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, 2013
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.
 
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
  
Three Months Ended March 31, 2013
                                                            
Interest income
   $ 31,589     $ 239     $ 10,035     $ —     $ 16,307     $ 7,285     $ 6,706     $ 72     $ (866 )   $ 71,367  
Interest expense
     7,131       —       —       1,232       12,383       1,878       —       952       (866 )     22,710  
Net interest income (expense)
     24,458       239       10,035       (1,232 )     3,924       5,407       6,706       (880 )     —       48,657  
Impairment (reversal)
     3,183       —       —       —       848       —       (1,258 )     —       —       2,773  
Other revenues
     —       —       —       12,997       503       —       —       —       —       13,500  
Other income (loss)
     4,497       74       2,827       8       —       —       1,191       —       —       8,597  
Property operating expenses
     —       —       —       8,116       247       —       —       —       —       8,363  
Depreciation and amortization
     —       —       —       4,022       57       —       —       —       —       4,079  
Other operating expenses
     194       —       221       2,388       719       42       95       13,851       —       17,510  
Income (loss) from continuing operations
     25,578       313       12,641       (2,753 )     2,556       5,365       9,060       (14,731 )     —       38,029  
Income (loss) from discontinued operations
     —       —       —       —       —       —       (16 )     —       —       (16 )
Net income (loss)
     25,578       313       12,641       (2,753 )     2,556       5,365       9,044       (14,731 )     —       38,013  
Preferred dividends
     —       —       —       —       —       —       —       (1,395 )     —       (1,395 )
Income (loss) applicable to common stockholders
   $ 25,578     $ 313     $ 12,641     $ (2,753 )   $ 2,556     $ 5,365     $ 9,044     $ (16,126 )   $ —     $ 36,618  
                                                                                 
March 31, 2013
                                                                                
                                                                                 
Investments
   $ 1,347,691     $ 5,254     $ 339,143     $ 177,993     $ 708,998     $ 1,634,243     $ 470,509     $ —     $ (61,847 )   $ 4,621,984  
Cash and restricted cash
     11,494       —       —       10,207       —       —       —       524,565       —       546,266  
Derivative assets
     —       —       —       176       —       —       —       —       —       176  
Other assets
     7,556       6       —       7,537       91       9,893       2,350       299       (155 )     27,577  
Total assets
     1,366,741       5,260       339,143       195,913       709,089       1,644,136       472,859       524,864       (62,002 )     5,196,003  
Debt
     (1,015,560 )     —       —       (120,525 )     (641,685 )     (1,473,586 )     —       (51,242 )     61,847       (3,240,751 )
Derivative liabilities
     (26,612 )     —       —       —       —       —       —       —       —       (26,612 )
Other liabilities
     (5,510 )     —       (280 )     (4,935 )     (1,444 )     (142 )     (854 )     (66,131 )     155       (79,141 )
Total liabilities
     (1,047,682 )     —       (280 )     (125,460 )     (643,129 )     (1,473,728 )     (854 )     (117,373 )     62,002       (3,346,504 )
Preferred stock
     —       —       —       —       —       —       —       (61,583 )     —       (61,583 )
GAAP book value
   $ 319,059     $ 5,260     $ 338,863     $ 70,453     $ 65,960     $ 170,408     $ 472,005     $ 345,908     $ —     $ 1,787,916  
                                                                                 
Investments in equity method investees at fair value
   $ —     $ —     $ 102,588     $ —     $ —     $ —     $ —     $ —     $ —     $ 102,588  
Additions to investments in real estate
     —       —       —       130       129       —       —       —       —       259  

 

 
   
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
  
                                                             
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 revenues
     —       —       —       —       509       —       —       —       —       509  
Other income (loss)
     29,913       92       1,216       —       —       —       (1,469 )     —       —       29,752  
Property operating expenses
     —       —       —       —       338       —       —       —       (113 )     225  
Depreciation and amortization
     —       —       —       —       2       —       —       —       —       2  
Other operating expenses
     241       1       123       —       844       —       13       7,138       —       8,360  
Income (loss) from continuing operations
     74,969       206       3,130       —       3,440       546       (762 )     (8,041 )     —       73,488  
Income (loss) from discontinued operations
     —       —       —       —       —       —       (17 )     —       —       (17 )
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  
 
(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, 2013
  
   
Investments
    
Debt
  
   
Outstanding
    
Carrying
    
Outstanding
    
Carrying
  
   
Face Amount
    
Value
    
Face Amount*
    
Value*
  
Manufactured housing loan portfolio I
   $ 114,355     $ 96,752     $ 86,490     $ 78,102  
Manufactured housing loan portfolio II
     146,865       144,274       112,046       111,447  
Subprime mortgage loans subject to call options
     406,217       406,115       406,217       406,115  
Real estate securities
     62,633       55,117       43,989       40,021  
Other commercial real estate
     N/A       6,740       6,000       6,000  
    $ 730,070     $ 708,998     $ 654,742     $ 641,685  
 
*
An aggregate face amount of $70.5 million (carrying value of $61.8 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 $1.5 billion of recourse debt is comprised of (i) a $1.3 billion repurchase agreement secured by $1.4 billion carrying value of FNMA/FHLMC securities and (ii) a $158.0 million repurchase agreement secured by $233.8 million carrying value of non-agency residential mortgage backed securities (“RMBS”).
(E)
The following table summarizes the investments in the unlevered other segment:
 
   
March 31, 2013
  
   
Outstanding
Face Amount
    
Carrying
Value
    
Number of
Investments
  
Real estate securities
   $ 592,450     $ 292,337       63  
Real estate related loans
     265,209       96,612       2  
Residential mortgage loans
     112,716       75,536       646  
Other investments
     N/A       6,024       1  
    $ 970,375     $ 470,509       712  
 
(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, and therefore does not consolidate them.
 
In addition, Newcastle’s investments in RMBS, 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 March 31, 2013, 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.
 
Newcastle has not consolidated the entities in which Newcastle holds a 50% interest that made an investment in Excess MSRs. Newcastle has determined that the decisions that most significantly impact the economic performance of these entities will be made collectively by Newcastle and the other investor in the entities. In addition, these entities have sufficient equity to permit the entities to finance their activities without additional subordinated financial support. Based on Newcastle’s analysis, these entities do not meet any of the VIE criteria.
 
Newcastle had variable interests in the following unconsolidated VIE at March 31, 2013, in addition to the subprime securitizations which are described in Note 4:
 
Entity
  
Gross Assets (A)
    
Debt (A) (B)
    
Carrying Value of Newcastle’s Investment (C)
  
Newcastle CDO V
   $ 225,628     $ 241,263     $ 5,254  
 
(A)
Face amount.
(B)
Includes $42.2 million face amount of debt owned by Newcastle with a carrying value of $5.3 million at March 31, 2013.
(C)
This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at March 31, 2013, related to $17.8 million face amount of CDO V Class I, III, and IV-FL  notes.