Annual report pursuant to Section 13 and 15(d)

FAIR VALUE OF FINANCIAL INSTRUMENTS

v3.3.1.900
FAIR VALUE OF FINANCIAL INSTRUMENTS
12 Months Ended
Dec. 31, 2015
Fair Value Disclosures [Abstract]  
FAIR VALUE
FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table summarizes the carrying values and estimated fair values of Newcastle’s financial instruments at December 31, 2015 and 2014:
 
December 31, 2015
December 31, 2014
 
Carrying
Value
 
Estimated
Fair Value
 
Fair Value Method (A)
 
Carrying
Value
 
Estimated
Fair Value
Assets
 
 
 
 
 
 
 
 
 
Real estate securities, available-for-sale
$
59,034

 
$
59,034

 
Broker/counterparty quotations, pricing services, pricing models
 
$
231,754

 
$
231,754

Real estate securities, pledged as collateral
105,963

 
105,963

 
Broker/counterparty quotations, pricing services
 
407,689

 
407,689

Real estate related and other loans, held-for-sale, net
149,198

 
165,270

 
Broker/counterparty quotations, pricing services, pricing models
 
230,200

 
246,678

Residential mortgage loans, held-for-sale, net
532

 
569

 
Broker/counterparty quotations, pricing models
 
3,854

 
4,076

Subprime mortgage loans subject to call option (B)
380,806

 
380,806

 
(B)
 
406,217

 
406,217

Restricted cash
4,469

 
4,469

 
 
 
15,714

 
15,714

Cash and cash equivalents
45,651

 
45,651

 
 
 
73,727

 
73,727

Non-hedge derivative assets (C)
127

 
127

 
Counterparty quotations, pricing services
 

 

 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
CDO bonds payable (D)
$
92,933

 
$
15,193

 
Pricing models
 
$
227,673

 
$
134,491

Other bonds and notes payable (D)
16,162

 
16,620

 
Pricing models
 
27,069

 
28,102

Repurchase agreements
418,458

 
418,625

 
Counterparty quotations, market comparables
 
441,176

 
441,176

Credit facilities and obligations under capital leases
11,258

 
11,258

 
Pricing models
 
161,474

 
161,474

Financing of subprime mortgage loans subject to call option (B)
380,806

 
380,806

 
(B)
 
406,217

 
406,217

Junior subordinated notes payable
51,225

 
24,649

 
Pricing models
 
51,231

 
28,918

Interest rate swaps, treated as hedges (C)

 

 
Counterparty quotations
 
1,963

 
1,963

Non-hedge derivative liabilities (C)
684

 
684

 
Counterparty quotations, pricing services
 
2,365

 
2,365


(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)
Represents an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 6).
(C)
Represents derivative assets and liabilities including interest rate swaps and TBA forward contracts (Note 9).
(D)
Newcastle notes that the unrealized gain on the liabilities within such structures cannot be fully realized. Assets held within CDOs and other non- recourse 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.

Fair Value Measurements
Valuation Hierarchy
The fair value of financial instruments is categorized based on the priority of the inputs to the valuation technique and categorized into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Newcastle follows this hierarchy for its financial instruments measured at fair value.
Level 1 - Quoted prices in active markets for identical instruments.
Level 2 - Valuations based principally on observable market parameters, including:
quoted prices for similar assets and liabilities in active markets,
inputs other than quoted prices that are observable for the asset or liability (such as interest rates and yield curves observable at commonly quoted intervals, implied volatilities and credit spreads), and
market corroborated inputs (derived principally from or corroborated by observable market data).
Level 3 - Valuations determined using unobservable inputs that are supported by little or no market activity, and that are significant to the overall fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using non-binding market quotations, pricing models, discounted cash flow methodologies, or similar techniques where significant inputs are unobservable, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Fair value may be based upon broker quotations, counterparty quotations or pricing services quotations, which provide valuation estimates based upon reasonable market order indications or management's good faith estimate, and are subject to significant variability based on market conditions, such as interest rates, credit spreads and market liquidity. A significant portion of Newcastle’s loans, securities and debt obligations are currently not traded in active markets and therefore have little or no price transparency. As a result, Newcastle has estimated the fair value of these illiquid instruments based on internal pricing models or quotations subject to Newcastle's controls described below.
 
Newcastle has various processes and controls in place to ensure that fair value measurements are reasonably estimated. With respect to broker and pricing service quotations, and in order to ensure these quotes represent a reasonable estimate of fair value, Newcastle’s quarterly procedures include a comparison of such quotations to quotations from different sources, outputs generated from its internal pricing models and transactions completed, as well as on its knowledge and experience of these markets. With respect to fair value estimates generated based on Newcastle’s internal pricing models, Newcastle’s management validates the inputs and outputs of the internal pricing models by comparing them to available independent third party market parameters and models, where available, for reasonableness. Newcastle believes its valuation methods and the assumptions used are appropriate and consistent with other market participants.
Fair value measurements categorized within Level 3 are sensitive to changes in the assumptions or methodology used to determine fair value and such changes could result in a significant increase or decrease in the fair value. For Newcastle’s investments in real estate securities, real estate related and other loans and residential mortgage loans categorized within Level 3 of the fair value hierarchy, the significant unobservable inputs include the discount rates, assumptions relating to prepayments, default rates and loss severities. Significant increases (decreases) in any of the discount rates, default rates or loss severities in isolation would result in a significantly lower (higher) fair value measurement. The impact of changes in prepayment speeds would have differing impacts on fair value, depending on the seniority of the investment. Generally, a change in the default assumption is accompanied by directionally similar changes in the assumptions used for the loss severity and the prepayment speed.
Recurring Fair Value Measurements - Real Estate Securities and Derivatives
The following table summarizes financial assets and liabilities measured at fair value on a recurring basis at December 31, 2015:
 
