1999.
In October 2001, Newcastle Holdings filed a new registration statement on Form
S-11, which included a potential public offering of additional shares, and filed
five amendments thereto between December 2001 and February 2002. The SEC had
comments to Amendment No. 5 and Newcastle Holdings is currently evaluating
another amendment.
PURCHASE AND SALE COMMITMENTS -- In the ordinary course of business,
Newcastle Holdings enters into various commitments and letters of intent
relating to the purchase and sale of loans and real estate. There can be no
assurance that any of these transactions will ultimately be consummated. As of
December 31, 2001, Newcastle Holdings was not subject to any such commitments.
LITIGATION -- Newcastle Holdings is a defendant in legal actions from
transactions conducted in the ordinary course of business. Management, after
consultation with legal counsel, believes the ultimate liability, if any,
arising from such actions which existed at December 31, 2001 will not materially
affect Newcastle Holdings' consolidated results of operations or financial
position.
ENVIRONMENTAL COSTS -- As a commercial real estate owner, Newcastle
Holdings is subject to potential environmental costs. At December 31, 2001,
management of Newcastle Holdings is not aware of any environmental concerns that
would have a material adverse effect on Newcastle Holdings' consolidated
financial position or results of operations.
DEBT COVENANTS -- Newcastle Holdings' long-term debt contains various
customary loan covenants. Such covenants do not, in management's opinion,
materially restrict Newcastle Holdings' investment strategy or ability to raise
capital. Newcastle Holdings is in compliance with all of its loan covenants at
December 31, 2001.
14. EARNINGS PER SHARE
Newcastle Holdings is required to present both basic and diluted earnings
per share ("EPS") on the face of its statement of operations. Basic EPS is
calculated by dividing net income after preferred dividends and amortization by
the weighted average number of common shares outstanding during the year.
Diluted EPS is calculated by dividing net income after preferred dividends and
amortization by the weighted average number of shares of common stock
outstanding and the dilutive potential common shares related to outstanding
stock options (Note 11). The option exercise price of $20.00 per share equals
the initial issuance price and is subject to adjustment pursuant to such option
agreements (Note 11). In the absence of an active trading market, Newcastle
Holdings uses net book value per common share ($18.83, $18.22 and $16.96 at
December 31, 2001, 2000 and 1999, respectively) to assess whether options are
dilutive. Based upon the treasury stock method, the options are not dilutive for
the periods ended December 31, 2001, 2000 or 1999.
F-50
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. SUBSEQUENT EVENTS
In 2002, Newcastle Holdings has agreed to sell one of its GSA Properties
(Note 4) with a net basis of $32.8 million for a gross purchase price of $34.5
million, subject to closing expenses, in the second quarter of 2002.
16. DISCONTINUED OPERATIONS
In May 2002, Newcastle Holdings sold one of its GSA Properties with a net
basis at $33.0 million for a net purchase price of approximately $34.1 million,
at a gain of $1.1 million. In May 2002, it sold a commercial property located in
Brussels, Belgium for gross proceeds of approximately $8.9 million, at a loss of
approximately $0.8 million. Pursuant to SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets," Newcastle Holdings has
retroactively recorded the operations of such properties in Income from
Discontinued Operations for all periods presented.
F-51
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, 2002 DECEMBER 31, 2001
------------- -----------------
(UNAUDITED)
ASSETS
Operating real estate, net................................ $ 487,628 $ 524,834
CBO collateral, net....................................... 1,006,882 522,258
Marketable securities, available for sale................. 21,776 14,467
Loans and mortgage pools receivable, net.................. 45 10,675
Investments in unconsolidated subsidiaries................ 86,406 73,208
Cash and cash equivalents................................. 13,578 31,360
Restricted cash........................................... 10,337 34,508
Due from affiliates....................................... 12,957 11,334
Deferred costs, net....................................... 15,435 17,988
Receivables and other assets.............................. 26,058 21,487
---------- ----------
$1,681,102 $1,262,119
========== ==========
LIABILITIES, MINORITY INTEREST, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
LIABILITIES
CBO bonds payable......................................... $ 867,058 $ 445,514
Other bonds payable....................................... 351,392 319,303
Notes payable............................................. 51,570 111,116
Repurchase agreements..................................... 1,457 1,457
Credit facility........................................... 38,250 20,000
Derivative liabilities.................................... 30,510 11,732
Dividends payable......................................... 9,893 8,882
Accrued expenses and other liabilities.................... 12,645 10,633
---------- ----------
1,362,775 928,637
---------- ----------
MINORITY INTEREST........................................... 103 2,527
Redeemable preferred stock, $.01 par value, 100,000,000
shares authorized, 1,020,517 shares issued and
outstanding at
December 31, 2001...................................... -- 20,410
STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 500,000,000 shares
authorized, 16,488,517 shares issued and outstanding at
June 30, 2002 and December 31, 2001.................... 165 165
Additional paid-in capital................................ 309,356 309,356
Dividends in excess of earnings........................... (14,457) (7,767)
Accumulated other comprehensive income.................... 23,160 8,791
---------- ----------
318,224 310,545
---------- ----------
$1,681,102 $1,262,119
========== ==========
See notes to consolidated financial statements.
