Quarterly report pursuant to Section 13 or 15(d)

SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES

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SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES
 6 Months Ended
Jun. 30, 2012
Notes to Financial Statements  
SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES

 

2. SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES

 

Newcastle conducts its business through the following segments: (i) investments financed with non-recourse collateralized debt obligations (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered CDOs”), (iii) unlevered investments in excess mortgage servicing rights (“unlevered Excess MSRs”), (iv) investments financed with other non-recourse debt (“non-recourse other”), (v) investments and debt repurchases financed with recourse debt (“recourse”), (vi) other unlevered investments (“unlevered other”) and (vii) corporate. With respect to the non-recourse CDOs and non-recourse other segments, subject to the passing of certain periodic coverage tests, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis.

 

In the fourth quarter of 2011, Newcastle changed the composition of its reportable segments such that the unlevered segment is further broken down into (i) unlevered CDOs, (ii) unlevered Excess MSRs and (iii) unlevered other. Management believes the additional segments better reflect its investments in deconsolidated CDOs and its new investment in Excess MSRs. Segment information for previously reported periods in the accompanying financial statements has been restated to reflect this change to the composition of its segments.

 

The corporate segment consists primarily of interest income on short term investments, general and administrative expenses, interest expense on the junior subordinated notes payable and management fees pursuant to the Management Agreement.

 

Summary financial data on Newcastle's segments is given below, together with a reconciliation to the same data for Newcastle as a whole:

 

    Non- Recourse CDOs (A)     Unlevered CDOs (B)     Unlevered Excess MSRs     Non- Recourse Other (A) (C)     Recourse (D)     Unlevered Other (E)     Corporate     Inter- segment Elimination (F)     Total  
Six Months Ended June 30, 2012                                                                        
Interest income   $ 110,440     $ 230     $ 6,519     $ 36,463     $ 1,768     $ 4,851     $ 103     $ (3,037 )   $ 157,337  
Interest expense     34,640       —       —       25,334       561       —       1,903       (2,811 )     59,627  
Net interest income (expense)     75,800       230       6,519       11,129       1,207       4,851       (1,800 )     (226 )     97,710  
Impairment (reversal)     (789 )     —       —       2,703       —       (495 )     —       —       1,419  
Other income (loss)     24,533       176       4,739       —       —       (1,055 )     —       —       28,393  
Expenses     483       1       1,494       1,693       —       25       17,603       —       21,299  
Income (loss) from continuing operations     100,639       405       9,764       6,733       1,207       4,266       (19,403 )     (226 )     103,385  
Income (loss) from discontinued operations     —       —       —       330       —       (31 )     —       226       525  
Net income (loss)     100,639       405       9,764       7,063       1,207       4,235       (19,403 )     —       103,910  
Preferred dividends     —       —       —       —       —       —       (2,790 )     —       (2,790 )
Income (loss) applicable to common stockholders   $ 100,639     $ 405     $ 9,764     $ 7,063     $ 1,207     $ 4,235     $ (22,193 )   $ —     $ 101,120  
                                                                         
Three Months Ended June 30, 2012                                                                        
Interest income   $ 56,038     $ 115     $ 4,482     $ 18,037     $ 954     $ 4,328     $ 52     $ (1,568 )   $ 82,438  
Interest expense     17,004       —       —       12,671       293       —       949       (1,455 )     29,462  
Net interest income (expense)     39,034       115       4,482       5,366       661       4,328       (897 )     (113 )     52,976  
Impairment (reversal)     7,742       —       —       1,055       —       (298 )     —       —       8,499  
Other income (loss)     (5,380 )     84       3,523       —       —       414       —       —       (1,359 )
Expenses     242       —       1,371       850       —       12       10,465       —       12,940  
Income (loss) from continuing operations     25,670       199       6,634       3,461       661       5,028       (11,362 )     (113 )     30,178  
Income (loss) from discontinued operations     —       —       —       162       —       (14 )     —       113       261  
Net income (loss)     25,670       199       6,634       3,623       661       5,014       (11,362 )     —       30,439  
Preferred dividends     —       —       —       —       —       —       (1,395 )     —       (1,395 )
Income (loss) applicable to common stockholders   $ 25,670     $ 199     $ 6,634     $ 3,623     $ 661     $ 5,014     $ (12,757 )   $ —     $ 29,044  
                                                                         
