Annual report pursuant to Section 13 and 15(d)

SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES

v2.4.0.6
SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES
 12 Months Ended
Dec. 31, 2012
Segment Reporting And Variable Interest Entities  
SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES
3.  
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 (Note 10) and management fees pursuant to the Management Agreement (Note 12).
 
Summary financial data on Newcastle’s segments is given below, together with 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
  
Year Ended December 31, 2012
                                                            
Interest income
   $ 196,517     $ 490     $ 27,508     $ -     $ 72,343     $ 8,984     $ 10,491     $ 170     $ (6,044 )   $ 310,459  
Interest expense
     56,607       -       -       1,688       51,278       2,582       -       3,813       (6,044 )     109,924  
Net interest income (expense)
     139,910       490       27,508       (1,688 )     21,065       6,402       10,491       (3,643 )     -       200,535  
Impairment (reversal)
     (7,381 )     -       -       -       4,119       -       (2,402 )     -       -       (5,664 )
Other revenues
     -       -       -       18,026       2,049       -       -       -       -       20,075  
Other income (loss)
     259,688       337       17,423       (82 )     930       -       1,421       -       -       279,717  
Property operating expenses
     -       -       -       11,539       1,404       -       -       -       -       12,943  
Depreciation and amortization
     -       -       -       5,784       1,191       -       -       -       -       6,975  
Other operating expenses
     915       1       5,695       6,846       3,314       -       45       35,079       -       51,895  
Income (loss) from continuing operations
     406,064       826       39,236       (7,913 )     14,016       6,402       14,269       (38,722 )     -       434,178  
Income (loss) from discontinued operations
     -       -       -       -       -       -       (68 )     -       -       (68 )
Net income (loss)
     406,064       826       39,236       (7,913 )     14,016       6,402       14,201       (38,722 )     -       434,110  
Preferred dividends
     -       -       -       -       -       -       -       (5,580 )     -       (5,580 )
                                                                                 
Income (loss) applicable to common stockholders
   $ 406,064     $ 826     $ 39,236     $ (7,913 )   $ 14,016     $ 6,402     $ 14,201     $ (44,302 )   $ -     $ 428,530  
                                                                                 
December 31, 2012
                                                                                
Investments
   $ 1,411,731     $ 5,998     $ 245,036     $ 181,887     $ 755,421     $ 1,049,029     $ 107,189     $ -     $ (62,336 )   $ 3,693,955  
Cash and restricted cash
     2,064       -       -       9,720       -       -       -       222,178       -       233,962  
Derivative assets
     -       -       -       165       -       -       -       -       -       165  
Other assets
     7,422       7       33       4,946       113       2,740       1,924       202       (157 )     17,230  
Total assets
     1,421,217       6,005       245,069       196,718       755,534       1,051,769       109,113       222,380       (62,493 )     3,945,312  
Debt
     (1,095,598 )     -       -       (120,525 )     (651,540 )     (925,191 )     -       (51,243 )     62,336       (2,781,761 )
Derivative liabilities
     (31,576 )     -       -       -       -       -       -       -       -       (31,576 )
Other liabilities
     (5,681 )     -       (406 )     (5,084 )     (2,684 )     (171 )     (77 )     (44,969 )     157       (58,915 )
Total liabilities
     (1,132,855 )     -       (406 )     (125,609 )     (654,224 )     (925,362 )     (77 )     (96,212 )     62,493       (2,872,252 )
Preferred stock
     -       -       -       -       -       -       -       (61,583 )     -       (61,583 )
GAAP book value
   $ 288,362     $ 6,005     $ 244,663     $ 71,109     $ 101,310     $ 126,407     $ 109,036     $ 64,585     $ -     $ 1,011,477  
 
   
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
  
Year Ended December 31, 2011
                                                            
Interest income
   $ 218,131     $ 344     $ 1,260     $ -     $ 73,364     $ 2,234     $ 2,636     $ 167     $ (5,840 )   $ 292,296  
Interest expense
     86,110       -       -       -       53,252       693       5       3,815       (5,840 )     138,035  
Net interest income (expense)
     132,021       344       1,260       -       20,112       1,541       2,631       (3,648 )     -       154,261  
Impairment (reversal)
     (3,876 )     -       -       -       8,469       -       (3,483 )     -       -       1,110  
Other revenues
     -       -       -       -       1,899       -       -       -       -       1,899  
Other income (loss)
     171,963       3,739       367       -       2,561       -       2,232       -       -       180,862  
Property operating expenses
     -       -       -       -       1,110       -       -       -       -       1,110  
Depreciation and amortization
     -       -       -       -       12       -       -       -       -       12  
Other operating expenses
     1,058       -       1,055       -       3,603       -       19       24,525       -       30,260  
Income (loss) from continuing operations
     306,802       4,083       572       -       11,378       1,541       8,327       (28,173 )     -       304,530  
Income (loss) from discontinued operations
     -       -       -       -       46       -       (57 )     -       -       (11 )
Net income (loss)
     306,802       4,083       572       -       11,424       1,541       8,270       (28,173 )     -       304,519  
Preferred dividends
     -       -       -       -       -       -       -       (5,580 )     -       (5,580 )
Income (loss) applicable to common stockholders
   $ 306,802     $ 4,083     $ 572     $ -     $ 11,424     $ 1,541     $ 8,270     $ (33,753 )   $ -     $ 298,939  
                                                                                 
