UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission File Number: 001-31458
---------------------------------
Newcastle Investment Corp.
--------------------------
(Exact name of registrant as specified in its charter)
Maryland 81-0559116
- --------------------------------- ------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1251 Avenue of the Americas, New York, NY 10020
----------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(212) 798-6100
----------------------------------------------------
(Registrant's telephone number, including area code)
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act). Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Common stock, $0.01 par value per share: 43,912,909 shares outstanding as of
November 4, 2005.
NEWCASTLE INVESTMENT CORP.
FORM 10-Q
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2005 (unaudited) and
December 31, 2004 1
Consolidated Statements of Income (unaudited) for the three and nine
months ended September 30, 2005 and 2004 2
Consolidated Statements of Stockholders' Equity (unaudited) for the nine
months ended September 30, 2005 and 2004 3
Consolidated Statements of Cash Flows (unaudited) for the nine months
ended September 30, 2005 and 2004 4
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
Item 4. Controls and Procedures 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 36
Item 3. Defaults upon Senior Securities 36
Item 4. Submission of Matters to a Vote of Security Holders 36
Item 5. Other Information 36
Item 6. Exhibits 36
SIGNATURES 38
CAUTIONARY STATEMENTS
The information contained in this quarterly report on Form 10-Q is not a
complete description of our business or the risks associated with an investment
in our company. We urge you to carefully review and consider the various
disclosures made by us in this report and in our other filings with the
Securities and Exchange Commission ("SEC"), including our annual report on Form
10-K for the year ended December 31, 2004, that discuss our business in greater
detail.
This report contains certain "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. 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. These forward-looking
statements involve risks, uncertainties and other factors that may cause our
actual results in future periods to differ materially from forecasted results.
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; adverse changes in
the financing markets we access affecting our ability to finance our real estate
securities portfolios in general or particular real estate related assets, or in
a manner that maintains our historic net spreads; changes in interest rates
and/or credit spreads, as well as the success of our hedging strategy in
relation to such changes; the quality and size of the investment pipeline and
the rate at which we can invest our cash, including cash inside our CBOs;
impairments in the value of the collateral underlying our real estate
securities, real estate related loans and residential mortgage loans and the
relation of any such impairments to our judgments as to whether changes in the
market value of our securities, loans or real estate are temporary or not and
whether circumstances bearing on the value of such assets warrant changes in
carrying values; legislative/regulatory changes; completion of pending
investments; the availability and cost of capital for future investments;
competition within the finance and real estate industries; and other risks
detailed from time to time in our SEC reports. 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 report. The factors noted above
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 Financial Condition and
Results of Operations - Application of 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 report to conform these
statements to actual results.
In addition, risks relating to our management and business, which are described
in our SEC reports include, specifically, (1) the following risks relating to
our management: (i) We are dependent on our manager and may not find a suitable
replacement if our manager terminates the management agreement. Furthermore, we
are dependent on the services of certain key employees of our manager and the
loss of such services could temporarily adversely affect our operations; (ii)
There are conflicts of interest inherent in our relationship with our manager
insofar as our manager and its affiliates manage and invest in other pooled
investment vehicles (investment funds, private investment funds, or businesses)
that invest in real estate securities, real estate related loans and operating
real estate and whose investment objectives overlap with our investment
objectives. Our management agreement with our manager does not limit or restrict
our manager or its affiliates from managing other investment vehicles that
invest in investments which meet our investment objectives. Certain investments
appropriate for Newcastle may also be appropriate for one or more of these other
investment vehicles and our manager or its affiliates may determine to make a
particular investment through another investment vehicle rather than through
Newcastle. It is possible that we may not be given the opportunity to
participate at all in certain investments made by our affiliates that meet our
investment objectives; and (iii) Our investment strategy may evolve, in light of
existing market conditions and investment opportunities, to continue to take
advantage of opportunistic investments in real estate related assets, which may
involve additional risks depending upon the nature of such assets and our
ability to finance such assets on a short or long term basis; and (2) the
following risks relating to our business: (i) Although we seek to match fund our
investments to limit refinance risk, in particular with respect to a substantial
portion of our investments in real estate securities and loans, we do not employ
this strategy with respect to certain of our investments, which increases
refinance risks for and, therefore, the yield of these investments; (ii) We may
not be able to match fund our investments with respect to maturities and
interest rates, which exposes us to the risk that we may not be able to finance
or refinance our investments on economically favorable terms; (iii) Prepayment
rates can increase, adversely affecting yields on certain of our loans; (iv) The
real estate related loans and other direct and indirect interests in pools of
real estate properties or loans that 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; and (v) We finance certain of our
investments with debt subject to margin calls based on a decrease in the value
of such investments, which could adversely impact our liquidity.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
- --------------------------------------------------------------------------------
September 30, 2005 December 31, 2004
(Unaudited)
--------------- ---------------
Assets
Real estate securities, available for sale $ 4,088,443 $ 3,369,496
Real estate securities portfolio deposit 24,055 25,411
Real estate related loans, net 668,558 591,890
Residential mortgage loans, net 684,321 654,784
Investments in unconsolidated subsidiaries 32,687 41,230
Operating real estate, net 16,839 57,193
Real estate held for sale -- 12,376
Cash and cash equivalents 16,409 37,911
Restricted cash 246,132 77,974
Derivative assets 54,161 27,122
Receivables and other assets 36,320 37,333
--------------- ---------------
$ 5,867,925 $ 4,932,720
=============== ===============
Liabilities and Stockholders' Equity
Liabilities
CBO bonds payable $ 3,093,865 $ 2,656,510
Other bonds payable 369,082 222,266
Notes payable 324,920 652,000
Repurchase agreements 983,573 490,620
Credit facility 42,000 --
Derivative liabilities 24,106 39,661
Dividends payable 28,384 25,928
Due to affiliates 6,380 8,963
Accrued expenses and other liabilities 101,811 40,057
--------------- ---------------
4,974,121 4,136,005
--------------- ---------------
Stockholders' Equity
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 2,500,000
shares of Series B Cumulative Redeemable Preferred Stock, liquidation
preference $25.00 per share, issued and outstanding 62,500 62,500
Common stock, $0.01 par value, 500,000,000 shares authorized, 43,789,819 and
39,859,481 shares issued and outstanding at September 30, 2005 and
December 31, 2004, respectively 438 399
Additional paid-in capital 782,091 676,015
Dividends in excess of earnings (13,265) (13,969)
Accumulated other comprehensive income 62,040 71,770
--------------- ---------------
893,804 796,715
--------------- ---------------
$ 5,867,925 $ 4,932,720
=============== ===============
1
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(dollars in thousands, except share data)
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
2005 2004 2005 2004
-------------- -------------- -------------- --------------
Revenues
Interest income $ 91,191 $ 55,767 $ 257,617 $ 160,937
Rental and escalation income 1,871 1,152 4,850 3,321
Gain on investments 6,788 6,227 13,111 15,809
-------------- -------------- -------------- --------------
99,850 63,146 275,578 180,067
-------------- -------------- -------------- --------------
Expenses
Interest expense 58,681 33,612 163,238 94,318
Property operating expense 594 616 1,827 1,787
Loan and security servicing expense 1,483 742 4,646 2,385
Provision for credit losses 4,091 -- 5,990 --
General and administrative expense 1,034 1,180 3,251 3,484
Management fee to affiliate 3,316 2,790 9,895 7,750
Incentive compensation to affiliate 2,416 2,494 5,271 6,104
Depreciation and amortization 182 108 453 316
-------------- -------------- -------------- --------------
71,797 41,542 194,571 116,144
-------------- -------------- -------------- --------------
Income before equity in earnings of unconsolidated
subsidiaries 28,053 21,604 81,007 63,923
Equity in earnings of unconsolidated subsidiaries 1,104 4,893 4,628 8,334
Income taxes on related taxable subsidiaries (43) (1,714) (321) (1,714)
-------------- -------------- -------------- --------------
Income from continuing operations 29,114 24,783 85,314 70,543
Income (loss) from discontinued operations 86 185 2,051 (550)
-------------- -------------- -------------- --------------
Net Income 29,200 24,968 87,365 69,993
Preferred dividends (1,523) (1,523) (4,570) (4,570)
-------------- -------------- -------------- --------------
Income Available For Common Stockholders $ 27,677 $ 23,445 $ 82,795 $ 65,423
============== ============== ============== ==============
Net Income Per Share of Common Stock
Basic $ 0.63 $ 0.61 $ 1.90 $ 1.80
============== ============== ============== ==============
Diluted $ 0.63 $ 0.60 $ 1.88 $ 1.77
============== ============== ============== ==============
Income from continuing operations per share of
common stock, after preferred dividends
Basic $ 0.63 $ 0.61 $ 1.85 $ 1.82
============== ============== ============== ==============
Diluted $ 0.63 $ 0.60 $ 1.84 $ 1.79
============== ============== ============== ==============
Income (loss) from discontinued operations per
share of common stock
Basic $ 0.00 $ 0.00 $ 0.05 $ (0.02)
============== ============== ============== ==============
Diluted $ 0.00 $ 0.00 $ 0.04 $ (0.02)
============== ============== ============== ==============
Weighted Average Number of Shares of
Common Stock Outstanding
Basic 43,789,819 38,234,481 43,595,411 36,273,142
============== ============== ============== ==============
Diluted 44,121,263 38,882,991 43,961,044 36,851,038
============== ============== ============== ==============
Dividends Declared per Share of Common Stock $ 0.625 $ 0.600 $ 1.875 $ 1.800
============== ============== ============== ==============
2
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(dollars in thousands)
- --------------------------------------------------------------------------------
Dividends
Preferred Stock Common Stock Additional in Excess
------------------------ ------------------------ Paid-in of
Shares Amount Shares Amount Capital Earnings
---------- ---------- ---------- ---------- ---------- ----------
Stockholders' equity - December 31, 2004 2,500,000 $ 62,500 39,859,481 $ 399 $ 676,015 $ (13,969)
Dividends declared -- -- -- -- -- (86,661)
Issuance of common stock -- -- 3,300,000 33 96,518 --
Exercise of common stock options -- -- 628,330 6 9,491 --
Issuance of common stock to directors -- -- 2,008 -- 67 --
Comprehensive income:
Net income -- -- -- -- -- 87,365
Net unrealized loss on securities -- -- -- -- -- --
Reclassification of net realized (gain)
on securities into earnings -- -- -- -- -- --
Foreign currency translation -- -- -- -- -- --
Reclassification of realized foreign
currency translation into earnings -- -- -- -- -- --
Unrealized gain on derivatives
designated as cash flow hedges -- -- -- -- -- --
Reclassification of realized loss on
derivatives designated as cash flow
hedges into earnings -- -- -- -- -- --
Total comprehensive income
---------- ---------- ---------- ---------- ---------- ----------
Stockholders' equity - September 30, 2005 2,500,000 $ 62,500 43,789,819 $ 438 $ 782,091 $ (13,265)
========== ========== ========== ========== ========== ==========
Stockholders' equity - December 31, 2003 2,500,000 $ 62,500 31,374,833 $ 314 $ 451,806 $ (14,670)
Dividends declared -- -- -- -- -- (71,278)
Issuance of common stock -- -- 6,750,000 67 172,643 --
Exercise of common stock options -- -- 107,500 1 1,428 --
Issuance of common stock to directors -- -- 2,148 -- 60 --
Comprehensive income:
Net income -- -- -- -- -- 69,993
Net unrealized gain on securities -- -- -- -- -- --
Reclassification of net realized (gains)
on securities into earnings -- -- -- -- -- --
Foreign currency translation -- -- -- -- -- --
Reclassification of realized foreign
currency translation into earnings -- -- -- -- -- --
Unrealized gain on derivatives
designated as cash flow hedges -- -- -- -- -- --
Reclassification of realized losses on
derivatives designated as cash flow
hedges into earnings -- -- -- -- -- --
Total comprehensive income
---------- ---------- ---------- ---------- ---------- ----------
Stockholders' equity - September 30, 2004 2,500,000 $ 62,500 38,234,481 $ 382 $ 625,937 $ (15,955)
========== ========== ========== ========== ========== ==========
Accum. Total
Other Stock-
Comp. holders'
Income Equity
---------- ----------
Stockholders' equity - December 31, 2004 $ 71,770 $ 796,715
Dividends declared -- (86,661)
Issuance of common stock -- 96,551
Exercise of common stock options -- 9,497
Issuance of common stock to directors -- 67
Comprehensive income:
Net income -- 87,365
Net unrealized loss on securities (41,202) (41,202)
Reclassification of net realized (gain)
on securities into earnings (7,157) (7,157)
Foreign currency translation (1,103) (1,103)
Reclassification of realized foreign
currency translation into earnings (626) (626)
Unrealized gain on derivatives
designated as cash flow hedges 38,701 38,701
Reclassification of realized loss on
derivatives designated as cash flow
hedges into earnings 1,657 1,657
----------
Total comprehensive income 77,635
---------- ----------
Stockholders' equity - September 30, 2005 $ 62,040 $ 893,804
========== ==========
Stockholders' equity - December 31, 2003 $ 39,413 $ 539,363
Dividends declared -- (71,278)
Issuance of common stock -- 172,710
Exercise of common stock options -- 1,429
Issuance of common stock to directors -- 60
Comprehensive income:
Net income -- 69,993
Net unrealized gain on securities 26,468 26,468
Reclassification of net realized (gains)
on securities into earnings (12,547) (12,547)
Foreign currency translation 535 535
Reclassification of realized foreign
currency translation into earnings (396) (396)
Unrealized gain on derivatives
designated as cash flow hedges 1,193 1,193
Reclassification of realized losses on
derivatives designated as cash flow
hedges into earnings 60 60
---------- ----------
Total comprehensive income 85,306
---------- ----------
Stockholders' equity - September 30, 2004 $ 54,726 $ 727,590
========== ==========
3
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
(dollars in thousands)
- --------------------------------------------------------------------------------
Nine Months Ended September 30,
-----------------------------------
2005 2004
--------------- ---------------
Cash Flows From Operating Activities
Net income $ 87,365 $ 69,993
Adjustments to reconcile net income to net cash provided by operating
activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization 629 1,675
Accretion of discount and other amortization 174 81
Equity in earnings of unconsolidated subsidiaries (4,628) (8,334)
Distributions of operating earnings from unconsolidated subsidiaries 4,049 --
Deferred rent (1,776) (1,112)
Gain on investments (13,893) (14,600)
Unrealized gain on non-hedge derivatives (6,559) (2,559)
Provision for credit losses 5,990 --
Non-cash directors' compensation 67 60
Change in:
Restricted cash (117,679) (390)
Receivables and other assets (1,016) (2,380)
Due to affiliates (2,583) 4,568
Accrued expenses and other liabilities 61,993 (4,841)
--------------- ---------------
Net cash provided by operating activities 12,133 42,161
--------------- ---------------
Cash Flows From Investing Activities
Purchase of real estate securities (815,728) (1,290,694)
Proceeds from sale of real estate securities 50,082 179,490
Deposit on real estate securities (treated as a derivative) (32,439) (55,408)
Purchase of and advances on loans (609,567) (400,365)
Proceeds from settlement of loans 1,024 123,595
Repayments of loan and security principal 540,749 340,494
Margin deposit on derivative instruments (39,099) --
Proceeds from sale of derivative instruments 762 --
Payments on settlement of derivative instruments (1,112) --
Purchase and improvement of operating real estate (188) (292)
Proceeds from sale of operating real estate 52,333 27,426
Contributions to unconsolidated subsidiaries -- (26,789)
Distributions of capital and gains from unconsolidated subsidiaries 9,122 12,366
Payment of deferred transaction costs (38) (276)
--------------- ---------------
Net cash used in investing activities (844,099) (1,090,453)
--------------- ---------------
Continued on Page 5
4
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
(dollars in thousands)
- --------------------------------------------------------------------------------
Nine Months Ended September 30,
-----------------------------------
2005 2004
--------------- ---------------
Cash Flows From Financing Activities
Issuance of CBO bonds payable 442,034 859,643
Repayments of CBO bonds payable (7,364) (26,762)
Issuance of other bonds payable 246,547 --
Repayments of other bonds payable (98,786) --
Borrowings under notes payable -- 40,000
Repayments of notes payable (327,080) (38,612)
Borrowings under repurchase agreements 675,500 368,300
Repayments of repurchase agreements (182,547) (259,743)
Draws on credit facility 42,000 --
Issuance of common stock 97,680 175,628
Costs related to issuance of common stock (1,129) (2,918)
Exercise of common stock options 9,497 1,429
Dividends paid (84,205) (64,025)
Payment of deferred financing costs (1,683) (2,453)
--------------- ---------------
Net cash provided by financing activities 810,464 1,050,487
--------------- ---------------
Net Increase in Cash and Cash Equivalents (21,502) 2,195
Cash and Cash Equivalents, Beginning of Period 37,911 60,403
--------------- ---------------
Cash and Cash Equivalents, End of Period $ 16,409 $ 62,598
=============== ===============
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense $ 153,122 $ 94,569
Cash paid during the period for income taxes $ 443 $ --
Supplemental Schedule of Non-Cash Investing and Financing Activities
Common stock dividends declared but not paid $ 27,369 $ 22,940
Preferred stock dividends declared but not paid $ 1,016 $ 1,016
Deposits used in acquisition of real estate securities (treated as
derivatives) $ 44,504 $ 75,824
5
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
(dollars in tables in thousands, except per share data)
- --------------------------------------------------------------------------------
1. GENERAL
Newcastle Investment Corp. (and its subsidiaries, "Newcastle") is a Maryland
corporation that was formed in 2002. Newcastle conducts its business through
three primary segments: (i) real estate securities and real estate related
loans, (ii) residential mortgage loans, and (iii) operating real estate.