F-52
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
SIX MONTHS SIX MONTHS
ENDED 6/30/02 ENDED 6/30/01
------------- -------------
REVENUES:
Rental and escalation income.............................. $ 37,532 $ 38,015
Interest and dividend income.............................. 31,100 28,370
Gain on settlement of investments......................... 5,108 8,941
Management fee from affiliates............................ 4,470 4,470
Incentive income from affiliate........................... (1,218) --
Other income.............................................. 12 22
---------- ----------
77,004 79,818
---------- ----------
EXPENSES:
Interest expense.......................................... 32,769 31,949
Property operating expense................................ 14,276 14,359
Loan servicing and REO expense............................ 423 511
General and administrative expense........................ 1,838 757
Management fees to affiliate.............................. 7,168 7,221
Preferred incentive return to affiliate................... 827 --
Depreciation and amortization............................. 6,802 6,383
---------- ----------
64,103 61,180
---------- ----------
Income before equity in earnings of unconsolidated
subsidiaries and minority interest..................... 12,901 18,638
Equity in earnings of unconsolidated subsidiaries......... 362 1,125
Minority interest......................................... (13) (208)
---------- ----------
Income from continuing operations........................... 13,250 19,555
Income from discontinued operations......................... 1,009 682
---------- ----------
NET INCOME.................................................. 14,259 20,237
Preferred dividends and related accretion................... (1,162) (1,264)
---------- ----------
INCOME AVAILABLE FOR COMMON SHAREHOLDERS.................... $ 13,097 $ 18,973
========== ==========
NET INCOME PER COMMON SHARE, BASIC AND DILUTED.............. $ 0.79 $ 1.15
========== ==========
Income from continuing operations per common share, after
preferred dividends and related accretion, basic and
diluted................................................... $ 0.73 $ 1.11
========== ==========
Income from discontinued operations per common share, basic
and diluted............................................... $ 0.06 $ 0.04
========== ==========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING, BASIC
AND DILUTED............................................... 16,488,517 16,496,969
========== ==========
See notes to consolidated financial statements.
F-53
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(DOLLARS IN THOUSANDS)
REDEEMABLE PREFERRED ACCUM.
STOCK COMMON STOCK DIVIDENDS OTHER TOTAL STOCK-
--------------------- ------------------- ADDITIONAL PD. IN EXCESS OF COMP. HOLDERS'
SHARES AMOUNT SHARES AMOUNT IN CAPITAL EARNINGS INCOME EQUITY
---------- -------- ---------- ------ -------------- ------------ -------- ------------
STOCKHOLDERS'
EQUITY -- DECEMBER 31,
2001.................... 1,020,517 $ 20,410 16,488,517 $165 $309,356 $ (7,767) $ 8,791 $310,545
Dividends declared........ -- -- -- -- -- (20,949) -- (20,949)
Redemption of preferred
shares.................. (1,020,517) (20,410) -- -- -- -- -- --
Comprehensive income:
Net income.............. -- -- -- -- -- 14,259 -- 14,259
Unrealized gain on
securities............ -- -- -- -- -- -- 33,385 33,385
Foreign currency
translation........... -- -- -- -- -- -- 3,625 3,625
Foreign currency
translation:
reclassification
adjustment............ -- -- -- -- -- -- 151 151
Unrealized (loss) on
derivatives designated
as cash flow hedges... -- -- -- -- -- -- (22,662) (22,662)
Realized (gain) on
derivatives designated
as cash flow hedges:
reclassification
adjustment............ -- -- -- -- -- -- (130) (130)
--------
Total comprehensive
income................ 28,628
---------- -------- ---------- ---- -------- -------- -------- --------
Stockholders'
equity -- June 30,
2002.................... -- $ -- 16,488,517 $165 $309,356 $(14,457) $ 23,160 $318,224
========== ======== ========== ==== ======== ======== ======== ========
STOCKHOLDERS'
EQUITY -- DECEMBER 31,
2000.................... 1,020,517 $ 20,167 16,499,765 $165 $309,551 $ (7,666) $ (1,395) $300,655
Dividends declared........ -- -- -- -- -- (17,521) -- (17,521)
Redemption of common
shares.................. -- -- (11,248) -- (195) -- -- (195)
Accretion of redeemable
preferred stock......... -- 243 -- -- -- (243) -- (243)
Transition
adjustment -- deferred
hedge gains and
losses.................. -- -- -- -- -- -- (1,820) (1,820)
Comprehensive income:
Net income.............. -- -- -- -- -- 20,237 -- 20,237
Unrealized gain on
securities............ -- -- -- -- -- -- 7,973 7,973
Unrealized loss on
securities:
reclassification
adjustment............ -- -- -- -- -- -- 954 954
Foreign currency
translation........... -- -- -- -- -- -- (2,346) (2,346)
Unrealized (loss) on
derivatives designated
as cash flow hedges... -- -- -- -- -- -- (3,582) (3,582)
--------
Total comprehensive
income................ 23,236
---------- -------- ---------- ---- -------- -------- -------- --------
Stockholders'
equity -- June 30,
2001.................... 1,020,517 $ 20,410 16,488,517 $165 $309,356 $ (5,193) $ (216) $304,112
========== ======== ========== ==== ======== ======== ======== ========
See notes to consolidated financial statements.