December 31, 2011
                                                                                
Investments
   $ 2,408,252     $ 3,940     $ 43,971     $ -     $ 783,777     $ 244,916     $ 18,751     $ -     $ (143,018 )   $ 3,360,589  
Cash and restricted cash
     105,040       -       -       -       -       -       9       157,347       -       262,396  
Derivative assets
     1,954       -       -       -       -       -       -       -       -       1,954  
Other assets
     23,203       8       -       -       116       593       2,085       1,208       (353 )     26,860  
Total assets
     2,538,449       3,948       43,971       -       783,893       245,509       20,845       158,555       (143,371 )     3,651,799  
Debt
     (2,410,151 )     -       -       -       (748,118 )     (233,194 )     -       (51,248 )     143,018       (3,299,693 )
Derivative liabilities
     (119,320 )     -       -       -       -       -       -       -       -       (119,320 )
Other liabilities
     (12,705 )     -       (4,186 )     -       (3,407 )     (23 )     (49 )     (20,680 )     353       (40,697 )
Total liabilities
     (2,542,176 )     -       (4,186 )     -       (751,525 )     (233,217 )     (49 )     (71,928 )     143,371       (3,459,710 )
Preferred stock
     -       -       -       -       -       -       -       (61,583 )     -       (61,583 )
GAAP book value
   $ (3,727 )   $ 3,948     $ 39,785     $ -     $ 32,368     $ 12,292     $ 20,796     $ 25,044     $ -     $ 130,506  
  
   
Non-Recourse CDOs (A)
    
Unlevered CDOs (B)
    
Unlevered
Excess MSRs
    
Non-Recourse
Senior Living
    
Non-Recourse Other (A)(C)
    
Recourse
    
Unlevered Other (E)
    
Corporate
    
Inter-segment Elimination (F)
    
Total
  
Year Ended December 31, 2010
                                                            
Interest income
   $ 226,717     $ -     $ -     $ -     $ 72,773     $ 976     $ 1,653     $ 68     $ (1,915 )   $ 300,272  
Interest expense
     108,437       -       -       -       60,705       656       356       3,980       (1,915 )     172,219  
Net interest income (expense)
     118,280       -       -       -       12,068       320       1,297       (3,912 )     -       128,053  
Impairment, net of the reversal of prior valuation allowances on loans
     (173,223 )     16       -       -       (38,561 )     (60 )     (29,030 )     -       -       (240,858 )
Other revenues
     -       -       -       -       1,708       -       -       -       -       1,708  
Other income (loss)
     289,158       475       -       -       (5,491 )     (663 )     (1,269 )     77       -       282,287  
Property operating expenses
     -       -       -       -       1,283       -       -       -       -       1,283  
Depreciation and amortization
     -       -       -       -       79       -       -       -       -       79  
Other operating expenses
     1,483       -       -       -       3,160       4       (197 )     25,089       -       29,539  
Income (loss) from continuing operations
     579,178       459       -       -       42,324       (287 )     29,255       (28,924 )     -       622,005  
Income (loss) from discontinued operations
     -       -       -       -       (536 )     -       193       -       -       (343 )
Net income (loss)
     579,178       459       -       -       41,788       (287 )     29,448       (28,924 )     -       621,662  
Preferred dividends
     -       -       -       -       -       -       -       (7,453 )     -       (7,453 )
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid
     -       -       -       -       -       -       -       43,043       -       43,043  
Income (loss) applicable to common stockholders
   $ 579,178     $ 459     $ -     $ -     $ 41,788     $ (287 )   $ 29,448     $ 6,666     $ -     $ 657,252  
 
(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:
 
   
December 31, 2012
    
December 31, 2011
  
   
Investments
    
Debt
    
Investments
    
Debt
  
   
Outstanding
    
Carrying
    
Outstanding
    
Carrying
    
Outstanding
    
Carrying
    
Outstanding
    
Carrying
  
   
Face Amount
    
Value
    
Face Amount*
    
Value*
    
Face Amount
    
Value
    
Face Amount*
    
Value*
  
Manufactured housing loan portfolio I
   $ 118,746     $ 100,124     $ 90,551     $ 81,963     $ 135,209     $ 112,316     $ 107,032     $ 97,631  
Manufactured housing loan portfolio II
     153,193       150,123       117,907       117,191       178,603       175,120       143,869       142,589  
Residential mortgage loans
     52,352       38,709       -       -       56,377       40,380       54,842       53,771  
Subprime mortgage loans subject to call options
     406,217       405,814       406,217       405,814       406,217       404,723       406,217       404,723  
Real estate securities
     63,505       53,979       44,585       40,572       67,965       43,497       47,697       43,404  
Operating real estate
     N/A       6,672       6,000       6,000       N/A       7,741       6,000       6,000  
    $ 794,013     $ 755,421     $ 665,260     $ 651,540     $ 844,371     $ 783,777     $ 765,657     $ 748,118  
 
*     
As of December 31, 2012 and December 31, 2011, aggregate face amounts of $71.1  million and $157.0 million (carrying values of $62.3 million and $143.0 million), respectively, of debt represents financing provided by the CDO segment (and included as investments in the CDO segment), which is eliminated upon consolidation.
 