The following table presents information on shares of Newcastle's common stock
issued subsequent to its formation:
Range of Net Proceeds
Year Shares Issued Issue Prices (1) (millions)
- ---------------------------------------------------------------------------
Formation 16,488,517 N/A N/A
2002 7,000,000 $ 13.00 $ 80.0
2003 7,886,316 $20.35-$22.85 $163.4
2004 8,484,648 $26.30-$31.40 $224.3
Nine Months 2005 3,930,338 $ 29.60 $106.1
-----------
September 30, 2005 43,789,819
===========
(1) Excludes prices of shares issued pursuant to the exercise of options and
shares issued to Newcastle's independent directors.
Newcastle is organized and conducts its operations to qualify as a real estate
investment trust ("REIT") for U.S. federal income tax purposes. As such,
Newcastle will generally not be subject to U.S. federal corporate income tax on
that portion of its net income that is distributed to stockholders if it
distributes at least 90% of its REIT taxable income to its stockholders by
prescribed dates and complies with various other requirements.
Newcastle is party to a management agreement (the "Management Agreement") with
Fortress Investment Group LLC (the "Manager"), an affiliate, under which the
Manager advises Newcastle on various aspects of its business and manages its
day-to-day operations, subject to the supervision of Newcastle's board of
directors. For its services, the Manager receives an annual management fee and
incentive compensation, both as defined in the Management Agreement.
Approximately 2.8 million shares of Newcastle's common stock were held by an
affiliate of the Manager and its principals at September 30, 2005. In addition,
an affiliate of the Manager held options to purchase approximately 1.3 million
shares of Newcastle's common stock at September 30, 2005.
The accompanying consolidated financial statements and related notes of
Newcastle have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial reporting and the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain
information and footnote disclosures normally included in financial statements
prepared under accounting principles 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's financial position,
results of operations and cash flows have been included and are of a normal and
recurring nature. The operating results presented for interim periods are not
necessarily indicative of the results that may be expected for any other interim
period or for the entire year. These financial statements should be read in
conjunction with Newcastle's December 31, 2004 consolidated financial statements
and notes thereto included in Newcastle's annual report on Form 10-K filed with
the Securities and Exchange Commission. Capitalized terms used herein, and not
otherwise defined, are defined in Newcastle's December 31, 2004 consolidated
financial statements.
2. INFORMATION REGARDING BUSINESS SEGMENTS
Newcastle conducts its business through three primary segments: real estate
securities and real estate related loans, residential mortgage loans, and
operating real estate.
6
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
(dollars in tables in thousands, except per share data)
- --------------------------------------------------------------------------------
Summary financial data on Newcastle's segments is given below, together with a
reconciliation to the same data for Newcastle as a whole:
Real Estate
Securities and Residential
Real Estate Mortgage Operating
Related Loans Loans Real Estate Unallocated Total
----------- ----------- ----------- ----------- -----------
September 30, 2005 and the Nine Months then Ended
- -------------------------------------------------
Gross revenues $ 232,803 $ 37,270 $ 4,892 $ 613 $ 275,578
Operating expenses (3,236) (7,472) (1,878) (18,294) (30,880)
----------- ----------- ----------- ----------- -----------
Operating income (loss) 229,567 29,798 3,014 (17,681) 244,698
Interest expense (140,240) (22,646) (249) (103) (163,238)
Depreciation and amortization -- -- (350) (103) (453)
Equity in earnings of unconsolidated
subsidiaries (A) 2,567 -- 1,740 -- 4,307
----------- ----------- ----------- ----------- -----------
Income (loss) from continuing operations 91,894 7,152 4,155 (17,887) 85,314
Income (loss) from discontinued operations -- -- 2,051 -- 2,051
----------- ----------- ----------- ----------- -----------
Net Income (Loss) $ 91,894 $ 7,152 $ 6,206 $ (17,887) $ 87,365
=========== =========== =========== =========== ===========
Revenue derived from non-U.S. sources:
Canada $ -- $ -- $ 10,269 $ -- $ 10,269
=========== =========== =========== =========== ===========
Belgium $ -- $ -- $ 58 $ -- $ 58
=========== =========== =========== =========== ===========
Total assets $ 5,125,114 $ 690,540 $ 35,241 $ 17,030 $ 5,867,925
=========== =========== =========== =========== ===========
Long-lived assets outside the U.S.:
Canada $ -- $ -- $ 16,839 $ -- $ 16,839
=========== =========== =========== =========== ===========
December 31, 2004
- -----------------
Total assets $ 4,136,203 $ 658,643 $ 108,322 $ 29,552 $ 4,932,720
=========== =========== =========== =========== ===========
Long-lived assets outside the U.S.:
Canada $ -- $ -- $ 57,193 $ -- $ 57,193
=========== =========== =========== =========== ===========
Belgium $ -- $ -- $ 12,376 $ -- $ 12,376
=========== =========== =========== =========== ===========
Three Months Ended September 30, 2005
- -------------------------------------
Gross revenues $ 85,742 $ 11,932 $ 1,889 $ 287 $ 99,850
Operating expenses (2,460) (3,144) (618) (6,712) (12,934)
----------- ----------- ----------- ----------- -----------
Operating income (loss) 83,282 8,788 1,271 (6,425) 86,916
Interest expense (50,992) (7,588) 2 (103) (58,681)
Depreciation and amortization -- -- (119) (63) (182)
Equity in earnings of unconsolidated
subsidiaries (A) 724 -- 337 -- 1,061
----------- ----------- ----------- ----------- -----------
Income (loss) from continuing operations 33,014 1,200 1,491 (6,591) 29,114
Income (loss) from discontinued operations -- -- 86 -- 86
----------- ----------- ----------- ----------- -----------
Net Income (Loss) $ 33,014 $ 1,200 $ 1,577 $ (6,591) $ 29,200
=========== =========== =========== =========== ===========
Revenue derived from non-U.S. sources:
Canada $ -- $ -- $ 1,917 $ -- $ 1,917
=========== =========== =========== =========== ===========
Belgium $ -- $ -- $ (4) $ -- $ (4)
=========== =========== =========== =========== ===========
(A) Net of income taxes on related taxable subsidiaries.
Continued on Page 8
7
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
(dollars in tables in thousands, except per share data)
- --------------------------------------------------------------------------------
Real Estate
Securities and Residential
Real Estate Mortgage Operating
Related Loans Loans Real Estate Unallocated Total
----------- ----------- ----------- ----------- -----------
Nine Months Ended September 30, 2004
- ------------------------------------
Gross revenues $ 162,983 $ 13,331 $ 3,338 $ 415 $ 180,067
Operating expenses (754) (1,691) (1,954) (17,111) (21,510)
----------- ----------- ----------- ----------- -----------
Operating income (loss) 162,229 11,640 1,384 (16,696) 158,557
Interest expense (86,703) (7,208) (407) -- (94,318)
Depreciation and amortization -- -- (315) (1) (316)
Equity in earnings of unconsolidated subsidiaries (A) 2,922 -- 3,698 -- 6,620
----------- ----------- ----------- ----------- -----------
Income (loss) from continuing operations 78,448 4,432 4,360 (16,697) 70,543
Income from discontinued operations -- -- (550) -- (550)
----------- ----------- ----------- ----------- -----------
Net Income (Loss) $ 78,448 $ 4,432 $ 3,810 $ (16,697) $ 69,993
=========== =========== =========== =========== ===========
Revenue derived from non-US sources:
Canada $ -- $ -- $ 10,338 $ -- $ 10,338
=========== =========== =========== =========== ===========
Belgium $ -- $ -- $ 3,955 $ -- $ 3,955
=========== =========== =========== =========== ===========
Three Months Ended September 30, 2004
- -------------------------------------
Gross revenues $ 56,887 $ 4,888 $ 1,157 $ 214 $ 63,146
Operating expenses (167) (600) (717) (6,338) (7,822)
----------- ----------- ----------- ----------- -----------
Operating income (loss) 56,720 4,288 440 (6,124) 55,324
Interest expense (30,632) (2,833) (147) -- (33,612)
Depreciation and amortization -- -- (107) (1) (108)
Equity in earnings of unconsolidated subsidiaries (A) 944 -- 2,235 -- 3,179
----------- ----------- ----------- ----------- -----------
Income (loss) from continuing operations 27,032 1,455 2,421 (6,125) 24,783
Income from discontinued operations -- -- 185 -- 185
----------- ----------- ----------- ----------- -----------
Net Income (Loss) $ 27,032 $ 1,455 $ 2,606 $ (6,125) $ 24,968
=========== =========== =========== =========== ===========
Revenue derived from non-US sources:
Canada $ -- $ -- $ 2,895 $ -- $ 2,895
=========== =========== =========== =========== ===========
Belgium $ -- $ -- $ 1,650 $ -- $ 1,650
=========== =========== =========== =========== ===========
(A) Net of income taxes on related taxable subsidiaries.
8
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
(dollars in tables in thousands, except per share data)
- --------------------------------------------------------------------------------
Unconsolidated Subsidiaries
The following table summarizes the activity affecting the equity held by
Newcastle in unconsolidated subsidiaries:
Operating Real Real Estate
Estate Subsidiary Loan Subsidiary
---------------- ----------------
Balance at December 31, 2004 $ 17,778 $ 23,452
Contributions to unconsolidated subsidiaries -- --
Distributions from unconsolidated
subsidiaries (7,686) (5,485)
Equity in earnings of unconsolidated
subsidiaries 2,061 2,567
---------------- ----------------
Balance at September 30, 2005 $ 12,153 $ 20,534
================ ================
Summarized financial information related to Newcastle's unconsolidated
subsidiaries was as follows (in thousands):
Operating
Real Estate Real Estate Loan
Subsidiary (A) (B) Subsidiary (A) (C)
----------------------------- -----------------------------
September 30, December 31, September 30, December 31,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Assets $ 77,762 $ 89,222 $ 41,301 $ 47,170
Liabilities (53,000) (53,000) -- --
Minority interest (456) (666) (233) (266)
------------ ------------ ------------ ------------
Equity $ 24,306 $ 35,556 $ 41,068 $ 46,904
============ ============ ============ ============
Equity held by Newcastle $ 12,153 $ 17,778 $ 20,534 $ 23,452
============ ============ ============ ============
Nine Months Ended September 30, Nine Months Ended September 30,
----------------------------- -----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Revenues $ 8,287 $ 16,869 $ 5,195 $ 5,963
Expenses (4,088) (5,843) (32) (99)
Minority interest (77) (203) (29) (34)
------------ ------------ ------------ ------------
Net income (loss) $ 4,122 $ 10,823 $ 5,134 $ 5,830
============ ============ ============ ============
Newcastle's equity in net income (loss) $ 2,061 $ 5,412 $ 2,567 $ 2,922
============ ============ ============ ============
(A) The unconsolidated subsidiaries' summary financial information is
presented on a fair value basis, consistent with their internal basis of
accounting.