F-54
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 14,259 $ 20,237
Adjustments to reconcile net income to net cash provided
by operating activities (inclusive of amounts related to
discontinued operations):
Depreciation and amortization........................... 7,162 6,856
Accretion of discount and other amortization............ (1,116) (1,638)
Equity in earnings of unconsolidated subsidiaries....... (362) (1,125)
Accrued incentive income from affiliate................. 609 --
Minority interest....................................... 13 208
Deferred rent........................................... (878) (1,055)
Gain on settlement of investments....................... (5,284) (8,941)
Change in:
Restricted cash......................................... 1,014 (736)
Receivables and other assets............................ (3,854) 2,363
Accrued expenses and other liabilities.................. 4,752 369
Due from affiliates..................................... 2,137 (3,264)
--------- --------
Net cash provided by operating activities: 18,452 13,274
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase and improvement of operating real estate......... (2,222) (3,347)
Proceeds from sale of operating real estate............... 42,799 --
Repayments of loan principal.............................. 9,589 24,666
Proceeds from settlement of loans and foreclosed real
estate.................................................. 350 27,854
Contributions to unconsolidated subsidiaries.............. (19,991) (18,184)
Distributions from unconsolidated subsidiaries............ 8,265 8,372
Purchase of CBO collateral................................ (521,274) (38,084)
Proceeds from sale of CBO collateral...................... 97,673 59,142
Payment of deferred transaction costs..................... (1,372) (4,174)
Purchase of marketable securities......................... (6,941) (250)
Proceeds from sale of marketable securities............... -- 10,284
--------- --------
Net cash provided by (used in) investing
activities:........................................ (393,124) 66,279
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under repurchase agreements.................... -- 10,000
Repayments of repurchase agreements....................... -- (14,911)
Repayments of notes payable............................... (65,670) (471)
Issuance of CBO bonds payable............................. 438,787 --
Repayments of CBO bonds payable........................... (17,742) --
Issuance of other bonds payable........................... 38,117 --
Repayments of other bonds payable......................... (8,151) (30,852)
Draws under credit facility............................... 20,000 7,000
Repayments of credit facility............................. (1,750) (34,000)
Minority interest distributions........................... (4,369) (4,075)
Redemption of common stock................................ -- (195)
Redemption of preferred stock............................. (20,410) --
Dividends paid............................................ (19,938) (17,670)
Payment of deferred financing costs....................... (1,984) (80)
--------- --------
Net cash provided by (used in) financing activities... 356,890 (85,254)
--------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (17,782) (5,701)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 31,360 10,575
--------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 13,578 $ 4,874
========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest expense.......... $ 26,814 $ 30,549
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
Common stock dividends declared but not paid.............. $ 9,893 $ --
Contribution of assets to unconsolidated subsidiary....... $ (1,454) $ --
Deposit used in acquisition of CBO collateral............. $ 23,631 $ --
See notes to consolidated financial statements.
F-55
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2002
1. GENERAL
Newcastle Investment Holdings Corp. (formerly Newcastle Investment Corp.
and prior to that Fortress Investment Corp.) ("Newcastle Holdings") is a
Maryland corporation that invests in real estate-related assets on a global
basis. Its primary businesses are (1) investing in marketable real
estate-related debt securities, (2) investing in commercial properties leased to
third parties, (3) investing in Fortress Investment Fund LLC (the "Fund") and
(4) investing in distressed, sub-performing and performing residential and
commercial mortgage loans, or portfolios thereof, and related properties
acquired in foreclosure or by deed-in-lieu of foreclosure.
The consolidated financial statements include the accounts of Newcastle
Holdings and its controlled subsidiaries, which include Fortress Partners, L.P.
(the "Operating Partnership"), its primary investment subsidiary. Capitalized
terms used herein, and not otherwise defined, are defined in the Newcastle
Holdings' December 31, 2001 financial statements.
Newcastle Holdings was incorporated on May 11, 1998. During 1998, Newcastle
Holdings sold 20,916,739 common shares for net proceeds of approximately $384.7
million, including 4,288 shares sold to certain employees of Fortress Investment
Group LLC (the "Manager") for proceeds of approximately $0.1 million. In 2000
and 2001, Newcastle Holdings repurchased 4,428,222 shares of common stock for
$32.4 million of cash and $46.3 million of Series A Cumulative Convertible
Preferred Stock, which was subsequently redeemed. At June 30, 2002, Newcastle
Holdings had 16,488,517 common shares and no preferred shares issued and
outstanding.
Newcastle Holdings has elected to be taxed as a real estate investment
trust ("REIT") under the Internal Revenue Code of 1986 (the "Code"). As such,
Newcastle Holdings will generally not be subject to federal income tax on that
portion of its income that is distributed to shareholders if it distributes at
least 90% of its REIT taxable income to its shareholders by the due date of its
federal income tax return and complies with various other requirements.
Newcastle Holdings has entered into a management agreement (the "Management
Agreement") with the Manager under which the Manager advises Newcastle Holdings
on various aspects of its business and manages its day-to-day operations,
subject to the supervision of Newcastle Holdings' board of directors. For its
services, the Manager receives an annual management fee, as defined in the
Management Agreement. In addition, an affiliate of the Manager holds a nominal
equity interest in the Operating Partnership which provides for a Preferred
Incentive Return.
The accompanying consolidated financial statements and related notes of
Newcastle Holdings have been prepared in accordance with accounting principals
generally accepted in the United States for interim financial reporting.
Accordingly, certain information and footnote disclosures normally included in
financial statements prepared under accounting principals generally accepted in
the United States have been condensed or omitted. In the opinion of management,
all adjustments considered necessary for a fair presentation of Newcastle
Holdings' financial position, results of operations and cash flows have been
included and are of a normal and recurring nature. These financial statements
should be read in conjunction with Newcastle Holdings' financial statements for
the year ended December 31, 2001.
2. INFORMATION REGARDING BUSINESS SEGMENTS
Newcastle Holdings conducts its business in four primary segments:
revenue-producing real estate, real estate debt securities, real estate loans,
and its investment in the Fund.
