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
 9 Months Ended
Sep. 30, 2012
Segment Reporting And Variable Interest Entities  
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 in senior living assets financed with non-recourse debt (“non-recourse senior living”), (v) investments financed with other non-recourse debt (“non-recourse other”), (vi) investments and debt repurchases financed with recourse debt (“recourse”), (vii) other unlevered investments (“unlevered other”) and (viii) 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 Senior Living     Non-Recourse Other (A) (C)     Recourse (D)     Unlevered Other (E)     Corporate     Inter-segment Elimination (F)     Total  
Nine Months Ended September 30, 2012                                                            
Interest income   $ 161,490     $ 339     $ 16,422     $ —     $ 54,753     $ 4,981     $ 7,234     $ 135     $ (5,167 )   $ 240,187  
Interest expense     49,334       —       —       692       38,597       1,387       —       2,857       (4,829 )     88,038  
Net interest income (expense)     112,156       339       16,422       (692 )     16,156       3,594       7,234       (2,722 )     (338 )     152,149  
                                                                                 
Impairment (reversal)     3,173       —       —       —       3,202       —       58       —       —       6,433  
Other revenues     —       —       —       7,548       —       —       —       —       —       7,548  
Other income (loss)     256,358       259       6,513       (21 )     —       —       1,066       —       —       264,175  
Property operating expenses     —       —       —       4,742       —       —       —       —       —       4,742  
Depreciation and amortization     —       —       —       2,370       —       —       —       —       —       2,370  
Other operating expenses     713       1       2,180       4,848       2,513       —       35       23,618       —       33,908  
Income (loss) from continuing operations     364,628       597       20,755       (5,125 )     10,441       3,594       8,207       (26,340 )     (338 )     376,419  
Income (loss) from discontinued operations     —       —       —       —       422       —       (48 )     —       338       712  
Net income (loss)     364,628       597       20,755       (5,125 )     10,863       3,594       8,159       (26,340 )     —       377,131  
Preferred dividends     —       —       —       —       —       —       —       (4,185 )     —       (4,185 )
Income (loss) applicable to common stockholders   $ 364,628     $ 597     $ 20,755       (5,125 )   $ 10,863     $ 3,594     $ 8,159       (30,525 )   $ —     $ 372,946  
                                                                                 
Three Months Ended September 30, 2012                                                                                
Interest income   $ 51,050     $ 109     $ 9,903     $ —     $ 18,290     $ 3,213     $ 2,383     $ 32     $ (2,130 )   $ 82,850  
Interest expense     14,694       —       —       692       13,263       826       —       954       (2,018 )     28,411  
Net interest income (expense)     36,356       109       9,903       (692 )     5,027       2,387       2,383       (922 )     (112 )     54,439  
                                                                                 
Impairment (reversal)     3,962       —       —       —       499       —       553       —       —       5,014  
Other revenues     —       —       —       7,548       —       —       —       —       —       7,548  
Other income (loss)     231,825       83       1,774       (21 )     —       —       2,121       —       —       235,782  
Property operating expenses     —       —       —       4,742       —       —       —       —       —       4,742  
Depreciation and amortization     —       —       —       2,370       —       —       —       —       —       2,370  
Other operating expenses     230       —       686       1,650       820       —       10       9,213       —       12,609  
Income (loss) from continuing operations     263,989       192       10,991       (1,927 )     3,708       2,387       3,941       (10,135 )     (112 )     273,034  
Income (loss) from discontinued operations     —       —       —       —       92       —       (17 )     —       112       187  
Net income (loss)     263,989       192       10,991       (1,927 )     3,800       2,387       3,924       (10,135 )     —       273,221  
Preferred dividends     —       —       —       —       —       —       —       (1,395 )     —       (1,395 )
Income (loss) applicable to common stockholders   $ 263,989     $ 192     $ 10,991     $ (1,927 )   $ 3,800     $ 2,387     $ 3,924     $ (11,530 )   $ —       271,826  
September 30, 2012                                                                                
                                                                                 
Investments   $ 1,462,566     $ 5,471     $ 258,347     $ 141,553     $ 765,047     $ 667,560     $ 133,408     $ —     $ (69,182 )     3,364,770  
Cash and restricted cash     2,829       —       —       5,980       —       —       —       223,056       —       231,865  
Derivative assets     —       —       —       224       —       —       —       —       —       224  
Other assets     6,319       8       25,214       4,005       113       2,416       1,904       181       (157 )     40,003  
Total assets     1,471,714       5,479       283,561       151,762       765,160       669,976       135,312       223,237       (69,339 )     3,636,862  
Debt     (1,160,448 )     —       —       (88,400 )     (672,290 )     (599,959 )     —       (51,245 )     69,182       (2,503,160 )
Derivative liabilities     (36,519 )     —       —       —       —       —       —       —       —       (36,519 )
Other liabilities     (5,757 )     —       (5,390 )     (4,391 )     (2,484 )     (94 )     (67 )     (44,971 )     157       (62,997 )
Total liabilities     (1,202,724 )     —       (5,390 )     (92,791 )     (674,774 )     (600,053 )     (67 )     (96,216 )     69,339       (2,602,676 )
Preferred stock     —       —       —       —       —       —       —       (61,583 )     —       (61,583 )
GAAP book value   $ 268,990     $ 5,479     $ 278,171     $ 58,971     $ 90,386     $ 69,923     $ 135,245     $ 65,438     $ —       972,603  

 

 

    Non-Recourse CDOs (A)     Unlevered CDOs (B)     Unlevered Excess MSRs     Non-Recourse Senior Living     Non-Recourse Other (A)     Recourse     Unlevered Other     Corporate     Inter-segment Elimination (F)     Total  
                                                                                 