(B) Included in the operating real estate segment.
(C) Included in the real estate securities and real estate related loans
segment.
9
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
- --------------------------------------------------------------------------------
(dollars in tables in thousands, except per share data)
3. REAL ESTATE SECURITIES
The following is a summary of Newcastle's real estate securities at September
30, 2005, all of which are classified as available for sale and are therefore
marked to market through other comprehensive income.
Gross Unrealized
--------------------------------
Current
Face Amortized Carrying
Asset Type Amount Cost Basis Gains Losses Value
- --------------------------- -------------- -------------- -------------- -------------- --------------
CMBS-Conduit $ 1,210,967 $ 1,175,653 $ 36,083 $ (15,800) $ 1,195,936
CMBS-Large Loan 489,390 486,538 9,728 (509) 495,757
CMBS- B-Note 180,484 177,245 4,681 (867) 181,059
Unsecured REIT Debt 842,618 858,526 24,646 (6,707) 876,465
ABS-Manufactured Housing 176,590 159,968 2,415 (1,801) 160,582
ABS-Home Equity 448,959 447,143 5,156 (97) 452,202
ABS-Franchise 63,996 62,306 1,610 (1,052) 62,864
Agency RMBS 667,346 670,308 76 (6,806) 663,578
-------------- -------------- -------------- -------------- --------------
Total/Average (A) $ 4,080,350 $ 4,037,687 $ 84,395 $ (33,639) $ 4,088,443
============== ============== ============== ============== ==============
Weighted Average
----------------------------------------------
S&P
Number of Equivalent Maturity
Asset Type Securities Rating Coupon Yield (Years)
-------------- -------- -------- -------- --------
CMBS-Conduit 179 BBB- 6.10% 6.66% 7.46
CMBS-Large Loan 58 BBB 6.38% 6.62% 2.00
CMBS- B-Note 32 BBB- 6.63% 6.87% 6.21
Unsecured REIT Debt 93 BBB- 6.39% 6.02% 7.10
ABS-Manufactured Housing 9 B 7.11% 8.63% 6.44
ABS-Home Equity 72 A- 5.54% 5.63% 3.09
ABS-Franchise 16 A- 6.59% 8.24% 5.07
Agency RMBS 18 AAA 4.74% 4.60% 5.07
-------------- -------- -------- -------- --------
Total/Average (A) 477 BBB+ 5.98% 6.17% 5.72
============== ======== ======== ======== ========
(A) The total current face amount of fixed rate securities was $3,211.2
million, and of floating rate securities was $869.1 million.
Unrealized losses that are considered other than temporary are recognized
currently in income. There were no such losses incurred during the nine months
ended September 30, 2005. The unrealized losses on Newcastle's securities are
primarily the result of market factors, rather than credit impairment, and
Newcastle believes their carrying values are fully recoverable over their
expected holding period. None of the securities were delinquent as of September
30, 2005.
Gross Unrealized
--------------------------------
Current
Securities in an Face Amortized Carrying
Unrealized Loss Position Amount Cost Basis Gains Losses Value
- ------------------------- -------------- -------------- -------------- -------------- --------------
Less Than Twelve Months $ 1,487,651 $ 1,483,409 $ -- $ (15,749) $ 1,467,660
Twelve or More Months 541,803 547,981 -- (17,890) 530,091
-------------- -------------- -------------- -------------- --------------
Total $ 2,029,454 $ 2,031,390 $ -- $ (33,639) $ 1,997,751
============== ============== ============== ============== ==============
Weighted Average
----------------------------------------------
S&P
Securities in an Number of Equivalent Maturity
Unrealized Loss Position Securities Rating Coupon Yield (Years)
- ------------------------- -------------- -------- -------- -------- --------
Less Than Twelve Months 158 A- 5.68% 5.62% 6.12
Twelve or More Months 60 A- 5.49% 5.22% 6.99
-------------- -------- -------- -------- --------
Total 218 A- 5.63% 5.51% 6.35
============== ======== ======== ======== ========
The unrealized losses on a majority of the securities in the "Twelve or More
Months" category were caused by changes in market interest rates, offset by
changes in market credit spreads. None of the securities in this category are in
default or delinquent and Newcastle has performed credit analyses in relation to
such securities which support its belief that the carrying values of such
securities are fully recoverable over their expected holding period. Although
management expects to hold these securities until their recovery, there is no
assurance that such securities will not be sold or at what price they may be
sold.
As of September 30, 2005, Newcastle had $172.4 million of restricted cash held
in CBO financing structures pending its investment in real estate securities and
loans.
4. REAL ESTATE RELATED LOANS AND RESIDENTIAL MORTGAGE LOANS
The following is a summary of real estate related loans and residential mortgage
loans at September 30, 2005. The loans contain various terms, including fixed
and floating rates, self-amortizing and interest only. They are generally
subject to prepayment.
Weighted
Current Average Delinquent
Face Carrying Loan Wtd. Avg. Maturity Carrying
Loan Type Amount Value Count Yield (Years) (C) Amount (D)
----------- ----------- ----------- ----------- ----------- -----------
B-Notes $ 124,999 $ 125,281 26 7.46% 2.19 $ --
Mezzanine Loans (A) 298,522 298,524 7 7.86% 2.17 --
Bank Loans 57,344 57,657 3 5.96% 2.76 --
Real Estate Loans 20,222 19,792 1 20.02% 2.25 --
ICH CMO Loans (B) 170,951 167,304 100 8.65% 2.90 22,276
----------- ----------- ----------- ----------- ----------- -----------
Total Real Estate
Related Loans $ 672,038 $ 668,558 137 8.18% 2.41 $ 22,276
=========== =========== =========== =========== =========== ===========
Residential Loans $ 397,141 $ 403,562 1,087 4.72% 2.80 $ 8,099
Manufactured Housing
Loans $ 298,330 280,759 7,386 7.85% 4.93 7,637
----------- ----------- ----------- ----------- ----------- -----------
Total Residential
Mortgage Loans $ 695,471 $ 684,321 8,473 6.00% 3.71 $ 15,736
=========== =========== =========== =========== =========== ===========
10
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
- --------------------------------------------------------------------------------
(dollars in tables in thousands, except per share data)
(A) One of these loans has a contractual exit fee which Newcastle will begin
to accrue if and when management believes it is probable that such exit
fee will be received.
(B) In October 2003, pursuant to FIN No. 46, Newcastle consolidated an entity
which holds a portfolio of commercial mortgage loans which has been
securitized. This investment, which is referred to as the ICH CMO, was
previously treated as a non-consolidated residual interest in such
securitization. The primary effect of the consolidation is the requirement
that Newcastle reflect the gross loan assets and gross bonds payable of
this entity in its financial statements.
(C) The weighted average maturity for the residential mortgage loan portfolio
was calculated based on a constant prepayment rate (CPR) of approximately
30%.
(D) This face amount of loans is 30 or more days delinquent.
Newcastle has entered into credit derivative instruments with a major investment
bank, whereby Newcastle receives the sum of all interest, fees and any positive
change in value amounts (the total return cash flows) from a reference asset
with a specified notional amount, and pays interest on such notional plus any
negative change in value amounts from such asset. These agreements are recorded
in Derivative Assets and treated as non-hedge derivatives for accounting
purposes and are therefore marked to market through income. Under the
agreements, Newcastle is required to post an initial margin deposit to an
interest bearing account and additional margin may be payable in the event of a
decline in value of the reference asset. Any margin on deposit (recorded in
Restricted Cash), less any negative change in value amounts, will be returned to
Newcastle upon termination of the contract. The following table presents
information on these instruments as of September 30, 2005.
Loan Type of Notional Margin Receive Pay Fair
Month Executed Reference Asset Amount Amount Interest Rate Interest Rate Value
- --------------------- ----------------- -------- -------- -------------- -------------- -------
November 2004 Bank Loan $106,314 $ 18,149 LIBOR + 2.000% LIBOR + 0.500% $ 1,396
February 2005 Bank Loan 97,997 19,600 LIBOR + 3.000% LIBOR + 0.625% 1,406
June 2005 Mezzanine Loan 15,000 5,224 LIBOR +4.985% LIBOR + 1.350% 99
August 2005 Bank Loan 118,954 15,000 LIBOR + 2.000% LIBOR + 0.500% 1,933
-------- -------- -------
$338,265 $ 57,973 $ 4,834
======== ======== =======
5. RECENT ACTIVITIES
In October 2005, Newcastle issued 1.6 million shares ($40.0 million face amount)
of its 8.05% Series C Cumulative Redeemable Preferred Stock (the "Series C
Preferred") for net proceeds of approximately $38.6 million. The Series C
Preferred is non-voting, has a $25 per share liquidation preference, no maturity
date and no mandatory redemption. Newcastle has the option to redeem the Series
C Preferred beginning in October 2010.
In October 2005, Newcastle's Manager exercised options to acquire approximately
0.1 million shares of Newcastle's common stock for $2.2 million.
In July 2005, Newcastle entered into a three-year, $50.0 million revolving
credit facility with Key Bank, secured by a deposit account into which cash
received by Newcastle from certain eligible CBO investments is deposited. This
credit facility involved an upfront fee paid by Newcastle of 0.75% of the $50
million commitment and bears interest at LIBOR + 2.50%. The facility also calls
for unused commitment fees of 0.25% if drawn 50% or less, and 0.125% if drawn
greater than 50%. In October 2005, the facility was increased to $75.0 million
in exchange for an upfront fee of $0.2 million.
In June 2005, Newcastle closed on the sale of the industrial/distribution
property in the Bell Canada portfolio for CAD $47.6 million (USD $38.1 million)
and recorded a gain (net of Canadian taxes) of approximately $0.9 million, net
of $2.1 million of prepayment penalties on the related debt. Newcastle posted a
CAD $4.9 million letter of credit to cover potential Canadian taxes arising from
this sale, however no taxes are expected to be paid in excess of those accrued
at closing.
In June 2005, Newcastle closed on the sale of the last property in the LIV
portfolio for EUR 10.4 million (USD $12.7 million) and recorded a loss of
approximately $0.7 million.
11
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
- --------------------------------------------------------------------------------
(dollars in tables in thousands, except per share data)
In April 2005, Newcastle completed its seventh CBO financing, whereby a
portfolio of real estate securities and loans was purchased by a consolidated
subsidiary which issued $447.0 million face amount of investment grade senior
bonds and $53.0 million face amount of non-investment grade subordinated bonds
in a private placement. The non-investment grade bonds were retained by
Newcastle and the $442.1 million carrying amount of the investment grade bonds,
which bore interest at a weighted average effective rate, including discount and
issue cost amortization and the effect of hedges, of 4.48%, had an expected
weighted average life of approximately 8.9 years. The largest tranche, the
$323.0 million face amount of Class I-MM notes, was issued subject to
remarketing procedures and related agreements whereby the securities are
remarketed and sold on a periodic basis. $439.6 million face amount of the
senior bonds bear floating interest rates. Newcastle obtained an interest rate
swap in order to hedge its exposure to the risk of changes in market interest
rates with respect to these bonds.
Newcastle enters into short-term warehouse agreements with major investment
banks for the right to purchase commercial mortgage backed securities, unsecured
REIT debt and preferred equity, real estate related loans and real estate
related asset backed securities for its real estate securities portfolios, prior
to their being financed with CBOs. These agreements are treated as non-hedge
derivatives for accounting purposes and are therefore marked to market through
current income. If the related CBO is not consummated, except as a result of
Newcastle's gross negligence, willful misconduct or breach of contract,
Newcastle will be required to pay the Net Loss, if any, as defined, up to the
related deposit, less any Excess Carry Amount, as defined, earned on such
deposit. Although Newcastle currently anticipates completing the most recent CBO
in the near term, there is no assurance that such CBO will be consummated or on
what terms it will be consummated. The following table summarizes the
agreements:
September 30, 2005 Income Recorded
- ----------------------------------------------------------- ------------------
Deal Collateral Aggregate Fair Nine Months Ended
Status Accumulated (1) Deposit Value September 30, 2005
- ------- ------------------ ----------------- ----------- ------------------
Closed N/A N/A N/A $ 1,662
Open $ 242,954 $ 23,567 $ $24,055 137
------------
$ 1,799
============
(1) Excludes $98.3 million of collateral accumulated on balance sheet and
recorded in real estate securities.
In March 2005, Newcastle closed on the sale of the vacant property in the Bell
Canada portfolio for CAD $14.3 million (USD $11.8 million) and recorded a gain
of approximately $0.4 million, net of $0.9 million of prepayment penalties on
the related debt. Newcastle posted a CAD $1.1 million letter of credit to cover
potential Canadian taxes arising from this sale, however no taxes are expected
to be paid.
An unconsolidated subsidiary of Newcastle's that owns a portfolio of convenience
and retail gas stores had entered into a property management agreement with a
third party servicer which, in March 2005, was transferred to an affiliate of
our Manager; our allocable portion of the related fees, approximately $20,000
per year for three years, were not changed.