F-56
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Summary financial data on Newcastle Holdings' segments is given below,
together with a reconciliation to the same data for Newcastle Holdings as a
whole (in thousands):
R.E. DEBT REAL ESTATE
REAL ESTATE SECURITIES LOANS FUND UNALLOCATED TOTAL
----------- ---------- ----------- ------- ----------- ----------
JUNE 30, 2002 AND THE SIX MONTHS
THEN ENDED
Gross revenues................... $ 37,535 $ 35,221 $ 128 $(1,183) $ 5,303 $ 77,004
Operating expenses............... (15,064) (174) (176) 609 (9,727) (24,532)
-------- ---------- ------- ------- ------- ----------
Operating income................. 22,471 35,047 (48) (574) (4,424) 52,472
Interest expense................. (13,328) (16,644) (438) -- (2,359) (32,769)
Depreciation and amortization.... (6,372) -- -- (329) (101) (6,802)
Equity in earnings of
unconsolidated subsidiaries.... -- -- -- 303 59 362
-------- ---------- ------- ------- ------- ----------
Income before minority
interest....................... 2,771 18,403 (486) (600) (6,825) 13,263
Minority interest................ -- -- (13) -- -- (13)
-------- ---------- ------- ------- ------- ----------
Income from continuing
operations..................... 2,771 18,403 (499) (600) (6,825) 13,250
Income from discontinued
operations..................... 1,009 -- -- -- -- 1,009
-------- ---------- ------- ------- ------- ----------
Net Income....................... $ 3,780 $ 18,403 $ (499) $ (600) $(6,825) $ 14,259
======== ========== ======= ======= ======= ==========
Revenue derived from non-US
sources:
Canada......................... $ 7,752 $ -- $ -- $ -- $ -- $ 7,752
======== ========== ======= ======= ======= ==========
Belgium........................ $ 2,635 $ -- $ -- $ -- $ -- $ 2,635
======== ========== ======= ======= ======= ==========
Italy.......................... $ -- $ -- $ 180 $ -- $ -- $ 180
======== ========== ======= ======= ======= ==========
Total assets..................... $536,800 $1,022,942 $ 693 $99,695 $20,972 $1,681,102
======== ========== ======= ======= ======= ==========
Long-lived assets outside the US:
Canada......................... $ 60,838 $ -- $ -- $ -- $ -- $ 60,838
======== ========== ======= ======= ======= ==========
Belgium........................ $ 71,020 $ -- $ -- $ -- $ -- $ 71,020
======== ========== ======= ======= ======= ==========
DECEMBER 31, 2001
Total assets..................... $565,481 $ 560,155 $12,920 $97,562 $26,001 $1,262,119
======== ========== ======= ======= ======= ==========
Long-lived assets outside the US:
Canada......................... $ 51,060 $ -- $ -- $ -- $ -- $ 51,060
======== ========== ======= ======= ======= ==========
Belgium........................ $ 68,399 $ -- $ -- $ -- $ -- $ 68,399
======== ========== ======= ======= ======= ==========
F-57
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
R.E. DEBT REAL ESTATE
REAL ESTATE SECURITIES LOANS FUND UNALLOCATED TOTAL
----------- ---------- ----------- ------- ----------- ----------
SIX MONTHS ENDED JUNE 30, 2001
Gross revenues................... $ 38,289 $ 29,330 $ 4,631 $ 434 $ 7,134 $ 79,818
Operating expenses............... (15,003) (116) (266) -- (7,463) (22,848)
-------- ---------- ------- ------- ------- ----------
Operating income................. 23,286 29,214 4,365 434 (329) 56,970
Interest expense................. (14,047) (13,948) (2,228) -- (1,726) (31,949)
Depreciation and amortization.... (5,925) -- -- (231) (227) (6,383)
Equity in earnings of
unconsolidated subsidiaries.... -- -- -- 2,910 (1,785) 1,125
-------- ---------- ------- ------- ------- ----------
Income before minority
interest....................... 3,314 15,266 2,137 3,113 (4,067) 19,763
Minority interest................ -- -- (208) -- -- (208)
-------- ---------- ------- ------- ------- ----------
Income from continuing
operations..................... 3,314 15,266 1,929 3,113 (4,067) 19,555
Income from discontinued
operations..................... 682 -- -- -- -- 682
-------- ---------- ------- ------- ------- ----------
Net Income....................... $ 3,996 $ 15,266 $ 1,929 $ 3,113 $(4,067) $ 20,237
======== ========== ======= ======= ======= ==========
Revenue derived from non-US
sources:
Canada......................... $ 8,374 $ -- $ 79 $ -- $ -- $ 8,453
======== ========== ======= ======= ======= ==========
Belgium........................ $ 3,636 $ -- $ -- $ -- $ -- $ 3,636
======== ========== ======= ======= ======= ==========
Italy.......................... $ -- $ -- $ 717 $ -- $ -- $ 717
======== ========== ======= ======= ======= ==========
The following table summarizes the activity affecting the equity held by
the Company in unconsolidated subsidiaries:
FORTRESS
AUSTIN INVESTMENT
HOLDINGS FUND LLC TOTAL
-------- ---------- -------
Balance 12/31/01............................................ $4,977 $68,231 $73,208
------ ------- -------
Contributions to unconsolidated subsidiaries................ 3,237 16,754 19,991
Contribution of assets to unconsolidated subsidiary......... 1,454 -- 1,454
Distributions from unconsolidated subsidiaries.............. (522) (7,743) (8,265)
Equity in earnings of unconsolidated subsidiaries........... 59 303 362
Equity in OCI of unconsolidated subsidiaries................ -- (15) (15)
Other....................................................... -- (329) (329)
------ ------- -------
Balance 6/30/02............................................. $9,205 $77,201 $86,406
====== ======= =======
F-58
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Summarized financial information related to Newcastle Holdings'
unconsolidated subsidiaries was as follows (in thousands):
INCLUDED IN REAL ESTATE LOANS SEGMENT
AUSTIN HOLDINGS FORTRESS INVESTMENT FUND LLC(A)
------------------------------ --------------------------------
6/30/02 12/31/01 6/30/02 12/31/01