June 30, 2012                                                                        
Investments   $ 2,509,771     $ 3,957     $ 265,132     $ 772,025     $ 403,392     $ 134,230     $ —     $ (141,088 )   $ 3,947,419  
Cash and restricted cash     62,692       —       9,278       —       —       —       93,369       —       165,339  
Derivative assets     966       —       —       —       —       —       —       —       966  
Other assets     51,457       6       16,815       196       958       4,344       6,543       (353 )     79,966  
Total assets     2,624,886       3,963       291,225       772,221       404,350       138,574       99,912       (141,441 )     4,193,690  
Debt     (2,356,186 )     —       —       (725,336 )     (317,972 )     —       (51,246 )     141,088       (3,309,652 )
Derivative liabilities     (101,809 )     —       —       —       —       —       —       —       (101,809 )
Other liabilities     (31,861 )     —       (33,031 )     (2,927 )     (65,777 )     (2,601 )     (43,655 )     353       (179,499 )
Total liabilities     (2,489,856 )     —       (33,031 )     (728,263 )     (383,749 )     (2,601 )     (94,901 )     141,441       (3,590,960 )
Preferred stock     —       —       —       —       —       —       (61,583 )     —       (61,583 )
GAAP book value   $ 135,030     $ 3,963     $ 258,194     $ 43,958     $ 20,601     $ 135,973     $ (56,572 )   $ —     $ 541,147  

 

    Non- Recourse CDOs (A)     Unlevered CDOs (B)     Unlevered Excess MSRs     Non- Recourse Other (A)     Recourse     Unlevered Other     Corporate     Inter- segment Elimination (F)     Total  
                                                                         
Six Months Ended June 30, 2011                                                                        
Interest income   $ 111,399     $ 23     $ —     $ 35,006     $ 597     $ 992     $ 63     $ (1,734 )   $ 146,346  
Interest expense     47,285       —       —       25,990       242       —       1,906       (1,508 )     73,915  
Net interest income (expense)     64,114       23       —       9,016       355       992       (1,843 )     (226 )     72,431  
Impairment (reversal)     (44,158 )     —       —       1,797       —       (3,912 )     —       —       (46,273 )
Other income (loss)     98,234       3,527       —       1,490       —       1,107       —       —       104,358  
Expenses     639       —       —       1,636       —       115       11,864       —       14,254  
Income (loss) from continuing operations     205,867       3,550       —       7,073       355       5,896       (13,707 )     (226 )     208,808  
Income (loss) from discontinued operations     —       —       —       (185 )     —       (41 )     —       226       —  
Net income (loss)     205,867       3,550       —       6,888       355       5,855       (13,707 )     —       208,808  
Preferred dividends     —       —       —       —       —       —       (2,790 )     —       (2,790 )
Income (loss) applicable to common stockholders   $ 205,867     $ 3,550     $ —     $ 6,888     $ 355     $ 5,855     $ (16,497 )   $ —     $ 206,018  
                                                                         
Three Months Ended June 30, 2011                                                                        
Interest income   $ 56,571     $ 12     $ —     $ 17,525     $ 450     $ 510     $ 43     $ (968 )   $ 74,143  
Interest expense     22,672       —       —       12,835       144       —       954       (855 )     35,750  
Net interest income (expense)     33,899       12       —       4,690       306       510       (911 )     (113 )     38,393  
Impairment (reversal)     (5,913 )     —       —       643       —       (3,797 )     —       —       (9,067 )
Other income (loss)     55,127       3,452       —       (337 )     —       647       —       —       58,889  
Expenses     326       —       —       892       —       70       6,116       —       7,404  
Income (loss) from continuing operations     94,613       3,464       —       2,818       306       4,884       (7,027 )     (113 )     98,945  
Income (loss) from discontinued operations     —       —       —       97       —       (20 )     —       113       190  
Net income (loss)     94,613       3,464       —       2,915       306       4,864       (7,027 )     —       99,135  
Preferred dividends     —       —       —       —       —       —       (1,395 )     —       (1,395 )
Income (loss) applicable to common stockholders   $ 94,613     $ 3,464     $ —     $ 2,915     $ 306     $ 4,864     $ (8,422 )   $ —     $ 97,740  

 

(A) Assets held within CDOs and other non-recourse structures are 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. Therefore, impairment recorded in excess of Newcastle’s investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot economically be incurred and will eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of such non-recourse financing structure.
     