In January 2005, Newcastle sold 3.3 million shares of its common stock in a
public offering at a price to the public of $29.60 per share, for net proceeds
of approximately $96.6 million. For the purpose of compensating the Manager for
its successful efforts in raising capital for Newcastle, in connection with this
offering, Newcastle granted options to the Manager to purchase 330,000 shares of
Newcastle's common stock at the public offering price, which were valued at
approximately $1.1 million.
During the nine months of 2005, Newcastle's Manager and certain of the Manager's
employees exercised options to purchase approximately 0.6 million shares of
Newcastle's common stock. In connection with these exercises, Newcastle received
proceeds of approximately $9.5 million.
In January 2005, Newcastle, through a consolidated subsidiary, acquired a
portfolio of approximately 8,100 manufactured housing loans for an aggregate
purchase price of approximately $308.2 million. The loans, which were all
current at the time of acquisition, are primarily fixed rate. Newcastle's
acquisition was initially funded with approximately $246.5 million of one-year
bonds provided by two investment banks which are subject to adjustment based on
the market value and performance of the related portfolio. The debt bears
interest at LIBOR + 1.25%. Newcastle obtained an interest rate swap in order to
hedge its exposure to the risk of changes in market interest rates with respect
to this financing and the anticipated permanent financing of this portfolio.
12
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
- --------------------------------------------------------------------------------
(dollars in tables in thousands, except per share data)
In January 2005, Newcastle entered into a servicing agreement with a portfolio
company of a private equity fund advised by an affiliate of Newcastle's manager
for such company to service the above described portfolio of manufactured
housing loans. As compensation under the servicing agreement, the portfolio
company will receive, on a monthly basis, a net servicing fee equal to 1.00% per
annum on the unpaid principal balance of the loans being serviced.
6. DERIVATIVE INSTRUMENTS
The following table summarizes the notional amounts and fair (carrying) values
of Newcastle's derivative financial instruments, excluding the credit derivative
instruments described in Note 4 and the warehouse agreements described in Note
5, as of September 30, 2005.
Notional Amount Fair Value Longest Maturity
--------------- ---------- ----------------
Interest rate caps, treated as hedges (A) $ 361,526 $ 2,127 October 2015
Interest rate swaps, treated as hedges (A) $ 2,599,255 $ 24,691 November 2018
Non-hedge derivative obligations (A) (B) (B) $ (54) July 2038
(A) Included in Derivative Assets or Derivative Liabilities, as
applicable. Derivative Liabilities also include accrued interest.
(B) Represents two essentially offsetting interest rate caps and two
essentially offsetting interest rate swaps, each with notional
amounts of $32.5 million, an interest rate cap with a notional
amount of $17.5 million, and five interest rate swaps with an
aggregate notional amount of $16.8 million.
7. EARNINGS PER SHARE
Newcastle is required to present both basic and diluted earnings per share
("EPS"). Basic EPS is calculated by dividing net income available for common
stockholders by the weighted average number of shares of common stock
outstanding during each period. Diluted EPS is calculated by dividing net income
available for common stockholders by the weighted average number of shares of
common stock outstanding plus the additional dilutive effect of common stock
equivalents during each period. Newcastle's common stock equivalents are its
outstanding stock options. Net income available for common stockholders is equal
to net income less preferred dividends.
The following is a reconciliation of the weighted average number of shares of
common stock outstanding on a diluted basis.
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
2005 2004 2005 2004
-------------- -------------- -------------- --------------
Weighted average number of shares of common
stock outstanding, basic 43,789,819 38,234,481 43,595,411 36,273,142
Dilutive effect of stock options, based
on the treasury stock method 331,444 648,510 365,633 577,896
-------------- -------------- -------------- --------------
Weighted average number of shares of common
stock outstanding, diluted 44,121,263 38,882,991 43,961,044 36,851,038
============== ============== ============== ==============
As of September 30, 2005, Newcastle's outstanding options were summarized as
follows:
Held by the Manager 1,293,407
Issued to the Manager and subsequently transferred to
certain of the Manager's employees 627,490
Held by directors and former directors 14,500
---------
Total 1,935,397
=========
13
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2005
- --------------------------------------------------------------------------------
(dollars in tables in thousands, except per share data)
8. INCOME TAXES
Newcastle Investment Corp. is organized and conducts its operations to qualify
as a REIT under the Internal Revenue Code of 1986, as amended. A REIT will
generally not be subject to U.S. federal corporate income tax on that portion of
its income that it distributes to its stockholders if it distributes at least
90% of its REIT taxable income to its stockholders by prescribed dates and
complies with various other requirements.
Newcastle has elected to treat NC Circle Holdings II LLC as a taxable REIT
subsidiary ("TRS"), effective February 27, 2004. NC Circle Holdings II LLC owns
a portion of Newcastle's investment in one of its unconsolidated subsidiaries.
To the extent that NC Circle Holdings II LLC generates taxable income, Newcastle
has provided for relevant income taxes based on a blended statutory rate of 40%.
Newcastle accounts for income taxes using the asset and liability method under
which deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. No such material differences have been recognized through September 30,
2005.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following should be read in conjunction with the unaudited consolidated
financial statements and notes included herein.
GENERAL
Newcastle Investment Corp. is a real estate investment and finance company. We
invest in real estate securities, loans and other real estate related assets. We
seek to deliver stable dividends and attractive risk-adjusted returns to our
stockholders through prudent asset selection, active management and the use of
match funded financing structures, which reduce our interest rate and financing
risks. Our objective is to maximize the difference between the yield on our
investments and the cost of financing these investments while hedging our
interest rate risk. We emphasize asset quality, diversification, match funded
financing and credit risk management.
We own a diversified portfolio of moderately credit sensitive real estate debt
investments including securities and loans.
Our portfolio of real estate securities includes commercial mortgage backed
securities (CMBS), senior unsecured debt issued by property REITs, real estate
related asset backed securities (ABS) and agency residential mortgage backed
securities (RMBS). Mortgage backed securities are interests in or obligations
secured by pools of mortgage loans. We generally target investments rated A
through BB, except for our agency RMBS which are generally considered AAA rated.
We also own, directly and indirectly, interest in loans and pools of loans,
including real estate related loans, commercial mortgage loans, residential
mortgage loans, and manufactured housing loans. We also own, directly and
indirectly, interests in operating real estate.
We employ leverage in order to achieve our return objectives. We do not have a
predetermined target debt to equity ratio as we believe the appropriate leverage
for the particular assets we are financing depends on the credit quality of
those assets. As of September 30, 2005, our debt to equity ratio was
approximately 5.4 to 1. We maintain access to a broad array of capital resources
in an effort to insulate our business from potential fluctuations in the
availability of capital. We utilize multiple forms of financing including
collateralized bond obligations (CBOs), other securitizations, and term loans,
as well as short term financing in the form of repurchase agreements and our
credit facility.
We seek to match fund our investments with respect to interest rates and
maturities in order to minimize the impact of interest rate fluctuations on
earnings and reduce the risk of refinancing our liabilities prior to the
maturity of the investments. We seek to finance a substantial portion of our
real estate securities and loans through the issuance of debt securities in the
form of CBOs, which are obligations issued in multiple classes secured by an
underlying portfolio of securities. Our CBO financings offer us the structural
flexibility to buy and sell certain investments to manage risk and, subject to
certain limitations, to optimize returns.
We were formed in 2002 as a subsidiary of Newcastle Investment Holdings Corp.
(referred to herein as Holdings). Prior to our initial public offering, Holdings
contributed to us certain assets and liabilities in exchange for approximately
16.5 million shares of our common stock. Our operations commenced in July 2002.
In May 2003, Holdings distributed to its stockholders all of the shares of our
common stock that it held, and it no longer owns any of our common equity.
The following table presents information on shares of our common stock issued
since our formation:
Range of Net Proceeds
Year Shares Issued Issue Prices (1) (millions)
- ---------------------------------------------------------------------------
Formation 16,488,517 N/A N/A
2002 7,000,000 $ 13.00 $ 80.0
2003 7,886,316 $20.35-$22.85 $163.4
2004 8,484,648 $26.30-$31.40 $224.3
Nine Months 2005 3,930,338 $ 29.60 $106.1
-----------
September 30, 2005 43,789,819
===========
(1) Excludes prices of shares issued pursuant to the exercise of options and
shares issued to Newcastle's independent directors.
As of September 30, 2005, approximately 2.8 million shares of our common stock
were held by an affiliate of our manager and its principals. In addition, an
affiliate of our manager held options to purchase approximately 1.3 million
shares of our common stock at September 30, 2005.
15
We are organized and conduct our operations to qualify as a REIT for U.S.
federal income tax purposes. As such, we will generally not be subject to U.S.
federal corporate income tax on that portion of our income that is distributed
to stockholders if we distribute at least 90% of our REIT taxable income to our
stockholders by prescribed dates and comply with various other requirements.
We conduct our business by investing in three primary business segments: (i)
real estate securities and real estate related loans, (ii) residential mortgage
loans and (iii) operating real estate.
Revenues attributable to each segment are disclosed below (unaudited) (in
thousands).
Real Estate
For the Nine Securities and Residential
Months Ended Real Estate Mortgage Operating
September 30, Related Loans Loans Real Estate Unallocated Total
------------- ------------ ------------ ------------ ------------ ------------
2005 $ 232,803 $ 37,270 $ 4,892 $ 613 $ 275,578
2004 $ 162,983 $ 13,331 $ 3,338 $ 415 $ 180,067
16
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with U.S. generally accepted accounting principles
("GAAP"). The preparation of financial statements in conformity with GAAP
requires the use of estimates and assumptions that could affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities and the reported amounts of revenue and expenses. Actual results
could differ from these estimates. The following is a summary of our accounting
policies that are most effected by judgments, estimates and assumptions.
Variable Interest Entities
In December 2003, Financial Accounting Standards Board Interpretation ("FIN")
No. 46R "Consolidation of Variable Interest Entities" was issued as a
modification of FIN 46. FIN 46R clarified the methodology for determining
whether an entity is a variable interest entity ("VIE") and the methodology for
assessing who is the primary beneficiary of a VIE. VIEs are defined as entities
in which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. A VIE is required to be consolidated by its primary beneficiary,
and only by its primary beneficiary, which is defined as the party who will
absorb a majority of the VIE's expected losses or receive a majority of the
expected residual returns as a result of holding variable interests.
To date, we have consolidated our existing CBO transactions (the "CBO Entities")
because we own the entire equity interest in each of them, representing a
substantial portion of their capitalization, and we control the management and
resolution of their assets. We have determined that certain of the CBO Entities
are VIEs and that we are the primary beneficiary of each of these VIEs and will
therefore continue to consolidate them. We have also determined that the
application of FIN 46R did not result in a change in our accounting for any
other entities which were previously consolidated. However, it did cause us to
consolidate one entity which was previously not consolidated, ICH CMO, as
described below under "- Liquidity and Capital Resources." We will continue to
analyze future CBO entities, as well as other investments, pursuant to the
requirements of FIN 46R. These analyses require considerable judgment in
determining the primary beneficiary of a VIE since they involve subjective
probability weighting of subjectively determined possible cash flow scenarios.
The result could be the consolidation of an entity acquired or formed in the
future that would otherwise not have been consolidated or the non-consolidation
of such an entity that would otherwise have been consolidated.
Valuation and Impairment of Securities
We have classified our real estate securities as available for sale. As such,
they are carried at fair value with net unrealized gains or losses reported as a
component of accumulated other comprehensive income. Fair value is based
primarily upon broker quotations, as well as counterparty 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 credit
spreads. Changes in market conditions, as well as changes in the assumptions or
methodology used to determine fair value, could result in a significant increase
or decrease in our book equity. We must also assess whether unrealized losses on
securities, if any, reflect a decline in value which is other than temporary
and, accordingly, write the impaired security down to its value through
earnings. For example, a decline in value is deemed to be other than temporary
if it is probable that we will be unable to collect all amounts due according to
the contractual terms of a security which was not impaired at acquisition.
Temporary declines in value generally result from changes in market factors,
such as market interest rates and credit spreads, or from certain macroeconomic
events, including market disruptions and supply changes, which do not directly
impact our ability to collect amounts contractually due. Significant judgment is
required in this analysis. To date, no such write-downs have been made.
Revenue Recognition on Securities
Income on these securities is recognized using a level yield methodology based
upon a number of assumptions that are subject to uncertainties and
contingencies. Such assumptions include the expected disposal date of such
security and the rate and timing of principal and interest receipts (which may
be subject to prepayments, delinquencies and defaults). These uncertainties and
contingencies are difficult to predict and are subject to future events, and
economic and market conditions, which may alter the assumptions. For securities
acquired at a discount for credit quality, the net income recognized is based on
a "loss adjusted yield" whereby a gross interest yield is recorded in Interest
Income, offset by a provision for expected credit losses which is accrued on a
periodic basis to Provision for Credit Losses.
17
Valuation of Derivatives
Similarly, our derivative instruments are carried at fair value pursuant to
Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities," as amended. Fair 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. Fair 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.
Impairment of Loans
We purchase, directly and indirectly, real estate related, commercial mortgage
and residential mortgage loans, including manufactured housing loans, to be held
for investment. We must periodically evaluate each of these loans or loan pools
for possible impairment. Impairment is indicated when it is deemed probable that
we will be unable to collect all amounts due according to the contractual terms
of the loan, or, for loans acquired at a discount for credit quality, when it is
deemed probable that we will be unable to collect as anticipated. Upon
determination of impairment, we would establish a specific valuation allowance
with a corresponding charge to earnings. Significant judgment is required both
in determining impairment and in estimating the resulting loss allowance. We
have recorded approximately $2.3 million of impairment with respect to the ICH
CMO loans in 2005. To date, no other impairments have been recorded.
Revenue Recognition on Loans
Income on these loans is recognized similarly to that on our securities and is
subject to similar uncertainties and contingencies. For loans acquired at a
discount for credit quality, the net income recognized is based on a "loss
adjusted yield" whereby a gross interest yield is recorded in Interest Income,
offset by a provision for expected credit losses which is accrued on a periodic
basis to Provision for Credit Losses. We have recorded approximately $3.7
million of provision with respect to our residential mortgage loan segment in
2005.