------------- ------------- -------------- --------------
Assets............................... $12,480 $ 7,947 $699,254 $612,083
Liabilities.......................... (2,641) (2,353) -- --
Minority interest.................... (309) (352) -- --
------- ------- -------- --------
Equity............................... $ 9,530 $ 5,242 $699,254 $612,083
======= ======= ======== ========
Equity held by Newcastle
Holdings(B)........................ $ 9,205 $ 4,977 $ 77,201 $ 68,231
======= ======= ======== ========
SIX MONTHS SIX MONTHS SIX MONTHS SIX MONTHS
ENDED 6/30/02 ENDED 6/30/01 ENDED 6/30/02 ENDED 6/30/01
------------- ------------- ------------- -------------
Revenues............................. $ 585 $ (902) $ 9,740 $92,061
Expenses............................. (477) (1,013) (4,470) (5,470)
Minority interest.................... (45) 36 -- --
------- ------- -------- -------
Net income........................... $ 63 $(1,879) $ 5,270 $86,591
======= ======= ======== =======
Newcastle Holdings' equity in net
income............................. $ 59 $(1,785) $ 303 $ 2,910
======= ======= ======== =======
- ---------------
(A) Fortress Investment Fund LLC's summary financial information is presented on
a fair value basis, consistent with its internal basis of accounting, while
Newcastle Holdings' equity is presented on a GAAP basis. Newcastle Holdings'
equity in net income excludes its incentive income.
(B) Newcastle Holdings also had a $3.7 million and $3.2 million receivable from
Austin at June 30, 2002 and December 31, 2001, respectively.
3. RECENT ACTIVITIES
In June 2002, Newcastle Holdings declared a common dividend of $0.60 per
common share which was paid in July 2002. In March 2002, Newcastle Holdings
declared a common dividend of $0.60 per common share which was paid in April
2002.
In April 2002, Newcastle Holdings completed the CBO II Transaction whereby
a consolidated subsidiary issued $444.0 million of investment grade senior
securities and $56.0 million of non-investment grade subordinated securities
(the "CBO II Securities") in a private placement. The senior securities were
issued for net proceeds of $438.8 million after issue costs. The subordinated
securities have been retained by Newcastle Holdings. The CBO II Securities are
primarily collateralized by a portfolio of CMBS, unsecured REIT debt,
asset-backed securities, and a limited amount of other securities, which was
acquired with the proceeds from the CBO II Securities and with the deposit
Newcastle Holdings had made on such securities. The senior securities, which
bore interest at a weighted average effective rate, including discount and cost
amortization, of approximately 3.69% at closing, had an expected weighted
average life of approximately 8.04 years at closing. One class of the senior
securities bears a floating interest rate. Newcastle Holdings obtained an
interest rate swap and cap in order to hedge its exposure to the changes in
market interest rates with respect to this security, at an initial cost of $1.2
million.
In April 2002, Newcastle Holdings repurchased the $17.5 million Class E
Note (the "Note"). The repurchase of the Note represents a repayment of debt and
will be recorded as a reduction of CBO Bonds
F-59
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Payable. The Note is included in the CBO II Collateral which was purchased in
connection with the CBO II Transaction. The Note will be eliminated in
consolidation.
In April 2002, Newcastle Holdings refinanced the Bell Canada Properties by
issuing approximately $37.6 million of investment grade debt securities in a
private placement. These securities are secured by the Bell Canada Properties
and lease payments thereunder. The issued securities, which bore interest at a
weighted average effective rate, including cost amortization, of approximately
6.70% at closing, had an expected weighted average life of approximately 5.1
years at closing. Newcastle Holdings has retained one class of the issued
securities. The proceeds from the issued securities were used, in part, to repay
the Bell Canada Mortgage.
In May 2002, Newcastle Holdings sold one of its GSA Properties with a net
basis of $33.0 million for a net purchase price of approximately $34.1 million,
at a gain of $1.1 million. In May 2002, it sold a commercial property located in
Brussels, Belgium for gross proceeds of approximately $8.9 million, at a loss of
approximately $0.8 million. Pursuant to Statement of Financial Accounting
Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets," Newcastle Holdings has retroactively recorded the operations of such
properties in Income from Discontinued Operations for all periods presented.
In June 2002, Newcastle Holdings redeemed the remaining $20.4 million of
its outstanding redeemable preferred stock.
In June and July 2002, Newcastle Holdings formed a new subsidiary,
Newcastle Investment Corp. ("Newcastle") and primarily contributed the following
assets, and related liabilities, to it: the Belgian Properties, the Bell Canada
Properties, the CBO Collateral, the CBO II Collateral, and two marketable
securities. In addition, Newcastle Holdings has created $125 million face of
mezzanine bonds issued by its subsidiaries which indirectly own the GSA
Properties. The bonds are not entitled to any scheduled interest or amortization
prior to their maturity date in May 2011. None of the bonds are secured by
mortgages on the GSA Properties; approximately $85 million face amount of the
bonds are secured by equity interests in the direct or indirect owners of the
GSA Properties; and approximately $40 million face amount of the bonds are
unsecured. $121 million of these bonds were contributed to Newcastle and held at
their discounted value of approximately $42 million. These bonds are currently
eliminated in consolidation.
