Drive Shack Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

FAIR VALUE (Tables)

FAIR VALUE (Tables)

9 Months Ended

Sep. 30, 2014

Schedule of carrying value and fair value of assets and liabilities

The carrying values and fair values of Newcastle’s assets and liabilities at September 30, 2014 were as follows:



	Principal Balance or Notional Amount		Carrying Value		Estimated Fair Value		Fair Value Method (A)	Weighted Average Yield/Funding Cost (B)		Weighted Average Life (Years)
Assets
Financial instruments:
Real estate securities, available-for-sale (C)*	$	386,557	$	310,639	$	310,639	Broker quotations, counterparty quotations, pricing services, pricing models	9.75	%	3.3
Real estate related and other loans, held-for-sale, net	324,048		224,992		239,701		Broker quotations, counterparty quotations, pricing services, pricing models	14.53	%	1.7
Residential mortgage loans, held-for-sale, net	4,686		4,036		4,317		Broker/counterparty quotations	7.74	%	1.7
Subprime mortgage loans subject to call option (D)	406,217		406,217		(D)		(D)	9.09	%	(D)
Restricted cash (I)			4,624		4,624
Cash and cash equivalents (I)			257,584		257,584
Investments in senior housing real estate, net (H)			1,582,477
Investments in other real estate, net (H)			245,510
Intangibles, net (H)			201,909
Other investments (H)			26,456
Assets of discontinued operations (H)			6,863

Liabilities
Financial instruments:
CDO bonds payable (G)	$	229,833	$	230,858	$	127,254	Pricing models	4.23	%	3.3
Other bonds and notes payable (G)	88,223		82,063		82,070		Broker quotations, pricing models	5.86	%	1.7
Repurchase agreements	63,804		63,804		63,804		Market comparables	1.81	%	0.1
Mortgage notes payable	1,147,364		1,148,008		1,157,815		Pricing models	4.93	%	6.0
Credit facilities and obligations under capital leases, golf	160,692		160,692		160,692		Pricing models	5.24	%	3.4
Financing of subprime mortgage loans subject to call option (D)	406,217		406,217		(D)		(D)	9.09	%	(D)
Junior subordinated notes payable	51,004		51,233		31,833		Pricing models	7.36	%	20.6
Interest rate swaps, treated as hedges (E)(F)*	83,673		2,852		2,852		Counterparty quotations	N/A		(E)
Non-hedge derivatives (E)(F)*	130,342		1,676		1,676		Counterparty quotations	N/A		(E)
Liabilities of discontinued operations			412

*Measured at fair value on a recurring basis.

(A)

Methods are listed in order of priority. In the case of real estate securities and real estate related and other loans, broker quotations are obtained if available and practicable, otherwise counterparty quotations or pricing service valuations are obtained or, finally, internal pricing models are used. Internal pricing models are only used for (i) securities and loans that are not traded in an active market, and, therefore, have little or no price transparency, and for which significant unobservable inputs must be used in estimating fair value, or (ii) loans or debt obligations which are private and untraded.


(B)	The weighted average yield and weighted average funding cost are disclosed for financial instrument assets and liabilities, respectively.


(C)	Excludes eight CDO securities with a zero value, which had an aggregate face amount of $112.5 million.


(D)	Represents an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 6).

(E)

As of September 30, 2014, all derivative liabilities, which represent three interest rate swaps, were held within Newcastle’s nonrecourse structures. An aggregate notional balance of $214.0 million is subject to the credit risks of the respective CDO structures. As they are senior to all the debt obligations of the respective CDOs and the fair value of each of the CDOs’ total investments exceeded the fair value of each of the CDOs’ derivative liabilities, no credit valuation adjustments were recorded. Newcastle’s interest rate swap counterparties include Bank of America and Bank of New York Mellon. Newcastle’s derivatives are included in accounts payable, accrued expenses and other liabilities in the consolidated balance sheets.


(F)	Interest rate swaps, treated as hedges:



	Maturity	Aggregate Notional Amount		Weighted Average Fixed Pay Rate		Aggregate Fair Value
Interest rate swap agreements which receive 1-Month LIBOR:
	April 2016	$	83,673	5.04	%	$	2,852

Non-hedge derivatives:



	Maturity	Aggregate Notional Amount		Weighted Average Fixed Pay Rate		Aggregate Fair Value
Interest rate swap agreements which receive 1-Month LIBOR:
	March 2015	$	130,342	4.85	%	$	1,676

(G)

Newcastle notes that the unrealized gain on the liabilities within such structures cannot be fully realized. Assets held within CDOs and other nonrecourse structures are generally not available to satisfy obligations outside of such financings, except to the extent Newcastle receives net cash flow distributions from such structures. Furthermore, creditors or beneficial interest holders of these structures have no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its invested equity in them and economically their book value cannot be less than zero. As a result, the fair value of Newcastle’s net investments in these non-recourse financing structures is equal to the present value of their expected future net cash flows.