Impairment of Operating Real Estate
We own operating real estate held for investment. We review our operating real
estate for impairment annually or whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Upon
determination of impairment, we would record a write-down of the asset, which
would be charged to earnings. Significant judgment is required both in
determining impairment and in estimating the resulting write-down. To date, we
have determined that no write-downs have been necessary on the operating real
estate in our portfolio. In addition, when operating real estate is classified
as held for sale, it must be recorded at the lower of its carrying amount or
fair value less costs of sale. Significant judgment is required in determining
the fair value of such properties. In December 2003, we classified five
properties as held for sale and recorded a loss of $1.5 million; these
properties were sold in June 2004. In March 2004, we classified one property as
held for sale, which did not result in a loss; this property was sold in June
2005 at a loss of $0.7 million. No other losses have been recorded with respect
to operating real estate subsequent to our initial public offering.
18
RESULTS OF OPERATIONS
The following table summarizes the changes in our results of operations from the
three and nine months ended September 30, 2004 to the three and nine months
ended September 30, 2005 (dollars in thousands):
Period to Period Period to Period
Change Percent Change
----------------------------- ------------------------------
Nine Months Three Months Nine Months Three Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005/2004 2005/2004 2005/2004 2005/2004 Explanation
------------ ------------ ------------ ------------ ------------
Interest Income $ 96,680 $ 35,424 60% 64% (1)
Rental and escalation income 1,529 719 46% 62% (2)
Gain on investments (2,698) 561 (17%) 9% (3)
Interest expense 68,920 25,069 73% 75% (1)
Property operating expense 40 (22) 2% (4%) (2)
Loan and security servicing expense 2,261 741 95% 100% (1)
Provision for credit losses 5,990 4,091 N/A N/A (4)
General and administrative expense (233) (146) (7%) (12%) (5)
Management fee to affiliate 2,145 526 28% 19% (6)
Incentive compensation to affiliate (833) (78) (14%) (3%) (6)
Depreciation and amortization 137 74 43% 69% (2)
Equity in earnings of unconsolidated
subsidiaries, net of taxes on related (2,313) (2,118) (35%) (67%) (7)
taxable subsidiaries
------------ ------------ ------------ ------------
Income from continuing operations $ 14,771 $ 4,331 21% 17%
------------ ------------ ------------ ------------
(1) Changes in interest income and expense are primarily related to our
acquisition during the periods of interest bearing assets and related
financings, as follows:
Nine Months Ended Three Months Ended
September 30, 2005/2004 September 30, 2005/2004
---------------------------- -----------------------------
Period to Period Period to Period
Increase (Decrease) Increase (Decrease)
---------------------------- -----------------------------
Interest Interest Interest Interest
Income Expense Income Expense
------------ ------------ ------------ ------------
Real estate security and loan portfolios (A) $ 40,578 $ 29,750 $ 14,135 $ 11,381
Agency RMBS 11,641 10,728 5,428 5,071
Residential mortgage loan portfolio 2,764 5,491 (307) 1,400
Manufactured housing loan portfolio 20,650 9,947 7,353 3,355
Other real estate related loans (B) 17,165 1,938 8,615 857
Other (C) 3,882 11,066 200 3,005
------------ ------------ ------------ ------------
$ 96,680 $ 68,920 $ 35,424 $ 25,069
------------ ------------ ------------ ------------
(A) Represents our fifth through our seventh CBO financings and the
acquisition of the related collateral, as well as the deposit on our
eighth CBO financing (including unrealized gains thereon).
(B) Includes unrealized gains on total return swaps.
(C) Primarily due to increasing interest rates on floating rate assets
and liabilities owned during the entire period, with interest
expense offset by the repayment of debt as a result of property
sales.
Changes in loan and security servicing expense are also primarily due to
these acquisitions.
(2) These changes are primarily the result of the effect of the sale of
certain properties and the termination of a lease (including the
acceleration of lease termination income), offset by foreign currency
fluctuations.
(3) These changes are primarily a result of the volume of sales of real estate
securities. Sales of real estate 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.
(4) These changes are primarily the result of the acquisition of manufactured
housing and residential mortgage loan pools at a discount for credit
quality and $2.3 million of impairment recorded with respect to the ICH
CMO loans.
(5) The decrease in general and administrative expense is primarily a result
of decreased insurance and Canadian taxes, offset by increased costs as a
result of our increased size.
19
(6) The increase in management fees is a result of our increased size
resulting from our equity issuances during this period. The decrease in
incentive compensation is primarily a result of the FFO loss we recorded
related to the sale of properties during the period, offset by our
increased earnings.
(7) The decrease in earnings from unconsolidated subsidiaries is primarily a
result of a decrease in earnings from an interest in an LLC which owns a
portfolio of convenience and retail gas stores. A significant portion of
such portfolio, which was held for sale from the date it was acquired, has
been sold during the period. Note that the amounts shown are net of income
taxes on related taxable subsidiaries.
20
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 REIT taxable income. Our primary sources of funds for liquidity
consist of net cash provided by operating activities, borrowings under loans,
and the issuance of debt and equity securities. Our debt obligations are
generally secured directly by our investment assets.
We expect that our cash on hand and our cash flow provided by operations, as
well as our credit facility, will satisfy our liquidity needs with respect to
our current investment portfolio over the next twelve months. However, we
currently expect to seek additional capital in order to grow our investment
portfolio. We have an effective shelf registration statement with the SEC which
allows us to issue various types of securities, such as common stock, preferred
stock, depository shares, debt securities and warrants, from time to time, up to
an aggregate of $750 million, of which approximately $351 million remained
available as of September 30, 2005 ($311 million after the issuance of the
Series C Preferred as described below under "- Preferred Stock").
We expect to meet our long-term liquidity requirements, specifically the
repayment of our debt obligations, through additional borrowings 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. Our ability to meet our long-term liquidity
requirements relating to capital required for the growth of our investment
portfolio is subject to obtaining additional equity and debt financing.
Decisions by investors and lenders to enter into such transactions with us will
depend upon a number of factors, such as our historical and projected financial
performance, compliance with the terms of our current credit arrangements,
industry and market trends, the availability of capital and our investors' and
lenders' policies and rates applicable thereto, and the relative attractiveness
of alternative investment or lending opportunities. We maintain access to a
broad array of capital resources in an effort to insulate our business from
potential fluctuations in the availability of capital.
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 core business strategy is dependent upon our ability to
finance our real estate securities and other real estate related assets with
match funded debt at rates that provide a positive net spread. If spreads for
such liabilities widen or if demand for such liabilities ceases to exist, then
our ability to execute future financings will be severely restricted.
Furthermore, in an environment where spreads are tightening, if spreads tighten
on the assets we purchase to a greater degree than they tighten on the
liabilities we issue, our net spread will be reduced.
We expect to meet our short-term liquidity requirements generally through our
cash flow provided by operations and our credit facility, as well as investment
specific borrowings. In addition, at September 30, 2005 we had an unrestricted
cash balance of $16.4 million. Our cash flow provided by operations differs from
our net income due to four primary factors: (i) accretion of discount or premium
on our real estate securities and loans (including the accrual of interest and
fees payable at maturity), discount on our debt obligations, deferred financing
costs and interest rate cap premiums, and deferred hedge gains and losses, (ii)
gains and losses from sales of assets financed with CBOs, (iii) depreciation of
our operating real estate, and (iv) straight-lined rental income. Proceeds from
the sale of assets which serve as collateral for our CBO financings, including
gains thereon, are required to be retained in the CBO structure until the
related bonds are retired and are therefore not available to fund current cash
needs.
Our match funded investments are financed long-term and their credit status is
continuously monitored; therefore, these investments are expected to generate a
generally stable current return, subject to interest rate fluctuations. See
"Quantitative and Qualitative Disclosures About Market Risk -- Interest Rate
Exposure" below. Our remaining investments, generally financed with short term
repurchase agreements, are also subject to refinancing risk upon the maturity of
the related debt. See "Debt Obligations" below.
With respect to our operating real estate, we expect to incur expenditures of
approximately $4.4 million relating to tenant improvements, in connection with
the inception of leases, and capital expenditures during the twelve months
ending September 30, 2006.
With respect to one of our real estate related loans, we were committed to fund
up to an additional $13.3 million at October 31, 2005, subject to certain
conditions to be met by the borrower.
21
Debt Obligations
The following tables present certain information regarding our debt obligations
and related hedges as of September 30, 2005 (unaudited) (dollars in thousands):
Debt Obligation/Collateral
- -------------------------- Weighted Weighted
Current Unhedged Weighted Average Average
Month Face Carrying Average Final Stated Funding Maturity
Issued Amount Value Funding Cost Maturity Cost (1) Years
--------------------------------- ----------------------------------------------------------
CBO Bonds Payable
- -----------------
Real estate securities Jul 1999 $ 429,530 $ 425,998 5.23% (2) Jul 2038 4.76% 3.53
Real estate securities and loans Apr 2002 444,000 440,878 4.97% (2) Apr 2037 6.46% 4.74
Real estate securities and loans Mar 2003 472,000 468,291 4.96% (2) Mar 2038 4.90% 6.45
Real estate securities and loans Sep 2003 460,000 455,543 4.64% (2) Sep 2038 5.08% 6.83
Real estate securities and loans Mar 2004 414,000 410,386 4.63% (2) Mar 2039 4.65% 7.42
Real estate securities and loans Sep 2004 454,500 450,514 4.55% (2) Sep 2039 4.72% 7.45
Real estate securities and loans Apr 2005 447,000 442,255 3.94% (2) Apr 2040 4.50% 8.47
----------------------- --------- ---------
3,121,030 3,093,865 5.01% 6.40
----------------------- --------- ---------
Other Bonds Payable
- -------------------
ICH CMO loans (3) (3) 146,748 146,748 6.66% (2) Aug 2030 6.66% 1.60
Manufactured housing loans (4) Jan 2005 222,576 222,334 LIBOR+1.25% Jan 2006 5.49% 0.33
----------------------- --------- ---------
369,324 369,082 5.96% 0.83
----------------------- --------- ---------
Notes Payable
- -------------
Residential mortgage loans (4) Nov 2004 324,920 324,920 LIBOR+0.16% Nov 2007 4.14% 1.50
----------------------- --------- ---------
324,920 324,920 4.14% 1.50
----------------------- --------- ---------
Repurchase Agreements (4)(10)
- -----------------------------
Residential mortgage loans Rolling 44,729 44,729 LIBOR+ 0.43% Dec 2005 4.40% 0.25
ABS-manufactured housing Rolling 88,596 88,596 LIBOR+ 0.63% Various (7) 4.44% 0.23
Agency RMBS (5) Rolling 644,415 644,415 LIBOR+ 0.13% Oct 2005 (5) 4.45% 0.08
Real estate securities Rolling 26,335 26,335 LIBOR+ 0.71% Oct 2005 4.23% 0.08
Real estate related loans Rolling 179,498 179,498 LIBOR+ 1.04% Oct 2005 4.81% 0.08
----------------------- --------- ---------
983,573 983,573 4.51% 0.10
----------------------- --------- ---------
Credit facility (6) 42,000 42,000 LIBOR+ 2.50% (8) Jul 2008 5.34% 2.80
----------------------- --------- ---------
Total debt obligations $4,840,847 $4,813,440 4.93% 4.34
======================= ========= =========
Aggregate
Debt Obligation/Collateral Collateral Notional
- -------------------------- Face Weighted Face Amount of
Amount Collateral Average Amount Currently
of Floating Carrying Maturity of Floating Effective
Rate Debt Value (Years)(9) Rate Collateral Hedges
------------------------------------------------------------------
CBO Bonds Payable
- -----------------
Real estate securities $ 334,530 $ 576,480 5.29 $ - $ 281,907
Real estate securities and loans 372,000 501,700 5.80 73,142 290,000
Real estate securities and loans 427,800 520,490 5.33 146,860 276,060
Real estate securities and loans 442,500 508,978 4.73 189,679 192,500
Real estate securities and loans 382,750 446,844 5.59 196,300 165,300
Real estate securities and loans 442,500 497,418 5.80 228,453 189,373
Real estate securities and loans 439,600 487,247 6.81 195,809 243,421
----------- ----------- ----------- ------------- -----------
2,841,680 3,539,157 5.63 1,030,243 1,638,561
----------- ----------- ----------- ------------- -----------
Other Bonds Payable
- -------------------
ICH CMO loans (3) 3,626 167,304 2.90 3,626 -
Manufactured housing loans (4) 222,576 280,759 4.93 - 237,820
----------- ----------- ----------- ------------- -----------
226,202 448,063 4.19 3,626 237,820
----------- ----------- ----------- ------------- -----------
Notes Payable
- -------------
Residential mortgage loans (4) 324,920 356,147 2.80 350,640 -
----------- ----------- ----------- ------------- -----------
324,920 356,147 2.80 350,640 -
----------- ----------- ----------- ------------- -----------
Repurchase Agreements (4)(10)
- -----------------------------
Residential mortgage loans 44,729 47,415 2.80 46,501 -
ABS-manufactured housing 88,596 110,133 5.83 - 70,000
Agency RMBS (5) 644,415 663,578 5.07 - 638,579
Real estate securities 26,335 40,067 2.36 12,450 14,295
Real estate related loans 179,498 263,293 2.05 263,330 -
----------- ----------- ----------- ------------- -----------
983,573 1,124,486 4.27 322,281 722,874
----------- ----------- ----------- ------------- -----------
Credit facility (6) 42,000 - 0.00 - -
----------- ----------- ----------- ------------- -----------
Total debt obligations $ 4,418,375 $ 5,467,853 5.02 $ 1,706,790 $ 2,599,255
=========== =========== =========== ============= ===========
(1) Includes the effect of applicable hedges.
(2) Weighted average, including floating and fixed rate classes.