Newcastle Holdings filed a registration statement with the Securities and
Exchange Commission ("SEC") on Form S-11 in June 2002 in order to register the
common stock of Newcastle and sell approximately $100 million of additional
Newcastle common stock in a public offering. The SEC has made comments on this
registration statement and Newcastle Holdings is currently in the process of
filing an amendment. Newcastle has agreed to enter into a management agreement
with the Manager which will be effective subsequent to this offering under
substantially the same terms as Newcastle Holdings' Management Agreement.
In July 2002, Newcastle entered into an agreement with a major investment
bank whereby such bank will purchase up to $450 million of commercial mortgage
backed securities, unsecured REIT debt, real estate loans and asset backed
securities (the "CBO III Collateral"), subject to Newcastle's right to purchase
such securities from them. The CBO III Collateral is expected to be included in
a securitization transaction in which Newcastle would acquire the equity
interest (the "CBO III Transaction"). As of August 14, 2002, $86.9 million of
the $450 million has been accumulated. If the CBO III Transaction is not
consummated as a result of Newcastle's failure to acquire the equity interest or
otherwise as a result of Newcastle's gross negligence or willful misconduct,
Newcastle would be required to either purchase the CBO III Collateral or pay the
difference between the original purchase price of the CBO III Collateral and the
price at which the CBO III Collateral is sold to a third-party (a "Collateral
Loss"). If the CBO III Transaction fails to close for any other reason,
Newcastle would be required to either purchase
F-60
NEWCASTLE INVESTMENT HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
the CBO III Collateral or pay the lesser of $15 million and the Collateral Loss
or, if Newcastle had paid a deposit on the CBO III Collateral in exchange for
interest and principal payments on such securities, the Collateral Loss, net of
any such deposit. Although Newcastle currently anticipates completing the CBO
III Transaction during the fourth quarter of 2002, there is no assurance that
the CBO III transaction will be consummated.
In June 2002, Newcastle entered into a financing arrangement with a major
investment bank to fund a portion of the purchase price for up to $235 million
face amount of mortgage loans, contingent upon Newcastle's public offering. This
financing arrangement will permit Newcastle to further borrow an amount up to
90% of the purchase price of the mortgage loans at a rate of LIBOR plus 0.75%.
At June 30, 2002 Due From (To) Affiliates is comprised of: $9.4 million of
net Incentive Return receivable from the Fund, $3.7 million receivable from
Austin primarily related to the Fund co-investment program, $0.6 million of
Incentive Return payable, and $0.4 million receivable from the Manager.
4. DERIVATIVE INSTRUMENTS
The following table summarizes the notional amounts and fair (carrying)
values of Newcastle Holdings' derivative financial instruments as of June 30,
2002 (amounts in thousands).
LONGEST
NOTIONAL AMOUNT FAIR VALUE MATURITY
--------------- ---------- ------------
Interest rate caps treated as hedges, net(A)....... $184,493 $ 7,418 October 2015
Interest rate swaps, treated as hedges, net(B)..... $504,007 $(28,119) April 2011
Non-hedge derivative obligations(B)................ (C) $ (156) July 2038
- ---------------
(A) Included in Deferred Costs, Net.
(B) Included in Derivative Liabilities.
(C) Represents two essentially offsetting interest rate caps and two essentially
offsetting interest rate swaps, each with notional amounts of $32.5 million
as of June 30, 2002, an interest rate cap with a notional amount of $17.5
million as of June 30, 2002, and an interest rate cap with a notional amount
of approximately $59.8 million as of June 30, 2002.
F-61
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- ------------------------------------------------------
PROSPECTIVE INVESTORS MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS
PROSPECTUS. NEITHER NEWCASTLE, NOR ANY UNDERWRITER HAS AUTHORIZED ANYONE TO
PROVIDE PROSPECTIVE INVESTORS WITH DIFFERENT OR ADDITIONAL INFORMATION. THIS
PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT SEEKING AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. THE
INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT ONLY AS OF THE DATE OF THIS
PROSPECTUS, REGARDLESS OF THE TIME OF THE DELIVERY OF THIS PROSPECTUS OR ANY
SALE OF THESE SECURITIES.
UNTIL , 2002, (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS THAT BUY, SELL OR TRADE OUR COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS REQUIREMENT IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
------------------------
TABLE OF CONTENTS
------------------------
PAGE
----
Prospectus Summary......................... 1
Risk Factors............................... 14
Cautionary Statement Regarding Forward-
looking Statements....................... 26
Use of Proceeds............................ 27
Distribution Policy........................ 27
Capitalization............................. 30
Dilution................................... 31
Selected Pro Forma Consolidated Financial
Information.............................. 32
Selected Historical Consolidated Financial
Information of Newcastle Investment
Holdings Corp. .......................... 35
Management's Discussion and Analysis of Pro
Forma Financial Condition and Results of
Operations............................... 39
Management's Discussion and Analysis of
Historical Financial Condition and
Results of Operations of Newcastle
Investment Holdings Corp. ............... 49
Newcastle Investment Corp.................. 62
Our Manager and the Management Agreement... 80
Management................................. 89
Certain Relationships and Related Party
Transactions............................. 93
Security Ownership of Certain Beneficial
Owners and Management.................... 94
Description of Capital Stock............... 96
Shares Eligible for Future Sale............ 102
Important Provisions of Maryland Law and of
Our Charter and Bylaws................... 104
Federal Income Tax Considerations.......... 107
ERISA Considerations....................... 123
Underwriting............................... 126
Legal Matters.............................. 129
Experts.................................... 129
Where You Can Find More Information........ 129
Index to Financial Statements.............. F-1
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
Newcastle Logo
NEWCASTLE
INVESTMENT CORP.