Nine Months Ended September 30, 2011                                                                                
Interest income   $ 164,523     $ 120     $ —     $ —     $ 54,421     $ 1,626     $ 1,933     $ 99     $ (3,983 )   $ 218,739  
Interest expense     67,173       —       —       —       39,660       455       —       2,859       (3,645 )     106,502  
   Net interest income (expense)     97,350       120       —       —       14,761       1,171       1,933       (2,760 )     (338 )     112,237  
Impairment (reversal)     (27,904 )     —       —       —       7,012       —       (3,731 )     —       —       (24,623 )
Other income (loss)     115,425       3,643       —       —       2,561       —       1,531       —       —       123,160  
Expenses     779       —       —       —       2,679       —       4       17,958       —       21,420  
Income (loss) from continuing operations     239,900       3,763       —       —       7,631       1,171       7,191       (20,718 )     (338 )     238,600  
Income (loss) from discontinued operations     —       —       —       —       (131 )     —       (56 )     —       338       151  
Net income (loss)     239,900       3,763       —       —       7,500       1,171       7,135       (20,718 )     —       238,751  
Preferred dividends     —       —       —       —       —       —       —       (4,185 )     —       (4,185 )
Income (loss) applicable to common stockholders   $ 239,900     $ 3,763     $ —     $ —     $ 7,500     $ 1,171     $ 7,135     $ (24,903 )   $ —     $ 234,566  
                                                                                 
Three Months Ended September 30, 2011                                                                                
Interest income   $ 53,403     $ 97     $ —     $ —     $ 18,816     $ 1,029     $ 941     $ 36     $ (1,929 )   $ 72,393  
Interest expense     19,909       —       —       —       13,329       213       —       953       (1,817 )     32,587  
Net interest income (expense)     33,494       97       —       —       5,487       816       941       (917 )     (112 )     39,806  
Impairment (reversal)     17,550       —       —       —       3,919       —       181       —       —       21,650  
Other income (loss)     18,262       116       —       —       —       —       424       —       —       18,802  
Expenses     250       —       —       —       933       —       (111 )     6,094       —       7,166  
Income (loss) from continuing operations     33,956       213       —       —       635       816       1,295       (7,011 )     (112 )     29,792  
Income (loss) from discontinued operations     —       —       —       —       54       —       (15 )     —       112       151  
Net income (loss)     33,956       213       —       —       689       816       1,280       (7,011 )     —       29,943  
Preferred dividends     —       —       —       —       —       —       —       (1,395 )     —       (1,395 )
Income (loss) applicable to common stockholders   $ 33,956       213     $ —     $ —     $ 689     $ 816     $ 1,280     $ (8,406 )   $ —     $ 28,548  

 

(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:

 

    September 30, 2012  
    Investments     Debt  
    Outstanding     Carrying     Outstanding     Carrying  
    Face Amount     Value     Face Amount*     Value*  
Manufactured housing loan portfolio I   $ 122,453     $ 102,745     $ 93,926     $ 85,145  
Manufactured housing loan portfolio II     158,542       155,933       123,797       122,961  
Residential mortgage loans     53,384       39,208       11,746       11,746  
Subprime mortgage loans subject to call options     406,217       405,525       406,217       405,525  
Real estate securities     64,044       53,797       44,959       40,913  
Operating real estate      N/A       7,839       6,000       6,000  
    $ 804,640     $ 765,047     $ 686,645     $ 672,290  

 

* An aggregate face amount of $78.0 million (carrying value of $69.2 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 $600.0 million of recourse debt is comprised of (i) a $538.5 million repurchase agreement secured by $577.1 million carrying value of FNMA/FHLMC securities, (ii) a $1.8 million repurchase agreement secured by $26.4 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle and is eliminated in consolidation and (iii) a $59.6 million repurchase agreement secured by $90.4 million carrying value of non-agency residential mortgage backed securities (“RMBS”).
(E) The following table summarizes the investments in the unlevered other segment:

 

    September 30, 2012  
    Outstanding     Carrying     Number of  
    Face Amount     Value     Investments  
Real estate securities*   $ 322,922     $ 115,400       41  
Real estate related loans     28,801       9,418       2  
Residential mortgage loans     3,735       2,566       133  
Other investments     N/A       6,024       1  
    $ 355,458     $ 133,408       177  

 

* During the nine months ended September 30, 2012, Newcastle purchased 20 non-agency RMBS with an aggregate face amount of $185.2 million for an aggregate purchase price of approximately $108.3 million, or an average price of 58.5% of par. As of September 30, 2012, these securities had an aggregate face amount of $181.4 million and a carrying value of $109.5 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 CDO V), 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 September 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.

 

On September 12, 2012, Newcastle deconsolidated CDO X subsequent to the completion of the sale of 100% of its interests in CDO X to the sole owner of the senior notes and another third party. The sale and resulting deconsolidation has reduced Newcastle’s gross assets by $1.1 billion, reduced liabilities by $1.2 billion, decreased other comprehensive income by $25.5 million and resulted in a gain on sale of $224.3 million. As of September 30, 2012, Newcastle had no continuing involvement with CDO X.

 

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

 

                Carrying Value of Newcastle’s  
Entity   Gross Assets (A)     Debt (A) (B)     Investment (C)  
Newcastle CDO V   $ 286,993     $ 295,558     $ 5,471  

 

(A) Face amount.
(B) Includes $42.7 million face amount of debt owned by Newcastle with a carrying value of $5.5 million at September 30, 2012.
(C) This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at September 30, 2012, related to $19.2 million face amount of CDO V Class I, III, and IV-FL notes.