 
 
Fair Value
 
Carrying Value
 
Level 2
 
Level 3
 
Total
 
 
 
Market Quotations
(Observable)
 
Market Quotations (Unobservable)
 
Internal Pricing Models
 
 
Assets:
 
 
 
 
 
 
 
 
 
Real estate securities, available for sale:
 
 
 
 
 
 
 
 
 
CMBS
$
39,684

 
$

 
$
39,684

 
$

 
$
39,684

Non-Agency RMBS
9,619

 

 
9,619

 

 
9,619

CDO (A)
9,731

 

 

 
9,731

 
9,731

Real estate securities, available for sale total
$
59,034

 
$

 
$
49,303

 
$
9,731

 
$
59,034

 
 
 
 
 
 
 
 
 
 
Real estate securities, pledged as collateral:
 
 
 
 
 
 
 
 
 
FNMA/FHLMC
$
105,963

 
$
105,963

 
$

 
$

 
$
105,963

Real estate securities, pledged as collateral
$
105,963

 
$
105,963

 
$

 
$

 
$
105,963

 
 
 
 
 
 
 
 
 
 
Derivative assets:
 
 
 
 
 
 
 
 
 
TBAs, not treated as hedges
$
127

 
$
127

 
$

 
$

 
$
127

Derivative assets total
$
127

 
$
127

 
$

 
$

 
$
127

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
 
TBAs, not treated as hedges
$
684

 
$
684

 
$

 
$

 
$
684

Derivative liabilities total
$
684

 
$
684

 
$

 
$

 
$
684


(A)
Represents non-consolidated CDO securities, excluding eight securities with zero value, which had an aggregate face amount of $116.0 million as of December 31, 2015.


Significant Unobservable Inputs
The following table provides quantitative information regarding the significant unobservable inputs used by Newcastle for assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 This table excludes inputs used to measure fair value that are not developed by Newcastle, such as broker prices and other third-party pricing service valuations.

Asset Type
 
Amortized
Cost
Basis
 
Fair
Value
 
Weighted Average Significant Input
 


Discount
Rate
 
Prepayment Speed
 
Cumulative Default Rate
 
Loss Severity
 
 
 
 
 
 
 
 
 
 
 
 
 
CDO
 
$

 
$
9,731

 
10.3
%
 
4.7
%
 
18.5
%
 
32.2
%
Total
 
$

 
$
9,731

 
 
 
 
 
 
 
 


All of the inputs used in the table 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 (e.g., CMBS projections are developed differently than home equity ABS projections) but conform to industry conventions. Newcastle uses assumptions that generate its best estimate of future cash flows of each respective security.

The prepayment speed vector specifies the percentage of the collateral balance that is expected to voluntarily pay off at each point in the future. The prepayment speed 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 affect 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 cumulative 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.

Newcastle’s investments in instruments measured at fair value on a recurring basis using Level 3 inputs changed as follows:
 
Level 3 Assets
 
CMBS
 
Non-Agency RMBS
 
Equity/Other Securities
 
Derivative Transactions
 
Total
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
284,469

 
$
57,581

 
$
59,757

 
$
43,662

 
$
445,469

Total gains (losses) (A)
 
 
 
 
 
 
 
 
 
Included in net income (B)
15,384

 
4,165

 
976

 
12,498

 
33,023

Included in other comprehensive income (loss)
(21,154
)
 
2,909

 
5,193

 

 
(13,052
)
Amortization included in interest income
17,184

 
5,218

 
1,924

 

 
24,326

Purchases, sales and settlements
 
 
 
 
 
 
 
 
 
Purchases

 

 

 

 

Proceeds from sales
(73,252
)
 
(15,787
)
 
(57,053
)
 

 
(146,092
)
Proceeds from repayments
(43,868
)
 
(9,051
)
 
(2,841
)
 
(56,160
)
 
(111,920
)
Balance at December 31, 2014
$
178,763

 
$
45,035

 
$
7,956

 
$

 
$
231,754

Transfers
 
 
 
 
 
 
 
 
 
Transfer into Level 3

 

 
367

 

 
367

Total gains (losses) (A)
 
 
 
 
 
 
 
 
 
Included in net income (B)
12,038

 
14,826

 
(367
)
 

 
26,497

Included in other comprehensive income (loss)
(18,797
)
 
(12,933
)
 
1,775

 

 
(29,955
)
Amortization included in interest income
6,866

 
2,849

 