7,000,000 SHARES
COMMON STOCK
------------------------
PROSPECTUS
------------------------
BEAR, STEARNS & CO. INC.
LEHMAN BROTHERS
BANC OF AMERICA
SECURITIES LLC
, 2002
- ------------------------------------------------------
- ------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses expected to be
incurred in connection with the sale and distribution of the securities being
registered.
Securities and Exchange Commission registration fee......... $ 11,480
National Association of Securities Dealers, Inc. and Blue
Sky Registration Fees..................................... 12,978
Printing and engraving expenses............................. 500,000
Legal Fees and Expenses..................................... 1,500,000
Accounting Fees and Expenses................................ 1,000,000
Miscellaneous............................................... 125,542
----------
Total.................................................. $3,150,000
==========
ITEM 32. SALES TO SPECIAL PARTIES.
See Item 33.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES
On June 6, 2002 we issued 1 share of our common stock to Newcastle
Investment Holdings for $1.00. On July 12, 2002 we issued to Newcastle
Investment Holdings 999 shares of our common stock in exchange for a
contribution of certain assets with a book value, as of March 31, 2002, of
approximately $190 million.
In May 1999, a special purpose subsidiary, Government Lease Trust (formed
by Fortress GSA Securities L.L.C.), issued approximately $400 million face
amount of securities in transactions exempt from the registration requirements
of the Securities Act pursuant to Rule 144A and Regulation S thereunder to
qualified institutional buyers and persons outside the United States.
In July 1999, Newcastle Investment Holdings, through special purpose
subsidiaries, Fortress CBO Investments I, Limited, and Fortress CBO Investments
I Corp., issued approximately $500 million of collateralized bond obligations in
transactions exempt from the registration requirements of the Securities Act
pursuant to Rule 144A and Regulation S thereunder to qualified institutional
buyers and persons outside the United States.
In April 2002, Fortress Asset Trust issued approximately $70 million face
amount of securities secured by the lease payments and by the five Bell Canada
properties in a transaction exempt from the registration requirements of the
U.S. Securities laws pursuant to Rule 144A and Regulation S thereunder to
qualified institutional buyers and persons outside the United States.
On April 25, 2002, Newcastle CDO I Limited and Newcastle CDO I Corp. issued
$500 million face amount of collateralized bond obligations and other securities
in a transaction exempt from the registration requirements of the Securities Act
pursuant to Rule 144A and Regulation S thereunder to qualified institutional
buyers and persons outside the United States.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Maryland law permits a Maryland corporation to include in its charter a
provision limiting the liability of its directors and officers to the
corporation and its stockholders for money damages except for liability
resulting from (a) actual receipt of an improper benefit or profit in money,
property or services or (b) active and deliberate dishonesty established by a
final judgment and which is material to the cause of action. The
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Company's Charter contains such a provision which eliminates directors' and
officers' liability to the maximum extent permitted by Maryland law.
The Charter authorizes the Company, to the maximum extent permitted by
Maryland law, to indemnify any present or former director or officer or any
individual who, while a director of the Company and at the request of the
Company, serves or has served another corporation, real estate investment trust,
partnership, joint venture, trust, employee benefit plan or other enterprise as
a director, officer, partner or trustee, from and against any claim or liability
to which that person may become subject or which that person may incur by reason
of his or her status as a present or former director or officer of the Company
and to pay or reimburse their reasonable expenses in advance of final
disposition of a proceeding. The Bylaws obligate the Company, to the maximum
extent permitted by Maryland law, to indemnify any present or former director or
officer or any individual who, while a director of the Company and at the
request of the Company, serves or has served another corporation, real estate
investment trust, partnership, joint venture, trust, employee benefit plan or
other enterprise as a director, officer, partner or trustee and who is made a
party to the proceeding by reason of his service in that capacity from and
against any claim or liability to which that person may become subject or which
that person may incur by reason of his or her status as a present or former
director or officer of the Company and to pay or reimburse their reasonable
expenses in advance of final disposition of a proceeding. The Charter and Bylaws
also permit the Company to indemnify and advance expenses to any person who
served a predecessor of the Company in any of the capacities described above and
any employee or agent of the Company or a predecessor of the Company.
Maryland law requires a corporation (unless its charter provides otherwise,
which the Company's charter does not) to indemnify a director or officer who has
been successful in the defense of any proceeding to which he is made a party by
reason of his service in that capacity. Maryland law permits a corporation to
indemnify its present and former directors and officers, among others, against
judgments, penalties, fines, settlements and reasonable expenses actually
incurred by them in connection with any proceeding to which they may be made a
party by reason of their service in those or other capacities unless it is
established that (a) the act or omission of the director or officer was material
to the matter giving rise to the proceeding and (i) was committed in bad faith
or (ii) was the result of active and deliberate dishonesty, (b) the director or
officer actually received an improper personal benefit in money, property or
services or (c) in the case of any criminal proceeding, the director or officer
had reasonable cause to believe that the act or omission was unlawful. However,
under Maryland law, a Maryland corporation may not indemnify for an adverse
judgment in a suit by or in the right of the corporation or for a judgment of
liability on the basis that personal benefit was improperly received, unless in
either case a court orders indemnification and then only for expenses. In
addition, Maryland law permits a corporation to advance reasonable expenses to a
director or officer upon the corporation's receipt of (a) a written affirmation
by the director or officer of his good faith belief that he has met the standard
of conduct necessary for indemnification by the corporation and (b) a written
undertaking by him or on his behalf to repay the amount paid or reimbursed by
the corporation if it is ultimately determined that the standard of conduct was
not met.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, the registrant has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is
therefore unenforceable.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
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ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) The following financial statements are being filed as part of this
Registration Statement:
NEWCASTLE INVESTMENT CORP.