(3) See "Liquidity and Capital Resources" below regarding the consolidation of
ICH CMO.
(4) Subject to potential mandatory prepayments based on collateral value.
(5) A maximum of $1 billion is available. The commitment matures in November
2005.
(6) A maximum of $75 million can be drawn.
(7) The longest maturity is December 2005.
(8) In addition, unused commitment fees of between 0.125% and 0.250% are paid.
(9) Total excludes credit facility.
(10) The counterparties on our repurchase agreements include: Bank of America
Securities LLC ($658.7 million), Bear Stearns Mortgage Capital Corporation
($178.2 million), Greenwich Capital Markets Inc. ($76.6 million), and
others ($70.1 million).
22
Our debt obligations existing at September 30, 2005 (gross of $27.4 million of
discounts) had contractual maturities as follows (unaudited) (in thousands):
Period from October 1, 2005 through December 31, 2005 $ 983,573
2006 222,576
2007 324,920
2008 42,000
2009 --
2010 --
Thereafter 3,267,778
----------
Total $4,840,847
==========
Certain of the debt obligations included above are obligations of our
consolidated subsidiaries which own the related collateral. In some cases,
including the CBO and Other Bonds Payable, such collateral is not available to
other creditors of ours.
In connection with the sale of two classes of CBO bonds, we entered into two
interest rate swaps and three interest rate cap agreements that do not qualify
for hedge accounting.
In November 2001, we sold the retained subordinated $17.5 million Class E Note
from our first CBO to a third party. 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 represented a repayment of debt and was recorded
as a reduction of CBO bonds payable. The Class E Note is included in the
collateral for our second CBO. The Class E Note is eliminated in consolidation.
Two classes of CBO bonds, with an aggregate $718.0 million face amount, were
issued subject to remarketing procedures and related agreements whereby such
bonds are remarketed and sold on a periodic basis. $395.0 million of these bonds
are fully insured by a third party with respect to the timely payment of
interest and principal thereon.
In October 2003, pursuant to FIN No. 46R, we consolidated an entity which holds
a portfolio of commercial mortgage loans which has been securitized. This
investment, which we refer to as the ICH CMO, was previously treated as a
non-consolidated residual interest in such securitization. The primary effect of
the consolidation is the requirement that we reflect the gross loan assets and
gross bonds payable of this entity in our financial statements.
In July 2004, we refinanced $342.5 million of the AAA and AA bonds in our first
CBO. $322.5 million of AAA bonds were refinanced at LIBOR + 0.30% from LIBOR +
0.65% and $20.0 million of AA bonds were refinanced at LIBOR + 0.50% from LIBOR
+ 0.80%.
In July 2005, we entered into a revolving credit facility with KeyBank, secured
by a deposit account into which cash received by us from certain eligible CBO
investments is deposited.
23
Other
We have entered into credit derivative instruments with a major investment bank,
whereby we receive the sum of all interest, fees and any positive change in
value amounts (the total return cash flows) from a reference asset with a
specified notional amount, and pay interest on such notional plus any negative
change in value amounts from such asset. These agreements are recorded in
Derivative Assets and treated as non-hedge derivatives for accounting purposes
and are therefore marked to market through income. Under the agreements, we are
required to post an initial margin deposit to an interest bearing account and
additional margin may be payable in the event of a decline in value of the
reference asset. Any margin on deposit, less any negative change in value
amounts, will be returned to us upon termination of the contract. The following
table presents information on these instruments as of September 30, 2005.
Loan Type of Notional Margin Receive Pay Fair
Month Executed Reference Asset Amount Amount Interest Rate Interest Rate Value
- --------------------- ----------------- -------- -------- -------------- -------------- -------
November 2004 Bank Loan $106,314 $ 18,149 LIBOR + 2.000% LIBOR + 0.500% $ 1,396
February 2005 Bank Loan 97,997 19,600 LIBOR + 3.000% LIBOR + 0.625% 1,406
June 2005 Mezzanine Loan 15,000 5,224 LIBOR +4.985% LIBOR + 1.350% 99
August 2005 Bank Loan 118,954 15,000 LIBOR + 2.000% LIBOR + 0.500% 1,933
-------- -------- -------
$338,265 $ 57,973 $ 4,834
======== ======== =======
We enter into short-term warehouse agreements with major investment banks for
the right to purchase commercial mortgage backed securities, unsecured REIT debt
and preferred equity, real estate related loans and real estate related asset
backed securities for our real estate securities portfolios, prior to their
being financed with CBOs. These agreements are treated as non-hedge derivatives
for accounting purposes and are therefore marked to market through current
income. If the related CBO is not consummated, except as a result of our gross
negligence, willful misconduct or breach of contract, we will be required to pay
the Net Loss, if any, as defined, up to the related deposit, less any Excess
Carry Amount, as defined, earned on such deposit. Although we currently
anticipate completing the most recent CBO in the near term, there is no
assurance that such CBO will be consummated or on what terms it will be
consummated. The following table summarizes the agreements (in thousands):
September 30, 2005 Income Recorded
- ----------------------------------------------------------- ------------------
Deal Collateral Aggregate Fair Nine Months Ended
Status Accumulated (1) Deposit Value September 30, 2005
- ------- ------------------ ----------------- ----------- ------------------
Closed N/A N/A N/A $ 1,662
Open $ 242,954 $ 23,567 $ $24,055 137
------------
$ 1,799
============
(1) Excludes $98.3 million of collateral accumulated on balance sheet and
recorded in real estate securities.
24
Stockholders' Equity
Common Stock
The following table presents information on shares of our common stock issued
since December 31, 2004:
Net Proceeds Options Granted
Period Shares Issued Range of Issue Prices (1) (millions) to Manager
------ ------------- ------------------------- ---------- ----------
Nine Months 2005 3,930,338 $ 29.60 $ 106.1 330,000
(1) Excludes prices of shares issued pursuant to the exercise of options
and shares issued to our independent directors.
At September 30, 2005, we had 43,789,819 shares of common stock outstanding.
As of September 30, 2005, our outstanding options were summarized as follows:
Held by the Manager 1,293,407
Issued to the Manager and subsequently transferred to
certain of the Manager's employees 627,490
Held by directors and former directors 14,500
---------
Total 1,935,397
=========
In October 2005, our Manager exercised options to acquire approximately 0.1
million shares of our common stock for $2.2 million.
Preferred Stock
In March 2003, we issued 2.5 million shares of 9.75% Series B Cumulative
Redeemable Preferred Stock (the "Series B Preferred"). In October 2005, we
issued 1.6 million shares of 8.05% Series C Cumulative Redeemable Preferred
Stock (the "Series C Preferred"). The Series B Preferred and Series C Preferred
have a $25 liquidation preference, no maturity date and no mandatory redemption.
We have the option to redeem the Series B Preferred beginning in March 2008 and
the Series C Preferred beginning in October 2010.
Other Comprehensive Income
During the nine months ended September 30, 2005, our accumulated other
comprehensive income changed due to the following factors (in thousands):
Accumulated other comprehensive income, December 31, 2004 $ 71,770
Net unrealized loss on securities (41,202)
Reclassification of net realized (gain) on securities into earnings (7,157)
Foreign currency translation (1,103)
Reclassification of realized foreign currency translation into earnings (626)
Unrealized gain on derivatives designated as cash flow hedges 38,701
Reclassification of realized loss on derivatives designated as cash flow hedges into earnings 1,657
--------
Accumulated other comprehensive income, September 30, 2005 $ 62,040
========
Our book equity changes as our real estate securities portfolio and derivatives
are marked-to-market each quarter, among other factors. The primary causes of
mark-to-market changes are changes in interest rates and credit spreads. During
the period, increasing interest rates and tightening credit spreads resulted in
a net decrease in unrealized gains on our real estate securities portfolio. In
an environment of widening credit spreads and increasing interest rates, we
believe our new investment activities will benefit. While such an environment
will likely result in a decrease in the fair value of our existing securities
portfolio and, therefore, reduce our book equity and ability to realize gains on
such existing securities, it will not directly affect our earnings or our cash
flow or our ability to pay dividends.
In addition, the slight strengthening of the U.S. dollar against the Canadian
dollar has resulted in a decrease in unrealized gains on our Canadian operating
real estate.
Common Dividends Paid
Declared for Amount
the Period Ended Paid Per Share
------------------ ---------------- ---------
March 31, 2005 April 27, 2005 $0.625
June 30, 2005 July 27, 2005 $0.625
September 30, 2005 October 27, 2005 $0.625
25
Cash Flow
Net cash flow provided by operating activities decreased from $42.2 million for
the nine months ended September 30, 2004 to $12.1 million for the nine months
ended September 30, 2005. This change primarily resulted from the acquisition
and settlement of our investments as described above.
Investing activities (used) ($844.1 million) and ($1,090.5 million) during the
nine months ended September 30, 2005 and 2004, respectively. Investing
activities consisted primarily of investments made in certain real estate
securities and other real estate related assets, net of proceeds from the sale
or settlement of investments.
Financing activities provided $810.5 million and $1,050.5 million during the
nine months ended September 30, 2005 and 2004, respectively. The equity
issuances, borrowings and debt issuances described above served as the primary
sources of cash flow from financing activities. Offsetting uses included the
payment of related deferred financing costs, the purchase of hedging
instruments, the payment of dividends, and the repayment of debt as described
above.
See the consolidated statements of cash flows included in our consolidated
financial statements included herein for a reconciliation of our cash position
for the periods described herein.
INTEREST RATE, CREDIT AND SPREAD RISK
We are subject to interest rate, credit and spread risk with respect to our
investments.
Our primary interest rate exposures relate to our real estate securities, loans
and floating rate debt obligations, 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 and hedges. Changes in the level of interest rates
also can effect, among other things, our ability to acquire real estate
securities and loans, the value of our real estate securities, loans and
derivatives, and our ability to realize gains from the settlement of such
assets.
Our general financing strategy focuses on the use of match funded structures.
This means that we seek to match the maturities of our debt 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 our earnings. In addition, we generally match fund
interest rates on our investments 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), directly or through the use of interest rate swaps, caps or
other financial instruments, or through a combination of these strategies, which
allows us to reduce the impact of changing interest rates on our earnings. See
"Quantitative and Qualitative Disclosures About Market Risk - Interest Rate
Exposure" below.
Real Estate Securities
Interest rate changes may also impact our net book value as our real estate
securities and related hedge derivatives are marked to market each quarter. Our
loan investments and debt obligations are not marked to market. Generally, as
interest rates increase, the value of our fixed rate securities decreases, and
as interest rates decrease, the value of such securities will increase. In
general, we would expect that over time, decreases in the value of our real
estate securities portfolio attributable to interest rate changes will be offset
to some degree by increases in the value of our swaps, and vice versa. However,
the relationship between spreads on securities and spreads on swaps may vary
from time to time, resulting in a net aggregate book value increase or decline.
Our real estate securities portfolio is largely financed to maturity through
long-term CBO financings that are not redeemable as a result of book value
changes. Accordingly, unless there is a material impairment in value that would
result in a payment not being received on a security, changes in the book value
of our securities portfolio will not directly affect our recurring earnings or
our ability to pay dividends.
The commercial mortgage and asset backed securities we invest in are generally
junior in right of payment of interest and principal to one or more senior
classes, but benefit from the support of one or more subordinate classes of
securities or other form of credit support within a securitization transaction.
The senior unsecured REIT debt securities we invest in reflect comparable credit
risk. Credit risk refers to each individual borrower's ability to make required
interest and principal payments on the scheduled due dates. We believe, based on
our due diligence process, 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 commercial mortgage
and asset backed securities, and the issuer's underlying equity and subordinated
debt, in the case of senior unsecured REIT debt securities, are designed to bear
the first risk of default and loss. We further minimize credit risk by actively
monitoring our real estate securities portfolio and the underlying credit
quality of our holdings and, where appropriate, repositioning our investments to
upgrade the credit quality on our investments. While we have not experienced any
significant credit losses, in the event of a significant rising interest rate
environment and/or economic downturn, loan and collateral defaults may increase
and result in credit losses that would adversely affect our liquidity and
operating results.
26
Our real estate securities portfolio is diversified by asset type, industry,
location and issuer. At September 30, 2005, we had 516 real estate securities
and loans, excluding the ICH CMO loans as described above. Our largest
investment in a real estate security or real estate related loan was $139
million and our average investment size was $9.6 million at September 30, 2005.
The weighted average credit spread on this portfolio (i.e. the yield premium on
our investments over the comparable U.S. Treasury rate or LIBOR) was 2.47% as of
September 30, 2005. Furthermore, our real estate securities are supported by
pools of underlying loans. For instance, our CMBS investments had over 18,700
underlying loans at September 30, 2005. We expect that this diversification
helps to minimize the risk of capital loss, and will also enhance the terms of
our financing structures. At September 30, 2005, our real estate securities and
real estate related loans (excluding the ICH CMO loans) had an overall weighted
average credit rating of approximately BBB-, and approximately 69% had an
investment grade rating (BBB- or higher).
Our real estate securities are also subject to spread risk. Our fixed rate
securities are valued based on a market credit spread over the rate payable on
fixed rate U.S. Treasuries of like maturity. In other words, their value is
dependent on the yield demanded on such securities by the market based on their
credit relative to U.S. Treasuries. Excessive supply of such securities combined
with reduced demand will generally cause the market to require a higher yield on
such securities, resulting in the use of a higher (or "wider") spread over the
benchmark rate (usually the applicable U.S. Treasury security yield) to value
such securities. Under such conditions, the value of our real estate securities
portfolio would tend to decline. Conversely, if the spread used to value such
securities were to decrease (or "tighten"), the value of our real estate
securities portfolio would tend to increase. Our floating rate securities are
valued based on a market credit spread over LIBOR and are effected similarly by
changes in LIBOR spreads. Such changes in the market value of our real estate
securities portfolio may affect our net equity, net income or cash flow directly
through their impact on unrealized gains or losses on available-for-sale
securities, and therefore our ability to realize gains on such securities, or
indirectly through their impact on our ability to borrow and access capital. If
the value of our securities subject to repurchase agreements were to decline, it
could affect our ability to refinance such securities upon the maturity of the
related repurchase agreements. See " Quantitative and Qualitative Disclosures
About Market Risk - Credit Spread Curve Exposure" below.