(B) Represents unlevered investments in CDO securities issued by Newcastle. These CDOs have been deconsolidated as Newcastle does not have the power to direct the relevant activities of the CDOs.

 

 

(C) The following table summarizes the investments and debt in the other non-recourse segment:

 

    June 30, 2012  
    Investments     Debt  
    Outstanding Face     Carrying     Outstanding Face     Carrying  
    Amount     Value     Amount*     Value*  
Manufactured housing loan portfolio I   $ 125,948     $ 105,225     $ 98,268     $ 89,282  
Manufactured housing loan portfolio II     165,494       162,402       130,949       129,968  
Residential mortgage loans     54,744       40,007       53,266       52,195  
Subprime mortgage loans subject to call options     406,217       405,247       406,217       405,247  
Real estate securities     66,762       51,407       46,862       42,644  
Operating real estate      N/A       7,737       6,000       6,000  
    $ 819,165     $ 772,025     $ 741,562     $ 725,336  

  

  * An aggregate face amount of $154.8 million (carrying value of $141.1 million) of debt represents financing provided by the CDO segment (and included as investments in the CDO segment), which is eliminated upon consolidation.
  (D)  The $318.0 million of recourse debt is comprised of (i) a $316.1 million repurchase agreement secured by $337.6 million carrying value of FNMA/FHLMC securities and (ii) a $1.9 million repurchase agreement secured by $27.3 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle and is eliminated in consolidation.
  (E) The following table summarizes the investments in the unlevered other segment:

 

    June 30, 2012  
    Outstanding
Face Amount		     Carrying
Value		     Number of
Investments		  
Real estate securities*   $ 318,909     $ 125,260       30  
Residential mortgage loans     4,322       2,946       144  
Other investments      N/A       6,024       1  
    $ 323,231     $ 134,230       175  

  

  * During the three months ended June 30, 2012, Newcastle purchased 10 non-agency residential mortgage backed (“RMBS”) securities with an aggregate face amount of $181.6 million for an aggregate purchase price of approximately $122.4 million, or an average price of 67.4% of par. As of June 30, 2012, these securities had an aggregate face amount of $177.4 million and a carrying value of $119.5 million.
  (F) Represents the elimination of investments and financings and their related income and expenses between the CDO segment and other non-recourse segment as the corresponding inter-segment investments and financings are presented on a gross basis within each of these segments.

 

Variable Interest Entities (“VIEs”)

 

The VIEs in which Newcastle has a significant interest include (i) Newcastle’s CDOs, in which Newcastle has been determined to be the primary beneficiary and therefore consolidates them (with the exception of CDOs V and VII), since it has the power to direct the activities that most significantly impact the CDOs’ economic performance and would absorb a significant portion of their expected losses and receive a significant portion of their expected residual returns, and (ii) the manufactured housing loan financing structures, which are similar to the CDOs in analysis. Newcastle’s CDOs and manufactured housing loan financings are held in special purpose entities whose debt is treated as non-recourse secured borrowings of Newcastle. Newcastle’s subprime securitizations are also considered VIEs, but Newcastle does not control their activities and no longer receives a significant portion of their returns. These subprime securitizations are not consolidated.

 

In addition, Newcastle’s investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. Newcastle is not obligated to provide, nor has it provided, any financial support to these VIEs. Newcastle monitors these investments and, to the extent Newcastle determines that it potentially owns a majority of the currently controlling class, it analyzes them for potential consolidation. As of June 30, 2012, Newcastle has not consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the provisions governing these structures, Newcastle does not have the power to direct the activities that most significantly impact their economic performance.

 

Newcastle had variable interests in the following unconsolidated VIE at June 30, 2012, in addition to the subprime securitizations which are described in Note 4:

 

Entity   Gross Assets (A)     Debt (B)     Carrying Value of Newcastle’s Investment (C)  
Newcastle CDO V   $ 298,549     $ 298,995     $ 3,957  

 

(A) Face amount.
(B) Includes $42.3 million face amount of debt owned by Newcastle with a carrying value of $4.0 million at June 30, 2012.
(C) This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at June 30, 2012, related to $5.3 million face amount of CDO V Class I notes.