HISTORICAL FINANCIAL STATEMENT
Balance Sheet at June 6, 2002
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Pro Forma Balance Sheet at June 30, 2002 (unaudited)
Notes to Consolidated Pro Forma Balance Sheet at June 30, 2002
(unaudited)
Consolidated Pro Forma Statement of Income for the Six Months Ended
June 30, 2002 (unaudited)
Notes to Consolidated Pro Forma Statement of Income for the Six Months
Ended June 30, 2002 (unaudited)
Consolidated Pro Forma Statement of Income for the Year Ended December
31, 2001 (unaudited)
Notes to Consolidated Pro Forma Statement of Income for the Year Ended
December 31, 2001(unaudited)
Consolidated Pro Forma Statement of Income for the Six Months Ended
June 30, 2001 (unaudited)
Notes to Consolidated Pro Forma Statement of Income for the Six Months
Ended June 30, 2001 (unaudited)
Consolidated Pro Forma Statement of Income for the Year Ended December
31, 2000 (unaudited)
Notes to Consolidated Pro Forma Statement of Income for the Year Ended
December 31, 2000 (unaudited)
Consolidated Pro Forma Statement of Income for the Year Ended December
31, 1999 (unaudited)
Notes to Consolidated Pro Forma Statement of Income for the Year Ended
December 31, 1999 (unaudited)
NEWCASTLE INVESTMENT HOLDINGS CORP.
HISTORICAL CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors
Consolidated Balance Sheets at December 31, 2001 and 2000
Consolidated Statements of Income for the Years Ended December 31,
2001, 2000 and 1999
Consolidated Statements of Stockholders' Equity and Redeemable
Preferred Stock for the Years Ended December 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
Notes to Consolidated Financial Statements for the Years Ended December
31, 2001, 2000 and 1999
Consolidated Balance Sheets at June 30, 2002 (unaudited) and December
31, 2001
Consolidated Statements of Income for the Six Months Ended June 30,
2002 and 2001 (unaudited)
Consolidated Statements of Stockholders' Equity and Redeemable
Preferred Stock for the Six Months Ended June 30, 2002 and 2001
(unaudited)
Consolidated Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (unaudited)
Notes to Consolidated Financial Statements for the Six Months Ended
June 30, 2002 and 2001 (unaudited)
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(b) The following is a list of exhibits filed as part of this Registration
Statement.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
1.1 Form of Underwriting Agreement
3.1 Articles of Incorporation of the Registrant**
3.2 By-laws of the Registrant**
4.1 Form of Certificate for Common Stock**
4.2 Form of Rights Agreement between the Registrant and American
Stock Transfer & Trust Company, as Rights Agent**
5.1 Opinion of Piper Rudnick LLP relating to the legality of the
common stock*
8.1 Opinion of Skadden, Arps, Slate, Meagher & Flom LLP*
10.1 Form of Management and Advisory Agreement, dated as of
, 2002 by and among the Registrant and Fortress
Investment Group LLC**
10.2 Limited Liability Company Agreement of Fortress Investment
Group LLC, dated February 6, 1998**
10.3 Investment Guidelines**
10.4 Newcastle Investment Corp. Nonqualified Stock Option and
Incentive Award Plan**
10.5 Form of Stock Option Agreement**
10.6 Letter Agreement, dated July 10, 2002, between the
Registrant and Bear, Stearns & Co. Inc.**
10.7 Letter Agreement, dated August 13, 2002, between the
Registrant and Bear Stearns Mortgage Capital Corporation**
21.1 Subsidiaries of the Registrant**
23.1 Consent of Ernst & Young LLP
23.2 Consent of Piper Rudnick LP (contained in Exhibit 5.1)
23.3 Consent of Skadden, Arps, Slate, Meagher & Flom LLP
(contained in Exhibit 8.1)
23.4 Consent of David Grain**
23.5 Consent of Stuart McFarland**
- ---------------
* To be filed by amendment.
** Previously filed.
ITEM 37. UNDERTAKINGS.
(a) The undersigned registrant hereby undertakes to provide to the
underwriter at the closing specified in the underwriting agreements,
certificates in such denominations and registered in such names as required by
the underwriter to permit prompt delivery to each purchaser.
(b) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
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(c) The undersigned registrant hereby undertakes that:
(i) The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed
as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed
to be part of this registration statement as of the time it was declared
effective.
(2) For the purposes determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
II-5
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-11 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, State of New York, on September 23, 2002.
NEWCASTLE INVESTMENT CORP.
By: /s/ WESLEY R. EDENS
------------------------------------
Name: Wesley R. Edens
Title: Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ WESLEY R. EDENS Chief Executive Officer and September 23, 2002
- ------------------------------------------------ Chairman of the Board
Wesley R. Edens
/s/ KENNETH M. RIIS President September 23, 2002
- ------------------------------------------------
Kenneth M. Riis
/s/ MICHAEL I. WIRTH Chief Financial Officer September 23, 2002
- ------------------------------------------------ (Principal Financial and
Michael I. Wirth Accounting Officer)
/s/ RANDAL A. NARDONE Director September 23, 2002
- ------------------------------------------------
Randal A. Nardone
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