Furthermore, shifts in the U.S. Treasury yield curve, which represents the
market's expectations of future interest rates, would also affect the yield
required on our real estate securities and therefore their value. This would
have similar effects on our real estate securities portfolio and our financial
position and operations to a change in spreads.
Loans
Similar to our real estate securities portfolio, we are subject to credit and
spread risk with respect to our real estate related, commercial mortgage and
residential mortgage loan portfolios. However, unlike our real estate securities
portfolio, our loans generally do not benefit from the support of junior classes
of securities, but rather bear the first risk of default and loss. We believe
that this credit risk is mitigated through our due diligence process and
periodic reviews of the borrower's payment history, delinquency status, and the
relationship of the loan balance to the underlying property value. At September
30, 2005, our residential mortgage loan portfolio was characterized by high
credit quality borrowers with a weighted average FICO score of 713 at
origination, and had a weighted average loan to value ratio of 72.5%. As of
September 30, 2005, approximately $351 million face amount of our residential
mortgage loans were held in securitized form, of which over 92% of the principal
balance was AAA rated.
Our loan portfolios are diversified by geographic location and by borrower. Our
residential mortgage loans and manufactured housing loans were well diversified
with 1,087 loans and 7,386 loans, respectively, at September 30, 2005. We
believe that this diversification also helps to minimize the risk of capital
loss.
Our loan portfolios are also subject to spread risk. Our floating rate loans are
valued based on a market credit spread to LIBOR. The value of the loans is
dependent upon the yield demanded by the market based on their credit relative
to LIBOR. The value of our floating rate loans would tend to decline should the
market require a higher yield on such loans, resulting in the use of a higher
spread over the benchmark rate (usually the applicable LIBOR yield). Our fixed
rate loans are valued based on a market credit spread over U.S. Treasuries and
are effected similarly by changes in U.S. Treasury spreads. If the value of our
loans subject to repurchase agreements were to decline, it could affect our
ability to refinance such loans upon the maturity of the related repurchase
agreements.
Any credit or spread losses incurred with respect to our loan portfolios would
affect us in the same way as similar losses on our real estate securities
portfolio as described above, except that our loan portfolios are not marked to
market.
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2005, we had the following material off-balance sheet
arrangement:
- The $24.1 million carrying value of our deposit on our eighth real
estate securities portfolio, as described above under "- Liquidity
and Capital Resources." Except as a result of our gross negligence,
willful misconduct or breach of contract, our potential loss is
limited to the amount shown, which is included in our consolidated
balance sheet.
27
At this time, we do not anticipate a substantial risk of incurring a loss with
respect to the arrangement.
We are also party to total return swaps which are treated as non-hedge
derivatives. For further information on these investments, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
CONTRACTUAL OBLIGATIONS
During the first nine months of 2005, we had all of the material contractual
obligations referred to in our annual report on Form 10-K for the year ended
December 31, 2004, as well as the following:
- --------------------------------------------------------------------------------
Contract Category Change
- --------------------------------------------------------------------------------
CBO bonds payable The financing for our seventh real estate
securities and loans portfolio was closed in April
2005.
- --------------------------------------------------------------------------------
Other bonds payable The financing for the January 2005 purchase of a
portfolio of manufactured housing loans was
obtained.
- --------------------------------------------------------------------------------
Credit facility We entered into our credit facility.
- --------------------------------------------------------------------------------
Interest rate swaps, treated
as hedges The floating rate bonds in our seventh CBO
transaction and other floating rate debt
issuances, as well as certain assets, were
hedged with interest rate swaps.
- --------------------------------------------------------------------------------
Real estate securities
portfolio deposit We began accumulating collateral for our
eighth CBO transaction under an agreement
with a major investment bank.
- --------------------------------------------------------------------------------
The terms of these contracts are described under "Quantitative and Qualitative
Disclosures About Market Risk" below.
INFLATION
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.
FUNDS FROM OPERATIONS
We believe FFO is one appropriate measure of the operating performance of real
estate companies because it provides investors with information regarding our
ability to service debt and make capital expenditures. We also believe that FFO
is an appropriate supplemental disclosure of operating performance for a REIT
due to its widespread acceptance and use within the REIT and analyst
communities. Furthermore, FFO is used to compute our incentive compensation to
the Manager. FFO, for our purposes, represents net income available for common
stockholders (computed in accordance with GAAP), excluding extraordinary items,
plus depreciation of operating real estate, 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 prior to the commencement of our operations includes certain
adjustments related to our predecessor's investment in Fund I. 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. Our calculation of FFO may be different from the calculation used by
other companies and, therefore, comparability may be limited.
Funds from Operations (FFO) is calculated as follows (unaudited) (in thousands):
For the Nine For the Three
Months Ended Months Ended
September 30, September 30,
2005 2005
------------- -------------
Income available for common stockholders $ 82,795 $ 27,677
Operating real estate depreciation 523 118
Accumulated depreciation on operating real estate sold (6,939) --
------------ -------------
Funds from Operations (FFO) $ 76,379 $ 27,795
============ =============
28
Funds from Operations was derived from our segments as follows (unaudited) (in
thousands):
Book Equity at Average Invested
September 30, Common Equity FFO
2005 for the for the Return on
Nine Months Nine Months Invested
Ended Ended Common
September 30, September 30, Equity
2005 (2) 2005 (ROE) (3)
-------------- ---------------- ------------ ---------
Real estate securities and real estate related loans $ 767,574 $ 678,203 $ 91,894 18.1%
Residential mortgage loans 93,940 97,197 7,152 9.8%
Operating real estate 34,953 51,244 (210) (0.5%)
Unallocated (1) (123,851) (53,320) (22,457) N/A
-------------- ---------------- ------------ ---------
Total (2) 772,616 $ 773,324 $ 76,379 13.2%
================ ============ =========
Preferred stock 62,500
Accumulated depreciation (3,352)
Accumulated other comprehensive income 62,040
--------------
Net book equity $ 893,804
==============
Book Equity at Average Invested
September 30, Common Equity FFO
2005 for the for the Return on
Three Months Three Months Invested
Ended Ended Common
September 30, September 30, Equity
2005 (2) 2005 (ROE) (3)
-------------- ---------------- ------------ ---------
Real estate securities and real estate related loans $ 767,574 $ 695,459 $ 33,014 19.0%
Residential mortgage loans 93,940 98,176 1,200 4.9%
Operating real estate 34,953 35,212 1,695 19.3%
Unallocated (1) (123,851) (52,693) (8,114) N/A
-------------- ---------------- ------------ ---------
Total (2) 772,616 $ 776,154 $ 27,795 14.3%
================ ============ =========
Preferred stock 62,500
Accumulated depreciation (3,352)
Accumulated other comprehensive income 62,040
--------------
Net book equity $ 893,804
==============
(1) Unallocated FFO represents ($1,523) and ($4,570) of preferred dividends
and ($6,591) and ($17,887) of corporate general and administrative
expense, management fees and incentive compensation for the three and nine
months ended September 30, 2005, respectively.
(2) Invested common equity is equal to book equity excluding preferred stock,
accumulated depreciation and accumulated other comprehensive income.
(3) FFO divided by average invested common equity, annualized.
RELATED PARTY TRANSACTIONS
In January 2005, we entered into a servicing agreement with a portfolio company
of a private equity fund advised by an affiliate of our manager for such company
to service our portfolio of manufactured housing loans. As compensation under
the servicing agreement, the portfolio company will receive, on a monthly basis,
a net servicing fee equal to 1.00% per annum on the unpaid principal balance of
the loans being serviced. We acquired a portfolio of such loans in January 2005,
in which we had an investment of approximately $280.8 million at September 30,
2005.
29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest rates,
credit spreads, foreign currency exchange rates, commodity prices and equity
prices. The primary market risks that we are exposed to are interest rate risk
and credit spread risk. These risks are highly sensitive to many factors,
including governmental monetary and tax policies, domestic and 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. For a further understanding of how
market risk may affect our financial position or operating results, please refer
to "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Application of Critical Accounting Policies."
INTEREST RATE EXPOSURE
Our primary interest rate exposures relate to our real estate securities, loans
and floating rate debt obligations, as well as our interest rate swaps and caps.
Changes in the general level of interest rates can affect 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 and hedges. Changes in the level of interest rates
also can affect, among other things, our ability to acquire real estate
securities and loans, the value of our real estate securities, loans and
derivatives, and our ability to realize gains from the settlement of such
assets. While our strategy is to utilize interest rate swaps, caps and match
funded financings in order to limit the effects of changes in interest rates on
our operations, there can be no assurance that our profitability will not be
adversely affected during any period as a result of changing interest rates. In
the event of a significant rising interest rate environment and/or economic
downturn, loan and collateral defaults may increase and result in credit losses
that would adversely affect our liquidity and operating results. As of September
30, 2005, a 100 basis point increase in short term interest rates would increase
our earnings by approximately $0.4 million per annum.
Interest rate changes may also impact our net book value as our real estate
securities and related hedge derivatives are marked to market each quarter. Our
loan investments and debt obligations are not marked to market. Generally, as
interest rates increase, the value of our fixed rate securities decreases, and
as interest rates decrease, the value of such securities will increase. In
general, we would expect that over time, decreases in the value of our real
estate securities portfolio attributable to interest rate changes will be offset
to some degree by increases in the value of our swaps, and vice versa. However,
the relationship between spreads on securities and spreads on swaps may vary
from time to time, resulting in a net aggregate book value increase or decline.
Our real estate securities portfolio is largely financed to maturity through
long-term CBO financings that are not redeemable as a result of book value
changes. Accordingly, unless there is a material impairment in value that would
result in a payment not being received on a security, changes in the book value
of our portfolio will not directly affect our recurring earnings or our ability
to pay dividends. As of September 30, 2005, a 100 basis point change in short
term interest rates would impact our net book value by approximately $43.4
million.
Our general financing strategy focuses on the use of match funded structures.
This means that we seek to match the maturities of our debt 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 our earnings. In addition, we generally match fund
interest rates on our investments 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), directly or through the use of interest rate swaps, caps,
or other financial instruments, or through a combination of these strategies,
which allows us to reduce the impact of changing interest rates on our earnings.
Our entire portfolio of assets and the related liabilities had weighted average
lives of 4.83 years and 4.34 years, respectively, as of September 30, 2005. Our
financing strategy is dependent on our ability to place the match funded debt we
use to finance our investments at rates that provide a positive net spread. If
spreads for such liabilities widen or if demand for such liabilities ceases to
exist, then our ability to execute future financings will be severely
restricted.
Interest rate swaps are agreements in which a series of interest rate flows are
exchanged with a third party (counterparty) over a prescribed period. The
notional amount on which swaps are based is not exchanged. In general, our swaps
are "pay fixed" swaps involving the exchange of floating rate interest payments
from the counterparty for fixed interest payments from us. This can effectively
convert a floating rate debt obligation into a fixed rate debt obligation.
Similarly, an interest rate cap or floor agreement is a contract in which we
purchase a cap or floor contract on a notional face amount. We will make an
up-front payment to the counterparty for which the counterparty agrees to make
future payments to us should the reference rate (typically one- or three-month
LIBOR) rise above (cap agreements) or fall below (floor agreements) the "strike"
rate specified in the contract. Should the reference rate rise above the
contractual strike rate in a cap, we will earn cap income; should the reference
rate fall below the contractual strike rate in a floor, we will earn floor
income. Payments on an annualized basis will equal the contractual notional face
amount multiplied by the difference between the actual reference rate and the
contracted strike rate.
30
While a REIT may utilize these types of derivative instruments to hedge interest
rate risk on its liabilities or for other purposes, such derivative instruments
could generate income that is not qualified income for purposes of maintaining
REIT status. As a consequence, we may only engage in such instruments to hedge
such risks within the constraints of maintaining our standing as a REIT. We do
not enter into derivative contracts for speculative purposes nor as a hedge
against changes in credit risk.
Our hedging transactions using derivative instruments also involve certain
additional risks such as counterparty credit risk, the enforceability of hedging
contracts and the risk that unanticipated and significant changes in interest
rates will cause a significant loss of basis in the contract. The counterparties
to our derivative arrangements are major financial institutions with high credit
ratings with which we and our affiliates may also have other financial
relationships. As a result, we do not anticipate that any of these
counterparties will fail to meet their obligations. There can be no assurance
that we will be able to adequately protect against the foregoing risks and will
ultimately realize an economic benefit that exceeds the related amounts incurred
in connection with engaging in such hedging strategies.
CREDIT SPREAD CURVE EXPOSURE
Our real estate securities are also subject to spread risk. Our fixed rate
securities are valued based on a market credit spread over the rate payable on
fixed rate U.S. Treasuries of like maturity. In other words, their value is
dependent on the yield demanded on such securities by the market based on their
credit relative to U.S. Treasuries. Excessive supply of such securities combined
with reduced demand will generally cause the market to require a higher yield on
such securities, resulting in the use of higher (or "wider") spread over the
benchmark rate (usually the applicable U.S. Treasury security yield) to value
such securities. Under such conditions, the value of our real estate securities
portfolio would tend to decline. Conversely, if the spread used to value such
securities were to decrease (or "tighten"), the value of our real estate
securities portfolio would tend to increase. Our floating rate securities are
valued based on a market credit spread over LIBOR and are effected similarly by
changes in LIBOR spreads. Such changes in the market value of our real estate
securities portfolio may effect our net equity, net income or cash flow directly
through their impact on unrealized gains or losses on available-for-sale
securities, and therefore our ability to realize gains on such securities, or
indirectly through their impact on our ability to borrow and access capital.