 

 
9,715

Purchases, sales and settlements
 
 
 
 
 
 
 
 
 
Purchases

 

 

 

 

Proceeds from sales
(102,607
)
 
(37,582
)
 

 

 
(140,189
)
Proceeds from repayments
(36,579
)
 
(2,576
)
 

 

 
(39,155
)
Balance at December 31, 2015
$
39,684

 
$
9,619

 
$
9,731

 
$

 
$
59,034


(A)
None of the gains (losses) recorded in earnings during the periods is attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting dates.
(B)
These gains (losses) are recorded in the following line items in the Consolidated Statements of Operations:
 
Year Ended December 31,
 
2015
 
2014
Gain on settlement of investments, net
$
28,854

 
$
20,525

Other income, net

 
12,498

OTTI
(2,357
)
 

Total
$
26,497

 
$
33,023

Gain on sale of investments, net, from investments transferred into Level 3 during the period
$

 
$




Non Recurring Fair Value Measurements - Loans

Loans which Newcastle does not have the ability or intent to hold into the foreseeable future are classified as held-for-sale. Held-for-sale loans are carried at the lower of amortized cost or fair value and are therefore recorded at fair value on a non-recurring basis. These loans were written down to fair value at the time of the impairment, based on broker quotations, pricing service quotations or internal pricing models. All the loans were within Level 3 of the fair value hierarchy. For real estate related and other loans, the most significant inputs used in the valuations are the amount and timing of expected future cash flows, market yields and the estimated collateral value of such loan investments. For residential mortgage loans, significant inputs include management’s expectations of prepayment speeds, default rates, loss severities and discount rates that market participants would use in determining the fair values of similar pools of residential mortgage loans.
The following tables summarize certain information for real estate related and other loans as well as for residential mortgage loans held-for-sale as of December 31, 2015:
 
 
 
 
 
 
Significant Input
 
 
 
 
 
 
Range
 
Weighted Average
Loan Type
 
Carrying Value
 
Fair Value
 
Discount Rate
 
Loss Severity
 
Discount Rate
 
Loss Severity
Mezzanine
 
$
19,433

 
$
19,433

 
0.0% - 8.0%
 
0.0% - 100.0%
 
8.0
%
 
47.8
%
Bank Loan
 
129,765

 
145,837

 
0% - 22.5%
 
0.0% - 100.0%
 
22.4
%
 
22.7
%
Total Real Estate Related and Other Loans Held for Sale, Net
 
$
149,198

 
$
165,270

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Significant Input (Weighted Average)
 
 
 
 
 
 
 
 
 
 
 
 
 
Loan Type
 
Carrying Value
 
Fair Value
 
Discount Rate
 
Prepayment Speed
 
Constant Default Rate
 
Loss Severity
Residential Loans
 
$
532

 
$
569

 
62.0
%
 
0.8
%
 
75.7
%
 
22.5
%
Total Residential Mortgage Loans, Held-for-Sale, Net
 
$
532

 
$
569

 
 
 
 
 
 
 
 

Liabilities for Which Fair Value is Only Disclosed
The following table summarizes the level of the fair value hierarchy, valuation techniques and inputs used for estimating each class of liabilities not measured at fair value in the statement of financial position but for which fair value is disclosed:
Type of Liabilities
 
 
 
 
Not Measured At Fair
 
 
 
 
Value for Which
 
 
 
 
Fair Value Is Disclosed
 
Fair Value Hierarchy
 
Valuation Techniques and Significant Inputs
 
 
 
 
 
CDO bonds payable
 
Level 3
 
Valuation technique is based on discounted cash flows. Significant inputs include:
 
 
 
 
Underlying security and loan prepayment, default and cumulative loss expectations
 
 
 
 
Amount and timing of expected future cash flows
 
 
 
 
Market yields and credit spreads implied by comparisons to transactions of similar tranches of CDO debt by the varying levels of subordination
 
 
 
 
 
 
Other bonds and notes payable
 
Level 3
 
Valuation technique is based on discounted cash flows. Significant inputs include:
 
 
 
 
Amount and timing of expected future cash flows
 
 
 
 
Interest rates
 
 
 
 
Broker quotations
 
 
 
 
Market yields and credit spreads implied by comparisons to transactions of similar tranches of securitized debt by the varying levels of subordination
 
 
 
 
 
 
Repurchase agreements
 
Level 2
 
Valuation technique is based on market comparables. Significant variables include:
 
 
 
 
Amount and timing of expected future cash flows
 
 
 
 
Interest rates
 
 
 
 
Collateral funding spreads
 
 
 
 
 
 
Golf credit facilities
 
Level 3
 
Valuation technique is based on discounted cash flows. Significant inputs include:
 
 
 
 
Amount and timing of expected future cash flows
 
 
 
 
Interest rates
 
 
 
 
 
 
Junior subordinated notes payable
 
Level 3
 
Valuation technique is based on discounted cash flows. Significant inputs include:
 
 
 
 
Amount and timing of expected future cash flows
 
 
 
 
Interest rates
 
 
 
 
Market yields and the credit spread of Newcastle