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
 3 Months Ended
Mar. 31, 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 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  
Three Months Ended March 31, 2012                                                                        
Interest income   $ 54,402     $ 115     $ 2,037     $ 18,426     $ 814     $ 523     $ 51     $ (1,469 )   $ 74,899  
Interest expense     17,636       —       —       12,663       268       —       954       (1,356 )     30,165  
Net interest income (expense)     36,766       115       2,037       5,763       546       523       (903 )     (113 )     44,734  
Impairment (reversal)     (8,531 )     —       —       1,648       —       (197 )     —       —       (7,080 )
Other income (loss)     29,913       92       1,216       —       —       (1,469 )     —       —       29,752  
Expenses     241       1       123       843       —       13       7,138       —       8,359  
Income (loss) from continuing operations     74,969       206       3,130       3,272       546       (762 )     (8,041 )     (113 )     73,207  
Income (loss) from discontinued operations     —       —       —       168       —       (17 )     —       113       264  
Net income (loss)     74,969       206       3,130       3,440       546       (779 )     (8,041 )     —       73,471  
Preferred dividends     —       —       —       —       —       —       (1,395 )     —       (1,395 )
Income (loss) applicable to common stockholders   $ 74,969     $ 206     $ 3,130     $ 3,440     $ 546     $ (779 )   $ (9,436 )   $ —     $ 72,076  
March 31, 2012                                                                        
                                                                         
Investments   $ 2,488,278     $ 3,978     $ 42,587     $ 781,932     $ 240,624     $ 12,835     $ —     $ (142,193 )   $ 3,428,041  
Cash and restricted cash     107,875       —       —       —       —       —       156,425       —       264,300  
Derivative assets     1,832       —       —       —       —       —       —       —       1,832  
Other assets     22,040       7       —       107       616       1,998       959       (354 )     25,373  
Total assets     2,620,025       3,985       42,587       782,039       241,240       14,833       157,384       (142,547 )     3,719,546  
Debt     (2,371,181 )     —       —       (737,263 )     (228,080 )     —       (51,247 )     142,193       (3,245,578 )
Derivative liabilities     (108,774 )     —       —       —       —       —       —       —       (108,774 )
Other liabilities     (12,702 )     —       (371 )     (3,021 )     (21 )     (47 )     (26,364 )     354       (42,172 )
Total liabilities     (2,492,657 )     —       (371 )     (740,284 )     (228,101 )     (47 )     (77,611 )     142,547       (3,396,524 )
Preferred stock     —       —       —       —       —       —       (61,583 )     —       (61,583 )
GAAP book value   $ 127,368     $ 3,985     $ 42,216     $ 41,755     $ 13,139     $ 14,786     $ 18,190     $ —     $ 261,439  

 

    Non-Recourse CDOs (A)     Unlevered CDOs (B)     Unlevered Excess MSRs     Non-Recourse Other (A)     Recourse     Unlevered Other     Corporate     Inter-segment Elimination (F)     Total  
Three Months Ended March 31, 2011                                                                        
Interest income   $ 54,828     $ 11     $ —     $ 17,481     $ 147     $ 482     $ 20     $ (766 )   $ 72,203  
Interest expense     24,613       —       —       13,155       98       —       952       (653 )     38,165  
Net interest income (expense)     30,215       11       —       4,326       49       482       (932 )     (113 )     34,038  
Impairment (reversal)     (38,245 )     —       —       1,154       —       (115 )     —       —       (37,206 )
Other income (loss)     43,107       75       —       1,827       —       460       —       —       45,469  
Expenses     313       —       —       744       —       45       5,748       —       6,850  
Income (loss) from continuing operations     111,254       86       —       4,255       49       1,012       (6,680 )     (113 )     109,863  
Income (loss) from discontinued operations     —       —       —       (282 )     —       (21 )     —       113       (190 )
Net income (loss)     111,254       86       —       3,973       49       991       (6,680 )     —       109,673  
Preferred dividends     —       —       —       —       —       —       (1,395 )     —       (1,395 )
Income (loss) applicable to common stockholders   $ 111,254     $ 86     $ —     $ 3,973     $ 49     $ 991     $ (8,075 )   $ —     $ 108,278  

 

  (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:

  

    March 31, 2012  
    Investments      Debt  
    Outstanding     Carrying     Outstanding     Carrying  
    Face Amount     Value     Face Amount*     Value*  
Manufactured housing loan portfolio I   $ 130,488     $ 108,839     $ 103,026     $ 93,829  
Manufactured housing loan portfolio II     171,858       168,837       137,425       136,300  
Residential mortgage loans     55,640       40,229       54,107       53,036  
Subprime mortgage loans subject to call options     406,217       404,979       406,217       404,979  
Real estate securities     67,512       51,309       47,384       43,119  
Operating real estate      N/A       7,739       6,000       6,000  
    $ 831,715     $ 781,932     $ 754,159     $ 737,263  

 

  * An aggregate face amount of $156.0 million (carrying value of $142.2 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 $228.1 million of recourse debt is comprised of (i) a $226.2 million repurchase agreement secured by $240.6 million carrying value of FNMA/FHLMC securities and (ii) a $1.9 million repurchase agreement secured by $27.9 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:

 

    March 31, 2012  
    Outstanding Face Amount     Carrying
Value		     Number of
Investments		  
Real estate securities   $ 141,493     $ 4,036       20  
Residential mortgage loans     4,696       2,775       156  
Other investments      N/A       6,024       1  
    $ 146,189     $ 12,835       177  

 

  (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 March 31, 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 March 31, 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   $ 300,576     $ 302,332     $ 3,978  

 

(A) Face amount.
(B) Includes $42.0 million face amount of debt owned by Newcastle with a carrying value of $4.0 million at March 31, 2012.
(C) This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at March 31, 2012, related to $5.4 million face amount of CDO V Class I notes.