(H)	Newcastle has certain assets that are subject to measurement at fair value on a nonrecurring basis. For these assets, measurement at fair value in the period subsequent to their initial recognition is applicable if determined to be impaired. During the nine months ended September 30, 2014, Newcastle did not have any material impaired assets that were required to be measured at fair value.


(I)	The carrying value of these assets and liabilities approximates fair value.

Schedule of fair value of hedge and non-hedge derivatives

Interest rate swaps, treated as hedges:



	Maturity	Aggregate Notional Amount		Weighted Average Fixed Pay Rate		Aggregate Fair Value
Interest rate swap agreements which receive 1-Month LIBOR:
	April 2016	$	83,673	5.04	%	$	2,852

Non-hedge derivatives:



	Maturity	Aggregate Notional Amount		Weighted Average Fixed Pay Rate		Aggregate Fair Value
Interest rate swap agreements which receive 1-Month LIBOR:
	March 2015	$	130,342	4.85	%	$	1,676

Schedule of assets and liabilities measured at fair value on a recurring basis

The following table summarizes such financial assets and liabilities measured at fair value on a recurring basis at September 30, 2014:



	Principal Balance or				Fair Value
	Notional Amount		Carrying Value		Level 2		Level 3		Total
Assets
Real estate securities, available-for-sale:
CMBS	$	240,403	$	206,085	$	—	$	206,085	$	206,085
REIT debt (A)	29,200		30,293		30,293		—		30,293
Non-Agency RMBS	87,113		60,231		—		60,231		60,231
ABS - other real estate	8,464		—		—		—		—
CDO (B)	21,377		13,721		—		13,721		13,721
Equity securities	—		309		—		309		309
Real estate securities total	$	386,557	$	310,639	$	30,293	$	280,346	$	310,639

Liabilities
Derivative Liabilities:
Interest rate swaps, treated as hedges	$	83,673	$	2,852	$	2,852	$	—	$	2,852
Interest rate swaps, not treated as hedges	130,342		1,676		1,676		—		1,676
Derivative liabilities total	$	214,015	$	4,528	$	4,528	$	—	$	4,528



(A)	REIT debt is measured at fair value based on more observable quotes. Therefore, is categorized as a Level 2 fair value hierarchy measurement.


(B)	Represents non-consolidated CDO securities, excluding eight securities with a zero value, which had an aggregate face amount of $112.5 million.

Schedule of change in fair value of Level 3 investments

Newcastle’s investments in instruments measured at fair value on a recurring basis using Level 3 inputs changed during the nine months ended ended September 30, 2014 as follows:




	CMBS						ABS
	Conduit			Other			Subprime		Other			Equity/Other Securities			Linked Transactions			Total
Balance at December 31, 2013	$	198,935		$	85,534		57,581		$	—		$	59,757		$	43,662		$	445,469
Total gains (losses) (A)
Included in net income (B)	15,402			—			—		—			717			12,498			28,617
Included in other comprehensive income (loss)	(18,663		)	(231		)	5,432		—			4,874			—			(8,588		)
Amortization included in interest income	14,986			368			4,101		72			1,866			—			21,393
Purchases, sales and repayments
Purchases	—			—			—		—			—			—			—
Proceeds from sales	(72,438		)	—			—		—			(50,390		)	—			(122,828		)
Proceeds from repayments	(5,713		)	(12,095		)	(6,883	)	(72		)	(2,794		)	(56,160		)	(83,717		)
Balance at September 30, 2014	$	132,509		$	73,576		60,231		$	—		$	14,030		$	—		$	280,346


(A)	None of the gains (losses) recorded in earnings during the period is attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date.


(B)	These gains (losses) are recorded in the following line items in the consolidated statements of income:



	Nine Months Ended September 30, 2014
Gain (loss) on settlement of investments, net	$	16,119
Other income (loss), net	12,498
OTTI	—
Total	$	28,617

Gain (loss) on settlement of investments, net, from investments transferred into Level 3 during the period	$	—

Schedule of gains losses on fair value of real estate securities

These gains (losses) are recorded in the following line items in the consolidated statements of income:



	Nine Months Ended September 30, 2014
Gain (loss) on settlement of investments, net	$	16,119
Other income (loss), net	12,498
OTTI	—
Total	$	28,617

Gain (loss) on settlement of investments, net, from investments transferred into Level 3 during the period	$	—

Schedule of securities valuation methodology and results

As of September 30, 2014, Newcastle’s securities valuation methodology and results are further detailed as follows:



					Fair Value
	Outstanding Face		Amortized Cost		Multiple		Single		Internal Pricing
Asset Type	Amount (A)		Basis (B)		Quotes (C)		Quote (D)		Models (E)		Total
CMBS	$	240,403	$	168,387	$	144,830	$	61,255	$	—	$	206,085
REIT debt	29,200		28,856		30,293		—		—		30,293
Non-Agency RMBS	87,113		37,892		46,177		14,054		—		60,231
ABS - other real estate	8,464		—		—		—		—		—
CDO (F)	21,377		6,394		—		6,708		7,013		13,721
Equity securities	—		—		—		309		—		309
Total	$	386,557	$	241,529	$	221,300	$	82,326	$	7,013	$	310,639


(A)	Net of incurred losses.


(B)	Net of discounts (or gross of premiums) and after OTTI.


(C)	Management generally obtained pricing service quotations or broker quotations from at least two sources, one of which was generally the seller (the party that sold us the security). Management selected one of the quotes received as being most representative of fair value and did not use an average of the quotes. Even if Newcastle receives two or more quotes on a particular security that come from non-selling brokers or pricing services, it does not use an average because management believes using an actual quote more closely represents a transactable price for the security than an average level.

	Newcastle measures the fair value of REIT debt based on quoted market prices in less active markets or pricing service quotations and models utilizing observable market inputs. For securities that are categorized as a Level 3 fair value hierarchy measurement, there is a wide disparity between the quotes Newcastle receives. Management believes using an average of the quotes in these cases would generally not represent the fair value of the asset. Based on Newcastle’s own fair value analysis using internal models, management selects one of the quotes which are believed to more accurately reflect fair value. Newcastle never adjusts quotes received. These quotations are generally received via email and contain disclaimers which state that they are “indicative” and not “actionable” – meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price.


(D)	Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party that sold us the security) or a pricing service.


(E)	Securities whose fair value was estimated based on internal pricing models are further detailed as follows:



					Impairment		Unrealized		Weighted Average Significant Input
	Amortized Cost Basis (B)		Fair Value		Recorded In Current Period		Gains (Losses) in Accumulated OCI		Discount Rate		Prepayment Speed (G)		Cumulative Default Rate		Loss Severity
CDO	—		7,013		—		7,013		10.5	%	5.0	%	19.3	%	72.5	%
Total	$	—	$	7,013	$	—	$	7,013

At September 30, 2014, there was no ABS or CMBS fair value based on model mark assumptions.

All of the assumptions listed have some degree of market observability, based on Newcastle’s knowledge of the market, relationships with market participants, and use of common market data sources. Collateral prepayment, default and loss severity projections are in the form of “curves” or “vectors” that vary for each monthly collateral cash flow projection. Methods used to develop these projections vary by asset class but conform to industry conventions. Newcastle uses assumptions that generate its best estimate of future cash flows of each respective security.

The prepayment vector specifies the percentage of the collateral balance that is expected to voluntarily pay off at each point in the future. The prepayment vector is based on projections from a widely published investment bank model which considers factors such as collateral FICO score, loan-to-value ratio, debt-to-income ratio, and vintage on a loan level basis. This vector is scaled up or down to match recent collateral-specific prepayment experience, as obtained from remittance reports and market data services.

Loss severities are based on recent collateral-specific experience with additional consideration given to collateral characteristics. Collateral age is taken into consideration because severities tend to initially increase with collateral age before eventually stabilizing. Newcastle typically uses projected severities that are higher than the historic experience for collateral that is relatively new to account for this effect. Collateral characteristics such as loan size, lien position, and location (state) also effect loss severity. Newcastle considers whether a collateral pool has experienced a significant change in its composition with respect to these factors when assigning severity projections.

Default rates are determined from the current “pipeline” of loans that are more than 90 days delinquent, in foreclosure, or are REO. These significantly delinquent loans determine the first 24 months of the default vector. Beyond month 24, the default vector transitions to a steady-state value that is generally equal to or greater than that given by the widely published investment bank model.

The discount rates Newcastle uses are derived from a range of observable pricing on securities backed by similar collateral and offered in a live market. As the markets in which Newcastle transacts have become less liquid, Newcastle has had to rely on fewer data points in this analysis.


(F)	Represents non-consolidated CDO securities, excluding eight securities with a zero value, which had an aggregate face amount of $112.5 million.
(G)	Projected annualized average prepayment rate.

Schedule of securities valued based on internal pricing models

Securities whose fair value was estimated based on internal pricing models are further detailed as follows:



					Impairment		Unrealized		Weighted Average Significant Input
	Amortized Cost Basis (B)		Fair Value		Recorded In Current Period		Gains (Losses) in Accumulated OCI		Discount Rate		Prepayment Speed (G)		Cumulative Default Rate		Loss Severity
CDO	—		7,013		—		7,013		10.5	%	5.0	%	19.3	%	72.5	%
Total	$	—	$	7,013	$	—	$	7,013

At September 30, 2014, there was no ABS or CMBS fair value based on model mark assumptions.