(D)    
The $925.2 million of recourse debt is comprised of (i) a $772.9 million repurchase agreement secured by $820.5 million carrying value of FNMA/FHLMC securities, (ii) a $1.4 million repurchase agreement secured by $21.0 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle and is eliminated in consolidation and (iii) a $150.9 million repurchase agreement secured by $228.5 million carrying value of non-agency residential mortgage backed securities (“RMBS”).
 
(E)    
The following table summarizes the investments in the unlevered other segment:
 
   
December 31, 2012
    
December 31, 2011
  
   
Outstanding
Face Amount
    
Carrying
Value
    
Number of
Investments
    
Outstanding
Face Amount
    
Carrying
Value
    
Number of
Investments
  
Real estate securities*
   $ 229,299     $ 68,863       38     $ 141,903     $ 3,674       21  
Real estate related loans
     80,298       29,831       2       24,543       6,366       1  
Residential mortgage loans
     3,645       2,471       130       5,227       2,687       170  
Other investments
     N/A       6,024       1       N/A       6,024       1  
    $ 313,242     $ 107,189       171     $ 171,673     $ 18,751       193  
 
* During the year ended December 31, 2012, Newcastle purchased 17 non-agency RMBS with an aggregate face amount of $90.9 million for an aggregate purchase price of approximately $61.7 million, or an average price of 67.9% of par. As of December 31, 2012, these securities had an aggregate face amount of $89.3 million and a carrying value of $61.3 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 as described below), 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 were not consolidated under the current or prior guidance.
 
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 monitors these investments and analyzes the potential need to consolidate the related securitization entities pursuant to the VIE consolidation requirements. These analyses require considerable judgment in determining whether an entity is a VIE and determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that otherwise would not have been consolidated or the de-consolidation of an entity that otherwise would have been consolidated.
 
As of December 31, 2012, Newcastle has not consolidated these potential VIEs. This determination is based, in part, on the assessment that Newcastle does not have the power to direct the activities that most significantly impact the economic performance of these entities, such as if Newcastle owned a majority of the currently controlling class. In addition, Newcastle is not obligated to provide, and has not provided, any financial support to these entities.
 
On January 1, 2010, as a result of the adoption of the new guidance, Newcastle deconsolidated a non-recourse financing structure, CDO VII. Newcastle determined that it does not have the current power to direct the relevant activities of CDO VII as an event of default had occurred and we may be removed as the collateral manager by a single party. The deconsolidation reduced Newcastle’s gross assets by $149.4 million, reduced liabilities by $437.8 million and increased equity by $288.4 million. The deconsolidation also reduced revenues and expenses, but its impact was not material to the net income applicable to common stockholders.
 
In April 2011, Newcastle sold its retained interests in Newcastle CDO VII, a non-consolidated VIE of Newcastle.  As a result of the sale of Newcastle’s retained interests in CDO VII and the subsequent liquidation of the VIE, CDO VII has been removed from Newcastle’s non-consolidated VIE disclosure.
 
On June 17, 2011, Newcastle deconsolidated a non-recourse financing structure, CDO V. Newcastle determined that it does not currently have the power to direct the relevant activities of CDO V as an event of default had occurred and Newcastle may be removed as the collateral manager by a single party. The deconsolidation has reduced Newcastle’s gross assets by $301.6 million, reduced liabilities by $357.0 million, resulted in a gain on deconsolidation of $45.1 million and decreased accumulated other comprehensive loss by $10.3 million. The deconsolidation also reduced revenues and expenses from June 17, 2011 onwards, but its impact was not material to net income applicable to common stockholders.
 
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 December 31, 2012, Newcastle had no continuing involvement with CDO X as it had been liquidated.
 
Newcastle has interests in the following unconsolidated VIE at December 31, 2012, in addition to the subprime securitizations which are described in Note 5:
 
Entity
  
Gross Assets (A)
    
Debt (B)
    
Carrying Value of Newcastle's Investment (C)
  
CDO V
   $ 264,246     $ 280,503     $ 5,998  
 
(A)    
Face amount.
(B)    
Includes $42.7 million face amount of debt owned by Newcastle with a carrying value of $6.0 million at December 31, 2012.
(C)    
This amount represents Newcastle’s maximum exposure to loss from this entity, which was its fair value at December 31, 2012, related to $18.8 million face amount of CDO V Class I, III and IV-FL notes.