Furthermore, shifts in the U.S. Treasury yield curve, which represents the
market's expectations of future interest rates, would also effect the yield
required on our real estate securities and therefore their value. This would
have similar effects on our real estate securities portfolio and our financial
position and operations to a change in spreads.
Our loan portfolios are also subject to spread risk. Our floating rate loans are
valued based on a market credit spread to LIBOR. The value of the loans is
dependent upon the yield demanded by the market based on their credit relative
to LIBOR. The value of our floating rate loans would tend to decline should the
market require a higher yield on such loans, resulting in the use of a higher
spread over the benchmark rate (usually the applicable LIBOR yield). Our fixed
rate loans are valued based on a market credit spread over U.S. Treasuries and
are effected similarly by changes in U.S. Treasury spreads. If the value of our
loans subject to repurchase agreements were to decline, it could affect our
ability to refinance such loans upon the maturity of the related repurchase
agreements.
Any decreases in the value of our loan portfolios due to spread changes would
effect us in the same way as similar changes to our real estate securities
portfolio as described above, except that our loan portfolios are not marked to
market.
As of September 30, 2005, an immediate 25 basis point movement in credit spreads
would impact our net book value by approximately $43.7 million, but would not
directly affect our earnings or cash flow.
31
FAIR VALUES
Fair values for a majority of our investments are readily obtainable through
broker quotations. 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 instruments 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 credit spread
environments as of September 30, 2005 and do not take into consideration the
effects of subsequent interest rate or credit spread fluctuations.
We note that the values of our investments in real estate securities, loans and
derivative instruments, primarily interest rate hedges on our debt obligations,
are sensitive to changes in market interest rates, interest rate spreads, credit
spreads and other market factors. The value of these investments can vary, and
has varied, materially from period to period.
Interest Rate and Credit Spread Risk
We held the following interest rate and credit spread risk sensitive instruments
at September 30, 2005 (unaudited) (dollars in thousands):
Carrying Principal Balance Weighted Average Maturity Fair
Value or Notional Amount Yield/Funding Cost Date Value
----------- ------------------ ------------------ -------- -----------
Assets:
Real estate securities, available for sale (1) $ 4,088,443 $ 4,080,350 6.17% (1) $ 4,088,443
Real estate securities portfolio deposit (2) 24,055 Note (2) Note (2) (2) 24,055
Real estate related loans (3) 668,558 672,038 8.18% (3) 668,345
Residential mortgage loans (4) 684,321 695,471 6.00% (4) 684,321
Interest rate caps, treated as hedges (5) 2,127 361,526 N/A (5) 2,127
Total return swaps (6) 4,834 Note (6) N/A (6) 4,834
Liabilities:
CBO bonds payable (7) 3,093,865 3,121,030 5.01% (7) 3,157,337
Other bonds payable (8) 369,082 369,324 5.96% (8) 373,346
Notes payable (9) 324,920 324,920 4.14% (9) 324,920
Repurchase agreements (10) 983,573 983,573 4.51% (10) 983,573
Credit facility (11) 42,000 42,000 5.34% (11) 42,000
Interest rate swaps, treated as hedges (12) (24,691) 2,599,255 N/A (12) (24,691)
Non-hedge derivative obligations (13) 54 Note (13) N/A (13) 54
(1) These securities contain various terms, including fixed and floating rates,
self-amortizing and interest only. Their weighted average maturity is 5.72
years. The fair value of these securities is estimated by obtaining third
party broker quotations, if available and practicable, and counterparty
quotations.
(2) The fair value of the real estate securities portfolio deposit, which is
treated as a non-hedge derivative, is determined by obtaining third party
broker quotations on the underlying securities, if available and
practicable, and counterparty quotations, including a counterparty
quotation on the portion of the fair value resulting from the Excess Carry
Amount, as defined, earned on such deposit. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Liquidity and
Capital Resources" for a further discussion of this deposit.
(3) Represents the following loans:
Loan Type Current Weighted Floating Rate
Face Carrying Weighted Avg. Average Loans as a %
Amount Value Yield Maturity (Years) of Carrying Value Fair Value
- ------------------------------- --------- ------------- ---------------- ----------------- ----------
B-Notes $ 124,999 $ 125,281 7.46% 2.19 84.7% $ 125,170
Mezzanine Loans 298,522 298,524 7.86% 2.17 100.0% 298,524
Bank Loans 57,344 57,657 5.96% 2.76 100.0% 57,657
Real Estate Loans 20,222 19,792 20.02% 2.25 -% 19,690
ICH CMO Loans 170,951 167,304 8.65% 2.90 2.1% 167,304
--------- --------- ------------- ---------------- ----------------- ----------
$ 672,038 $ 668,558 8.18% 2.41 69.7% $ 668,345
========= ========= ============= ================ ================= ==========
32
The fixed rate B-Notes were valued by obtaining counterparty quotations.
The rest of the B-Notes, as well as the mezzanine loans and bank loans,
bear floating rates of interest and we believe that, for similar financial
instruments with comparable credit risks, their effective rates
approximate market rates. Accordingly, the carrying amounts outstanding
are believed to approximate fair value. The one fixed rate real estate
loan was valued by obtaining a third party valuation. The ICH CMO loans
were valued by discounting expected future receipts by a rate calculated
based on current market conditions for comparable financial instruments,
including market interest rates and credit spreads.
(4) This aggregate portfolio of residential loans consists of a portfolio of
floating rate residential mortgage loans as well as a portfolio of
primarily fixed rate manufactured housing loans. The $403.6 million
portfolio of residential mortgage loans has a weighted average maturity of
2.80 years. We believe that, for similar financial instruments with
comparable credit risks, the effective rate on this portfolio approximates
a market rate. Accordingly, the carrying amount of this portfolio is
believed to approximate fair value. The $280.7 million manufactured
housing loan portfolio, which has a weighted average maturity of 4.93
years, was valued by discounting expected future receipts by a rate
calculated based on current market conditions for comparable financial
instruments, including market interest rates and credit spreads. Based on
this analysis, the carrying amount of this portfolio is believed to
approximate fair value.
(5) Represents cap agreements as follows:
Notional Balance Effective Date Maturity Date Capped Rate Strike Rate Fair Value
--------------------- -------------- --------------- ------------- ----------- ----------
$ 281,907 Current March 2009 1-Month LIBOR 6.50% $ 206
18,000 January 2010 October 2015 3-Month LIBOR 8.00% 342
8,619 December 2010 June 2015 3-Month LIBOR 7.00% 541
53,000 May 2011 September 2015 1-Month LIBOR 7.50% 1,038
--------------------- ----------
$ 361,526 $ 2,127
===================== ==========
The fair value of these agreements is estimated by obtaining counterparty
quotations.
(6) Represents total return swaps which are treated as non-hedge derivatives.
The fair value of these agreements, which is included in Derivative
Assets, is estimated by obtaining counterparty quotations. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations - Liquidity and Capital Resources" for a further discussion
of these swaps.
(7) These bonds were valued by discounting expected future payments by a rate
calculated based on current market conditions for comparable financial
instruments, including market interest rates and credit spreads. The
weighted average maturity of the CBO bonds payable is 6.40 years. The CBO
bonds payable amortize principal prior to maturity based on collateral
receipts, subject to reinvestment requirements.
(8) The ICH CMO bonds were valued by discounting expected future payments by a
rate calculated based on current market conditions for comparable
financial instruments, including market interest rates and credit spreads.
They amortize principal prior to maturity based on collateral receipts and
have a weighted average maturity of 1.60 years. The manufactured housing
loan bonds have a weighted average maturity of 0.33 years, bear a floating
rate of interest, and are subject to adjustment monthly based on the
market value of the loan portfolio. We believe that, for similar financial
instruments with comparable credit risks, their effective rate
approximates a market rate. Accordingly, the carrying amount outstanding
is believed to approximate fair value.
(9) The residential mortgage loan financing has a weighted average maturity of
1.50 years, bears a floating rate of interest, and is subject to
adjustment monthly based on the market value of the loan portfolio. We
believe that, for similar financial instruments with comparable credit
risks, its effective rate approximates a market rate. Accordingly, the
carrying amount outstanding is believed to approximate fair value.
(10) These agreements bear floating rates of interest and we believe that, for
similar financial instruments with comparable credit risks, the effective
rates approximate market rates. Accordingly, the carrying amounts
outstanding are believed to approximate fair value. These agreements have
a weighted average maturity of 0.10 years.
(11) This facility, which has a weighted average maturity of 2.80 years, bears
a floating rate of interest and we believe that, for similar financial
instruments with comparable credit risk, the effective rate approximates a
market rate. Accordingly, the carrying amount outstanding is believed to
approximate fair value.
33
(12) Represents swap agreements as follows (in thousands):
Notional Balance Effective Date Maturity Date Swapped Rate Fixed Rate Fair Value
- ---------------- -------------- ------------- -------------- ---------- ----------
$ 281,907 Current March 2009 1-Month LIBOR* 3.1250% $ (9,380)
290,000 Current April 2011 3-Month LIBOR 5.9325% 15,904
276,060 Current March 2013 3-Month LIBOR 3.8650% (12,231)
192,500 Current March 2015 1-Month LIBOR 4.8880% 2,496
165,300 Current March 2014 3-Month LIBOR 3.9945% (6,938)
189,373 Current September 2014 3-Month LIBOR 4.3731% (4,595)
243,421 Current March 2015 1-Month LIBOR 4.8495% 2,513
237,820 Current February 2014 1-Month LIBOR 4.2070% (3,559)
5,000 Current November 2008 1-Month LIBOR 3.5400% (146)
5,000 Current November 2018 1-Month LIBOR 4.4800% (51)
48,000 Current January 2009 1-Month LIBOR 3.6500% (1,332)
12,000 Current January 2015 1-Month LIBOR 4.5100% (217)
72,542 Current October 2009 1-Month LIBOR 3.7150% (1,508)
69,001 Current September 2009 1-Month LIBOR 3.7090% (1,426)
23,754 Current December 2009 1-Month LIBOR 3.8290% (438)
8,051 Current August 2009 1-Month LIBOR 4.0690% (98)
23,359 Current February 2010 1-Month LIBOR 4.1030% (292)
36,682 Current April 2010 1-Month LIBOR 4.5310% (33)
31,786 Current March 2010 1-Month LIBOR 4.5260% (30)
26,781 Current April 2010 1-Month LIBOR 4.1640% (298)
45,418 Current March 2010 1-Month LIBOR 4.0910% (543)
46,644 Current May 2010 1-Month LIBOR 3.9900% (744)
23,301 Current April 2010 1-Month LIBOR 3.9880% (368)
39,744 Current September 2010 1-Month LIBOR 4.3980% (196)
19,406 Current September 2010 1-Month LIBOR 4.4300% (78)
47,766 Current August 2010 1-Month LIBOR 4.4865% (114)
29,962 Current August 2010 1-Month LIBOR 4.4210% (112)
22,909 Current June 2010 1-Month LIBOR 4.4870% (50)
24,128 Current August 2010 1-Month LIBOR 4.4900% (54)
47,345 Current July 2010 1-Month LIBOR 4.4290% (217)
14,295 Current January 2009 1-Month LIBOR 3.2900% (556)
- ---------------- ----------
$ 2,599,255 $ (24,691)
================ ==========
*up to 6.50%
The fair value of these agreements is estimated by obtaining counterparty
quotations. A positive fair value represents a liability.
(13) These are two essentially offsetting interest rate caps and two
essentially offsetting interest rate swaps, each with notional amounts of
$32.5 million, an interest rate cap with a notional balance of $17.5
million, and five interest rate swaps with an aggregate notional amount of
$16.8 million. 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 dates of the latter swaps range from
November 2008 through January 2009. The fair value of these agreements is
estimated by obtaining counterparty quotations.
34
ITEM 4. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures. The Company's management, with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act")) as of the end of the period covered by this report. The
Company's disclosure controls and procedures are designed to provide
reasonable assurance that information is recorded, processed, summarized
and reported accurately and on a timely basis. Based on such evaluation,
the Company's Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, the Company's disclosure
controls and procedures are effective.
(b) Internal Control Over Financial Reporting. During the fiscal quarter to
which this report relates, the Company began using two new information
technology systems in a live environment. As a result of, and in
conjunction with, the implementation of the new systems, the Company
implemented certain new internal controls and modified others. The nature
of these new or modified internal controls did not have a material impact
on the Company's financial reporting. No other changes in the Company's
internal control over financial reporting (as such term is defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the
fiscal quarter to which this report relates that have materially affected,
or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
35
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not party to any material legal proceedings.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
3.1 Articles of Amendment and Restatement (incorporated by reference to the
Registrant's Registration Statement on Form S-11 (File No. 333-90578),
Exhibit 3.1).
3.2 Articles Supplementary Relating to the Series B Preferred Stock
(incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3 By-laws (incorporated by reference to the Registrant's Registration
Statement on Form S-11 (File No. 333-90578), Exhibit 3.2).
4.1 Rights Agreement between the Registrant and American Stock Transfer and
Trust Company, as Rights Agent, dated October 16, 2002 (incorporated by
reference to the Registrant's Quarterly Report on Form 10-Q for the period
ended September 30, 2002, Exhibit 4.1).
36
10.1 Amended and Restated Management and Advisory Agreement by and among the
Registrant and Fortress Investment Group LLC, dated September23, 2003
(incorporated by reference to the Registrant's Registration Statement on
Form S-11 (File No. 333-106135), Exhibit 10.1).
31.1 Certification of Chief Executive Officer as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized:
NEWCASTLE INVESTMENT CORP.
(Registrant)
By: /s/ Wesley R. Edens
-----------------------------
Name: Wesley R. Edens
Title: Chairman of the Board
Chief Executive Officer
Date: November 9, 2005
By: /s/ Debra A. Hess
-----------------------------
Name: Debra A. Hess
Title: Chief Financial Officer
Date: November 9, 2005
38