Schedule of fair value for real estate related and other loans and residential mortgage loans held for sale

The following tables summarize certain information for real estate related and other loans and residential mortgage loans held-for-sale as of September 30, 2014:



							Valuation			Significant Input
	Outstanding						Allowance/			Range				Weighted Average
	Face		Carrying		Fair		(Reversal) In			Discount		Loss		Discount		Loss
Loan Type	Amount		Value		Value		Current Year			Rate		Severity		Rate		Severity
Mezzanine	$	132,053	$	99,666	$	102,512	$	(31	)	5.0-9.0%		0% -100%		7.2	%	22.5	%
Bank Loan	169,659		106,296		118,156		1,299			15.0 - 35.9%		0% - 100%		21.8	%	27.1	%
B-Note	22,067		18,761		18,761		(3,454		)	12.0	%	0.0	%	12.0	%	0.0	%
Whole Loan	269		269		272		—			4.0	%	0.0	%	4.0	%	0.0	%

Total Real Estate Related and other Loans Held-for-Sale, Net	$	324,048	$	224,992	$	239,701	$	(2,186	)

The following table summarizes certain information for residential mortgage loans held-for-sale as of September 30, 2014:



							Valuation		Significant Input (Weighted Average)
	Outstanding						Allowance/
	Face		Carrying		Fair		(Reversal) In		Discount		Prepayment		Constant		Loss
Loan Type	Amount		Value		Value		Current Year (A)		Rate		Speed		Default Rate		Severity
Residential Loans	4,686		4,036		4,317		527		7.7	%	0.2	%	23.8	%	5.1	%
Total Residential Mortgage Loans, Held-for-Sale, Net	$	4,686	$	4,036	$	4,317	$	527



(A)	The valuation allowance (reversal) excludes $0.4 million allowance related to the manufactured housing portfolio that was sold in May 2014.

Schedule of fair value of derivatives

Newcastle’s derivatives are recorded on its balance sheet as follows:



		Fair Value
	Balance sheet location	September 30, 2014		December 31, 2013
Derivative Assets
Linked transactions at fair value	Receivables and other assets	$	—	$	43,662
		$	—	$	43,662
Derivative Liabilities
Interest rate swaps, designated as hedges	Accounts payable, accrued expenses and other liabilities	$	2,852	$	6,203
Interest rate swaps, not designated as hedges	Accounts payable, accrued expenses and other liabilities	1,676		7,592
		$	4,528	$	13,795

Schedule of outstanding derivatives

The following table summarizes information related to derivatives:



	September 30, 2014			December 31, 2013
Cash flow hedges
Notional amount of interest rate swap agreements	$	83,673		$	105,031
Cumulative unrealized loss in OCI on effective portion	(2,884		)	(6,117		)
Deferred hedge gain related to anticipated financings, which have subsequently occurred, net of amortization	116			170
Deferred hedge loss related to dedesignation, net of amortization	—			(45		)
Expected reclassification of deferred hedges from AOCI into earnings over the next 12 months	76			53
Expected reclassification of current hedges from AOCI into earnings over the next 12 months	(2,369		)	(3,915		)

Non-hedge Derivatives
Notional amount of interest rate swap agreements	130,342			185,871
Notional amount of linked transactions (A)	—			116,806


(A)	This represents the current face amount of the underlying financed securities comprising linked transactions.

Schedule of gains (losses) on derivatives

The following table summarizes gains (losses) recorded in relation to derivatives:



	Income statement	Three Months Ended September 30,						Nine Months Ended September 30,
	location	2014			2013			2014			2013
Cash flow hedges
Realized gain (loss) on the ineffective portion	Other income (loss)	$	(158	)	$	—		$	101		$	—
Realized loss recognized at dedesignation	Other income (loss)	(34		)	—			(34		)	—
Realized loss reclassified from AOCI into income, related to effective portion	Interest expense	(1,024		)	(1,280		)	(3,481		)	(4,848		)
Realized hedge gain reclassified from AOCI into income, related to anticipated financings	Interest expense	18			17			53			50
Realized hedge loss reclassified from AOCI into income, related to effective portion of dedesignated hedges	Interest expense	(2		)	(16		)	(11		)	(48		)
Non-hedge derivatives gain (loss)
Interest rate swaps	Other income (loss)	1,762			1,894			5,866			7,302
Linked transactions	Other income (loss)	—			—			12,499			—
Linked transactions	Interest expense	—			(110		)	(211		)	(118		)